Annual report 2017

We want to shape a responsible energy industry of tomorrow in our country.

Risks

We are analysing the Group's operations and risks in the short and long term. We place emphasis on monitoring PGE's surroundings and events that might have an impact on it.

OPERATIONAL RISKS

We continually identify and monitor risks that may affect our business. We also take action to mitigate them and limit their impact.

The main risks and threats for PGE S.A. and PGE Group are presented below along with their assessment and outlook in the horizon of the next year.

Level risk

Outlook risk

◄►

 

low

medium

high

 

decrease

increase

stable

low level

medium level

high level

Risk does not pose a threat and may be tolerated

Risk requiring a proper reaction to be prepared based on cost and benefit analysis

Intolerable risk requiring immediate and active reaction, leading simultaneously to limitation of possible consequences and of probability of occurrence thereof

Market

and product risks

 

related to prices and volumes of offered products and services

Prices of electricity and related products – resulting from a lack of certainty with regard to the future levels and volatility of commodity prices relative to open contract positions - this particularly concerns electricity and associated products (property rights, CO2 emission allowances).

Electricity sales volumes – this risk derives from a lack of certainty with regard to the conditions determining the demand and supply of electricity, directly affecting the volume of market sales by PGE Group.

◄►

Tariffs (regulated prices) – resulting from the requirement to approve rates for distribution services and electricity and heat prices for particular groups of entities.

Property risks

 

related to development and maintenance of assets

Failures – connected with the operation and degradation over time of energy equipment and facilities (maintenance and repair work, diagnostics).

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Damage to property – connected with the physical protection of energy equipment and facilities against destructive external factors (including fire, weather phenomena and intentional damage).

Development and investments – connected with strategic plans for expanding the generation, distribution and sales potential as well as on-going investments.

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Operating risks

 

related to on-going economic processes

Electricity and heat production – connected with production planning and impact of the factors that determine production capacities.

Fuel management – connected with uncertainty regarding the quality, timeliness and volumes of fuel supply (mainly coal) and the effectiveness of inventory management processes.

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Human resources – pertaining to provision of employees with the relevant experience and competences, who are capable of performing specific tasks.

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Social dialogue – connected with a failure to achieve agreement between the Group’s management and employees, what could lead to strikes/collective labour disputes.

Regulatory and legal risks

 

related to compliance with external and internal legal provisions

Legal changes in support systems – connected with uncertainty as to the future shape of the support system for production of certified energy.

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Purchase of property rights and CO2 emission allowances – resulting from possible changes to statutory requirement for electricity sellers to purchase a specified quantity of property rights and to uncertainty with regard to the volume of CO2 emission rights granted free of charge in the future.

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Compensation for termination of long-term contracts (LTCs) – there is a possibility that the level of adjustments to advances collected for stranded costs, as calculated by the Group, will be questioned by the President of the Energy Regulatory Office (URE), as a result of which the Group will be obligated to return advances received for terminating the LTCs. The number of installations affected by this is steadily decreasing and this risk will diminish over time (see note 33.1 of the consolidated financial statements).

Environmental protection – resulting from industry regulations specifying which "environmental" requirements energy installations should meet and what the principles for using the natural environment are. Future environmental regulations and uncertainty concerning their final shape (in particular with regard to the revision of BAT / BREF) may translate into a change in the level of capital expenditures of PGE Group.

Unresolved legal status – connected with difficulties in respect of land acquisition or access to land in the course of new investments (particularly in the Distribution segment).

◄►

Concessions – resulting from the statutory requirement to hold concessions with regard to conducted operations.

Discriminatory actions – related to the Group's use of practices that limit or eliminate competition, breach the law and consumer interests.

Financial risks

 

related to financial management

Credit risk – connected with counterparty default, partial and/or late payment of receivables or a different type of breach of contractual terms (for example failure to deliver/collect goods or failure to pay for any associated damages or contractual penalties).

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Liquidity risk – connected with the possibility of losing the ability to meet current liabilities and obtain financing for business operations.

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Interest rate risk – resulting in particular from the negative impact of changes in market interest rates on PGE Group's cash flows generated by floating-rate financial assets and liabilities.

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Foreign exchange risk – understood in particular as risk that PGE Group's cash flows denominated in currencies other than the functional currency are exposed to due to negative exchange rate movements. 

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The main risk mitigation actions for PGE Group are presented below along with a description of the main tools used for risk management.

 

Market and product risks

Impact: Revenue and product and service offerings

Measures: PGE Group has rules for managing market risk (price- and volume-related), which include a global risk appetite measure, VaR-based position limits and management of consolidated exposure to commodity pricing risk through mechanisms for protection against risk exceeding acceptable levels. Those rules provide consistent guidance in respect of process organisation in the context of commercial strategy and mid-term planning. PGE Group follows rules pertaining to a strategy for hedging key exposures in the area of electricity and related product trading that correspond to the adopted risk appetite in the mid-term. Position hedging levels are established with consideration given to the results of analysing pricing risk in respect of electricity and related products. Target hedging levels are specified taking into consideration the Group’s financial standing, including in particular its strategic objectives.

PGE Group researches, monitors and analyses the electricity and related products markets in order to optimally use its generation and selling capacities.

