Significant risk factors and threats

Risk related to price and availability of natural gas

In its search for alternative and competitive sources of gas, the Group companies seek to diversify both the geographical regions and the suppliers of their gas imports. Negotiations with alternative gas suppliers are conducted at the Group level, which allows the Group to leverage its stronger bargaining position.

The Group takes steps to satisfy its overall gas demand through a combination of a long-term contract with its strategic supplier (PGNiG S.A.), annual or shorter contracts with a number of other suppliers, and transactions on energy exchanges and the OTC market to meet its short-term demand. Currently, gas purchased by the Group is priced based on gas prices quoted on energy exchanges, which means that the Group purchases gas at prices paid by its competitors in the European Union.

The gas interconnector and gas storage facility extension projects, currently being implemented in Poland, and the launch of the LNG terminal in Świnoujście have minimised the risk of disruptions in gas supply.

The Group companies are also teking steps to reduce gas consumption.

Risks associated with the planning and execution of strategic projects

The Group companies are working on investment projects commenced in previous years, while embarking on new strategic ones, important for the Group’s interests, including investments in property, plant and equipment. Delivery of the Strategy depends on a range of factors, including those outside of the Group’s control. The risks to the implementation of the Strategy are external developments in the Group’s environment, such as macroeconomic factors, market conditions, business environment and activities of the main competitors. They could adversely affect the Group’s ability to develop its business as planned and to deliver its strategic objectives.

The Operationalisation of the Group’s Strategy for 2014−2020 lists the strategic projects pursued by the Group. The risk inherent in the execution of strategic projects, including investment and other projects, lies in the possibility that major growth-oriented initiatives will not be completed according to plan or will not deliver the expected results, and that the objectives they are intended to achieve will not be adequately translated into the project planning, monitoring or execution processes. In order to minimise the risks to the execution of strategic projects at the Group, internal procedures have been put in place to define and govern the preparation and execution of investment projects. Oversight has been introduced over strategic projects and their assumptions, and regular updates are provided on projects’ status.

The execution of investment projects includes change management, where special attention is given to changes in foreign exchange rates, commodity prices, as well as the requirements to be met by newly constructed units. As a result, execution timetables and expenditure budgets can be updated on an ongoing basis. In addition, controlling officers monitor progress of financing of the projects to identify potential threats. These policies also take into account the obligations and requirements imposed on beneficiaries of public funding.

As part of the planning and execution of strategic projects, in the fourth quarter of 2016 the Group begun the process of reviewing its growth strategy. The work will involve a review of rationale and scope of the strategic projects, and analysis of potential new strategic objectives.

Risk associated with new legal requirements relating to production processes, including environmental regulations

Risk associated with the implementation of the Industrial Emissions Directive (IED)

Following the implementation of the Industrial Emissions Directive (IED) in January 2014, the Group will be required to bring its production facilities into compliance with the new regulations. The Group will have to undertake specific adaptation work, and bear its costs. To ensure that there is sufficient time for taking appropriate steps to adapt the Group’s facilities to the changing regulations, the parent continuously monitors all planned and actual changes in the legal environment which could affect the Group’s business. Any necessary projects are provided for in the Group’s investment plans and subsequently executed.

Risk associated with greenhouse gas emissions

Greenhouse gas emissions are covered by legal regulations governing the European Union’s emissions trading scheme (EU ETS). The system is based on the allocation of free greenhouse gas emission allowances for emitting installations and, if free allowances are not sufficient, on the purchase thereof in auctions. Each year, the number of the allowances allotted decreases by several percent. If the actual CO₂ emissions are not covered by the free allowances, the Group may need to incur additional capital expenditure on projects designed to reduce NOx and CO₂ emissions. The volume of CO₂ emissions depends on the energy intensity of production processes. In order to mitigate the risk, the companies have been taking steps to reduce the energy intensity of production processes and the greenhouse gas or NOx emissions.

Risk related to BAT (Best Available Techniques) conclusions

Following the scheduled review of the regulations on the Best Available Techniques for the Manufacture of Large Volume Inorganic Chemicals: Ammonia, Acids & Fertilisers, there is a risk of implementing stricter and broader requirements relating to the air pollution emissions standards. Similarly, there is a risk that new BATs will be defined for the installations for which so far no BATs have been specified. The period for adapting production installations to the emission requirements specified in the BAT conclusions is four years.

