Who we are. Natural gas TPA Development of sales driven by opportunities in the opening market Supply of gas to the Group

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1 annual report 2012

2 2 Table of contents Who we are 3 The most important events in Letter from the President of the Management Board 8 Letter from the President of the Supervisory Board 10 About the DUON Capital Group 11 Organisation of the Capital Group 11 Supervisory Board 12 Management Board 13 History 14 Natural gas and electricity markets in Poland 15 Gas market 15 Electric energy market 17 Grupa DUON on the gas and energy markets 19 Activities of Grupa DUON 20 Infrastructure segment 20 Network gas 20 LNG 21 Trading segment 22 Natural gas TPA 23 Electric energy TPA 23 Wholesale trade 23 Strategy and perspectives for development 25 Financial results of Grupa DUON in Realisation of forecast results in Results forecast for DUON on the capital market 36 Shareholding 37 Dividend policy 37 Corporate governance 38 Incentive programme 42 Glossary 44 Contact 46

3 Who we are 3 The DUON Capital Group is one of the leading independent providers of natural gas and electric energy in Poland. Our recipients comprise industrial entities, small and medium-sized companies, as well as individual and municipal customers. The DUON Group s mission is to completely satisfy the energy needs of customers through products and services based on natural gas and electricity. Our strategic goal is to become the largest independent supplier of gas and electricity in Poland. This goal will be accomplished by the Group s activities in two complementary segments: Infrastructure segment Trading segment expansion of infrastructure enabling the sale of gas in new locations; investments in natural gas-powered installations, enabling us to produce and sell heat and/or electric energy (boiler houses and cogeneration systems), purchases of gas and electric energy on the Polish and European wholesale markets and sale to end recipients with the use of third party infrastructure, i.e. transmission and distribution system operators (e.g. OGP Gaz-System, PSE-Operator) based on the Third Party Access principle; combined sale of gas and electric energy (so-called dual fuel ) following the example of more developed markets (e.g. Great Britain). Source: own study Network natural gas 9 locations 400 km of networks 40 m m 3 in 2012 About 3,000 customers LNG 19 locations 50 km of networks 12 roadtankers Market share of over 80% 28 m m 3 in 2012 About 800 customers Heat and/or electric energy gas boilers, cogeneration Natural gas TPA Development of sales driven by opportunities in the opening market Supply of gas to the Group Electric energy TPA 5,000 customers at the end of k MWh in 2012 Dual fuel combined delivery of gas and energy annual report 2012

4 4 Selected financial data m PLN m EUR sales revenues 252,3 114,2 60,3 27,7 EBIT 8,7 0,1 2,1 0,0 EBITDA 13,6 4,5 3,2 1,1 net profit 6,2-3,2 1,5-0,8 cash flows from operating activities 14,7-14,0 3,6-3,2 total assets 270,6 254,8 66,2 57,7 liabilities 78,1 70,8 19,1 16,0 net debt 32,5 35,9 7,9 8,2 equity 192,5 184,00 47,1 41,7 weighted average number of shares (units) book value per share (in PLN) 1,91 2,93 0,46 0,66 earnings per share (in PLN) 0,06-0,05 0,01-0,01 sales revenues (m PLN) EBITDA (m PLN) net profit (m PLN) 252,3 13,6 6,2 72,3 114,2 4,7 4, ,0-3,

5 The most important events in January We signed two important LNG sale agreements worth over PLN 64 million, due to which the sale contract portfolio volume in new locations exceeded 20 million m 3. The registry court registered the increase of Grupa DUON S.A. capital to PLN 102,468,553 through the public issue of shares series J conducted in We completed another stage of reorganisation of the DUON Capital Group, consisting of the merger of two distribution companies (Carbon and Gaslinia) with DUON Dystrybucja S.A.; this was a continuation of the process begun in 2011 of merging companies involved in gas distribution into one entity. February 77,963,828 shares series J and K were introduced to trade. Shares series J are so-called merger shares, issued for the requirements of the merger of KRI and CP Energia in April Shares series K were issued for the requirements of public offering in March The General Meeting decided on the transfer of the Group s Headquarters to Wysogotowo and liquidation of the office in Warsaw, which constituted another stage of the DUON Capital Group s reorganisation. We conducted sale of electricity via Internet portals for group purchases, unique on a European scale. April We began to import network gas from Western Europe via interconnectors for the customers of our infrastructure segment, which allowed us to diversify the network gas purchase portfolio, previously dominated by the sole Polish supplier. annual report 2012

6 6 June July As a result of the General Meeting, the registry court registered the change of the Group s name to DUON. Thus we introduced the DUON brand to the Group s names; the creation of the brand is one of the strategic goals for the coming years. The DUON brand reflects well the character of our activities conducted in two segments: trading and infrastructure, based on two products: natural gas and electric energy. As part of the rebranding we applied the DUON brand to the names of other Group companies: KRI changed to DUON Dystrybucja, and KRI Marketing and Trading to DUON Marketing and Trading. We completed the reorganisation of the Group through the merger of Kriogaz Polska with DUON Dystrybucja. Thus we managed to save PLN 3 million per year in general administrative expenses as a result of post-integration synergies. September We introduced a new tariff for the sale and distribution of natural gas, and consequently managed to increase the margin on gas sale in the infrastructure segment. October We became the first in Poland to begin supply of LNG from the terminal in Zeebrugge (Belgium). Adding Zeebrugge to our supply sources enabled us to increase the level of LNG supply security and gain experience which will definitely prove useful when the LNG terminal in Świnoujście is opened. December We acquired 66% of shares in a heating company producing heat based on natural gas, distributed in the city of Praszka. This purchase was strategically justified since it enabled us to extend the value chain with heat production. We were the first entity on the purchase side to conclude transactions on the newly opened gas exchange. Since then we have been active on this market, and hope for its further development.

