Prospectus. Grupa LOTOS Spółka Akcyjna of Gdańsk ul. Elbląska 135, Gdańsk

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1 Prospectus Grupa LOTOS Spółka Akcyjna of Gdańsk ul. Elbląska 135, Gdańsk On the basis of this Prospectus, the Company will seek admission of 16,173,362 Series C ordinary bearer shares to trading on the Main Market of the Warsaw Stock Exchange. (This is a translation of the document originally issued in Polish) Offeror IPOPEMA Securities S.A. This Prospectus was approved by the Financial Supervision Authority on 8 th December 2010

2 Table of contents I SUMMARY... 4 II RISK FACTORS RISK FACTORS ASSOCIATED WITH THE ENVIRONMENT IN WHICH THE ISSUER AND ITS GROUP OPERATE RISK FACTORS ASSOCIATED WITH THE BUSINESS OF THE ISSUER AND ITS GROUP RISKS RELATED TO THE UPSTREAM OPERATIONS OF THE ISSUER AND ITS GROUP RISKS RELATED TO IMPLEMENTATION OF THE 10+ PROGRAMME BY THE ISSUER ENVIRONMENTAL RISKS RISKS RELATED TO THE ISSUER S AND ITS SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT RISKS RELATED TO THE SHARES AND TRADE IN THE SHARES III REGISTRATION DOCUMENT RESPONSIBLE PERSONS AUDITORS FINANCIAL HIGHLIGHTS RISK FACTORS INFORMATION ON THE ISSUER THE ISSUER S BUSINESS ORGANISATIONAL STRUCTURE PROPERTY, PLANT AND EQUIPMENT OPERATIONAL AND FINANCIAL REVIEW CAPITAL RESOURCES RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES TREND INFORMATION PROFIT FORECASTS OR ESTIMATES ADMINISTRATIVE, MANAGEMENT, AND SUPERVISORY BODIES AND SENIOR MANAGEMENT REMUNERATION AND OTHER BENEFITS IN RELATION TO THE LAST FULL FINANCIAL YEAR FOR MEMBERS OF THE ADMINISTRATIVE, MANAGEMENT, AND SUPERVISORY BODIES AND THE SENIOR MANAGEMENT PRACTICES OF THE ADMINISTRATIVE, MANAGEMENT, AND SUPERVISORY BODIES EMPLOYMENT MAJOR SHAREHOLDERS RELATED PARTY TRANSACTIONS FINANCIAL INFORMATION CONCERNING THE ISSUER S ASSETS AND EQUITY AND LIABILITIES, FINANCIAL POSITION AND PROFITS AND LOSSES ADDITIONAL INFORMATION MATERIAL AGREEMENTS OTHER THAN AGREEMENTS ENTERED INTO IN THE ORDINARY COURSE OF BUSINESS THIRD PARTY INFORMATION AND STATEMENT BY EXPERTS AND DECLARATION OF ANY INTEREST

3 24 DOCUMENTS ON DISPLAY INFORMATION ON HOLDINGS IV SECURITIES NOTE RESPONSIBLE PERSONS RICK FACTORS BASIC INFORMATION INFORMATION CONCERNING THE SECURITIES TO BE ADMITTED TO TRADING INFORMATION ON THE TERMS OF THE OFFERING ADMISSION TO TRADING AND DEALING ARRANGEMENTS SELLING SECURITIES HOLDERS COSTS OF THE ISSUE DILUTION ADDITIONAL INFORMATION V ANNEXES ARTICLES OF ASSOCIATION DEFINITIONS AND ACRONYMS EXCERPT FROM THE NATIONAL COURT REGISTER (KRS)

4 I SUMMARY The information set out in this Summary is an introduction to the Prospectus only and should be read in conjunction with more detailed information contained in the remainder hereof. Prospective investors are advised to carefully read the entire Prospectus, in particular information on the risks associated with the investment in the shares, covered by Chapter II Risk Factors. Any decision to invest in the securities should always be based on consideration of the entire Prospectus by the investor. Should an investor bring a claim before a court regarding the information contained in the Prospectus, such investor shall bear the cost of translating the Prospectus before the court proceedings are initiated. Persons who have prepared this Summary (or its translation) shall be liable for losses only to the extent that this Summary is misleading, inaccurate or inconsistent with the other parts of the Prospectus. Introduction to Trading of Series C Shares Acquired in a Private Placement No share issue or public offering of the Company shares will be carried out based on this Prospectus. This Prospectus has been prepared in connection with the intent to seek admission and introduction to trading on the regulated market of the Warsaw Stock Exchange of 16,173,362 Series C shares in the increased share capital of Grupa LOTOS, subscribed for by the State Treasury. The share capital increase was effected through a private placement with the State Treasury of 16,173,362 shares with a par value of PLN 1 per share and issue price of PLN per share, pursuant to a relevant resolution adopted by the Annual General Shareholders Meeting on June 30th Series C Shares are ordinary bearer shares. Pursuant to Resolution No. 35 of June 30th 2009, the Issuer s Annual General Shareholders Meeting authorised the Company, represented by the Management Board, to execute an agreement with the Polish NDS for the registration of Series C Shares at the deposit operated by the Polish NDS. It is the Issuer s intention that Series C Shares should be introduced to trading on the official listing market operated by the Warsaw Stock Exchange (Giełda Papierów Wartościowych w Warszawie S.A.) under ISIN Code PLLOTOS00025, under which Series A and Series B shares of the Issuer are currently traded. To this end, after this Prospectus is approved, the Issuer will promptly apply to the Polish NDS for registering Series C Shares in the NDS system, and then to the Warsaw Stock Exchange for introducing Series C Shares to trading in accordance with Par. 19 of the WSE Rules. The Grupa LOTOS shares placed in the Polish NDS deposit have been assigned ISIN codes PLLOTOS00025 and PLLOTOS All 16,173,362 Series C Shares in Grupa LOTOS were subscribed for by the State Treasury, represented by the Minister of the State Treasury, against a non-cash contribution. The primary objective behind the issue of Series C Shares in Grupa LOTOS was to acquire full control over companies of the LOTOS Group. Prior to the transaction, Grupa LOTOS held 69.00% of shares in LOTOS Petrobaltic, 80.04% of shares in LOTOS Czechowice and 80.01% of shares in LOTOS Jasło. Following the share capital increase and the contribution 4

5 in kind of shares in those three companies, the Issuer holds, respectively, 99.32% of shares in LOTOS Petrobaltic, 85.04% of shares in LOTOS Czechowice and 85.01% of shares in LOTOS Jasło. The increase in the Issuer s share capital effected through the issue of Series C Shares was registered on July 17th The table below shows the Issuer s shareholder structure after the registration of Series C Shares: Table 1 Shareholder Structure of Grupa LOTOS Shareholder No. of shares/ No. of votes at GM % of share capital / % the total vote held State Treasury 1 69,076, % ING OFE (Open-Ended Pension Fund) 2 6,524, % Other shareholders 54,272, % Total 129,873, % Source: the Issuer. The LOTOS Group Grupa LOTOS is a joint-stock company (spółka akcyjna), whose shares have been listed on the regulated market of the Warsaw Stock Exchange since The Company shares are included in the following WSE indices: WIG-20 (blue chip index), WIG-Paliwa (index of fuel sector companies) and RESPECT Index (index of socially responsible companies). The LOTOS Group is an oil concern whose business consists in the production and processing of crude oil, as well as wholesale and retail sale of high-quality petroleum products. The Group supplies unleaded gasoline, diesel oil and aviation fuel, and is the leading producer and seller of motor oils, bitumens and paraffins in Poland. Service stations under the LOTOS brand operate in all parts of Poland. Through its subsidiary companies, LOTOS Petrobaltic and LOTOS EPN, the Group is present in the Baltic Sea and the Norwegian Continental Shelf, where it conducts exploration and production operations relating to crude oil. The ultimate strategic objective of the LOTOS Group is to create shareholder value through optimal leveraging of the existing potential and implementing development projects in the key areas of its operations. 1 In accordance with the shareholder s statement delivered to the Issuer on January 29th As at the prospectus date, the Issuer did not receive any other statement from the shareholder to the effect that the above stated shareholder s holding of the Company shares changed. 2 In accordance with the shareholder s statement delivered to the Issuer on November 23rd At the General Shareholders Meeting held on June 28th 2010, ING Otwarty Fundusz Emerytalny (Open-Ended Pension Fund) registered 8,500,000 shares in the Company, representing 6.54% of Grupa LOTOS share capital. As at the prospectus date, the Issuer did not receive any other statement from the shareholder to the effect that the above stated shareholder s holding of the Company shares changed. 5

6 In connection with the requirement for listed companies to apply International Financial Reporting Standard 8 Operating Segments for annual periods beginning after January 1st 2009, the Issuer has changed the presentation of its operations with respect to operating segments with effect from For management purposes, the Group is divided into business units which correspond to industry segments. The Group s operating activities comprise two main reportable operating segments: upstream segment comprising activities related to the acquisition of crude oil and natural gas reserves, and crude oil and natural gas production, downstream segment comprising the production and processing of refined petroleum products and their wholesale and retail sale, as well as auxiliary, transport and service activities. Grupa LOTOS S.A. is part of the downstream segment. The upstream segment comprises the entire group of LOTOS Petrobaltic, the Issuer s subsidiary company. Financial Performance The financial information on the LOTOS Group for the years presented below has been compiled on the basis of the audited consolidated financial statements for the financial years 2007, 2008 and 2009 prepared in accordance with the IFRS. The data for H was sourced from the semi-annual consolidated financial statements reviewed by an auditor. Table 2 Consolidated statement of comprehensive income historical data LOTOS Group Consolidated statement of comprehensive income (PLNm) Sales revenue 13, , ,321.1 Cost of sales (11,368.6) (15,315.0) (12,775.8) Gross profit 1, ,545.3 Impairment losses on goodwill (21.5) (12.6) 0.0 Selling costs (697.5) (737.3) (726.4) General and administrative expenses (313.5) (316.8) (332.7) Other operating income Other operating expenses (92.2) (88.6) (140.7) Operating profit/(loss) (145.8) Finance income Finance expenses (38.7) (464.6) (303.9) Interest in investments in associated undertakings Loss of control over subsidiary Pre-tax profit/(loss) 1,004.5 (503.7) 1,109.6 Corporate income tax (190.4) (197.8) Net profit/(loss) from continuing operations (389.4) attributable to owners of the parent (453.5)

7 - attributable to non-controlling interests Exchange differences on translating foreign operations and other comprehensive income (3.9) Total comprehensive income (362.6) attributable to owners of the parent (426.7) attributable to non-controlling interests Source: the Issuer; the above data includes retrospective presentation adjustments introduced in 2009 to ensure comparability of financial information. Table 3 Consolidated statement of comprehensive income data for the period January September 2010 LOTOS Group Consolidated statement of comprehensive income (PLNm) Jan Sep 2009 Jan Sep 2010 Sales revenue 10, ,941.5 Cost of sales (9,163.2) (12,455.7) Gross profit 1, ,485.8 Selling costs (521.1) (630.3) General and administrative expenses (226.3) (277.4) Other operating income Other operating expenses (58.5) (68.6) Operating profit/(loss) Finance income Finance expenses (156.2) (265.2) Pre-tax profit/(loss) 30.8 Corporate income tax Net profit/(loss) from continuing operations (188.8) (47.0) - attributable to owners of the parent attributable to non-controlling interests Total comprehensive income attributable to owners of the parent attributable to non-controlling interests Source: the Issuer. Table 4 Consolidated statement of financial position historical data LOTOS Group Dec Dec Dec Assets 9, , ,226.0 Non-current assets 4, , ,094.4 Current assets, including: 5, , ,

8 LOTOS Group Dec Dec Dec Inventories 2, , ,023.1 Receivables 1, , ,668.2 Cash and cash equivalents Assets held for sale Equity and liabilities 9, , ,226.0 Share capital Statutory reserve funds ,311.3 Retained earnings 4, , ,353.9 Translation of foreign operations Equity attributable to owners of the parent 5, , ,809.4 Non-controlling interests Total equity 6, , ,846.2 Liabilities, including: 3, , ,379.8 Non-current loans and borrowings , ,942.6 Current loans and borrowings Debt and capital employed Financial debt 1, , ,701.1 Net debt , ,339.0 Capital employed 6, , ,185.2 Source: the Issuer; the above data includes retrospective presentation adjustments introduced in 2009 and 2010 to ensure comparability of financial information. Table 5 Consolidated statement of financial position as at September 30th 2010 and comparative data LOTOS Group Consolidated statement of financial position (PLNm) Dec Sep Assets 15, ,027.7 Non-current assets 10, ,738.2 Current assets, including: 5, ,283.9 Inventories 3, ,850.5 Receivables 1, ,935.0 Cash and cash equivalents Assets held for sale Equity and liabilities 15, ,027.7 Share capital Statutory reserve funds 1, ,311.3 Retained earnings 5, ,

9 Translation of foreign operations Equity attributable to owners of the parent 6, ,251.5 Non-controlling interests Total equity 6, ,266.1 Liabilities, including: 15, ,027.7 Non-current loans and borrowings 10, ,738.2 Current loans and borrowings 5, ,283.9 Source: the Issuer. Risk Factors Risk factors associated with the environment in which the Issuer and its Group operate Risk related to overall macroeconomic climate Risks related to future legal environment Risks related to applicable tax laws General risk of changes in tax laws or their interpretations by tax authorities and administrative courts Risk related to transfer prices Risk related to excise duty Risk factors associated with the business of the Issuer and its Group Financial risks Risk related to prices of products and raw materials Currency risk Interest rate risk Credit risk Technological risks Technical risk Risk of Industrial failure Risk of human error Risk related to competition in fuel retailing Risk related to the Act on Remunerating Persons Who Manage Certain Legal Entities (the Compensation Cap Act) Risk that the experience of members of the governing bodies of the LOTOS Group companies may prove insufficient Risk of refusal or revocation of a licence or of failure to obtain a licence extension 9

10 Risk related to special rights vested in the Minister of the State Treasury Risk of terrorist attacks Risks related to the upstream operations of the Issuer and its Group Risk related to the estimation of deposit size Risk related to the launch of production from new deposits Risk related to oil and gas prices Risk related to high cost of the technologies used by the Company Risk related to decommissioning of mines Risk of failure to obtain the extension of licences for exploration and appraisal of minerals Insurance risk Risk of certain project partners or shareholders not granting their approval to implement a project Risk of failure to obtain a permit for the construction of transmission pipelines in a particular location Risk related to restrictions on exploitation of gas deposits Risk related to the interpretation of the provisions of Polish Energy Law concerning pipelines that cross Polish borders Risk related to joint and several liability of all licence partners Risk of delays in field development plans resulting from discovery of a deposit extending beyond the licence area Risk related to availability of drilling equipment Risk related to the management of certain assets by third parties Risk related to regulations on the prevention of environmental damage Risks related to implementation of the 10+ Programme by the Issuer Risk related to ensuring market for products of the new refinery units Environmental risks Risk of more stringent standards and legal regulations concerning environmental protection Risk of environmental damage caused by the operations of the Issuer or other LOTOS Group companies Risk of increased expenditure on projects with negative impact on the environment Risk related to the Company s participation in the Greenhouse Gas Emissions Trading Scheme Investment risks related to the proximity of protected areas Risks related to the Issuer s and its subsidiaries property, plant and equipment Risk related to security interests in the Issuer s property, plant and equipment Risk related to real estate with unresolved legal status 10

11 Risk related to former owners claims to significant real estate (pertaining to the right of perpetual usufruct and the ownership) Risk related to the planned property, plant and equipment Risk related to the termination or expiry of material agreements for the Issuer s use of significant real estate under a legal title other than ownership or right of perpetual usufruct Risks related to the shares and trade in the shares Risk of refusal to introduce or of delayed introduction of the Issuer shares to trading on the regulated market operated by the WSE Risk related to the PFSA imposing sanctions on the Issuer Risk related to the WSE suspending trading in the shares or excluding the shares from trading on the regulated market Risk related to share price volatility 11

12 II RISK FACTORS Prior to making any investment decisions, prospective investors are advised to carefully consider the risk factors discussed below, as well as the other information contained in this Prospectus. Risk factors, understood as sources of uncertainty, are inherent in any business activity. The risk factors discussed below identified on the basis of the Issuer s best current knowledge may not be the only risks affecting the Issuer and its business. In future, risks may emerge that are difficult to foresee at this point in time, such as acts of god and events remaining outside the Group s control. It ought to be noted that the occurrence of any of the risks described below may have a material adverse effect on the LOTOS Group s business, financial position and performance, and thus indirectly on the market price of Issuer shares. As a result, investors may not achieve the expected rates of return and may lose a part or all of their investments. The order in which the risk factors are presented is not intended to reflect the likelihood of their occurrence or their importance. 1 Risk Factors Associated with the Environment in Which the Issuer and its Group Operate 1.1 Risk Related to Overall Macroeconomic Climate The financial standing of the Issuer and the Group depends on the economic conditions prevailing in Poland and globally. Factors with a bearing on the Group s financial performance include: the rate of GDP growth, the inflation rate, the unemployment rate, the level of personal incomes, the government s fiscal and monetary policies, development of the road infrastructure in Poland, as well as of development of services and retail trade. In the event of any economic downturn in Poland or worldwide, a decline in consumer demand or the application of any economic policy measures negatively affecting the market position of the Issuer and its Group, the Group s performance may deteriorate. 1.2 Risks Related to Future Legal Environment The LOTOS Group s business and financial performance are affected by legal regulations (both internal Polish law, and external EU regulations) pertaining to such issues as mandatory stocks, product quality standards, environmental protection, fuel storage, implementation of the National Indicative Target, service stations and pipelines, and competition. Accordingly, the enactment of any new, more stringent regulations, especially in the area of fuel quality and environmental protection, may drive up the operating expenses and capital expenditure of the Issuer and the Group, although the same will apply to the Issuer s competitors. 12

13 1.3 Risks Related to Applicable Tax Laws General Risk of Changes in Tax Laws or Their Interpretations by Tax Authorities and Administrative Courts The tax laws (including those applicable to social security contributions) in addition to being complicated and opaque are also subject to frequent, unpredictable changes. Consequently, their application by tax payers and tax authorities gives rise to many controversies and disputes, which usually need to be resolved by administrative courts. Furthermore, there occur discrepancies in the practice of tax authorities and in judicial decisions given by administrative courts with regard to the tax laws. Striving to ensure that the tax laws are applied in a secure and consistent manner with respect to selected crucial issues, the Company has pursued a policy of applying for individual interpretations of these laws. It sometimes happens that cases where the underlying facts or future circumstances are identical, are resolved in a mutually contradictory or inconsistent manner. As a consequence, disputes are currently pending, and are likely to arise in the future, regarding interpretations of the tax laws obtained by the Company. Should any such interpretations be reversed, the Company may be required to pay taxes on transactions to which they related. Moreover, there can be no assurance that it will not be necessary to adopt different approaches to identical facts in connection with differing interpretations obtained by the Company, or the risk that future disputes may arise on that account with tax authorities. Tax authorities are entitled to inspect the correctness of the Company s tax settlements with respect to tax liabilities that have not become time-barred. Typically, the limitation period applicable to a tax liability expires after five years from the end of the calendar year in which the deadline for the tax payment lapsed. Following such an inspection, the competent tax authorities may assess the Company s tax arrears. All the factors discussed above may have a significant effect on the Company s business, its development plans, legal status, financial position, revenues, profits and other economic parameters of its business Risk Related to Transfer Prices The Company and its subsidiaries enter into numerous intra-group transactions, related mainly to sale of fuels and provision of services. While the Company takes due care to conclude related-party transactions at arm s length, there is a risk of potential disputes with tax authorities on that account. Such disputes may arise, for instance, due to rapid changes in the market conditions taken into account when determining the selling prices of fuels or services applied in such transactions, if they are not factored in properly or at the right time. As a consequence, there is a risk that tax authorities may challenge the market basis of prices applied in such transactions or the correctness of transfer price documentation (or any parts of it). Such circumstances may have a material adverse effect on the Company s business, performance or financial position Risk Related to Excise Duty The Company is a supplier of goods on which excise duty is charged, although some of them are subject to preferential excise duty rates. In order to claim such preferential rates, the Company has to fulfil a number of formal conditions in respect of each transaction. For that purpose, the Company has developed and implemented internal procedures for collecting the documentation required by law as a condition for applying preferential excise duty rates. In addition, the Company performs periodic reviews of its documents, often relying on independent expert support, which allow it to constantly refine the internal procedures with a view to 13

