Financial situation of the Group

8. Impact of coronavirus pandemic on the ORLEN Group’s operations

In 2021, the COVID-19 pandemic continued to impact the global economy and the situation in the country, causing disruptions in the economic and administrative system. With respect to the market environment, the Group continued to still observe uncertainly about the future course of the pandemic and the scale and distribution over time of the secondary effects of the „rebound” from the pandemic recession reflected in high volatility in demand as well as in prices of refining and petrochemical products and raw materials, including crude oil, energy and CO₂ emission allowances, which affected sales prices and the level of margin achieved in all operating segments.

Since the outbreak of the COVID-19 pandemic in the European Union, efforts to stop unfavourable climate change have significantly accelerated. The acceleration of the energy transformation has had a negative impact on the outlook for global demand for fossil fuels, including crude oil and liquid fuels. The deep, though short-lived, global recession caused by the pandemic and the acceleration of the energy transformation had a strong impact on the global refining industry, which processing capacity turned out to be significantly higher than the current and expected demand and requires reduction. To enforce reduction, refining margins have fallen deeply below the processing profitability thresholds and will remain under pressure until the refining potential is appropriately adjusted.

From the surplus assessed in the period 2020-2025 at 4.5 mbd, by mid-December 2021 a power reduction by 3.7 mbd was reduced or announced. The largest volume of shutdowns occurred in North America and the Asia-Pacific region and improved refining fundamentals in these regions. In Europe, the performed and declared capacity reduction concerns ten refineries with a total potential of nearly 0,9 mbd.

Global capacity, estimated at approximately 1.0 mbd, remains to be reduced, of which 0.8 mbd is allocated to Europe.

The increase in demand for crude oil and liquid fuels, related to the recovery in the global economy observed from the beginning of the 2^nd quarter of 2021, combined with the seasonal effect, improved refining margins, temporarily easing the pressure on reducing refining capacity. The improvement in margins was, however, limited by the unexpected, dynamic increase in crude oil prices to nearly 80 USD/bbl. The reason for the strong increase in prices since the 2^nd half of 4^th quarter of 2021 was the unexpected demand for liquid fuels from the energy sector due to high gas prices.

The strong increase in energy costs exerted upward pressure on the market prices of refining products, but the improvement in market margins wasn’t related to the improvement in the economic situation of the refinery.

The petrochemical industry turned out to be the beneficiary of the pandemic, as the demand for its products increased significantly and, consequently, the petrochemical margins increased.

The acceleration of the energy transformation has led to an increase in demand for natural gas and the lack of supply reserves has triggered hyperbolic increases in in the prices of this raw material, which, together with rising emission allowance prices following the publication climate package of the Fit for 55, have led to strong increases in energy prices. In the ORLEN Group opinion, this is a temporary situation which, once gas is recognized as an essential transition fuel in the process of energy transformation in Europe, will lead to an increase in gas-based energy capacity and mitigate price pressures.

Since the outbreak of the pandemic PKN ORLEN and entities comprising the Group have taken a number of actions in order to adapt to constantly changing business environment, as well as to prevent the spread of COVID-19 infections, both within its own employees and to support the government’s fight against coronavirus, which were continued in the 2021. The Group adjusts its operations on an ongoing basis to the changing epidemiological situation.

During the period covered by these consolidated financial statements as well as presently all ORLEN petrol stations remain open, there are no disruptions in any area of operations within the concern or other production plants of ORLEN Group. There were also no material disruptions in Group’s operations on foreign markets. In Group’s opinion currently there are no threats to the supply chain, both with respect to purchase of raw materials and merchandise, as well as in the field of internal logistic processes (among others supply of liquid fuels from the production plant to fuel terminals and then to petrol stations).

The total cost incurred in 2021 and 2020 due the preventive measures taken by the Group in order to limit the spread of the virus at the premises and protection of employees and customers amounted to PLN (30) million and PLN (92) million, respectively.

In 2021 the Group has not observed any significant deterioration in repayment ratio nor an increase in bankruptcies or restructuring among its clients. Due to effective management of trade credit and debt recovery the Group assess that despite the protracted coronavirus pandemic, the risk of unsettled receivables by customers did not change significantly, and the level of repayment of receivables presented in the balance sheet as at 31 December 2021, which payment dates fall in the coming months, will not change significantly. Due to the above, as at 31 December 2021, the Group did not identify any indicators for modification of assumptions taken for estimation of expected credit loss in terms of the potential need to include additional risk factor related to current economic situation and forecasts for the future.

The Group analyses on the current basis the situation on the markets and incoming signals from contractors which could indicate deterioration of financial situation and if there is a need, the Group will update adopted estimates for ECL calculation in following reporting periods.

As at the date of preparation of these consolidated financial statements the financial situation of the Group is stable. Working capital increased by PLN 4,442 million compared to the end of 2020, which was mainly related to growth in crude oil prices and prices of products, which translated into the value of inventories, receivables and liabilities. The Group’s results in 2021 by operating segments are presented in note 11.

