Key risk factors
In the course of its business, the ORLEN Group monitors and assesses its risk exposures on an ongoing basis and takes steps to minimise their effect on its financial position. PKN ORLEN has developed and implemented an Enterprise Risk Management Policy and Procedure, which have served to comprehensively regulate its Enterprise Risk Management (ERM) system. ERM provides reliable information on risks at the ORLEN Group and enables effective management of those risks, which makes it one of the key tools in the implementation of the Group's strategic and operating objectives.
Integrated Enterprise Risk Management System
The main purpose of the ERM system is to identify risks which may potentially affect the ORLEN Group's operations and the pursuit of its business objectives, as well as to maintain risk exposure within specific limits. The risks defined in the model are assigned to specific processes, while the responsibility for the processes is assigned to risk owners – the employees who, given their position and scope of responsibilities, are charged with managing key controls designed to mitigate the effects of potential risk materialisation.
Risk assessment is carried out on a regular basis, twice a year, and involves evaluating each risk's relevance by:
- assessing the gross risk, which corresponds to the situation prior to the implementation of risk-specific controls,
- testing and evaluating the effectiveness of controls,
- assessing the net risk, which corresponds to the situation following the implementation of risk-specific controls.
After each assessment of controls and risks, appropriate remedial action plans are dawn up for specific risks, alongside reports on PKN ORLEN's current risk profile and evaluations of individual processes.
The ORLEN Group's operating activities expose it to the following commodity risks:
- risk of changes in refining and petrochemical margins on products sold,
- risk of changes in the Brent/Urals differential,
- risk of changes in crude oil and refining product prices caused by temporal mismatch arising when crude oil purchased for processing is transported by sea or by temporary surplus of operating reserves of crude oil, semi-finished products or products, as well as by futures contracts,
- risk of changes in CO2 emission allowances,
- the risk of changes in crude oil and refining product prices associated with the obligation to maintain mandatory crude oil and fuel stocks.
Under the ORLEN Group’s hedging strategies, the refining margin risk and the Urals-Brent differential risk are hedged on a non-systematic basis.
The risk of changes in crude oil and/or refining product prices associated with the temporal mismatch is identified and hedged systematically and regularly.
The ORLEN Group manages the risk of changes in CO2 emission allowance prices on a regular basis, by verifying the number of CO2 emission allowances at least once a year and determining the method for balancing future deficiencies or surpluses. In 2013, the Group executed a number of EUA futures which will be redeemed in the future in settlement of CO2 emissions. The transactions are not disclosed in the consolidated financial statements, as the purchased emission allowances will be used for the Company's own needs.
The risk of changes in crude oil and refining product prices related to the obligation to maintain mandatory crude oil and fuel stocks is deliberately not hedged due to the volume and permanent character of the exposure, as well as its non-cash effect of the ORLEN Group's performance.
The ORLEN Group's operations expose it to the following currency risks:
- economic currency exposure in the following 12 months related to cash inflows net of expenses indexed or denominated in a currency other than the functional currency,
- balance-sheet exposure to currency risk related to foreign currency denominated assets (trade and other receivables, cash and cash equivalents, other) and liabilities (trade payables and other liabilities, bank borrowings, debt securities, other),
- currency risk related to capital expenditure.
The risk related to economic currency exposure is actively hedged on a regular basis using currency futures.
Under the ORLEN Group's hedging strategies, selected elements of balance-sheet currency exposure are hedged opportunistically.
The currency risk related to capital expenditure is hedged systematically using currency forwards for currencies in which the expenditure is incurred.
Interest rate risk
The ORLEN Group is exposed to the risk related to changes in cash flows caused by interest rate movements. Certain assets and liabilities held by the Group have interest income and expense driven by floating interest rates.
The ORLEN Group hedges its consolidated exposure to changes in cash flows caused by interest rate movements. The key measure of the Group's exposure to interest rate risk is the ratio of items whose interest costs are tied to floating interest rates to total net debt. The purpose of interest rate risk management is to maintain this ratio at a certain level over a specific period. This is accomplished by using interest rate swaps and cross-currency interest rate swaps.
CREDIT AND LIQUIDITY RISK
The ORLEN Group is exposed to liquidity risk related to the ratio of current assets to current liabilities. As at the end of 2013, the current ratio of 1.5 was at a safe level.
The objective of liquidity management is safety and stability of the ORLEN Group's finances, and the primary tool used to reduce the liquidity risk is an ongoing analysis of maturity-matching of assets and liabilities.
Furthermore, the ORLEN Group pursues a policy to diversify its financing sources and uses a range of instruments to effectively manage its liquidity.