14 minimising tax-related risks. Nevertheless, given that in many cases customs authorities (competent for excise duty) adopt a very stringent approach to the obligations of excise duty payers, and there is no established, unambiguous practice with regard to some excise duty-related issues, one cannot rule out the risk of disputes with customs authorities regarding the Company s right to apply preferential excise duty rates, especially in view of the large number and value of transactions executed by the Company. 2 Risk Factors Associated with the Business of the Issuer and its Group 2.1 Financial Risks The LOTOS Group is exposed to a number of market risks, including mainly the refining margin risk, as well as currency and interest rate risks. In managing those risks, the Issuer relies on derivatives and other financial instruments. Grupa LOTOS has internal procedures in place for managing financial risks, whereas members of the LOTOS Group may use the advice and intermediation of Grupa LOTOS with respect to management of such risks, but enjoy discretion in deciding about the extent to which such risks are hedged and the hedging method Risk Related to Prices of Products and Raw Materials The refining margin risk is connected with the difference between the prices of products sold and the prices of raw materials purchased. Crude oil is the key raw material used by the Issuer. The prices of crude oil on global markets are subject to significant fluctuations driven by changes in global demand for and supply of crude oil, as well as various political factors. The Issuer purchases crude oil under futures and spot contracts, at prices linked to crude oil prices on international markets. On the other hand, the prices of petroleum products offered by the Issuer and its Group depend on the prices quoted on global exchanges. As in the case of other oil companies, the financial position and performance of the Issuer and its Group depend on the difference between the prices of crude oil and the prices of petroleum products on global markets, and changes of the refining margin affect all market players to a similar degree. In 2008 and 2009, the refining margins tended to be lower than in previous years. There is a risk that they may stabilise close to that level in the following years. Additionally, any increases in the prices of petroleum products may dampen demand for such products, which may adversely affect the LOTOS Group s financial standing and performance. In order to mitigate the refining margin risk, the Issuer may decide to enter into hedging transactions, based on its assessment of the prevailing market situation Currency Risk The main sources of the Issuer s exposure to currency risk include foreign currency loans, imports of raw materials, exports of products, as well as domestic sales where prices are linked to foreign currencies. The natural currency of the Issuer s operating market is USD. This currency is used in market quotations for crude oil and petroleum products. Consequently, the Issuer has a structurally long position in USD on its operating activity. For this reason it was decided that USD was the most appropriate currency for contracting and repaying long-term loans to finance the 10+ Programme, as such an approach contributes to reducing the 14

15 structurally long position, and consequently to mitigating the strategic currency risk. In 2009, almost all export sales and import purchases made by the Issuer and the Group were denominated in USD. As at the end of October 2010, the value of foreign currency loans at Grupa LOTOS was USD 1,865.6m. Under the agreement on the financing of the 10+ Programme, Grupa LOTOS has the obligation to maintain a specified level of the hedge ratio for the currency risk (EUR/USD and USD/PLN) which arises in connection with the fact that the currency in which the investment projects are financed is different from the currencies in which project execution agreements are denominated. This obligation remains binding only with respect to payments under agreements for the execution of 10+ Programme projects to be made by mid The Issuer actively manages its currency position and changes it depending on the expected market developments. As at October 29th 2010, the Issuer s currency position, including currency hedges (in the time horizon adopted by the Company i.e. until June 30th 2011) was positive in USD at 3,020,502 and negative in EUR at -377, Interest Rate Risk The Issuer is exposed to market risk arising from changes of interest rates, primarily in connection with floating interest rate loans, reinvestments of surplus cash, and the balance of future cash flows. As at the end of June 2010, the value of floating interest rate loans (denominated both in the złoty and in foreign currencies) was PLN 4,545.9m at the non-consolidated level. Under the agreement on the financing of the 10+ Programme, Grupa LOTOS has the obligation to maintain a specified level of the hedge ratio for the interest rate risk which arises in connection with the LIBOR USD floating interest rate on the credit facility contracted to finance the 10+ Programme in the period until mid In connection with its obligation to maintain the hedge ratio prescribed in the credit facility agreement and given its intention to partly mitigate the interest rate risk which is not covered by mandatory hedges, the Company has entered into hedging transactions. Taking advantage of the favourable market conditions, the Company has hedged a part of its exposure in a time horizon of up to ten years Credit Risk Credit risk is related to uncertainty about the solvency of financial and business partners. Management of credit risk relating to counterparties in financial transactions consists in ongoing monitoring of the credit exposure in relation to the limits granted. The counterparties must have an appropriate credit rating assigned by leading rating agencies or hold guarantees issued by institutions meeting the minimum rating requirement. The Company enters into financial transactions with reputed firms that have a good credit standing. As regards management of credit risk relating to counterparties in business transactions, all customers requesting trade credit undergo verification of their creditworthiness, whose results determine the level of credit limits granted. Furthermore, due to a low concentration of credit risk and the fact that the Company s receivables are monitored on an ongoing basis, the risk of non-collection of receivables is negligible. 15

16 2.2 Technological Risks Technological risks are related to possible failure to meet the required operating parameters for the refinery units, or the risk that the technologies employed would have to be modified in response to market changes. With a view to minimising technological risks, new refinery units are built based on reliable technologies offered by international firms. Moreover, technology assessment of the main units is provided by independent consultants, while agreements for delivery and installation of new units provide for penalties payable by contractors if the units fail to meet the required operating parameters. An additional factor reducing technological risks is the Issuer s extensive track record of successful start-ups of refinery units. 2.3 Technical Risk The LOTOS Group s operating activity in the area of crude oil production and refining is a complex process, subject to rigorous technical regimes. In the course of such activity, various defects of plant, equipment or materials may be identified. Any required repairs or replacements may drive up costs and result in delays, which may affect the LOTOS Group s future financial performance. 2.4 Risk of Industrial Failure In connection with the amount and type of hazardous substances present on the premises of the Issuer and certain LOTOS Group companies, the Issuer and those companies are deemed to be exposed to a high risk of industrial failure, including in particular a risk of emission, fire or explosion taking place in the course of an industrial process, storage or transport, involving one or more hazardous substances, and resulting in an immediate, or delayed, threat to human life or health, or to the environment. Any such failure may materially affect the Issuer s and the LOTOS Group s financial performance. 2.5 Risk of Human Error The activities of the LOTOS Group companies may be materially affected by the occurrence of human error. Any errors made by the service staff due to insufficient qualifications or psychological and physical abilities may cause failures or lead to lower quality of products, which may adversely affect the Issuer Group s financial performance. 2.6 Risk of Competition in Fuel Retailing Competition among the key players on the Polish petroleum products market concentrates in the retail segment, where in addition to the Polish companies foreign corporations are also present. Over the last dozen or so years, the retail market has been developing very rapidly. Nearly all of the largest oil companies engage in intensive competitive activities, focused predominantly on those markets which are the most attractive in terms of the volume of demand and margins: the regions of Silesia, Wielkopolska and Mazowsze. Within the LOTOS Group, LOTOS Paliwa is responsible for the development of the service station network. Through the network development and better adaptation of the offer structure to customers needs, LOTOS Paliwa has been strongly increasing its share in the fuel retail market in Poland. The consolidation of the fuel retail market in Poland continues. Small operators are expected to establish and develop ever-stronger relationships with major market players and integrate into DOFO station networks of such corporations as Grupa LOTOS S.A., PKN Orlen, BP, Shell or Statoil, while larger companies will acquire smaller networks. 16

17 Russian oil companies, which are the principal crude oil suppliers to the CEE markets, have a large influence on the region s retail segment. They are interested in cooperation with and investments in Central European fuel companies. The competition may also be driven by the development of service station networks operated by retail chain stores, which offer products at significantly lower prices than those asked by the other operators on the fuel retail market. Given the location of retail chain stores in Poland, their current pricing policy may lead to price wars. 2.7 Risk Related to the Act on Remunerating Persons Who Manage Certain Legal Entities (the Compensation Cap Act) Members of the Management and Supervisory Boards of the Issuer and its subsidiaries are subject to the provisions of the Act on Remunerating Persons Who Manage Certain Legal Entities. Under the Act, the remuneration of the Issuer s Management Board members may not be higher than six times (and in the case of members of Management Boards of subsidiaries four times) the average monthly remuneration in the enterprise sector, net of bonuses paid out from profit in the fourth quarter of the preceding year, as announced by the President of the Central Statistics Office. The limit results in such persons receiving lower remuneration than the remuneration paid to members of management boards of enterprises that do not fall under the provisions of the Act on Remunerating Persons Who Manage Certain Legal Entities. A direct consequence of this situation is that in the future it may be difficult to hire qualified staff to the management positions at the LOTOS Group companies. 2.8 Risk that the Experience of Members of the Governing Bodies of the LOTOS Group Companies May Prove Insufficient Due to the fact that the composition of the governing bodies is subject to certain restrictions under specific legal regulations (including the Act on Commercialisation and Privatisation of State-Owned Enterprises and the Act on Limitation of Business Activity of Persons Exercising Public Functions), there can be no assurance that in the future the members of the governing bodies will have sufficient experience to be able to assess the advisability of making certain investment decisions. Accordingly, there exists a risk that wrong corporate decisions will be made, including in particular decisions to abandon certain projects which could be profitable in the future. Such situations may have a direct impact on the Issuer Group s financial position and performance as well as the generated cash flows. 2.9 Risk of Refusal or Revocation of a Licence or of Failure to Obtain a Licence Extension A substantial part of the LOTOS Group s activities, in particular production, trade and storage of liquid fuels, is subject to the regulations of the President of the Energy Regulatory Office (URE). In many areas the decisions of the President of URE may be highly discretionary and no assurance can be given that an action taken by the President of URE will not have an adverse effect on the LOTOS Group. Moreover, the regulatory policy of the President of URE may be unpredictable and may change at short notice. 17

18 In addition, the President of URE s full independence from the Polish government is not guaranteed as in accordance with the Energy Law the President may be removed at any time by the President of the Council of Ministers. Therefore, the decisions of the President of URE may be also influenced by political factors. Changes in regulations applicable to the power sector may require the LOTOS Group to incur significant unexpected costs. If power companies fail to meet the requirements of the Energy Law, the President of URE may impose significant financial penalties on them and in some cases failure to comply with the regulations may result in a loss of licences necessary to conduct certain activities. Furthermore, in accordance with the Energy Law, if a threat specified therein (for instance, a threat to Poland s energy security, a threat to safety of people, or a threat of a significant financial loss) occurs, the Council of Ministers may impose, at the request of the Minister of Economy and for a specified period, restrictions on the sale of fuels and on the supply and consumption of electricity and heat across the entire country or in its part. Decisions of regulatory authorities or changes in the regulatory environment may have a material adverse effect on the LOTOS Group s business, its financial position and performance. In order to continue its operations in their current form, the LOTOS Group must maintain the required licences and obtain extension of their validity terms when necessary. Acquisition of new licences may be required for the Group s further growth. If any of the existing licences or other administrative permits is revoked or not extended, or if its scope is limited, or if any new licences or other administrative permits are refused, this may adversely affect the LOTOS Group s business, its financial position and performance Risk Related to Special Rights Vested in the Minister of the State Treasury The Act on Special Rights Vested in the Minister Competent for the State Treasury and How Those Rights Should Be Exercised at Certain Companies or Groups of Companies Operating in the Electricity, Oil and Gas Fuels Sectors, dated March 18th 2010 (Dz.U. of 2010, No. 65, item 404), provides for special rights of the Minister of the State Treasury with respect to companies and groups of companies operating in the electricity, oil and gas fuels sectors, whose assets have been included in the single list of facilities, process units and installations, equipment, and services comprising critical infrastructure. Despite the fact that the Issuer has not been notified by the Minister of the State Treasury of any of its assets having been placed on the list of critical infrastructure, it is highly probable that some of the units and installations operated by the LOTOS Group will be included in such a list. Under the above Act, the Minister of the State Treasury has the right to object to a resolution adopted by a company s management board or its other act in law concerning disposal of critical infrastructure assets which constitute a real threat to the functionality, continuity and integrity of critical infrastructure. The Minister of the State Treasury may also lodge an objection against a resolution of a company s governing body concerning: dissolution of the company, change of intended use or discontinuation of the use of the company s critical infrastructure asset, change of the company s business profile, sale or lease of its business or an organised part of its business, or encumbrance of the business with limited property rights, adoption of a business and financial plan, investment plan or long-tem strategic plan, transfer of the company s registered office abroad if the implementation of such resolution would constitute a real threat to the functionality, continuity and integrity of critical infrastructure. The Act provides for the procedure of appealing to the administrative court against the Minister of the State Treasury s objection. In addition, in accordance with the above Act, the management board of a company, in consultation with the Minister of the State Treasury and the Head of the Government Centre for Security (Rządowe Centrum 18

19 Bezpieczeństwa), appoints and removes from office a proxy responsible for the protection of the critical infrastructure. The proxy has the right to participate in the meetings of the company s management board on which matters related to the critical infrastructure are addressed, and to request the company s governing bodies to provide all documents, information and explanations regarding issues related to the critical infrastructure. The aim behind the appointment of the proxy is to enable the Minister of the State Treasury to obtain information on acts in law performed by the company s governing bodies with respect to critical infrastructure assets. There exists a risk that the Company s restructuring activities will be considered by the Minister of the State Treasury as acts which constitute a real threat to the functionality, continuity and integrity of critical infrastructure and that such activities will be blocked, which may adversely affect the LOTOS Group s financial position and performance. Another consequence of the Act is that the Minister of the State Treasury will receive information which may not be disclosed to other shareholders Risk of Terrorist Attacks On account of their operations Grupa LOTOS and its subsidiaries are exposed to the risk of terrorist attacks, which may lead to a loss of all or some of their significant assets. The consequences of such an attack may affect the LOTOS Group s operations and financial position. However, the risk is of a general nature as it applies to a similar extent to other companies operating in Poland. 3 Risks Related to the Upstream Operations of the Issuer and Its Group The Issuer s Group conducts upstream operations described in Section 6.1 of the Registration Document. Material risks related to such operations are presented below. 3.1 Risk Related to the Estimation of Deposit Size The information on the amount of hydrocarbons accessible to the LOTOS Group at present or potentially in the future is based on geological documentation and field development plans (or equivalent documents in Lithuania and Norway). Such information is subsequently revised in resource surveys and deposit models or following the acquisition of data from the neighbouring licence areas. On the one hand, such revisions contribute to more precise appraisal of the deposits, but on the other, they may lead to a change of a field boundaries or the need to adjust the field development concept. Moreover, the estimation procedure applied to determine the amount of resources may be imprecise as it depends on many variable factors and assumptions, including the interpretation of geological and geophysical data, assumptions concerning the intended manner of production from the formation, and assumptions with respect to behaviour of hydrocarbons in the reservoir. The estimated amount of resources is also dependent on assumptions concerning the sales of a given type of hydrocarbons, taxation and licence fees. Therefore, there can be no assurance that the estimated amount of resources will be not be revised (increased or decreased) as more reservoir parameters are measured. Any material reduction of the 19

20 estimated deposit size may shorten the assumed production period. If such reduction is made with respect to a long-term project or prospect, it may also cause the Company to decide not to proceed with production activities on a given field. In consequence, such unfavourable changes may adversely affect the LOTOS Group s future financial performance. 3.2 Risk Related to the Launch of Production from New Deposits An important aspect of the LOTOS Group companies operations is the need to ensure future production capacity by obtaining access to new crude oil and natural gas reserves. At present, the LOTOS Group is carrying out analyses and making preparations as part of a few new investment projects. There are many reasons why the LOTOS Group may not be able to discover or acquire oil and gas resources or establish their commercial production. For example, it may fail to obtain a licence or be unable to negotiate commercially reasonable terms of acquisition of such resources, their exploration, appraisal and launch of production. Moreover, there exist a number of risks which are entirely beyond the control of the LOTOS Group companies, including risks related to accidents, environmental risks or the risk of delays in the delivery of equipment. If the activities aimed at acquiring new deposits and producing hydrocarbons from such deposits are limited or abandoned, or if there occur any unexpected formal and legal or technical difficulties during preparations preceding the launch of production, the LOTOS Group s production capacity may be reduced and consequently the production of hydrocarbons may be lower than assumed, which may affect the LOTOS Group s future performance. 3.3 Risk Related to Oil and Gas Prices The profitability and cash flows of the LOTOS Group and its subsidiaries will by driven by future prices of crude oil and natural gas, which are known to fluctuate. There are many causes of such fluctuations, including local and global supply and demand, expected future supply, estimated future economic growth in the countries which have the largest share in consumption of global hydrocarbons production, cost and availability of new production technologies, political, economic and military developments in countries and regions where oil and gas are produced, in particular in the Middle East. Moreover, hydrocarbon prices are influenced by tax systems in oil and gas producing countries as well as by cartel activities. Any significant drop in prices of crude oil and natural gas relative to their historical levels may have a material adverse effect on the LOTOS Group s financial performance. 3.4 Risk Related to High Cost of the Technologies Used by the Company The technology applied by the LOTOS Group in offshore production of crude oil and natural gas involves the use of specialist machinery and equipment manufactured by few shipyards in the world. In connection with the global consolidation of manufacturers of some of the above machinery, equipment and platforms, as well as the possibility of additional certification requirements which may be imposed on designers and manufacturers of such equipment, there exists a risk of an unexpected rise in its prices, which could increase the capital expenditure required to implement the Group s development strategy. 20

21 3.5 Risk Related to Decommissioning of Mines In accordance with the provisions of the Geological and Mining Law, the LOTOS Group companies are required to decommission production infrastructure and plug wells after discontinuing operations in a given production area. LOTOS Petrobaltic maintains a mine decommissioning fund and LOTOS Petrobaltic s subsidiaries also maintain such funds or recognise provisions in accordance with the accounting and tax regulations applicable in the countries in which they operate. In addition, based on the documents prepared by the Company and approved by relevant authorities (field development plan, mine operation plan, or similar or equivalent documents), the expected scope and nature of action that the LOTOS Group companies will be required to take in the future to decommission the existing mines is known with a certain degree of accuracy. There exists a risk that in the future the action which is currently planned and described in the above documents will be considered insufficient as a result of regulatory changes or changes in standards applicable in the Baltic Sea, the North Sea, the Norwegian Continental Shelf or in Lithuania. The planned action may also be insufficient due to changes in certain geological and technical parameters of the fields where the mines operate. Accordingly, there can be no assurance that the costs of mine decommissioning will not exceed the anticipated level, which may adversely affect the LOTOS Group s financial performance. 3.6 Risk of Failure to Obtain the Extension of Licences for Exploration and Appraisal of Minerals In June and July 2010, Petrobaltic applied to the Minister of Environment for the extension of seven licences for offshore exploration and appraisal of minerals in Poland. No assurance can be given that the Minister of Environment will extend all licences or that the conditions for granting the extensions will match Petrobaltic s expectations. As the regulations have changed since the licences were granted, new (additional) requirements may be imposed on LOTOS Petrobaltic, whose scope is currently unknown. Failure to obtain the extension of some licences or imposition of new requirements in administrative decisions may affect LOTOS Petrobaltic s future investment plans, and therefore have an adverse effect on the LOTOS Group s financial performance. 3.7 Insurance Risk Although operations of the LOTOS Group s subsidiaries are insured, all companies conducting exploration, appraisal and production of minerals are exposed to non-insurable risks and/or certain risks which would require purchase of separate insurance with many exclusions and a very high deductible. Furthermore, no assurance can be given that the insurance taken out will be adequate to cover possible losses or liabilities. The occurrence of an unfavourable event not covered by insurance, in whole or in part, could directly affect the Group s financial position, its performance and the generated cash flows. 3.8 Risk of Certain Project Partners or Shareholders Not Granting Their Approval to Proceed with a Project The Petrobaltic Group is pursuing many of its minerals exploration and appraisal projects with two or more partners, which is now a common practice around the world, applied in order to leverage the expertise of multiple parties and to reduce the risk related to a particular project. 21

