Grupa LOTOS S.A. - Annual Report 2010

PLN '000	Dec 31 2010	Dec 31 2009 (restated)
Land	398,030	395,869
Buildings and structures	2,851,534	1,931,190
Plant and equipment	2,535,512	771,728
Vehicles and other	388,722	339,842
Total property. plant and equipment	6,173,798	3,438,629
Tangible assets under construction	4,197,422	6,086,780
Prepayments for tangible assets under construction	16,262	153,536
Total tangible assets under construction	4,213,684	6,240,316
Total	10,387,482	9,678,945

As at December 31st 2010, financing costs capitalised in tangible assets under construction and prepayments for tangible assets under construction amounted to PLN 155,474 thousand (as at December 31st 2009: PLN 191,703 thousand).

Changes to Property, Plant and Equipment and Prepayments for Tangible Assets under Construction

PLN '000	Land	Buildings and structures	Plant and equipment	Vehicles and other	Tangible assets under construction		- exploration and evaluation assets Prepayments for tangible assets under construction	Total
						- exploration and evaluation assets  (1)
Gross book value as at Jan 1 2009 (restated)	400,485	2,181,906	1,305,173	505,837	2,788,049	94,710	1,200,713	8,382,163
Increase	7,326	357,255	257,014	169,541	3,443,277	(3,511)	(1,047,177)	3,187,236
- purchase	-	34	1,887	51,332	2,642,403	22,543	258,581	2,954,237
- transfer from investments	5,653	258,896	202,916	106,828	(589,781)	(26,054)	-	(15,488)
- change in Group structure	1,605	79,887	48,797	184	105	-	-	130,578
- transfer	42	2,340	3,689	7,947	(6,463)	-	-	7,555
- reclassified to assets held for sale	-	-	(167)	(20,729)	-	-	-	(20,896)
- reclassified from assets held for sale	26	-	-	-	-	-	-	26
- exchange differences on translation of foreign operations	-	-	(157)	(3,354)	69,827	-	7	66,323
- settled prepayments	-	-	-	-	1,272,779	-	(1,272,779)	-
- borrowing costs	-	-	-	-	38,943	-	(32,986)	5,957
- assets related to decommissioning of the Offshore Oil and Gas Facilities	-	15,853	-	-	15,178	-	-	31,031
- other	-	245	49	27,333	286	-	-	27,913
Decrease	(1,118)	(19,396)	(14,051)	(13,512)	(70,965)	(20,360)	-	(119,042)
- sale	(675)	(5,140)	(6,859)	(8,556)	(48,575)	-	-	(69,805)
- liquidation	-	(1,717)	(4,680)	(4,198)	(303)	-	-	(10,898)
- change in Group structure	(443)	(12,539)	(2,512)	(595)	(710)	-	-	(16,799)
- other	-	-	-	(163)	(21,377)	(20,360)	-	(21,540)
Gross book value as at Dec 31 2009 (restated)	406,693	2,519,765	1,548,136	661,866	6,160,361	70,839	153,536	11,450,357
Gross book value as at Jan 1 2010	406,693	2,519,765	1,548,136	661,866	6,160,361	70,839	153,536	11,450,357
Increase	3,787	1,060,148	1,896,719	146,096	(1,822,732)	31,860	(137,194)	1,146,824
- purchase	-	-	6,094	31,422	929,016	31,860	57,075	1,023,607
- transfer from investments	4,246	1,061,710	1,901,476	111,402	(3,091,898)	-	-	(13,064)
- transfer	(16)	(1,481)	59	405	-	-	-	(1,033)
- reclassified to assets held for sale	(443)	(8,987)	(11,164)	(529)	-	-	-	(21,123)
- exchange differences on translation of foreign operations	-	-	116	2,943	23,603	-	-	26,662
- settled prepayments	-	-	-	-	194,269	-	(189,901)	4,368
- borrowing costs	-	-	-	-	116,210	-	(4,368)	111,842
