Factors affecting
financial performance
Macroeconomic situation

PGE Group’s main operating area continues to be Poland, and the domestic macroeconomic backdrop has a substantial impact on Company’s results. At the same time, the condition of Poland’s economy remains largely tied to the situation across the European Union and in global markets. The Group’s financial results are affected by both the situation in specific segments of the economy and the financial markets, which constitute the source of PGE Group’s debt financing.

As a rule of thumb, there is a correlation between rising electricity demand and economic growth. Considering PGE Group’s position on the Polish power generation market, as well as its substantial share in the electricity sales and distribution market, changes in power and heat demand may have a significant impact on the Company’s results.

The GDP data for Poland published so far indicate that strong economic growth continues – GDP (not adjusted seasonally) grew 3.3% in the third quarter of 2014, and 3.4% and 3.5% y/y in the first and second quarter, respectively. According to preliminary GUS (Central Statistical Office of Poland ) data for 2014, full-year GDP growth reached 3.3%. Among the main GDP components, domestic demand growth was 4.6% y/y, what means significant growth compared to 2013. Growth of value added by industrial production was weaker than in 2013 reaching 3.6% y/y.

Industry accounts for approx. 45% of domestic electricity consumption hence the economic and financial situation in this sector has an impact on PGE Group’s business. Total industrial output during 2014 expanded by 3.3% y/y, with positive growth in the crucial industrial-processing sector (4.6% y/y) and negative growth in mining and extraction (-4.2% y/y) and the energy sector (-4.1% y/y).

Sold industrial production dynamics in Poland (y-o-y)



Source: Central Statistical Office of Poland

Throughout all of 2014, gross electricity consumption increased by 0.49% from the previous year. The fourth quarter alone brought an increase of 0.9% y/y. Energy consumption varied significantly through the year, resulting mainly from relatively high average temperature in the first quarter. Adjusting for weather and calendar factors, electricity demand grew approx. 1.0% in 2014. Despite higher domestic consumption, electricity production fell by 3.65% y/y, resulting from a change in the cross-border exchange balance.

GDP change vs. change in gross electricity consumption.



Source: Central Statistical Office of Poland, PSE S.A.
*Average from forecasts in Q4 2014


Supply markets

Provision of raw materials
Lignite, hard coal, natural gas and biomass are key fuels used to generate electricity and heat by power plants and heat and power plants belonging to the PGE Group. The cost of fuel procurement constitutes a major share in electricity generation costs. PGE S.A., on the ground of Agreement for Commercial Management of Generation Capacities, secures hard coal and gas supplies to the branches of the Conventional Generation segment and as of August 1, 2014 also supplies of biomass.

Lignite supplies are carried out within a framework of regular cooperation between branches operating in the structure of PGE GiEK S.A. The KWB Bełchatów mine supplies lignite to the Elektrownia Bełchatów plant and the KWB Turów mine supplies it to the Elektrownia Turów plant. The Group set up internal rules with respect to the performance and settlement of lignite supplies between individual branches of PGE GiEK S.A.

The main supplier of the hard coal for the production needs in the Conventional Generation segment is Kompania Węglowa S.A. with an approximate share of 72% in the yearly demand for this raw material. Majority of the rest of supplies were provided by Jastrzębska Spółka Węglowa S.A. and Katowicki Holding Węglowy S.A.

Natural gas for electricity and heat production in CHPs: Gorzów, Lublin Wrotków and Rzeszów, is mainly supplied on the ground of agreements with Polskie Górnictwo Naftowe i Gazownictwo S.A. (PGNiG S.A.). Gas supply for the Rzeszów CHP is secured through purchases on the OTC market and the TGE exchange (Towarowa Giełda Energii S.A.). In connection with the statutory support system for electricity production in gas-fuelled high-efficiency cogeneration being restored, gas supplies to the Lublin Wrotków and Rzeszów CHPs were resumed in the second half of 2014. The Gorzów CHP was supplied with gas throughout the year, while the Zgierz CHP received gas during the period from May to October 2014.