22 Despite numerous advantages of such a solution, there is always a risk that certain partners may refuse to grant their approval to proceed with a project on the grounds of too great a risk, which may result in abandonment or suspension of a ready-to-launch project. In such cases, it may not be possible to implement the project with only certain parties bearing the risk. Such situations may result in a reduced number of executed projects and can therefore affect the LOTOS Group s financial position, its performance and the generated cash flows. 3.9 Risk of Failure to Obtain a Permit for the Construction of Transmission Pipelines in a Particular Location Certain long-term projects executed by the Petrobaltic Group are situated in places where it may be difficult to obtain a permit for the construction of oil or gas transmission pipelines due to spatial planning restrictions, local planning policy, protection of certain areas, or lack of relevant resolutions of the competent authorities. Therefore, certain projects (both off- and onshore) may require expenditure to obtain permits and approvals for the construction of pipelines that is significantly higher than expected. In such cases, the LOTOS Group s financial position, its performance and the generated cash flows may be adversely affected Risk Related to Restrictions on Exploitation of Gas Deposits Due to recurring problems with maintaining uninterrupted and stable gas supplies in the CEE region, the governments of some countries may impose special restrictions on the exploitation of certain natural gas deposits. Such restrictions may be based on the existing laws or may follow from new regulations. As a result, the sale of gas (for example its exports, off-peak or non-winter sale) may be limited. Such restrictions may affect LOTOS Petrobaltic to the same or similar extent as other natural gas investors, and their introduction may have an adverse effect on the LOTOS Group s financial position and performance, as well as the generated cash flows Risk Related to the Interpretation of the Provisions of Polish Energy Law Concerning Pipelines that Cross Polish Borders Under Polish Energy Law, interconnections with other gas systems should be operated by the transmission system operator (an energy company involved in the transmission of gas fuels). As LOTOS Petrobaltic intends to exploit gas deposits located outside the territory of Poland, it may be assumed (although the issue is not perfectly clear) that they should be viewed as covered by other gas system. Accordingly, it may be required that the section of the gas system connecting the offshore mine with land (i.e. the section crossing the Polish border) should be operated by the transmission system operator. Also, in such a case it may be necessary that other entities should be given access to the transmission system in accordance with the Third Party Access principle (TPA), or that an exemption from such requirement under Art. 4i of the Polish Energy Law should be obtained. Currently there are a number of disputes concerning application of the TPA principle in relation to a few gas transmission pipelines which cross Polish borders. This may have an adverse effect on the interpretation of this issue with respect to such offshore pipelines planned by LOTOS Petrobaltic. If any of the difficulties described above occur, the LOTOS Group s financial standing, its performance and the generated cash flows may be affected. 22

23 3.12 Risk Related to Joint and Several Liability of All Licence Partners In line with the Norwegian government s regulations governing operations conducted on the Norwegian Continental Shelf, all licences granted to partners in a consortium impose joint and several liability on all consortium members. Such joint and several liability may apply not only during exploration and appraisal of minerals, but also during their production, and it also extends to all ships (such as tankers or service ships) moored to production platforms. Therefore, if any of licence partners cannot meet its financial liabilities, LOTOS EPN s liability under such licence may be increased, which may affect the company s financial position, its performance and the generated cash flows. Furthermore, when LOTOS EPN applied for an authorisation to operate on the Norwegian Continental Shelf, LOTOS Petrobaltic issued guarantees for LOTOS EPN s liabilities. Therefore any material liability of LOTOS EPN as described above may also directly affect the LOTOS Group s financial position Risk of Delays in Field Development Plans Resulting from Discovery of a Deposit Extending beyond the Licence Area One of the geological risks related to exploration and appraisal of minerals is that a discovered and documented hydrocarbon accumulation may be partly located outside of the licence area. Such a situation requires obtaining an extension of the licence area already held, or connecting separate licence areas, which is often time-consuming and requires permits and approvals of many parties. Due to the great number of executed projects, there can be no assurance that a situation described above will not occur, adversely affecting development of a given field. The risk applies mainly to the operations on the Norwegian Continental Shelf, but it may also occur with respect to the operations in the Baltic Sea, including in particular the licences held by Petrobaltic for areas located close to the borders of the Polish Exclusive Economic Zone Risk Related to Availability of Drilling Equipment Exploration and documentation activities related to hydrocarbon deposits depend on the availability of drilling machines and other ancillary equipment. The current high demand for drilling equipment, coupled with its limited availability, may adversely affect the ability of the LOTOS Group companies to fulfil their obligations under field development plans and plans for mineral exploration. In particular, this refers to projects where LOTOS EPN is not the operator and where it has indirect influence (through influence on the licence operator). Limited access to drilling equipment may adversely affect the financial position of the LOTOS Group companies, their performance and the generated cash flows Risk Related to the Management of Certain Assets by Third Parties All production assets of the LOTOS Group located in Poland and in the Polish Exclusive Economic Zone are managed by LOTOS Petrobaltic. On the other hand, assets held by the subsidiaries in Norway and Lithuania (except for three licences listed below) are managed by entities over which LOTOS Petrobaltic exercises 23

24 indirect corporate supervision within the scope of its powers, or exercises supervision as a consortium member. With respect to licences PL 556, PL 503 and PL 498, LOTOS EPN is the licence operator (see Section 11.1 of the Registration Document). Operational agreements with entities which are operators under other licences on the Norwegian Continental Shelf as well as agreements with shareholders exercising operational control over assets located in Lithuania, grant LOTOS Petrobaltic the right to hold consultations and require the company s approval for important issues. LOTOS Petrobaltic s ability to control day-to-day management and decisions whether to embark on or abandon an exploration and appraisal project, is, however, limited. Management errors of the abovementioned entities may result in delays or increased costs. Such situations may have an adverse effect on the financial position of the LOTOS Group, its performance and the generated cash flows Risk Related to Regulations on the Prevention of Environmental Damage New regulations that have been implemented by the UE since 2007 allow the competent authorities to impose limitations on businesses viewed as potential polluters in order to prevent or remedy environmental damage. In accordance with the abovementioned regulations, if the environmental damage or imminent threat of the damage is caused by several operators, they are jointly and severally liable for the damage. The remedial measures to be taken are defined by virtue of an administrative decision. Additionally, in the event of damage to the environment, the competent authorities may require the perpetrator to undertake compensatory remediation aimed at compensating for losses that occur from the date of the damage until the recovery of the baseline or equivalent condition or until the achievement of a similar condition of environmental components or their functions. The new regulations enable competent authorities to require that security be provided, including financial security in the form of a deposit, a bank guarantee, an insurance guarantee or an insurance policy. The governmental authorities of the two countries where LOTOS Petrobaltic conducts activities which may fall under the environmental damage regulations do not have much experience in interpreting and implementing the new laws. Irrespective of the above, there can be no assurance that the application of those regulations will not have a material effect on investment decisions made by the Company. If the authorities instructions, decisions or interpretations substantially affect the possibility of designing particular units for exploration, appraisal and production of minerals, the Company may be forced to abandon certain investment projects or shorten the life of existing ones. Such limitations may lead to some projects being completely abandoned or executed within a limited scope only and/or with use of more expensive technical solutions. This may have a material adverse effect on the financial performance of LOTOS Petrobaltic and its subsidiaries. 24

25 4 Risks Related to Implementation of the 10+ Programme by the Issuer Given the fact that implementation of the 10+ Programme (see Section 5.2 of the Registration Document) reached 99.81% as at the end of September 2010, most risks connected with the programme diminished or ceased to exist. However, these risks are still being monitored and controlled. They include, among other things: delivery/fitting in of defective installations/equipment and materials, leading to the necessity of repairs and replacements, increased costs and delays, bankruptcy of subcontractors, as a result of various phenomena caused by the global crisis, leading to delays in execution of the project, forfeiture of payments made and the necessity to buy additional material, construction failures caused by difficult working conditions or non-observance of applicable procedures, leading to work stoppages, delays and exceeding the budget, failure to achieve full process parameters by the new units due to hidden design/engineering defects, leading to additional costs having to be incurred to bring a unit to a condition where it achieves its basic design/engineering parameters, or loss of profit, adverse weather conditions resulting in delays and damage to installed equipment, protests and objections raised by third-party individuals or institutions, related e.g. to the project s environmental impact, leading to work stoppages and delays or administrative decisions being withheld, accidents caused by difficult working conditions or high concentration of work carried out in a confined area, or failure to observe the health and safety at work rules, temporary suspension of financing, leading to work stoppages due to lack of funds. 4.1 Risk Related to Ensuring Market for Products of the New Refinery Units The implementation of the 10+ Programme will increase the Gdańsk refinery s annual capacity to 10.5 million tonnes and will result in a rise in production volumes, which involves the risk of insufficient market demand for the new products. In order to minimise this risk, the Issuer was gradually increasing its share in the domestic market by importing fuels while the 10+ Programme was being carried out. In view of the above and given the current structural shortage of diesel oil in Poland as well as the Issuer s export capacity, there should be no difficulty in selling additional quantities of products after the 10+ Programme is completed. 25

26 5 Environmental Risks 5.1 Risk of More Stringent Standards and Legal Regulations Concerning Environmental Protection Legal regulations on the economic use of environment and natural resources by businesses are amended on an ongoing basis. In recent years, the EU laws on environmental protection have become more and more stringent. It should be noted that the draft of a new directive on industrial emissions, which introduces stricter rules and conditions for emitting pollutants into the atmosphere, is at the last stage of the legislative procedure. Moreover, Polish legislators are currently drafting new regulations concerning the implementation of waste management principles that would comply with the new Waste Framework Directive, clarifying the criteria for classification of substances and materials as waste and defining new, more comprehensive principles of waste management. The EU member states have already commenced implementation of the energy and climate package whereby greenhouse gas emissions are to be reduced by 20% by 2020, however, the level is likely to be raised to 30%. There can be no assurance that there will be no further legislative changes tightening environmental regulations in the sector of the Issuer or other LOTOS Group companies. Such potential changes may require the companies of the LOTOS Group to ensure compliance with the new requirements (e.g. to alter their technologies in order to reduce emissions into the air or improve waste management), thus generating capital expenditure and consequently adversely affecting the Group s financial performance. 5.2 Risk of Environmental Damage Caused by the Operations of the Issuer or Other LOTOS Group Companies The operations of the Issuer and other LOTOS Group companies have a significant impact on the natural environment. The nature of the companies business entails the risk of incidents that may cause pollution of various components of the environment (in particular the risk of industrial failure or leakage of substances to terrestrial and aquatic environment from the units operated by the Issuer or other LOTOS Group companies), and consequently give rise to financial liability. When environmental damage occurs, the Issuer and/or other LOTOS Group companies may be required to undertake remediation activities in order to remove the pollution. In addition, where the incident involves damage to property or injury to a person, the Issuer and/or other LOTOS Group company may also be obliged to pay compensation under civil liability. While the Issuer and the LOTOS Group companies implement all available organisational and investment measures to counteract the risk of environmental damage, such risk cannot be fully eliminated. The cost of any potential remediation effort and the Issuer s financial liability may be estimated only on a case by case basis, after the occurrence of an incident. Therefore, at the present stage it is impossible to assess its potential adverse impact on the LOTOS Group s financial performance. 5.3 Risk of Increased Expenditure on Projects with Negative Impact on the Environment Pursuant to the applicable laws and due to the business profile of the Issuer s Group, most of the investment projects planned by the Issuer and other companies of the LOTOS Group (including new construction projects, major upgrades of units, or exploration, appraisal and production activities related to hydrocarbon reserves), must be analysed in terms of their potential environmental impact, and in particular, adverse effect on environmentally sensitive areas (such as areas protected under Natura 2000 programme, nature reserves, 26

27 national and landscape parks). Grupa LOTOS or another company of the LOTOS Group implementing a particular project may be required to prepare the assessment of the project s environmental impact and apply for a decision defining environmental conditions for the project. The issuance of such a decision is a precondition for obtaining other necessary permits for the project execution (including a building permit or a licence for exploration, appraisal and production of minerals). Following the assessment of environmental impact, certain obligations may be imposed on the investor to eliminate the adverse effect on the environment, which in practice usually involves additional capital expenditure and higher costs of project execution. Increased capital expenditure may adversely affect the Issuer s financial performance. 5.4 Risk Related to the Company s Participation in the Greenhouse Gas Emissions Trading Scheme The Issuer participates in the EU Emissions Trading Scheme in connection with its emissions of carbon dioxide from its CHP and refinery installations. The emission allowances allocated to the Issuer for (a part of the second trading period) covered the actual emissions from the Issuer s installations in that period. However, the ongoing modernisation and extension of the Gdańsk refinery, implemented under the 10+ Programme, will contribute to an increase in carbon dioxide emissions from the Issuer s installations and thus the emission allowances granted to date will not be sufficient (the Issuer estimates that it will need about 1,500 additional allowances in each settlement year). The Issuer has applied for additional allowances for next years. The proceedings are pending. Without additional allowances the Issuer would have to reduce carbon dioxide emissions (that is to limit the production) or to purchase allowances on the market. This may adversely affect the Issuer s financial performance. It also should be noted that in the next, third trading period of the Emissions Trading Scheme ( ), the scheme will operate under amended rules, with the amendments including changes in the allowance allocation rules. After 2012, the basic way for obtaining allowances will be auctioning (purchase of required allowances at an auction). Only in special cases, specified under the ETS Directive and the implementation regulations, and exclusively within predefined time windows, operators of the installations covered by the scheme will be entitled to obtain a pool of emission allowances free of charge. As the EU implementation regulations are currently being drafted and agreed upon, as at the Prospectus Date it was not definitely determined what quantity of free-of-charge allowances the Issuer will be entitled to. However, no assurance can be given that the Issuer will not have to purchase a part of required allowances at an auction, which may adversely affect the LOTOS Group s financial performance. 5.5 Investment Risks Related to the Proximity of Protected Areas Some of the areas covered by licences for the exploration and appraisal of minerals (or equivalent documents) held by the Petrobaltic Group s companies (including subsidiaries operating in Lithuania and Norway) are located in the direct proximity of protected areas or overlap with such areas. This does not hinder the operations of the Petrobaltic Group as they are carried out now, but any planned investment activities of the Petrobaltic Group need be analysed in terms of their potential impact on the protected areas. Such analyses also have to cover any possible interaction between the planned method of transporting the minerals produced to the end user and the location of protected areas. The applicable legal regulations stipulate that business activities which adversely affect the natural environment in (and in the vicinity of) protected areas may be subject to significant limitations. Such limitations might prevent the execution of certain investment projects, limit the scope of such projects, and/or force the 27

28 use of more expensive technological solutions. Consequently, this may adversely affect the financial performance of LOTOS Petrobaltic and its subsidiaries. 6 Risks Related to the Issuer s and Its Subsidiaries Property, Plant and Equipment 6.1 Risk Related to Security Interests in the Issuer s Property, Plant and Equipment As stated in Section 8.1. of the Registration Document, the majority of the Issuer s significant real estate and movables have been encumbered to secure the Issuer s liabilities contracted in connection with the implementation of the 10+ Programme. In accordance with the agreement creating registered pledge over assets, dated June 27th 2008 (described in more detail in Section of the Registration Document) the creditors claims may be enforced against the pledged assets by taking over the ownership of the refinery. Accordingly, a risk exists that the Issuer may lose its assets if it is not able to settle its financial liabilities, including in particular where the gains on the implementation of the investment programme prove lower than expected. 6.2 Risk Related to Real Estate with Unresolved Legal Status The total area of real estate described in Section 8.1 of the Registration Document does not include the real estate to which the Issuer does not hold any legal title and on which transmission infrastructure is located. The Issuer uses without a legal title third parties real estate on which fuel and water pipelines, as well as the Issuer s associated infrastructure are located. The legal status of the Issuer s use of some of the real estate located along the route of the pipeline running to the storage reservoir in Przejazdowo and being predominantly property of natural persons, as well as some of the real estate located along the route of the pipeline running to Port Północny (the Northern Port) being predominantly property of the City of Gdańsk or the State Treasury, has not been resolved. Under Art of the Polish Civil Code, the owners of real property through which the pipelines run are entitled to claims against the Issuer for the establishment of easement, remuneration and compensation for extra-contractual use, as well as a claim for the removal of infrastructure from the real estate or its relocation. 6.3 Risk Related to Former Owners Claims to Significant Real Estate (Pertaining to the Right of Perpetual Usufruct and the Ownership) The Issuer s significant real estate was originally acquired by the State Treasury in accordance with legal regulations which are no longer effective, and the available archival documentation is incomplete. Accordingly, it cannot be definitely determined whether all conditions for effective and legal acquisition were met. Therefore, a risk exists that the former owners might raise claims to this real estate. In addition to claims for discontinuing extra-contractual use of real estate and removal of the infrastructure located thereon, it is also possible that the former owners would raise claims against the Issuer for remuneration for extra-contractual use of the real estate and for compensation. Currently, two proceedings are pending for a declaration of nullity of decisions on expropriation of real estate, pertaining to land lots representing a part of the Issuer s significant real estate. The proceedings pertain to lots located in Przejazdowo in the Municipality of Pruszcz Gdański: Lot 28

29 No. 5/3 (the flare exclusion zone) and Lots No. 5/13 and No. 5/14 (a part of the access road to the refinery and a lane in Benzynowa street), which are entered in the Land and Mortgage Register maintained by the District Court for Gdańsk-Północ in Gdańsk under No. KW GD1G/ / Risk Related to the Planned Property, Plant and Equipment Execution of the investment project connected with the extension of the refinery under the 10+ Programme, as described in detail in Section 5.2. of the Registration Document, requires the Issuer to obtain a number of administrative decisions and permits for the construction and operation of facilities. Given the fact that some of significant units described in Section of the Registration Document are still under construction, there is a risk related to the obligation to obtain operating permits for such units and a risk that the competent administrative body may lodge objections in the cases provided for in the Construction Law of July 7th 1994 (Dz.U. No. 156, item 118, as amended). Any delay in obtaining or failure to obtain the necessary permits and administrative decisions may cause a delay in the commissioning of certain units constructed under the 10+ Programme, which in turn may make it impossible to meet the production and financial targets, thus adversely affecting the implementation of the Issuer s growth strategy. 6.5 Risk Related to the Termination or Expiry of Material Agreements for the Issuer s Use of Significant Real Estate under a Legal Title Other Than Ownership or Right of Perpetual Usufruct The Issuer uses real estate in the form of land with a total area of 118,237 square metres under agreements providing for a legal title other than ownership or right of perpetual usufruct. Some of the agreements are deemed of material importance to the Issuer on account of the type of the Issuer s transmission infrastructure located on the real estate. The infrastructure includes a storm pump station, water pipelines, fuel pipelines with the accompanying infrastructure supporting product dispatch and wastewater discharge. In the case of some of those agreements there is a risk that they may be terminated or expire upon the lapse of their respective terms, thus depriving the Issuer of the legal title to real estate and placing it under the obligation to remove the equipment and units or installations located on such real estate. 7 Risks Related to the Shares and Trade in the Shares 7.1 Risk of Refusal to Introduce or of Delayed Introduction of the Issuer Shares to Trading on the Regulated Market Operated by the WSE Series C Shares will be admitted to trading on a regulated market under Par. 19 of the WSE Rules, provided that the requirements specified in the WSE Rules and in the provisions of the Regulation of the Minister of Finance on detailed requirements for an official stock-exchange listing market and issuers of securities admitted to trading on such market, dated May 12th 2010 (Dz.U. No. 84, item 547), are met. If it is found that Series C Shares do not meet the conditions stipulated in the legal regulations referred to above, the Management Board of the WSE may decide to refuse to admit the shares to trading on the regulated market. The application for the introduction of the shares to trading on a regulated market may be resubmitted only after the lapse of six months from the date of delivery of the WSE Management Board s resolution on the refusal, and if an appeal has been submitted, from the date of delivery of another resolution on the refusal. 29

