7. Other factors with a bearing on the Group’s financial statements

In 2021, the Group’s results continued to be impacted by the COVID-19 pandemic.

Since March 2020, the market environment of the Group has been extremely volatile and unpredictable. The Group has been operating in an environment prone to rapid changes triggered by the pandemic and by measures taken to contain its impact, both in Poland and globally.

The balance and liquidity in international trade, including trade in goods and services, has been disturbed and passenger traffic has fallen markedly. Restrictions were imposed on both air and road transport. Many countries banned non-essential travel, restricted the use of services, retail outlets, institutions of culture and schools. Borders were closed for tourist traffic and migrant workforce. On March 14th 2020, the state of epidemic emergency was introduced in Poland.

The effects of the pandemic were also seen in 2021, despite the much lower scale of the imposed restrictions compared with 2020.

The year 2021 saw a strong recovery in the global market for oil and related products, driven by increased demand. Uneven and unexpectedly high demand for energy commodities led to a surge in their market prices in 2021, particularly crude oil and natural gas, which also had a positive impact on the Group’s revenue and operating results, which reflects an accelerating rebound in, and an improved outlook for, key markets, supported by the increasing number of COVID-19 vaccines administered worldwide. However, the risk of market instability cannot be ruled out, given the progress of successive waves of the pandemic.

As at December 31st 2021, the Group assessed whether there was any indication of impairment of non-financial non-current assets. When analysing indications of asset impairment, both the macroeconomic environment, influencing assets’ potential to generate value, and internal factors affecting the ability to use this potential in practice, should be taken into account. Among external indications of possible impairment, COVID-19 was a significant event in the reporting period and continues to be considered a disrupting factor. Following analyses of the current macroeconomic environment, an analysis of impairment indicators for individual cash-generating units and calculation of their recoverable amount, in 2021 the Group identified the need to reverse some of the impairment losses on non-current assets recognised in previous years and to recognise impairment losses on property, plant and equipment and intangible assets (for more information, see Notes 10.1.1.1 and 10.1.2.2), as well as impairment losses on shares in equity-accounted joint ventures (Note 10.2).

The strong increase in crude oil and gas prices associated with the market disruptions caused by the COVID-19 pandemic is having an impact both on demand for and the cost to purchase, manufacture and sell the Group’s products. The Group estimated net realisable value of inventory as at December 31st 2021, and did not identify any indication of impairment of inventories as at that date.

Large-scale operational disruptions that could potentially entail liquidity constraints for certain entities may also have an adverse impact on the credit quality of various actors along the supply chain. As at December 31st 2021, the Group assessed the potential impact of the COVID- 19 pandemic on its calculation of expected credit losses and the related impairment losses on financial assets. The Group’s credit policy, security instruments used and factoring agreements in place allow it to assume that the loss ratio for receivables recognised as at the reporting date will remain largely unchanged.

The Group monitors market developments and any information on its customers that could suggest a deterioration of their financial standing. Based on relevant analyses, the Group has not changed the assumptions used to evaluate its expected credit loss as at December 31st 2021 from those used at December 31st 2020.

The liquidity position of the Group is monitored on an ongoing basis by the liquidity and financing team, whose task is to ensure adequate security and high efficiency of the Group’s financing, and to strengthen coordination of implementation of the Group’s financial strategy.

As at the date of these consolidated financial statements, the Group remains liquid and has financing available for its operating and investing activities.

In 2021, despite the persisting unfavourable conditions caused by the COVID-19 pandemic, the Group optimally managed its own financial resources as well as the resources of other Group entities. Its key financial and liquidity ratios, including current ratio (1.7; 2020: 1.4), quick ratio (0.9; 2020: 0.8), as well as total debt ratio (43.0%; 2020: 47.0%) remained at safe levels, with liabilities were being serviced in a timely manner. Cash flows provided by operating activities were sufficient to meet the capex requirements and partly repay the outstanding debt. As a consequence of a PLN 2,574.2m increase in working capital, the ratio of working capital to total assets was 18.1%, compared with 9.7% in 2020. The turnover ratios also changed. The inventory turnover was shorter by 22.9 days compared with the year before, at 50.2 days. As a result of a 0.9% increase in average trade receivables and growing revenue (an increase of 58.4%), the average collection period shortened to
23.9 days, compared with 37.7 days in 2020. As a result of higher average trade payables (by 11.7%) and higher cost of sales (up 37.7%), the average payment period was 27.2 days, having shortened by 6.5 days year on year. These changes led to the cash conversion cycle of 46.9 days, compared with 77.1 days in 2020.