Biomass is obtained via procurement procedures from suppliers operating on the Polish biomass market.

Purchases of transmission and distribution services
Under the existing legislation, power undertakings in Poland must have:
In view of the above obligations, companies dealing with generation, trade and distribution of electricity in Poland (including entities in the PGE Group) are, directly or indirectly, dependent on agreements for the provision of transmission services, which provide for rules with regard to the settlement of services rendered to a TSO and methods for fixing and settling energy divergences of BM Units arising as a result of balancing the domestic electricity demand by the Operator. Agreements for the provision of transmission services are made with the company Polskie Sieci Elektroenergetyczne S.A. (“PSE S.A.”), which operations include rendering electricity transmission while maintaining the operational security of the National Power System. Pursuant to the provisions of the Energy Law, PSE S.A. as the TSO is responsible for grid flow in the transmission system, current and long-term security of the system, maintenance, repairs and necessary development of the transmission grid, including connection with other power systems.

Power undertakings, which operate under a license and whose active Generation Units are connected to the National Power Grid, must enter into a contract for transmission services (“Contract”) with PSE S.A.

Under the Agreement and the Transmission Network Code, a power undertaking is obliged to report on a daily basis any concluded Electricity Sale Contracts to PSE S.A. TSO, as an operator in charge of the performance of the signed agreements and the trade balancing through the Balancing Market, carries out cyclical settlements of deviations of electricity supplied and received. The obligation referred to above creates dependency of a systemic nature which additionally affects companies within the PGE Group to the extent defined by law and determined by the scope and character of their operations.

An integral part of a transmission Contract is an Agreement on the Terms and Conditions for the Provision of Ancillary Services (“Agreement”), concluded pursuant to the single source procurement procedure (i.e. through negotiations) with PSE S.A. The Agreement remains in force for one calendar year. The generation units of the PGE Capital Group render selected services from the catalogue of ancillary services to PSE S.A. the extent which has been agreed and provided for in the Agreement.

In 2014, PGE GiEK S.A. extended provision of the following system services:
  1. Energy consumption reduction at the TSO's request ("negawatts"), valid for the next two years (i.e. 2015 and 2016), the service consists of shutting down, specific volumes of electricity supply in 4-hour blocks at a request issued by the TSO in order to ensure the continuous security of the National Power System (KSE). Agreements have been executed with:
    • PGE GiEK S.A. Branch KWB Bełchatów,
    • PGE GiEK S.A. Branch KWB Turów.
  2. Generating unit availability (i.e. GWS – generation forced by grid considerations) during the period from January 1, 2014 to December 31, 2014. This service consists of generating electricity by heat and power plants that have signed agreements to provide the GWS service at the hours and volumes specified in the TSO's request, issued in order to ensure the continuous security of the National Power System. Agreement for 2014 have been executed with:
    • PGE GiEK S.A. Branch Bydgoszcz CHPs,
    • PGE GiEK S.A. Branch ZEDO,
    • PGE GiEK S.A. Branch Lublin-Wrotków CHP.
  3. Cold reserve intervention service ("IRZ"), consisting of providing PGE GiEK S.A.'s generating units (Units 1 and 2 at Dolna Odra) to the TSO for management and operation for the balancing of active power, in intervention mode, in order to ensure the continuous security of the National Power System, including in particular:
    • maintaining the contractor's generating units on stand-by and, following receipt of a request from the TSO, load active power at a level specified in the request,
    • usage of the capacity of the contractor's generating units, which consists of turning the units on and feeding the electricity produced by these units into the grid, at a volume and time specified in the TSO's request.
Electricity trading
In 2014, pursuant to the electricity trading model applied in the PGE Group, the Group’s generators sold electricity on power exchanges (under the provisions of art. 49a section 1 and 2 of the Energy Law, i.e. under the so-called “power exchange obligation”), to PGE S.A. and to external customers. Energy purchased by PGE S.A. came from power exchange, trading platforms and from generators from the Group. Then energy was sold in the PGE Group, among others to the Supply company and to the Distribution company. Energy was also sold outside the PGE Group in bilateral contracts on domestic market. In addition, the Supply company in the PGE Group purchased energy from local markets, i.e. from generating sources located in the areas where the company acts as a supplier of last resort.