30 Nevertheless, the Issuer will make every effort to arrange for Series C Shares to be introduced to trading on the regulated market operated by the WSE as soon as possible after the Prospectus approval date. However, the shares may be introduced to stock-exchange trading only after: the Management Board of the Polish NDS adopts a resolution to register Series C Shares and assign an ISIN code thereto, the Management Board of the WSE adopts a relevant resolution to introduce Series C Shares to stockexchange trading after their registration with the Polish NDS. If the proceedings before the Polish NDS or WSE get prolonged, in particular by the Issuer s fault, the introduction of Series C Shares to trading on the WSE may be delayed, which would in turn limit the possibility of reselling the shares. 7.2 Risk Related to the PFSA Imposing Sanctions on the Issuer Potential investors are advised to consider the risks related to the possibility of PFSA imposing sanctions on the Issuer if the Issuer violates the law or there is a reasonable suspicion that such violation has occurred or may occur. In particular, pursuant to Art. 17 of the Public Offering Act, if the Issuer or any other entity acting on behalf of, or on instructions from, the Issuer violates the law in connection with the seeking of admission of securities to trading on a regulated market, or there is a reasonable suspicion that such violation has occurred or may occur, the PFSA may: order that the admission of the securities to trading on a regulated market be withheld for a period of not more than 10 business days; or proscribe admission of the securities to trading on a regulated market; or p, at the expense of the Issuer, information concerning the illegal activities with respect to seeking of admission of securities to trading on a regulated market. Pursuant to Art. 18 of the Public Offering Act, the PFSA may apply the measures provided for in Art. 17 of the Act also if the contents of the documents or information submitted to the PFSA or made available to the public indicate that: the admission of the securities to trading on a regulated market would materially compromise investors interests; circumstances exist that, in the context of legislation in force, may lead to termination of the Issuer s legal existence; activities of the Issuer were, or are, conducted in gross violation of applicable laws, which may have a material impact on the assessment of Issuer s securities, or, in the context of legislation in force, may lead to termination of the Issuer s legal existence or to the Issuer s bankruptcy; or the legal status of the securities does not comply with applicable laws, and in the context of those laws there is a risk that the securities would be considered nonexistent or burdened with a legal defect having a material impact on their assessment. Investors should also note that pursuant to Art of the Act on Trading in Financial Instruments, if justified by the security of trading on the WSE or a threat to investors interests, at the demand of the PFSA the 30

31 Management Board of the WSE withholds the admission to trading on the WSE or the listing of the securities or other financial instruments indicated by the PFSA for up to ten days. Pursuant to Art. 96 of the Public Offering Act, if the Issuer fails to perform or improperly performs the obligations and orders listed in Art of the Act or acts in breach of the obligations referred to therein, the PFSA may: issue a decision excluding given securities from trading on a regulated market for a definite or indefinite period, or impose, taking into account in particular the financial standing of the entity on which the penalty is to be imposed, a pecuniary penalty of up to PLN 1,000,000, or apply both these sanctions jointly. Further, pursuant to Art. 176 of the Act on Trading in Financial Instruments, if the Issuer fails to perform or improperly performs the obligations connected with inside information and referred to in Art. 157, Art. 158 or Art. 160 of the Act, the PFSA may: issue a decision that the relevant securities be excluded from trading on the regulated market; or impose a pecuniary penalty of up to PLN 1,000,000; or issue a decision that the securities be excluded, for a definite or indefinite period, from trading on the regulated market and impose the pecuniary penalty referred to above. In such circumstances, investors may find it difficult to sell the Issuer shares and may have to incur higher additional costs and settle for a significantly lower price than the market price quoted at the last trading session on the day before the Issuer shares were excluded from stock-exchange trading. 7.3 Risk Related to the WSE Suspending Trading in the Shares or Excluding the Shares from Trading on a Regulated Market Pursuant to Par. 30 of the WSE Rules, the Management Board of the WSE may suspend trading in the shares on the WSE for up to three months: at the Issuer s request, if the Management Board of the WSE decides that such suspension is required by the interests and security of the trading participants, or if the Issuer is in breach of the regulations governing the WSE. Moreover, pursuant to Par of the WSE Rules, the WSE Management Board suspends trading in shares for a period of maximum one month upon request of the PFSA made in accordance with Art of the Act on Trading in Financial Instruments if the trading in specified securities or other financial instruments is performed in circumstances suggesting a possible threat to the proper operation of a regulated market, security of trading on that market, or investors interests. Further, pursuant to Par. 31 of the WSE Rules, the WSE Management Board delists securities: if their transferability has become restricted, upon request of the PFSA made in accordance with the Act on Trading in Financial Instruments, 31

32 if they are no longer in book-entry form, or if they are delisted from trading on a regulated market by a relevant supervision authority. Moreover, the WSE Management Board may also delist securities: if they cease to fulfil the conditions for admission to stock-exchange trading other than the unrestricted transferability condition, if the Issuer is persistently in breach of any of the WSE rules and regulations, at the Issuer s request, upon declaration of the Issuer s bankruptcy or in the event of the court s dismissal of a bankruptcy petition on the grounds that the assets owned by the Issuer are insufficient to cover the costs of the proceedings, if it deems it justified by the need to safeguard the interest of trade participants and ensure their security, in the event of the Issuer s merger with another entity, its division or transformation, if no stock-exchange transactions in a given financial instrument have been executed in the last three months, in the event of the Issuer engaging in illegal activities, if liquidation proceedings are opened with respect to the Issuer. Suspension of trading in the Shares on the WSE or their exclusion from trading for any of the reasons referred to above may adversely affect the liquidity of the Shares and, consequently, may lead to a decline in the value or price thereof. 7.4 Risk Related to Share Price Volatility The price and liquidity of the Issuer shares depend on the number and volume of buy and sell orders placed by stock-exchange investors. Investors behaviour is driven by various external factors which are not directly connected with the Issuer s financial standing. Therefore, trading in the shares on a regulated market may be subject to significant share price volatility. Accordingly, in the periods of market disruptions, caused for instance by developments of the economic or political situation, both in Poland and globally, and adversely affecting the financial markets, investors may find it difficult to sell the Issuer shares at a satisfactory price. 32

33 III REGISTRATION DOCUMENT 1 Responsible Persons 1.1 Persons Responsible for Information Contained in this Prospectus Issuer Company name: Grupa LOTOS Spółka Akcyjna Abbreviated name: Grupa LOTOS S.A. Registered office: Gdańsk Address: ul. Elbląska 135, Gdańsk Contact numbers: Tel: Fax: lotos@grupalotos.pl Web page: The following persons may make declarations of will on behalf of the Company: - two Members of the Management Board acting jointly, - one Member of the Management Board acting jointly with a commercial proxy. DECLARATION UNDER COMMISSION REGULATION (EC) NO. 809/2004 of April 29th 2004 Acting on behalf of Grupa LOTOS S.A. as the entity responsible for all the information contained in this Prospectus, we hereby represent that to the best of our knowledge, after taking all reasonable care to ensure that such is the case, the information contained in this Prospectus is true, reliable and in accordance with the facts, and contains no omission likely to affect its import.. Paweł Olechnowicz President of the Management Board.. Mariusz Machajewski Vice-President of the Management Board. Marek Sokołowski Vice-President of the Management Board.. Maciej Szozda Vice-President of the Management Board 33

34 1.2 Entities Responsible for the Preparation of this Prospectus Legal Advisor Company name Kancelaria Prawna Domański i Wspólnicy Spółka Komandytowa Abbreviated name: Kancelaria Prawna Domański i Wspólnicy Sp.K. Registered office: Gdańsk Address: ul. Elbląska 135, Gdańsk Contact numbers: Tel: Fax: kancelaria@kpdi.pl Website: The person acting on behalf of Kancelaria Prawna Domański i Wspólnicy Sp.K.: Robert Ignatiuk General Partner Based on the information furnished or confirmed by the Company, Kancelaria Prawna Domański i Wspólnicy Sp.K. prepared with due professional care and remains responsible for the following parts of this Prospectus: a) in Part II Risk Factors, Sections: 2.7, 2.8, 2.9, 2.10, 5.1, 5.2, 5.3, 5.4, 6 b) in Part III Registration Document, Sections: 6.4, 8, 11.2,17, 19, 22 c) in Part IV Securities Note, Sections: 4.5, 4.8, 4.10 DECLARATION UNDER COMMISSION REGULATION (EC) NO. 809/2004 of April 29th 2004 Acting on behalf of Kancelaria Prawna Domański i Wspólnicy Sp.K., I hereby represent that to the best of my knowledge, after taking all reasonable care to ensure that such is the case, the information contained in the parts of this Prospectus for which Kancelaria Prawna Domański i Wspólnicy Sp.K. is responsible, is true, reliable and in accordance with the facts, and contains no omission likely to affect its import. Robert Ignatiuk General Partner 34

35 1.2.2 Offeror Company name: IPOPEMA Securities S.A. Abbreviated name: IPOPEMA Registered office: Warsaw Address: ul. Waliców 11, Warsaw Contact numbers: Tel: Fax: ipopema@ipopema.pl Web page: The persons acting on behalf of Ipopema: Mariusz Piskorski Vice-President of the Management Board Mirosław Borys Vice-President of the Management Board The Offeror has prepared with due care, on the basis of information provided or confirmed by the Company, and is responsible for, the following sections of this Prospectus. IPOPEMA Securities S.A. participated in the preparation of the following parts of this Prospectus: a) in Part II Risk Factors, Section 7 b) in Part IV Securities Note, Section 6 DECLARATION UNDER COMMISSION REGULATION (EC) NO. 809/2004 of April 29th 2004 Acting on behalf of IPOPEMA Securities S.A. of Warsaw, we hereby represent that to the best of our knowledge, after taking all reasonable care to ensure that such is the case, the information contained in the parts of this Prospectus for which IPOPEMA Securities S.A. is responsible, is true, reliable and in accordance with the facts, and contains no omission likely to affect its import. Mariusz Piskorski Vice-President of the Management Board Mirosław Borys Vice-President of the Management Board 35

36 2 Auditors 2.1 First Names and Surnames (Names), Addresses and Membership of Professional Organisations The auditor which reviewed the interim consolidated financial statements of the LOTOS Group and the condensed financial statements of Grupa LOTOS S.A. for the six months ended June 30th 2010, which are incorporated by reference in Section 20 of the Registration Document, was: Ernst & Young Audit Sp. z o.o. of Warsaw, with registered office at Rondo ONZ 1, Warsaw, Poland, tel.: , fax: Ernst & Young Audit Sp. z o.o. is a member of the National Board of Chartered Auditors (Krajowa Rada Biegłych Rewidentów) and is entered in the register of entities qualified to audit financial statements under No Ernst & Young Audit Sp. z o.o. does not hold any material interest in the Company. In particular, as at the Prospectus Date it does not hold Shares representing more than 1% of the Company s share capital. The auditor issuing opinion on the historical financial information of the LOTOS Group for the twelve months ended December 31st 2007, December 31st 2008 and December 31st 2009, which is incorporated by reference in Section 20 of the Registration Document, was: Deloitte Audyt Sp. z o.o., with registered office at al. Jana Pawła II 19, Warsaw, Poland, tel.: , fax: Deloitte Audyt Sp. z o.o. is a member of the National Board of Chartered Auditors (Krajowa Rada Biegłych Rewidentów) and is entered in the register of entities qualified to audit financial statements under No. 73. Deloitte Audyt Sp. z o.o. does not hold a material interest in the Company. In particular, as at the Prospectus Date, it does not hold Shares representing more than 1% of the Company s share capital. Deloitte Audyt Sp. z o.o. audited the consolidated financial statements of the LOTOS Group for the financial years 2007, 2008 and 2009 prepared in accordance with the IFRS endorsed by the EU. The opinion from the audit of the consolidated financial statements of the LOTOS Group for the financial year ended December 31st 2009 prepared in accordance with the IFRS endorsed by the EU was signed by Piotr Sokołowski, qualified auditor, Reg. No. 9752, Member of the Management Board of Deloitte Audyt Sp. z o.o. Marta Towpik, qualified auditor, Reg. No , Member of the Management Board of Deloitte Audyt Sp. z o.o. The opinion from the audit of the consolidated financial statements of the LOTOS Group for the financial year ended December 31st 2008 prepared in accordance with the IFRS endorsed by the EU was signed by: Maria Rzepnikowska, qualified auditor, Reg. No. 3499, President of the Management Board of Deloitte Audyt Sp. z o.o. Piotr Sokołowski, qualified auditor, Reg. No. 9752, Member of the Management Board of Deloitte Audyt Sp. z o.o. 36

37 The opinion from the audit of the consolidated financial statements of the LOTOS Group for the financial year ended December 31st 2007 prepared in accordance with the IFRS endorsed by the EU was signed by: Wacław Nitka, qualified auditor, Reg. No. 2749, Member of the Management Board of Deloitte Audyt Sp. z o.o. Piotr Sokołowski, qualified auditor, Reg. No. 9752, Member of the Management Board of Deloitte Audyt Sp. z o.o Information on Resignation, Dismissal or Change of the Auditor In the period covered by the historical financial information, which is incorporated by reference in this Prospectus, neither the auditor nor Grupa LOTOS S.A. terminated the agreement for the audit of the Issuer s financial statements. In connection with the policy of periodical change of auditor, pursuant to a resolution of the Supervisory Board of Grupa LOTOS S.A. of December 17th 2009, Ernst&Young Audit Sp. z o.o., with registered office at Rondo ONZ 1, Warsaw, Poland, entered in the list of qualified auditors of financial statements maintained by the National Chamber of Chartered Auditors (KIBR) under Reg. No. 130, was appointed to act as the qualified auditor of the Company s financial statements for 2010, 2011 and

38 3 Financial Highlights The selected historical financial information was prepared on the basis of the annual consolidated financial statements for the years and the consolidated financial statements for the first half of 2010 together with the comparative data prepared in accordance with the IFRS. The annual consolidated financial statements for the years were audited, and the H financial statements were reviewed by a qualified auditor. The H financial statements were not audited by a qualified auditor. 3.1 Selected Financial Information Historical Data Table 6 Financial highlights historical information (PLN 000) LOTOS GROUP Year ended Dec (comparative data) Year ended Dec (comparative data) Year ended Dec (comparative Sales revenue 13,125,123 16,294,738 14,321,041 Operating profit/(loss) 713,664 (145,828) 419,793 Pre-tax profit/(loss) 1,004,494 (503,700) 1,109,608 Net profit/(loss) from continuing operations 814,147 (389,415) 911,812 Profit/(loss) from continuing operations attributable to owners of the parent 777,160 (453,549) 900,761 Profit from continuing operations attributable to noncontrolling interests 36,987 64,134 11,051 Total comprehensive income 810,245 (362,559) 928,661 Comprehensive income attributable to owners of the parent 773,258 (426,693) 908,083 Comprehensive income attributable to noncontrolling interests 36,987 64,134 20,578 Net cash provided by/(used in) operating activities 157, , ,498 Net cash provided by/(used in) investing activities (816,440) (2,417,112) (3,339,669) Net cash provided by/(used in) financing activities 513,145 1,963,145 2,155,844 Total net cash flow (147,061) (138,751) (486,988) Basic earnings/(loss) per ordinary share (PLN) 6.84 (3.74) 7.44 Diluted earnings/(loss) per ordinary share (PLN) data) As at Dec As at Dec As at Dec (comparative data) (comparative data) (comparative data) Total assets 9,883,830 12,319,949 15,225,952 Equity attributable to owners of the parent 5,948,618 5,521,925 6,809,393 Non-controlling interests 334, ,078 36,752 Total equity 6,283,309 5,918,003 6,846,145 Source: the Issuer. 38

39 3.2 Selected Interim Financial Information Table 7 Financial highlights for the period January September 2010 and comparative data (PLN 000) LOTOS GROUP 9 months ended 9 months ended Sep Sep comparative data unaudited Sales revenue 10,296,523 13,941,537 Operating profit/(loss) 354, ,357 Pre-tax profit/(loss) 871, ,910 Net profit/(loss) from continuing operations 682, ,857 Profit/(loss) from continuing operations attributable to owners 673, ,852 of the parent Profit from continuing operations attributable to noncontrolling 9,267 2,005 interests Total comprehensive income 703, ,195 Comprehensive income attributable to owners of the parent 694, ,180 Comprehensive income attributable to non-controlling 9,267 2,015 interests Net cash provided by/(used in) operating activities 655, ,750 Net cash provided by/(used in) investing activities (2,806,861) (912,795) Net cash provided by/(used in) financing activities 1,829, ,598 Total net cash flow (321,906) 376,832 Basic earnings/(loss) per ordinary share (PLN) Diluted earnings/(loss) per ordinary share (PLN) - - As at As at Dec Sep (restated) (unaudited) (audited) Total assets 15,225,952 17,027,696 Equity attributable to owners of the parent 6,809,393 7,251,508 Non-controlling interests 36,752 14,582 Total equity 6,846,145 7,266,090 Source: the Issuer. 4 Risk Factors The description of risk factors that are material to the securities to be admitted to trading and relevant to the assessment of market risk associated with the securities is presented in Chapter II Risk Factors of this Prospectus. 39

40 5 Information on the Issuer 5.1 History and Development Legal Name (as specified in the Articles of Association) and Trade Name Pursuant to Par. 1.1 of the Articles of Association, the Issuer operates under the name Grupa LOTOS Spółka Akcyjna and may use the abbreviated name Grupa LOTOS S.A Relevant Register and Registration Number The Issuer was entered in Section B of the Commercial Register maintained by the District Court in Gdańsk, 9th Commercial Division, under entry No. 6553, by virtue of the court s decision of October 1st On April 10th 2002, the Issuer was entered in the Register of Entrepreneurs of the National Court Register maintained by the District Court for Gdańsk-Północ in Gdańsk, 7th Commercial Division, under entry No. KRS , by virtue of the Registry Court s decision of April 10th Date of Incorporation and Duration The state-owned enterprise operating under the name Rafineria Nafty Gdańsk w budowie (under construction) was established by virtue of an order issued by the Minister of Industry and Commerce on March 18th 1972 (sign. EZ6D, ref. No. 39) pursuant to Art. 4.1 of the Decree on State-Owned Enterprises of October 26th 1950 (consolidated text: Dz.U. of 1960, No. 18, item 111), and Par. 7.3 of the Order on Organisation and Responsibilities of Investment Departments at State-Owned Organisations (M.P. No. 41, item 234, as amended) issued by the Chairman of the Council of Ministers Planning Committee on July 27th Following the technological commissioning of the fuel unit, the state-owned enterprise Rafineria Nafty Gdańsk w budowie (under construction) was transformed into an operational enterprise under the name of Gdańskie Zakłady Rafineryjne pursuant to an order of the Minister of Chemical Industry dated July 7th 1976 (sign. EZ , ref. No. 54), amending the order of the Minister of Industry and Commerce dated March 18th By virtue of the order of July 7th 1976, the company name was changed to Gdańskie Zakłady Rafineryjne and its business profile to: (i) refining of crude oil into motor fuels and fuel oils, and (ii) acting as investor. Upon coming into force of the Polish Act on State-Owned Enterprises of September 25th 1981 (Dz.U. No. 24, item 122), which defined the rules governing functioning of state-owned enterprises, by way of an order of the Minister of Chemical and Light Industry dated October 12th 1982 (No. 103/Org/82) the organisation of the enterprise was adjusted to comply with the provisions of the Act. Moreover, by virtue of the Act, the Minister of Chemical and Light Industry assumed the role of the enterprise s founding body and of the authority supervising its operations. Gdańskie Zakłady Rafineryjne was entered in the Register of State-Owned Enterprises maintained by the District Court in Gdańsk, under entry No. PP-119. In 1991, by virtue of Art. 5 of the Polish Privatisation Act, the Minister of Ownership Transformations transformed Gdańskie Zakłady Rafineryjne, then operating as a state-owned enterprise, into a state-owned stock company operating under the name of Rafineria Gdańska Spółka Akcyjna (Notarial Deed of September 18th 1991, prepared by Paweł Błaszczak, Notary Public in Warsaw, Rep. No. 8932/91 hereinafter referred to as the Deed of Transformation ). 40

