Main types of risks in LOTOS Capital Group

Risks in the LOTOS Group’s operations

Risks inherent in the LOTOS Group’s operations include risks specific to the Oil & Gas industry, such as market risk, exploration risk, crude oil production and processing risks, related to process safety, human safety and the environment, as well as risks related to development projects and initiatives pursued by the Group. The organisation understands risk as a potential threat that needs to be managed in line with the adopted risk appetite policy, and as an opportunity that can be exploited to its advantage.

One of the key challenges affecting the LOTOS Group’s business in 2020 was the market situation caused by the COVID-19 pandemic. The procedures and preventive measures in place helped maintain operational efficiency across the LOTOS Group, from the upstream segment to downstream refining and marketing.

It is anticipated that in the near term the pandemic will continue to have strong implications for the Group’s day-to-day operations and macroeconomic trends that affect its business and performance.

The other key risk factor in the current period that will have bearing on the LOTOS Group’s further growth is the global trend towards a low- and zero-emission economy. Climate risks, as a source of both threats and opportunities, are increasingly better identified and managed by the LOTOS Group. Aware of their magnitude, the organisation puts them high on the list of priorities in setting new business goals and development plans.

Market risk related to the prices of crude oil, gas and petroleum products is one of the key risks with material bearing on the Group’s financial performance. These prices depend on international market quotations, which are beyond the Company’s control. Although this is a natural risk for all industry operators, the LOTOS Group has put in place various measures to mitigate its adverse impact, but also capture the resulting opportunities.

Any identified risks at the LOTOS Group are managed via the Enterprise Risk Management (ERM) system, which has been continually refined.

As part of the system:

risks are identified and evaluated, with performance figures and possible deviations planned and forecast in the context of a volatile and uncertain environment,
business decisions are made on an informed basis, taking into account the risks involved,
and the Group’s risk profile is actively managed by mitigating risks to the achievement of its objectives and capturing opportunities.

All the LOTOS Group companies have in place an Enterprise Risk Management Policy accompanied by a detailed procedure.

2020 was a period of turbulent changes affecting the operation of the LOTOS Group. The COVID-19 pandemic was a tough time that is certain to have a significant bearing on the economies around the world, including the oil industry, in the coming years. Regulatory changes introduced in recent years, both globally and locally, are aimed at slowing climate change. LOTOS considers the challenges arising from these shifts, for example the European Green Deal, as an opportunity as well as a threat. We will seek to take advantage of these challenges, including by implementing innovative alternative fuel projects to adjust our product mix to consumer expectations and behaviours and to the new emerging model of operation of particular transport subsectors.

Mateusz Socha

Compliance and Risk Office

Risk categories at the LOTOS Group

Strategic risks

Development of the LOTOS Group and its financial performance are correlated with the overall economic climate in Poland and globally. The year 2020 was a difficult time of the COVID-19 pandemic, which is bound to shape the oil industry in the years to come.

The pandemic wrought havoc on global fuel markets, as the restrictions imposed by many governments altogether prohibited or impeded the movement of people and goods. This led to a slump in fuel demand, which caused the OPEC+ countries to reduce crude oil output.

The pandemic-related situation remains a major challenge for the aviation industry. Flights worldwide shrank 40% year on year in 2020. Industry organisations (including IATA) predict that the situation on the aviation market will not improve to pre-pandemic levels until several years from now.

The dynamic changes in the oil industry in recent months were also due to other developments, such as the US maintaining its sanctions on Iran and Venezuela, blockade of ports in Libya, the OPEC+ countries competing for market shares, and US presidential election.

The coming months and years will also be subject to strong uncertainty and risks arising from the COVID-19 pandemic and other global trends. Adverse factors, including an estimated 2.8% decline in Poland’s GDP in 2020 and restrictions imposed on the social and economic activity, reduced demand for fuel products, affecting the LOTOS Group’s financial performance. The coming months will show whether the vaccination programme leads to the easing of lockdown restrictions and, consequently, to an increase in fuel consumption.

The economic impacts of the pandemic, but also the energy transition, are reflected in forecasts predicting gradual reductions in refinery production, as more plants are closed down or converted into biorefineries or other operations. This may affect not only simple refineries but also more complex plants with a large share of middle distillates in their product mix.

In recent years, wide-ranging efforts have been afoot (both globally and locally) to tackle climate change. The European Green Deal is the new economic development strategy for the European Union. The transition of the EU economy towards climate neutrality is a means of achieving the objective of changing the EU’s status from the world’s third largest greenhouse gas emitter into the first climate neutral region. The transition is expected to be completed within three decades. This will have a significant impact on the operation and further development of the refining industry. Through changes in the taxation regime, higher prices of CO2 emission allowances, higher costs to finance certain projects and growing requirements regarding the share of renewable energy in transport, these initiatives will affect the LOTOS Group’s operating expenses and performance. These changes may also have an indirect effect through changes in consumer expectations and behaviour, as well as changes in the operating models of the various transport sub-sectors (decarbonisation of public transport and car sharing).