7 2012 in numbers 250% increase of sales revenues 7 300% increase of EBITDA 9% increase of gas sales volume through our own infrastructure 4 new LNG stations commissioned 4 new LNG stations under construction 240 new gas connections 5000 recipients of electric energy at the end of 2012 annual report 2012

8 8 Letter from the President of the Management Board Dear Shareholders, It is with great pleasure that I present the Financial Statements of the DUON Group for As I announced in my previous letter to shareholders, the successfully completed measures aimed at achieving synergies from the merger of KRI and CP Energia in 2011, a further increase in gas sales through our own infrastructure and dynamic development of activity in a new area trading with electric energy and natural gas on the TPA (Third Party Access) basis resulted in a significant increase in revenues and the expected stable and significant improvement in the financial performance. Last year, the consolidated sales revenue amounted to PLN 252 million - 120% higher than in EBITDA has more than tripled to PLN 13.6 million in 2012 and net income, in contrast to previous years, was positive at PLN 6.2 million. We can proudly announce that 2012, was the best year in the history of our Group s listing on the Warsaw Stock Exchange. Last year, we completed restructuring measures in order to focus on two core business segments, i.e. the distribution of gas through own networks and LNG regasification stations (the infrastructure segment) and the development of activities in the area of trading in gas and electric energy on the TPA (Third Party Access) basis (the trading segment). These measures were crowned in June 2012 with the change of the name from CP Energia S.A. to Grupa DUON S.A., followed by changes of the Capital Group companies names to DUON Dystrybucja S.A. and DUON Marketing and Trading S.A. respectively. The unification of names of the companies combined with a broad range of marketing and PR activities helped to increase and strengthen the awareness of a new brand among potential customers, as well as in the energy and gas industry. The new brand reflects the Group s strategy built around the two aforementioned activities, namely infrastructure and trading and two basic products, i.e. gas and electric energy. We will strive to ensure that the DUON brand becomes a permanent symbol of reliability and expertise and an alternative choice for customers looking for the best solutions and energy products. Operationally, 2012 was a very successful year in both business segments. In the infrastructure segment we commissioned four LNG re-gasification stations which added 4.4 million m3 to last year s sales and will translate into an increase in the annual sales volume in 2013 by 10 million m3. Total sales of natural gas through our own infrastructure reached 68.1 million m3 and were 9% higher than the result achieved in We also signed further LNG sales contracts for which we will make investments in LNG regasification stations in four new locations. Gradually, we are increasing the degree of diversification of LNG suppliers, so in 2012 we started to take LNG from the terminal at Zeebrugge in Belgium. All of these actions strengthened DUON s position as a leader on the Polish low tonnage LNG market. In addition, just before the end of 2012, we acquired a majority stake in a company, DUON Praszka, which produces and distributes heat in one of the locations where we have gas networks. In the coming years this transaction will help to achieve additional margin on sold gas. The trading segment has seen a dramatic increase in sales of electric energy to end customers on the TPA basis. Last year we sold 164 MWh to over 5,000 recipients and we already have contracts signed for 2013 for a total volume of approx. 250 MWh, an increase of approx. 52% p.a. In April last year we started trading in gas on the TPA basis, supplying gas, in the first place, to customers connected to our own distribution network and selling, in intragroup transactions, approx. 15 million m3 of natural gas purchased in foreign wholesale markets. We expect that 2013 will be a breakthrough year for the liberalizing gas market in Poland. We have acquired first contracts with end customers on the TPA basis and with the launch of the gas exchange and introduction of a virtual point on the transmission network, we started to actively trade in gas in the wholesale

9 9 market in Poland. In fact, DUON was the first company to make a purchase transaction on the Polish gas exchange. We expect that the results of the development of this part of the business will be reflected in this year s performance. The maintenance of a high rate of growth of financial results which will translate into an increase in the Group s value is our basic goal for the coming years. The implementation of this goal is confirmed by, among other things, the forecast result for 2013 which is published together with the Financial Statements. We expect that this year, EBITDA will increase by 30% over 2012 rising to PLN 17,7 million. A key contributor to this result will be the contracted increase in the sales of natural gas distributed through own networks and LNG stations (increase in volume by 9 million m3, i.e. 13%, compared to 2012), putting to use further LNG re-gasification stations and intensive development of sales of electric energy and natural gas on the TPA basis. I am firmly convinced that the foundations, on which we have built a strong, diversified Group operating in the Polish energy market, provide solid grounds to be optimistic about the future. Our present success is a joint achievement of all employees of the DUON Capital Group who, with great commitment and dedication have actively supported the implementation of the Company s development strategy. On behalf of the Management Board I thank them for their hard work and efforts that, from today s perspective, are starting to bear fruit for all of those who are interested in the development of our Group. We are facing new challenges and opportunities to strengthen the position of DUON as a major, independent entity operating in the electric energy and natural gas markets. I assure you that we are able to take advantage of this opportunity. Yours faithfully Mariusz Caliński, CEO March 2013 annual report 2012

