32.1.  Financial instruments by category (carrying amounts)

32.2.  Fair value hierarchy

32.3.  Fair value of financial instruments

32.4.  Items of income, expenses, profit and loss related to financial assets and liabilities, presented in the consolidated statement of comprehensive income

32.5.  Objectives and policies of financial risk management

The Group is exposed to financial risks, including in particular:

• credit risk,
• market risk,
• liquidity risk.

In order to manage financial risk effectively, the Parent operates ‘Policy of Financial Risk Management at PGNiG S.A.’, (the "Policy"), which defines the division of competencies and tasks among the Company’s organisational units in the process of financial risk management and control. The body responsible for ensuring compliance with the Policy and its periodic updates is the Risk Committee, which proposes risk management procedures, monitors the Policy implementation and revises the Policy as needed.

32.5.1.  Credit risk

Credit risk is defined as the probability of failure by the Group’s trading partner to meet its obligations on time or failure to meet such obligations at all. The credit risk resulting from a third party’s inability to perform its obligations under a financial instruments contract is generally limited to the amounts, if any, by which the third party’s liabilities exceed the Group’s liabilities. As a rule, the Group concludes transactions in financial instruments with multiple entities with high creditworthiness. The key criteria applied by the Group in the selection of counterparties include their financial standing as confirmed by rating agencies, as well as their respective market shares and reputation.

The PGNiG Group is exposed to credit risk in connection with its:

• fund placements,
• trade receivables,
• loans and other financial assets,
• hedging transactions.
• financial guarantees provided,

The maximum exposures to credit risk for individual financial instrument categories are presented below.

Maximum exposure to credit risk

32.5.1.1.  Cash and cash equivalents

The Group identifies, measures and minimises its credit exposure to individual banks with which it places its funds. The credit exposure was reduced through diversification of the portfolio of counterparties (mainly banks) with which the Group companies place their funds. The Parent has also concluded Framework Agreements with all its relationship banks. These Framework Agreements stipulate detailed terms of execution and settlement of financial transactions between the parties.

The Group measures the related credit risk by regularly reviewing the banks’ financial standing, as reflected in ratings assigned by rating agencies such as Fitch, Standards&Poor’s and Moody’s.

In 2014, the Group invested its long-term cash surplus of significant value in highly liquid, credit risk-free instruments, in particular treasury bills and bonds.

32.5.1.2.  Trade and other receivables

Material credit risk (in value terms) is related to receivables, mainly receivables under gas fuel sales, as well as electricity and related products sales, including carbon credits, and certificates of origin for electricity.

Transactions made at the Polish Power Exchange do not generate exposure to credit risk, as the system of guaranteed settlements through the agency of the Commodity Exchange Clearing House provides each member of the Clearing House with the safety of settlements in the case of insolvency of any individual market participants. In order to minimise the risk of uncollectible receivables arising in connection with sale transactions executed outside of the PPE, uniform rules designed to secure trade receivables are in place and must be observed while concluding general supply contracts.

Prior to the conclusion of a sale contract of significant value, the financial standing of the potential customer is reviewed in order to assess the customer’s creditworthiness. Such assessment serves as the basis for determining the form of security required in connection with the contract. For new contracts, the type of security instrument used is agreed between PGNiG S.A. and the customer. As part of the mandatory harmonisation of sale contracts with the requirements of the Polish Energy Law, the Company enters into negotiations with certain customers with to create or strengthen contract performance security. In 2014, the process of procuring security for receivables was adapted to the changing conditions in the energy market, particularly with respect to securing past-due receivables from small and medium-sized business customers.

Balances of receivables from customers are monitored on an ongoing basis, in line with the Group's policy. If payment is not received within the contractual term, appropriate steps are taken, in line with the Group's debt collection procedures.

32.5.1.3.  Loans and other financial assets

Exposure to credit risk under loans advanced arises in connection with loans advanced by the Parent to the PGNiG Group companies: subsidiaries not accounted for with the full method, associates and joint ventures. Loans to those entities are advanced in line with an internal procedure, which stipulates detailed rules governing the conclusion and monitoring of loan agreements, thus minimising the Group’s exposure to credit risk under such agreements. Loans are advanced only if the borrower meets a number of conditions and provides appropriate security.

