DIRECTORS REPORT ON THE OPERATIONS OF GRUPA LOTOS S.A. IN 2011

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1 S.A. Management Board: Paweł Olechnowicz Mariusz Machajewski Marek Sokołowski Maciej Szozda Supervisory Board: Wiesław Skwarko Marcin Majeranowski Małgorzata Hirszel Oskar Pawłowski Michał Rumiński Agnieszka Trzaskalska Registered address of Grupa LOTOS S.A.: ul. Elbląska 135, Gdańsk, Poland Investor Relations contact details: tel Auditor: Ernst & Young Audit Sp. z o.o. This is a translation of a document originally issued in Polish

2 S.A. I. INFORMATION ON GRUPA LOTOS S.A DESCRIPTION OF GRUPA LOTOS S.A ORGANISATIONAL STRUCTURE OF GRUPA LOTOS S.A. AND GRUPA LOTOS S.A. S BRANCHES (PLANTS) CHANGES IN ORGANISATION AND MANAGEMENT OWNERSHIP CHANGES AT THE LOTOS GROUP GRUPA LOTOS S.A. S EMPLOYMENT STRUCTURE CHANGES IN ORGANISATIONAL OR CAPITAL LINKS BETWEEN THE PARENT AND OTHER ENTITIES KEY OPERATING ACTIVITIES R&D ACHIEVEMENTS KET PRODUCTS, GOODS AND SERVICES CHANGES IN SALES MARKETS AND SOURCES OF SUPPLY OF MATERIALS, GOODS FOR RESALE AND SERVICES EXTERNAL AND INTERNAL FACTORS MATERIAL FOR THE DEVELOPMENT OF GRUPA LOTOS S.A., AS WELL AS KEY RISKS AND THREATS GRUPA LOTOS S.A.'S DEVELOPMENT PROSPECTS IN THE CONTEXT OF ITS MARKET STRATEGY EVENTS SIGNIFICANT FOR THE OPERATIONS OF GRUPA LOTOS S.A ENVIRONMENTAL ISSUES AGREEMENTS, RELATED-PARTY TRANSACTIONS AND COURT PROCEEDINGS AGREEMENTS SIGNIFICANT FOR THE OPERATIONS OF GRUPA LOTOS S.A MATERIAL RELATED-PARTY TRANSACTIONS EXECUTED ON NON-ARMS' LENGTH TERMS AGREEMENTS BETWEEN THE ISSUER AND THE MANAGEMENT STAFF AND REMUNERATION, AWARDS OR BENEFITS PAID TO THE MANAGEMENT AND SUPERVISORY STAFF OF GRUPA LOTOS S.A AGREEMENT WITH QUALIFIED AUDITOR OF FINANCIAL STATEMENTS COURT, ARBITRATION OR ADMINISTRATIVE PROCEEDINGS II. FINANCIAL STANDING OF GRUPA LOTOS S.A KEY FINANCIAL AND ECONOMIC DATA CONTAINED IN THE ANNUAL SEPARATE FINANCIAL STATEMENTS AND ASSESSMENT OF FACTORS AND NON- RECURRING EVENTS WITH A BEARING ON GRUPA LOTOS S.A. S PERFORMANCE STATEMENT OF COMPREHENSIVE INCOME STATEMENT OF FINANCIAL POSITION

3 S.A STATEMENT OF CASH FLOWS ASSESSMENT OF FACTORS AND NON-RECURRING EVENTS AFFECTING THE OPERATING PERFORMANCE EXPLANATION OF DIFFERENCES BETWEEN ACTUAL FINANCIAL PERFORMANCE AND PREVIOUSLY PUBLISHED FORECASTS INVESTMENTS INVESTMENTS IN TANGIBLE AND INTANGIBLE ASSETS EQUITY INVESTMENTS ASSESSMENT OF FEASIBILITY OF PLANNED INVESTMENTS, INCLUDING EQUITY INVESTMENTS, IN VIEW OF AVAILABLE FUNDS FINANCING SOURCES BORROWINGS INCURRED AND LOANS ADVANCED IN THE FINANCIAL YEAR SURETIES, GUARANTEES AND OTHER CONTINGENT AND OFF-BALANCE- SHEET LIABILITIES ASSESSMENT OF FINANCIAL RESOURCES MANAGEMENT USE OF ISSUE PROCEEDS TO IMPLEMENT THE ISSUE OBJECTIVES III. GRUPA LOTOS SHARES PRICE OF GRUPA LOTOS SHARES ON THE WARSAW STOCK EXCHANGE AGGREGATE NUMBER AND PAR VALUE OF THE COMPANY SHARES AND SHARES IN THE COMPANY S RELATED ENTITIES, HELD BY MANAGEMENT AND SUPERVISORY STAFF KNOWN AGREEMENTS WHICH MAY GIVE RISE TO CHANGES IN THE SHAREHOLDER STRUCTURE CONTROL SYSTEMS FOR EMPLOYEE STOCK OPTION PLANS BUY-BACK OF OWN SHARES PAYMENT OF DIVIDEND FOR IV. CORPORATE GOVERNANCE SHAREHOLDER STRUCTURE LARGE HOLDINGS OF SHARES HOLDERS OF SECURITIES WHICH CONFER SPECIAL CONTROL POWERS, WITH THE DESCRIPTION OF THE POWERS LIMITATIONS ON THE VOTING RIGHTS AT THE GM RESTRICTIONS ON TRANSFERABILITY OF THE SHARES THE COMPANY'S GOVERNING BODIES GENERAL MEETING

4 S.A SUPERVISORY BOARD MANAGEMENT BOARD. POWERS OF INDIVIDUAL MEMBERS RULES FOR AMENDING THE ARTICLES OF ASSOCIATION OF GRUPA LOTOS S.A CORPORATE GOVERNANCE PRINCIPLES APPLICABLE AT GRUPA LOTOS IN VOLUNTARY CORPORATE GOVERNANCE PRINCIPLES APPLIED BY GRUPA LOTOS OBLIGATORY CORPORATE GOVERNANCE PRINCIPLES APPLIED BY GRUPA LOTOS INTERNAL AUDIT AND RISK MANAGEMENT SYSTEMS IN THE PROCESS OF PREPARING FINANCIAL STATEMENTS GLOSSARY OF INDUSTRY TERMS SIGNATURES OF THE MANAGEMENT BOARD MEMBERS

5 S.A. I. INFORMATION ON GRUPA LOTOS S.A. 1. DESCRIPTION OF GRUPA LOTOS S.A. Grupa LOTOS S.A. ("Grupa LOTOS S.A.", "the Company") is a Polish oil company whose business consists in production and processing of crude oil as well as wholesale and retail sale of petroleum products. The Company is a producer and supplier of such products as unleaded petrol, diesel oil, light fuel oil and aviation fuel. Grupa LOTOS S.A. also specialises in the production and sale of motor oils and bitumens in Poland. The LOTOS Group's main market is Poland. In 2011, domestic sales represented 73.4% of the Company's total revenue. The strategy provides for the consolidation of the LOTOS Group s position as a strong, innovative and successfully developing entity, which plays a crucial role in ensuring Poland s energy security and operates in compliance with the principles of social responsibility and sustainable growth ORGANISATIONAL STRUCTURE OF GRUPA LOTOS S.A. AND GRUPA LOTOS S.A. S BRANCHES (PLANTS) The corporate structure of Grupa LOTOS S.A. as at December 31st 2011, as shown in the following chart, reflects the division of competences and relations between various functions and tasks performed at the Company, and establishes the hierarchy of organisational units and management. A division is a group of organisational units reporting to specific executive officers who hold decision-making powers within a certain area of the business. Organisational units are separated mainly based on the criterion of the function performed. The basic responsibility of an office is to support the Chief Executive Officer s or the division directors decision-making process. A department is responsible for performing a specific function assigned to it, and ranks one level below an office in the organisational hierarchy. A complex is an operating component of the enterprise, directly performing operating and executory functions. Grupa LOTOS S.A. has no branches (plants) within the meaning of the Polish Accountancy Act. 5

6 S.A. Organisational chart of Grupa LOTOS S.A. (as at December 31st 2011) 6

7 S.A CHANGES IN ORGANISATION AND MANAGEMENT The changes in the organisational structure of Grupa LOTOS S.A. implemented in 2011 were designed to streamline the operations of individual divisions and their respective organisational units OWNERSHIP CHANGES AT THE LOTOS GROUP Share capital increase Entity Date Share capital before the increase Amount of increase Share capital after the increase Currency Notes LOTOS Petrobaltic S.A. Nov ,400,000 4,200,000 96,600,000 PLN new issue of shares AB LOTOS GEONAFTA Nov ,126 7, ,526 LTL new issue of shares LOTOS Parafiny Sp z o.o. Miliana Shipping Group Ltd Dec ,783,000 9,000,000 28,783,000 PLN new issue of shares Dec ,000 1,000 2,000 EUR acquisition of new shares in exchange for a non-cash contribution made by six companies LOTOS Norge AS Dec ,000, ,733, ,733,964 NOK new issue of shares LOTOS Asfalt Sp z o.o. Dec ,000,000 18,000,000 20,000,000 PLN increase in par value of existing shares (10:1) LOTOS Norge AS* Jan ,733,964 91,984, ,718,441 NOK new issue of shares LOTOS Petrobaltic S.A.* Feb ,600,000 2,800,000 99,400,000 PLN new issue of shares * effected after the balance-sheet date Divestments Acquiree Acquirer Date Details Notes LOTOS Parafiny Sp z o.o.* Krokus Chem Sp z o.o. Jan Sale of all shares; share purchase agreement executed on November 30th 2011 PLASTEKOL Organizacja Odzysku S.A. IGT Polska Sp z o.o. Feb Sale of 95.5% of shares LOTOS Jasło Group company * effected after the balance-sheet date Share buyback Company's Entity Date ownership Notes interest LOTOS Czechowice S.A. Apr % Completion of the squeeze-out process LOTOS Jasło S.A. Apr % Completion of the squeeze-out process LOTOS Petrobaltic S.A. Dec % Ownership interest increased from 99.32% (as at January 1st 2011) 7

8 S.A. Other ownership changes Entity Date Description LOTOS Petrobaltic S.A. Mar Disposal of one share in AB Geonafta to Grupa LOTOS S.A. Aphrodite Offshore Services N.V. Jun Disposal of one share in Miliana Shipping Company Ltd to LOTOS Petrobaltic S.A. LOTOS Gaz S.A. Jan Decision to liquidate the company Changes in the LOTOS Group's assets in Lithuania Before the restructuring... Nov 30th 2011 * change of legal form (UAB to AB) in 2011 AB LOTOS Geonafta After the restructuring... 8

9 S.A. Restructuring of sea transport business into a shipping group within the LOTOS Petrobaltic Group; share capital increase Before the restructuring... After the restructuring... (i) July 22nd 2011 establishment of two subsidiaries: Miliana Shipping Group Ltd and Miliana Shipmanagement Ltd. (ii) December 13th 2011 transfer of six companies to Miliana Shipping Group Ltd 1.4. GRUPA LOTOS S.A. S EMPLOYMENT STRUCTURE As at December 31st 2011, Grupa LOTOS S.A. employed 1,329 staff (1,309 FTEs). Grupa LOTOS S.A. s employment structure by type of job (as at December 31st 2011): Item Men Women Total FTEs blue-collar jobs white-collar jobs Total ,329 1,309 9

10 S.A. Grupa LOTOS S.A. s employment structure by education level: Education White-collar jobs Blue-collar jobs Total No. % University degree % Secondary education (technical) % Secondary education (general) % Vocational education % Primary-level education % Total , % 1.5. CHANGES IN ORGANISATIONAL OR CAPITAL LINKS BETWEEN THE PARENT AND OTHER ENTITIES As at December 31st 2011, the LOTOS Group comprised Grupa LOTOS, as the parent entity, and 32 production and service companies. Entities in which the Company directly holds interests in the share capital or in the total vote Name Registered office Business profile Ownership interest (%) Dec Dec Parent Grupa LOTOS Gdańsk Production and processing of refined petroleum products (mainly fuels) and their wholesale Not applicable Not applicable Direct subsidiaries LOTOS Paliwa Sp. z o.o. Gdańsk Wholesale and retail sale of fuels and light fuel oil, management of the LOTOS service station network 100% 100% LOTOS Gaz S.A. w likwidacji (in liquidation) Kraków The company does not conduct operations 100% 100% LOTOS Oil S.A. Gdańsk Production and sale of lubricating oils and lubricants, and sale of base oils 100% 100% LOTOS Asfalt Sp. z o.o. Gdańsk Production and sale of bitumens 100% 100% LOTOS Ekoenergia Sp. z o.o. Gdańsk The company has not commenced operations 100% 100% LOTOS Kolej Sp. z o.o. Gdańsk Railway transport 100% 100% LOTOS Serwis Sp. z o.o. Gdańsk Maintenance of mechanical and electric operations and controlling devices, overhaul and repair services 100% 100% LOTOS LAB Sp. z o.o. Gdańsk Laboratory analyses 100% 100% LOTOS Straż Sp. z o.o. Gdańsk Fire safety 100% 100% LOTOS Ochrona Sp. z o.o. Gdańsk Personal and property protection 100% 100% 10

