Risks
Regulatory Environment
In 2012, work was under way on a set of three acts which are to regulate the energy sector, i.e. the Gas Law, the Energy Law and the Law on Renewable Energy Sources.
Work also continued on amending the Regulation of the Minister of Economy on detailed rules for determining and calculating tariffs for gas fuels and on settlement of transactions in gas fuels trading (the Tariff Regulation). The draft of the amended Tariff Regulation introduces, among other things, entry-exit transmission tariffs, rules for computation of charges for short-term and intermittent services and for virtual reverse flow services provided by the transmission and distribution system operators, as well as rules for computation of charges for storage services rendered on a packaged or stand-alone basis by the storage system operator. The draft provides for the possibility of offering transmission services under an auction system in the case of interconnections between transmission systems within the EU and for passing through costs of gas fuel transport to the tariffs of other energy utilities. The purpose of the draft amendment is also to align the Tariff Regulation with the Minister of Economy’s Regulation on detailed conditions for the operation of the gas system of July 2nd 2010 (known as the Gas System Regulation)
The Energy Efficiency Act came into force in August 2011. The Act implements Directive 2006/32/EC of the European Parliament and of the Council of April 5th 2006 on energy end-use efficiency and energy services. The Energy Efficiency Act establishes a national target for economical energy use, according to which savings of end-use energy until 2016 should be no less than 9% of the annual national consumption of energy. In line with the new act, PGNiG, as a trading company, is required to purchase energy efficiency certificates or else to pay a non-compliance penalty. This will drive up the cost of regulated activities and, consequently, inflate the price paid for gas by customers.
Changes of laws and delays in amending legal acts create risks, resulting chiefly from uncertainty as to the final scope of the regulatory changes and the short time for adaptation to such changes, which might adversely affect the financial performance and growth prospects of the PGNiG Group.
Tariff calculation
PGNiG’s ability to cover the costs of its core operating activities depends on the prices and rates approved by the President of the Energy Regulatory Office. While approving tariffs for a given period, the President of the Energy Regulatory Office considers other external factors which are beyond the control of PGNiG Group companies. In an attempt to protect customers, the President of the Energy Regulatory Office may consider certain business costs as unjustified. Moreover, the President of the Office does not always accept the assumptions adopted by PGNiG with respect to main drivers of cost changes and profit targets allowing for business risk. Lower tariff prices and charges might adversely affect PGNiG’s profitability.
Purchase price of imported gas
Prices of imported gas are denominated in USD or EUR and are based on indexation formulae reflecting the prices of petroleum products and/or gas prices on the liquid market of Western Europe. Changes in foreign exchange rates and prices of petroleum products and gas materially affect the cost of imported gas. Any accurate forecast of changes of natural gas prices is encumbered with a high risk of error. There is a risk that despite the legal possibility of adjusting prices approved for a tariff term, an increase in the price of imported gas may not be fully passed on to customers or that changes in gas selling prices may lag behind changes in gas import prices.
Resource discoveries and estimates
The main risk inherent in exploration activities is the risk of failure to discover resources, i.e. exploration risk. This means that not all the identified potential deposit sites have deposits of hydrocarbons which can qualify as an accumulation. Whether or not a sufficient accumulation exists depends on a number of geological factors. Furthermore, the actual quantity and quality of the accumulated hydrocarbons may differ from estimates. When the results of successful exploration activity, in the form of new proved reserves, do not compensate for the production from the existing reserves, PGNiG Group’s proved recoverable reserves will diminish.
Irrespective of the methods applied, data on the volume and quality of commercial reserves of crude oil and natural gas is always an estimate. Actual production, income and expenses relating to a given deposit may significantly differ from estimates. Formation characteristics determined at the relevant document preparation stage are reviewed after production starts. Each downgrade of the size of the reserves or production quantities may lead to a lower revenue and adversely affect PGNiG Group’s financial performance.
The risk associated with exploration for unconventional gas in Poland relates to the lack of confirmed presence of shale gas and tight gas. Even if the existence of in-place petroleum is confirmed, its production may prove uneconomic due to insufficient gas recovery and the high investment expenditure necessary for drillings and construction of production infrastructure. Another material factor is sometimes difficult access to unconventional gas plays given the environmental regulations and the necessity to obtain the landowners’ consent for access to the area.
Competition in Exploration
Both on the Polish market and abroad there is a risk of competition from other companies in the acquisition of licences for exploration for and appraisal of hydrocarbon deposits. Certain competitors of the PGNiG Group, especially global majors, enjoy strong market positions. They are likely to bid for and be able to acquire highly prospective licences.
Delays in Upstream Projects
Under the applicable Polish legal regulations, the process of obtaining a licence for exploration for and appraisal of crude oil and natural gas deposits lasts from one to one and a half years. On foreign markets, such procedures may even take two years from the time that the winning bid is awarded until the relevant contract is ratified. Prior to the commencement of field work, the Company is also required to make a number of arrangements, including obtaining formal and legal permits and approvals for entering the area, meeting environmental protection requirements and, in some cases, requirements related to protection of archaeological sites. It is also required to hold tenders to select a contractor. All this delays the execution of an agreement with a contractor by another few months. Frequently, the waiting time for customs clearance of imported equipment is very long. These factors create a risk of delay in the start of exploration work.