41 By virtue of the Deed of Transformation, the Issuer s equity was created from the initial capital and enterprise fund of Gdańskie Zakłady Rafineryjne. The equity included share capital of PLZ 787,000,000,000 (following redenomination: PLN 78,700,000), which was divided into 7,870,000 bearer Shares with a par value of PLZ 100,000 (following redenomination: PLN 10) per share, and reserve funds created from the remaining portion of the equity. Based on the closing balance of the enterprise, prepared as at September 30th 1991, the equity of Gdańskie Zakłady Rafineryjne totalled PLZ 1,510,412,000,000 (following redenomination: PLN 151,041,200). The Issuer has been established for indefinite term Registered Office, Legal Form, Legal Basis for Operations, Country of Domicile, Address and Telephone Numbers of the Registered Office (or Principal Place of Business If Different from the Registered Office) Company name: Grupa LOTOS Spółka Akcyjna Legal form: joint-stock company Country of domicile: Poland Registered office: the city of Gdańsk Address: ul. Elbląska 135, Gdańsk, Poland Telephone: Fax: lotos@grupalotos.pl Website: REGON (Industry Identification Number): NIP (Tax Identification Number): , PL The Company operates in the form of a joint-stock company under the provisions of the Commercial Companies Code and other generally applicable Polish laws Important Events in the Development of the Issuer s Business The state-owned enterprise Rafineria Nafty Gdańsk w budowie was established by virtue of the decision of the Minister of Industry and Commerce dated March 18th On July 7th 1976, following the technological commissioning of the fuel unit, the state-owned enterprise Rafineria Nafty Gdańsk w budowie was transformed into an operational enterprise with the annual throughput of 3 million tonnes of crude oil. In 1991, the state-owned enterprise Gdańskie Zakłady Rafineryjne was transformed into a state-owned stock company, then operating under the name of Rafineria Gdańska Spółka Akcyjna. At the beginning of 1996, the Issuer initiated the process of spinning off particular operations into subsidiaries, starting with the formation of LOTOS Paliwa, a company established to oversee and manage the LOTOS service station network. LOTOS Paliwa was entered in the Commercial Register in January The undertaking received the assets separated from the Issuer s enterprise, including the Issuer s CODO and COCO stations. In August 2001, LOTOS Paliwa was entrusted with overseeing the DODO station network. 41

42 In 2000, the Issuer established LOTOS Kolej (originally Zakład Transportu Kolejowego Rafinerii Gdańskiej Sp. z o.o.), to engage in rail transport on behalf of the Issuer. LOTOS Kolej was entered in the Commercial Register in January In 2002, the Supervisory Board approved a restructuring programme developed by the Management Board ( Restructuring Programme ), whose principal objective was to transform the Issuer into a modern energy concern with a national reach, comprising a group of companies operating in the areas of crude oil extraction, production, trading and services auxiliary to the Issuer s core business. On May 28th 2003, the Issuer s name was changed from Rafineria Gdańska S.A. to Grupa LOTOS. In the first days of February 2005, as part of the government s strategy for Polish oil sector, an agreement was executed between Nafta Polska and Grupa LOTOS whereunder Nafta Polska disposed of its entire shareholdings in Petrobaltic (a 69.00% interest) and southern refineries, i.e. Rafineria Czechowice refinery (an 80.04% interest), Rafineria Jasło refinery (an 80.01% interest), and Rafineria Nafty Glimar refinery (a 91.54% interest; company in bankruptcy). On June 9th 2005, the shares of Grupa LOTOS S.A. were floated on the Warsaw Stock Exchange. Following the issue of 35,000,000 Series B shares, an increase in the share capital of Grupa LOTOS S.A. to PLN 113,700,000 was registered on June 28th In August 2005, upon the completion of an overhaul shutdown, the Gdańsk refinery s annual processing capacity reached 6 million tonnes of crude oil. In , the Company has been implementing its new strategy for the LOTOS Group, whose objectives were to: increase the economic effectiveness of crude oil processing through optimal utilisation of the existing refinery complex and implementation of the key investment projects, i.e. the 10+ Programme (for more details see Section of the Registration Document), develop crude oil exploration and production activities, increase sales efficiency, strengthen its position on the wholesale and retail fuel market. The 10+ Programme was launched in August 2007, while a month later LOTOS EPN, a Polish-Norwegian company, was established to be responsible for exploration and production of crude oil on the Norwegian Continental Shelf. In May and October 2008, LOTOS EPN purchased a 20% interest in production licences relating to the YME field in the North Sea. In June 2008, the Issuer signed a credit facility agreements to finance the 10+ Programme for the total amount of USD 1.75bn with a consortium of 17 financial institutions. In February 2009, as a result of the financial crisis on the global capital markets, the Management Board of Grupa LOTOS S.A. implemented a Package of Anti-Crisis Measures, which produced savings of PLN 470.1m in the form of suspended or abandoned investment projects and cost savings of PLN 252.5m. 42

43 The Spring 2009 overhaul shutdown commenced in March The objective of the shutdown, apart from the need to perform the maintenance work on the refinery, was to integrate all new process units under construction with the existing system of the refinery without further disruption to the production process. On July 17th 2009, an increase in the share capital of Grupa LOTOS S.A. following the issue of 16,173,362 Series C Shares, paid up by contributions in the form of shares in Petrobaltic S.A., LOTOS Jasło S.A. and LOTOS Czechowice S.A., was registered. In April 2010, one of the key units constructed under the 10+ Programme, i.e. the crude distillation unit (CDU/VDU), was put into service. In 2010, the Issuer s Supervisory Board approved the new strategy for the LOTOS Group for The new Strategy provides for the continuation of the current policy oriented towards stimulating sustainable growth of the core business, that is exploration for and production of hydrocarbons, deep conversion of feedstock in fuel production, and trade in high-margin petroleum products, with the focus on the overriding strategic objective of building shareholder value. 5.2 Investments of the Issuer s Group Major Investment Projects of the Issuer s Group in The main investment project of the LOTOS Group carried out in the years were connected with expanding the throughput capacity of the Gdańsk refinery and increasing oil production. The key projects in the period were the 10+ Programme and the YME Project. Below is presented the capital expenditure incurred by the Issuer s Group in the years on tangible assets under construction and purchase of property, plant and equipment and intangible assets. Table 8 Tangible assets under construction and purchase of property, plant and equipment (PLN 000) Construction and assembly work 104, ,030 1,195,522 Procurement of ordered materials and equipment purchases 61, ,580 2,059,623 Purchase of intangible assets 24,334 12,565 52,269 Other expenditure 296, , ,745 Prepayments for tangible assets under construction 681, , ,581 Settled prepayments - 47, ,012-1,305,765 Total 1,120,447 2,852,348 2,996,975 Source: the Issuer. 43

44 5.2.2 Description of Major Investment Projects Currently Implemented by the Issuer s Group The key domestic and foreign investment projects currently implemented by the Issuer s Group are the 10+ Programme and the YME Project, both continued from previous years Domestic Projects The main domestic investment project currently implemented by the LOTOS Group is the 10+ Programme, the Issuer s largest project which is of key importance to future growth of the Company s shareholder value. The 10+ Programme is designed to increase the economic effectiveness of crude oil processing through increased processing volumes, higher conversion ratio and product desulphurisation. As part of the project a complex of refining units is being built at the Gdańsk refinery. It is a modern and integrated solution enabling crude oil processing to be intensified. Below is presented the capital expenditure incurred on the project. Table 9 Capital expenditure on the 10+ Programme (PLN 000) Jan 1 Sep Capital expenditure on 10+ Programme 795,754 1,868,108 2,211, ,431 internal sources of financing 66.34% 13.53% 37.80% 21.86% Source: the Issuer. external sources of financing 33.66% 86.47% 62.20% 78.14% Following completion of the 10+ Programme, the Gdańsk refinery will be able to satisfy the domestic demand for highest-quality fuels, while production surplus may be exported, given the refinery s seaside location. In line with the LOTOS Group s strategy for , following completion of the 10+ Programme, the main objective will be to ensure effective management of heavy residue of crude oil processing, including in particular the asphalten fraction from the ROSE unit, which is planned to be eliminated completely from the product portfolio. 44

45 Source: the Issuer With respect to the execution of the 10+ Programme, the Company s efforts in 2007 focused on reviewing the received bids, preparing the contractor selection process and launching the implementation phase of the project, commencing the performance of concluded execution agreements, further selection of contractors and efforts relating to the arrangement of financing: technological, market, legal and insurance analyses of the 10+ Programme, as well as work on a financing concept for the Programme, negotiations and cooperation with financial institutions. Work was also continued on optimising the concept for the utilisation of the ROSE unit, based on the Kellog Brown & Root technology, as part of the implemented configuration of the 10+ Programme. The time of execution of the heavy residue gasification unit would depend on the market situation with respect to the sale of heavy products, in particular bitumens, whose sale is an alternative for heavy residue gasification. As part of the work aimed at arranging financing for the 10+ Programme, the transaction structure and an information package for banks were being prepared. Wood MacKenzie (WMK) was engaged to perform a market analysis for the purposes of the 10+ Programme. WMK presented its assessment of the European product market from the perspective of the production structure to be introduced by Grupa LOTOS S.A. in the future, as well as an analysis of the bitumen market. The volume of domestic sales as projected by Grupa LOTOS S.A. was also confirmed as achievable. A comparative analysis of Grupa LOTOS S.A. s competitiveness before and after the implementation of the 10+ Programme was performed. The comparison included 107 European refineries. The final report on the 45

46 analysis confirmed the correctness of Grupa LOTOS S.A. s market assumptions justifying the execution of the 10+ Programme, including in particular: demand forecasts for individual products and possibility of marketing the products in Poland and other European countries, price forecasts, and the favourable effect of the 10+ Programme on the Company s competitive position. Stone & Webster performed a technological analysis of the 10+ Programme for the financing institutions. The final due diligence report included a positive assessment of the 10+ Programme and identified no material risks in any of the Programme s aspects covered by the due diligence examination (including the budget, timetable, contractor selection strategy, management strategy, environmental issues, permits, and technology). The Linklaters law firm was selected as the legal adviser to the financial institutions and engaged to perform a legal due diligence of the 10+ Programme and Grupa LOTOS S.A. The legal due diligence report, containing a positive assessment of Grupa LOTOS S.A., was prepared towards the end of December Linklaters was also involved in the preparation of the term sheet proposed to prospective participants in financing. Miller was selected as the insurance adviser to the financial institutions. Based on a due diligence examination concerning the insurance programme connected with the execution of the 10+ Programme, Miller accepted and positively assessed Grupa LOTOS S.A. s insurance assumptions for the coming years. Insurance policies covering construction and assembly risks connected with the commencement of the 10+ Programme (in line with the assumptions of Grupa LOTOS S.A. s Insurance Programme for ) were arranged. Work was completed on extended operating insurance for the existing assets of Grupa LOTOS S.A. s Gdańsk refinery. The policy for was signed on November 30th Financing The process of developing a concept of and arranging the financing for the 10+ Programme and other needs of the Company had a few phases. On December 20th 2007, the Issuer signed a credit facility agreement with a consortium of four banks (described in more detail in Section 22.2 of the Registration Document as credit facility agreement for the refinancing and financing of mandatory stocks). This was the first step in the process of raising financing for Grupa LOTOS S.A. s needs connected with the execution of the 10+ Programme. The facility enabled the then existing inventories to be refinanced and the funds frozen in the inventories to be released. Subsequently, on December 21st 2007, Grupa LOTOS S.A. sent to the interested financial institutions an invitation to submit bids for the financing of the 10+ Programme and the Company s working capital, in the amount of USD 1,550m and USD 200m, respectively. The invitation was accompanied by an information package and was made available to banks and other financial institutions. The deadline for submitting bids was set for January With respect to the execution of the 10+ Programme, the Company s efforts in 2008 focused on the performance of concluded execution agreements, further selection of contractors, and arrangement of financing. 46

47 Financing On June 27th 2008, Grupa LOTOS signed a credit facility agreement with a consortium of financial institutions (described in more detail in Section 22.2 of the Registration Document as credit facility agreement for the financing of the 10+ Programme). The credit facility agreement, together with the credit facility agreement for the refinancing and financing of the inventories of Grupa LOTOS S.A. of December 20th 2007, secured funds sufficient to meet the Company s total requirement for external financing in connection with the implementation of the 10+ Programme. Figure 1 Financing structure chart Source: the Issuer In 2009, the implementation of the 10+ Programme focused on performing the concluded execution agreements, as well as on commissioning for subsequent start-up of key units of the 10+ Programme, including the HDS, HGU, ASR and CDU/VDU units, and certain parts of auxiliary facilities. 100% 80% 60% 40% 20% 100% 100% 100% 100% 91% 59% 99% 0% HDS KAS HGU CDU MHC ROSE U&O 47

48 Legend: HDS hydrodesulphurisation unit (for diesel oils) KAS = ASR amine sulphur recovery unit HGU hydrogen generation unit CDU crude distillation unit MHC mild hydrocracking unit ROSE residuum oil supercritical extraction unit U&O utilities and offsites Source: the Issuer. Staff 2009 Project The Staff 2009 Project, which envisages hiring 120 employees to operate the units constructed as part of the 10+ Programme, was fully implemented. All employees who will operate the units were trained. Source: the Issuer

49 As at the end of September 2010, the work under the 10+ Programme was completed in 99.81% compared with the planned 99.82%. The completion status was close to that assumed in the Early Start plan, which means that the work is performed in line with the schedule. The engineering, procurement and construction process has been completed with respect to the HDS, ASR, CDU/VDU and HGU units, as well as most auxiliary facilities. In April 2010, tests of the CDU/VDU unit were run. Chart 1 Completion status of the 10+ Programme Source: the Issuer. CDU/VDU Unit Start-up of the CDU/VDU unit in March 2010 enabled the utilisation ratios of units already placed in service under the 10+ Programme (i.e., HDS and ASR) to be increased. After all material parameters and full operational capacity of the CDU/VDU unit were achieved in May 2010, it operates under load consistent with the current production plan of the Gdańsk refinery. The total annual throughput of crude oil should increase from approx. 6m tonnes to approx. 8m tonnes in Another change in the volume of processed crude oil is planned for the fourth quarter of 2010, following the start-up of the MHC unit Foreign Projects The key foreign investment project currently implemented by the LOTOS Group is the upstream YME Project, located in the south-east of the Norwegian Sea, i.e. in the so-called Egersund Basin, approx. 100 nautical miles off the shore. It has been conventionally divided into two areas: Gamma and Beta, located approx. 12 km apart, with water depths of 93 meters and 77 meters, respectively. The YME field was closed in 2001 due to its high water content and low crude prices (below USD 15 per barrel). In 2004, licence PL316, which covers the area where the field is located, was granted to a joint venture comprising the following companies: Paladin Resources AS, Talisman Energy Norge AS and Revus Energy ASA. 49

50 In 2008 and 2009, LOTOS EPN acquired a 20% interest in the project. The current structure of the jointventure developing the YME field is as follows: Talisman Energy Norge AS (60%), LOTOS EPN (20%), Wintershall (10%) and AEDC (10%). Below is presented the capital expenditure incurred on the project. Table 10 Capital expenditure on the YME Project (NOK 000) Jan 1 Sep Capital expenditure on YME Project 1,023, , ,955 internal sources of financing % 77.97% 56.26% external sources of financing 0.00% 22.03% 43.74% Source: the Issuer. Drilling on the YME field, with the use of the Mærsk Giant drilling platform, commenced in Nine wellbores, including six producers and three water injectors, were planned to be drilled as part of the project. By mid 2010, six producers and three water injectors had been drilled as planned. Gas pressure in the drilled wells was found to be higher than expected. The wells completion intervals in the deposit are also longer than expected. The planned production life of the field (ten years) is shorter than the expected operational life of the platform (15 years). The oil production centre on the YME field is covered by a standard Bareboat Charter Agreement entered into with SBM MOPUSTOR YME LTD on January 5th The agreement is concluded for a five-year lease term, with an option to extend the lease term to 15 years. The lessee has the option to purchase the facility for USD 478m at the end of the year of its delivery and for USD 143m at the end of the five-year lease period, as well as at any time between those dates. The lease agreement is effective from the moment the platform was constructed. In its annual report for 2009 prepared in March 2010, the auditor of LOTOS EPN stated that the total liabilities of LOTOS EPN under the lease agreement (for the period until 2023) amount to the equivalent of USD 203,096,560. The reserves and resources of the YME field estimated by LOTOS Petrobaltic and LOTOS EPN on the basis of the results of existing surveys are presented in Table 11. Table 11 Reserves and resources attributable to LOTOS EPN, based on the company s own estimates Reserves and resources attributable to LOTOS EPN Reserves and resources (million bbl) (i.e. attributable to its 20% interest) Reserves Crude oil (1P/2P/3P) 9.4 / / 14.3 Contingent (1C/2C/3C) 0 / 0.5 / 2.2 Prospective (P90/P50/P10) - - Source: LOTOS EPN. 50

51 Chart 2 YME Project s production forecast (attributable to the 20% interest of LOTOS EPN) 3,0 2,5 2,0 1,5 mln bbl/rok 1,0 0,5 0, Source: LOTOS EPN. Each partner in the project will have the right and obligation to take delivery its share of crude oil from the YME field in proportion to its interest in the field. However, in the first 24 months the partners agreed to jointly take deliveries of crude oil. Following the first 24 months, each partner will have the ability to take delivery of its own shipments. The operator will be responsible for assigning and scheduling shipments and preparing and distributing shipment documentation. The costs of oil deliveries will be divided pro rata to the shipments delivered. The operator will be responsible for the initial payment of all the costs covered by the contract of affreightment (CoA) and will subsequently charge those costs to the partners pro rata to their shares in the shipment. A contract of affreightment (CoA) has been signed with Knutsen OAS (UK) Ltd. Grupa LOTOS S.A. will be able to buy YME crude oil in excess of the volumes resulting from LOTOS EPN s interest in the field from the operator on arm s length terms. In September 2008, the total investment budget of the YME Project was increased to NOK 6,386m. Currently, the estimates of LOTOS Petrobaltic show that the total investment budget of the YME Project should not exceed NOK 7,527m Information on Major Investment Projects to Be Implemented by the Issuer s Group in the Future As at the Prospectus Date, the key projects to be carried out in the future comprise further stages of the 10+ Programme and the YME Project. Other projects planned for execution are connected with licences PL455, PL497, PL498, PL503 and PL515. LOTOS EPN s planned capital expenditure on exploration and appraisal of fossil fuels in the years is estimated at: NOK 86m in 2010, NOK 68.2m in 2011, NOK 197.3m 2012 and NOK 157.6m in The capital expenditure will be incurred subject to: selecting contractors to perform the 3D surveys; results of preliminary surveys; consent of all licence holders; 51