- assets related to decommissioning of the Offshore Oil and Gas Facilities	-	8,906	-	-	6,066	-	-	14,972
- other	-	-	138	453	2	-	-	593
Decrease	(660)	(5,727)	(16,894)	(14,240)	(3,592)	(188)	(80)	(41,193)
- sale	(628)	(2,814)	(6,006)	(10,078)	(708)	-	-	(20,234)
- liquidation	(28)	(2,875)	(10,882)	(4,162)	(614)	-	-	(18,561)
- other	(4)	(38)	(6)	-	(2,270)	(188)	(80)	(2,398)
Gross book value as at Dec 31 2010	409,820	3,574,186	3,427,961	793,722	4,334,037	102,511	16,262	12,555,988
Accumulated depreciation as at Jan 1 2009 (restated)	8,743	471,674	683,198	262,210	-	-	-	1,425,825
Increase	1,572	114,456	97,882	69,485	-	-	-	283,395
- depreciation	1,546	112,879	94,489	63,864	-	-	-	272,778
- transfer	-	1,577	3,657	4,326	-	-	-	9,560
- reclassified to assets held for sale	-	-	(158)	(9,445)	-	-	-	(9,603)
- reclassified from assets held for sale	26	-	-	-	-	-	-	26
- exchange differences on translation of foreign operations	-	-	(108)	(2,200)	-	-	-	(2,308)
- other	-	-	2	12,940	-	-	-	12,942
Decrease	(6)	(4,440)	(9,652)	(10,083)	-	-	-	(24,181)
- sale	(4)	(2,516)	(5,090)	(6,492)	-	-	-	(14,102)
- liquidation	-	(705)	(4,131)	(3,448)	-	-	-	(8,284)
- change in Group structure	(2)	(1,219)	(429)	(97)	-	-	-	(1,747)
- other	-	-	(2)	(46)	-	-	-	(48)
Accumulated depreciation as at Dec 31 2009 (restated)	10,309	581,690	771,428	321,612	-	-	-	1,685,039
Accumulated depreciation as at Jan 1 2010	10,309	581,690	771,428	321,612	-	-	-	1,685,039
Increase	1,339	138,191	134,221	94,175	-	-	-	367,926
- depreciation	1,339	144,286	140,409	91,934	-	-	-	377,968
- transfer	-	(829)	87	1,189	-	-	-	447
- reclassified to assets held for sale	-	(5,266)	(6,385)	(526)	-	-	-	(12,177)
- exchange differences on translation of foreign operations	-	-	78	1,578	-	-	-	1,656
- other	-	-	32	-	-	-	-	32
Decrease	(266)	(1,246)	(13,563)	(10,809)	-	-	-	(25,884)
- sale	(6)	(327)	(3,212)	(8,237)	-	-	-	(11,782)
- liquidation	-	(908)	(10,349)	(2,572)	-	-	-	(13,829)
- other	(260)	(11)	(2)	-	-	-	-	(273)
Accumulated depreciation as at Dec 31 2010	11,382	718,635	892,086	404,978	-	-	-	2,027,081
Impairment losses as at Jan 1 2009 (restated)	425	4,986	5,404	8,163	40,589	15,444	-	59,567
Increase	101	14,454	2,282	7,798	33,655	10	-	58,290
Decrease	-	(1,557)	(710)	(15,492)	(663)	-	-	(18,422)
Change in Group structure	(11)	(10,998)	(1,996)	(57)	-	-	-	(13,062)
Impairment losses as at Dec 31 2009 (restated)	515	6,885	4,980	412	73,581	15,454	-	86,373
Impairment losses as at Jan 1 2010	515	6,885	4,980	412	73,581	15,454	-	86,373
Increase	-	3,254	299	142	63,047	47,692	-	66,742
Reclassified to assets held for sale	-	(1,687)	(4,414)	(3)	-	-	-	(6,104)
Decrease	(107)	(4,435)	(502)	(529)	(13)	-	-	(5,586)
Impairment losses as at Dec 31 2010	408	4,017	363	22	136,615	63,146	-	141,425
Net book value as at Jan 1 2009 (restated)	391,317	1,705,246	616,571	235,464	2,747,460	79,266	1,200,713	6,896,771
Net book value as at Dec 31 2009 (restated)	395,869	1,931,190	771,728	339,842	6,086,780	55,385	153,536	9,678,945
Net book value as at Dec 31 2010	398,030	2,851,534	2,535,512	388,722	4,197,422	39,365	16,262	10,387,482