32.5.1.4.  Positive value of derivative financial instruments

The exposure to credit risk under financial derivatives is equal to the net carrying amount of the positive valuation of the derivative (at fair value). As in the case of placements, transactions in financial derivatives are executed with most reputable banks with high credit ratings. The Group companies have also concluded either Framework Agreements or ISDA Agreements with each of their relationship banks, stipulating detailed terms of service and limits of maximum exposure arising from the fair value of derivatives.

The Group believes that all these measures protect it from any material credit-risk-related losses.

As at December 31st 2014, the value of unimpaired past due receivables, as disclosed in the Group’s statement of financial position, was PLN 906m (2013: PLN 418m).

32.5.1.4.1. Receivables past due but not impaired as at the reporting date – by length of delay

32.5.1.5.  Guarantees issued

The Group's credit risk exposure under provided guarantees is substantially limited to the risk of default by the banks which, acting on the Group's instructions, issued guarantees to other external entities. However, the banks on which the Group relies for provision of guarantees are reputable institutions with high ratings; therefore, both the probability of their default and the associated credit risk are insignificant. As in the case of the risk related to cash deposits, the credit risk under provided guarantees is measured by regularly reviewing the financial standing of the banks issuing the guarantees.

32.5.2.  Market risk

Market risk is defined as the probability that the Group’s financial performance or economic value will be adversely affected by changes in the financial and commodity markets.

The main objective of the market risk management is to identify, measure, monitor and mitigate key sources of the risk, including:

• foreign exchange risk,
• interest rate risk,
• commodity risk (e.g. gas fuel, crude oil, energy and related products).

32.5.2.1.  Sensitivity analysis

To determine a reasonable range of changes which may occur with respect to currency or interest rate risks, the Group assumed an (implied) market volatility level for semi-annual periods, i.e. an average change of 10% as at the end of 2014 for the analysis of exchange rate sensitivity (as at the end of 2013:10%), +/-100 bpfor the analysis of interest rate sensitivity (as at the end of 2013, also +/-100 bp) and 40% for energy commodity derivatives ( December 31st 2013: 15%).

32.5.2.2.  Currency risk

Currency risk is defined as the probability that the Group’s financial performance will be adversely affected by changes in the price of one currency against another.

The hedging measures implemented by the Group are mainly intended to provide protection against the currency risk accompanying payments settled in foreign currencies (mainly payments for gas fuel supplies). To hedge its trade payables, the Group uses call options, option strategies and forward transactions.

The results of the analysis of sensitivity to currency risk carried out as at December 31st 2014 indicate that net profit would have been lower by PLN 306m, had the EUR/PLN, USD/PLN, NOK/PLN and the other currencies’ exchange rates increased by 10%, ceteris paribus (net profit decrease of PLN 249m due to stronger NOK, decrease of PLN 61m due to stronger USD, decrease of PLN 1m due to stronger EUR, and increase of PLN 5m due to strengthening of the other currencies).

The most significant factor with a bearing on the outcome of the sensitivity analysis is higher negative valuation of CCIRS derivatives hedging the credit facility advanced to PGNiG Upstream International AS, which is eliminated from the consolidated financial statements.

If the credit facility was recognised in the statement of financial position (as is the case in the Parent's separate financial statements), the cash flows related to the credit facility and the cash flows from the hedging transactions would offset one another. As a result, the changes in positive (negative) valuation of the credit facility would be offset by negative (positive) changes in the valuation of CCIRS transactions. In aggregate, the items would show no sensitivity to the exchange rate and interest rate changes.

Lower profit would be mainly attributable to an increase in the negative portion of the fair value of financial derivatives (negative fair value of swap transactions in NOK).

The adverse effect on the net profit of NOK-denominated financial instruments would be substantially amplified by an increase in valuation of the USD credit facility contracted by PGNiG Upstream International AS and reduced by an increase in the valuation of assets in this currency. Any increase in foreign exchange losses from valuation of the Euronotes in EUR would be offset by an increase in the positive portion of the fair value of financial derivatives for EUR.