52 crude oil price; prices of services and work on the Norwegian Continental Shelf; any potential new restrictions imposed by the Norwegian authorities in the area of technical safety of work. As at the Prospectus Date, the Issuer s management bodies made no binding commitments with respect to any major projects other than those connected with the implementation of the 10+ Programme and the YME Project described above. 52

53 6 The Issuer s Business 6.1 Core Business Description of, and Key Factors Relating to, the Nature of the Issuer s Operations and its Principal Activities, Stating the Main Categories of Products Sold and/or Services Performed for Each Financial Year for the Period Covered by the Historical Financial Information Nature of the Issuer s and its Group s Business The LOTOS Group is an oil concern whose business consists in crude oil production and processing, as well as wholesale and retail sale of high-quality petroleum products. The concern sells a range of products, including unleaded gasoline, diesel oil and aviation fuel. It is also Poland s leader in the production and sale of motor oils, bitumens and paraffin. A countrywide network of service stations operates under the LOTOS brand. Through LOTOS Petrobaltic S.A. and LOTOS Exploration and Production Norge AS the concern is also present on the Baltic Sea and at the Norwegian Continental Shelf, where it is active in the area of crude oil exploration and production. The strategic objective of the LOTOS Group is to create shareholder value through optimal leveraging of the available intellectual resources and physical assets, as well as implementing development programmes in the following areas: upstream segment, crude oil processing, trade. The Group s operating activities comprise two main reportable operating segments: upstream segment comprising activities related to the acquisition of crude oil and natural gas reserves, and crude oil and natural gas production, downstream segment comprising the production and processing of refined petroleum products and their wholesale and retail sale, as well as auxiliary, transport and service activities. Grupa LOTOS S.A. is part of the downstream segment. The upstream segment comprises the entire group of LOTOS Petrobaltic, the Issuer s subsidiary company. 53

54 Table 12 Companies with capital links to the Issuer as at the Prospectus Date Name Business profile Percentage of the share capital held by GL S.A. Parent Company Grupa LOTOS S.A. LOTOS Petrobaltic S.A. LOTOS Czechowice S.A. LOTOS Jasło S.A. LOTOS Serwis Sp. z o.o. LOTOS Lab Sp. z o.o. LOTOS Straż Sp. z o.o. LOTOS Ochrona Sp. z o.o. LOTOS Ekoenergia Sp. z o.o. UAB LOTOS Baltija LOTOS Park Technologiczny Sp. z o.o. LOTOS Gaz S.A. LOTOS Oil S.A. LOTOS Paliwa Sp. z o.o. LOTOS Kolej Sp. z o.o. LOTOS Asfalt Sp. z o.o. production and processing of refined petroleum products (mainly gasolines and diesel oils) and their wholesale exploration and exploitation of crude oil and natural gas reserves services consisting in the storage of stocks, distribution of fuels production and sale of heavy fuel oil, LDPE regranulate, distribution of fuels maintenance services related to: measurements, automation, control and measurement systems, electric and mechanical operations, communication, equipment and transport laboratory and test services related to: process tests, sampling and quality control, inspection of finished products in the sales network, tests of water, groundwater and sewage, measurements and preparation of documents regarding working conditions fire protection and rescue services, organisation and implementation of precautionary measures, issuing opinions on fire prevention documentation personal and property protection services, control of the traffic of persons, goods and vehicles the company does not conduct operating activities provision of advisory and support services to the LOTOS Group companies the company does not conduct operating activities the company does not conduct operating activities production and sale of motor oils, industrial oils and lubricants; sale of base oils and plasticizers domestic sale of unleaded gasolines (Pb 95, Pb 98), DYNAMIC fuels (Pb 98, ON), diesel oils, light fuel oil, LPG railway transport of petroleum products, goods and empty tanker wagons; provision of services at railway sidings production and sale of road bitumens, modified bitumens; sale of heavy fuel oil (1% and 3%) 99.32% 97.54% 98.03% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 54

55 Name Business profile Percentage of the share capital held by GL S.A. LOTOS Parafiny Sp. z o.o. LOTOS Tank Sp. z o.o. production and sale of paraffin for votive candles, industrial paraffin mass, standard paraffin, low-oil paraffin; production and sale of candles and votive candles sale of JET A-1 aviation fuel 100% 100% Significant Companies with Capital Links Przedsiębiorstwo Przeładunku Paliw Płynnych NAFTOPORT Sp. z o.o. reloading of crude oil and petroleum products 8.97% Indirect Subsidiary Undertakings LOTOS Exploration and Production Norge AS oil exploration and production at the Norwegian Continental Shelf 100% - LOTOS Petrobaltic S.A. LOTOS Biopaliwa Sp. z o.o KRAK GAZ Sp. z o.o. (In liquidation) RCEkoenergia Sp. z o.o. Plastekol Organizacja Odzysku S.A Miliana Shippig Company Ltd. Aphrodite Offshore Services N.V Energobaltic Sp. z o.o. AB Geonafta production and sale of fatty acid methyl esters (FAME) in bankruptcy by liquidation production and distribution of electricity, heat and gas wholesale of waste products and scrap metal, freight transport by road, sewage management as well as waste removal and neutralization services consisting in the storage and transport of crude oil, rescue and spill prevention assistance, as well as geotechnical services sea transport and sea fleet management, as well as purchasing, holding and transferring ownership rights, renting, leasing and commissioning the construction of ships, operation of ships and conclusion of charter agreements production and sale of heat and electricity, natural gas condensate and LPG exploration and production of crude oil in 100% - LOTOS Czechowice S.A. 100% - LOTOS GAZ S.A. 100% - LOTOS Czechowice S.A. 95.5% - LOTOS Jasło S.A. 99.9% - LOTOS Petrobaltic S.A. 100% - LOTOS Petrobaltic S.A 100% - LOTOS Petrobaltic S.A % - LOTOS 55

56 Name Business profile Percentage of the share capital held by GL S.A. the territory of the Republic of Lithuania Petrobaltic S.A. Source: the Issuer. Upstream Segment LOTOS Petrobaltic has been a part of the LOTOS Group since February The company is the core of the Group s upstream division. Its current headcount is over 400. Many of its employees have been working for more than 20 years in exploration and appraisal of minerals and production from offshore fields. LOTOS Petrobaltic formed its own group of companies, composed of 5 subsidiaries and associates: LOTOS EPN (100.00% held by LOTOS Petrobaltic), AB Geonafta (40.59% held by LOTOS Petrobaltic), Energobaltic Sp. z o.o. (100.00% held by LOTOS Petrobaltic), and two shipping companies: Aphrodite Offshore Services N. V. (AOS) (100.00% held by LOTOS Petrobaltic) and Miliana Shipping Company Ltd. (MSC) (99.90% held by LOTOS Petrobaltic). The core activities of the key companies are as follows: LOTOS EPN provides access to crude oil fields on the Norwegian Continental Shelf in the North Sea and the Norwegian Sea; Energobaltic is responsible for managing tail gas generated now and in the future during the production of oil from fields located in the Baltic Sea; The shipping companies are responsible for safe and timely transport of crude oil coming from the Baltic Sea and (in the future) from the Norwegian Continental Shelf. LOTOS Petrobaltic has extensive knowledge in the area of crude oil and gas production from offshore fields and operates in accordance with the applicable regulations, including the provisions of: International Convention for the Prevention of Pollution from Ships Marpol 73/78; Convention on the Prevention of Marine Pollution by Dumping of Wastes and Other Matter; International Convention Relating to Intervention on the High Seas in Case of Oil Pollution Casualties; The 1974 Helsinki Convention; Polish geology, mining, and environmental protection laws. LOTOS Petrobaltic is actively developing new areas of its activity. It takes part in programmes involving carbon dioxide injection projects with a view to acquiring and customising the Enhanced Oil Recovery (EOR) technology based on carbon dioxide injection. Analyses of the prospective use of deposit structures for CO 2 injections are currently underway. The Petrobaltic Group works closely with a number of experienced companies and research institutes as well as technical support providers, and since 2009 has been implementing a system of oil and gas resources 56

57 estimation in accordance with the Petroleum Reserves and Resources Classification adopted by Society of Petroleum Engineers and Word Petroleum Council Table 13 Crude oil and natural gas resources of the Petrobaltic Group according to the Society of Petroleum Engineers and World Petroleum Council s classification Total the Baltic Sea and the Norwegian Continental Shelf Category (*) crude oil natural gas million tonnes billion cubic meters Proved Reserves 6.3 (****) 4.5 (**) Contingent Resources 0.8 (***) 2.4 (*****) Source: in-house analysis of LOTOS Petrobaltic. (*) Exclusive of prospective resources that may potentially be discovered under exploration licences. (**) Gas resources are classified as undeveloped resources except 0.12 billion cubic meters of the B3 field and billion cubic meters of the B8 field that are already developed; 4.5 billion cubic meters is the total of proved reserves (2P = P1 + P2) of the B4 field [2.105 billion cubic meters], the B6 field [1.88 billion cubic meters], the B3 field [0.108 billion cubic meters] and the B8 field [0.422 billion cubic meters]; (***) This figure includes undeveloped resources of 0.38 million tonnes (the B21 field); 0.8 million tonnes is the total of contingent resources (2C = C1 + C2) of the B3 field [0.424 million tonnes] and the B21 field [0.379 million tonnes]; (****) 6.3 million tonnes is the total of proved resources (2P = P1 + P2) of the B3 field [1.034 million tonnes], the B8 field [3.545 million tonnes] and the YME field [1.730 million tonnes]; (*****) 2.4 billion cubic meters is the total of contingent resources (2C = C1 + C2) of the B3 field [0.045 billion cubic meters] and the B21 field [2.368 billion cubic meters]. Of these, only the B3 field resources are developed; In addition to the abovementioned resources, LOTOS Petrobaltic holds a minority stake in AB Geonafta based in Lithuania. The LOTOS Petrobaltic s share (based on its interest) in the proved resources of the developed oil fields of AB Geonafta and its subsidiaries (computed in proportion to the ownership interest), estimated on the basis of corporate records of these companies, were 4, thousand bbl as at December 31st 2009 (708 thousand cubic meters of oil assuming that 1 bbl = cubic meters). Given the specific ownership structure, minority interest, lack of operational control over the resources, and certain additional investment expenditure (of unknown amount) which may be required to make these resources available, LOTOS Petrobaltic does not add this amount to the amounts presented above. Poland the Baltic Sea In the strategy developed in 2008, the total capital expenditure on the exploration and appraisal of deposits and development of appraised oil fields in the Baltic Sea planned for was estimated at PLN 3.37bn. In the aftermath of the global economic downturn and changes in oil and gas markets, the actual capital expenditure in (H1) totalled PLN 156.3m, and capital expenditure on oil fields in the Baltic Sea currently planned for 2010 (H2) 2011 is estimated at about PLN 294m. Liabilities of LOTOS Petrobaltic relating to the applications filed by the company in Q for the extension of its exploration and appraisal licences go beyond the time horizon of the above forecasts and relate only to the exploration and appraisal phase (they do not cover expenditure on the development of appraised fields). Total expenditure needed to complete the work (including drillings performed using the contracted platform) specified in the applications for the extension of the licences and to perform the company s current licence obligations, is estimated at about PLN 432m. Performance of all licence obligations will depend on the outcomes of the first phase of exploration work, economic viability analysis, and availability of funding. 57

58 Described below are the five major fields covering the above-mentioned resources (B3, B8, B4, B6, and B21). B3 Field The area of production in the B3 field is covered by the mining usufruct agreement signed on April 13th 1994 between Minister of Environment, Natural Resources and Forestry and LOTOS Petrobaltic, as well as licences for crude oil and natural gas production in the sea area of the Republic of Poland, granted to Przedsiębiorstwo Poszukiwań i Eksploatacji Złóż Ropy i Gazu Petrobaltic Sp. z o.o. under Decision No. 108/94 of the Minister of Environment, Natural Resources and Forestry dated July 29th The B3 field was discovered and confirmed by drilling in By 1983, three wells had been drilled in this field and used as a basis for geological documentation of the category C resource. Three additional appraisal wells were drilled in ; they served as a basis for the establishment of the current category B and C resources. Oil production in the B3 field was launched in May 1992 on the B3-6 well. The field currently has 11 production wells. Cumulative production is currently at about 4.22 million cubic meters of oil and million Nm 3 (normal cubic meters) of gas (June 30th 2010). In 2008, in view of the gradually increasing content of formation waters and the obligation to meet the requirements of the Helsinki Convention and the new HELCOM Baltic Sea Action Plan ( zero discharge of separated waters into the Baltic Sea), PPiERiG Petrobaltic began to modify its methods of formation waters management. After separation of petroleum products, waters are pumped to rock mass (Middle Cambrian) together with sea water. In 2009, total oil production of LOTOS Petrobaltic reached thousand cubic meters (174.4 thousand tonnes). In the period January September 2010, production reached thousand cubic meters (121.4 thousand tonnes) in the B3 field and 38.2 thousand cubic meters (30.96 thousand tonnes) in the B8 field, giving the total of 189 thousand cubic meters (152.4 thousand tonnes). B8 Field The B8 field is covered by the mining usufruct agreement signed on September 5th 2006 between Minister of Environment and LOTOS Petrobaltic, and amended with Annex No. 1 of October 26th 2009, as well as licences for crude oil and natural gas production in the territorial sea of the Republic of Poland, granted to Przedsiębiorstwo Poszukiwań i Eksploatacji Złóż Ropy i Gazu Petrobaltic Sp. z o.o. under Decision No. 1/2006 of the Minister of Environment dated September 5th 2006, as amended by decision of the Minister of Environment No. DGiKGE /4579/09/MO of October 26th The B8 field was discovered and confirmed by drilling in Based on exploration work, documentation establishing category C oil and gas resources was prepared in 2004 and approved by the Minister of Environment. Four additional appraisal wells were drilled in and used in analyses forming a basis for verification of category C resources, as described in Annex No. 1 to the documentation, approved by decision of the Minister of Environment in Production from the B8 field was commenced on B8-2 well. Subsequently, additional wells were drilled and used for production B8-3K, B8-4Kbis, and B8-Z1bis (initially designed for injection but later used as a production well given significant oil flow). Having obtained the necessary decisions and modifications to the licence in 2009, the company drilled another well (B8-Z2) in June 2010 to be used for injections of formation waters. 58

59 Formation waters are pumped together with crude oil and then separated and discharged to the Baltic Sea. The content of petroleum substances in separated water did not exceed 15 ppm in line with the requirements of the MARPOL 73/78 Convention. Total production in is presented in the table below. Crude oil/natural gas production from the B8 field in Table 14 Production from the B8 field in The B8 field Crude oil [t] Natural gas [Nm3] ,987 6,037, , , ,971 11,022, ,283 2,200, (Q1)* 30,967 3,773,024 Source: LOTOS Petrobaltic SA * In Q2 and Q3 2010, no production activities were carried out on the B8 field. B4 Field Two natural gas fields, B4 and B6, are located in the Baltic Sea, km off Polish coast. These fields are situated in the vicinity of the B3 field, where oil is produced. The extreme point (No. 4) of the mining zone established for the B4 field (55 o N; 17 o E) is located about 15 km from the border of Poland's exclusive economic zone (within its area) and just over 100 km from the nearest land to the north (territory of Sweden) 108 km to the island of Öland and 128 km to Gotland. The B4 field was first documented in early 1980s and its initial geological resources, established by Decision No. KZK/012/M/4887/84/85 of the President of Central Office of Geology dated January 24th 1985, comprised: - 3,900 million cubic meters of gas, of which 2,689.7 million cubic meters were recoverable resources. The current resources in the B4 field are documented based on 2D re-interpretations of geophysical surveys from the 1980s and results of drilling works retained in the archives, as well as new exploration wells. Licence No. 6/2007 for natural gasoline gas production in the B4 field was granted by the Minister of Environment on May 11th The licence established the volume of commercial (recoverable) resources as at December 31st 2002 at 1, million cubic meters of natural (gasoline) gas in category C. The volume of non-commercial resources total million cubic meters, and the resources utilisation rate was established at 100%. Te licence was granted for 25 years. By Decision No. DGiKGe /5164/08/MO of the Minister of Environment, on August 14th 2008 licence No. 6/2007 of May 11th 2007 for natural gasoline gas production from the B4 field was amended by including the following provisions in Section 7: activities under this licence shall commence not later than within 84 months from the date the licence is granted". B6 Field Licence No. 2/2006 for natural gas condensate production in the B6 field was granted by the Minister of Environment on November 7th The licence established the volume of commercial resources as at December 31st 2003 at 1, million cubic meters of natural gas. At the request of LOTOS Petrobaltic, the licence was amended by decision of the Minister of Environment No. DGiKGe /5363/08/MO dated August 29th 2008 in the part referring to the extension of the licence for 26 years, i.e. until the end of In 59

60 addition, the time for commencement of the licensed activities was extended to 96 weeks, i.e. until November Geological and deposit analyses in B4 and B6 fields were performed in different periods from 1981 to Results obtained from different exploration wells were in line with the production conditions defined at that time. There is no final concept for the construction of transmission lines from B4 and B6 gas fields, the reason being the proximity to the B3 field producing oil and gas. B21 Field B21 is a long-term project, appraised with an exploration well. This field has resources classified as contingent by LOTOS Petrobaltic. In category 2C, these resources include million tonnes of crude oil and 2,368 billion cubic meters of natural gas. LOTOS Petrobaltic intends is to design a more precise and comprehensive appraisal method for this field, based on further analyses. Norway the Norwegian Continental Shelf The activities of LOTOS Petrobaltic in the Norwegian Continental Shelf are a part of a long-term strategy for the acquisition of additional crude oil resources and cooperation with world-class teams of experts in the field. LOTOS Exploration & Production Norge AS (LOTOS EPN) was established in October The company currently employs 12 persons. LOTOS EPN holds a 20% interest in the YME field ( licences No. 316, 316 B, 316DS, 316CS), 20% interest in licence No. PL455 and PL515, 10% interest in licence No. PL497, 25% interest in licence No. PL498, and 25% interest in licence No. PL503. In accordance with the strategy for LOTOS EPN, the company plans to produce oil at 500,000 tonnes/year (10,000 barrels/day) in Figure 2 Activities of LOTOS Petrobaltic in the Norwegian Continental Shelf Source: the Issuer. 60

61 LOTOS EPN is managed by a group of highly qualified experts with many years of experience and a proven track record in oil projects in Norway and around the world. In line with the plan for 2010, the company s operations are focused on the YME field project, as described in more detail in Section of the Registration Document. Since 2000, LOTOS Petrobaltic has been investing in Lithuania. On June 16th 2000, a newly established Lithuania-based company Naftos Gavyba was used to acquire an 80.94% stake of the Lithuanian oil company AB Geonafta, the only oil production company in Lithuania (together with its related companies). The consortium paid LTL 52m (approximately USD 13m) for the stake of over 80%. Despite holding a minority interest of 40.59%, LOTOS Petrobaltic is currently the major shareholder in AB Geonafta. Downstream Segment Financial results and market position of the LOTOS Group are dependent upon the Issuer s performance. Grupa LOTOS S.A. is the second largest producer and marketer of refined products in Poland. Production activities of Grupa LOTOS consist in managing the second largest refinery in Poland, whose annual crude oil distillation capacity as at the end of December 2009 amounted to 6m tonnes. The implementation of the 10+ Programme, described in Section of the Registration Document, increased the Gdańsk refinery s throughput capacity. The current annual capacity is estimated at approximately 8m tonnes and is expected to reach 10.5m tonnes after completion of the 10+ Programme. The following significant production units operate within the refinery: a) Atmospheric distillation units used to prepare feedstock for further process units through desalination, crude oil stabilisation which yields unstabilised gasoline, and fractioning of stabilised crude oil into gasoline, kerosene, light, medium and heavy diesel oil, and atmospheric residue. b) Merox units used to manufacture aviation fuel for turbine and jet engines. The feedstock for these units is kerosene fraction obtained through atmospheric distillation. The aim of the Merox process, commonly referred to as sweetening, is the conversion of mercaptans contained in kerosene fraction into disulphides, which remain in the kerosene fraction. c) Gasoline hydrotreating unit used to desulphurise, stabilise, and fraction the gasoline from an atmospheric distillation unit. The hydrotreater prepares feedstock for the reforming unit (naphta) and isomerisation unit (light gasoline). d) Light gasoline isomerisation unit used to increase the octane number of light gasoline. The product of isomerisation is known as isomerisate, with a research octane number (RON) of around 89. Isomerizate is a high-octane-number component for the production of motor gasolines, which is used to decrease the content of benzene and aromatic compounds in gasolines. e) Naphta reforming units used to increase the octane number of gasoline feedstock and obtain reformate, a high-octane number component used in blending gasolines. f) Diesel hydrodesulphurisation unit used for reducing the sulphur content in middle distillate obtained in the process of atmospheric distillation. Diesel oil desulphurisation is required under the applicable laws, which set the maximum admissible sulphur content in diesel oil at 10 ppm. 61