10 10 Letter from the CHAIRMAN OF THE Supervisory Board Dear Shareholders, 2012 has been a transformational year for DUON. The financial results and the recovering share price are the manifestation of a clear strategy and solid business execution. DUON s strategic aim is to be the largest independent energy supplier in Poland. This aim will be achieved by satisfying the energy needs of customers with products based on gas and electricity, growth markets where DUON s dual activities in infrastructure and trading are well positioned. The liberalization of Poland s gas and electricity markets to become like those familiar in other parts of Europe provides the opportunity for DUON to achieve its strategic aim. The process will open up new sources of supply and new trading platforms. At the same time, environmental pressures will likely lead to gas increasing its share of the energy mix in Poland. All of these factors bode well for DUON. Corporate governance plays an important part in protecting shareholder value at the same time as ensuring safe and efficient operations. DUON has fully functioning Remuneration and Audit Committees. In 2012 the company conducted a comprehensive risk review to see that it was prepared to pre-empt or react to challenges known and unknown. This was a very useful exercise and all of this work will stand DUON in good stead as it grows in 2013 and beyond. It is a delight to work with the people at DUON. Their diligence and purposefulness fills the Supervisory Board with great confidence that your business is in good hands and on your behalf I say to all of them thank you. Lawrence Ross Chairman of the Supervisory Board March 2013

11 About the DUON Capital Group 11 Organisation of the Capital Group Grupa DUON S.A. DUON Dystrybucja S.A. 100% DUON Marketing and Trading S.A. 100% Source: own study PGS Sp. z o.o. 100% DUON Praszka Sp. z o.o. 65,94% DUON Dystrybucja S.A. is a distribution company conducting the distribution and trade business (sale) of natural gas and LPG based on its own infrastructure (gas networks, re-gasification stations). DUON Marketing and Trading S.A. is a trading company selling natural gas and electric energy on the basis of third party infrastructure. DUON Praszka Sp. z o.o. is a producer and distributor of natural gas-based heat in the city of Praszka. PGS Sp. z o.o. is a transport company with a fleet of specialist road tankers and containers for the transport of liquefied gas (LNG). annual report 2012

12 12 Supervisory Board Lawrence Ross President of the Supervisory Board Represents Galiver Limited a company connected with the investment fund Lime Rock Partners on the DUON Supervisory Board. At Lime Rock Partners he currently holds the position of Senior Advisor, and was previously the Managing Director. For 22 years he has worked for 3i a leading British private equity/venture capital company operating on the international market. Mr Ross is qualified in the field of accountancy and is a member of the Institute of Chartered Accountants in England and Wales. In addition to the position held at Grupa DUON, he is a member of the Board of Directors at EnerMech, ITS Energy Services and Twister. He previously sat at the Board of Directors at Acteon Group, Bridge Energy, Caledus, Global Energy Services, PSL Energy Services and Serimax Holdings. He graduated from St Edmund s College, Ware, Herts. Katarzyna Robiński Vice-President of the Supervisory Board Represents RIT Capital Partners on the DUON Supervisory Board. She graduated from Cambridge University and the Stanford Graduate School of Business (MBA). She began her career at Goldman Sachs, and then held managerial positions, e.g. at UPL, Credit Suisse and The Sutton Company. She is co-founder of Robiński & Associates, a company specialising in merger and acquisition consultancy, and of Proxin Ogrody, active in the real estate market. Since 2003 she has been a partner of Prospect Investment Management a private equity fund which, among others, invested capital in KRI in David Morrison Member of the Supervisory Board A graduate of Eton College and Oxford University, he began his career at Dresdner Bank AG and then managed capital investment at 3i plc, Abingworth Management Ltd and Botts & Company Ltd. In 1999, he set up Prospect Investment Management a company which, on behalf of a small group of investors, manages investment in enterprises with high growth potential at the early stages of development (e.g. Pay- Point plc, Venture Production plc, MessageLabs Group, Vibration Technology Ltd, UK Specialist Hospitals Ltd, Purepower Group Ltd). In 2007, Prospect Investment Management participated in the investment of funds in KRI. On the DUON Supervisory Board he represents RIT Capital Partners. Rafał Wilczyński Member of the Supervisory Board A graduate of Poznań University of Economics and of MBA studies at Georgia State University, Atlanta. Since 2000 he has been connected with the PBG Capital Group where he held managerial positions in the scope of finances and sat on the Supervisory Boards of its subsidiaries. Between he worked at KRI S.A. as the Head of the Economic Department and the Economic Director. Krzysztof Kaczmarczyk Member of the Supervisory Board He is an independent member of the DUON Supervisory Board. He holds the position of the Management Board s Vice-President for Strategy and Development at Emitel a leading terrestrial radio-television station operator. He previously worked at Credit Suisse in Poland, responsible there for the media and metal sectors in Central and Eastern Europe, and has held managerial positions at Grupa TP S.A. and DB Securities S.A. He is an economist by education a graduate of the Warsaw School of Economics and the University of Warsaw.

