Directors’ Report on the operations of Grupa LOTOS S.A. and the LOTOS Group in 2017 Directors’ Report on the operations of Grupa LOTOS S.A. and the LOTOS Group for 2017 1 Directors’ Report on the operations of Grupa LOTOS S.A. and the LOTOS Group in 2017 1.Overview of Grupa LOTOS S.A. and its Group ................................................................................................................. 6 1.1. Key assets, principal business and results........................................................................................................... 6 1.2. Overview of the Group's organisation and management .......................................................................................... 8 1.2.1 Organisational structure of Grupa LOTOS S.A. and its Group .......................................................................... 8 2. Strategy of the LOTOS Group ....................................................................................................................................... 14 2.1. ‘Stability and Sustainable Growth’ − LOTOS Group Strategy 2017−2022 .......................................................... 14 2.2. Macroeconomic environment versus strategic assumptions .............................................................................. 14 2.3. Strategy implementation in 2017 – key metrics .................................................................................................. 16 2.4. Implementation of strategic objectives ............................................................................................................... 17 3. Macroeconomic environment of Grupa LOTOS S.A. and the LOTOS Group in 2017 ................................................ 21 3.1. Drivers of crude oil and gas prices ..................................................................................................................... 21 3.1.1. World population ....................................................................................................................................... 21 3.1.2. The global economic situation in 2017 ...................................................................................................... 22 3.1.3. Global and regional changes in oil supply and demand in 2017 ................................................................ 22 3.1.4. PLN/USD exchange rate ........................................................................................................................... 25 3.2. Crude oil and gas prices in 2017 ....................................................................................................................... 26 3.3. Drivers of profitability in the upstream business and current industry trends ...................................................... 28 3.4. Drivers of profitability in the refining business and current industry trends ......................................................... 28 4. Operations of Grupa LOTOS S.A. and the LOTOS Group ........................................................................................... 38 4.1 Upstream segment ............................................................................................................................................ 38 4.1.1. Overview of production assets, products and markets .............................................................................. 38 4.1.2. Upstream segment's logistics ................................................................................................................... 43 4.1.3. Competition for the upstream business ..................................................................................................... 44 4.1.4. Growth directions for the Upstream segment ............................................................................................ 45 4.1.5. Summary of threats and opportunities in the Upstream segment .............................................................. 47 4.2. Downstream segment – crude oil refining .......................................................................................................... 49 4.2.1. Competition for the refining business ........................................................................................................ 49 4.2.2. Key products, merchandise and services .................................................................................................. 51 4.2.3. Segment’s logistics (rail and sea transport) .............................................................................................. 53 4.2.4. Logistics – procurement and supply .......................................................................................................... 56 4.2.5. Summary of key threats and opportunities ................................................................................................ 58 4.3. Downstream – wholesale and retail sale ............................................................................................................ 59 4.3.1. Competition for the marketing business .................................................................................................... 59 4.3.1. Grey market for fuel in Poland ....................................................................................................................... 60 4.3.2. Distribution channels, products, markets .................................................................................................. 60 4.3.3. Overview of the retail business in Poland ................................................................................................. 66 4.3.4. LOTOS service station network and its competitive position ..................................................................... 68 5. Financial condition of Grupa LOTOS S.A. and its Group ............................................................................................ 72 5.1. Discussion of key financial and economic data and assessment of material factors and non-recurring events .. 72 5.1.1. Macroeconomic environment .................................................................................................................... 72 5.1.2. Consolidated statement of comprehensive income ................................................................................... 72 5.1.3. Consolidated statement of financial position ............................................................................................. 78 5.1.4. Consolidated statement of cash flows ....................................................................................................... 80 2 Directors’ Report on the operations of Grupa LOTOS S.A. and the LOTOS Group in 2017 5.1.5. Off-balance sheet items by entity, type and value ..................................................................................... 80 5.1.6. Non-recurring factors and events affecting financial performance ............................................................. 81 5.1.7. Ratio analysis ........................................................................................................................................... 81 5.1.8. Use of share issue proceeds to implement the issue objectives ............................................................... 85 5.1.9. Explanation of differences between actual financial performance and previously published forecasts for 2017 ..................................................................................................................... 85 5.1.10. Separate results and financial position of Grupa LOTOS S.A. .................................................................. 86 5.2. Key capital expenditure and equity investments in Poland and abroad .............................................................. 89 5.2.1. Expenditure on property, plant and equipment .......................................................................................... 89 5.2.2. Equity investments .................................................................................................................................... 90 5.3. Financing .......................................................................................................................................................... 91 5.3.1. Bank and non-bank borrowings ......................................................................................................................... 91 5.3.1. Other financing agreements ...................................................................................................................... 98 5.3.2. Intercompany loans................................................................................................................................... 99 LOTOS Group’s intercompany loans as at December 31st 2017:..................................................................................... 99 5.3.3. Financial resources management ........................................................................................................... 103 5.4. Management Board's representations ............................................................................................................. 103 5.4.1. On compliance of the full-year financial statements and the Directors’ Report on the Operations of Grupa LOTOS S.A. and the LOTOS Group ........................................................................................ 103 5.4.2. On selecting a qualified auditor of financial statements ..........................................................................