Risks

The risk is managed by analysing the chances of success of exploratory projects and by estimating the reserves under various scenarios (P90, P50 and P10) which represent the expected probability distribution of the size of reserves.

The risk associated with exploration for unconventional deposits of gas in Poland relates to the lack of confirmed presence of shale gas and tight gas. Exploration for shale gas has now been closed and the experience gained from such projects will allow PGNiG to minimise risks associated with exploration for tight gas. Even if the existence of in-place tight gas resources is confirmed, production may prove uneconomic due to insufficient recovery rates and high investment expenditures necessary to drill wells and construct production facilities. Another material factor is the difficulty of accessing unconventional gas plays given the environmental regulations and the requirement to obtain the landowners’ consent for access to the area.

Both in Poland and abroad there is a risk of competition from other companies seeking licences for exploration and appraisal of hydrocarbon deposits, although it should be noted that this risk has significantly diminished in the Polish market over the past year. Certain competitors of the PGNiG Group, especially global players, enjoy strong market positions and greater financial resources than those available to the Group. Thus, it is probable that such companies would submit their bids in tender procedures and be able to acquire promising licences, offering better terms than the Group could offer given its financial and human resources. This competitive advantage of oil majors is particularly important on the international market.

Under the applicable Polish laws and regulations, the process of obtaining a licence for exploration and appraisal of crude oil and natural gas reserves lasts from one to one and a half years. In foreign markets such procedures may even take up to two years from the time the winning bid is awarded until the actual contract is ratified. Prior to the commencement of field work, it is also required to make a number of arrangements, for instance to obtain legal permits and approvals for entering the area, and to meet the environmental protection requirements and, in some cases, requirements related to the protection of archaeological sites. It is also required to hold tenders to select a contractor. All this delays the execution of an agreement with the contractor by another few months. Frequently the waiting time for customs clearance of imported equipment is very long. Further, PGNiG’s obligation to comply with the Public Procurement Law frequently protracts tender procedures. Notices of appeal and complaints submitted by bidders lead to lengthy court proceedings and, consequently, to delays in implementing an entire project. A protracting project exacerbates the risk related to estimation of capital expenditures. The risk is managed through ongoing monitoring of the project status and by taking action by the licence Operator whenever any issue arises.

Capital intensity of an exploration project depends on prices of energy and materials. Cost of exploratory work is especially sensitive to steel prices, which are passed onto prices of casing pipes and production tubing used in drilling. An increase in prices of energy and materials translates into higher costs of exploratory work. Profitability of foreign exploration projects also depends to a significant extent on prices of oil derivative products and on exchange rates. To reduce drilling costs, in 2011 PGNiG introduced the daily rate system into its procedure for selecting drilling contractors and paying for their work.

Ensuring compliance with environmental laws in Poland and abroad may lead to a significant increase in the Group’s operating expenses. Currently, PGNiG incurs significant capital expenditures and costs to ensure compliance of its operations with the ever more complex and stringent regulations concerning safety and health at work and environmental protection. The Act of May 18th, 2005 Amending the Natural Environment Protection Law and Certain Other Acts (Dz.U. No. 113, item 954 of June 27th, 2005) introduced more stringent regulations governing projects which might affect Natura 2000 sites. It also imposed more stringent obligations with regard to operations in habitats of protected species of plants and animals Also in countries where PGNiG is engaged in exploration activities, a trend towards tightening environmental regulations is observed. Upstream operations at sea entail a significant risk of environmental pollution in the event of an oil spill. The risk is monitored on an ongoing basis and various barriers and technical solutions are put in place to minimize it.

Hydrocarbon deposits developed by PGNiG are usually located at great depths, which involves extremely high pressures and, in many cases, the presence of hydrogen sulphide. Consequently, the risk of hydrocarbon blowout or leakage is very high, which in turn may pose a threat to people (employees and local population), natural environment and production equipment.

In some countries, exploration and production activities may be hindered by frequent and unexpected changes in legislation, which may create particularly serious risks in countries with authoritarian regimes.

Some countries where the PGNiG Group is conducting exploration are threatened by armed conflicts and terrorist attacks, which may lead to limitation, suspension or even discontinuation of such activities. The PGNiG Group’s operations are also exposed to the risk of social or political unrest in some regions. Changes of governments may result in withholding issuance of petroleum licences. Those countries are also at risk of internal conflicts and civil unrest due to poverty and demographic issues. In certain countries, operations of exploration companies may be hindered by the absence of adequate infrastructure, which may be an obstacle in transporting equipment, personnel and materials to the sites. Problems may also arise in providing supplies and ensuring appropriate health care. These risks may lead to limitation or suspension of the Company’s exploration activities.