In order to meet the BAT requirements, companies should monitor on an on-going basis any drafts of new laws and regulations and actively present their opinions on the proposed legislation. The measures taken by the Group in this respect include:

• analysing the effectiveness of the technologies used in the context of trends prevailing in the competitive environment,
• planning and implementing projects designed to bring the production installations into compliance with the BAT/BREF standards,
• searching for new solutions used in the processes, in particular to improve efficiency and reduce energy intensity in the context of regulations in place and the current level of technology,
• developing and extending the product range by adding new fertilizers based on components produced in the existing units.

Risk of adverse changes in the supply-demand balance

In the Agro Fertilizers segment, the Group identifies risks related to:

• increased imports of nitrogen and compound fertilizers, produced from cheaper raw materials, to Poland and the EU, and consequently persisting oversupply and aggressive pricing policies pursued by importers struggling to maintain their shares in the fertilizer market;
• launch of significant new manufacturing capacities, particularly in the urea market (USA, Algeria) where oversupply periodically affects prices of other nitrogen fertilizers;
• increase of production capacities of nitrate fertilizers in Hungary and stronger impact of this product on the market in southern Poland;
• ban on trade in nitrate and CAN in Turkey, introduced for an indefinite period in response to terror attacks in the country − search for EU markets to sell products manufactured in or imported by Turkey;
• M&A activity in the chemical sector, which might enable chemical producers to exert stronger pressures on the EU fertilizer market;
• stronger competition as new products are marketed and more effective technologies are applied.

In order to mitigate the identified risks and to strengthen and consolidate its leadership in the segment, the Group has been taking steps to optimise its cost base and broaden the portfolio of products and services.

Measures taken by the Group to strengthen its competitive advantages in the fertilizers segment:

• implementation of the Group’s updated distribution strategy,
• implementation of projects designed to improve the efficiency of production processes,
• strengthening the Group’s market position through acquisitions and placement of new products in the market,
• taking active part in the consolidation processes in the chemical industry,
• initiation of anti-dumping proceedings,
• active participation in the work of Fertilizers Europe,
• cooperation with universities and research institutes,
• supporting agricultural producers by providing them with access to state-of-the-art fertilizing and production solutions.

In the Plastics segment, the Group identifies risks related to:

• global oversupply of caprolactam and polyamide − excess volumes from the Far East are shipped to Europe, as a result of which EU manufacturers’ traditional export markets begin to shrink and prices decline to unsatisfactory levels;
• M&A activity in the chemical sector, which might enable chemical producers to exert stronger pressures on the EU market.

To minimise the effect of the expected market trends, the Group has undertaken a number of initiatives to strengthen its competitive position:

• construction of a new PA6 production unit in Tarnów, which will fully balance caprolactam production within the Group and eliminate the need to sell a less processed product;
• the parent is finalising the details of the project to construct a new modified plastics facility in Tarnów, within the Kraków special economic zone, that will help further expand the product chain;
• continuation of the policy to diversify sales of caprolactam and polyamide;
• preparation of a long-term caprolactam manufacturing cost reduction programme;
• leveraging the synergies between Tarnów’s and Puławy’s units following the integration of the companies’ production capacities and sales potential;
• adaptation to customer expectations by offering new products tailored to specific customer needs;
• the Group seeks to optimise the pool of raw material suppliers, with particular emphasis on direct partnerships with producers under long-term strategic contracts, and to develop an optimum procurement logistics model;
• the Group monitors the situation for any possible threats to be able to take necessary steps and mitigate adverse effects of such negative developments.

In the Chemicals segment, the Group has identified risks related to:

• weaker demand for titanium white from paint and varnish manufacturers, higher quality requirements in the plastics and paper industries, and significant increase in the production capacities of Chinese manufacturers;
• higher supply of OXO alcohols on balanced European markets, driven by heavy inflows of cheaper alcohols, especially from the Russian market;
• import of plasticisers to the balanced and highly competitive EU market, on which a wide range of plasticisers are available − the risk related to imports of non-phthalate plasticizers from the Korean and Turkish markets is particularly significant.

The Group protects its business against those risks:

• by adapting its product mix to the market requirements and needs, for instance by launching a unit producing Oxoviflex™, a non-phthalic plasticizer and, as production capacities grow, by seeking new customers for this product; by ensuring high purity of OXO alcohols and identifying market niches − e.g. improving DEHP plasticizer for medical applications or arranging deliveries tailored to the needs of end users (flexitanks for deep-sea freight of small volumes of products);
• through initiatives designed to minimise production costs;
• through active participation in marketing initiatives and trade associations.