11 S.A. Name Registered office Business profile Ownership interest (%) Dec Dec LOTOS Parafiny Sp. z o.o. Jasło Production and sale of paraffin 100% 100% LOTOS Tank Sp. z o.o. Gdańsk Logistics services 100% 100% LOTOS Czechowice S.A. (parent of another group) Czechowice- Dziedzice Storage and distribution of fuels 100% 97.5% LOTOS Jasło S.A. Jasło Storage and distribution of fuels; renting and operating of own or leased real estate from March 24th % 98.1% LOTOS Petrobaltic S.A. (parent of another group) (4) Gdańsk Acquisition of crude oil and natural gas deposits and their exploitation 99.9% 99.3% LOTOS Park Technologiczny Sp. z o.o. Jasło The company does not conduct operations 100% 100% Indirect subsidiaries RCEkoenergia Sp. z o.o. LOTOS Biopaliwa Sp. z o.o. PLASTEKOL Organizacja Odzysku S.A. Aphrodite Offshore Services N.V. Czechowice- Dziedzice Czechowice- Dziedzice Production and distribution of electricity, heat and gas Production of fatty acid methyl esters (FAME) 100% 97.5% 100% 97.5% Jasło Provision of services % Curaçao Netherlands Antilles The company does not conduct operations 99.9% 99.3% LOTOS Exploration and Production Norge AS Stavanger, Norway Oil exploration and production at the Norwegian Continental Shelf, provision of services related to oil exploration and production 99.9% 99.3% ENERGOBALTIC Sp. z o.o. Władysławowo Production of electricity, heat, LPG and natural gas condensate 99.9% 99.3% AB LOTOS Baltija Vilnius Lithuania Business and legal advisory services % AB LOTOS Geonafta (parent of another group) Gargždai Lithuania Oil exploration and production in the Republic of Lithuania, provision of services related to oil exploration and production 99.95% 40.3% UAB Genciu Nafta Gargždai Lithuania Crude oil exploration and production in the Republic of Lithuania 99.9% 40.3% Miliana Shipholding Company Ltd. (formerly Miliana Shipping Company Ltd.) (parent of another group) Nicosia Cyprus Provision of services related to storage and transport of crude oil, and managing own financial assets 99.9% 99.3% Miliana Shipmanagement Ltd. Miliana Shipping Group (parent of another group) Kambr Navigation Company Ltd. Petro Aphrodite Company Ltd. Nicosia Cyprus Nicosia Cyprus Nicosia Cyprus Nicosia Cyprus Sea transport services 99.9% - Management of own assets 99.9% - Ship chartering 99.9% - Ship chartering 99.9% - 11

12 S.A. Name Petro Icarus Company Ltd. Granit Navigation Company Ltd. St. Barbara Navigation Company Ltd. Bazalt Navigation Company Ltd. Registered office Nicosia Cyprus Nicosia Cyprus Nicosia Cyprus Nicosia Cyprus Ownership interest (%) Business profile Dec Dec Ship chartering 99.9% - Ship chartering 99.9% - Ship chartering 99.9% - Ship chartering 99.9% - Other companies UAB Minjos Nafta UAB Manifoldas Gargždai Lithuania Gargždai Lithuania Crude oil exploration and production in the Republic of Lithuania Crude oil exploration and production in the Republic of Lithuania 49.9% 20.1% 49.9% 20.1% 2. KEY OPERATING ACTIVITIES 2.1. R&D ACHIEVEMENTS 2011 was the first year of operation of the Grupa LOTOS refinery in its new configuration, with expanded processing capacities from 6 million to 10.5 million tonnes a year, following the completion of the 10+ Programme. In 2011, the last two key installations of the 10+ Programme, i.e. the hydrocracking (MHC) and solvent deasphalting (ROSE) units, were launched. The design plans assumed a 60% rate of conversion of the heaviest oil fractions to high-grade petroleum products, such as diesel oils, gasolines and LPG, for the hydrocracking unit. Further increase in the conversion rate at the MHC unit resulted from technological process changes at Grupa LOTOS. Grupa LOTOS started producing and marketing a new product, paraffin fraction. Grupa LOTOS s R&D efforts focused on developing technologies for the Oil Unit's products. The R&D projects carried out in 2011 included: innovation work related to the production of Group II base oils; production of the first batch of base oils with sulphur residue below 0.5%m/m (to be used as feedstock for production of higher quality engine oils); upgrade of Group I base oils production technology using the new paraffin fraction (improved oil efficiency, enabled production of SAE 30/95 base oil with kinematic viscosity of >90cSt at 40 o C, improved physical and chemical properties (viscosity coefficient in particular) of base oils; upgrade of heavy extract production technology using the new paraffin fraction (higher content of aromatic hydrocarbons, which is an advantage in synthetic rubber and rubber compounds production); 12

13 S.A. production of ceresine as a component for production of white ceresine meeting the requirements set by the American Food and Drug Administration (FDA) KEY PRODUCTS, GOODS AND SERVICES Grupa LOTOS S.A. s sales revenue by products, goods for resale and services for period for period PLN 000 % share PLN 000 % share Gasoline 6,804, % 5,904, % Raw gasoline 480, % 239, % Reformate 477, % 347, % Diesel oil 21,628, % 15,223, % Light fuel oil 1,301, % 952, % Heavy fuel oil 1,580, % 1,269, % Aviation fuel 1,398, % 559, % Bunker fuel 107, % 77, % Components for bitumen production 1,431, % 946, % Base oils 695, % 441, % Liquid gas 188, % 146, % Other refinery products, goods for resale and materials 411, % 136, % Total petroleum products, goods for resale and materials 36,505, % 26,246, % Other goods for resale and materials 10, % 9, % Services 104, % 88, % Effect of accounting for cash flow hedge accounting (90) Total 36,620, % 26,344, % Elimination of excise duty and fuel charge (9,331,424) (8,220,008) Total 27,289,314 18,124,675 Grupa LOTOS S.A. s sales volumes by products, goods for resale and services for period for period t % share 000 t % share Gasoline 1, % 1, % Raw gasoline % % Reformate % % Diesel oil 4, % 4, % Light fuel oil % % Heavy fuel oil % % Aviation fuel % % Bunker fuel % % 13

14 S.A. for period for period t % share 000 t % share Components for bitumen production % % Base oils % % Liquid gas % % Other refinery products, goods for resale and materials Total petroleum products, goods for resale and materials % % 9, % 8, % Following the launch of new processing capacities under the 10+ Programme, the volume of crude oil processed by Grupa LOTOS S.A. and, as a result, its sales revenue, increased in In 2011, sales volumes of Grupa LOTOS S.A. rose by 14.2%, or 1,225 thousand tonnes, relative to 2010, to 9,874 thousand tonnes. As overall sales rose, sales of highmargin products also improved. Like in the previous year, diesel oil accounted for the largest share in the total sales volume. The volume of diesel oil sales was 4,755 thousand tonnes in 2011, up by 16.74% on The share of diesel oil in total sales was 48.2%. The second largest item in the structure of Grupa LOTOS S.A. s sales were motor gasolines, whose share in total sales volume was 14.6%. In 2011, Grupa LOTOS S.A. s gasoline sales were 1,447 thousand tonnes, down by 0.1% year on year. The third largest item in the structure of sales by product groups were components for bitumen production, with their share in total sales at 9.9%. As at the end of 2011, total sales were 978 thousand tonnes (up by 13.9% on 2010). In 2011, the highest sales increases were recorded for aviation fuel and raw gasoline. In 2011, the sales volumes of aviation fuel and raw gasoline grew by 82.1% and 64.2%, respectively, relative to Sales of motor gasolines and heavy fuel oil dropped in Their sales volumes were 1,447 thousand tonnes (-0.1% relative to 2010) and 910 thousand tonnes (-5.4% relative to 2010), respectively. 14

15 S.A. Polish petroleum product market and the sales structure of Grupa LOTOS in 2011 Changes in the structure and volume of the Company's sales (thousands of tonnes) % share of the Polish fuel market Following the completion of the 10+ Programme, the volume of crude oil processed by Grupa LOTOS S.A. and, as a result, its sales revenue increased. Grupa LOTOS S.A.'s sales volume (up by 14.2% on 2010) grew by 1,225 thousand tonnes, to 9,874 thousand tonnes. It should be noted that sales of high-margin products improved, which especially applied to the sales of diesel oil (ON), whose share in total sales increased to 48.2%. The Polish economy generated better-than-expected results, which had a positive effect on the domestic diesel oil market. As a result, demand for diesel oil increased by 8% in 2011 relative to In 2011, the Company sold 4,755 thousand tonnes of diesel oil (up by 16.74% on 2010). 15

16 S.A. Motor gasolines are the second-largest product group in the structure of Grupa LOTOS' sales, with a 14.6% share in total sales and sales volume of 1,447 thousand (down by 0.1% on 2010). In 2011, demand for gasoline in Poland fell, with domestic consumption of motor gasolines down by 4.5%* compared with 2010, which could be attributed to higher prices and lower real purchasing power of Polish motorists. In 2011, Grupa LOTOS maintained its share in the gasoline market at a similar level as in Components for bitumen production were the third-largest product group in the structure of Grupa LOTOS' sales in 2011, with a 9.90% share in total sales and sales volume of 978 thousand tonnes (up by 13.9% on 2010). Market demand for bitumens remained strong, chiefly on the back of mild weather favourable to road construction. Moreover, a number of road construction projects entered their final phases (also in connection with preparations for the Euro 2012 championships), when demand for bitumen is the highest. In 2011, domestic consumption of light fuel oil (LFO) fell by 11.1%* (against 2010). In 2011, Grupa LOTOS increased its market share in that product group after improving its sales on Following completion of the 10+ Programme, the Company's capacity to produce middle distillates increased. To capitalise on this improvement, having first fulfilled its obligations to domestic business partners, Grupa LOTOS exported diesel oil and aviation fuel with favourable margins. In 2011, Grupa LOTOS recorded the highest increase in its sales of aviation fuel (up by 82.1% on 2010), which were closely followed by sales of raw gasoline (up by 64.2% on 2010). Thanks to placing high-conversion installations in operation and transferring some heavy residues for bitumen production in the Gdańsk refinery, Grupa LOTOS limited production and sales of low-margin heavy fuel oil (HFO). In 2011, HFO's share in the Company's sales structure by products fell to 910 thousand tonnes (down by 5.40% on 2010). *Source: POPiHN, the Company. 16

17 S.A CHANGES IN SALES MARKETS AND SOURCES OF SUPPLY OF MATERIALS, GOODS FOR RESALE AND SERVICES Grupa LOTOS S.A. s net sales revenue by markets for period for period PLN 000 % share PLN 000 % share Domestic sales: 31,286, % 23,377, % - products 30,742, % 22,991, % - goods for resale and materials 544, % 385, % Export sales: 5,334, % 2,967, % - products 5,132, % 2,967, % - goods for resale and materials 201, % % Effect of accounting for cash flow hedge accounting (90) 0.0% - - Total 36,620, % 26,344, % of which: excise duty and fuel charge (9,331,424) (8,220,008) Total 27,289,314 18,124,675 Grupa LOTOS S.A. s sales revenue by products and markets for period for period t % share 000 t % share Gasoline 1, % 1, % Diesel oils 4, % 4, % Diesel oil for heating purposes % % Heavy fuel oil % % Domestic sales Aviation fuel % % Bunker fuel % % Bitumen components % % Base oils % % LPG (Liquefied Petroleum Gas) % % Other refinery products, goods for resale and materials % % Domestic sales, total 7,708 78,1% 6, % Gasoline % % Raw gasoline % % Reformate % % Export sales Diesel oils % % Heavy fuel oil % % Aviation fuel % % Base oils % % Other refinery products, goods for resale and materials % 0 0.0% 17

18 S.A. for period for period t % share 000 t % share Export sales, total 2, % 1, % TOTAL 9, % 8, % Domestic vs. export sales In 2011, Grupa LOTOS S.A.'s domestic sales grew to 7,708 thousand tonnes, having increased by 720 thousand tonnes (up by 10.3% year on year, which was in line with the previous year's trend - up by 9.2% year on year). The key drivers of the domestic sales in 2011 included an increase in the volume of diesel oil sold (up by 590 thousand tonnes, or 14.54% year on year, to 4,645 thousand tonnes), a rise in the volume of components for bitumen production sold (up by 119 thousand tonnes, or 13.82%, to 978 thousand tonnes), and a higher volume of diesel oil for heating purposes (light fuel oil) sold (up by 18 thousand tonnes, or 4.7% year on year). In 2011, Grupa LOTOS S.A.'s export sales were over 2,166 thousand tonnes (up by 30.4% on 2010). The increase was due mainly to higher sales of: diesel oil (up by 511.1% year on year to 110 thousand tonnes), aviation fuel (up by 116.0% year on year to 378 thousand tonnes), and raw gasoline (up by 64.2% year on year to 174 thousand tonnes). Grupa LOTOS S.A. s key customers in 2011 In 2011, Grupa LOTOS S.A.'s key customers with over 10% shares in its total sales included: LOTOS Paliwa Sp. z o.o. (a wholly-own subsidiary of Grupa LOTOS S.A.) and Shell POLSKA Sp. z o.o. (to the best of the Company s knowledge, until the date of publication of this Director s Report, there were no formal links between Grupa LOTOS S.A. and Shell POLSKA Sp. z o.o.). The companies accounted for 44.51% and 10.99%, respectively, of Grupa LOTOS S.A. s total sales. In 2010, Grupa LOTOS S.A.'s key customer accounting for more than 10% of its total sales revenue was LOTOS Paliwa Sp. z o.o. (a wholly-owned subsidiary of Grupa LOTOS S.A.), with a 45.79% share in the Company's total sales. 18

19 S.A. Grupa LOTOS S.A. s purchases of raw materials, goods for resale and petroleum materials by region for period for period PLN 000 % share PLN 000 % share Domestic purchases 2,744, % 1,717, % Foreign purchases 24,346, % 15,189, % Total purchases 27,090, % 16,906, % Grupa LOTOS S.A. s structure of purchases for period for period PLN 000 % share PLN 000 % share Raw materials 26,755, % 16,595, % Goods for resale 334, % 310, % Services 981, % 832, % Materials 193, % 166, % Other purchases* 98, % 902, % Total 28,363, % 18,806, % *Including tangible assets, tangible assets under construction, prepayments for tangible assets under construction and intangible assets. Grupa LOTOS S.A. s structure of purchases petroleum products for resale for period for period PLN 000 % share PLN 000 % share Diesel oils 83, % 190, % Gasolines 249, % 120, % Other % - - Total 334, % 310, % Grupa LOTOS S.A. s structure of purchases raw materials, semi-finished products, chemicals and petroleum materials for period for period PLN 000 % share PLN 000 % share Crude oil 22,863, % 13,867, % Diesel oil 657, % 1,063, % MTBE/ETBE gasoline components 295, % 264, % FAME 1,584, % 889, % Gasolines 40, % 54, % Heavy fuel oil 209, % 42, % Ethyl alcohol 167, % 156, % 19