  

As at December 31st 2009, the net value of the items of property, plant and equipment serving as collateral for the Group’s liabilities was PLN 5,970,414  thousand (as at December 31st 2009: PLN 2,133,547 thousand).

The cost of servicing the liabilities incurred to finance tangible assets under construction and prepayments for tangible assets under construction in the year ended December 31st 2010 amounted to PLN 111,842 thousand (December 31st 2009: PLN 117,840 thousand).

As at December 31st 2010, the net value of the oil and gas facilities decommissioning asset referred to in Note 36.1 amounted to PLN 112,929 thousand (December 31st 2009: PLN 106,600 thousand).

In the year ended December 31st 2010, the cost of depreciation of property, plant and equipment in respect of which technical feasibility and commercial viability of extracting a mineral resource have been demonstrated amounted to PLN 6,146 thousand (December 31st 2009: PLN 5,827 thousand).

Costs of direct purchases of materials and investment services related to exploration and evaluation assets amounted to PLN 15,098 thousand (2009: PLN 7,525 thousand), including direct cash flows from investing activities related to exploration and evaluation assets of PLN 14,965 thousand (2009: PLN 7,452 thousand). As at December 31st 2010, investment liabilities amounted to PLN 133 thousand (December 31st 2009: PLN 73 thousand).

In the year ended December 31st 2010, impairment losses on exploration and evaluation assets amounted to PLN 47,692 thousand (December 31st 2009: PLN 10 thousand). Furthermore, in 2010 the Group charged depreciation on exploration and evaluation assets in the amount of PLN 36 thousand.

In the year ended December 31st 2010, the Group recognised an impairment loss related to the IGCC project in the amount of PLN 14,230  thousand (December 31st 2009: PLN 33,588 thousand).

Prospects for Development of the B-4 and B-6 Gas Fields

The item “Tangible assets under construction” includes expenditure of PLN 48,113 thousand incurred by LOTOS Petrobaltic S.A. on gas exploration at the B-4 and B-6 fields (including exploration and evaluation assets of PLN 47,520 thousand), on which an impairment loss was recognised in 2010 (the impairment loss was charged to other operating expenses). According to the findings of the analyses which have been carried out, significant capital expenditure is required to obtain profitable commercial production of hydrocarbons. Given the results of the activities carried out to date with the aim of finding a partner for a joint development of the B-4 and B-6 gas fields, the Management Board of LOTOS Petrobaltic S.A. made a decision to intensify the process. In the medium term, LOTOS Petrobaltic S.A. does not plan to incur any material expenditure on development of the B-4 and B-6 gas fields, until there are any concrete arrangements regarding the terms of potential cooperation with a business partner as part of a joint venture.

Information on Interests in Norwegian Production and Exploration Licences

The item “Tangible assets under construction” includes expenditure of NOK 2,345,122 thousand (the equivalent of PLN 1,189,212 thousand, translated at the mid-exchange rate for NOK quoted by the National Bank of Poland for December 31st 2010) incurred by LOTOS Exploration and Production Norge AS on the purchase of interests in Norwegian production licences and on the YME field development, additionally adjusted by the tax effect connected with the YME field purchase transaction, of NOK 75,966 thousand (i.e. PLN 38,522 thousand, translated at the mid-exchange rate for NOK quoted by the National Bank of Poland for December 31st 2010).

The Group tested these assets for impairment based on a discounted cash flow analysis of LOTOS Exploration and Production Norge AS's interests in the hydrocarbon reserves held under the acquired production licences covering the YME field development project. As at December 31st 2010, the carrying value of these interests amounted to NOK 2,270 million, taking into account the tax effect connected with the YME field purchase transaction.

The YME field impairment test as at December 31st 2010 was carried out assuming a change in crude oil prices by +/-15%/bbl relative to Brent crude oil spot and forward prices as at January 3rd 2011, a +/-15% change on the USD/NOK forward rate as at January 3rd 2011, and a +/-15% change in the YME field reserves, analysing a weighted average cost of capital of 6.5% to 9% subject to a 78% marginal tax rate.

The Group determines the recoverable amount of the YME field based on the values in use, using the discounted cash flow method. Future cash flows were calculated by LOTOS Exploration and Production Norge AS based on 10-year production volume and cost forecasts prepared by Talisman Energy AS (the field operator).

As at December 31st 2010, the carrying amount of the assets related to the YME field was within the limits of the recoverable amount ranges, determined by assuming a +/-15%/bbl change in crude oil prices, a +/-15% change in the USD/NOK exchange rate and a +/-15% change in the field reserves, and analysing a weighted average cost of capital of 6.5% to 9% after tax. Therefore, the Management Board concluded that the tests did not demonstrate any necessity to recognise impairment losses.

Sensitivity to Changes in the Adopted Assumptions

Calculation of the YME field's recoverable amount is most sensitive to the following variables:

• Volatility in crude oil prices
• Volume of recoverable crude oil reserves in the YME field
• NOK/USD exchange rate fluctuations
• Discount

Due to high market volatility, in particular with respect to crude oil prices, the adopted assumptions might be subject to reasonable changes, as a result of which the YME field's carrying amount may exceed its recoverable amount. Therefore, it is uncertain whether the assets recognised in connection with the YME field will be realised, as the projected cash flows depend on a number of factors in the future, in particular crude price fluctuations.