Currency risk

The Group has a positive exposure to the euro and the US dollar which is hedged based on on-going monitoring of movements in the euro and US dollar exchange rates. The Group hedges its currency exposures using currency forwards and natural hedging.

In 2015, having implemented the new centralised Financing Model, the Group extended its hedge time horizon by using a portion of long-term financing in the form of a euro-denominated facility. In line with its accounting policy, for such currency instruments (maturing in more than one year) the Group uses hedging relationships with future revenue planned to be generated in foreign currencies.

The Group’s Risk Committee analyses and sets consolidated targets for currency exposure of the Group as a whole and for its leading companies, and recommends target levels and horizons of hedges, types of currency instruments, and exchange rates for hedge transactions. Hedging transactions are executed by those Group companies where the exposure actually occurs.

The applied risk management methods enable the Group to limit the existing risk by using selected hedging instruments and strategies, based on long-term and one-year currency exposure plans and their updates to account for quarterly operational plans and short-term projection of currency flows and currency expenditures, and based on the transactions already registered in the financial and accounting system. However, these methods do not eliminate that risk completely. In addition, currency risk may affect the domestic nitrate fertilizer market in the context of bilateral trade with other EU countries. Strong fluctuations in exchange rates may affect the Group’s business, financial condition or results of operations.

Risk related to availability and efficiency of capital and other sources of funding

One of the factors important for the successful development of the Group’s business is the implementation of strategic projects and availability of capital for the financing of such projects, as discussed in Operationalisation of the Strategy for 2014−2020. There is a risk that insufficient access to capital or other sources of funding, or availability of such capital or other sources of funding at excessive cost, might adversely affect prospects for the Group’s development and delivery of its strategy or that the Group might use the available capital in an inefficient manner and thus achieve returns that fall short of investors’ expectations.

Under the consolidated financing model implemented in 2015, the Group executed a harmonised package of corporate financing agreements, thus enhancing its long-term security, based on uniform financing covenants agreed with banks, including a net debt to EBITDA ratio, which should not exceed 3.0x.
The Group also intends to pursue major investment projects via SPVs and to secure their financing in the form of project finance (without recourse to the Group), which may lead to a significant increase in debt in the future and require optimising selected covenants of the existing corporate financing agreements.

Risk of negative effect of CO₂ trading prices on the financial result

The Group has in place a monitoring system for emissions covered by the EU ETS. It also performs ongoing balancing of greenhouse gas emissions. The Group monitors its actual emissions and the market prices of emission allowances, and takes appropriate steps in response to their fluctuations. The Group may be forced to incur higher-than-expected costs if it reports a deficit in emission allowances as at the end of the year and faces an increased demand for EUAs on the market.

The Group mitigates the risk of an adverse effect of EUA prices on the carbon market by averaging the price of emission units purchased on the spot market and by purchasing CO₂ emission allowances in financial derivatives with physical delivery in the future, in accordance with the purchase strategy in force from time to time. The Group effectively implements its strategy of rolling purchases of emission allowances, to ensure full coverage of any deficit of emission allowances that should be allocated for a given year and subsequently redeemed, with exercise prices not higher than projected. The Group has appointed the EU ETS Management Committee comprising representatives of all key Group companies. Its main objective is to supervise a joint model for managing CO₂ emission allowances at the Group companies, in particular the CO₂ emissions trading strategy, and subsequently the implementation of the emissions trading strategy across the Group.

Risk of major industrial accidents or technical failures disrupting the continuity of processes and operation of key production units

The Group has reliable safety systems and preventive measures in place at all organisational and technological levels, including occupational health and safety as well as protection against industrial accidents; however, no assurance can be given that these will completely eliminate the risk of such accidents and ensure the continuity of production processes. Their relevance is assessed by external and internal inspection authorities, as well as accreditation/certification bodies.