However, the LOTOS Group notes not only challenges, but also opportunities arising from climate change, striving to exploit them through innovative projects, such as production of alternative fuels.

Detailed information on identified climate risks is presented in the table below.

Climate change risks

Risk factors	Threats	Opportunities
Revision of the Directive on the promotion of the use of energy from renewable sources (RED)
Increased mandatory share of renewable energy in transport, which will increase the use of low-emission fuels, including advanced biofuels, synthetic liquid and gaseous fuels, and hydrogen.	– Increase in costs related to the purchase and production of biofuels and possible penalties for failure to meet the targets regarding the share of renewable energy in transport	+ Possibility of entering new markets for advanced biofuels or hydrogen + Possibility of obtaining dedicated support for low-emission projects and possibility of new investments in the sector whose products may be in greater demand across the European Union.
Revision of the Energy Taxation Directive (ETD)
The proposed changes in the fuel and energy taxation system will increase the minimum tax thresholds and diversify them so that low-emission alternative fuels can be as cheap as possible compared with petroleum-based counterparts.	– Possible gradual decline in demand for conventional fuels – Increased tax burden on conventional fuels, disruption of the existing relations between taxes on diesel oil, gasoline and LPG	+ Growing interest in low-emission alternatives, such as electricity, hydrogen or fuels with a higher content of advanced biocomponents + Potentially higher profitability of projects connected with the production and use of alternative fuels in transport, given their preferential tax treatment.
Introduction of EU regulations on sustainable aviation fuels (ReFuelEU Aviation initiative)
The initiative concerns the development of sustainable (low-emission) aviation fuels (SAF); various options are considered, including commitment for the refining industry to produce a specified volume of low-emission aviation fuels.	– High costs of the mandatory production of SAF (if this option is ultimately included in the regulations), due, among other things, to limited availability of the raw materials and costly certification procedures for such fuels; it is estimated that the cost of introducing SAF is several times higher than for conventional fuels	+ Entry into the prospective and probably high-margin nascent market for sustainable aviation fuels.
Revision of the Alternative Fuels Infrastructure Directive
The initiative focuses on establishing mandatory targets for the development of alternative fuels infrastructure in the EU, with the objective of increasing the number of electric vehicle charging stations, hydrogen, CNG and LNG refuelling stations, as well as LNG refuelling stations at ports for LNG-fuelled vessels.	– Growing number of electric vehicles may, as a result, contribute to a decline in demand for conventional fuels, especially gasoline – Need to incur new infrastructure construction costs	+ Expansion of the electric mobility segment gives opportunities to offer recharging services and expand the non-fuel business (longer charging times for electric vehicles relative to combustion ones means more time spent by customers in a station’s retail space) + Development of the alternative fuels market and generation of revenue from sale of such fuels (electricity, hydrogen, CNG/LNG).
Revision of the EU ETS
The proposed changes to the ETS are intended to accelerate growth in the prices of CO2 emission allowances and thus to stimulate investments in emission free technologies.	– Increase in operating expenses of Grupa LOTOS S.A. due to higher prices of emission allowances and lower number of free allowances	+ Increased profitability of innovative decarbonisation projects (e.g. the Green H2 project)
EU hydrogen strategy and legislation promoting the use of hydrogen
The strategy is designed to identify barriers to increased production and use of clean hydrogen, to define measures to remove those barriers and promote the production and use of clean hydrogen on a large scale, as well as development of the hydrogen market and the necessary cost-effective infrastructure. Proposals of legal acts that would comprehensively regulate the production and use of hydrogen in the economy are expected in 2021.	– Establishment of too stringent criteria for the recognition of energy for hydrogen production as renewable – Introduction of binding hydrogen share targets, without adequate demand-side tools	+Possibility of entry into the promising green hydrogen market +Possibility of achieving the (growing) targets imposed on Grupa LOTOS S.A. with regard to the share of renewable energy in transport +Access to preferential financing models for hydrogen projects.
Introduction of a legislative package on sustainable financing (EU taxonomy)
The legislative package introduces a general framework to support the gradual development of a classification system for environmentally sustainable economic activities, which will be used to reorient private sector capital flows and EU programmes towards investments classified as climatically sustainable.	– Increase in finance costs and possible impediments to the financing of projects not classified as sustainable (‘green’) – Increase in the cost of insurance covering economic activities not considered environmentally sustainable in the taxonomy	+ Preferential funding for projects included in the taxonomy, i.e. designed to reduce emissions, e.g. production of green hydrogen, advanced alternative fuels, or generation of energy from renewable sources.
National Reduction Target specifies a minimum reduction of greenhouse gas emissions over the fuel life cycle – amendment to the Act on Fuel Quality Monitoring and Control System
The amendment to the Act on Fuel Quality Monitoring and Control System provides for a change in the method of calculating penalties for failure to meet the fuel life cycle emissions reduction target – National Reduction Target. It provides for the introduction of absolute values into the model instead of reference to the prices of emission allowances. In addition, the amendment provides for confirmation of the NRT validity beyond 2020, facilitation of joint LPG settlements, and establishment of a register of documents supporting the achievement of upstream emission reductions.	– Additional costs for the LOTOS Group resulting from the extension of the obligation beyond 2020 and increase in the fine amount	+ Possibility of paying an emission charge, reduced risk from introducing certificates of upstream emission reductions (UER) and facilitated joint LPG settlements after the amendment takes effect.
National Indicative Target defines a minimum share of renewable energy in transport and implements the amended RED Directive (RED II) by amending the Act on Biocomponents and Liquid Biofuels
RED II provides for an increase in the minimum share of renewable energy in transport to 14% (compared with the current 10%) and a minimum share of advanced biofuels of 3.5% by 2030.	– Increase in operating expenses due to higher requirements regarding the share of renewable energy in transport (e.g. necessity to use more expensive, advanced biofuels; potential penalties)	+ Entry into the new market of advanced biofuels, for which demand in the EU should grow.
Amendment to the Energy Efficiency Act
The amendment provides for an extension of the catalogue of entities obliged to achieve energy efficiency improvement targets. The obliged entities will have to demonstrate annually an appropriate reduction in the amount of energy delivered to end users.	– Increase in costs due to the need to meet the efficiency targets set out in the Act, which will most likely require payment of an emission charge or purchase of white certificates.