13 13 Management Board Mariusz Caliński President of the Management Board The President of Grupa DUON S.A. since April 2011, he is responsible for areas related to strategic management, development and communications. He has been involved in the gas market and Grupa DUON since 2008, when he took over the position of CEO and then President of the Management Board at KRI. Before that he was CEO and President of the Management Board at Sulzer Chemtech Polska, a company owned by Swiss concern Sulzer A.G. He is a graduate of Poznań University of Economics, Finance and Banking Faculty. Michał Swół Vice-President of the Management Board Vice-President of the Management Board of Grupa DUON S.A. since 2009, responsible for financial matters. His professional experience includes the position of Manager of Corporate Finances at KPMG ( ) and Assistant Director at the Financial Policy Office of Nafta Polska S.A. ( ), and he is connected with many mergers and acquisitions, evaluations, reorganisations and strategic consultations, primarily for companies from the oil, gas and chemical sectors. A graduate of Warsaw School of Economics, Finance and Banking Faculty, and a member of the Chartered Institute of Management Accountants (CIMA). In 2012, he was awarded in the 7th edition of the Financial Director of the Year competition organised by Forbes. Krzysztof Noga Member of the Management Board He is responsible for development of the trading sector and Group marketing at Grupa DUON. He has eighteen years of experience in the power industry, where he has held managerial positions, e.g. at PGNiG Energia S.A., Energa S.A., PGE S.A., PSE Electra S.A. and Elnord S.A. A graduate of the School of Engineering in Zielona Góra, Faculty of Electrical Engineering, and of MBA studies at the University of Gdańsk/ Erasmus Rotterdam. He is qualified to sit on Supervisory Boards of State Treasury companies, and is co-founder of the Association of Energy Trading. annual report 2012

14 14 History The history of Grupa DUON goes back to the year 2000, when KRI Sp. z o.o. in Wysogotowo near Poznań was set up through allocation of the organised part of the enterprise operated by Technologie Gazowe Piecobiogaz (legal predecessor of PBG S.A.) to KRI. Initially, KRI sold heat energy. In 2002 it began distribution and sale of natural gas, distributed both in the traditional way through pipelines and also in liquefied form (LNG). After transformation into a joint-stock company in 2007, KRI S.A. acquired financial investors in its shareholding entities represented by investment funds Lime Rock Partners and Prospect Investment Management. The same year, KRI S.A. purchased PGS Sp. z o.o., specialising in LNG transport. In 2010, the offer of KRI S.A. was extended by the sale of LPG, and KRI Marketing and Trading S.A. was established, whose main activity focuses on trade in natural gas and electric energy based on third party infrastructure. CP Energia S.A. (former name of Grupa DUON S.A.) was established in Warsaw in 2005 by Capital Partners S.A. and PL Energia S.A. CP Energia, similarly to KRI, developed operations related to the trade and distribution of natural gas based on investment in natural gas distribution infrastructure, i.e. distribution networks and LNG stations. At the end of 2006, CP Energia began to import LNG from Russia. In October 2007 it debuted on the Warsaw Stock Exchange was a ground-breaking year in the history of KRI and CP Energia. On 7 April 2011, the merger of the KRI and CP Energia Capital Groups took place. The transaction consisted of the Establishment of KRI Commencement of operations in the infrastructure segment Establishment of CP Energia issue of shares series J by CP Energia which were fully taken up at the time by the shareholders of KRI in exchange for a non-cash contribution in the form of 100% of shares of KRI. This was a reverse takeover, which means that from a legal point of view CP Energia was the acquiring company and treated as the Parent Company. However, due to the fact that the previous owner of KRI took up 66% of shares of CP Energia, and thus acquired the right to direct and influence the operational and financial policy of the company, from the economic-accounting perspective KRI was treated as the Parent Company, a fact which was reflected in the consolidated financial statements of CP Energia published after the conclusion of the merger with KRI. In May 2012, by decision of the General Meeting of CP Energia, the name of the Parent Company was changed to Grupa DUON S.A. Under the DUON brand the Group develops its operations in two basic areas: trading and distribution, offering gas and electric energy to its customers. CP Energia s debut on the Warsaw Stock Exchange Merger of the KRI and CP Energia Capital Groups Commencement of operations in the trading segment Change of the name of the Capital Group to DUON > > > > > > > >