As at December 31st 2014, net profit would have been higher by PLN 282m, if the EUR, USD, NOK and the other currencies depreciated against the złoty by 10%, ceteris paribus (net profit higher by PLN 249m due to weaker NOK, higher by PLN 46m due to weaker USD, lower by PLN 8m due to weaker EUR, and lower by PLN 5m due to depreciation of the other currencies). A positive result would be mainly attributable to an increase in the positive portion of the fair value of financial derivatives (positive fair value of swap transactions in NOK). Any increase in foreign exchange gains from valuation of the Euronotes in EUR would be offset by an increase in the negative portion of the fair value of financial derivatives for EUR. The result for EUR would be slightly reduced due to the decrease in assets (receivables) measured in the same currency. On the other hand, any decrease in the valuation of the USD-denominated credit facility contracted by PGNiG Upstream International AS would have a positive effect on net profit, which would be partially offset by a decrease in assets (receivables) measured in the same currency.

The results of the analysis of sensitivity to currency risk carried out as at December 31st 2013 indicate that net profit would have been lower by PLN 329m, had the EUR/PLN, USD/PLN, NOK/PLN and other currencies’ exchange rates increased by 10%, ceteris paribus (net profit decrease of PLN 262m due to stronger NOK, decrease of PLN 58m due to stronger USD, decrease of PLN 11m due to stronger EUR, and increase of PLN 2m due to strengthening of other currencies).

The most significant factor with a bearing on the outcome of the sensitivity analysis is higher negative valuation of CCIRS derivatives hedging the credit facility advanced to PGNiG Upstream International AS, which is eliminated from the consolidated financial statements.

If the credit facility was recognised in the statement of financial position (as is the case in the Parent's separate financial statements), the cash flows related to the credit facility and the cash flows from the hedging transactions would offset one another. As a result, the changes in positive (negative) valuation of the credit facility would be offset by negative (positive) changes in the valuation of CCIRS transactions. In aggregate, the items would show no sensitivity to the exchange rate and interest rate changes.

Lower profit would be mainly attributable to an increase in the negative portion of the fair value of financial derivatives (negative fair value of swap transactions in NOK).

The adverse effect on the net profit of NOK-denominated financial instruments would be substantially amplified by an increase in valuation of the USD credit facility contracted by PGNiG Upstream International AS and reduced by an increase in the valuation of assets in this currency. Any increase in foreign exchange losses from valuation of the Euronotes in EUR would be offset by an increase in the positive portion of the fair value of financial derivatives for EUR.

As at December 31st 2013, net profit would have been higher by PLN 325m, if the EUR, USD, NOK and other currencies depreciated against the złoty by 10%, ceteris paribus (net profit higher by PLN 263m due to weaker NOK, higher by PLN 62m due to weaker USD, higher by PLN 2m due to weaker EUR, and lower by PLN 2m due to depreciation of other currencies). A positive result would be mainly attributable to an increase in the positive portion of the fair value of financial derivatives (positive fair value of swap transactions in NOK). Any increase in foreign exchange gains from valuation of the Euronotes in EUR would be offset by an increase in the negative portion of the fair value of financial derivatives for EUR. On the other hand, any decrease in the valuation of the USD-denominated credit facility contracted by PGNiG Upstream International AS would have a positive effect on net profit, which would be partially offset by a decrease in assets (receivables) measured in the same currency.

32.5.2.2.1. Sensitivity of financial instruments denominated in foreign currencies to exchange rate fluctuations charged to profit or loss

32.5.2.2.2. Analysis of derivative financial instruments' sensitivity to fluctuations of exchange rates charged to equity

The analysis of derivative instruments' sensitivity to exchange rate fluctuations, charged to equity and presented in the table below, shows that a 10% increase in the PLN/USD and PLN/EUR exchange rates would cause an increase in equity through other comprehensive income. A 10% decline in the PLN/USD and PLN/EUR exchange rates would reduce equity. This is due to the valuation of derivative instruments used by the Group to hedge against an increase in USD- and EUR-denominated liabilities and cost of gas purchases. Valuation of the effective portion of such hedges is charged to equity.

32.5.2.3.  Interest rate risk

Interest rate risk is defined as the probability that the Group's financial performance will be adversely affected by changes in interest rates.