New products are introduced on the retail market and actively promoted through nationwide marketing campaigns. Maintaining a diverse product portfolio and focusing efforts on tailoring its offering to the market, the Group diversifies channels used to reach the end-customers and diversifies target groups with account take to client’s volume potential. Efforts aimed at current client retention are based on a model consisting of a diversified portfolio of customer loyalty schemes and client-acquisition activities. The portfolio also includes special offers dedicated to former clients who moved over to the competitors, as well as industry offerings dedicated to specific types of economic activity. PGE Group also introduces bundled offers. Particular attention is paid to ensuring a high level of customer service by developing employees’ competences and building relations with business and retail clients. Having implemented tools to support these processes, the Group effectively manages information flows, which directly translates into comfortable client relations as well as better sales planning and organisation.

 

Operational risks

Impact: costs

Measures: PGE Group's results are to a large extent dependent on the costs incurred in the course of operations. The Group optimises costs inter alia by monitoring fuel prices and reserves and securing supply through long-term contracts with suppliers and through price fixing formulas. Inspections, repairs and modernisations of the existing assets optimise equipment lifecycles and the required availability of key components of those assets. Cost levels are affected by securing CO2 emission allowances partly free of charge and purchase of lacking allowances with the assumption of securing sales margins.

Intensive and effective dialogue is also carried out in order to avoid escalation of potential disputes with social partners and to work out the most favourable solutions with regard to the associated employment and employment costs within PGE Group.

 

Property risks

Impact: assets

Measures: PGE Group actively pursues a strategy for building up and modernising its production capacities. The Group diversifies its current structure of production sources due to energy generation technology. Currently PGE Group is running two key investments (Opole, Turów) alongside a number of grid investments, RES investments as well as modernisation and replacement projects. We are continuously carrying out maintenance and repair work. Our main generation assets are insured against failure and damage to property. The reliability of power supply to end users is systematically improving.

 

Regulatory and legal risks

Impact: compliance with regulations

Measures: PGE Group's operations are subject to a host of national and international laws and regulations. Monitoring legal changes that are being introduced or proposed ensures that the activities conducted in key business segments are in compliance with the law and that PGE Group has solutions that take into account the potential changes in its legal environment. PGE S.A. is one of the members of the Polish Electricity Association, which opened an office in Brussels. Through the Association’s operations, PGE S.A. actively influences the proceeding and shaping of EU law and engages in dialogue with EU institutions.

The Group adapts its internal regulations and practices to make sure that its activities are in compliance with power sector regulations and the binding law. 

The extraction of fossil fuels as well as the production and distribution of electricity and heat have impact on the environment therefore the Group continuously improves its activities aimed at protecting and improving the state of the environment by implementing technological and organisational solutions ensuring efficient and effective management in this area.

 

Financial risks

Impact: financial management

Measures: PGE Group manages credit risk stemming from commercial transactions. Prior to executing a transaction, a counterparty assessment is carried out and forms the basis for applying credit limits, which are regularly updated and monitored. Exposures that exceed established limits are hedged in accordance with the Group’s credit risk management policy. 

PGE Group applies a central financing model, which is generally used by PGE S.A. when raising external capital. PGE Group subsidiaries use a variety of intra-group financing sources such as: loans, bonds, bank account consolidation agreements (cash pooling). Liquidity risk is monitored using periodic liquidity planning concerning operating, investing and financing activities. As regards currency risk and interest rate risk, PGE Group has implemented internal management procedures. PGE Group companies execute derivative transactions involving interest rate- and/or currency-based instruments (IRS, CCIRS) only in order to hedge identified risk exposures.

STRATEGIC RISKS AND OPPORTUNITIES

We do not focus exclusively on risks concerning on-going activities. We look further to the future. We identify potential changes and prepare for them ahead of time so as to secure our long-term growth.

Although threats to on-going activities have an impact on PGE's operating and financial results, strategic risks may be decisive when it comes to strategy implementation and the future of the entire organisation. Their identification is the key to ensuring PGE Group's sustainability. Assessment of impact on the Group's objectives, image and business continuity is performed at the top management level. This allows us to prepare for arising challenges and ensure the Group's development in the long term.

Strategic risks identified by us include:

Impact

 

 

very low

low

medium

high

very high

Cybersecurity

Risk associated with intentional disruption of information processing and exchange IT systems used at PGE Group and intentional interference with IT infrastructure responsible for managing and supervising the operation of generation and distribution equipment.

Energy policy - a growth vision for the sector

Risk of changes concerning the directions of development and re-definition of the energy sector's role and rules for power market operations.

Forces of nature

Risk associated with more frequent extreme weather events having impact on electricity and heat generation and distribution.

Environmental restrictions

Risk connected with stricter environmental restrictions applicable to PGE Group's electricity and heat production and mining activities

Human resources

Risk associated with restricted availability of employees who are of key importance to PGE Group's processes

Legal

Risk of the instability of law outlining rules for the Group's operations

Macroeconomic

Risk of negative change in economic situation and fluctuations of macroeconomic indicators having impact on PGE Group's activities

Technological revolution

Risk of technological change causing a decrease of profitability of electricity and heat production at PGE Group's generation assets and their distribution using grid assets owned by PGE Group

Competition

Risk associated with the development by competition of a product offering that would decrease PGE Group's share in the energy market

In analysing these risks as threats to PGE, we at the same time try to identify any opportunities that might arise as a result of the changes that are taking place. Responding to risks is becoming a growth opportunity for the Group if we adapt to the changing world ahead of time. In this context, we are especially closely looking at changes in the technology environment, trying to be an active participant of these changes.

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