Prevention of industrial accidents at the Group companies is achieved through a range of activities, including:

• identification of hazards inherent in technological processes, storage and transport, and implementation of technical solutions and organisational measures to minimize the risk of an accident,
• ongoing monitoring of operations of plant and equipment and evaluation of their technical condition,
• fitting of plants and units with safety and protection systems to minimise the risk of major accidents and environmental contamination, as well as risks to life and health,
• implementation of new projects and upgrades based on technical and organisational solutions designed to ensure occupational health and safety (the Group’s facilities are compliant with the Best Available Techniques (BAT) reference documents, which are the source of the world’s strictest safety requirements, including environmental regulations),
• carrying out scheduled technical stopovers and maintenance shutdowns to ensure that the units are kept in a proper working order,
• continuous improvement of the employees’ qualifications through training courses, etc.
• introduction across the Group of corporate rules on how to report industrial accidents and failures, as well as how to investigate them and take preventive measures to mitigate the risk of their recurrence in the future,
• analysis and periodic update of technical and technological risks at Grupa Azoty,
• implementation of an operational excellence programme,
• implementation of the Product Stewardship standard, covering all stages of the fertilizer lifecycle, which has been confirmed by the issuing of a certificate.

Risk related to maintaining continuity of ammonia production and availability of ammonia at economically viable prices

To mitigate the risk and to strengthen and consolidate its leading position, the Group takes steps to:

• diversify suppliers of natural gas and ammonia,
• maintain ammonia stocks at optimum levels across the Group, to ensure continuity of supplies and production of ammonia and caprolactam,
• prepare reduced-output scenarios based on break-even points for key products,
• analyse on an ongoing basis maximum ammonia purchase prices to achieve product profitability,
• analyse on an ongoing basis fixed and variable costs of production to determine economic viability of purchasing ammonia outside the Group,
• maintain the operational reliability of units by carrying out overhauls, upgrades and investments, in particular in areas covered in the technical risk analysis.

Risk of implementation/tightening of EU or local regulations which would restrict the use or application of the company’s products

The Group monitors and implements new regulatory requirements on an ongoing basis. The Group takes an active part in the work of registration consortia and European associations to obtain advance information about upcoming changes in the legislation. In each case the Group reviews the impact of new regulations on its products. Potential risks associated with the tightening of laws, restricting the use of the company’s products are related to EU Directives or Regulations such as Regulation (EC) No. 2003/2003 of the European Parliament and of the Council of 13 October 2003 relating to fertilizers certified with a certificate of conformity. The Group is currently in the process of identifying threats associated with the new draft of the fertilizers regulation, which is designed to implement the principles of the Circular Economy package. The proposal assumes an uninterrupted flow of goods on the single EU market, preceded by the mandatory harmonisation of fertilizing products (CE marking). The European Commission’s proposal also covers the use of organic waste and bio-waste as raw materials to manufacture fertilizers. The new rules will apply to all types of fertilisers to ensure the highest level of soil protection. The Regulation introduces strict limits for heavy metal contamination, including cadmium content in phosphate fertilizers. The European Commission assumes that this will reduce health and environmental risks. Moreover, in this way the EU intends to reduce the dependence of the fertilizer industry on imports of phosphorus-bearing materials. Work is under way to implement into Polish law the Directive of the European Parliament and of the Council on the reduction of national emissions of certain atmospheric pollutants and amending Directive 2003/35/EC (NEC Directive, COM(2013)92). The draft proposes that ammonia emissions be reduced. The agricultural sector can expect new requirements for ammonia emissions from different types of mineral fertilizers, primarily those based on ammonia (especially urea) rather than nitrate fertilizers. The Group also monitors other aspects of EU regulations, such as free trade agreements (DCFTA Ukraine, TTIP). The parent also takes steps to ensure that the entire manufacturing and distribution process meets the safety requirements applicable to trading in its products.

Risk of failure to meet deadlines for reduction of NOx, SOx and particulate matter emissions

The Group takes steps to ensure its compliance with the requirements of the IED Directive (on industrial emissions) which entered into force as of January 1st 2016 and defined new emission standards for the combustion of fuels in installations (Regulation of Minister of the Environment of November 4th 2014 on emission standards for certain units, fuel combustion sources, as well as waste incineration and co-incineration equipment). The new standards in particular apply to SOx, NOx and particulate matter emission limits.

The IED Directive and the Environmental Protection Law provide for postponing the effective date of the more restrictive emissions standards. One such mechanism is the Transitional National Plan (TNP). The fuel combustion facilities operated by the Group have also been submitted for inclusion in the TNP.

The following investment projects have been undertaken to meet the above standards:

• Grupa Azoty KĘDZIERZYN Group – new coal-fired generating unit;
• Parent – wet flue gas desulfurization unit;
• Grupa Azoty POLICE Group – flue gas desulfurization unit.

When the projects are completed, the Group will achieve compliance with the emission requirements under the IED Directive and Polish regulations.

 

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