20 S.A. for period for period PLN 000 % share PLN 000 % share Additives 25, % 20, % Gasoil 109, % 87, % Fuel oil components 747, % 101, % Other 55, % 47, % Total 26,756, % 16,596, % Grupa LOTOS S.A. s key suppliers In 2011, as in the previous year, Grupa LOTOS S.A. had two suppliers whose shares in its purchases exceeded 10% of total sales revenue, i.e. Mercuria Energy Trading of Switzerland and Petraco Oil Company Ltd. of the United Kingdom. The two suppliers' shares in the purchases made by Grupa LOTOS S.A. were 37.54% (2010: 36.87%) and 29.99% (2010: 19.82%), respectively. To the best of the Company s knowledge, by the date of publication of this Director s Report there were no formal links between Grupa LOTOS S.A. and any of these suppliers EXTERNAL AND INTERNAL FACTORS MATERIAL FOR THE DEVELOPMENT OF GRUPA LOTOS S.A., AS WELL AS KEY RISKS AND THREATS The key external and internal factors material to the development of the Company. Risks and threats External factors Prices of crude oil and petroleum products their development has a material effect on the Company s financial performance. PLN/USD exchange rate the performance of the Company is also affected by foreign exchange rates, as the prices of crude oil and of some products are quoted in the American dollar, and Grupa LOTOS S.A.'s has debt in that currency. Demand and supply for petroleum products market demand and supply trends have a material impact on the Company's financial performance. The demand for diesel oil is expected to rise in the long run, while the demand for motor gasolines is expected to weaken. These trends are reflected in the strategy implemented by the Company. Internal factors Development of the upstream segment with a view to strengthening the Company's independence from external sources of feedstock, improvement of financial performance and enhancement of Grupa LOTOS' value for shareholders; 20

21 S.A. Strengthening of the market position of Grupa LOTOS, with special emphasis on the development and improved profitability of retail sales; Optimisation of operations in the production and sales segment, that is effective use of the assets which have been modernised or delivered under the 10+ Programme (increased processing capacity of the Gdańsk refinery and flexibility of production); Efficiency enhancing measures taken up in line with the Optimum Expansion Programme announced by the Company's Management Board. The effect of the Optimum Expansion Programme is estimated at around PLN 220m in Risks and threats Risks related to Grupa LOTOS are identified and analysed for the feasibility of reducing their potential effect on the Company' operations. The Group gradually improves its tools and methods used to identify and assess the risks. Relative to previous years, the Company has been able to consistently reduce the expected level of certain operational, financial and market risks. This has been possible thanks to such developments as the launch of new installations constructed as part of the 10+ Programme and implementation of measures mitigating the identified operational risks. Risks related to the government s strategy for the petroleum industry Legal risks in Grupa LOTOS operations arise from the Polish government s normative acts and EU directives. In order to identify legal risks, the Company monitors the European Union s policy with respect to the petroleum sector and cooperates on a regular basis with government authorities responsible for the preparation and implementation of governmental strategies for the sector. The Company issues opinions on drafts of EU and Polish legal acts, and monitors relevant regulations, concerning in particular mandatory stocks of crude oil, fuels, biocomponents and biofuels. For more information on legal risks, see Risks related to changes and interpretations of the tax law Changes in tax laws may be a source of both opportunities and risks for the Company. As a member of organisations of employers and entrepreneurs, Grupa LOTOS participates in issuing opinions on draft legal acts and updates its internal procedures. Financial risks In 2011, the former Financial Risk Management Committee at Grupa LOTOS was replaced by the Price Risk and Trading Committee responsible for the oversight and coordination of the price risk management process and for monitoring and coordination of trading activities requiring cross-segment interaction. The powers of the Financial Risk Management Committee in the area of currency risk, interest rate risk and credit risk management have been vested directly in the Chief Financial Officer. In addition, a team for liquidity optimisation and coordination of financing has been 21

22 S.A. set up to coordinate and supervise key efforts in the area of liquidity risk management, arrangement of financing, and debt structure management at the LOTOS Group. The key financial risk faced by Grupa LOTOS is the risk related to prices of raw materials and petroleum products. We continue research and work on a new policy for managing the risk, which ties in closely with our plans to upscale trading operations. Concurrently, to enable implementation of specific price risk management processes, streamline management functions and improve security of operations in the broad price risk and trading area, the Company has launched the process of selecting a new Energy Trading and Risk Management system. Currency risk is managed in line with the Strategy of Currency Risk Management at Grupa LOTOS S.A. The management horizon is determined in line with the rollover budgeting period. The US dollar (USD) is the key currency on Grupa LOTOS' operating market. Consequently, the Company has a structurally long position in USD on its operating activities. Therefore, the US dollar was chosen as the most adequate currency for contracting and repaying long-term facilities, including the facilities used to finance the 10+ Programme. Interest rate risk management is connected with the expected schedule of payments under the facilities taken out to finance inventories and the implementation of the 10+ Programme, and the resulting interest accruing at floating rates (LIBOR USD). The risk related to prices of CO 2 allowances is managed in line with the Strategy for Managing the Risk Related to Prices of CO 2 Allowances by Grupa LOTOS S.A. Pursuant to the Kyoto Protocol, the current management horizon runs until the end of Liquidity risk is subject to monitoring on an ongoing basis which involves analysing data in respect of projected cash flows and the financing sources available now or in the future. Based on results of the analysis, appropriate working-capital decisions are taken whose aim is to match maturity dates of assets and liabilities as closely as possible and to secure and retain access to diverse sources and forms of financing. Measures designed to mitigate the risk of restricting or change in conditions of access to external financing includes cooperation with creditworthy entities and use of a broad range of financial instruments. Management of counterparty credit risk in financial transactions consists in monitoring of credit exposures in relation to the limits granted. Grupa LOTOS enters into financial transactions with reputable firms with sound credit standing, and diversifies the group of institutions with which it cooperates. As regards management of credit risk relating to counterparties in non-financial transactions, all customers who request trading on credit terms are subject to credit assessment, For more information on financial risk management and the impact of risks on the Company's financial performance, see Note 35 to Grupa LOTOS S.A.'s Separate Financial Statements for Risks related to the upstream business Risks related to the upstream business include production and technical risks, exploration risks, risks related to the geological characteristics of the fields and weather-related risks. 22

23 S.A. One of the major risks is the risk associated with production of hydrocarbons. These include risks of environmental contamination, such as oil spills, marine collisions, fires, gas eruptions and other failures. Grupa LOTOS applies a number of preventive measures. The operating and process systems are subject to technological audit. The plant engineering services management system and preventive measures are being improved. The exploration risk relates to incorrect estimation of in-place resources. Such resources are estimated (in accordance with the SPE 2007 international resources classification system) for three scenarios P10/P50/P90, which means that quantities are given that can be potentially recovered with the 10%, 50% and 90% probability. In addition, the internal Chance of Success (CoS) rate is analysed when evaluating the potential of the play covered by geological testing. In the design phase there is the risk of having to conduct additional, indepth geological analyses of plays with high production potential. Risks related to the supply of raw materials Grupa LOTOS pursues its policy of diversification of crude oil supplies, taking into consideration security of supplies and capitalising on the coastal location of the Gdańsk refinery. Selection of types of crude and directions of supplies is the result of process optimisation efforts to maximise the integrated margin. Risks related to operating activities The management of risks related to operating activities covers process- and technologyrelated risks, workplace safety and environmental risks, and legal risks. Risks related to implementation of the 10+ Programme The risks related to operating activities identified in the course of implementing the 10+ Programme were mitigated or eliminated. Compared with 2010, probability of the risk that latent defects in the materials and equipment supplied would be revealed in the course of operation decreased, as no major defects were revealed during the start-up, launch or initial operation of the units constructed under the 10+ Programme. Environmental risks Grupa LOTOS' operations involve the risk of failure to comply with the requirements and legal regulations of environmental laws, risk related to shortage of CO 2 emission allowances and risk of a serious industrial failure. For the refining units which participate in the EU Emissions Trading Scheme, the number of allowances will be sufficient until the end of the current trading period, i.e Process and technology-related risks, risks related to workplace safety One of the key risks, addressed through specifically designed preventive and preparatory measures, is the risk of industrial failure. Emergency events may disrupt the work of refining units, cause fire, explosion, excessive emissions of pollutants into the environment or occupational work. Various comprehensive measures have been deployed to monitor the technical condition of the plant and equipment and to prevent failure. Given the nature of Grupa LOTOS production processes, workplace safety is of utmost importance for the Company. 23

24 S.A. Risk of stricter quality requirements for petroleum products The source of information about future changes in the quality requirements is Technical Committee 222 at the Polish Committee for Standardisation, responsible for petroleum products and process liquids. Thanks to active participation in the work of the subcommittees of Technical Committee 222, Grupa LOTOS is able to issue opinions on proposed EU standards. Grupa LOTOS has an additional impact on the level of quality requirements, in particular requirements applicable to engine fuels, through participation in the works of an industry association, the Polish Organisation of Oil Industry and Trade (POPiHN). In Q1 2012, requirements were changed concerning the admissible content of biocomponents in gasolines and diesel oils; the admissible content of FAME has been increased to 7% of the total volume. Work is also under way to admit to trading gasolines with ethanol content of up to 10% of the volume, but it is unlikely to occur before Grupa LOTOS is prepared for those changes and thus they do not pose any threat to the Company's continuing as a going concern. Marketing risks The marketing activity of the LOTOS Group is conducted in the environment of continuous price competition and dynamic changes, which implies the need to implement tools for monitoring parameters related to prices and margins with a view to effective management of sales results designed to optimise the margins realised. In the retail sector, the Group is diversifying into market segments less susceptible to downward pressure on margins caused by competition, while making efforts aimed to foster sustained customer loyalty, for example by enhancing the loyalty scheme at LOTOS service stations and LOTOS Biznes schemes. The LOTOS Group also manages the risk of reduced domestic demand. The risk is primarily managed using various techniques, including diversification of distribution channels (diversification of customer base), operation of a competitive pricing policy and optimisation of operating expenses. Risk management in the marketing area is also focused on maintaining uninterrupted supplies of products to the market. At Grupa LOTOS, the process is on an ongoing basis coordinated through the cooperation of the sales, logistics, production, and trading and optimisation areas. Costs of implementation of hedging strategies Many of the planned and implemented risk mitigation measures involve organisational or procedural changes at the LOTOS Group, which usually entail insignificant costs. However, some measures require large expenditures. In such cases, the ALARP principle ( As Low As Reasonably Practicable") is applied, whereby risks are reduced to a level as low as reasonably practicable. Risks are considered acceptable if it is impossible to reduce them any further or if the costs of their reduction outweigh the benefits to be gained. Any hedging strategies, including plans to mitigate risks or transfer them (e.g. by way of insurance), are therefore implemented following careful analysis, focused especially on costs involved. 24

25 S.A GRUPA LOTOS S.A.'S DEVELOPMENT PROSPECTS IN THE CONTEXT OF ITS MARKET STRATEGY Market strategy In the marketing area, the strategic objective is to maximise the economic benefits from trading in gasoline, diesel oil and aviation fuel by flexibly adjusting product streams and further strengthening the market position. The sales force concentrates its efforts on further development of the Company's business, based on the expanding distribution network and efficient product logistics, as well as rapid development of trading activities in the area of crude oil and petroleum products. The harmonisation of activities in these four areas allows the Company to have quicker access to information supporting decision making, and thus to respond more rapidly to the changing market environment. In the refining area, the Company's strategic objective is to maintain its highly competitive position among the European refineries and to ensure optimum use of its assets, including the already existing ones and those it will come to hold following completion of new development projects. The specific objectives set for the individual areas of the marketing segment are as follows: Fuels The objective is to maximise the economic effect by flexibly controlling the product flows and further strengthening the market position: - Maintaining a 30% share in the domestic fuel market; to achieve sales exceeding the Gdańsk refinery s fuel production capacities by 15%. The objective is to continue to rapidly develop the country-wide network of LOTOS service stations, as a fully controlled and highly effective distribution channel by: securing a 10% share in the domestic retail market by the end of the time horizon covered by the strategy, expanding the network of service stations and enhancing sales through the existing network. Other petroleum products In the category of lubricating oils, the objective is to retain the lead of the Polish market, while in other product categories to achieve the optimum economic effect by leveraging the available resources and market conditions. 25

26 S.A. Supply chain optimisation In order to maximise its integrated margin, the LOTOS Group will focus on making optimum use of its assets and coordinating the key areas of the supply chain: planning, procurement, production and distribution. Crude oil supplies Thanks to its newly expanded processing capacities, the LOTOS Group will continue its policy aimed to diversify the routes and sources of crude oil supplies by: maintaining access to the sources of crude oil supplied via pipelines and by sea, flexibly selecting the types and routes of crude oil supplies, so as to maximise the integrated margin, intensifying its presence on the international oil market, increasing the share of its own production in crude oil supplies. STRATEGY IMPLEMENTATION AND GROWTH PROSPECTS Downstream segment Marketing area Through strengthening its main sales channels and searching for new growth opportunities, the LOTOS Group has been pursuing its strategic objective. By aligning the offer with market needs, in 2011 the Group further expanded its market presence. According to data based on a report by the Polish Organisation of Oil Industry and Trade (POPiHN), the LOTOS Group's share in the Polish fuel market was 33.5% in As regards retail sales, LOTOS Paliwa strives to deliver its strategic objective of achieving a 10% share in the market by In 2011, its share in the retail market was 7.6%. The objective will be implemented based on further roll-out of the stations network in the premium segment (including motorway stations) and dynamic development of the LOTOS Optima network. Grupa LOTOS has been dynamically developing its trading structures and competence to meet the target set for 2015, i.e. to achieve sales exceeding the Gdańsk refinery s fuel production capacities by 15%. In the logistics area, the measures to be taken will be oriented towards integrating all components of the logistics chain, including those controlled by the Group and by the third parties. With regard to non-fuel products, the LOTOS Group leverages on its market position and searches for new development directions to maximise economic benefits. 26