15 Natural gas and electricity markets in Poland 15 Gas market We can distinguish the following segments of the natural gas market in Poland: Extraction of natural gas and LNG production Storage Transmission Distribution Trading The natural gas market in Poland is a quasi-monopolistic one, dominated in all the aforementioned segments, with the exception of transmission, by a single vendor, namely PGNiG. That entity acquires natural gas from its own mines and from import and sells it directly to end recipients. The national gas extraction covers approx. 30% of the recipients demand. The remaining demand is covered by import contracts including, in particular, the long-term contract concluded with Russian company Gazprom Export, guaranteeing gas supplied based on the take-or-pay clause. In 2011, import from the East covered approx. 63% of the national demand for natural gas. These deliveries were supplemented with deliveries constituting intra-community purchases from Germany and the Czech Republic covering approx. 7% of demand. According to data obtained in the course of the cyclical monitoring studies of the ERO, the total consumption of natural gas in Poland in 2011 amounted to 14.3 billion m 3. Deliveries of gas from abroad amounting to 10.9 billion m3 were supplemented with gas from domestic sources amounting to 4.3 billion m 3. Activity related to the wholesale trade in natural gas in Poland, understood as the sale of gas to entities that resell it further (including, e.g. sale to DUON Dystrybucja S.A.), has been dominated by PGNiG S.A. so far, operating only within the PGNiG Capital Group. In principle, gas trading enterprises not belonging to PGNiG CG have not dealt with wholesale trade thus far. In 2012, the trade in natural gas took place only under bilateral contracts, and gas sale via the exchange or hubs significant from the perspective of the opportunity of trade exchange, and gaining significance in the EU did not function in Poland. This situation is gradually changing. In December 2012, the Polish Power Exchange launched a gas market which, along with the increase in turnover, will enable the creation of a wholesale gas market in Poland. In January 2013, the new Instruction of Transmission System Operation and Maintenance (IRiESP) came into force an element that is essential for the operation of a commodity market and wholesale trade. The IRiESP introduced, among others: principles of functioning of the so-called virtual point, defined as a point of gaseous fuel delivery inside the transmission system of unspecified physical location where the trade in gaseous fuel takes place, the possibility of offering natural gas transmission services via auctions in the case of connections between the national transmission system and the transmission systems of other countries, changes to the method of contracting transmission services (single framework agreement), operation of a balancing services market, providing tools for balancing of the system. 1 The high concentration of the Polish gas market resulting from the leading position of PGNiG CG (ca. 98% of the market) has been influencing the structure of the retail market and the speed of changes taking place there for many years. Entities with the largest sales volumes in 2011 (having ca. 2% of the market in total), in addition to PGNiG CG were: EWE energia Sp. z o.o., HANDEN Sp. z o.o., G.EN. Gaz Energia S.A. and Egesa Grupa Energetyczna S.A., entities belonging to the DUON Group. These enterprises conduct trade business involving the resale of natural gas purchased from PGNiG S.A. to end recipients. The great majority of them sell gas via owned, local distribution networks. These enterprises mainly operate in areas not served by PGNiG S.A., i.e. with the use of owned distribution networks built by them, and fill the market gap combining distribution and trading activities. The model of natural gas distribution via pipelines is based on the occurrence of natural monopolies in locations at which distribution companies have their infrastructure; hence domination of one supplier on this market is insignificant. From this perspective, the distribution business is very stable. 1 Source: ERO 70% of Polands demand for natural gas is covered by import 14,3 bn. m 3 total consumption of natural gas in Poland in 2011 annual report 2012

16 16 30,5 m m 3 of LNG were sold in Poland in % of the LNG market share is owned by DUON Volume and structure of gas sales to end recipients in Poland in 2011 Volume in m m 3 No. of recipients TOTAL , End recipients Industry, including: 8 729, Nitrogen plants 2 374,61 20 Power plants; heat and power plants 1 133, Heating plants 271, Other recipients consuming up to 1 million m 3 /year 863, Other recipients consuming from 1 million to 25 million m 3 /year Other recipients consuming more than 25 million m 3 /year 1 946, , End recipients trade and services 1 390, Households 3 730, Other 530, Source: ERO President Activity Report 2011, March 2012 LNG Part of the natural gas market is the market where the object of trade is liquefied natural gas (LNG). As a result of cooling it to -163 C, natural gas transforms into its liquefied phase. The volume of such liquid is 600 times lower than in gaseous form. The liquefaction of natural gas is connected with its thorough purification, removing carbon dioxide, nitrogen, water, mercury, etc. After the LNG is restored to its gaseous phase, hardly any pollution is left in it and the gas is almost entirely devoid of moisture. Thanks to liquefaction and considerable volume reduction, LNG can be transported in tanks, even at long distances, by sea on tank ships or on land by road tankers, in a relatively cheap manner and without the need to build capital-consuming gas pipelines. Most experts share the opinion that LNG as liquefied gas poses no threat to the user because, in the event of a spill, it does not explode but rather evaporates and diffuses in the air or burns slowly. In Poland, the LNG market developed as an alternative to the traditional gas delivery method via pipeline networks. In places where construction of a pipeline is unprofitable or technically impossible, natural gas may be delivered to customers in the form of LNG by road tankers. In order to make it possible for the customers to receive gas, special stations are built and equipped with liquefied gas storage tanks and a set of vaporisers which transform the gas from liquefied form into gaseous form. After vaporisation, gas is delivered to customers directly through terminals or small distribution networks. Re-gasification stations may be dedicated to individual recipients or groups of recipients. In Poland there are communes supplied with gas based on LNG technology where natural gas, despite the lack of connection to the domestic gas system, is delivered to individual recipients. According to the data compiled by the ERO 2, 30.5 million m 3 of gas were sold in normal conditions on the LNG market in Poland in The DUON Group occupies a leading position on this market it has a share in sale volume of over 80% and an equally high share in LNG road transportation services. Due to the features and conditions of LNG distribution, i.e. in particular the possibility of transport to any place in the country and the quality- and combustion-efficiency-to-price ratio, the energy carrier is competitive towards the majority of other petroleum carriers whose distribution does not depend on transmission grids and whose features make it possible to consider them substitutes. They include: LPG (propane-butane gas), fuel oils (mazut, medium, light, Eksterm), coal (pulverised coal, eco-pea, coke), biomass. Network natural gas is not an LNG substitute, due to the basic difference between LNG and network natural gas, i.e. the method of delivery to the end recipient. 2 ERO President Activity Report ERO Newsletter 02/2012, 29 June 2012