Fuel purchase costs

Volume and cost of purchase of fuels from third party suppliers in the fourth quarter of 2014 and 2013.

Type of fuel 2014 2013
Volume (tons 000’) Cost (PLNm) Volume (tons 000’) Cost (PLNm)
Hard coal 6,197 1,536 6,109 1,557
Gas (cubic metres thousand) 378,949 258 377,177 271
Biomass 1,236 353 1,061 304
Fuel oil (heavy and light) 40 75 44 96
TOTAL
2,222
2,228


In 2014 the costs of purchasing primary fuels from providers outside the Group amounted to PLN 2,222 million and were at the 2013 level.

The following aspects had the biggest impact on the changes in costs of fuel purchase in PGE Capital Group:

In accordance with the amended Energy Law, which came into force on April 30, 2014, cogeneration support scheme was restored and prolonged until June 30, 2019. Support for CHP plants which generate electricity and heat in gas-fired installations improves efficiency of these producers and contributes to the increase in the consumption of this type of fuel, what occurred in the fourth quarter of 2014 and attributed to the keeping of volume of gas used in the whole 2014 at the similar level as in 2013. In 2014 approximately 71% of the electricity was produced from internally sourced lignite, whose extraction price is fully controlled by PGE Capital Group.

Tariffs

PGE Group companies earn part of their income based on tariffs approved by the President of the Energy Regulatory Office:
  1. tariffs for the sale of electricity to households (G tariff group);
  2. tariffs of the distribution companies (distribution system operators, DSO);
  3. tariffs for heat.
Sales of electricity
In 2014 tariffs for sales of energy to the corporate customers (key and business) and to individuals (other than G tariff customers connected to the distribution network of PGE Dystrybucja S.A.) were not subject to approval of the President of the Energy Regulatory Office.

In 2014 sales of electricity to off-takers from the G tariff group, connected to the distribution network of PGE Dystrybucja S.A., was conducted on the basis of electricity Tariff for PGE Obrót S.A. approved by the decision of the President of the Energy Regulatory Office for the period from January 1, 2014 till December 31, 2014. In comparison to the analogical period of 2013 tariffs in G tariff group decreased by approximately 8%.

Distribution of electricity
Methodology of and assumptions for tariffs determination were published in the document “Tariffs for the DSO for the year 2014”, which was prepared and published by the President of the Energy Regulatory Office.

Tariff of PGE Dystrybucja S.A. for 2014 was approved by the President of the Energy Regulatory Office and came into force on January 1, 2014.

Distribution tariffs for 2014 approved by the President of the Energy Regulatory Office, contributed to changes in average payments for customers in particular tariff groups in comparison to year 2013:
An average price of energy distribution services in comparison to last tariffs binding in 2013 increased by approx. 2.78 %.

During the reporting period the approved tariffs for distribution services were not subject to any changes.

Increase of distribution tariffs takes into account significant increase in fees (quality and transition) transferred from the Transmission System Operator tariff, that increase regulated revenue but do not affect the result of PGE Dystrybucja S.A.

Tariff for heat
Pursuant to art. 47 sections 1 and 2 of the Energy Law, energy companies, which hold licences, set tariffs for heat and propose their duration. Submitted tariff is subject to the approval by the President of the Energy Regulatory Office, provided that it is consistent with rules and regulations referred to in art. 44-46 of the Energy Law. Detailed rules for tariffs determination are defined in the Regulation of the Polish Minister of Economy of September 17, 2010 on detailed rules for calculation of tariffs and on settlements with regard to heat supply. Conduction of proceedings concerning heat tariffs approval lies within the competence of regional Branches of the Energy Regulatory Office.