27 S.A. Production area In 2011, Grupa LOTOS's refinery came on stream following the completion of the 10+ Programme, which made it one of the most advanced and efficient refineries in Europe. In order to remain highly competitive and ensure optimum use of assets, the Company implemented various projects designed to boost the refinery's efficiency: connection of a gas pipeline to the site, modernisation of burners in the CHP plant's boilers, modernisation of process furnaces in two production units, reuse of flare gas all projects are expected to be completed in 2013 and reduce CO2 emissions by approximately 20%, commencement of construction of a xylene separation unit to recover additional highmargin products and enhance the quality of reformate, preparation of a technological concept and cost estimate for development of Hydrowax, implementation of the Operational Excellence Programme. In 2011, the Company defined investment scenarios for the refinery s technological development, which provide for a further improvement of the conversion ratio through processing of asphalt from the ROSE process and vacuum residue. In 2011, Solomon Associates presented a comparative analysis of Grupa LOTOS' performance. The refinery study encompassed 320 refineries from around the world representing 85% of the global refining capacity. As Grupa LOTOS' facility has a large oil unit, it was included in both fuel and lube refinery studies. Even though some units installed under the 10+ programme were not fully operational, Grupa LOTOS' refinery was among 25% of the most energy efficient refineries under analysis. The refinery was also highly rated in terms of mechanical availability, maintenance costs and ROACE. 27

28 S.A. Upstream segment The LOTOS Group conducts international operations through its subsidiary LOTOS Petrobaltic, aiming to produce 24 thousand boe a day, i.e. 1.2 million tonnes a year, by In 2011, the upstream segment's operations were focused on Poland, Lithuania and Norway. LOTOS Petrobaltic carried out activities in seven exploration licence areas (Gaz Północ, Gaz Południe, Gotlandia, Łeba, Rozewie, Sambia W and Sambia E) and four production licence areas (Łeba, Smołdzino, Lubiatowo and Kuźnica). In the Baltic Sea, the company produced from the B3 field and developed the B8 field. AB LOTOS Geonafta, a subsidiary of LOTOS Petrobaltic, produced from onshore oil deposits in Lithuania. Norwegian operations are carried out by LOTOS Exploration and Production Norge AS (LOTOS EPN), LOTOS Petrobaltic's subsidiary established in 2007 and based in Stavanger, Norway Poland: continued production from the B3 field, work aimed at developing the B8 field, including positive results obtained from the B8- Z5 injection well, which confirmed parameters of the assumed development concept, work, in partnership with other companies, on developing the gas fields (the B4 and B6 fields and the B21 prospect) in the Gaz Północ and Gaz Południe licence areas, building competence in exploration for unconventional gas, two licence applications were submitted, concerning Słupsk W and Słupsk E licence areas, Lithuania: closing of the transaction of acquisition of control over the Lithuanian assets (the interest in AB LOTOS Geonafta increased from 40.59% to 99.9%), five production wells were drilled in licence areas managed by companies of the AB LOTOS Geonafta Group, Norway Norwegian Continental Shelf: LOTOS EPN's continued participation in development of the YME field, acquisition of seismic data for the PL 503 licence, where LOTOS EPN Norge is the operator, award of a 25% interest in the PL 503B licence in January 2011, 28

29 S.A. continuation of exploration projects following submission of licence applications in 2011, two new licences were awarded in January The volume of crude oil and natural gas reserves held by the LOTOS Group Provisions Dec Dec Crude oil (2P*) 6.9 million tonnes (1) 6.2 million tonnes Crude oil (2C**) 1.4 million tonnes (1) 1.3 million tonnes Natural gas (2P*) 0.5 billion cubic metres 0.5 billion cubic metres Natural gas (2C**) 6.5 billion cubic metres 6.5 billion cubic metres (1) reserves cover AB LOTOS Geonafta Group s area of operations in Lithuania. In 2011, LOTOS Petrobaltic S.A. executed a transaction to acquire control over Lithuanian assets. The interest of LOTOS Petrobaltic S.A. in AB LOTOS Geonafta increased from 40.59% to 100% (see Note 2). *2P proved and probable reserves **2C conditional reserves EVENTS SIGNIFICANT FOR THE OPERATIONS OF GRUPA LOTOS S.A. Focus on core business In line with the strategy for , the LOTOS Group operates based on the principle of self-financing of its business units, which means, among other things, that the Group will not be retaining any businesses which operate at permanently negative margins. Taking advantage of market opportunities, the Group s assets are restructured in order to improve operating efficiency and the core business focus. In pursuance of its strategy to focus on the core business, the LOTOS Group sold its shares in LOTOS Parafiny Sp. z o.o. The transaction was completed on January 10th 2012 and involved disposal of 100% of the shares by Grupa LOTOS S.A. to Krokus Chem Sp. z o.o., in which Nova Polonia Natexis II and the management staff of LOTOS Parafiny hold shares. As part of the transaction, on November 29th 2011 the parties signed a seven-year agreement on supply of slack waxes by Grupa LOTOS S.A. to LOTOS Parafiny Sp. z o.o. (as reported by Grupa LOTOS in Current Report No. 37/2011 of November 30th 2011). Optimal Expansion Programme Given the difficult conditions persisting on the European financial markets, which may result in an economic slowdown in Poland, and with a view to ensuring the Group s stable development, Grupa LOTOS has implemented the Optimal Expansion Programme for The Programme provides for the launch of a number of projects designed to improve the efficiency of the Group s operations, such as curbing expenditure by reducing the increase in headcount to a level required by development projects, reducing the administrative, 29

30 S.A. marketing and sponsorship costs and executing projects designed to improve the efficient use of assets. These measures will result in freezing or reducing certain cost groups despite an increase in the Group s scale of operations. The effect of these steps and of the planned freezing of some investments is estimated at approximately PLN 220m in 2012 for the entire LOTOS Group. The programme will not restrict the development of strategic projects, such as exploration for and production of hydrocarbons or expansion of retail operations. The measures described above are designed to reduce the ratio of the indicated cost groups to sales revenue derived from the increase in crude throughput to 9.17 million tonnes in 2011 and its further increase planned for Moreover, the LOTOS Group is going to carry out restructuring projects, aimed to permanently enhance its operational efficiency ENVIRONMENTAL MATTERS Reduction of environmental impact For many years, the Company's strategy for reducing its environmental impact has been based on the principles of sustainable growth, in compliance with the environmental standards prescribed by law and with due regard to corporate social responsibility. The negative environmental impact is minimised by: on-going monitoring of ambient air and water pollutant concentration and of hydrocarbon concentration in the area immediately surrounding the refinery, enabling quick response if the metrics reflecting the refinery s environmental impact show any undesirable upward trends, discharge of wastewater whose quality is fully compliant with legal requirements thanks to a three-stage wastewater treatment plant, use of treated wastewater to produce process water, use of condensate to produce boiler feedwater, strict supervision over waste management, use of equipment and measures designed to help protect the environment (i.e. double sealing of tanks with floating roofs, ensuring air tightness of all process facilities and connecting them to the emergency discharge system, where hydrocarbons are burned in flares, ensuring that the process of pumping fuel to road tankers and railway tank-cars is performed using the airtight vapour recovery system). 30

31 Development plans DIRECTORS REPORT ON THE OPERATIONS OF GRUPA LOTOS S.A. In , the environmental impact of the individual industrial processes and the refinery as a whole will be mitigated by implementation of the following projects designed to significantly reduce the level of atmospheric emissions: recovery and reuse of flare gas, use of natural gas for hydrogen production, introduction of natural gas to the energy mix of Grupa LOTOS, replacement of process furnaces in the light distillate hydrorefining units and furfurol extraction units. For more information on environmental impact, see 3. AGREEMENTS, RELATED-PARTY TRANSACTIONS AND COURT PROCEEDINGS 3.1. AGREEMENTS SIGNIFICANT FOR THE OPERATIONS OF GRUPA LOTOS S.A. 31

32 S.A. Material agreements executed in 2011 and after the balance-sheet date No. Counterparty Date Subject of the agreement Estimated net value (PLN) More information Current Report No. 1 BP Europa SE Jan Sale of liquid fuels 1,700m 3/ Current Report No. 2 Petraco Oil Company Ltd. Feb Purchase of crude oil 867m 10/ Current Report No. 3 Eminent Energy Ltd. Apr Purchase of crude oil 670m 11/ Current Report No. 4 Statoil ASA Apr Purchase of crude oil 791m 12/ Current Report No. 5 Petraco Oil Company Ltd. Jun Purchase of crude oil 834m 16/ Current Report No. 6 Petraco Oil Company Ltd. Aug Purchase of crude oil 829m 26/ Current Report No. 7 The Neste Oil Group Oct Sale of liquid fuels 702m 29/ Current Report No. 8 Eminent Energy Ltd. Oct Purchase of crude oil 765m 31/ Current Report No. 9 Petraco Oil Company Ltd. Nov Purchase of crude oil 626m 33/ Statoil Poland Sp. z o.o. Nov Annex extending an agreement on sale of fuels 9,850m Current Report No. 34/ Current Report No. 11 O.W. Supply Trading A/S Nov Sale of heavy fuel oil 730m 35/ Polskie Górnictwo Naftowe i Gazownictwo S.A. Nov Annex to a comprehensive gaseous fuel purchase agreement 3,240m Current Report No. 36/2011 Current Report No. 13 LOTOS Parafiny Sp z o.o. Nov Sale of slack waxes 780m 37/ Current Report No. 14 The Neste Oil Group Dec Sale of liquid fuels 1,500m 38/ Current Report No. 15 Eminent Energy Ltd. Dec Purchase of crude oil 911m 39/2011 Current Report No. 16 Mercuria Energy Trading S.A. Dec Purchase of crude oil 1,085m 40/ Current Report No. 17 The Shell Group Dec Sale of liquid fuels 5,092m 41/2011 Agreements concluded after the balance-sheet date 2 Current Report No. 18 BP Europa SE Jan Sale of liquid fuels 1,841m 1/2012 Link

33 S.A. 2 Current Report No. 19 TNK Trade Ltd. Jan Purchase of crude oil 705m 3/2012 Agreements concluded after the balance-sheet date 1 Current Report No. 20 Petraco Oil Company Ltd. Feb Purchase of crude oil 626m 9/ Current Report No. 21 Eminent Energy Ltd. Apr Purchase of crude oil 841m 22 Mercuria Energy Trading S.A. Apr Purchase of crude oil (two contracts concluded at the same time) 808m 12/2012 Current Report No. 13/ ) total value of agreements with the counterparty since the release of the previous current report (following the execution of the described agreement, the criterion of value of a significant agreement was met). 1) total value of agreements with the counterparty in 12 months preceding the agreement (following the execution of the described agreement, the criterion of value of a significant agreement was met). 33

34 3.1. MATERIAL RELATED-PARTY TRANSACTIONS EXECUTED ON NON-ARMS' LENGTH TERMS In the year ended December 31st 2011, Grupa LOTOS S.A.'s related-party transactions were executed on standard market terms prevailing in For more information, see Note 33.1 to the separate financial statements of Grupa LOTOS S.A. for AGREEMENTS BETWEEN THE ISSUER AND THE MANAGEMENT STAFF AND REMUNERATION, AWARDS OR BENEFITS PAID TO THE MANAGEMENT AND SUPERVISORY STAFF OF GRUPA LOTOS S.A. Compensation agreements Apart from standard employment contracts concluded by Grupa LOTOS S.A. with the management staff in 2011, no agreements were executed that would provide for compensation to the management staff in the event they resign or are dismissed without good reason or in the event they resign or are dismissed as a result of the Company s takeover by another entity. Remuneration paid or payable to members of the Management Board of Grupa LOTOS S.A. for 2011 (PLN '000) Management Board members Short-term employee benefits (salaries and wages) Length-ofservice awards Share-based employee benefits Management board subsidiaries * Total remuneration paid Paweł Olechnowicz ,187 Marek Sokołowski Mariusz Machajewski Maciej Szozda Total 1, ,795 4,056 * Short-term employee benefits, remuneration paid to the members of the Management Board of Grupa LOTOS S.A. for serving on the supervisory boards and the boards of directors of direct and indirect subsidiaries. Remuneration paid or payable to members of the Supervisory Board of Grupa LOTOS S.A. (PLN '000) Supervisory Board members Term of office Total remuneration paid Wiesław Skwarko Leszek Starosta Małgorzata Hirszel Oskar Pawłowski Michał Rumiński Rafał Wardziński Ewa Sibrecht-Ośka Rafał Lorek Total

35 As at December 31st 2011, the Company did not grant any loans or similar benefits to members of its management and supervisory staff. As at December 31st 2011 and as at the date of release of this Directors' Report, i.e. April 20th 2012, members of the Grupa LOTOS Supervisory Board did not serve on management or supervisory boards of Grupa LOTOS S.A.'s subsidiaries AGREEMENT WITH QUALIFIED AUDITOR Based on the resolution adopted by the Supervisory Board of Grupa LOTOS S.A. on December 17th 2009, Ernst &Young Audit Sp. z o.o., entered in the register of entities qualified to audit financial statements maintained by the National Board of Chartered Auditors under entry No. 130, was appointed as the qualified auditor to audit the Company s financial statements for 2010, 2011 and On May 18th 2010, Grupa LOTOS S.A. and Ernst & Young Audit Sp. z o.o. of Warsaw concluded an agreement providing amongst other things for: review of the separate and consolidated financial statements for the first six months of 2010, 2011 and 2012, audit of the separate and consolidated financial statements in Total remuneration for the audit, review and verification procedures (PLN '000) Audit of the annual separate and consolidated financial statements of Grupa LOTOS S.A. (1) Attestation services (1), including: review of separate and consolidated financial statements Other services (2) 4 10 Tax advisory services - - Total (1) The remuneration for the audit, review and verification of the financial statements, as well as for other services provided by Ernst & Young Audit Sp. z o.o. under the agreement of May 18th 2010 regarding the review of the separate and consolidated financial statements for the first six months of 2010, 2011 and 2012 and for the audit of the separate and consolidated financial statements in (2) Fees paid for auditor training services COURT, ARBITRATION OR ADMINISTRATIVE PROCEEDINGS In 2011 no court, arbitration or administrative proceedings were pending concerning the Issuer s or its subsidiary s liabilities or debts with a value (total value of proceedings) equal to or exceeding 10% of the Company s equity. For more information, see Note 32.4 to the separate financial statements of Grupa LOTOS S.A. for