17 17 Liberalisation of the gas market Liberalisation of the gas market is a process leading to a break with the traditional, monopolised model for the provision of gas supply services by vertically-integrated enterprises (combining extraction activity with distribution and trade), leading to a limitation of the state s active role in regulation of gas prices and replacing this with market prices. It is a set of actions whose aim is to bring about the development of a transparent wholesale natural gas market and vendor replacement mechanisms on the retail market. One of the important actions conducted within market liberalisation is implementation of the TPA principle; imposing on the energy enterprises dealing with gas transmission and distribution an obligation to make their own infrastructure available to sellers i.e. trading companies. Even though recipients officially obtained the right to replace the vendor (industrial recipients in 2004, households in 2007), in practice it was difficult to take advantage of that right. Barriers of access to the national gas market have included limited possibilities of the acquisition of transmission capacity and storage volumes as a prerequisite of the introduction of new entities to the national system, and the lack of possibilities of gas purchases on the wholesale market due to its non-existence. The lack of a wholesale market with associated infrastructure, i.e. a virtual market, a balancing market or a market of differentiated offers, reduced potential participants interest in entry to that market. Recipients had no possibility of diversifying gas deliveries and practically no influence on prices, regardless of the constancy and volume of power consumption. the release of natural gas prices for all recipients. The document recommends, among others, gradual elimination in the period from 1 July 2012 to 1 July 2014 of tariffs for institutional recipients and introduction of an exchange obligation in the following volumes: from 1 July 2013: 30% of annual domestic gas demand, from 1 January 2014: 50% of annual domestic gas demand, from 1 July 2014: 70% of annual domestic gas demand. The ERO, in the Road Map... also proposed legislative changes to improve the process of choosing a different vendor (the possibility of renegotiating complex agreements with PGNiG), the establishment of a market maker of a gas market, and pointed to the need for infrastructure development (including the development of interconnection in Lasów, construction of new interconnections between Poland and Lithuania, as well as between Poland and Slovakia, and construction of an LNG terminal). Changes on the Polish gas market are monitored by European Union bodies, since one of the goals for integration of Poland with other Union states is the guarantee of a harmonised energy market by In Europe, the majority of trading in the gas market constitutes trade completed through hubs and energy exchanges, and is thus contrary to the Polish market where the majority of trading is completed through bilateral contracts with the dominant entity. Hence further legislation and organisational changes on the Polish gas market are obligatory from the perspective of Union conditions. Electric energy market 90% of the electric energy produced on the Polish market is based on lignite and coal 157 TWh - electric energy consumption in Poland in 2012 For new vendors and recipients interested in vendor replacement, the barrier includes restrictions contained in contracts with the existing vendor, the lack of effective procedures regulating vendor replacement, and the existing tariff structure which requires the separation of the tariff for infrastructural services, fully regulated, and the price for gas as a commodity, which should be priced according to market terms. At the beginning of 2013, the ERO published a document entitled Road Map of gas price release, presenting a proposed programme of activities needed to achieve systemic changes in the domestic gas market, leading to the development of competition and, consequently, We can distinguish the following segments of the electrical energy market in Poland: Production Transmission Distribution Trading Most of the electric energy produced on the Polish market is based on lignite and coal (ca. 90%). Other production capacities are based on natural gas and renewable energy sources (solar, wind, water, etc.). The import of electric energy constitutes a marginal share of the entire 16,7m consumers - size of the electric energy retail market in Poland annual report 2012

18 k recipients changed their electric energy vendor by the end of 2012 domestic consumption. In 2012, electric energy consumption in Poland amounted to 157 TWh and was slightly lower than consumption in 2011 (a fall of 0.57%). The electric energy retail market consists of approx m consumers end recipients, among whom: approx. 89% are households (so-called G group) the volume of energy delivered to this group constitutes approx. 25% of the entire electric power supply, approx. 10% are small and medium-sized companies (so-called C group) energy volume for this group constitutes approx. 15% of the energy market XII 2009 Tariff group G VI 2010 XII 2010 The model of the electricity market in Poland is similar to the one used across the European Union. Creation of the Energy Law in April 1997 is considered as the symbolic beginning of the development of the market in Poland. The law sanctioned the road map for the liberalisation of the Polish energy market, which in the next ten years was to move from a natural monopoly to a fully competitive segment. As across the European Union, energy companies were first required to separate within their structure by 2004 functions related to the marketing and distribution of energy, so that customers would slowly become accustomed to the fact that they would soon be able to choose different representatives of one of these segments. During that period, only the largest off-takers (>10 GWh) were able to change vendors. This was supposed to alter after 1 July 2007, when all customers were to be able to change their vendors and energy groups were obliged to separate activities related to distribution and introduce unbundling. In theory, Poland has had a free energy market since 2007, which means that every customer can change energy supplier. At the same time, due to administrative decisions, there is still an obligation to approve tariffs of enterprises selling electric energy for households comprehensively (i.e. parallel sale of power and provision of distribution services), so full liberalisation applies only in relation to the institutional customer segment. By the end of 2012, over 141 thousand recipients changed their electric energy vendor, including 76 thousand households (tariff group G) and 65 thousand companies (tariff groups A, B and C). In the scale of the entire market, the percentage of recipients who took advantage of their right is still very small (approx. 0.85%). Number of customers who changed electric energy vendor in Poland VI 2011 Tariff groups A, B, C XII 2011 I 2012 II 2012 III 2012 IV 2012 V 2012 VI 2012 VII 2012 VIII 2012 IX 2012 X 2012 XI 2012 XII 2012 Source: own study based on monitoring.html