Cost of exploration
Exploratory work is capital intensive, given the prices of energy carriers and materials. Cost of exploratory work is especially sensitive to steel prices, which are passed onto prices of casing pipes and lifting casing used in drilling. An increase in prices of energy and materials translates into an increase in the cost of exploratory work. Moreover, profitability of foreign exploration projects significantly depends on the prices of petroleum products and currency exchange rates. In 2011, PGNiG introduced the daily rate system into the drilling contractors tender procedure, which is expected to reduce the costs of drilling services.
Furthermore, trends to implement increasingly more stringent environmental protection regulations are seen both at home and in other countries where the Group conducts exploration operations.
Hydrocarbons are usually produced from deposits 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 (workers and local population), the natural environment and production equipment.
Measures taken to mitigate those risks require significant capital expenditure and involve the cost of bringing operations into compliance with applicable health, safety and environmental protection regulations.
Political and economic situation
The PGNiG Group’s exploration sites are located in countries threatened by war, social or political unrest, and terrorist activity.
In certain countries, the lack of adequate infrastructure 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. They may also lead to a limitation, suspension or discontinuation of the Company’s exploration and production activities.
Trade in Natural Gas
PGNiG is the largest supplier of natural gas in Poland. PGNiG’s share in the gas market is approximately 96%, the remaining 4% are suppliers from outside the PGNiG Group, which usually purchase gas from PGNiG. However, the upcoming gas market deregulation in Poland is bound to trigger major changes in the market itself and the related legal framework. Plans are in place to deregulate gas prices for institutional customers and then, in two or three years, for households. In 2012, a natural gas market was launched on the Polish Power Exchange. Under a decision issued by the President of the Energy Regulatory Office, natural gas trading handled by PGNiG on the exchange is exempt from the tariff obligation. Despite the protracted work on the project, a set of three energy acts, including the Gas Law, is to be enacted in 2013. As a result of the expected changes, the Company’s share in natural gas sales volume may fall, to the benefit of the existing as well as new gas trading entities.
Increase in the Volume of Mandatory Stocks
Pursuant to the Act on Mandatory Stocks, as of October 1st 2012, the volume of mandatory stocks must be increased from 20 to 30 days of average annual imports and must be kept in gas storage facilities whose technical parameters ensure delivery of the total stocks to the gas system within 40 days. Delivery of the total stocks to the gas system within the statutory time limit is possible only on condition that the buffering capacity of the storage facilities is increased at the cost of their working capacity. This will result in a reduction of the available trading capacity.
Additionally, due to the required volume of mandatory stocks and the technical parameters necessary to deliver the gas to the system, a significant portion of the stocks was placed in the Mogilno underground gas storage cavern, being Poland’s only peak-demand storage facility. As a result, the mandatory stocks significantly limit the use of the Mogilno facility for balance purposes in periods of peak gas demand.
Competition in Distribution
Liberalisation of the gas market is contributing to intensified competition faced by the Gas Distribution Companies. Companies distributing natural gas are progressively expanding their gas networks and attracting new customers. Additionally, new players have emerged, offering LNG distribution services. The barriers to market entry are definitely lower here, as LNG distribution involves significantly lower capital expenditure and does not require a connection to the gas system or adequate reserve capacity to be maintained in the transmission and distribution networks.
Another issue which affects the Gas Distribution Companies’ competitive position is the tariff policy of the Energy Regulatory Office, which prevents the Gas Distribution Companies from operating a flexible pricing policy for their key customers. With the lack of flexible pricing, the competitors’ offers may prove an attractive alternative for the Gas Distribution Companies’ customers.
Transmission easement
More and more frequently, the Gas Distribution Companies are facing excessive financial claims raised by owners of land plots where the gas network was developed in the past. Transmission easement serves as a basis for determining the scope of the use of third-party property by a transmission company, for which relevant consideration is due to the owner. The owners’ claims give rise to additional, frequently considerable costs, and thus may adversely affect the financial performance of the Gas Distribution Companies.
Electricity generation
Absence of regulations defining support mechanisms for high-efficiency co-generation of heat and electricity and lack of a stable policy supporting investments in renewable energy sources and co-generation are material risk factors affecting electricity generation activities. These factors are a source of uncertainty in the process of calculating electricity prices for 2013–2015. The risk affects both electricity producers and sellers and is hedged with appropriately formulated agreements for sale/purchase of property rights.
Furthermore, in order to meet more stringent gas and dust emission standards to be implemented in 2016, producers have to modernise their power and CHP plants and may be forced to shut down a number of generating units (a total of some 4,000 to 6,000 MWe by 2020) where installation of expensive flue gas treatment systems is not economically viable. In order to meet the more stringent emission standards, PGNiG Termika has gradually been modernising its generating assets.
Maintaining the share in the municipal heat market
Following expansion of the Warsaw municipal waste incineration plant, the quantity of heat supplied to the city’s municipal network will increase. As a result, PGNiG Termika’s share in total heat supplies to the municipal network covering the Warsaw area will fall from the current 98% to 95% in 2019.
Joint marketing efforts conducted with Dalkia Warszawa S.A. and connecting further western areas of Warsaw to the municipal heating network should significantly reduce potential future decline in the volume of energy produced at PGNiG Termika’s generating plants. With a view to maintaining its share in the municipal heat market, the company also offers “green” heat generated in biomass-fired units, continues to sell energy at competitive prices, and takes advantage of the TPA rule to gain access to new end users.