36 II. FINANCIAL STANDING OF GRUPA LOTOS S.A. 1. KEY FINANCIAL AND ECONOMIC DATA CONTAINED IN THE ANNUAL SEPARATE FINANCIAL STATEMENTS AND ASSESSMENT OF FACTORS AND NON- RECURRING EVENTS WITH A BEARING ON GRUPA LOTOS S.A. S PERFORMANCE 1.1. STATEMENT OF COMPREHENSIVE INCOME In 2011, Grupa LOTOS S.A. recorded sales revenue of PLN 27,289.3m (up by 50.6% on 2010). The main drivers of the increase were higher prices of crude oil and petroleum products on global markets and a 14.2% increase in sales volume. In 2011, the average price of Brent dtd was USD/bbl (up by 39.9% over 2010). The average net selling price in 2011 was PLN 2,764 per tonne, which represented a rise of PLN 668 per tonne (31.9%) relative to Net revenue from domestic sales represented 80.5% of total net sales revenue (83.6% in 2010). Macroeconomic data Crude oil (USD/bbl) /2010 DATED Brent FOB prices % Urals CIF Rotterdam prices % Brent/Urals differential * % Model refining margin USD/bbl** % * Brent vs. Urals spread. **Model margin for an output structure in an averaged scenario of typical annual operation of Grupa LOTOS S.A.'s refinery, assuming maximization of output of middle distillates. An annual throughput has been assumed that corresponds to the maximum distillation capacity if Urals crude was the only input (the value of Urals crude is determined as the difference between DTD Brent and the Urals Rtd vs. forward Dtd Brent spread). The figure for 2010 is presented for comparison. In 2010, Grupa LOTOS S.A.'s refinery operated in a different technological configuration due to the then ongoing implementation of the 10+ Programme. Petroleum products (USD/t) /2010 Crack margin: Gasoline % Crack margin: Diesel oil (10 ppm) % Crack margin: Light fuel oil % Crack margin: Aviation fuel % Crack margin: Heavy fuel oil % Currency (USD/PLN) /2010 Dollar exchange rate at end of period % Average PLN/USD exchange rate % The total volume of petroleum products and goods sold by the Company in 2011 was 9,874.4 thousand tonnes (i.e. 14.2% up on 2010). Diesel oils accounted for the largest share in total sales (48.2%) and showed the largest increase in sales volume. In 2011, 4,754.6 thousand 36

37 tonnes of diesel oil was sold (681.9 thousand tonnes more than in 2010). In 2011, the volume of domestic sales rose year on year by thousand tonnes, or 10.3%, while export sales increased by thousand tonnes, or 30.4%. The share of domestic sales in the total sales volume fell by 2.7 percentage points. In 2011, cost of sales of Grupa LOTOS S.A. was PLN 25,893.2m (up by 53.8% relative to 2010). The average unit cost of sales was PLN 2,622 per tonne, 34.7% more than in As the unit cost of sales increased more than the average selling price, Grupa LOTOS S.A.'s sales margin in 2011 was down by 4.9% relative to However, as a result of a 1,225.0 thousand tonnes rise in sales volume, in 2011 Grupa LOTOS S.A. recorded gross profit of PLN 1,396.1m, up by PLN 110.8m relative to Key drivers of the year-on-year improvement in gross profit in 2011: higher volume of fuels sold in 2011 and optimisation of fuel sales structure; The higher volumes and improved structure of the fuel sales in 2011 contributed to an approximately PLN 380.8m increase in operating profit. higher crack margins on fuels: average crack spreads on diesel oil (ULSD 10 ppm), Gasoil 0.1, JET fuel and Gasoline 10 ppm at, respectively, USD per tonne (up by 28.6% on 2010), USD per tonne (up by 27.9%), USD (up by 41.5%) and USD per tonne (up by 2.9%); Higher cracks on fuels had a positive effect on the 2011 gross profit of approximately PLN 597.9m.. weighted average method of inventory valuation applied by the Company boosted gross profit by PLN 978.4m (compared with a positive effect of PLN 405.0m in 2010). With the applied method of inventory valuation, the appreciation of the US dollar and higher crude oil prices added over PLN 573.4m to the 2011 operating profit. Key factors with negative effect on gross profit in 2011 (compared with 2010): fluctuations of the USD exchange rate in 2011 resulted in net foreign exchange losses on operating activities of PLN 317.8m, connected mainly with feedstock purchases (in 2010, the Company recorded a net foreign exchange gain on operating activities of PLN 44.0m); Exchange differences on operating activities brought the Company's gross profit down by approximately PLN 361.8m relative to valuation of own consumption; Significantly higher prices of crude oil in 2011 drove up the cost of energy used in the production processes and reduced gross profit by PLN 652.6m (relative to 2010). lower crack margin (down by 45.9% relative to 2010) on heavy fuel oil; Significant decline of the crack margin on heavy fuel oil reduced the 2011 gross profit by PLN 387.1m (relative to 2010). crack margin on other refining products. Given the high prices of crude oil, in 2011 the crack margin on other refining products drove the operating result down by PLN 51.2m (compared with 2010). 37

38 Selling costs increased by PLN 90.2m (up by 20.0% relative to 2010), chiefly as a result of a 14.2% rise in sales volume (export sales up by 24.1% on 2010). Average unit cost of sales per tonne rose to PLN 54.7 (up by 5.1% relative to 2010) primarily due to higher share of exports sales. General and administrative expenses were by PLN 18.7m, or 8.6%, higher than in 2010, driven by such factors as increased insurance costs related to higher valuation of assets following the completion of the 10+ Programme. In 2011, the Company reported a net loss on other operating activities of PLN -17.1m (2010: net loss of PLN -12.3m). The amount included, among other items, impairment loss on tangible assets under construction of PLN 12.9m related to the IGCC project. In 2011, Grupa LOTOS S.A.'s operating profit was PLN 603.4m (2010: PLN 606.3m). Statement of comprehensive income of Grupa LOTOS S.A. (PLNm) /2010 Sales revenue 27, , , % Cost of sales -25, , , % Gross profit 1, , % Selling costs % General and administrative expenses % Other operating income % Other operating expenses % Operating profit % Finance income % Finance expenses % Pre-tax profit/(loss) % Corporate income tax % Net profit from continuing operations % The Company posted a net loss on financing activities of PLN m chiefly as a result of the following: net foreign exchange loss on revaluation of bank borrowings of PLN m; net loss on valuation and settlement of market risk hedging derivative instruments of PLN m; net loss on interest on debt, interest income and commission fees of PLN m; dividend received in 2011 of PLN 240.5m; other net exchange gains of PLN 63.1m. Starting from January 1st 2011, Grupa LOTOS S.A. introduced cash flow hedge accounting with respect to foreign-currency denominated facilities used to finance the 10+ Programme, designated as hedges of future USD-denominated petroleum product sales transactions. As 38

39 a consequence, in the period from January 1st to December 31st 2011, foreign exchange losses taken to the cash flow hedging reserve were PLN m. In 2011, net valuation and settlement of market risk hedging transactions at Grupa LOTOS S.A. was negative at PLN m. In 2011, total net loss on settlement and valuation of derivative instruments, including forwards hedging the foreign exchange risk and futures hedging the risk of changes in prices of CO2 emission allowances, was PLN -47.2m. The net loss on settlement and valuation of interest rate hedging transactions in 2011 was PLN -88.4m. In 2011, the effect of settlement and valuation of hedges of petroleum product prices was positive and was PLN 25.9m. The 2010 net finance expenses of PLN 85.8m mainly resulted from foreign exchange loss on revaluation of borrowings and other debt instruments (PLN m), negative valuation and settlement of financial instruments (PLN m) and dividend received (PLN 251.9m). The differences between net finance income recorded by Grupa LOTOS S.A. in 2011 and 2010 resulted in a decline in the 2011 net profit on continuing operations to PLN 307.7m (down by 33.8% relative 2010) STATEMENT OF FINANCIAL POSITION Assets (PLNm) ASSETS Dec Dec Change % Total assets 16, , , % Total non-current assets 8, , % Property, plant and equipment 7, , , % Tangible assets under construction , , % Intangible Assets % Non-current financial assets 1, , % Prepayments and accrued income % Total current assets 8, , , % Inventories 5, , , % Trade and other receivables 2, , % Current income tax receivable Prepayments and accrued income % Current financial assets % Cash and cash equivalents % Assets held for sale As at December 31st 2011, the Company had total assets of PLN 16,451.4m. 39

40 Total assets grew by PLN 1,771.4m mainly as a result of the following: PLN 1,338.8m higher valuation of inventories (including a PLN 1,448.5m rise in mandatory reserves) due to higher prices of crude oil and petroleum products as well as higher volume of mandatory reserves (increase in reserves of fuels and heavy fuel oil by 71.7 thousand cubic meters, and crude oil by thousand) due to an increase in the refinery's throughput capacity; PLN 501.6m increase in trade and other receivables, attributable chiefly to rising prices of petroleum products and exchange rates in 2011 and a 14.2% increase in the volume of products and goods sold. As at December 31st 2011, the share of non-current assets in Grupa LOTOS S.A.'s total assets fell from 57.9% in 2010 to 50.9% in The share of current assets rose on the back of a higher share of inventories in total assets. Equity and liabilities (PLNm) EQUITY AND LIABILITIES Dec Dec Change % Total equity and liabilities 16, , , % Total equity 5, , % Share capital % Statutory reserve funds 1, , % Cash flow hedging reserve Retained earnings 4, , % Total non-current liabilities 4, , % Interest-bearing borrowings 4, , % Long-term provisions % Deferred tax liabilities % Other financial liabilities % Total current liabilities 5, , , % Trade payables, accruals and deferred income, and other liabilities 3, , , % Current income tax payable % Interest-bearing borrowings 1, , % Short-term provisions % Other financial liabilities % Grupa LOTOS S.A.'s equity was PLN 5,833.4m as at the end of 2011, down by PLN 111.6m on 2010, despite a net profit of PLN 307.7m. Lower equity was attributable to PLN m foreign exchange losses on valuation of cash flow hedges net of the tax effect, taken to the cash flow hedging reserve. The share of equity in total equity and liabilities fell from 40.5% in 2010 to 35.5% in The Company's non-current liabilities grew by PLN 621.1m in 2011, primarily as a result of higher valuation of debt (higher exchange rate used). 40

41 As at December 31st 2011, current liabilities were PLN 5,637.6m, having grown by PLN 1,261.9m relative to December 31st In 2011, trade payables, accruals and deferred income and other liabilities increased by PLN 1,194.0m, following primarily from a 43.1% higher value of crude oil purchased in December 2011 compared with the crude oil purchased in December As at December 31st 2011, the financial debt of Grupa LOTOS S.A. was PLN 6,469.0m, up by PLN 788.5m relative to December 31st The ratio of financial debt (adjusted by free cash) to equity was 110.8% (i.e. by 15.5pp more than as at December 31st 2010) STATEMENT OF CASH FLOWS Cash flows (PLNm) Change Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities Change in net cash Cash and cash equivalents at beginning of the period Cash and cash equivalents at end of the period As at December 31st 2011, the Company s cash balance (including current account overdrafts) was negative at PLN m. In the twelve months of 2011, net cash flows were PLN 21.1m (down by PLN 252.6m relative to 2010). Net cash provided by the Company's operating activities was PLN 138.9m (PLN 143.5m less than in 2010, primarily as a result of higher working capital requirements due to an increase in prices of crude oil and petroleum products). Net cash used in investing activities was PLN 30.0m and was mainly related to expenditure of PLN 150.0m incurred on acquisition of tangible and intangible assets as part of the investment programme and PLN 144.7m of expenditure incurred on acquisition of long-term financial assets (mainly on acquisition of new issue Series B shares in LOTOS Petrobaltic S.A.). Net cash from investing activities also includes dividend income of PLN 240.5m. Net cash used in financing activities of PLN m mainly resulted from a net loss on settlement of financial instruments. 41

42 1.4. ASSESSMENT OF FACTORS AND NON-RECURRING EVENTS AFFECTING THE OPERATING PERFORMANCE Main factors and non-recurring events affecting the Company's performance in 2011 were as follows: record high crude oil throughput of 9.2 million tonnes (an increase of 13.2% relative to 2010), in connection with the use of the integrated CDU/VDU unit constructed under the 10+ Programme and a 12.4% higher production volume; significant growth of the average annualised price of Brent dtd (up by 39.9%); significant effect of higher USD exchange rate as at the end of 2011 (up by 15.5% relative to 2010) on revaluation of foreign-currency denominated bank borrowings and valuation of inventories; introduction of cash flow hedge accounting with respect to foreign-currency denominated facilities used to finance the 10+ Programme, designated as hedges of future USD-denominated petroleum product sales transactions EXPLANATION OF DIFFERENCES BETWEEN ACTUAL FINANCIAL PERFORMANCE AND PREVIOUSLY PUBLISHED FORECASTS Grupa LOTOS S.A. did not publish any separate performance forecasts for INVESTMENTS 2.1. INVESTMENTS IN TANGIBLE AND INTANGIBLE ASSETS The table presents capital expenditure incurred by Grupa LOTOS S.A. in 2011 (PLN 000). Tangible assets under construction and purchases of property, plant and equipment and intangible assets, including: Capital expenditure for period Jan 1 Dec Construction and assembly work 40,967 Procurement from external suppliers purchases 40,547 Purchases of intangible assets 14,059 Other capital expenditure 21,515 Prepayments for tangible assets under construction 3,315 Settled prepayments (5,670) Total 114, EQUITY INVESTMENTS In 2011, Grupa LOTOS S.A. did not make any equity investments outside of the group of related entities. 42