19 DUON Group on the gas and energy markets 19 Natural gas Players PGNIG Gaz-System PGNiG 6 subsidiaries of PGNiG DUON EWE Energia G.EN. Gaz Energia Facts Electric energy Players Facts Extraction Production Extraction covers approx. 30% of demand for natural gas, the rest is imported In the future it is possible that entities extracting shale gas will enter the market PGE Tauron ENEA EDF ZE PAK GDF SUEZ Other smaller production facilities Share of production from coal and lignite constitutes approx. 90% Other production facilities include gas power stations and stations based on renewable resources (water, wind, biomass, biogas) Transmission Storage Distribution Trading End customers Length of transmission grid: 10,000 km Gaz-System has implemented an investment programme in order to increase the length of the transmission grid by approx. 1,000 km by 2014 PSE 242 lines with a total length of 13,396 km Storage capacity of 1.8 bn m 3 Monopolistic position of PGNiG PGNiG continues its investment plan in order to increase capacity by another 1.7 bn m 3 by 2021 It is not possible to store electric energy Length of the distribution network: 170 thousand km, 450 km of which is owned by DUON DUON has a leading position in LNG distribution (according to the number of LNG re-gasification stations and its LNG road transportation) Distribution companies acting within vertically consolidated energy groups (ENEA, Energa, PGE, Tauron, RWE) Industrial energy enterprises Other local distributors Length of the distribution network (mv and lv together): 734 thousand km, of which thousand km are overhead lines and thousand km are cable lines PGNIG DUON EWE Energia G.EN.Gaz Energia Egesa Grupa Energetyczna In 2012 more than 200 recipients changed their vendor and began buying gas on a TPA basis In LNG trading DUON has a leading position (more than 80% share in sale volume) Trading companies acting within vertically consolidated energy groups (ENEA, Energa, PGE, Tauron, RWE) Industrial energy enterprises DUON and other trading subsidiaries In 2012 more than 100 thousand recipients changed their vendor and began buying energy on a TPA basis, this constitutes an increase of approx. 350% in comparison to the number of vendor changes in 2011 Total number of recipients on the gas market: 6.6 m, including 200 thousand enterprises DUON supplies 3,800 recipients, 3,200 of whom are households Total annual natural gas consumption: 14.3 bn m 3, including 30 m m 3 of LNG 70% of entire natural gas consumption is by enterprises In 2012 DUON delivered to recipients 68.1 m m 3 of gas in total, including 28.5 m m 3 of LNG 16.7 m recipients, including approx. 1.8 m enterprises DUON serves approx. 5,000 recipients Total consumption is 157 TWh, approx. 75% of which is by enterprises In 2012 DUON delivered 164 GWh of electric energy to end recipients annual report 2012

20 20 Activities of DUON Group DUON currently has 450 km of its own gas pipelines 3800 customers are connected to the gas pipelines owned by the DUON Group We are one of the leading independent Polish providers of natural gas and electric energy. Our recipients comprise industrial customers, small and medium-sized companies, as well as individual and municipal recipients. We operate in two complimentary segments: infrastructure, within which we sell natural gas, including LNG, delivered to recipients via our own infrastructure (gas networks and re-gasification stations), and trading, within which we sell electric energy and natural gas delivered to recipients through third party infrastructure (distribution and transmission system operators). Infrastructure segment The Group s activities in the infrastructure segment focus on the supply of network natural gas and LNG (Liquefied Natural Gas) through its own infrastructure, its own distribution networks and LNG re-gasification stations, to institutional customers and households. Currently the Group has, via DUON Dystrybucja, approx. 400 km of its own gas pipelines in 9 network locations connected to the national gas system and approx. 50 km of gas pipelines in locations based on LNG, connected to 19 re-gasification stations. Approx. 3,800 customers are connected to the gas pipelines owned by the DUON Group, including 600 institutional customers and 3,200 households. As part of the infrastructure segment, the Group also sells LPG, heat and LNG transportation services, as well as so-called emergency supply services (temporary natural gas supplies for failure periods or repair of gas systems). Transportation services and emergency supply services are provided by PGS Sp. z o.o., while sale of heat is conducted by DUON Praszka Sp. z o.o. (in Praszka) and within the activities of DUON Dystrybucja S.A. (in Chojna). Development of the infrastructure segment is realised by investing in infrastructure for gas sales in new locations and increasing the sales of gas in locations currently supported. Within the infrastructure segment, the development of construction projects for cogeneration systems and boiler houses fuelled by natural gas are also planned, since due to the environmentally-friendly EU regulations this is the preferred fuel for newly established systems of this type. Actions in this scope will depend on the development of the government support system for production of energy based on natural gas. Chojna LNG Map of the infrastructure segment locations Myślibórz Gozdnica Osiecznica Network gas Jarogniewice Czempiń Sława Góra Złotów Czyżew- Lewkowo Lubicz -Osada Nowy Dwór Mazowiecki Małkinia Hajnówka Trzemeszno Maków Mazowiecki Krośniewice Osieck Praszka Czarne Dolne Dobryszyce Kuźnia Raciborska Przysucha Wolica Gołdap Suwałki Grajewo Augustów Network gas Gas is supplied in the traditional way, i.e. using high-pressure gas pipelines and distribution networks wherever possible due to technological reasons and cost-effectiveness in terms of investment expenditure. DUON takes comprehensive care of gas delivery to recipients, i.e. by the construction of a distribution pipeline connected to a Polish transmission pipeline system, and construction of the terminal directly at the customer s location. Fuel gas is supplied direct- Source: own study

