The Group is exposed to financial risks, including:

• market risk (risk related to prices of raw materials and petroleum products, risk related to prices of CO₂ allowances, currency risk, interest rate risk),
• liquidity risk,
• credit risk related to financial and trade transactions.

The Price Risk and Trading Committee operates at the Parent, which is responsible for:

• oversight and coordination of the price risk management process,
• monitoring and coordination of trading activities requiring cross-segment interaction.

The powers in the area of currency risk, interest rate risk and credit risk management have been vested directly in the Chief Financial Officer. In addition, a team for liquidity optimisation and coordination of financing coordinates and supervises key efforts in the area of liquidity risk management, arrangement of financing, and debt management at the LOTOS Group.

To ensure efficiency and operational security of financial risk management, Grupa LOTOS S.A. has distinguished the following areas: financial transactions (front-office), risk analysis and control (middle-office) and documentation and settlement (back-office).

Financial risk management seeks to achieve the following key objectives:

• increase the probability that budget and strategic objectives will be met,
• limit volatility of cash flows,
• ensure short-term financial liquidity,
• maximise the result on market risk management within the assumed risk level limits.

In order to achieve those objectives, relevant documents have been prepared and approved at appropriate decision-making levels at Grupa LOTOS S.A. Those documents specify the necessary framework for effective and secure functioning of the financial risk management process, including principally:

• the methodology for quantifying exposures to particular risks,
• acceptable financial instruments,
• the method of assessing financial risk management,
• limits within risk management,
• the reporting method,
• credit limits.

The Parent monitors all managed market risks on an ongoing basis. Opening positions with respect to risks which do not arise as part of the Company’s core business is prohibited. Grupa LOTOS S.A. uses liquid derivatives which it is able to measure by applying commonly used valuation models. The valuation of the underlying position and derivatives is performed based on market inputs provided by reliable sources.

On January 1st 2011, the Parent commenced hedge accounting with respect to cash flows (i.e. foreign-currency facilities used to finance the 10+ Programme, designated as hedges of future USD-denominated petroleum product sale transactions). In H2 2012, the Group extended the scope of application of cash flow hedge accounting through the establishment of new hedging relationships with respect to foreign-currency denominated credit facilities intended for financing of the 10+ Programme, designated as hedges of future USD-denominated petroleum product sales transactions.

33.1 Risk related to prices of raw materials and petroleum products

The Parent considers risk related to prices of raw materials and petroleum products, as well as currency risk, to be particularly important.

Currently, the Parent is continuing research into and work on a new policy for managing the risk, which ties in closely with our plans to develop trading operations. Concurrently, to enable implementation of specific price risk management processes, streamline management functions and improve security of operations in the broad price risk and trading area, the Company has started to roll-out the selected Energy Trading and Risk Management system.

In 2012, the Company entered into commodity swaps in connection with sales of bitumen components at fixed prices, to ensure that the initial risk profile remains unchanged. Part of the swaps were settled in 2012, and part of them will be settled in 2013. As at December 31st 2011, the Group carried no open positions on commodity contracts.

Open commodity swaps as at December 31st 2012:

33.2 Risk related to prices of carbon (CO₂) allowances

The risk related to prices of carbon dioxide (CO₂) allowances is managed in line with the assumptions set forth in The Strategy for Managing the Risk Related to Prices of Carbon Dioxide (CO₂) Allowances by Grupa LOTOS S.A.

The Company determines its underlying CO₂ allowances position, which represents the difference between the number of CO₂ allowances (held or estimated) and CO₂ emissions (released or estimated) for each individual trading period (phase), for which emission allowances are granted.

As part of risk management procedures, the Company sets a volume limit for the total position in  CO₂ allowances (the underlying position adjusted for the position resulting from executed contracts, i.e transactions involving purchase/sale of emission allowances) based on the number of allowances granted for a given phase. The Company monitors the total position for a given phase, representing the aggregate of total positions for individual years within the phase.