Source: the Company.

Regulatory risk at the national and European level has strong relevance to the LOTOS Group’s operations. This risk is closely associated with the climate risks described in Table 30. The Company keeps monitoring the legal environment and communicates its position as part of legislative processes, which is always formulated so as to make the best use of opportunities and reduce the potential adverse impact of new regulations. The Company intends to remain in compliance with all the regulatory requirements.

One of the key risk categories relevant to the LOTOS Group’s strategy is the risk related to its ongoing and planned strategic projects. In 2020, a number of exploration and production projects, including development of the B8 field and development of the YME field in the Norwegian Continental Shelf, were delayed due mainly to the COVID-19 pandemic (→ Current Report No. 7/2020). The delays were due, among other things, to the subcontractors’ inability to perform the full scope of oilfield services and shipyard work.

Another challenge for the coming years lies in the implementation of other projects, currently in the planning phase, which would enable further growth of the LOTOS Group, including the construction of an oil hydrocracker (HBO) to produce modern base oils, the CCGT project, and the Green H2 project to create a large-scale green hydrogen production facility, consisting of electrolysers, hydrogen storage facilities and fuel cells or, alternatively, hydrogen turbines.

By regularly monitoring the progress of, and risks related to, its strategic projects, the LOTOS Group is able to anticipate the situation and thus to implement measures designed to control risks or leverage opportunities. As part of project management, the Group applies portfolio management practices, taking into consideration the organisation’s internal condition and external market environment, and directing capital flows to various projects at different stages of the delivery cycle.

Competence risk is related to the difficulty in attracting or retaining competent and experienced staff, necessary for the Group to attain its strategic objectives. Recent years have shown that the labour market in Poland is transforming. The industrial sector and niche industries often face a shortage of qualified specialist workforce. This is an important issue, requiring employers to be flexible and make active efforts in recruiting and retaining staff with appropriate qualifications.

Financial risks

For detailed information on financial risk and policies to manage that risk, see Note 27 on p. 73 to the consolidated financial statements for 2020. A general overview of individual financial risks is presented below.

Market risk: prices of petroleum commodities and products

Grupa LOTOS S.A.’s margins on sale of petroleum products are largely dependent on a spread between its selling prices and the prices of crude oil. The prices of refining products, crude oil and natural gas may fluctuate widely driven by external events, such as changes in the supply and demand forces globally or regionally, dynamic geopolitical factors or shifts in market preferences.