The banking sector has the largest share in the ORLEN Group's financing structure, providing it with syndicated credit facilities (core of the financing) and bilateral facilities (overdraft facilities, multi-purpose credit lines, investment facilities) with varying maturities.
Considering the increasingly more stringent regulations relating to long-term bank financing, the ORLEN Group additionally uses two bond programmes, which enable it obtain financing outside the banking market.
The bonds issued under the Programme launched in 2007 may be acquired by financial institutions and other companies. This Programme is also used to manage the working capital at the ORLEN Group.
In 2013, an additional public bond issue programme, addressed to retail investors, was launched.
The ORLEN Group deems the credit risk related to its cash and bank deposits as low, as all entities with which the ORLEN Group invests free cash operate in the financial sector. They include domestic banks and branches of foreign banks enjoying high credit rating.
The credit risk is measured as the maximum credit risk for each class of financial assets, which corresponds to their carrying amount. To minimise the risk, as at December 31st 2013, the ORLEN Group held bank and insurance guarantees of PLN 2,223m. Additionally, the ORLEN Group takes security from its customers in the form of cash blocked on bank accounts, mortgages, and promissory notes.
The ORLEN Group is exposed to credit risk related to the guarantees issued for the benefit of its trading partners. The maximum exposure under guarantees issued is the amount the ORLEN Group would have to pay if a trading partner claimed payment under the guarantee. As at December 31st 2013, sureties and guarantees issued in the ordinary course of business in respect of liabilities to third parties amounted to PLN 508m and included mainly performance bonds, customs duty guarantees, bid bonds, and payment guarantees.
Credit risk is related to the risk of default by customers with whom sales transactions are executed. In its trading activity, the ORLEN Group sells its products and services on a deferred payment basis. Assigning a trade credit limit may give rise to a risk of default on the part of the customers receiving our products or services.
The risk is partially limited across the ORLEN Group, as the large number of customers with trade credit limits is dispersed throughout various sectors of the economy, both in Poland and abroad.
The risk is minimised by applying special procedures for assigning trade credit limits to trading partners. A financial condition assessment is carried out on a case by case basis for each customer in order to investigate their creditworthiness and solvency. An essential component of the credit risk management process at the Group is ongoing monitoring of the average collection period. The Group accepts various forms of collateral to secure its receivables (mortgages, guarantees, sureties, cash blocked on bank accounts, security deposits, and promissory notes).Customers who are ultimately assigned trade credit limits are initially required to make prepayments or pay cash. The ORLEN Group prepares information on the maturity structure of receivables, which helps to reduce past-due receivables.
Additionally, to minimise the customer insolvency risk, part of ORLEN Group receivables is insured under trade credit insurance programmes.
The ORLEN Group is exposed to a number of risks specific to the refining sector. Key risks associated with the industry and its market environment are the following:
- Fuel consumption
The overall economic situation has a material effect on the fuel consumption seen on the market and thus has a bearing on the sales and prices of the ORLEN Group's products and its financial position. The ORLEN Group’s fuel trading operations are subject to risk resulting from the existence of the grey market, chiefly involving the marketing of cheaper fuel and tax evasion. The Polish Organisation of Oil Industry and Trade (POPiHN) estimates that the grey market's share in Poland's total fuel market was 10%-12% in 2013, which corresponds to more than 1 million tonnes of fuels.
- Crude processing / raw material supplies
The ORLEN Group's crude processing activities may be disrupted as a result of irregular raw material supplies, unavailability of pipeline transportation or unstable situation in oil-producing countries. Other important factors include changes in the parameters of the received crude, and the resulting reduction in ‘white’ product yield, as well as overhaul shutdowns of production units.
The expansion of existing refineries in Russia and the construction of new ones may translate into reduced crude oil exports, limiting the feedstock's availability to European customers, including the ORLEN Group. Additionally, greater oil demand in China may stoke Russian crude exports to Asian markets, thereby limiting the feedstock's availability on European markets.
Crude oil processing throughput affects the supply of the ORLEN Group's products on the market and, consequently, its financial performance.
PKN ORLEN purchases gas under a long-term agreement with PGNiG and short-term contracts with alternative suppliers.
Thanks to gas market deregulation, ORLEN Group companies are able to purchase gas from local suppliers. Due to the lack of the pricing mechanisms present on liquid European gas markets, gas prices in Poland may be lower or higher than those on neighbouring deregulated markets (e.g. in Germany and the Czech Republic).The ORLEN Group takes steps to ensure the steady supply of raw materials, chiefly by diversifying supply sources and adapting production facilities to processing various grades of feedstock. Furthermore, the ORLEN Group is implementing a number of exploration and production projects with a view to securing its own sources of natural gas and crude oil.