The Group is exposed to interest rate risk primarily in connection with its financial liabilities. For detailed information on the Group's financial liabilities and the applicable interest rates, see Note 24.

The Parent measures its market risk (including the currency and interest rate risks) by monitoring VaR (value at risk). VaR means that the maximum loss arising from a change in the market (fair) value will not exceed that value over the next n business days, given a specified probability level (e.g. 99%). VaR is estimated using the variance-covariance method.

The Group analysed the sensitivity of financial instruments under contracted borrowings, notes in issue and variable-rate lease liabilities, assuming interest rate changes of -/+/-100 bp for 2014 (-/+/-100 bp as at the end of 2013).

As at December 31st 2014, the sensitivity of liabilities under borrowings, notes in issue, and variable-rate lease liabilities to interest rate changes of -/+/-100 bp was -/+ PLN 58m (-/+ PLN 77m as at the end of 2013). The sensitivity of loans advanced to interest rate changes of -/+/-100 bp for 2014 was -/+ PLN 2m (-/+ PLN 2m as at the end of 2013).

32.5.2.3.1. Sensitivity of financial instruments to interest rate changes

32.5.2.4.  Commodity price risk

Commodity price risk is defined as the probability that the Group’s financial performance will be adversely affected by changes in commodity prices.

The Group's exposure to commodity price risk arises mainly in connection with its contracts for gas fuel deliveries and sales contracts entered into through the process of daily bidding and sale of the fuel at the PPE. It stems from volatility of prices of gas and oil products quoted on global markets. Under some of the contracts for gas fuel deliveries, the pricing formula relies on a weighted average of the prices from previous months, which mitigates the volatility risk.

Commodity risk is also related to electricity trading, certificates of origin and carbon credits. Electricity trading is conducted on regulated exchange markets in Poland and abroad, but the Group also enters into transactions outside of the regulated markets, under framework agreements. The Group actively manages its exposure to commodity price risk using implemented VaR measures. VaR values are measured and VaR limits are set and actively monitored to limit the potential losses related to the exposure to commodity price risk assumed by the Company.

In addition, under the Energy Law an application for tariff adjustment may be filed if, within a quarter, the purchase costs of gas rise by more than 5%. In 2014, the Group closely monitored and hedged against the risk. To hedge against commodity price risk, the Group used Asian call options settled as European options, risk reversal option strategies, commodity swaps, as well as futures and forwards.

The Group analysed the sensitivity of energy commodity derivatives. For the sensitivity analysis for 2014, a 40% volatility was assumed for such instruments (15% as at December 31st 2013).

The tables below present an analysis of sensitivity of energy commodity derivatives to price changes for 2014 and 2013.

32.5.2.4.1. Sensitivity of derivative financial instruments to commodity price fluctuations charged to profit or loss

The above tables present only the effect of price fluctuations on profit or loss. Some changes in the value of energy commodity derivatives affect equity directly.

The table below presents the effect of changes in energy commodity derivatives on equity.

32.5.2.4.2. Analysis of derivative financial instruments' sensitivity to fluctuations of commodity prices charged to equity

The analysis of derivative instruments' sensitivity to fluctuations of commodity prices, charged to equity, as presented in the table above, shows that a 40% increase (15% increase at the end of 2013) in commodity prices would result in equity increase through other comprehensive income. A 40% decline in the prices (15% decline at the end of 2013) would reduce equity. This is due to the fact that the Group uses derivatives to hedge against an increase in prices of energy commodities, and the valuation of the effective portion of such hedges is charged to equity.

32.5.3.  Liquidity risk

The main objective of the liquidity risk management is to monitor and plan the Company's liquidity on a continuous basis. Liquidity is monitored through at least 12-month projections of future cash flows, which are updated once a month. PGNiG S.A. reviews the actual cash flows against projections at regular intervals – an exercise which comprises an analysis of unmet cash-flow targets, as well as the related causes and effects.

The liquidity risk should not be equated exclusively with the risk of loss of liquidity by the Group. An equally serious threat is that of having excess structural liquidity, which could adversely affect the Group’s profitability.