Grupa LOTOS S.A. identifies the following risk factors related to the prices of petroleum commodities and products:

volatility of the refining margin, measured as the difference between liquid indices of a reference petroleum product basket (e.g. aviation fuel, gasoline, diesel oil, fuel oil) and a liquid index of reference commodity (e.g. Urals crude),
volatility of prices with respect to the commodity and product inventory volumes deviating from the required levels of emergency and operational stocks,
volatility of differentials between the reference indices and indices used in commercial contracts (e.g. Urals-Brent differential, i.e. the difference between different types of crude oil),
use of non-standard pricing formulae in trade contracts.

Market risk: currency exchange rates

In its operations the LOTOS Group is exposed to currency risks related to:

trading in raw materials, petroleum products and other commodities,
investment cash flows,
cash flows from financing activities, including deposits and borrowings,
measurement of derivatives indexed to or denominated in a currency other than the functional currency (PLN).

The LOTOS Group has a structurally long position in USD (which means it benefits from a rise in the exchange rate of the US dollar against the Polish złoty) as its cash inflows dependent on the USD exchange rate (mainly revenue from sale of petroleum products) are higher than the corresponding cash outflows (e.g. outflows on purchase of crude oil). On the other hand, some of the LOTOS Group’s debt is denominated in foreign currencies, primarily the US dollar, as a result of which an appreciation of the US currency against the Polish złoty increases the cost of servicing these liabilities, as well as the value of the liabilities disclosed in the financial statements as at the measurement date.

Market risk: interest rates

Grupa LOTOS S.A is exposed to the risk of changes in cash flows caused by interest rate movements, as interest income and expense related to certain assets and liabilities accrues based on floating interest rates. This is driven primarily by the expected facility repayment schedules, as well as the amount of interest computed by reference to the floating LIBOR USD rate.

In connection with the ongoing reform of inter-bank offered rates (LIBOR), which will result in cessation of the currently applied interest rates (including the planned discontinuation of LIBOR at the end of 2021) and their replacement with other benchmarks, Grupa LOTOS S.A. is actively monitoring the progress of the reform to the extent applicable to the Company, taking all necessary decisions and steps to prepare for the transition to new interest rates.

In 2021, the Company plans to hold talks with its financial partners so that relevant clauses relating to new interest rate benchmarks are included in due time into its existing agreements.

Market risk: prices of carbon dioxide (CO₂) emission allowances

Grupa LOTOS S.A. participates in the European carbon dioxide (CO2) emission trading scheme and manages the related risk on an ongoing basis in accordance with a detailed risk management strategy it has adopted for carbon dioxide emission prices. The current trading period (Phase III) ended in 2020. At present, Grupa LOTOS S.A. holds surplus allowances, purchased in view of the prevailing market situation and the strategic nature of a deficit of allowances expected after 2020. The new allocation of allowances for 2021–2025 is due in the first half of 2021.

Liquidity risk is associated with ensuring that all liabilities are settled in a timely manner. The risk can materialise because of a mismatch between streams of receivables and payables or inadequate sources of funding. Liquidity is managed across the LOTOS Group based on current liquidity forecasts.

Some investment projects undertaken by Grupa LOTOS S.A. and its subsidiaries, as well as their day-to-day operations, are partly financed with borrowed funds. Therefore, there is a risk that LOTOS Group companies may face difficulties in raising external finance or obtaining acceptable terms of such finance for their further development. This may be caused by instability on financial and capital markets in Poland or abroad, more restrictive policies applied by financing institutions with respect to new agreements or interpretation and performance of existing agreements, any adverse economic developments in Poland or abroad, and non-performance or improper performance by LOTOS Group companies of their obligations under financing agreements. There is also a noticeable trend of limiting access to external financing for conventional fuel projects.

The ability to raise additional debt is also constrained by the LOTOS Group companies’ obligations to service their existing debt. Currently, their economic performance, liquidity position and debt levels are satisfactory.

In the course of its trading operations, the LOTOS Group sells products and services to other business entities on a deferred payment basis, which may give rise to the risk of default on the part of its trading partners (credit risk of trade partners).

In entering into financial contracts with financial institutions, due consideration is given to the risk that the counterparty may default on amounts owed to Grupa LOTOS S.A. on settlement of a given transaction. In addition, the credit exposure also includes bank deposits and cash held in bank accounts (credit risk of financial transaction counterparties).

Operational risks

Operational risks are identified as part of ongoing processes carried out at the LOTOS Group, as factors with a potential impact on the achievement of the Group’s operational objectives. Operational risk factors are identified in the LOTOS Group’s internal processes and in its environment, including the supply chain.