21 21 ly to the user; maintenance-free and without interruption. It does not require storage facilities at the consumer level. All of this makes the use of network natural gas extremely convenient. Currently, DUON uses two supply sources of network gas for the infrastructure segment. These stem from the Western European markets, realised due to capacity booking within the Group of the transmission interconnectors on the Polish-German and Polish-Czech borders, along with purchases from the main player on the gas market, PGNiG S.A. Liquefied natural gas obtained from the supplier is transported by DUON using its own tankers to re-gasification stations previously built by DUON. Re-gasification stations in most cases are dedicated to one or a handful of large industrial recipients. On the DUON infrastructure map there are also locations connected to the supply grid based on LNG, i.e. where an extensive Directions of LNG supplies LNG For locations where the construction of a transmission pipeline is unprofitable or impossible, e.g. due to environmental conditions, the DUON Group offers the supply of natural gas using LNG technology, which plays a very important role in the Group s strategy. DUON acquires LNG from various sources. The only LNG producer currently existing in Poland is the PGNiG Group, which owns two systems for the production of liquefied natural gas, in Odolanów and in Grodzisk Wielkopolski. A separate source of the DUON Group s LNG supplies is import. At present, a significant majority of the LNG imports are sourced from Russia, via a system in Kingisepp (near St. Petersburg). That system belongs to ZAO Kriogaz from the Gazprombank Group. LNG produced in that system is partly transported to Poland and partly distributed across Russian territory. Moreover DUON acquires LNG from the terminal located in Zeebrugge (Belgium). The launch of a new LNG plant constructed by Gas-Oil, a Gazprom Group subsidiary, is expected in 2013, and DUON intends to obtain LNG from it for customers in Poland. The new system is located in Kaliningrad, i.e. in an advantageous location from the perspective of the distance from north-eastern Poland. Additionally, the Gazprombank Group, via Kriogaz, plans further investment in gas liquefaction stations after 2014, and it will be possible to import the gas to Poland from these. Świnoujście (from 2014) LNG import terminal Zeebrugge LNG import terminal The start of supplies from Kaliningrad, from a LNG production installation constructed by ZAO Kriogaz for Gas-Oil, a subsidiary of Gazprom, is planned for 2013 Gazprombank plans to build the next LNG production installations in the Kaliningrad area in the coming years via ZAO Kriogaz, purchased from the DUON Group in 2011 Current LNG supplies from Russia, from the ZAO Kriogaz facility in Kingisepp (near St. Petersburg) The launch of a LNG terminal under construction since 2009 in Świnoujście is planned for Polskie LNG S.A. (belonging to OGP Gaz-System S.A.) is the investor in the project. At the first stage of the operation, the LNG terminal will make it possible to collect 5 billion m³ of natural gas annually. It will be possible to increase the transmission capabilities of the terminal up to 7.5 billion m3 per annum in the future. Current LNG supplies from the facilities in Odolanów and Grodzisk Wielkopolski owned by PGNiG current directions of LNG supplies new directions of LNG supplies Source: own study annual report 2012

22 22 gas distribution network has been built from re-gasification stations, via which gas also reaches individual recipients. The technology used by DUON makes it possible to deliver natural gas in its gaseous form to locations where topographical, environmental or economic problems make it impossible to connect them to the transmission system. These are the so-called white spots in the domestic gas system which will not be connected to the system in the near future. Liquefied gas in such cases becomes an economically-attractive energy source for production plants and individual clients. Map of the Polish gas transmission system The regulations and procedures in force extend the time required for the connection of the constructed gas pipeline to the national network of gas transmission pipelines. Therefore, LNG is used by DUON also as a temporary solution until the completion of all legal and constructional procedures related to the Issuer s connection to the Operator s (Operator Gazociągów Przesyłowych Gaz-System S.A.) network or to distribution networks managed by a local Distribution System Operator. This solution allows for rapid market coverage due to the earlier commencement of gas deliveries to customers, and a shortening of the investment process and investment return period. LNG is also used to cover the peak demands of network customers who require supplies of large amounts of gas in a short period of time and who exceed the booked capacity specified in contracts with a network operator. Gdańsk Włocławek Rembelszczyzna Tietierowka Trading segment As part of the trading segment, the Group sells natural gas and electric energy to end recipients on a TPA basis (Third Party Access), i.e. via the networks of operators of transmission and distribution systems. Gas and electric energy are purchased on wholesale markets in Poland and Europe (e.g. energy exchanges) and delivered to individuals and corporate customers via the third party infrastructure. The Group also offers joint supply of electric energy and natural gas under the so-called dual fuel formula. Source: OGP Gaz-System S.A. Lasów Lwówek Poznań Wrocław Świerklany Warszawa Tarnów Wysokoje Drozdowicze The progressive liberalisation of the electricity and natural gas markets creates opportunities for the Group in the trading segment. On the gas market there is a gradual development of the wholesale market and the launch of new cross-border powers (gas interconnectors) which allow the import of gas from Europe. In the longer term, the abolition of gas tariffs for institutional clients is expected. These factors open up opportunities for the DUON Group to win new customers by giving them an offer competitive to those of existing gas suppliers. The process of electricity market development is at a more advanced stage, therefore the Group managed to attract many customers who have benefited from the right of changing supplier. Within the trading segment, the DUON Group offers two main products: natural gas and electric energy on a TPA (Third Party Access) basis. The Group also conducts wholesale trade in these products.