With respect to product logistics, the ORLEN Group is largely dependent on local companies, such as PERN Przyjaźń S.A. and its subsidiary OLPP Sp. z o.o. in Poland or ČEPRO in the Czech Republic. In terms of product logistics, the Mažeikiai refinery relies on a single provider of rail transport services – AB Lietuvos Geležinkeliai. Changes in tariffs of national monopolists have a direct effect on product logistics costs incurred by the ORLEN Group and thus could potentially affect the ORLEN Group's financial performance.
- National Indicative Target costs
As of 2008, fuel producers have been required to achieve the National Indicative Target (NIT), which specifies the minimum share of biocomponents and other renewable fuels, calculated according to their calorific value, in the total amount of fuels and liquid biofuels consumed during a calendar year in the transport sector. A penalty of approximately PLN 17,5 thousand may be imposed on a fuel producer for each tonne of biocomponents below the specified minimum amount. As of January 1st 2012, fuel producers may use a lowered NIT which corresponds to 0.85 of the NIT for a given year if at least 70% of the biocomponents used during fuel production have been supplied by domestic producers listed in the producer register of the Agricultural Market Agency.
- CO2 emission allowances
On February 26th 2014, the European Commission approved a draft list of installations for which a certain number of CO2 emission allowances were to be allocated free of charge. The legislative process at the national level is nearing completion. Additionally, PKN ORLEN will receive CO2 emission allowances for electricity generation in 2013. As the emission allowances allocated to the ORLEN Group free of charge may be insufficient to meet its needs, it may be necessary for the Group to purchase additional emission allowances at changing market prices or to limit production.
The CO2 emission management at the ORLEN Group involves annual monitoring and balancing of CO2 emissions based on production data for installations covered by the emission trading scheme and balancing of any deficit/surplus in line with the rules applicable to intragroup transactions or transactions on the forward and spot markets.
- ‘Colour’ certificates
‘Colour’ certificates are designed to provide support to utilities producing electricity from renewable energy sources and in high-efficiency cogeneration. The certificates are allocated in an amount corresponding to the amount of energy produced and the structure of fuel used. The certificates are allocated in an amount corresponding to the amount of energy produced and the structure of fuel used.
Current legislative work on amending the Polish Energy Law aims to restore the support system for high-efficiency cogeneration by 2018; however, any cogeneration certificates which had been issued, but not redeemed, prior to the act’s coming into force have expired.
- Industrial emissions
The Industrial Emissions Directive introduces more stringent sulfur dioxide, nitrogen oxides and dust emission standards as of 2016. Failure to comply with these industrial emissions standards may have a material effect on the ORLEN Group's operations and performance. To address these requirements, the ORLEN Group is building flue gas desulfurization, denitrification and dust removal units, which will reduce emissions of sulfur dioxide, nitrogen oxides and dust at the CCGT unit in Płock by more than 90%.
- Mandatory stocks
Maintaining mandatory stocks causes the ORLEN Group to incur additional financing and storage costs and may have a non-cash effect on the Group's operating performance resulting from changes in market prices of the stocks.
- Risk of losses related to operations and non-recurring losses
The ORLEN Group is exposed to the risk of losses incurred in the course of its business activity and the risk of non-recurring losses. The ORLEN Group mitigates potential adverse effects of such losses with a professional insurance programme customised to its needs. The programme is developed and relevant insurance agreements are concluded by a dedicated captive insurance company, ORLEN Insurance Ltd. The insurance coverage guaranteed under policies issued by ORLEN Insurance Ltd. is reinsured by major international insurance and reinsurance companies as part of a programme led by AIG Europe and Allianz and involving the largest global insurance companies, such as AIG, Allianz, HDI, Munich Re and ACE, as well as Polish insurers – PZU and TUiR Warta. In addition to comprehensive insurance of assets, the ORLEN Group also holds other insurance policies enabling it to minimise the adverse effects of losses, such as business liability insurance or transportation insurance.
- Court and regulatory proceedings, tax, customs and excise duty inspections
ORLEN Group companies are involved in court or regulatory proceedings or may potentially be involved in such proceedings in the future. Additionally, a number of tax, customs and excise duty inspections are ongoing at the companies. Although the ORLEN Group does not currently expect any of the proceedings to which it is a party to have a material adverse affect on its financial position and performance, there can be no assurance that the result of any ongoing or future proceedings will not have a material adverse effect on the Group's financial position or performance.
- Regulatory risk
Changes in existing regulations or the implementation of new regulations may have a material adverse effect on the ORLEN Group's financial position and performance.