Exploration projects undertaken by the LOTOS Group involve both the risk of drilling a well without a hydrocarbon flow, as well as the risk of inaccurate estimation of hydrocarbon resources and reserves discovered by drilling. It is possible that the presence of resources inferred from geological and seismic data is not confirmed after a well is drilled, and that the estimated resources are smaller than originally expected. There is also a risk that further drilling to appraise a deposit will result in a downward revision of resource estimates due to unfavourable changes in the reservoir properties. For this reason, analyses and decisions in exploration activities involve multiple stages, with different risk mitigation methods used along the way.

Hydrocarbon production processes are often carried out in challenging conditions, mainly offshore. High pressure and increased corrosive effects compound the risk of failures of production equipment, such as downhole pumps, extraction equipment and transmission facilities, which in turn may negatively affect production volumes and financial performance.

Failure to achieve production targets may also result from declining well capacity rates (changes in reservoir pressure) and reservoir properties differing from those documented at the field development stage.

A production process involves the risk of an oil spill, fire or blowout, which may result in environmental contamination, risks to the health and lives of staff, reduction or discontinuation of production, as well as the need to incur significant financial expenditure to remove the damage or pay the resulting fines. The risk is attributable to the quality of operation of the exploration and production infrastructure, application of inadequate technical and organisational solutions, as well as the level of awareness and skills possessed by staff and subcontractors.

In 2020, the pandemic made it necessary to define a new risk that production may be limited due to the spread of COVID-19. To date, there has been no interruption in or limitation of oil or gas production at LOTOS Petrobaltic S.A. or the LOTOS Upstream Group, thanks mainly to the crisis scenario procedures to be followed in the event of detection of COVID-19 infections, especially on drilling platforms.

One of the two key pillars of the LOTOS Group’s operations is the processing of crude oil and refining of petroleum products. Its essential element is to ensure the safety of people, processes, infrastructure and the environment. A potential industrial accident taking place at the refinery could disrupt refining production and, in extreme cases, cause a fire or release of hazardous substances. Such incidents could potentially pose a risk to people in the vicinity. Any hydrocarbon leaks could contaminate land and surface water or, in the case of emergencies resulting in major emissions into the atmosphere, cause air pollution. At Grupa LOTOS S.A., all risks to process, human and environment safety are managed with the utmost care and measures are taken to minimise such risks.

2020 brought a new risk factor: the COVID-19 pandemic. It involves a risk that production may be stopped if key human resources are unavailable. Grupa LOTOS S.A. has identified COVID-19 infections among its employees, but proper monitoring and effective response allowed it continuously sustain safe refining operations. Based on the accumulated experience, effective organisational solutions have been developed in recent months to prevent the risk from materialising, although its materialisation cannot be ruled out if the epidemic continues to spread at a significant rate.

Having no upstream production assets that would fully cover its demand for crude oil, the LOTOS Group has also identified the risk of disruption of the continuity of crude oil supplies. The continuity of crude oil supplies to the Group may be affected by the following main factors:

technical failures, including failures of the pipeline system used to supply crude oil, terrorist attacks, acts of sabotage, riots, revolutions, war, natural disasters, adverse weather conditions, or other events of force majeure,
uneven deliveries of crude oil resulting in a temporary decrease in work-in-process stocks, and consequently in the refinery’s lower throughput volumes and failure
to meet the oil quality requirements.

Grupa LOTOS S.A. follows the adopted Crude Oil Supply Policy to ensure operational continuity and security of crude oil supplies through, among other measures, diversification of supply directions, crude oil grades and suppliers. The Company maintains the availability of crude oil supplies by pipeline, rail and sea. Thanks to the LOTOS refinery’s convenient location near the sea coast and successful measures taken within the supply chain, in 2019, when oil supplies over the Druzhba pipeline were temporarily discontinued (see Current Reports No. 7/2019 and 16/2019), the Company was not forced to shut down its refining units and customers did not suffer any adverse consequences of the oil contamination incident.

The LOTOS Group identifies a risk from its relations with suppliers and subcontractors along the entire length of the supply chain. The market of suppliers of goods and services meeting the requisite quality standards expected by the organisation has been shrinking visibly in recent years. This aspect is particularly relevant to the plant maintenance and overhaul policy, but also to the smooth execution of major development projects.

Effective management of this risk is crucial in the context of the maintenance shutdown scheduled for the spring of 2021. A maintenance shutdown is a project for which Grupa LOTOS S.A. prepares in advance. Several independent contractors were selected to perform the main tasks. This approach enables the contractors to properly prepare for the work, which can be carried out efficiently on the back of well-planned cooperation.

Safety risk is one of the key risks identified at the LOTOS Group. Because of the nature of its industry, accidents may occur at every stage of the Group’s production processes and along its logistics chain. They may happen during oil production and refining processes, during transport of products by road or by rail, and while rig crews are being carried by helicopters.