Given the specific structure of the project, involving significant tax benefits and the related tax shield, and provided that the assumptions adopted at the end of 2010 remain unchanged, the major part of the projects' recoverable amount will be absorbed in 2011-2014. Therefore, when applying the units-of-production depreciation method (which consists in charging to expenses the depreciation attributable to a unit of produced crude oil) the carrying amount of the YME field related assets may be decreasing at a slower rate than their recoverable amount, which may entail the necessity to make charges to expenses to decrease the assets' carrying amount in excess of the recoverable amount.

As at December 31st 2010, LOTOS Exploration and Production Norge AS held exploration licences PL 316 and PL 316B (20% interest in the YME field) and the following exploration licence interests: 20% interest in licence PL 455, 10% interest in licence PL 497/497B, 25% interest in licence PL 498, 25% interest in licence PL 503, 20% interest in licence PL 515, and 50% interest in licence PL 556.

Furthermore, under “Intangible assets” LOTOS Exploration and Production Norge AS recognised expenditure of NOK 115,892 thousand as at December 31st 2010 (the equivalent of PLN 58,769 thousand, translated at the mid-exchange rate for NOK quoted by the National Bank of Poland for December 31st 2010) incurred on the exploration licences, and in particular the PL 455 licence. The balance sheet item “Intangible assets” is additionally adjusted by the tax effect of NOK 271 thousand (i.e. PLN 138 thousand, translated at the mid-exchange rate for NOK quoted by the National Bank of Poland for December 31st 2010). As at December 31st 2010, the net value of intangible assets related to exploration licences, net of impairment loss, amounts to NOK 60,246 thousand (the equivalent of PLN 30,551 thousand, translated at the mid-exchange rate for NOK quoted by the National Bank of Poland for December 31st 2010) (see Note 18).

Volume of the Crude Oil and Natural Gas Reserves Held by the LOTOS Group

The volume of crude oil and natural gas reserves held by the LOTOS Group is as follows:

	Dec 31 2010	Dec 31 2009
Crude oil (2P*)	6.2 million tonnes	6.4 million tonnes
Crude oil (2C**)	1.3 million tonnes	0.8 million tonnes
Natural gas (2P*)	0.5 billion cubic metres	4.5 billion cubic metres
Natural gas (2C**)	6.5 billion cubic metres	2.4 billion cubic metres

  

As at December 31st 2010, the Group reclassified gas reserves from 2P (proved and probable reserves) to 2C (contingent resources), until there are any concrete arrangements regarding the terms of potential cooperation with a business partner as part of a joint venture and development of the B-4 and B-6 fields advances, enabling commercial production.

The 10+ Programme (Comprehensive Technical Upgrade Programme)

An element of the growth strategy of the LOTOS Group is the implementation of the 10+ Programme, designed to increase the throughput capacity of the Gdańsk Refinery by approximately 75%, that is to 10.5m tonnes of crude oil p.a., at a higher conversion ratio.

As at December 31st 2010, the 10+ Programme reached a 100% completion status, meaning it was completed as scheduled. All the work connected with the engineering design, procurement and construction has been completed for all the basic and auxiliary installations.

In 2010, the following basic units reached the Ready For Start Up status:

• mild hydrocracker (MHC),
• residue oil supercritical extraction (ROSE).

On December 31st 2010, the Final Acceptance Commission signed the Ready for Start Up Certificate for the ROSE unit, the last of the installations constructed as part of the 10+ Programme to have been officially handed over for start up to the target user (the Crude Oil Distillation Complex).

Also the following auxiliary infrastructure entered the Ready For Start Up phase in 2010:

• nitrogen production unit,
• hydrogen recovery unit (HRU),
• inter-facility pipeline connection systems (phase III),
• pumping stations,
• buildings of the S31 electrical substation,
• roads and yards commissioned gradually together with the installations.

The majority of the 10+ Programme units and facilities have been placed in operation in 2010, including:

• amine sulphur recovery unit (ASR),
• hydrogen generation unit (HGU),
• hydrodesulphurisation unit (HDS),
• refinery-harbour product pipeline,
• hydrogen recovery unit (HRU),
• crude distillation unit (CDU/VDU),
• product tanks,
• pumping stations.

Work on the 10+ Programme units which has been scheduled for 2011 includes mainly work related to start up of the MHC and the ROSE units, as well as additional work related to operational recommendations for the CDU/VDU unit and extension of the utilities and off-sites.

At present, Grupa LOTOS S.A. is making preparations to launch in 2012-2015 the second phase of the 10+ Programme, which will focus on the management of heavy residue. As at December 31st 2010, capitalised expenditure on the IGCC project, including a reduction of production lines capacity and a different method of processing of gases, was PLN 6,239 thousand (as at December 31st 2009: PLN 20,468 thousand).