The Group has in place a centralised cash management system (cash pool) covering the majority of Group companies. The cash pool makes it possible to effectively use any surplus funds, while reducing the system participants’ demand for day-to-day funding. In addition, as at December 31st 2021 the Group had undrawn overdraft facility, credit facility and factoring limits.

Currently, the Group’s economic performance, liquidity position and debt remain at comfortable levels, with no significant risks identified as at the date of issue of these consolidated financial statements that could adversely affect this situation.

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.

The Fit for 55 legislative proposal presented in July 2021, which includes more than a dozen legislative acts, is to provide the basis for achieving the EU’s objective of reducing greenhouse gas emissions by 55% by 2030 (compared to 1990). The final regulations that will result from Fit for 55, will have a significant impact on the operations and 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 results.

Regulatory risk at the national and European level has strong relevance to the LOTOS Group’s operations.

The most important regulatory risks currently faced by the organisation are related to climate change. The Group monitors 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 LOTOS Group pursues a number of projects which contribute to climate neutrality, including projects in such areas as advanced biofuels, alternative fuels (such as hydrogen) and gas fuels: LNG, i.e., liquefied natural gas and CNG, i.e., compressed natural gas, as well as energy efficiency improvement projects aimed at reducing emissions and increasing the share of energy from renewable sources.

Climate-related risks stem from the Group’s obligation to meet certain targets relating to a minimum share of other renewable fuels and biocomponents contained in fuels used across all modes of transport, relative to the total amount of liquid fuels and biofuels consumed during a calendar year in road and railway transport, calculated according to their calorific value. This National Indicative Target (NIT) obligation is stated in the Act on Biocomponents and Liquid Biofuels of August 25th 2006. To date, the Group has met its National Indicative Target, in keeping with the applicable regulations (adjusted by the reduction coefficient and emission charge). For information on the provision for the NIT substitute fee, see Note 10.13.

A reduction of greenhouse gas emissions over the entire fuel life cycle per energy unit is another metric used. This obligation, referred to as the National Reduction Target (NRT), follows from the Act on Fuel Quality Monitoring and Control System of August 25th 2006. For information on the provision for the NRT fee and for any penalties, see Notes 10.13 and 10.13.1.

Under the Energy Law, which implements the support of production of electricity generated from renewable energy sources in the internal market, the LOTOS Group, as an energy company, is subject to an obligation to acquire and present certificates of origin for redemption or to pay a substitute fee resulting from the obligation to acquire and present for redemption certificates of origin in a given year, for which it recognises a provision (see Note 10.13).

The Group’s production facilities are covered by the EU ETS (European Union Emissions Trading System/Scheme). The projected shortfall of free CO2 emission allowances granted to the Group under the EU ETS in the settlement period of 2021-2025, in relation to the planned emissions in this period, may result in the need to purchase additional allowances. Therefore, the Group is exposed to the risk of higher prices of carbon dioxide emission allowances (CO2), which may have a direct effect on the Group’s operating costs. The year 2021 saw a significant increase in the price of CO2 emission allowances. In addition, the changes proposed in the Fir for 55 strategy may significantly reduce the pool of free allowances available in the ETS, and thus further increase their prices. For information on the management of the CO2 emission allowance price risk and its impact on the Group’s results, see Note 11.2.2 For information on the accounting treatment of CO2 emission allowances and the provision for the costs of covering their shortfall, see Notes 10.1 and 10.13.

Processes carried out by the LOTOS Group, such as exploration for, development and production of hydrocarbons, refining production, product transport and logistics involve a risk of impact on the natural environment. The Group has an obligation to decommission oil and gas extraction facilities or to demolish, disassemble or remove other property, plant and equipment and restore the site to its original condition. At each reporting date, the Group analyses the costs necessary to decommission oil and gas extraction facilities and the expenditure to be incurred on future site restoration (see Note 10.13.1).

In parallel with the recognition and remeasurement of provisions for decommissioning of oil and gas extraction facilities, the Group recognises corresponding assets for future costs of decommissioning of oil and gas extraction facilities. Assets for future costs of decommissioning of crude oil and gas extraction facilities are depreciated using the units-of-production method, where depreciation per unit of produced crude oil or natural gas is charged to expenses. For information on assets related to future costs of decommissioning of oil and gas extraction facilities, see Note 10.1.2.3.

At the end of the reporting period, the Group assesses the impact of climate issues on the estimates underlying the future cash flows included in the impairment tests of property, plant and equipment and intangible assets. The Group also reviews annually the adopted useful lives and residual values of these assets based on current estimates.

As at the date of authorisation of these financial statements for issue, the Management Board of the Parent did not find any threat to the Group companies continuing as going concerns in the foreseeable future.