In the Group’s opinion, the ongoing coronavirus pandemic did not affect the level of risk in relation to guarantees granted as at 31 December 2021 and the probability of activation of these guarantees remains low.

The Group does not identify currently and within the next 12 months problems with liquidity. The Group also does not see risk of default on loans or other financing agreements. The Group takes optimization actions consisting, among others, on obtaining financing for projects in the project finance formula no recourse or with limited recourse to PKN ORLEN and the Group (i.e. financing directly to the SPV) and assumes maintaining a safe level of net debt and financial covenants included in the financing agreements.

As at the date of preparation of these consolidated financial statements, the Group estimates, that it has sufficient sources of funding for implementation of all strategic development and investment projects as well as acquisitions as planned.

Information regarding the impact of the COVID-19 pandemic on the assumptions and approach to the ongoing impairment tests performed at the end of 2020, the status of the impairment tests, as well as the impairment losses recognised as at the time of preparation of these financial statements were included in note 14.4.

9. Financial and operating results

Profit or loss

Sales revenues of the ORLEN Group for 2021 amounted to PLN 131,141 million and was higher by PLN 45,161 million (y/y).The increase of sales revenues (y/y) results from higher sales volumes by 2% (in the Refineries and Retail segments partially limited by lower sales volumes in the Petrochemical and Upstream segment) and reflects an increase of 69% in crude oil prices and, consequently, also the listing of the main products. In the 12-month period of 2021 in comparison to the same period of 2020 the prices of the fuel increased by 75%, diesel oil by 58%, aviation fuel by 69%, heavy heating oil by 69%, ethylene by 38% and propylene by 50%.

The operating expenses totally increased by PLN (35,704) million (y/y) to PLN (121,911) million. The largest item in this cost structure constitute the costs of materials and energy consumption related mainly to the crude oil and other chemicals used in technological processes. The increase of costs of materials and energy consumption by 53% (y/y) resulted from the higher by 0.4 million tonnes (y/y) of crude oil processing as a result of improved macroeconomic situation and a lower (y/y) mainly in PKN ORLEN and ORLEN Unipetrol Group scope of completed maintenance shutdowns of installations.

The result on other operating activities amounted to PLN 3,913 million and was higher by PLN 61 million (y / y) mainly due to the effect of changes in impairment losses on property, plant and equipment, intangible assets, right-of-use assets, other non-current assets and fixed assets held for sale in the amount of PLN 2,402 million (mainly these related to assets in the Upstream segment, for which impairment allowances were created in 2020 in the amount of PLN (1,687) million, and in 2021 a reversal of impairment allowances was recognized in the amount of PLN 1,046 million – additional information in note 14.4.) and changes in the net effect of the settlement and measurement of derivative financial instruments related to operational exposure (instruments not designated for hedge

accounting purposes) in the amount of PLN 1,073 million. The impact of the above-mentioned changes was offset by the effect of recognizing in 2020 a gain from the bargain purchase of 80% of ENERGA S.A. shares (ENERGA) in the amount of PLN (4,062) million.

As a result, profit from operations amounted to PLN 13,870 million and was higher by PLN 9,962 million (y/y).

Net finance expenses in the described period amounted to PLN (179) million and included mainly net interest expenses in the amount of PLN (443) million and settlement and valuation of derivative financial instruments in the amount of PLN 294 million.

After the deduction of tax charges in the amount of PLN (2,495) million, the net profit of the ORLEN Group for 2021 amounted to PLN 11,188 million and was higher by PLN 8,363 million (y/y).

Statement of financial position

As at 31 December 2021, the total assets of the ORLEN Group amounted to PLN 106,754 million and was higher by PLN 22,706 million in comparison with 31 December 2020.

As at 31 December 2021, the value of non-current assets amounted to PLN 68,706 million and was higher by PLN 9,273 million in comparison with the end of the previous year, mainly due to increase in property, plant and equipment, intangible assets and goodwill by PLN 8,068 million and an increase in the value of investments accounted for using the equity method by PLN 367 million, mainly as a result of the recognition of an investment in the Baltic Power joint venture in the amount of PLN 268 million (additional information in note 7.3.7) and recognition of a higher share in the results of jointly controlled entities.

The change in balance of property, plant and equipment, intangible assets and goodwill by PLN 8,068 million (y/y) comprised:

investment expenditures in the amount of PLN 8,751 million including development of fertilizer production capacities in Anwil, construction of the Glycol installation in ORLEN Południe and Visbreaking Installation in Płock, expenditure of the production capacity of the Olefin installation in Płock, projects in the Energy segment related mainly to the modernization of existing assets and the connection of new customers and modernization of the TG1 turbine generator of power plant in Płock and projects in Retail and Upstream segment;
depreciation and amortisation in the amount of PLN (4,651) million;
impairment allowances of property, plant and equipment and intangible assets net in the amount of PLN 811 million;
goodwill recognised on the acquisition of new subsidiaries in the amount of PLN 434 million. Additional information in notes 7.3, 14.2.1;
purchase of CO₂ allowances and energy certificates in the amount of PLN 1,655 million;
amortisation of CO₂ allowances and energy certificates in the amount of PLN (2,238) million;
allowances received free of charge in the amount of PLN 1,998 million,
effect of recognition of new assets at the date of acquisition of new subsidiaries in the amount of PLN 674 million and
effect of differences in balance on translating foreign operations in the amount of PLN 797 million.

