Strategy implementation in 2016

Notably the slump in oil and gas prices and rapid expansion of the LNG market. The Polish gas market evolved as steep price declines materialised elsewhere in Europe. Moreover, European market gas prices have virtually ceased to move in parallel with petroleum prices: this trend has been observed for the past several years. Gas spot prices in Germany and other European markets have tumbled by more than 40%, thereby making gas imports to Poland much more attractive than the PGNiG SA tariff. Falling oil prices also led to major implications for the Group. The flip side of lower gas procurement costs under long-term contracts making imports a more attractive source of supply takes the form of upending the economics of international upstream projects with a predominant share of oil in their total reserves. Consequently, the international exploration and production segment took a hit to its valuation. Global LNG infrastructure has been expanding rapidly in recent years. On one hand, new export-focused projects have come on line (liquefaction terminals), mainly in North America and Australia. On the other hand, import capacities (regasification terminals), mainly in Europe have grown. The outcome is a glut on the global LNG markets, pushing prices down in the direction of global price convergence. As a participant of the global LNG market, PGNiG will be able to take advantage of favourable pricing terms and secure additional gas supplies for Poland. Since the LNG supply is abundant, gas trading on spot markets using short-term and medium-term contracts has gained in importance. Moreover, the destination clause is losing relevance, the number of market players is on the rise and the global LNG fleet is becoming more available.

As the obligation to sell a specific portion of gas on the power pool has come into force, PGNiG is compelled to sell high-methane gas on commodity exchanges or other regulated markets. The process of deregulation coupled with the obligation of selling gas on the power pool poses two major risks: significant customer churn and lower storage revenues. PGNiG has also had to adjust its contracts with customers to accommodate the liberalised market in terms of contracted capacity, volumes contracted per gas year and the supplier switching process.

The Group’s current mix of gas supply sources was structured to cover the entire demand for natural gas in Poland. However, considering the risk of losing a part of the Group’s market share and given the insufficient diversification of supplies, the Group’s gas portfolio may be unbalanced. Currently, the PGNiG Group’s gas supply mix is largely made up of contracts priced partly by reference to the prices of oil products (Yamal and Qatar Contracts). The differences in the pricing formulas used by PGNiG versus its competitors may exert some price pressure. Therefore, it has become imperative for the Group to explore opportunities to diversify gas supply and analyse feasibility. With the Yamal Contract nearing expiry, it must build a flexible portfolio of supply sources for Poland beyond 2022.

PGNiG’s regulatory environment is undergoing significant changes, particularly in the taxation of hydrocarbon production, the obligation to sell gas on the power pool and the uncertainty surrounding the support model for gas-fired cogeneration. All of these factors adversely affect the Group’s segment revenues.

• Diversification of supply sources – the Norwegian Corridor – PGNiG, supported by the Polish government, is holding talks with Norway and Denmark about connecting the Polish gas system with the Norwegian Continental Shelf.
• Diversification of supply sources – LNG terminal – PGNiG received 9 LNG deliveries under a long-term contract with Qatargas. Additionally, as part of short-term balancing, PGNiG purchased LNG on the spot market in Norway (Statoil contract).
• LNG trading office – opened for business in early 2017. It will be ready to operate by the end of Q1 2017. Ultimately, the London office will be the main trading office for short- and medium-term contracts for liquefied gas.
• Yamal contract – arbitration – PGNiG is taking steps to bring its long-term contract with Gazprom in line with prevailing conditions on the European market. On February 1^st, 2016, the Group filed a claim against OAO Gazprom and OOO Gazprom Export in arbitration proceedings pending before the Arbitration Institute in Stockholm.
• New gas contracts – The Group’s gas customer profile grew as PGNiG expanded its footprint in neighbouring countries. On August 4^th, 2016, the Group signed an agreement with Ukraine’s ERU Trading for natural gas supplies to industrial customers. PGNiG also entered into new gas sale contracts in Poland as the outcome of constantly striving to employ a high quality customised sales approach.
• Customer offer – The Group is evolving to meet the needs and expectations of its end users by offering them discount schemes. They are appreciated by its largest customers and have delivered superb results.

• Distribution
  • higher distributed gas volume (to ca. 11 bcm in 2016) by ramping up new connections.);
  • PSG’s new strategy’s primary objectives are (i) to increase the distributed gas volume, (ii) attract new customers, (iii) connect many more communes and municipalities to the mains gas network;
  • PSG‘s intends to align its organisational structure to Poland’s administrative division to simplify interactions with local governments and facilitate access to PSG’s services.
• Generation
  • on April 28th, 2016, PGNiG TERMIKA acquired a 100% equity stake in Przedsiębiorstwo Energetyki Cieplnej S.A. in Jastrzębie Zdrój;
  •  on August 11th, 2016 it acquired a shareholding in Spółka Energetyczna Jastrzębie S.A. from Jastrzębska Spółka Węglowa S.A.

The PGNiG Group’s strategy for the generation business is to expand its share in the heat generation and distribution market. With these acquisitions, the PGNiG Group expanded its business into new geographical markets in Poland.

• Exploration & Production in Poland
  • maintain stable natural gas and crude oil production in Poland;
  • discover reserves of new hydrocarbon deposits;
  • explore and appraise shale gas deposits in the most promising concessions. Work was discontinued in late 2016 because the initial estimates and forecasts of shale gas potential did not pan out.
• Exploration & Production abroad
  • in 2016, PGNiG Upstream Norway AS acquired five new exploration concessions on the Norwegian Continental Shelf. One of the Group’s key operating objectives is to ramp up hydrocarbon production. In connection with the proposed construction of the Norwegian Corridor and the Baltic Pipe (giving Poland access to gas from Norwegian fields), the PGNiG Group’s assets would ultimately help it generate natural cross-segment synergies, thereby leveraging the Group’s resources;
  • PGNiG began to drill a third well on the Rehman field in Pakistan (Rehman-2) with its primary goal being to increase natural gas production. As the next stage of exploration in Pakistan, in April 2016 a 3D seismic dataset was acquired to help the Group make informed decisions on where to drill boreholes in 2017;
  • following the lifting of sanctions imposed on Iran, PGNiG is looking into a possible return. On November 5^th, 2016 PGNiG and the National Iranian Oil Company signed a letter of intent for cooperation in Tehran on the Soumar oil field.

• Efficiency Improvement Programme − the PGNiG Group continued its efforts to reduce cost base and improve the cost discipline under the Efficiency Improvement Programme. Cost savings generated in 2016 amounted to PLN 830m, 5% above the target, on enhanced organisational and process-related efficiencies across the Group.
• Disposal of non-core properties and companies – one of the Group ‘s key strategic initiatives is to dispose of its non-core properties. In 2016, aggregate proceeds from property sales exceeded PLN 41m (vs the planned PLN 33m).
• Research, Development and Innovation – in 2016, the PGNiG initiated changes in its research and development (R&D) area. In particular, efforts were launched to formulate a new, extended R&D&I strategy, covering research, development and innovation.