Average sale price of heat in PGE increased by approx. 5.7% in comparison to the prices from 2013.

Electricity prices

Domestic market – trading volumes
In 2014, liquidity on the day-ahead market of Towarowa Giełda Energii S.A. (TGE) increased by 7% compared with 2013. The higher liquidity seen on the day-ahead market in the first half of 2014 (+16% on average) significantly slowed down in the second half, which led to a slight overall decrease in volumes (-1% y/y). The main reason for the reversal of this trend was substantial volatility, leading some traders to leave the market because of the significant price swings and escalating risk. Overall trading volume on the day-ahead market was 23.74 TWh.

Trading volumes on the futures market continued to trend up throughout all of 2014, generating 37% growth y/y. The structure of products traded changed in 2014 – the share of PEAK contracts fell relative to the BASE product.

Overall volume on the day-ahead and futures markets grew 32% to 170.87 TWh in 2014. This means that TGE trading volumes exceeded domestic electricity consumption levels, which amounted to a cumulative 158.73 TWh for the period from January to December 2014. The excess of electricity trading volumes over domestic consumption suggests an increasing share of speculative trading and dynamically growing electricity portfolio management, both of which have a positive impact on market liquidity.

Domestic market - Prices

Day-ahead market
In 2014, prices on the day-ahead market showed a pronounced uptrend, starting in January. The average day-ahead price (the IRDN index) in 2014 was PLN 184.15/MWh, compared with PLN 155.98/MWh in 2013, which was an 18% increase.

Moreover, the situation in 2014 was characterised by a 58% y/y uptick in price volatility. This was caused not only by growth in peak pricing, but also a decrease in off-peak prices. The strong growth of prices in peak hours demand resulted from having to start up new generating units from the merit order that are characterised by high variable costs. The decline in off-peak prices had to do with the changing structure of electricity production, and particularly dynamic growth of wind generation (up 23.38% y/y, according to PSE S.A.).

Monthly prices and price volatility at the day ahead market in 2013-2014 (TGE)*.


* arithmetic average price from all power exchange transactions concluded at the session (IRDN) and prices spread (sIRDN, offIRDN)

Futures market
In 2014, we observed rising prices for both BASE and PEAK contracts. They were supported by positive information about the Polish economy, particularly the stronger growth of GDP and industrial production. Market prices in both the day-ahead market and the futures market were furthermore affected by an update of the System Balancing and System Constraint Management section of the Transmission Grid Operation and Maintenance Manual, including an updated operating model for the Operational Capacity Reserve service.

The average price for the BASE_Y-15 instrument in 2014 was PLN 167.92/MWh, denoting an increase of 5% in comparison with the previous year. The average price for the PEAK5_YH-15 product in 2014 was PLN 218.69/MWh, meaning that it was nearly 15% higher than in 2013.

Average prices and price volatility on the futures market in 2013-2014 (TGE).



International markets
In 2014, prices on the Polish market were higher than those in Sweden, Germany, the Czech Republic and Slovakia. 2014 saw the average price on the German market decrease by 13% compared with 2013 – mainly due to higher wind and photovoltaics production. An even more pronounced decline was observed in the Scandinavian markets (-20%), driven by hydrological conditions. The rising average prices in Poland, coupled with strong declines in foreign markets, resulted in a situation where the Polish market became the most expensive out of those mentioned above. This led to a change in 2014 to a positive cross-border exchange balance.

Comparison of average prices on Polish market and on European markets in 2014.



In 2014, physical flows changed substantially. Because of the lower power prices in surrounding markets and given the low capacity reserve, the cross-border exchange balance was positive. There was a substantial increase in imports (up by nearly 72% y/y), concurrent with a decline in exports (-5% y/y). As regards cross-border exchange by country, the situation did not change much – Germany and Sweden remained the largest importers, while exports were mainly realized to the Czech Republic and Slovakia.