62 g) Hydrocracking unit used to process vacuum distillates and furfurol extracts into fuel components. The resulting components, with the minimum sulphur contents, undergo blending or further treatment. Under the 10+ Programme, hydrocracking will be supported by a new mild hydrocracker (MHC) (Inst. 930). h) Hydrogen generation unit operates based on the steam reforming process, in which hydrocarbons (from methane to hexanes) react with steam in the presence of a catalyst and yield hydrogen and carbon dioxide. The hydrogen-rich gas is purified in the Pressure Swing Absorption (PSA) system, generating hydrogen of 99.99% purity. Table 15 Key operating data of the Gdańsk refinery Installed refining capacity thousand tonnes 6,000 6,000 6,000 Crude oil processed thousand tonnes 6, ,203 5,461.6 Other feedstock processed thousand tonnes 1, ,311 1,705.9 Distillation capacity utilisation 102.6% 103.4% 99.8%* * Capacity utilisation was computed taking into consideration the actual number of days of the refinery s operation (overhaul shutdown in spring 2009). Source: the Issuer. The main products of crude oil distillation at the Gdańsk refinery are gasolines, diesel oil, aviation fuel, light fuel oil and heavy fuel oil. Table 16 Key production data for the Gdańsk refinery Gasolines thousand tonnes 1, , ,282.3 Diesel oil thousand tonnes 2, , ,224.7 Light fuel oil thousand tonnes Aviation fuel thousand tonnes Bunker oil thousand tonnes LPG thousand tonnes Heavy fuel oils thousand tonnes Heavy components thousand tonnes Other thousand tonnes Total thousand tonnes 7, , ,110.5 Source: the Issuer. The restructuring performed in recent years has brought about a dynamic development of the Group s sales capabilities, designed to increase sales revenue in individual business segments and thus to expand the LOTOS Group s market shares and improve sales margins. The organisational structure thus created determines the structure of the distribution channels used by the Issuer: It cooperates mainly with its subsidiaries. Currently, within the structures of the LOTOS Group, the following trading or production-andtrading companies operate in individual segments of the petroleum product market: LOTOS Paliwa, LOTOS Oil, LOTOS Asfalt, LOTOS Tank and LOTOS Parafiny. The restructuring of the LOTOS Group carried out in 62

63 recent years streamlined and clarified the division of responsibilities among individual trading companies with a view to optimising revenue and expenses at the Group level. The highest sales growth dynamics in domestic sales was seen in the case of diesel oil and aviation fuel. Two other product groups with high shares in domestic sales were gasolines and bitumens. Motor fuels (gasolines and diesel oil) were mainly sold to international corporations, institutional customers and service station operators. Sales of diesel oil have been on the rise for several years now, which is to a large extent attributable to the development of road transport and diesel engine technologies. In 2009, the Issuer sold aviation fuel in Poland through two distribution channels: at the Gdańsk airport, where a state-of-the-art handling terminal with the supporting infrastructure was launched in June 2009, and wholesale channel. Bitumens were sold domestically mainly to companies involved in the construction and modernisation of road surfaces. In , LOTOS Asfalt modernised road tanker loading terminals in Gdańsk, Jasło and Czechowice, and expanded storage capacity in Gdańsk and Jasło. Fast-paced development of trading activities and growth in sales volumes necessitated ongoing improvements in the logistics system and creation of an efficient distribution system that would meet customer expectations. Continual optimisation of the operated service station network, based on economic criteria, enabled the LOTOS Group to materially strengthen its position and share in the domestic fuel market. In and H1 2010, the LOTOS Group gradually moved towards increased use of own fuel depots and handling terminals, which included establishment of tax warehouses on the sites of the Jasło and Czechowice storage depots, and acquisition of a storage depot in Rypin from LOTOS Gaz (a subsidiary). The Jasło and Czechowice tanks, repaired as needed, were used on a regular basis. A number of CAPEX projects were completed, as part of which a new tank with a capacity of 32 thousand cubic metres was placed in service in Czechowice, and 11 new tanks were built in Gdańsk under the 10+ Programme, including: three tanks with a capacity of 32,000 cubic metres (diesel oil) two tanks with a capacity of 20,000 cubic metres (raw gasoline). The number of third-party storage facilities used by the Group, as well as the volume and type of fuels distributed by third-party operators (including OLPP and TanQuid) were adjusted taking into account market demand and new sources of supply. 63

64 Table 17 Capacities of tanks owned by the LOTOS Group Owner Location Product Total capacity (cubic metres) Light fuel oil 10,000 Diesel oil 171,200 Motor gasolines 110,000 Crude oil 400,000 Grupa LOTOS Gdańsk refinery JET aviation fuel 50,000 Diesel oil components/ semi-finished products 35,000 Gasoline components/ semi-finished products 108,200 Vacuum distillates (semi-finished products) 100,000 Motor gasolines 45,500 LOTOS Diesel oil 133,000 Czechowice Czechowice Light fuel oil 27,200 B100 1,500 Motor gasolines 11,355 LOTOS Jasło Jasło Diesel oil 79,090 Light fuel oil 2,135 Gdańsk Depot New Motor gasolines 5,000 Terminal Diesel oil 3,000 Piotrków Trybunalski Diesel oil 1,500 Depot B100 / Diesel oil 1,000 Light fuel oil 500 Diesel oil 660 Grupa LOTOS Poznań Depot B100 / Diesel oil 150 Source: the Issuer. Rypin Depot Light fuel oil 550 Motor gasolines 400 Diesel oil 700 B100 / Diesel oil 120 Light fuel oil 400 TOTAL 1,298,310 Due to restricted access to product pipelines, the majority of the LOTOS Group s fuels sold domestically are transported by rail, with rail transport services provided by LOTOS Kolej. 64

65 Table 18 Transport services provided by LOTOS Kolej Transport under licence (tonnes) Intra-Group transport services DELIVERED DELIVERED DELIVERED Dec Dec Dec ,140,282 4,234,738 4,738,239 - domestic 3,098,040 4,069,281 4,511,820 - international 42, , ,419 Transport services contracted by thirdparties 426, ,949 1,298,885 - domestic 418, , ,981 - international 7, , ,904 Total 3,566,513 5,015,688 6,037,123 - domestic 3,516,873 4,741,456 5,364,800 - international 49, , ,323 Source: the Issuer. Growing demand for transport services provided to the Group companies and third parties highlighted the need to upgrade the rolling stock owned by LOTOS Kolej by adding new modern electricity-powered TRAXX MS locomotives and by the electrification of the railway siding in Gdańsk. Furthermore, in order to enhance its operating efficiency, LOTOS Kolej implemented the Rail Logistics System (System Logistyki Kolejowej). Transport by road tankers, also used in the case of domestic sales but to a lesser extent, was provided by the Group s subsidiaries based on third-party services. Road transport was relied on mainly for the purposes of distributing fuels and bitumens by LOTOS Paliwa and LOTOS Asfalt Sp. z o.o., respectively. The LOTOS Group conducts retail sale of fuels through the country-wide service station network operating under the LOTOS brand. The network is managed by LOTOS Paliwa, a subsidiary of the Issuer. Sales of diesel oil and unleaded gasoline 95 have the largest share in the fuel sales structure. LOTOS Paliwa also offers automobile servicing, and advertising and promotion services. Automobile servicing primarily includes car wash and basic automotive service. The company has been gradually increasing the number of service stations offering such services. In order to enhance the competitiveness of the retail network, the Navigator loyalty scheme has been implemented and the product portfolio has been broadened to include premium fuels sold under the Dynamic brand. LOTOS Paliwa s business profile primarily includes: management and development of the service station network (including COCO, CODO, DODO and DOFO stations); sale of fuels to institutional customers and intermediaries; sale of diesel oil from the network of self-service pumps (LOTOS Diesel Service, LDS); wholesale and retail sale of light fuel oil. The LOTOS Group s objective as regards the retail network growth is to strengthen its market position in Poland. To this end, the development programme is supplemented with a restructuring process designed to 65

66 create a uniform retail network and a uniform portfolio of products and services offered in the network. Accordingly, in past years, the network structure has been changing, with the key change consisting in reducing the number of DODO stations and increasing the number of the COCO, CODO and DOFO stations. Mandatory Stocks and the National Indicative Target Because of the growing volume of fuels sold by the LOTOS Group, the Company was required to increase the level of mandatory stocks, and the amount of fuel biocomponents introduced to the market, including fuel components and B100 self-contained fuel. The construction and placement in operation of a FAME unit in Czechowice by LOTOS Biopaliwa in May 2008 helped the Group more efficiently fulfil the National Indicative Target, which is becoming more stringent every year. For the purpose of holding mandatory stocks of crude oil, components and final products, the Group used its own storage facilities at maximum capacity. The structure of the mandatory stocks held by the Group allowed it to optimise the available capacities and reduce the overall cost of fulfilling the mandatory stock obligation by providing third parties with services consisting in the building and maintaining of mandatory stocks in the crude oil processing potential. Strategy for the LOTOS Group The key elements of the strategy until 2015 are described below. 1. Upstream Segment In line with the Strategy, the LOTOS Group will embark on more intense activities in order to capitalise on the expected high margins in the production sector in the long term, when compared with the processing sector. The key assumptions for this business area are to increase overall production potential and gain access to more hydrocarbon reserves. In the upstream segment, the strategic objective is to increase hydrocarbon production, in line with the priorities of Poland s energy policy until 2030, through: enhanced security of supplies of crude oil for processing at the refinery due to direct access to hydrocarbon deposits; larger production of hydrocarbons achieved by implementing programmes for increasing production of crude oil and natural gas from land and off-shore deposits, domestically and abroad. By 2015, the daily production is planned to reach 24 thousand boe (approximately 1.2m tonnes annually), based on financing with the LOTOS Group s own resources. The activities taken to meet the production target of 1.2m tonnes in 1015 include the development of the B8 field and continued production from the B3 field. For the Norwegian Continental Shelf, the Strategy provides for production from the YME field, as well as exploration within the areas of licences currently held and obtainment of further exploration licences. The Group will continue its efforts to acquire its own reserves under exploration licences in order to create production potential for the future (and thus exploit the favourable tax environment created by the Norwegian government). First material effects of the exploratory work, in the form of the Group s increased share in proven reserves of crude oil and increased production from the discovered reserves, are not expected until 66

67 Accordingly, in order to expand production to 1.2m tonnes in 2015, the Group would also purchase shares in a licence with proven reserves already under development. With a view to implementing its strategic objective in the upstream segment, the LOTOS Group will seek to raise capital and establish cooperation with partners holding access to crude oil and natural gas deposits, in order to increase its proven recoverable reserves to approx. 330m boe and daily production to 100 thousand boe (i.e., approximately 5m tonnes of crude oil equivalent annually) by The Group will look to acquire access to deposits in areas which are characterised by moderate risk and are not of direct interest to major oil companies: offshore areas the Baltic, Norwegian, North and Barents Seas, land areas Poland and Lithuania. 2. Downstream Segment Trade Area In the trade area, the strategic objective is to maximise the economic benefits from trading in gasoline, diesel oil and jet fuel through a flexible control of product streams and continued strengthening of the market position. With respect to the sale of the other products, measures will be undertaken to optimise the economic benefits. The Group s quantitative objectives are: to reach and maintain the market position with a 30% share in the domestic market of gasolines, diesel oils and light fuel oils, to reach sales volume higher by 15% than the refinery s fuel production capacity. As regards the service station network, the LOTOS Group s objective is a dynamic growth of the countrywide network of LOTOS service stations with a view to building a fully controlled and highly efficient product sales channel. This objective will be achieved through: development of the CODO and DOFO service station network in the premium and economic segments, intensified sales and optimised sales structure. The development of the distribution network will be based on exploiting the following possibilities: organic growth, that is the construction of new stations, purchase or lease of stations from independent operators, acquisitions, if interesting opportunities to buy service station networks occur on the Polish market. The quantitative objective is to achieve a 10% share in the domestic retail market within the time horizon of the Strategy, through quantitative and qualitative growth of the station network and growing sales. 67

68 In order to maximise the integrated margin, the LOTOS Group will focus on optimum use of assets and coordination of its activities in the four key areas of the supply chain: planning, supplies, production and distribution. If the Group s operations in these four areas are harmonised, it will have quicker access to information supporting decision making, and thus will be able to respond more rapidly to the changing market environment. In the logistics area, the activity will be oriented towards integration of all components of the logistics chain, those held by the Group and those controlled by third parties. Given its expanded throughput capacities, the LOTOS Group plans to further diversify the directions and sources of crude oil supplies through: maintaining the availability of supply sources of crude oil delivered both over pipelines and by sea transport; flexible selection of crude oil grades and supply directions with a view to maximising the integrated margin; increased activity on the international crude oil market; increased share of the Group s own production in crude oil supplies. Operating Area In the refining area, the LOTOS Group s strategic objective is to maintain its high competitiveness in the European peer group and optimising the use of own assets, as well as of assets acquired as part of further growth-related projects. The conditions for further growth of the LOTOS Group s refinery in Gdańsk ( the Refinery ) are driven by: the crude processing economics and developments in the crude oil sector in the aftermath of the economic crisis; the increasing risk of marketing heavy products; the gradual implementation of more stringent environmental and quality requirements and standards; the technological configuration which will emerge after the completion of the 10+ Programme; and diversification of feedstock for the production of energy carriers. Having considered these factors and also the need to: enhance its operational flexibility; maintain energy security with the simultaneous reduction of the cost of energy supplies, and mitigate operating risk; the LOTOS Group intends to extend the scope of its operations to include power generation, and thus leverage possible synergies between the refining and the power sectors. 68

69 As the Group s experience is connected mainly with crude oil processing, the LOTOS Group intends to base its business diversification strategy on developing competences in the power generation area through engaging in cooperation with external partners that enjoy a strong position in the power sector. The Refinery s technological development will be oriented towards a further increase in the conversion ratio and deepening of oil conversion capabilities through further conversion of asphaltene residue from the ROSE process, with due consideration to the existing technological and economic conditions. The Strategy provides for an option of finding strategic external partners for joint ventures. 3. Financial Strategy The LOTOS Group will operate based on the principle of self-financing of its business units, which means, among others, that the Group will divest of those operations that prove permanently unprofitable. Where market opportunities allow it, the Group s assets will be restructured in order to improve operating efficiency and focus on the core business. Profitability The financial strategy s objective in terms of profitability will be for the LOTOS Group to achieve the target values of the EBITDA margin and the return on average capital employed (ROACE). It is assumed that at the end of the period covered by the strategy, the ratios would be as follows: EBITDA margin of at least 9%, ROACE of at least 12%. Balance Sheet Structure The objective of the LOTOS Group s financial policy is to maintain long-term liquidity, while using an appropriate level of financial leverage to support the achievement of the principal goal of maximising the return on equity attributable to the shareholders. The achievement of the above objectives, in line with the industry practices, will be done by striving to achieve the desired financing structure reflected by the ratio of net interest-bearing debt to equity. On a consolidated basis, the ratio will not exceed 0.4 at the end of the strategy term. Dividend Policy Dividend payments will be subordinated to the objective of optimising the financing structure of the LOTOS Group. The amount of dividend to be paid out from profit for the years covered by the strategy is planned at 30% of net profit. The dividend policy of subsidiary undertakings will be determined by the Management Board of Grupa LOTOS S.A. upon considering their financial standing and development programmes. 69

70 4. Capital Expenditure until 2015 The capital expenditure to be incurred to implement the strategy in the years will be up to PLN 5.7bn. Table 19 Structure of capital expenditure until 2015 Business area Upstream segment Expenditure Expenditure structure (in PLNbn) % Downstream segment, including: % Operating area % Trade area % Group total % Source: The Issuer. At present, the LOTOS Group relies mainly on long-term debt instruments to implement its development programmes. Depending on the market conditions, the LOTOS Group may: find partners for its investment projects, implement projects through Special Purpose Vehicles, raise funds on capital markets through its subsidiaries, outsource auxiliary production, outsource storage capacities, sell and lease back selected assets, sell non-core assets. Moreover, to optimise the capital structure or find partners with appropriate resources or experience, involvement of third-party investors in the implementation of the investment projects may also be considered. The level of involvement of such partners in a project will depend on their impact on the operating and trading activities of the LOTOS Group. 5. Key Macroeconomic and Price-Related Assumptions Adopted to Formulate the Main Objectives of the Financial Policy until

71 Table20 Macroeconomic and price-related assumptions Dtd Brent (USD/bbl) Ural DAF Adamowo (USD/bbl) Crack Gasoline 10ppm Cargoes CIF NWE (USD/t) Crack Diesel 10ppm Cargoes CIF NEW (USD/t) Crack Gasoil 0.1% Cargoes CIF NEW (USD/t) Crack Fuel Oil 3.5% Barges FOB Rotterdam (USD/t) EUR/PLN USD/PLN M LIBOR USD 1.15% 2.15% 3.00% 3.50% 4.15% 3M WIBOR 4.50% 5.00% 5.50% 5.50% 5.50% Source: The Issuer. 6. Development Directions until 2020 Following the implementation of the strategic tasks planned for completion by 2015, the LOTOS Group will continue to focus on measures aimed at increasing the Company s shareholder value. The development of the upstream segment is expected to have a key role here. The main objectives to be achieved by 2020 in the upstream segment include: increasing access to recoverable hydrocarbon reserves, with an intention to achieve the output of approx. 330m boe (barrel of oil equivalent) in 2020, which is to be achieved through: focusing initially on projects that are partially developed or at the final stage of development and, subsequently, on prospective projects (new licenses), which require higher expenditure but offer higher economic benefits, continuing production of/exploration for oil and gas in the Baltic Sea (the Polish Shelf), continuing exploration/production operations in the North Sea, purchasing licenses which make it possible to avoid engaging significant resources (both financial and human), continuing operations on the projects where reserves are already developed; considering the possibility of commencing exploration/production operations on land in Poland and Lithuania; monitoring niche areas which are not of key interest to major oil companies: Central Europe, Commonwealth of Independent States, North Africa. Both exploration and production operations may be carried out with the direct participation of: the LOTOS Group companies, third-party partners. 71