43 2.3. ASSESSMENT OF FEASIBILITY OF PLANNED INVESTMENTS, INCLUDING EQUITY INVESTMENTS, IN VIEW OF AVAILABLE FUNDS In 2011, Grupa LOTOS S.A. financed investments using its own resources, as well as external funds raised for the purposes of investments necessary as part of day-to-day operations of the downstream segment. Together with Grupa LOTOS S.A. s own resources, the contracted external financing fully covers the Company s financing needs connected with the ongoing and planned investment projects. As at the date of release of this Directors' Report, i.e. as at April 20th 2012, the Company does not expect to see any changes in its financing structure. 3. FINANCING SOURCES 3.1. BORROWINGS INCURRED AND LOANS ADVANCED IN THE FINANCIAL YEAR For more information on Grupa LOTOS S.A.'s bank borrowings as at December 31st 2011 and December 31st 2010, see Note 29 to the separate financial statements of Grupa LOTOS S.A. for 2011; for description of loans advanced by the Company, see Note 36 to the financial statements. Credit facility agreement for the refinancing and financing of inventories of Grupa LOTOS S.A. On August 23rd 2011, Grupa LOTOS S.A. and a syndicate of four banks, comprising: - BANK POLSKA KASA OPIEKI S.A. of Warsaw, - POWSZECHNA KASA OSZCZĘDNOŚCI BANK POLSKI S.A. of Warsaw, - BRE BANK S.A. of Warsaw, and - RABOBANK POLSKA S.A. of Warsaw, executed an amending agreement to extend by 12 months, i.e. until December 20th 2012, the credit facility agreement for the refinancing and financing of inventories of Grupa LOTOS S.A. of December 20th 2007, providing for a revolving credit facility of USD 400m (PLN 1,148,520 thousand at the mid-exchange rates quoted by the National Bank of Poland for August 23rd 2011). The facility bears interest at a floating annual interest rate based on 3M or 6M LIBOR, depending on the interest period, plus margin. The amending agreement was executed pursuant to the terms of the credit facility agreement of December 20th 2007, which permitted extension of the credit facility term by an additional calendar year. Concurrently, starting from December 20th 2011, Rabobank Polska S.A. ceased to be a party to the credit facility agreement. Pursuant to documents signed along with the amending agreement, as of that date its entire credit commitment was taken over by BRE Bank S.A. and Nordea Bank Polska S.A. of Gdynia. The other terms and conditions of the credit facility agreement of December 20th 2007 as well as its provisions concerning penalties do not differ from those commonly used in agreements of such type. 43

44 Loan advanced to LOTOS EPN The original repayment date of the loan advanced on October 22nd 2010 by Grupa LOTOS S.A. to LOTOS EPN of USD 7,000 thousand (PLN 20,031 thousand at the mid-exchange rate quoted by the National Bank of Poland for the transaction date) was September 30th 2011, but it was extended until May 30th The loan was used for financing of further implementation of the YME Production Project. On November 21st 2011, LOTOS EPN repaid the principal amount along with interest. The loan bore interest at a floating rate based on 3M LIBOR plus margin. LOTOS EPN created security in the form of blank promissory notes with a protest waived clause and a promissory note declaration for the benefit of Grupa LOTOS S.A. in order to secure the repayment of loans also contracted in prior years (principal, interest and possible default interest, as well as any other liabilities which may arise in connection with the execution and performance of the agreement). Loans advanced to LOTOS Gaz S.A. w likwidacji (in liquidation) On March 8th 2011, Grupa LOTOS S.A. advanced a loan to LOTOS Gaz of PLN 247 thousand. Under the signed annex, the original repayment date was extended until June 30th On March 29th 2011, Grupa LOTOS S.A. signed an agreement to grant a loan of PLN 352 thousand to LOTOS Gaz. Under the signed annex, the original repayment date was extended until June 30th Security for the repayment of both loans (including principal, interest and default interest, if any, as well as any other liabilities that may arise in connection with the execution and performance of the loan agreement) will be provided in the form of an assignment by LOTOS Gaz S.A. w likwidacji (in liquidation) of future accounts receivable related to payment of the price for the sale of its assets. On May 26th 2011, Grupa LOTOS S.A. signed an agreement to grant a loan of PLN 123 thousand to LOTOS Gaz S.A. The repayment date was extended until November 30th On August 5th 2011, Grupa LOTOS S.A. signed an agreement to grant a loan of PLN 160 thousand to LOTOS Gaz. The principal amount along with interest are to be repaid by June 30th On October 31st 2011, Grupa LOTOS S.A. signed an agreement to grant a loan of PLN 90 thousand to LOTOS Gaz. The principal amount along with interest are to be repaid by September 30th The three loans referred to above are secured with blank promissory notes with a protest waived clause and a promissory note declaration, issued by LOTOS Gaz for the benefit of Grupa LOTOS S.A. The loans bear interest at a fixed annual rate based on 3M WIBOR plus margin. 44

45 3.2. SURETIES, GUARANTEES AND OTHER CONTINGENT AND OFF-BALANCE- SHEET LIABILITIES As at December 31st 2011, the total value of security under promissory notes was PLN 540,000 thousand (December 31st 2010: PLN 440,000 thousand). For more information on Grupa LOTOS S.A.'s contingent liabilities and other guarantees and types of security in 2011, see Note 32 to the Company's Separate Financial Statements for ASSESSMENT OF FINANCIAL RESOURCES MANAGEMENT In 2011, Grupa LOTOS S.A. was able to meet all of its liabilities towards third parties. In the period from January 1st to December 31st 2011, the Company used investment and working capital overdraft facilities. As at December 31st 2011, the Company had available funds of PLN 1,213.1m under working capital facilities. As at December 31st 2011, the balance of overdraft facilities was PLN 169.6m. For more information on the structure of debt under bank borrowings, see Note 29 to the Company's Separate Financial Statements for In connection with the borrowings referred to under Bank Syndicate (1), Bank Syndicate (2), Bank Syndicate (3) and Bank Syndicate (4), as further described in the note referred to above, Grupa LOTOS S.A. is required to maintain the Tangible Consolidated Net Worth ratio at least at the level specified in the facility agreements. Further, in connection with the facility referred to under Bank Syndicate (1), the Company is also required to maintain the Loan to Pledged Inventory Value Ratio at a level not higher than specified in the facility agreement. As at December 31st 2011 and December 31st 2010, the above requirements were complied with. A synthetic assessment of the Grupa LOTOS S.A. s overall economic and financial standing has been prepared in the form of a ratio analysis covering margins, liquidity, turnover and debt levels. 45

46 Profitability ratios (PLNm or %) fall of the EBIT and EBITDA margin due to slightly lower operating result (down by 0.5%) with a concurrent significant increase in sales revenue (up by 50.6%); lower net profit (down by 33.8%) on higher sales revenue (up by 50.6%) and total assets (up by 12.1%) and slightly lower equity (down by 1.9%), resulted in deterioration of the net margin, as well as ROE and ROA ratios reflecting the rate of return on invested equity and the profitability of asset; lower EBIT and 15.2% higher net financial debt, driving ROACE down by 0.3pp. Calculation of profitability ratios EBIT margin EBITDA EBITDA margin Net margin Return on equity (ROE) Return on assets (ROA) operating profit/(loss) to net sales EBIT before amortisation/depreciation EBITDA to net sales net profit/(loss) to net sales net profit/(loss) to equity at the end of period net profit/(loss) to assets at the end of period Return on average capital employed (ROACE) operating profit/(loss) after tax to equity plus long-term and short-term borrowings and other debt instruments and net of cash and current financial assets (as at the end of the period) 46

47 Liquidity ratios (PLNm, absolute value or %) current ratio (1.43) and quick ratio (0.43) remained flat year on year; a PLN 601.8m increase in capital employed, in connection with the fact that current assets grew faster than current liabilities (up by PLN 1,863.7m and PLN 1,261.9m, respectively), and an increase of the share of capital employed in total assets. Calculation of liquidity ratios Current ratio current assets to current liabilities (as at the end of the period) Quick ratio current assets net of inventories to current liabilities (as at the end of the period) Capital employed current assets net of current liabilities (as at the end of the period) Capital employed to total assets capital employed to total assets (as at the end of the period) 47

48 Collection/payment cycles 31,35 Collection period 2010 Payment period 27, Dni Collection period 2011 Payment period 25,92 31,94 shortening of the collection period and lengthening of the payment period in 2011: the collection period shortened by five days as average trade receivables were growing slower (up by 24.5%) than sales revenue (up by 50.6%); the payment period lengthened by four days as the average trade payables grew faster (up by 77.6%) than cost of sales (up by 53.8%). Calculation of collection/payment cycles Average collection period (days) Average payment period (days) average trade receivables to net sales multiplied by 365 days of a given period average trade payables to cost of sales multiplied by 365 days of a given period Capital structure and debt ratios (PLNm or %) 48

49 a 5.0 percentage point increase in the share of liabilities in the financing of assets, owing to the liabilities growing more (up by 21.6%) than assets (up by 12.1%); a 16.3 percentage point rise in net financial debt to equity ratio (financial leverage), due to an increase in net financial debt (up by 15.2%) and a drop in equity (down by 1.9%); a 35.1 percentage point increase in liabilities to equity ratio, driven by a 21.6% increase in liabilities with concurrent fall of equity (down by 1.9%). Calculation of capital structure and debt ratios Debt ratio Net financial debt Net debt to equity ratio (financial leverage) total liabilities to total assets (as at the end of the period) long-term and short-term borrowings and other debt instruments net of cash and current financial assets (as at the end of the period) long-term and short-term borrowings and other debt instruments net of cash and current financial assets to equity (as at the end of the period) Debt to equity ratio total liabilities to equity (as at the end of the period) To ensure the Group s stable development, the Management Board of Grupa LOTOS S.A. decided to implement the Optimal Expansion Programme in the period from January 1st to the end of Optimal Expansion Programme The efficiency improvement measures set forth in the Programme should produce a financial effect of PLN 220m for the Group. The decision was made in line with the strategic objectives for , following the fastchanging macroeconomic landscape. The prevailing turmoil on the European financial markets may lead to an economic slowdown in Poland. The Programme is designed to secure the Group's operations against effects of these conditions USE OF ISSUE PROCEEDS TO IMPLEMENT THE ISSUE OBJECTIVES Grupa LOTOS S.A. did not issue any securities in III. GRUPA LOTOS SHARES 1. PRICE OF GRUPA LOTOS SHARES ON THE WARSAW STOCK EXCHANGE The Company shares are listed on Giełda Papierów Wartościowych w Warszawie S.A. (WSE). The trading currency is PLN. ISIN Giełda Papierów Wartościowych Thomson Reuters Bloomberg PLLOTOS00025 LTS LTOS.WA LTS PW 49

50 In 2011, Grupa LOTOS shares were included in the following indices: WIG WIG 20 WIG Paliwa RESPECT Index. As at December 31st 2011, the Company's market capitalisation was PLN 3.026bn. The share capital is divided into 129,873,362 with a par value of PLN 1 per share. Each share confers the right to one vote at the General Meeting. At the beginning of 2011, the price of the Company stock was PLN In 2011, the year low price was PLN 22.26, while the year high price was PLN The weighted average price per share was PLN At year end, the price was PLN Prices of Grupa LOTOS shares (PLN) At year end Low High Closing price ,21 32,80 31, ,05 37,85 36, ,26 49,50 23,30 *Based on WSE data. According to data furnished by the WSE, the total value of trades on the Company shares, that is the aggregate value of all transactions on Grupa LOTOS securities concluded in 2011, was PLN 3.299bn % of Grupa LOTOS shares were traded in The average trading volume was 377 thousand shares per session. Trade in Grupa LOTOS stock At year end Trading value (PLNm) Share in trade (%) Average trading volume per session , , , , , ,048 *Based on WSE data was the time of falling stock prices and turbulences on the stock exchange. On the back of economic deceleration and the Euro zone crisis, a downtrend was observed on the WSE. Over the entire year, the WIG index lost 20.8% and WIG %. The index of fuel companies, WIG-PALIWA, fell 16.6% year on year in During the first half of the year, the price of Grupa LOTOS shares followed an uptrend, yielding a positive rate of return in the range from 10% to 30% at the beginning of the period. At the beginning of the year, the price outperformed the WIG, WIG20 and WIG-PALIWA indices. In the second half of 2011, the trend reversed and the Company shares followed the market. 50

51 Price of Grupa LOTOS shares in 2011 Jan 5th Series C sharesintroduced to trading on WSE Feb 3rd Acquisition of AB Geonafta completed Apr 15th 2010 annual report published Jun 27th General Meeting of Grupa LOTOS S.A. Aug 23rd Extension of the credit facility agreement for the refinancing and financing of inventories Nov 3rd Q report published Jan 19th LOTOS Norge AS granted the operatorship of the licence PL 503B Feb 7th significant shareholder (INGOFE) sells a block of shares Aug 25th H semi-annual report published * Rebased (100 = closing price at December 31st 2010) Grupa LOTOS stock against the WSE indices * Rebased (100 = closing price at December 31st 2010) 51

52 Brokers' recommendations in 2011 Publication date Brokerage house Recommendation Target price (PLN) Price on the recommendation date (PLN) Raiffeisen Centrobank AG Buy Ipopema Securities S.A. Buy DI BRE Sell Societe Generale Buy ING Sell KBC Sell Raiffeisen Centrobank AG Buy ING Hold PKO BP Buy IDM SA Reduce Societe Generale Hold KBC Sell Erste Group Research Accumulate Deutsche Bank Sell Societe Generale Hold DI BRE Reduce Millennium DM Neutral Societe Generale Hold DI BRE Hold Societe Generale Hold AGGREGATE NUMBER AND PAR VALUE OF THE COMPANY SHARES AND SHARES IN THE COMPANY S RELATED ENTITIES, HELD BY MANAGEMENT AND SUPERVISORY STAFF To the best of the Company s knowledge, only the following member of management staff hold shares in Grupa LOTOS as at April 20th Shares and equity interests held by management/supervisory staff Management/supervisory staff Number of Grupa LOTOS shares Par value (PLN) Management Board, including: 8,636 8,636 Mr Marek Sokołowski 8,636 8,636 Supervisory Board 0 0 Total 8,636 8,636 To the best of the Company's knowledge, as at April 20th 2012 members of the management and supervisory staff did not hold any shares in Grupa LOTOS' related entities. 52