Monthly imports, exports and cross-border exchange balance in 2013-2014.



Prices of property rights

Green certificates – Renewable Energy Sources
In 2014, pursuant to the Energy Law and the relevant Ordinance of the Minister of Finance, companies selling electricity were required to obtain and present for redemption certificates of origin, or pay a substitute fee equal to not less than 13% of total annual sales to end users. The substitute fee, following adjustment through a decision of the ERO President, amounted to PLN 300.03/MWh. Trade in property rights deriving from renewable energy sources ("green certificates”) on the TGE exchange was accumulated in the first quarter of 2014, resulting from the fact that the settlement period for 2013 ended on March 31, 2014. Growth in green certificate prices in the first quarter of 2014 was caused by the introduction of regulations imposing the obligation for units generating electricity with the use of biomass to present certificates of biomass origin. This led to the ERO President suspending issuance of property rights deriving from biomass-firing or co-firing installations. Reduced supply and temporarily increased demand caused the price of green certificates to rise, peaking in February. Since then, green certificate prices trended downward, reaching a minimum in December.

Yellow, red and violet certificates - cogeneration
On April 30, 2014, the Energy Law and certain other acts were amended to extend the support scheme for producers of electricity and heat from cogeneration to June 30, 2019. The scheme in Poland has been in force since 2007 and requires energy trading companies to present for redemption certificates of origin for highly-efficient cogeneration or, if they do not have such certificates, to pay a substitute fee. Certificates can be obtained in respect of: energy generated in gas fuel-fired cogeneration installations or units with capacity below 1 MW ("yellow certificates," "PMGM"), energy generated in cogeneration units fuelled by methane or gas obtained from biomass processing ("purple certificates," "PMMET") and energy generated from other cogeneration sources ("red certificates," "PMEC").

In accordance with the above amendment, energy trading companies in 2014 had to hold yellow certificates for 3.9% of the electricity supplied to end users - with the figure set to be raised to 8% in 2018. As regards purple certificates, the level required in 2014 was 1.1%, set to be raised to 2.3% in 2018. For red certificates, the figure is 23.2% annually during 2014-2018. The deadline for paying the substitute fee and redeeming certificates of origin was also changed, from March 31 to June 30 of each year. As a result of these changes, the market de facto began operating in June 2014, which is also when the above certificates were listed on the TGE.

Prices for yellow, purple and red cogeneration certificates remained at levels close to the substitute fees throughout 2014. The average price for yellow certificates in 2014 amounted to PLN 105.20/MWh (substitute fee: PLN 110.00/MWh), purple certificates: PLN 60.55/MWh (substitute fee: PLN 63.26/MWh), red certificates: PLN 10.31/MWh (substitute fee: PLN 11.00/MWh). The steep prices resulted from a long-term deficit of supply relative to demand.

Prices of CO2 emission rights

Three types of emission rights are available on the market – EUA (European Union Allowances), CER (Certified Emission Reductions) and ERU (Emission Reduction Units). CER-type and ERU-type rights may be redeemed by business operators only to a limited extent, in settlement period 2013-2020 up to 1% of the allocations granted under the National Allocation Plan for years 2008-2012.

Years 2013-2020 constitute the third settlement period under the EU Emissions Trading System (EU-ETS). The third period has since the beginning featured a substantial surplus of CO2 allowances (more than 2 billion tonnes), resulting in low prices that do not compel investment in low-emission technologies. Given the above, the European Commission undertook a number of activities aiming to drive the allowance prices higher. The first one, backloading, is meant to withhold 900 million allowances schedule to be auctioned in 2014-2016 by reducing the auctioned volumes. The next step is the introduction of the Market Stability Reserve (MSR), aimed at consuming the existing surplus and leading to a balance between demand and supply. In addition, the European Commission proposed as part of its 2030 framework for climate and energy policies a CO2 reduction target of at least 40% compared to 1990. Taking into consideration the above measures undertaken by the EC and the decreasing annual allocations of free allowances, it should be expected that the growth of price of CO2 allowances will have a substantial impact on final electricity prices.