The value of current assets as at 31 December 2021 increased by PLN 13,433 million in comparison with the end of the previous year, mainly as an increase in inventories by PLN 6,131 million, balance of cash by PLN 1,656 million, trade and other receivables by PLN 5,401 million and valuation of derivative financial instruments by PLN 709 million mainly due to the valuation of CO₂ forward contracts. The increase in value of inventories is mainly the result of an increase in crude oil and petroleum product prices. The increase in trade receivables results mainly from higher sales in term of value and quantity.

As at 31 December 2021, total equity amounted to PLN 52,578 million and was higher by PLN 10,189 million in comparison with the end of 2020, mainly due to recognition of net profit for the 2021 in the amount of PLN 11,188 million, negative impact of the change in hedging reserve in the amount of PLN (414) million, dividends paid to PKN ORLEN’s shareholder from previous years’ profits in the amount of PLN (1,497) million and the impact of exchange differences on translating foreign operations in the amount of PLN 783 million, resulting mainly from the increase in CZK, USD and CAD exchange rates.

The value of trade and other liabilities increased by PLN 5,788 million compared to the end of 2020 mainly due to increase of trade liabilities by PLN 4,577 million, tax liabilities by PLN 1,056 million related mainly to excise tax and fuel charge as well as value added tax due to higher volume and quantity sales of product and a significant increase in fuel prices in 2021 compared to prices in 2020 and investment liabilities by PLN 255 million. The increase in trade liabilities results mainly from the higher prices on the markets.

Value of provisions as at 31 December 2021 amounted to PLN 8,106 million and was higher by PLN 3,543 million in comparison to the end of 2020. In 2021, the Group updated provisions from 2020 and recognised/reversed a provision for CO₂ emissions for the 12 months of 2021 in the total amount of PLN 5,466 million. The increase resulted mainly from increase of average weighted price and market prices, while maintenance of similar amounts of CO₂emissions. In addition the change of net provisions for CO₂ emissions resulted mainly from redemptions a provision in connection with CO₂ emissions for 2020 in amount of PLN (1,561) million.

As at 31 December 2021, net financial indebtedness of the ORLEN Group amounted to PLN 12,275 million and was lower by PLN (785) million in comparison with the end of 2020 mainly due to the net inflows, including inflows and repayments of loans, borrowings and redemption and issue of bonds in the amount of PLN 460 million, an increase in balance of cash by PLN (1,656) million, short-term deposits in the amount of PLN 60 million and the net effect of valuation and revaluation of debt due to foreign exchange differences, as well as new acquisitions within the Group in the total amount of PLN 351 million.

Statement of cash flows

Proceeds of net cash from operating activities for 2021 amounted to PLN 13,295 million and comprised mainly result from operations increased by depreciation and amortisation (EBITDA) in the amount of PLN 19,211 million adjusted by: share in profit from investments accounted for using the equity method in the amount of PLN (613) million, the negative impact of increase in a net working capital by PLN (4,442) million mainly related to increase in crude oil prices and prices of products, which translated into the value of inventories, receivables and liabilities decreased by paid income taxes in the amount of PLN (1,194) million, profit on investing activities in the amount of PLN (3,655) million mainly related to settlement and valuation of derivative financial instruments in the amount of PLN (2,660) million, change in provisions in the amount of PLN 6,099 million mainly as a result of an increase in weighted average prices and market prices of CO₂allowances.

Net cash used in investing activities for 2021 amounted to PLN (9,739) million and comprised mainly net cash flows for the acquisition and disposal of property, plant and equipment, intangible assets and right-of-use asset in the amount of PLN (11,130) million, and acquisition of shares of subsidiaries adjusted by acquired cash as at the acquisition date (mainly due to the acquisition of new subsidiaries – detailed information, note 7.3) in the amount of PLN (772) million and settlement of derivatives not designated as hedge accounting in the amount of PLN 2,027 million.

Net cash flows used in financing activities for 2021 amounted to PLN (2,006) million and comprised mainly dividends paid to PKN ORLEN’s shareholder in the amount of PLN (1,497) million, the net outflows of loans and borrowings in the amount of PLN (313) million, bond issues in the amount of PLN 3,225 million, mainly due to the issue of D series corporate bonds and A series Eurobonds by PKN ORLEN, redemption of bonds in the amount of PLN (2,452) million mainly by ORLEN Capital and interest paid in the amount of PLN (469) million and liabilities under lease agreements in the amount of PLN (701) million.

Following inclusion of the revaluation of cash due to exchange differences, the cash balance in 2021 increased by PLN 1,656 million and as at 31 December 2021 amounted to PLN 2,896 million.