These risk factors may stem from human errors or non-compliance with the applicable requirements and procedures, plant failures, releases of harmful substances, as well as natural disasters or other incidents likely to endanger human health and lives.

In order to minimise HSE risks, Grupa LOTOS S.A. undertakes a number of concurrent initiatives to improve the functioning of the personal and process safety areas. One of them is to build a safety culture based on the involvement of employees and subcontractors. At the same time, steps are taken to ensure operational process stability by maintaining the highest standards of safety. Having implemented and refined a Process Safety Management (PSM) system, in which processes are analysed and monitored on a comprehensive basis, Grupa LOTOS S.A. is able to continuously raise the level of human safety, as well as the safety of its natural and social environments.

HSE risks will be under special supervision during the maintenance shutdowns scheduled for 2021 and 2022. The nature of the maintenance work and the fact that an additional 2,000 people from various companies and regions will come to work on the plant premises can be a source of additional risks related to occupational safety and the potential spread of COVID-19. Based on the experience gathered so far by Grupa LOTOS S.A. as part of its epidemic risk management at a large production plant, additional organisational solutions and procedures are being put in place to mitigate such risks.

*HSE – Health, Safety and Environment

In addition to physical security of the organisation and its business partners, Grupa LOTOS S.A. is highly aware – given the ever increasing reliance on IT resources and process automation – of the risks associated with cybercrime. As a business technologically opens up to the world, new opportunities arise to access its strictly protected valuable business assets or resources stored in telephone or computer memories. Given the risk of interference that may lead to major accidents or damage, key information, operational control systems (OT) and production processes are strategic surveillance and security areas.

Reputation and compliance risk

Reputation risk relates to the perception of the LOTOS Group by its key stakeholders – customers, investors, employees and local communities. The development of social media has brought with it increasingly more opportunities but also risks, which, given the speed of reaction and very wide audiences, call for particular attention and caution.

Should the reputation risk materialise, it could undermine the public’s approval for the continuation and development of the Group’s business, thereby affecting its long-term financial performance.

Legal risk relates to non-compliance or partial compliance with existing laws (by contrast, the regulatory risk discussed above applies to possible future regulations). The legal requirements impose a number of obligations on the LOTOS Group, which have to be complied with by an operator engaged in licensed/regulated activities. In addition, given the scale of the Group’s operations, it is under particular scrutiny by the supervision authorities, social stakeholders and supply chain participants.

The application of legal provisions in practice indicates that they are often quite imprecise, and different interpretive approaches may yield varying interpretations. The LOTOS Group companies take all due care to minimise this risk.

Existing and future employees are the LOTOS Group’s key stakeholders. How they perceive and understand the LOTOS Group’s activities is vital for the effectiveness of its operations and implemented changes. However, if its internal communication is deficient, there is a risk that any changes planned will ultimately prompt employee protests or industrial action.

Processes carried out by the LOTOS Group, such as exploration for, development and production of hydrocarbons, refining production, product transport and logistics, may have an impact on the environment. This impact may be significant especially in the event of industrial failures and release of hazardous substances into the environment. In particular, oil spills from existing platforms or during transport of crude oil or petroleum products may have massive consequences. Therefore, the LOTOS Group companies apply measures and use tools to ensure maximum protection against potential oil spills and environmental contamination.

Social risk is analysed in the context of the LOTOS Group’s impact on the environment and stakeholders. The Group’s production processes or infrastructure projects may give rise to objections, in extreme cases expressed as social protests. So far, its communication with stakeholders has significantly mitigated that risk.

List of key risks at the LOTOS Group, including materiality levels and mitigation methods

Risk level:

Risk trend:

1– low risk

2– moderate risk

3– significant risk

→stable risk

↓ diminishing risk

↑ growing risk

Risk type	Level	Trend	Risk response
Risk from megatrends
Fluctuating supply and demand trends on the fuel market	3	↑	Performing long-term trend analyses and updating strategy to mitigate adverse effects or seize new opportunities to gain a competitive advantage (e.g. in electric mobility) Implementation of development projects to expand and diversify the existing asset portfolio Implementation of development projects to improve the flexibility of production/refinery processing operations and energy efficiency Implementation of innovation projects
Climate risk
Climate change threats and opportunities	2	↑	Undertaking new initiatives and projects, such as advanced biofuels, alternative fuels, e.g. hydrogen, LNG, CNG, as well as energy efficiency projects – measures to reduce emissions and increase the share of energy from renewable sources Commitment to research and development projects aimed at developing solutions with a favourable impact on the environment and climate change Monitoring and active participation in legislative processes (presentation of analyses, proposing regulatory solutions beneficial to the organisation), both at the EU and national level – for the LOTOS Group, key climate risks relate to its transformation and pertain to regulatory changes
Regulatory risk
Impact from amended legislation or failure to comply with new national or EU regulations (it can be the both a threat and opportunity)	2	→	Development of a compliance management system by the Compliance Department and External Regulation Department Monitoring new regulations and regulatory changes Active participation in legislative dialogue led by the Regulator and non-governmental organisations Scenario analysis of potential impacts of regulations Implementation of measures for adapting to planned or enacted regulatory changes
Risk in strategic projects
Delays, failure to achieve objectives/targets in the implementation of strategic projects	3	→	Comprehensive, step-by-step project planning Qualification of contractors Systematic risk review and management for each project Monitoring of progress made on projects, forecasting of project parameters, and mitigation of emerging risks Active project management, including close oversight and communication with contractors
Geopolitical risk
Disrupted or delayed supplies of crude oil or other essential feedstocks	2	→	Diversification of crude oil supplies (e.g. maintaining the availability of supply sources for oil supplied by pipeline and sea) Maintaining adequate levels of work-in-process stocks Production scheduling and procurement planning Providing for relief measures in supply contracts in case a delivery route becomes unavailable Following Grupa LOTOS S.A.’s Crude Oil Supply Policy
Competence risk
Difficulties with recruitment of qualified staff and retention of competent and experienced employees	2	→	Building an engaging work environment to enhance productivity Creating space for development and innovation within the organisation (activities of the LOTOS Academy, financing of training and higher education, possibility of participating in the PhD Theses Implementation Programme) Building a good employer image inside and outside the organisation Building a knowledge management system to enable effective knowledge sharing/transfer and develop staff competencies necessary to achieve near- and long-term business goals
Market risk
Fluctuating prices of feedstock and petroleum products, fluctuating foreign exchange and interest rates. Risk that could pose both threats and opportunities to the LOTOS Group’s operations.	3	↑	Following the adopted feedstock and petroleum product price risk management policy and currency risk management policy Monitoring market risk exposure on a daily basis Selecting a trading strategy in line with policy objectives, current market situation and applicable risk limits
Liquidity and financing risk
Mismanagement of working capital and constrained financing capacity	2	→	Assessing and forecasting the Group’s cash flows and liquidity Analysis of financing sources available to the Group Diversification of financing sources. Optimising liquidity and debt across the Group Effective management of strategic project portfolio
Credit risk
Insolvent trade partners or counterparties in financial contracts	2	→	Monitoring of partners' ratings and financial standing Setting trade credit limits and limits for counterparties in financial contracts in accordance with internal procedures Employment of diverse financial tools to minimise risk
Exploration risk
Incorrect estimation of resources, including incorrect estimation of hydrocarbon resources and reserves discovered by exploration wells; drilling of dry wells (without hydrocarbon flows)	2	→	Conduct of geological and reservoir engineering studies depending on the well (exploratory, appraisal, or appraisal and production well) Decision points included in the project (initial phase, execution phase, well results analysis and reservoir evaluation, design phase) to minimise dry well risk Applying international probability-of-success (PoS) standards Cooperation with experienced field operators on the Norwegian Continental Shelf
Production risk
Risk of drilling or production failure, resulting in reduced availability of affected infrastructure	2	→	Implementing a range of measures to mitigate such risks as blowout, well failure, oil spill, fire, and collision at sea and to monitor their effective oversight, including: monitoring of process parameters equipment performance tests use of appropriate safety measures compliance with applicable safety and operating procedures
Geological reservoir risk and downhole equipment-related risk	3	→	Reservoir analysis (updating integrated static and dynamic models) Assessing well and pump performance Workover of production wells Injection of chemicals (hydrate inhibitors) reducing the risk of downhole pump failures
Refining risk
Failure of refinery processing units	2	→	Inspecting the technical condition of processing equipment and components in line with maintenance schedules Risk-based inspections of infrastructure Having equipment inspected by the Technical Inspection Office and Company Technical Inspection Identifying Critical Equipment subject to special inspection rules Carrying out annual Failure Prevention Plans and Maintenance/Overhaul Plans Improving staff qualifications, including simulation-based training Automatic control, alarm and shutdown systems