Depending on the market situation and the set limits, the Company monitors the risk and maintains an appropriate total position in carbon allowances by entering into financial transactions on an on-going basis. The limit reflecting the risk of loss for the transactions (maximum loss limit) is defined by reference to the Company’s equity.

Underlying CO2 allowances position as at December 31st 2012 (in tonnes):

In 2012, the management of Phase II, which was nearing its end, continued; and management of Phase III for years 2013-2020 commenced. Phase II covers the period to the end of 2012, and is to be settled by the end of April 2013. Therefore, the two-phase division was retained in the tables containing information on the underlying position and financial instruments.

Given the lack of liquidity of the futures market in the period until 2020, the end of the risk management period for the risk related to the prices of CO₂ emission allowances in phase III was set at the end of 2014. However, with the passage of time, the risk management period will be extended to include successive years.

Underlying CO₂ allowances position as at December 31st 2011:

In 2012, the Company entered into EUA/CER swaps, as that was justified by the spread between those two types of emission allowances.

Open CO₂ allowances contracts as at December 31st 2012:

Open CO₂ allowances contracts as at December 31st 2011:

Total CO₂ allowances position as at December 31st 2012 (in tonnes):

As at December 31st 2012, Grupa LOTOS S.A. held open CER Futures contracts which were not included in the table listing open contracts but were disclosed in the table containing information on the total position. The CER Futures provide for the purchase of 620,000 CO₂ emission allowances and are to be settled in March 2013. Since Grupa LOTOS S.A. intends to settle the contracts by physical delivery,  the contracts were not measured and a provision was recognised for costs related to the purchase.

Total CO₂ allowances position as at December 31st 2011 (in tonnes):

For information on average annual CO₂ emission allowances granted for each of the years, see Note 35.

33.2.1 Sensitivity analysis with respect to market risk related to fluctuations in prices of carbon dioxide (CO₂) emission allowances

As at December 31st 2012 and December 31st 2011 the Parent held futures for the purchase of carbon dioxide (CO2) emission allowances (EUA – Emissions Unit Allowance), measured at fair value.

Below is presented an analysis of the sensitivity to risk related to fluctuations in prices of carbon dioxide (CO₂) emission allowances as at December 31st 2012 and December 31st 2011, assuming a 10% increase or decrease in the interest rate.

33.3 Currency risk

Currency risk is managed in line with the assumptions stipulated in The Strategy of Currency Risk Management at Grupa LOTOS S.A. The exposure management horizon is connected with the introduction of a budget rolled over to next four quarters as a permanent component of the planning activities at the Company. The four-quarter period is treated as the basis for determining the exposure management horizon. The base map of currency positions takes into account principally the volumes and price formulae for purchases of raw materials and sales of products, investments, credit facilities denominated in foreign currencies, as well as valuation of derivatives, and may be adjusted for a ratio reflecting the volatility in the prices of raw materials and petroleum products. The strategy provides for the calculation of the following limits:

• position limit (open currency contracts must not increase the Company’s underlying position and must not exceed the volume of the underlying position);
• maximum loss and liquidity limits are expressed as a percentage of the Company’s equity (the liquidity limit is calculated in order to reduce the risk of excessive accumulation of financial transactions over a limited period of time, the settlement of which could result in liquidity and operating problems);
• gross total and global currency position limits for the entire management period as well as for sub-periods.

For the purpose of the limits calculation, equity is remeasured on a quarterly basis. Moreover, when loss on risk management exceeds a pre-defined threshold, limits are immediately revised in order to prevent any significant exceeding of the maximum loss limit set by the Management Board of Grupa LOTOS S.A.
The strategy allows for the possibility of consolidated risk management at the Group level.

USD is used in market price quotations for crude oil and petroleum products. For this reason it was decided that USD is the most appropriate currency for contracting and repaying long-term credit facilities to finance the 10+ Programme, as this would reduce the structurally long position, and consequently also the strategic currency risk.