The Group monitors and plans its liquidity levels on a continuous basis. As part of its strategy to hedge against liquidity risk, as at December 31st 2014 the Group had in place the following debt security issuance programmes:

• Under the Note Issuance Programme Agreement executed by the Parent on June 10th 2010, the Parent may issue discount or coupon notes maturing in one to twelve months, for an aggregate amount of up to PLN 7,000m. The Agreement was originally concluded with six banks (Bank Pekao S.A., ING Bank åląski S.A., PKO BP S.A., Bank Handlowy w Warszawie S.A., Societe Generale S.A. and BNP Paribas S.A., Polish Branch). Under an annex of November 25th 2011, BRE Bank S.A. (currently mBank S.A.), Bank Zachodni WBK S.A. and Nordea Bank Polska S.A. acceded to the Agreement. Under an annex of August 8th 2014, Nordea Bank Polska was excluded from the Agreement, and the Agreement's term was extended until July 31st 2020. As at December 31st 2014, no debt was outstanding under the Agreement.
• On August 25th 2011, the Parent and PGNiG Finance AB executed documentation for a Euro Medium Term Notes Programme with Societe Generale S.A., BNP Paribas S.A. and Unicredit Bank AG, pursuant to which PGNiG Finance AB may issue notes with maturities of up to ten years, up to the aggregate amount of EUR 1,200m. The first tranche of PGNiG Finance AB securities under the Programme, comprising PLN 500m 5-year Euronotes, was issued on February 10th 2012. As at December 31st 2014, nominal debt outstanding under the Euronotes was PLN 2,131m (translated at the mid rate quoted by the National Bank of Poland for December 31st 2014).
• On May 22nd 2012, the Parent executed an agreement for organisation of a note programme for up to PLN 4,500m with Bank Pekao S.A. and ING Bank åląski S.A. On July 30th 2012, the issued five-year notes were floated on the Catalyst market, a multilateral trading facility operated by BondSpot. In the reporting period no notes were issued. As at December 31st 2014, nominal debt outstanding under the Programme was PLN 2,500m.
• On October 2nd 2014, the Parent executed an agreement for organisation of a note programme for up to PLN 1,000m with Bank Gospodarstwa Krajowego. In 2014, no notes were issued under the programme.
• On July 4th 2012, PGNiG Termika S.A. executed a note programme with the following banks: ING Bank åląski S.A., PKO Bank Polski S.A., Nordea Bank Polska S.A. and Bank Zachodni WBK S.A. On November 1st 2014, two of the underwriters for the issue, PKO BP and Nordea Bank, mergered. As a result of negotiations held with three banks: PKO BP, ING Bank åląski and BZ WBK, concerning the terms of the Note Programme, on December 15th 2014 annexes were signed to amend the underwriting, agency and deposit agreements. Under the Programme, PGNiG Termika S.A. may issue coupon or discount notes up to PLN 1,500m. In accordance with the annexes, the Programme is to expire on December 29th 2019, though it may be extended for two years, i.e. until December 29th 2021.

As at December 31st 2014, PGNiG TERMIKA S.A.'s nominal debt under notes in issue was PLN 190m.

Any surplus cash is invested, mainly in treasury securities, or deposited with reputable banks.

The liquidity risk at the Parent is significantly mitigated through the application of the “PGNiG S.A. Liquidity Management Procedure”. This procedure has been implemented across the Company’s organisational units. It offers a systematised set of measures designed to ensure proper liquidity management through: settlement of payments, preparation of cash-flow projections, optimum management of free cash flows, securing and restructuring of financing for day-to-day operations and investment projects, protection against the risk of temporary liquidity loss due to unforeseen disruptions, and appropriate servicing of credit agreements.

Measurement of the liquidity risk is based on an ongoing detailed monitoring of cash flows, which takes into account the probability that specific flows will materialise, as well as the planned net cash position.

The tables below present a breakdown of financial liabilities by maturity.

32.5.3.1.  Financial liabilities at amortised cost, by maturity

The items in the above tables are presented at gross (undiscounted) amounts.

In the current and comparative periods, the Group met its liabilities under borrowings in a timely manner. Further, there were no breaches of material provisions of any of its borrowing agreements that would trigger accelerated repayment.

32.5.3.2.  Derivative financial instruments by maturity

The Group has not identified any other material risks inherent in its day-to-day operations.