Prices of CO2 emission rights in 2014



Source: own work based on the data from ICE exchange (closing prices)

2014 was the second year of the third settlement period of the EU-ETS system. The year featured high volatility of prices of CO2 emission allowances. During this time, the EC's activities as well as political and economic events had a strong impact on the prices of CO2 allowances. Since the beginning of 2014, CO2 allowances became substantially more expensive on account of the backloading reform being implemented. On February 24, 2014, the European Parliament decided that 400 million allowances will be withheld from the market in 2014, another 300 million in 2015 and 200 million in 2016. The above decision resulted in the prices for CO2 allowances exceeding EUR 7.00/tonne.

In 2014, prices of certified emission reduction units (CERs) were in a downtrend, losing substantial value throughout the year, from EUR 0.43/tonne to EUR 0.04/tonne. The main reason for the fall in CER prices is their oversupply on the market and the limited capabilities to use them in the current settlement period. In accordance with the provisions of the EU-ETS Directive, installation operators may redeem CERs from various types of projects. CERs from projects that were eligible for use in the Community scheme during the period from 2008 to 2012, issued in respect of emission reductions until 2012, may be used only up to March 31, 2015.

In 2014, the value of ERUs went down to EUR 0.03-0.24/tonne.

Emission rights granted free of charge for years 2013-2020

The Regulation of the Council of Ministers, that sets the allocation of allowances for particular units of electricity producers in period 2013-2020, was adopted on April 8, 2014. Analogically, allocations of allowances for heat producers were set by the Regulation of the Council of Ministers of March 31, 2014.

PGE GiEK S.A. accounts were credited with free allowances for heating energy for 2014, while free allowances for electricity will be received by the Group by the end of April 2015, after verification of reports from investments submitted to the National Investment Plan.

The following table presents data concerning CO2 emission from major Group installations in 2014 in comparison to the allocations.

Emission of CO2 from major Group installations in 2014 in comparison to allocation of CO2 emission rights for 2014 (in Mg).

Operator CO2 emissions
in 2014
Allocation of CO2
emission rights for 2014
% of the emission covered
by the free allowances
Bełchatów Power Plant 36,886,457 15,535,037 42%
Turów Power Plant 8,140,080 6,247,900 77%
Opole Power Plant 6,422,060 3,587,594 56%
ZEDO 5,135,457 2,931,631 57%
Bydgoszcz CHPs 773,842 708,528 92%
Gorzów CHP 444,238 297,971 67%
Lublin Wrotków CHP 364,782 387,687 106%
Rzeszów CHP 237,758 140,185 59%
Kielce CHP 167,182 128,824 77%
Zgierz CHP 93,732 56,103 60%
TOTAL 58,665,588 30,021,460 51%
* estimates, emissions not verified - the data will be settled and certified by the authorised verifier of CO2 emission on the ground of yearly reports of volume of CO2 emissions

Termination of long-term contracts (LTC)

Due to the termination of LTCs in accordance with the LTC Act, the producers being earlier the parties to such contracts obtained a right to receive compensations for the coverage of so called stranded costs. Stranded costs were capital expenditures resulting from investments in generating assets made by the generator before May 1, 2004 that a generator is not able to recoup from revenues obtained from sales of generated electricity, spare capacity and ancillary services in a competitive environment after early termination of LTC. The LTC Act limits the total amount of funds that may be paid to all generators to cover stranded costs, discounted as at January 1, 2007, to PLN 11.6 billion, including PLN 6.3 billion for PGE.

In the period provided for by the LTC Act, i.e. till December 31, 2007, PGE S.A. signed LTC termination agreements with generators being parties to the then applicable LTCs. Therefore generators obtained a right to receive funds to cover their stranded costs.