72 The major areas of activity outside the upstream sector include: a. increasing Poland s energy security through the development of operations in the area of international trade in crude oil and petroleum products and optimisation of the distribution and logistics system; b. further improving the economic effectiveness of crude oil processing through the optimal management of heavy residue, ensuring the full utilisation of the Group s assets as well technical/technological and commercial conditions; c. measures undertaken to optimise the power management processes at the Grupa LOTOS s refinery through the extension of its connections with other power systems; d. pursuing modernisation initiatives resulting from the implementation of the Operational Excellence Programme, which are necessary to maintain the Group s highly competitive position in the region. Decisions concerning the planned development-oriented measures will be made based on appropriate feasibility studies, and will be implemented gradually as the LOTOS Group s financing capabilities allow it. The Group does not exclude the possibility of entering into arrangements with third parties based on equity involvement or establishing joint ventures with strategic partners Information on Significant New Products and/or Services That Have Been Introduced and, to the Extent the Development of New Products or Services Has Been Publicly Disclosed, the Status of Development The Company conducts its own R&D and implementation work to introduce new products and modernise existing ones, as well as to improve working conditions and production efficiency. The table below presents a list of modernised or new products created as a result of the Issuer s own R&D work conducted in and as at the Prospectus Date. Table 21 Products created as a result of the Issuer s own R&D work as Prospectus Date at Fuels B-100 diesel oil N LOTOS IFO 380 N LOTOS LPG M LOTOS IFO marine oil M LOTOS DYNAMIC N Eurodiesel oil M LOTOS DYNAMIC N DIESEL LOTOS RED M RG-1 fuel oil N Base oils and lubricants 72

73 Turdus Powertec N Hydromil and Hydromil N Kia Formula motor N Synthetic Plus 10W40 Super hydraulic oils oils Marinol RG CD 50 N Lotos Quazar motor N Titanis Super gearbox N marine oil oils oils Transmil Synthetic N gearbox oils Bitumens and other products Road bitumens QUANTILUS T50 oil M MODBIT polymermodified M Insulation industrial M plasticizer bitumens bitumen QUANTILUS oil Low-oil paraffin N Slack wax M plasticizers MES oil plasticizer Medium slack wax filtrate N Standard paraffin Ceresine Source: the Issuer. N - new product M - modernised product In 2010, the Issuer and LOTOS Parafiny Sp. z o.o. obtained two patents for their inventions ( The method of producing high-melting-point petroleum jelly and The method of producing low-melting-point petroleum jelly ). 6.2 Key Markets The Group s Key Products, Goods for Resale and Services Diesel oil, gasoline and bitumens accounted for the largest share of total sales revenue generated by the Group in The sales of petroleum products and goods for resale have consistently grown over recent years. The growth rate was particularly marked in the diesel oil category due to a number of factors, including rising popularity of diesel cars. Concurrently a decline was recorded in the other product groups, which was primarily an effect of market developments spurred by the economic crisis. Despite unfavourable market conditions prevailing throughout 2009, total revenue from sales of petroleum products and goods reported for the year by the Issuer s Group was more than 12% higher than in 2007 (yet at the same time it was 5% lower than in 2008). 73

74 Table 22 Consolidated sales revenue by type of product (in value terms) historical data 2009 % share 2008 % share 2007 % share Gasoline 5,079, % 5,227, % 5,248, % Diesel oil 11,744, % 11,107, % 8,516, % Light fuel oil 680, % 839, % 770, % Heavy fuel oil 423, % 657, % 550, % Aviation fuel 651, % 1,154, % 881, % Bunker fuel 106, % 468, % 395, % Bitumens 1,109, % 1,093, % 868, % Base oils 219, % 287, % 237, % Lubricants 316, % 368, % 410, % LPG 299, % 492, % 474, % Reformate 211, % 302, % 195, % Other refined products 218, % 216, % 181, % Total petroleum products and goods for resale 21,061, % 22,215, % 18,730, % Other goods for resale and materials 130, % 99, % 115, % Services 113, % 102, % 96, % Total 21,305, % 22,417, % 18,942, % Elimination of excise duty and fuel charge (6,984,582) (6,123,016) (5,817,676) Total 14,321,041 16,294,738 13,125,123 Source: the Issuer Key Markets The LOTOS Group engages in retail sale and wholesale. Refined products are primarily sold to oil companies by the Issuer (wholesale) or by the segment companies whose business profiles comprise trading or trading and production, such as LOTOS Paliwa, LOTOS Oil, LOTOS Asfalt, LOTOS Tank and LOTOS Parafiny. Domestic sales account for the largest portion of the LOTOS Group s sales revenue. The share of domestic sales in total consolidated sales rose from 85% in 2007 to 91% in The rise has had a favourable overall impact on sales margins recorded by the Group thanks to strong margins at home. Higher domestic sales were possible thanks to the consistently implemented strategy of strengthening the Group s market position, 74

75 underpinned by the development of sales forces and restructuring of trading activities as part of the Group s asset base rationalisation. The tables below show the Group s sales revenue by market ( ): Table 23 Consolidated net sales revenue of the LOTOS Group by market (PLN 000) 2009 % share 2008 % share 2007 % share Domestic including: sales, 19,402, % 18,999, % 16,136, % - products 17,045, % 17,799, % 15,335, % - goods for resale and materials 2,357, % 1,200, % 801, % Export including: sales, 1,903, % 3,418, % 2,806, % - products 1,745, % 3,278, % 2,729, % - goods for resale and materials 157, % 139, % 76, % Total 21,305, % 22,417, % 18,942, % Excise duty, fuel charge (6,984,582) (6,123,016) (5,817,676) Total 14,321,041 16,294,738 13,125,123 Source: audited consolidated financial statements for Table 24 Consolidated sales by product groups and markets (thousand tonnes) Market Product group 2009 % 2008 % 2007 % share share share Domestic sales Gasoline 1, % 1, % 1, % Diesel oil 3, % 2, % 2, % Light fuel oil % % % Heavy fuel oil % % % Aviation fuel % % % Bunker fuel % % % Lubricants % % % Base oils % % % Bitumens % % % LPG % % % Other petroleum products % % % 75

76 Market Product group 2009 % 2008 % 2007 % share share share Total domestic sales 6, % 5, % 5, % Export sales Gasoline % % % Diesel oil % % % Heavy fuel oil % % % Aviation fuel % % % Bunker fuel % % % Lubricants % % % Base oils % % % Bitumens % % % Reformate % % % Other petroleum products % % % Total export sales 1, % 1, % 1, % TOTAL 7, , % 7, Source: Directors Reports on the Group s operations for The highest sales growth dynamics in domestic sales was seen in the case of diesel oil and aviation fuel. Two other product groups with high shares in domestic sales were gasolines and bitumens. Motor fuels (gasolines and diesel oil) were mainly sold to international corporations, institutional customers and service station operators. Sales of diesel oil have been on the rise for several years now, which is to a large extent attributable to the development of road transport and diesel engine technologies. Continual adaptation of the fuel depot network used by the Group, based on economic criteria, helped consolidate the Group s position and increase its share in the domestic fuel market. In 2009, the Issuer sold aviation fuel in Poland through two distribution channels: at the Gdańsk airport, where a state-of-the-art handling terminal with the supporting infrastructure was launched in June 2009, and wholesale channel. Bitumens were sold domestically mainly to companies involved in the construction and modernisation of road surfaces Domestic Markets In , the largest share of the Issuer s domestic sales were sales to customers in the Province of Gdańsk. This naturally followed from the fact that the Group s production facilities are located in this region, and the LOTOS brand is widely recognised there. The Group s sales in the Province of Katowice account for slightly less than 20%. The region is an industrial one and densely populated, which drives demand for fuel. The aggregate share of the Province of Poznań and the Province of Warsaw exceeds 20% of total domestic sales. The two regions are home to more than one fourth of the LOTOS Group s service stations. 76

77 Table 25 Sales of gasoline and diesel oil by region Region Province of Gdańsk 31% 34% 27% Province of Katowice 18% 16% 18% Province of Poznań 12% 11% 12% Province of Warsaw 11% 12% 12% Province of Łódź 8% 8% 8% Province of Wrocław 7% 6% 6% Province of Bydgoszcz 2% 3% 3% Province of Olsztyn 2% 3% 3% Province of Szczecin 2% 2% 3% Other 7% 7% 8% Total domestic sales 100% 100% 100% Source: the Issuer. Within the LOTOS Group, LOTOS Paliwa is in charge of fuel distribution through a network of service stations. The service stations of LOTOS Paliwa s retail network operate under the following business models: company owned dealer operated (CODO) stations owned by LOTOS Paliwa and operated by a Manager, dealer-owned franchise-operated stations (DOFO) covered by the Commercial Partnership Programme, and dealer-owned dealer-operated stations (DODO) selling LOTOS products on the basis of concluded agreements but owned by third parties. LOTOS Paliwa s strategic objective is to achieve dynamic growth of the country-wide network of LOTOS service stations in order to build a fully controlled and highly effective sale channel for LOTOS products. The quantitative objective provides for reaching a 10% share in the domestic retail market by 2015, through the quantitative and qualitative development of the station network and increased sales. In , the company continued its efforts in the service station segment, designed to improve efficiency, as well as to enhance competitiveness and management proficiency. The major changes include: launch of premium fuels at the end of 2009, premium fuels under the Dynamic brand were available at all company-owned service stations at which it was technically feasible, i.e. at 139 stations; in 2009, total sales of the Dynamic fuels amounted to 71,345 cubic metres (2008: 47,541 cubic metres), which represented 14.7% of total sales of all fuels excluding LPG (2008: 12.4%); promotional activities LOTOS Paliwa s marketing activities focused on supporting sales in both retail and institutional segment, with a strong emphasis on the first of those customer groups; the LOTOS brand positioning strategy adopted in 2008 is being consistently implemented and revised to reflect the changing market needs. According to the new strategy, the LOTOS stations are to achieve the status of premium stations by saw the launch of the Navigator loyalty scheme; in April 2010 its third edition started. The effect of LOTOS Paliwa s marketing activities on the value of the LOTOS brand was assessed in a research conducted by Pentor RI, measuring the effect of product brands on the corporate brand awareness. The LOTOS brand awareness is created in 61.4% by the service stations brand and in 38.6% by the motor oils brand. service stations located along motorways at the beginning of 2009, LOTOS Paliwa commenced the lease of six Service Aeras located along the A2 motorway (the Police and Łęka Service Areas) and 77

78 the A4 motorway (the Kozłów, Rachowice, Oleśnica and Witowice Service Areas). At the end of March 2010, four service stations were in operation (the Oleśnica and Witowice Service Areas became new additions to the network at the end of April 2010). In 2010, in order to expand the network of service stations located along the motorways, the company s efforts will be focused on tenders, conducted by the General Directorate of National Roads and Motorways (GDDKiA) and/or Licence Holders, for the lease of Service Areas located along the sections of motorways and express ways (S type) which are now being built. At the end of September 2010, the company operated 317 service stations (including 153 CODO, 102 DOFO and 62 DODO stations). At the end of September, the company was a party to 109 partnership agreements, pursuant to which further DOFO stations will be launched. As a result of termination of agreements with dealers operating DODO stations, the number of such stations is shrinking. Selected DODO stations are moving to the Commercial Partnership Programme as envisaged in the company s strategy. The other stations will continue operating under the current business model until their agreements expire, are terminated or the stations move to the B2B segment. Table 26 Number of LOTOS stations in Sep Dec Dec Dec CODO stations DOFO stations (109)* 102 (107)* 98 (92)* 79 (90)* 71 DODO stations Total *Executed partnership agreements. Source: LOTOS Paliwa Foreign Markets In , the proportion of export sales to the Issuer s total sales revenue declined almost by half. This trend is a consequence of the Group s consistent efforts aimed at consolidating the Group s position on the Polish market and of the higher profitability of domestic sales. In , the largest market for the Group s export sales was Sweden (20% of total export sales), with growing shares of the Czech Republic (increase in total revenue from export sales from 4% in 2007 to 14% in 2009), Estonia (increase from 9% to 12%), and Finland (a 10% share in total revenue from export sales in 2009). 78

79 Table 27 Sales of the LOTOS Group s products and goods for resale by region (PLN 000) Item 2009 % share 2008 % share 2007 % share Total sales 19,530, % 20,836, % 17,439, % Domestic sales 18,078,742 93% 17,965,188 86% 15,040,541 86% Export sales, including to: 1,451,826 7% 2,871,757 14% 2,399,069 14% Sweden 296,584 20% 842,725 29% 701,873 29% Czech Republic 206,412 14% 142,774 5% 96,221 4% Estonia 175,809 12% 293,311 10% 205,010 9% Finland 147,689 10% 203,243 7% 22,241 1% United Kingdom 115,769 8% 157,803 5% 244,178 10% Denmark 83,981 6% 351,332 12% 227,085 9% Netherlands 80,080 6% 227,342 8% 422,663 18% Other 345,502 24% 653,228 23% 479,797 20% Source: the Issuer. Jet A-1 aviation fuel, gasoline and heavy fuel oil accounted for the largest share of total export sales revenue in Major export destinations for the aviation fuel were the countries bordering the Baltic Sea and the Czech Republic. Motor gasoline was sold mainly to Sweden, Latvia and the United Kingdom, and heavy fuel oil to Norway, the Netherlands and Sweden. Both in the case of the Issuer and its Group, the major portion of export sales was denominated in the US dollar. The Issuer boasts a significant competitive advantage over its peers in the region in terms of logistics due to the excellent geographical location. The LOTOS Group has access to a pipeline connecting it directly to the reloading infrastructure of Port Północny (the North Port of Gdańsk). The construction of a new transmission pipeline from the Group s refinery to Port Północny was completed in August It greatly enhanced transmission capacity and, consequently, increased exports thanks to higher production potential. Products for exports are transported to the target market mainly by sea. In 2007, LOTOS Asfalt added transport by sea to the modes of shipment used for distributing bitumens. At present, products are loaded directly from railroad tank cars to tanker ships in the Gdańsk port. Reloading of refined products, including those of the LOTOS Group, is handled by Naftoport, a company operating at the port Key Customers of the Issuer and Its Group The following is a list of the key customers of the Issuer s Group in the period January September 2010 along with information on their percentage shares in the consolidated net sales revenue. 79

80 Table 28 Key customers of Grupa LOTOS in the period January September 2010 Name and registered office % share in sales revenue Type of products sold STATOIL POLAND Sp. z o.o. of Warsaw 10.7% gasolines, diesel oil, light fuel oil BP POLSKA S.A. of Kraków 7.9% gasolines, diesel oil, light fuel oil LUKOIL POLSKA Sp. z o.o. of Warsaw 5.7% gasolines, diesel oil SHELL POLSKA Sp. z o.o. of Warsaw 4.5% gasolines, diesel oil Source: the Issuer. The Group s products were primarily purchased by the Polish representative offices of international companies as well as ANWIM S.A., a fuels wholesaler and one of the biggest independent companies operating in the Polish fuel sector. 6.3 Extraordinary Factors Relevant to the Information Provided in Section 6.1 and Section 6.2 In 2007, no extraordinary events with a bearing on the Issuer s core business or main markets occurred at the LOTOS Group. In 2008, the Issuer incurred significant capital expenditure on implementation of the 10+ Programme. In the same year, the Jasło refinery in the south of Poland discontinued processing of crude oil as a result of asset restructuring activities within the Issuer s Group. In the upstream segment 2008 saw the launch of exploration activities by the Issuer s subsidiary in Norway, LOTOS E&P Norge AS. Expansion in the upstream segment should increase the Group s independence in terms of feedstock supplies and further improve the financial performance and the Company s value. In spring 2009, the scheduled 33-day overhaul shutdown between March 15th and April 17th resulted in a lower utilisation of the Gdańsk refinery s capacity. During the shutdown, the planned overhaul work was performed as well as preparatory work to connect the units being built under the 10+ Programme to the existing technological system of the refinery. The global crisis and the Package of Anti-Crisis Measures adopted by Grupa LOTOS S.A., ensuring implementation of the key investment projects and helping the Company maintain financial liquidity, forced the Company to trim its original investment programme. In 2009, the Package produced savings of PLN 470.1m in the form of suspended or abandoned investment projects and cost savings of PLN 252.5m. Given the uncertain market situation and limited possibilities of raising financing, the Company s Management Board resolved to suspend or postpone certain projects envisaged in the LOTOS Group s strategy for the years ; the capital expenditure on those projects amounted to approximately PLN 2.1bn. However, the key investment projects being implemented by the Company, such as the 10+ Programme, the development of the YME field on the Norwegian Continental Shelf, and the planned capital expenditure on the development of fields in the Baltic Sea as part of LOTOS Petrobaltic S.A. s development programme, were unaffected. 80

81 6.4 Summary of Information Regarding the Extent to Which the Group is Dependent on Technology, Patents, Licences, and Industrial, Commercial or Financial Contracts or New Manufacturing Processes The Company s Dependence on Third-Party Technology The Company s business consists in the processing of crude oil and petroleum products, which requires application of state-of-the-art technologies, accessible only to operators with considerable experience in the industry. The Company has not developed all the technologies it requires to achieve efficiency of crude oil processing enabling it to remain in business. Thus, the Company needs to purchase technologies from business partners companies with appropriate experience, based all over the world. The Company s core business, with the Gdańsk refinery as its central point, is to a significant extent dependent on the acquisition of licences to use state-of-the-art technologies. Grupa LOTOS acquires long-term or indefinite-term licences, usually related to the units of the refinery. The Company protects its interest by acquiring irrevocable licences. The majority of licences were granted under English or Swiss law, or the laws of individual states of the USA. The Company also acquired and maintains licences for computer software indispensable for efficient management of a large company. The key licences held by the Company are long-term or indefinite-term irrevocable licences for the use of technological solutions employed in the units of the Gdańsk refinery, including in particular: - licence for the HDS unit; - licence for the hydrocracking unit; - licence for the ROSE process; - licence for the isocracking process; - licence for the Merox process. The Company uses a number of IT technologies to manage the core areas of its operations. Grupa LOTOS holds licences for the software used at the Company. Most agreements executed with software vendors provide for automatic application upgrades and inclusion of new functionalities in the licence scope. The Company purchases software from recognised foreign and Polish suppliers. The main system for managing the Company s activities was implemented by SAP, with the support from SAP Polska, Asseco, IMG Polska and IBM Polska as subcontractors. The Company implemented modules which are of vital importance for the core areas, including: financial accounting, property, plant and equipment, management accounting, risk management, supplies management, production planning and settlement, SAP fuel industryspecific solution, sales and distribution, elements of the quality assurance system, repairs management, investment project management, SAP NetWeaver Integration Platform, strategic management, data warehouse, document circulation, elements of logistic management, corporate portal and central repositories. In addition, the Company holds licences for other software, primarily for Microsoft software used pursuant to Enterprise Agreement concluded for three-year periods, as well as software developed by other companies: 81

82 ISCG, Vemco, Trend Micro, Landmark Graphics, ManageEngine, Koma Nord Sp. z o.o., Adobe, Quest Software and other. In both core and auxiliary activities, the Company relies on technical support, supply of upgrades and extension of functionalities. Grupa LOTOS purchases such services as part of regular cooperation with the same IT service providers who ensure continued operation of the software Intellectual Property Rights Owned by the Company The Company pursues an active policy of protecting the trademarks employed in all areas of its operations. Presently in Poland the Company has 166 registered word marks and 153 registered word-and-graphic and three-dimensional marks in a large number of categories. The Company is consistently acquiring protection for its trademarks in other countries where it operates. Thanks to promotional activities and the Company s repute, the intellectual property rights represent a major asset whose value is growing. The Company s easily recognisable graphic and word marks create positive associations with Grupa LOTOS among the end customers. This is of particular importance in view of the Company s aspirations regarding its share in the Polish retail fuel market. The Company promotes its brand through various activities, particularly cultural initiatives (in Pomerania Grupa LOTOS is a recognised patron of culture), as well as sports initiatives. The Company is a sponsor of the speedway and basketball teams (the LOTOS name is included in the teams names), and is the chief sponsor of Polski Związek Narciarski (the Polish Ski Association). The following logotype, being a part of the corporate visual identity system, is the Company s key word and graphics mark: The so-called LOTOS tao is a part of the logotype and is used a separate graphic mark as well: The Company s right to the above marks expires in 2013 but the Company has the possibility of extending its validity. 82