Sales
Risk of product sales below the target	2	↑	Ongoing analysis of demand change scenarios in each sales channel Adjustment of the refining product mix to market demand changes Standards of maintaining good relations with customers
HSE risk
Accidents along the entire production cycle and logistics chain (including road and rail accidents during product transport and aircraft accidents during rig crews transport)	2	→	Raising employees’ and subcontractors’ awareness of and commitment to safety culture Health and safety risk assessment and process risk analysis Regular inspections of OHS compliance at the workplace Implementation of the annual Health and Safety Plan for the LOTOS Group Supervision of subcontracting; operation of the contractor portal (with updated procedures and guidelines for subcontractors performing work on the premises of Grupa LOTOS S.A.) Given the air transport of crews to offshore drilling platforms, with respect to aviation accident risk: high safety requirements for aircraft fleet – AOC and E12 certificates, IFR approval, ongoing monitoring of weather conditions and proper logistics of passenger transport by sea, supervision of the terms of contracts with carriers.
Release of substances which may halt production processes and impact humans and the environment	2	→	Continuous improvement of the Process Safety Management (PSM) system Implementation of change management policies and procedures Risk analysis for each upgrade and new build project Process safety training for personnel Occupational safety instructions and procedures Registration and reporting of process safety incidents
Security risk
Destruction of critical infrastructure in an act of terrorism	2	→	Periodical drills to check security and communication systems Implemented procedures in case of physical security or protection breaches Participation in the Government Centre for Security’s training Communication with the Provincial Emergency Management Centre
External or internal interference with IT and OT systems (cyberattack) and failures	2	→	Implementation of the ISO 27001 system and Cybersecurity Act requirements Implementation of the Cybersecurity Rules at the LOTOS Group Use of internal system security management procedures IT security audits Regular security tests for ICT infrastructure Raising employees’ awareness of cyber security issues (training, information, tests) Cooperation with CERT ABW Computer Security Incident Response Team Operation and development of the Security Operation Centre (SOC) Office
Procurement risk
Shrinking market of suppliers of goods and services meeting the requisite quality standards	2	→	Supplier selection procedures Rules for dealing with key suppliers Maintaining good relations with suppliers based on transparent procedures
Buying from unreliable suppliers involved in VAT ‘carousel frauds’	2	→	Application of the split payment mechanism Detailed checks of trade partners Inclusion of relevant clauses in contracts with trade partners Due diligence
Legal risk
An intentional act or omission which constitutes violation of the law or a breach of the LOTOS Group’s internal regulations, committed to secure an unlawful gain or causing the Company to sustain undue losses (including corrupt practices).	2	→	Operation of the LOTOS Group’s Misconduct Prevention Policy, defining a systematic approach to misconduct prevention, including the rules of conduct and methods of communication. Operation of the Ethical Conduct Programme, which is pursued through the Code of Ethics, the Ethics Officer and the Ethics Hotline, as well as training activities. Application of the LOTOS Group’s gift policy Conducting audits and inspections
Violation of data protection laws	2	→	Application of internal data protection standards, including as part of personal data protection procedures and the security policy Audits, also by external auditors, to verify whether the organisation observes the applicable rules and how it is prepared to comply with the GDPR requirements Raising employees’ awareness (training, meetings)
Environmental risk
Leakage from vessels carrying crude oil / products made by the LOTOS Group	2	→	Working with service providers that observe the performance standards set out in resolutions of the International Maritime Organization (IMO) and comply with the maritime security conventions Including clauses on technical condition of ships in contracts with trading partners and providers of sea transport services Working with shipowners that are members of the International Tanker Owners Pollution Federation Ltd. (ITOPF) and hold the required insurance certificates Insurance coverage and membership in the International Oil Pollution Compensation Fund (IOPCF)
Oil spill on rig	2	→	Maintaining offshore equipment in good technical condition to minimise the risk of accidents on rigs Taking steps to control the risk of formation fluid invasion at the stage of planning and conducting well drilling operations Holding annual drills in oil spill control Selecting the right anti-spill equipment Insurance coverage
Periodical spikes in emissions from the refining process	1	→	Constantly monitoring the process and emission parameters, including through a continuous emission monitoring system (CEMS) launched in 2020 Maintaining high technical standards application of the best available techniques (BAT) requirements Implementation of environmental management plans
Personnel risk
Employees resisting changes introduced in the LOTOS Group	2	→	Open communication with employees, trade unions and Works Council about the planned changes Communicating the changes to media Opportunities for employees to gain new qualifications/ retrain Offering support in the event of a change of workplace and relocation; financial assistance Ongoing monitoring of employee sentiment
Social risk
Social protests against the Group’s projects	2	→	Maintaining good relations with stakeholders. Holding meetings to inform stakeholders about the Group’s projects Open communication on the Group’s current operations and projects Maintaining good relations with industry, local, nationwide and foreign media Working with the supervisory bodies and public authorities to prevent crises that may arise in the course of legislative procedures, whether Polish or EU. Supporting local communities through various CSR programmes/projects