53 3. KNOWN AGREEMENTS WHICH MAY GIVE RISE TO CHANGES IN THE SHAREHOLDER STRUCTURE The Management Board of Grupa LOTOS S.A. has no knowledge of any agreements which may give rise to future changes in the number of shares held by the existing shareholders and bondholders. 4. CONTROL SYSTEMS FOR EMPLOYEE STOCK OPTION PLANS In 2011, no control system for employee stock option plans existed at Grupa LOTOS. 5. BUY-BACK OF OWN SHARES In 2011, Grupa LOTOS did not buy back own shares. 6. PAYMENT OF DIVIDEND FOR 2010 Grupa LOTOS did not pay any dividend for IV. CORPORATE GOVERNANCE 1. SHAREHOLDER STRUCTURE LARGE HOLDINGS OF SHARES 2010 As of December 31st 2010, 113,630,889 shares in Grupa LOTOS S.A. were marked with code No. PLLOTOS00025, and 69,111 shares in Grupa LOTOS S.A. were marked with code No. PLLOTOS To the Company s knowledge based on the notifications received from the Shareholders, the shareholder structure of Grupa LOTOS as at December 31st 2010 was as follows: Shareholders as at December 31st 2010 Shareholders Number of shares/votes Par value of shares % of the share capital/ total vote at GM State Treasury 69,076,392 69,076, % ING OFE 6,524,479 6,524, % Other shareholders 54,272,491 54,272, % Total 129,873, ,873, % 53

54 Shareholder structure as at December 31st Series C shares in Grupa LOTOS at the Polish National Depository of Securities and in public trading on the stock exchange In Current Reports No. 34/2010 of December 30th 2010, No. 1/2011 of January 5th 2011 and No. 2/2011 of January 7th 2011, the Company reported that Krajowy Depozyt Papierów Wartościowych S.A. resolved to accept, to the depository of securities, 16,173,362 ordinary bearer Series C shares in the Company and mark them with ISIN code PLLOTOS On January 10th 2011, the Grupa LOTOS shares specified above were registered with the Polish NDS and the WSE Management Board decided to introduce them, by way of the ordinary procedure, to trading on the main market of the WSE. Following the registration, the total number of shares marked with ISIN code PLLOTOS00025 was 129,804,251. Reduction of ING Otwarty Fundusz Emerytalny's share of total vote at the General Meeting of Grupa LOTOS In Current Report No. 8/2011 of February 7th 2011, the Company reported that, following the sale transaction of Grupa LOTOS shares, settled on February 2nd 2011, ING Otwarty Fundusz Emerytalny reduced its share in total vote at the General Meeting of Grupa LOTOS below 5%. Prior to the transaction, ING Otwarty Fundusz Emerytalny held 6,640,532 Grupa LOTOS shares, representing 5.11% of share capital. On February 7th 2011, 5,957,442 Grupa LOTOS shares, representing 4.59% of share capital, were registered in ING Otwarty Fundusz Emerytalny's securities account. Grupa LOTOS shares in the State Treasury's portfolio As at the end of 2011, the State Treasury held a total of 69,076,392 ordinary bearer shares in Grupa LOTOS, representing 53.19% of the share capital and the same proportion of votes at the General Meeting of Grupa LOTOS. 54

55 Shareholders as at December 31st 2011 Shareholders Number of shares/votes Par value of shares % of the share capital/ total vote at GM State Treasury 69,076,392 69,076, % Other shareholders 60,796,970 60,796, % Total 129,873, ,873, % To Grupa LOTOS s knowledge, the shareholder structure as at the date of release of this report was as follows: Shareholder structure as at December 31st 2011 and April 20th 2012 Structure of share capital The share capital of Grupa LOTOS is divided into 129,873,362 fully paid-up ordinary shares with a par value of PLN 1 per share; each share carries the right to one vote at the General Meeting and the right to dividend. Structure of Grupa LOTOS' share capital by series 55

56 1.1. HOLDERS OF SECURITIES WHICH CONFER SPECIAL CONTROL POWERS, WITH THE DESCRIPTION OF THE POWERS Grupa LOTOS has not issued any securities which would vest the shareholders with any special control powers LIMITATIONS ON THE VOTING RIGHTS AT THE GM Each Grupa LOTOS share confers the right to one vote at the General Meeting, with the proviso that as long as the State Treasury holds the Company shares conferring the rights to at least one-fifth of the total vote at the General Meeting, the rights of the Company shareholders are limited so that none of them can exercise at the General Meeting more than one-fifth of the total number of votes at the Company as at the day of the General Meeting. The limitation does not apply to the State Treasury or its subsidiaries. For the purposes of the limitation provision, exercising voting rights by a subsidiary's parent (within the meaning of the Act on Public Offering and the Terms for Introduction of Financial Instruments to Organised Trading and on Public Companies of July 29th 2005) is deemed exercising the voting rights by that subsidiary. A shareholder whose voting right is limited in each case retains the right to exercise at least one vote RESTRICTIONS ON TRANSFERABILITY OF THE SHARES No restrictions apply to transferability of ownership rights to any shares issued by Grupa LOTOS. 56

57 2. THE COMPANY'S GOVERNING BODIES Grupa LOTOS S.A. corporate governance structure Shareholders General Meeting (Annual General Meeting / Extraordinary General Meeting) Supervisory Board (Appointed by General Meeting) Strategy and Development Committee Organization and Management Committee Audit Committee Management Board (Appointed by Supervisory Board) 2.1. GENERAL MEETING The General Meeting of Grupa LOTOS operates under Grupa LOTOS' Articles of Association (consolidated text of September 6th 2011) and the Rules of Procedure for the General Meeting of Grupa LOTOS (consolidated text of August 26th 2009). General Meetings are held at the Company s registered office and are convened by the Management Board of Grupa LOTOS, as provided for in the Articles of Association or in the Commercial Companies Code, by publishing an announcement on the Company s website and in the manner determined for publication of current reports, in accordance with the provisions of the Act on Public Offering, Conditions Governing the Introduction of Financial Instruments to Organised Trading, and Public Companies. Annual General Meetings (AGM) should be held no later than within six months after the end of the financial year. In 2011, the AGM was held on June 27th. The right to convene an AGM rests also with the Supervisory Board in the event that the Management Board fails to convene it within the specified time frame. 57

58 Extraordinary General Meetings (EGM) are convened by the Management Board on its own initiative, by the Supervisory Board (if the Supervisory Board deems it appropriate), or by shareholders representing at least half of the Company s share capital or at least half of the total vote at the Company. A shareholder or shareholders representing at least 1/20 of the Company s share capital may request that an EGM be convened and that certain items be placed on the agenda of a General Meeting. If an EGM is not convened within two weeks of the submission of such a request to the Management Board, the Registry Court may authorise the requesting shareholders to convene the Extraordinary General Meeting. A request to convene a General Meeting and include particular items on its agenda, made by parties entitled to do so, should be presented with grounds. A shareholder or shareholders representing at least 1/20 of the Company s share capital may, before a GM, submit to the Company draft resolutions concerning items which have been or are to be placed on the agenda of the General Meeting. Only persons who are the Company shareholders sixteen days prior to the date of a General Meeting (i.e. on the date of registration of participation in the GM) are entitled to participate in the General Meeting. Holders of rights under registered shares or provisional certificates (świadectwa tymczasowe) as well as pledgees and usufructuaries holding voting rights are entitled to participate in the General Meeting, provided that they are entered in the Share Register on the registration date. A Shareholder may participate in a General Meeting and exercise voting rights in person or by proxy. The proxy is obliged to disclose to the shareholder any circumstances leading to any actual or potential conflict of interests and may vote exclusively in line with the voting instructions issued by the appointing shareholder. Any matter to be discussed at a General Meeting is subject to prior consideration by the Supervisory Board. No resolution may be adopted on matters not included in the agenda of the General Meeting, unless the Company s entire share capital is represented at the GM and no objections to the adoption of such resolution are raised by any of the persons participating in the GM, with the exception of motions to convene an Extraordinary General Meeting and procedural motions. Resolutions of a General Meeting are adopted by the absolute majority of votes, unless the Articles of Association or Commercial Companies Code provide otherwise. Resolutions and proceedings of a General Meeting are recorded by a notary public. The minutes of the GM are signed by the Chairman of the GM and the notary public. The powers and proceedings of the General Meeting of Grupa LOTOS are stipulated in detail in the Company's Articles of Association and Rules of Procedure for the General Meeting. 58

59 2.2. SUPERVISORY BOARD The Supervisory Board of Grupa LOTOS operates under Grupa LOTOS S.A.'s Articles of Association (consolidated text of September 6th 2011) and the Rules of Procedure for the Supervisory Board of Grupa LOTOS S.A. (consolidated text of December 17th 2009). The Company s Articles of Association state that the Supervisory Board should comprise six to nine members, including the chairperson, deputy chairperson and secretary. Supervisory Board members are appointed and removed from office by the General Meeting in a secret ballot, by an absolute majority of votes. The General Meeting may appoint new members to the Supervisory Board from an unlimited number of candidates. As long as the State Treasury remains a shareholder in the Company, the State Treasury, represented by the competent minister, is entitled to appoint and remove one member of the Supervisory Board. Supervisory Board members are appointed for a joint term of three years. A Supervisory Board member or the entire Board may be removed at any time prior to expiry of the office term. 59

60 Members of the Supervisory Board Function on Supervisory Board of 7th term on Supervisory Board of 7th term Function on on Supervisory Board of 8th term on Supervisory Board of 8th term Biography, professional experience Chairman Jan 1 Jun Chairman Jun Wiesław Skwarko, Not applicable Not applicable Deputy Chairman Feb Marcin Majeranowski secretary Jan 1 Jun secretary Jun Oskar Pawłowski, member Jan 1 Jun member Jun Małgorzata Hirszel Not applicable Not applicable member Feb Agnieszka Trzaskalska 60

61 member Jan 1 Jun member Jun Michał Rumiński Leszek Starosta Deputy Chairman Jan 1 Jun member Jun Feb (removed from office) Rafał Wardziński member Jan 1 Jun Deputy Chairman Jun Jan (resigned from office) Ewa Sibrecht-Ośka member Jan 1 Jun member Jun 27 Nov (resigned from office) Rafał Lorek. independent member Jan 1 Jun Procedures for and the scope of powers and duties of the Supervisory Board are defined in the Rules of Procedure for the Supervisory Board of Grupa LOTOS S.A. 61

62 Supervisory Board's committees Standing committees: Members The Supervisory Boards' Strategy and Development Committee (SDC) Position held on the SDC during the Supervisory Board's 7th term of office Term of office Position held on the SDC during the Supervisory Board's 8th term of office Term of office Wiesław Skwarko, Chairman Jan 1 Jun Chairman Jul Małgorzata Hirszel member Jan 1 Jun member Jul Michał Rumiński member Jan 1 Jun member Jul Agnieszka Trzaskalska - - member Mar Marcin Majeranowski - - member Mar Rafał Wardziński member Jan 1 Jun member Jul Jan (resigned from the Supervisory Board) provides opinions and recommendations to the Supervisory Board on matters related to planned investment programmes with a material bearing on the Company's asset base. Members Position held on the OMC during the Supervisory Board's 7th term of office Organisation and Management Committee (OMC) Term of office Position held on the OMC during the Supervisory Board's 8th term of office Term of office Agnieszka Trzaskalska - - Chairwoman Mar Małgorzata Hirszel member Jan 1 Jun member Jul Oskar Pawłowski, member Jan 1 Jun member Jul Marcin Majeranowski - - member Mar Ewa Sibrecht-Ośka member Jan 1 Jun member Leszek Starosta Chairman Jan 1 Jun Chairman Michał Rumiński member Jan 1 Jun member Jul 11 Nov (resigned from the Supervisory Board) Jul Feb (removed from the Supervisory Board) Jul Mar (resigned from membership in the OMC) provides the Supervisory Board with opinions and recommendations regarding the management structure organisationrelated solutions, remuneration system and recruitment of personnel, with a view to enabling the Company to achieve its strategic objectives. 62

63 Members Position held on the AC during the Supervisory Board's 7th term of office The Supervisory Board's Audit Committee (AC) Term of office Michał Rumiński Chairman Jan 1 Jun Position held on the AC during the Supervisory Board's 8th term of office Chairman (since Aug ) Term of office Jul provision of ongoing advisory support to the Supervisory Board with respect to proper implementation of the policies related to budgetary and financial reporting, the Company s internal control function and cooperation with its Oskar Pawłowski, member Jan 1 Jun member Jul Wiesław Skwarko, member Jan 1 Jun member Jul Marcin Majeranowski - - member Mar Rafał Wardziński member Jan 1 Jun member Ewa Sibrecht-Ośka - - member Rafał Lorek. member Jan 1 Jun Jul Jan (resigned from the Supervisory Board) Jul 11 Nov (resigned from the Supervisory Board) 63

64 Delegation of specific duties to individual Supervisory Board members The Supervisory Board may delegate its members to perform specific supervisory duties individually. By virtue of a resolution of August 12th 2008: Wiesław Skwarko was delegated to exercise close, ongoing supervision over the implementation of the 10+ Programme, including: monitoring the progress of work under the project and the project s timely performance, supervising implementation of the strategy for raw materials procurement and marketing of products produced as part of the project, supervising consistent management of logistics during the project's implementation. Leszek Starosta was delegated to exercise close, ongoing supervision over the implementation of the 10+ Programme, including: supervising legal aspects of the contracts executed and performed under the project, supervising the contract conclusion procedures and administration proceedings related to the project performance. 64

65 2.3. MANAGEMENT BOARD. POWERS OF INDIVIDUAL MEMBERS The Management Board of Grupa LOTOS S.A. operates pursuant to the Articles of Association (consolidated text of September 6th 2011) and the Rules of Procedure for the Management Board of Grupa LOTOS S.A. adopted by virtue of Management Board Resolution No. 6/VI/2007 dated January 23rd 2007 and approved by virtue of Supervisory Board Resolution No. 70/VI/2007 dated January 29th 2007r. From January 1st to December 31st 2011 and as at the date of release of this Report, the Management Board of Grupa LOTOS S.A. of the seventh term of office was composed of four members: Management Board Members Function Scope of responsibilities Paweł Olechnowicz Marek Sokołowski President of the Management Board, Chief Executive Officer Vice-President of the Management Board, Chief Operation Officer In charge of the overall management and direction of the Company s operations. Mr. Olechnowicz is also acting Vice-President of the Management Board responsible for Oil and Gas Exploration & Production. Also responsible for oversight of companies allocated to the Group s management segment and exploration and production segment. In charge of the overall production and technical management, technology development (including health, safety and environmental management), and capex programmes (technical and technological development projects). In , Mr. Sokołowski was in charge of the refinery the 10+ Programme. Also responsible for oversight of companies allocated to the Group s operating segment. Vice-President of the Management Board, Chief Financial Officer In charge of the overall management of the Company s economic, financial and accounting functions, as well as the assets and restructuring processes. Mariusz Machajewski Vice-President of the Management Board, Chief Commercial Officer In charge of the overall management of marketing, supply and distribution processes at the LOTOS Group. Also responsible for oversight of companies allocated to the Group s marketing segment. Maciej Szozda For more information of the professional experience of the Management Board's members, see the Company's Web page: 65

66 Each member of the Management Board is authorised to represent the Company in all court and out-of-court transactions relating to the operation of the Company's business, with the exception of matters reserved for the General Meeting or Supervisory Board under the Commercial Companies Code or the Company's Articles of Association, as well as matters falling outside the scope of ordinary management of the business where they require the Management Board's prior resolution and matters within the powers of another member of the Management Board. The following matters require the Management Board's resolution: 1. Setting the organisational rules of the Company, including organisation of the Company s business, 2. Setting annual budget for the Company, 3. Adopting strategy for the LOTOS Group, 4. Setting rules of procedure for the Company s business as required under the law, 5. Making the Company s equity investments and implementing all projects related to capital expenditure in property, plant and equipment (with the exception of replacement projects) with a value of up to PLN 100,000, 6. Exercising the Company s voting rights at the General Meetings of the subsidiaries, with regard to: Appointing or removing members of the Management and Supervisory Boards, Coverage of loss, Increasing or reducing the share capital, Merging with another company or transforming the company, Selling or leasing the Company s business and/or encumbering it with usufruct rights, 7. Appointing and removing members of the Management and Supervisory Boards who are appointed or removed directly by Grupa LOTOS S.A., 8. Establishing companies under commercial law, 9. Acquiring and selling shares in limited-liability companies, 10. Acquiring and selling shares, except where the shares are acquired or disposed in public trading in securities, unless such acquisition or disposal results in gaining or losing the status of the parent, 11. Acquiring and disposing of real property, perpetual usufruct rights or interest in real property, 12. Establishing or joining partnerships, organisations or ventures which involve unlimited liability enforceable against the Company s assets, 13. Preparing: 66

67 DIRECTORS REPORT ON THE OPERATIONS OF GRUPA LOTOS the Company s financial statements for the previous financial year, in accordance with the Polish Accountancy Act, with the Directors Report on the Company s operations for the previous financial year, 14. consolidated financial statements and a report on the LOTOS Group s operations for the previous financial year, 15. Convening annual and extraordinary General Meetings in due time, on its own initiative, at a written motion of the Supervisory Board or at a request of a shareholder or shareholders representing at least one-tenth of the share capital, as well as in other cases as provided for in the Commercial Companies Code, 16. Setting the agenda of a GM, 17. Matters falling outside the scope of ordinary management of the enterprise, 18. Matters which have been objected to by at least one of the members of the Management Board, 19. Matters which must be resolved by way of Management Board resolutions if so required by the President of the Management Board or at least half of the members of the Management Board, and which fall within the scope of responsibilities of particular members of the Management Board, 20. Granting powers of proxy. Pursuant to the provisions of the Commercial Companies Code and the Company's Articles of Association, the Management Board, having obtained the Supervisory Board's opinion, is authorised to move to the GM for issuance of new shares or buyback of the existing shares. Further, if authorised accordingly by the relevant provisions of the Company's Articles of Association and the GM's resolution, the Management Board may, by way of a resolution(s) decide to issue new shares within the authorised share capital defined by the General Meeting. Ordinary matters of the Company, not requiring the Management Board's resolution, are carried out by the President acting independently and by individual members of the Management Board, in line with the division of powers and responsibilities defined under Grupa LOTOS' Organisational Rules. Moreover, the President of the Management Board conducts and supervises the Company's corporate matters in the scope of: Convening and presiding over meetings of the Management Board, Maintaining the Management Board's documentation, files and meeting minutes, Performing obligations under commercial law and matters relating to the register of entrepreneurs, Ensuring that necessary services are rendered to the Company's governing bodies and minutes of proceedings are prepared, 67

68 Representing the Management Board before the Company's other governing bodies, subject to the provisions of the Commercial Companies Code and the Company's Articles of Association. Rules of procedure for the Management Board, including procedures for calling meetings, adopting and archiving resolutions, as well as the scopes of powers and duties of individual Board members are set forth in the Rules of Procedure for the Management Board of Grupa LOTOS S.A. Rules governing appointment and removal of management staff As provided for in the Articles of Association, the Management Board comprises three to seven members appointed by the Supervisory Board. Members of the Management Board are appointed by the Supervisory Board following a qualification procedure carried out pursuant to the Regulation of the Polish Council of Ministers of March 18th 2003 concerning qualification procedures for members of management boards of certain commercial-law companies (Dz. U. No. 55, item 476), taking into consideration "The Best Practices to be Followed in the Selection of Candidates to Governing Bodies of Companies of Key Importance to the State Treasury," defined by the Minister of State Treasury. Management Board members are appointed for a joint term of three years. The President, Vice-Presidents and Members of the Management Board, as well as the entire Management Board, may at any time be removed from office or suspended in duties by the Supervisory Board if there is a valid reason for doing so. Each Member's mandate expires no later than on the date of the General Shareholders Meeting which approves the financial statements for the previous full financial year. Supervisory Board resolutions to appoint or remove a Management Board member or the entire Management Board from office require that at least two thirds of Supervisory Board members are present and voting. A Management Board member's mandate expires upon resignation from office RULES FOR AMENDING THE ARTICLES OF ASSOCIATION OF GRUPA LOTOS S.A. An amendment to the Articles of Association requires that a relevant resolution be adopted by the General Meeting by an absolute majority of votes, save for amendments to Par of the Articles of Association which require that four fifths of the total vote be cast in favour of the amending resolution and at least half of the Company's share capital be represented at the General Meeting. After the General Meeting adopts a resolution on amending the Company s Articles of Association, the Management Board of Grupa LOTOS S.A. notifies a registry court of the amendments. The amendments come into force upon their registration by the court. 68

69 A consolidated text of the Articles of Association incorporating the amendments is then produced by the Supervisory Board provided that the Board receives relevant authorisation from the General Meeting. 3. CORPORATE GOVERNANCE PRINCIPLES APPLICABLE AT GRUPA LOTOS 3.1. VOLUNTARY CORPORATE GOVERNANCE PRINCIPLES APPLIED BY GRUPA LOTOS Code of Best Practice for WSE Listed Companies, Chapter I Recommendations The key objectives that Grupa LOTOS pursues by adhering to the rules of corporate governance include: transparency of its operations as a listed company, trust in its relations with stakeholders, consistency in creating value for shareholders. Information policy and relations with the capital market Grupa LOTOS is keen to ensure that its relations with investors and stakeholders are forged and fostered based on the values of equality and dialogue to find solutions satisfactory for both parties. The Company is open to new communication tools, and strives to perfect the form and content of its message. Grupa LOTOS' Investor Relations Team (IR) makes every effort to present to investors a precise, reliable and transparent picture of the Company's operations and financial standing. The team provides up-to-date information in compliance with the principles of involvement of, availability to and equal treatment of all investors. To convey the information to investors, the Company uses a broad range of IR tools, including mailing, participation in conferences for shareholders, conference calls, one-on-one meetings, open-house days for analysts and investors and participation in Akcja Inwestor (Investor Campaign) organised by the Puls Biznesu daily. In 2011, the IR supported the Company's Management Board in organising meetings with investors and maintaining organised relations with equity analysts. On November 7th 2011, the annual Analyst's Day was organised in the Lithuanian city of Klaipeda, the seat of LOTOS Geonafta Group (producing crude oil from on-shore fields). Grupa LOTOS' Internet Investor Relations Service has been designed with a view to reaching a broader range of investors and analysts. The service is updated on an ongoing basis, and published in Polish and English. The corporate events calendar (quarterly earnings reports, operations of the GM and other events at the LOTOS Group which might affect the price of the Company shares) is 69

70 published in the bookmark Investor's Calendar. The calendar includes links to relevant materials (periodic reports, management presentations,.mp3 files with recordings of the Management Board's conference calls with analysts and all documents relating to the GM). Shareholders may use the Investor's Calculator available in the Investor Relations Service under the bookmark Listings. Code of Best Practice for WSE Listed Companies, Chapter I Recommendations, item 3 The Company analyses the possibility of enabling the shareholders to watch the General Meeting via a webcast on the Company's website. Code of Best Practice for WSE Listed Companies, Chapter I Recommendations, item 5 Remuneration of the Management Board and Supervisory Board members is subject to limitations and conditions prescribed under the Act on Remunerating Persons Who Manage Certain Legal Entities of March 3rd 2000 (Dz. U. of 2000 No 26, item 306, as amended). On November 13th 2009, the Supervisory Board acting within the powers vested in it by Par of the Company s Articles of Association and the Act of March 3rd 2000 decided that Vice-Presidents of the Company s Management Board would receive remuneration equal to six-fold the average monthly salary in the non-financial corporate sector, net of bonuses paid from profit in the fourth quarter of the preceding year, as announced by President of the GUS (Central Statistics Office). Concurring with the proposal of the Supervisory Board, contained in Resolution No. 63/VII/2009 of November 13th 2009, on December 17th 2009 the Extraordinary General Meeting determined the same remuneration policy for President of the Management Board, while repealing the General Meeting s resolution of August 18th 2000, which until then defined the rules of remuneration for members of the Management Board. In 2000, acting within its powers vested in it under Par. 9.4 of the Company's Articles of Association, the Extraordinary General Meeting determined the remuneration policy for the members of the Supervisory Board. Pursuant to the policy, Supervisory Board members receive monthly remuneration equal to the average monthly salary in the non-financial corporate sector net of bonuses paid from profit in the fourth quarter of the preceding year, as announced by the President of the GUS (Central Statistics Office). 70

71 Code of Best Practice for WSE Listed Companies, Chapter I Recommendations, item 9 Composition of the Supervisory Board by sex Supervisory Board Number of women Number of men Jan 1 Jun Jun 27 Nov Nov 8 Dec Feb Management personnel by sex (as at December 31st 2011) Number of women Number of men Management Board 0 4 Senior management 7 34 Lower management Total Code of Best Practice for WSE Listed Companies, Chapter I Recommendations, item 10 The LOTOS Group's Business Social Responsibility strategy is an integral part of the LOTOS Group's Strategy. Mission The LOTOS Group's mission is to strive towards innovative and sustainable growth in the areas of: exploration for, production and processing of hydrocarbons, trading in top quality petroleum products, Strategic objective The strategic objective of Grupa LOTOS until 2015 is to create shareholder value by best leveraging its existing potential and implementing development programmes in key business areas: exploration and production, oil refining and marketing. Corporate social responsibility strategy To effectively pursue business objectives, the Management Board of Grupa LOTOS has adopted the Corporate Social Responsibility Strategy for the LOTOS Group in The strategy incorporates social, environmental, ethical and human rights concerns into the Company's core operations and business strategy, and seeks to: maximise the ability to create common values for shareholders, other stakeholders and society at large, 71

72 recognise, prevent or mitigate possible adverse impacts of the Company's core operations. BUSINESS STRATEGY CORPORATE RESPONSIBILITY STRATEGY MAXIMISATION OF COMMON VALUES MINIMISATION OF RISKS Ethics Grupa LOTOS believes that business should be run in keeping with high ethical, environmental and social standards. Therefore, it has adopted a corporate system of values treated as a long-term commitment to all stakeholders. The four key values we uphold are as follows: Cleanliness striving to ensure compliance with the most exacting environmental standards, commitment to ethical and fair competition, and counteracting corruption and human rights abuses. Openness the Group's approach to change, global needs and people's expectations. Innovativeness in our view, it is concerned with efforts to appreciate and protect the Group's intellectual capital and employee competencies. We are also aware of our special responsibility as an oil conglomerate and a refinery owner towards the future, people, the environment, the country and the security of its position in the world. The system of fundamental CSR values is aligned with key LOTOS brand values which rest on three pillars: PEOPLE SOCIAL RESPONSIBILITY creating social values working environment, diversity, human rights, preventing social exclusion 72

73 NATURAL ENVIRONMENT ENVIRONMENTAL RESPONSIBILITY creating environmental values, eco-effectiveness, investment ENERGY SECURITY BUSINESS RESPONSIBILITY creating economic values risk management, intellectual capital, market share, brand values, reputation Code of Best Practice for WSE Listed Companies, Section I Recommendations, item 11 quality of reporting Grupa LOTOS's Press Office is responsible for maintaining a coherent and transparent communication policy of the LOTOS Group by keeping continued relations with the media. The manner of operation and responsibility of the office are set forth in Grupa LOTOS's procedures and are subject to periodical review and assessment. Participation in the WSE's RESPECT Index demonstrates Grupa LOTOS's adherence to the high reporting standards. Grupa LOTOS takes steps to introduce best practices in such areas as environmental protection, health and safety at work and security of management systems, which have not been regulated by the Polish law. Since November 19th 2009, Grupa LOTOS S.A. has been included in the first index of socially responsible companies in the CEE region, the RESPECT Index (Responsibility, Ecology, Sustainability, Participation, Environment, Community, Transparency), which includes companies listed on the regulated market of the WSE and granted A rating as a result of being leaders in sustainable development, corporate disclosure and communication with the financial markets. January 31st For the fourth time, Grupa LOTOS was selected for inclusion in the RESPECT Index, which currently comprises 23 listed names. The RESPECT Index also takes into account the criteria of profitability related to dividend payments and pre-emptive rights, which provides insight into the economic standing of the companies included in the Index. We were the first oil company to secure the Integrated Management System certificate and adopt Global Compact Principles 73