The underlying currency position represents all material cash flows (identified during currency risk identification process) whose value, expressed in Grupa LOTOS S.A.'s functional currency, over the risk management period depends on exchange rates, adjusted for a ratio reflecting the decreasing probability of generating such cash flows. To determine the underlying currency position, the Company takes into account deposits and borrowings, but excludes currency transactions.

Underlying currency position as at December 31st 2012:

Underlying currency position as at December 31st 2011:

Grupa LOTOS S.A. actively manages its currency position and changes it depending on the expected market developments.

Open currency contracts as at December 31st 2012:

Open currency contracts as at December 31st 2011:

The LOTOS Group companies executed transactions to hedge their currency risk and transactions to hedge the USD exchange rate in connection with the purchase of notes from a LOTOS Group company.

A currency swap comprises two transactions which in this document are assigned to purchase or sale, as applicable, under "currency swap".

Total currency position of the Parent for each currency as at December 31st 2012:

Total currency position of the Parent for each currency as at December 31st 2011:

33.3.1 Sensitivity analysis with respect to market risk related to fluctuations in currency exchange rates

Below is presented an analysis of the Group’s sensitivity to currency risk as at December 31st 2012 and December 31st 2011, along with the effect on the net profit or loss, assuming a 4% increase or decrease in the USD/PLN and EUR/PLN exchange rates and all other variables remaining unchanged.

33.4 Interest rate risk

The base map of interest rate positions is related to the cash flows which depend on future interest rates; in particular it is based on the planned schedule of repayments under the credit facilities for financing of inventories and implementation of the 10+ Programme and the associated interest calculated on the basis of a floating LIBOR USD rate. The structure of limits is based on the underlying’s nominal value hedge ratio. In a long-term perspective, a partial risk mitigation effect was achieved through the choice of a fixed interest rate for the SACE sub-tranche under the term facility granted to finance the 10+ Programme; see Note 28.

The obligation to maintain a specific level of the hedge ratio for the interest rate risk connected with the LIBOR USD floating interest rate on the facility contracted to finance the 10+ Programme expired on June 30th 2011, in accordance with the agreement on the financing of the 10+ Programme.

Underlying interest rate position means all material positions (identified in the interest rate risk identification process) whose value depends on the level of interest rates.

Underlying interest rate position as at December 31st 2012 and December 31st 2011 (USD '000):

As at December 31st 2012, the Company had open hedging transactions.

Open interest rate contracts as at December 31st 2012:

Open interest rate contracts as at December 31st 2011:

Total interest rate position as at December 31st 2012:

Total interest rate position as at December 31st 2011:

33.4.1 Sensitivity analysis with respect to market risk related to fluctuations in interest rates

Below is presented an analysis of the Group’s sensitivity to interest rate risk as at December 31st 2012 and December 31st 2011, assuming a 0.2% increase or decrease in the interest rate.

33.5 Liquidity risk

The liquidity risk management process at Grupa LOTOS S.A. consists in monitoring projected cash flows and the portfolio of financial assets and liabilities, matching maturities of assets and liabilities, analysing working capital, optimising flows within the Group and close cooperation with specific business areas in order to ensure safe and effective allocation of the liquidity.

In 2012, the Group implemented real cash-pooling services for most of its Polish subsidiaries. The structure is managed by Grupa LOTOS S.A. on an ongoing basis in terms of liquidity optimisation and interest balance.

In the period covered by the budget, liquidity is monitored on an ongoing basis across the Group as part of the financial risk management. In the mid- and long term, it is monitored as part of the planning process, which helps to develop a long-term financial strategy.

In the area of financial risk, in addition to active management of market risk, the Company applies the following liquidity management rules:

• no margins in derivatives trading on the OTC market,
• limited possibility of early termination of financial transactions,
• limits for low-liquidity spot financial instruments,
• credit limits for counterparties in financial and trade transactions,
• ensuring adequate quality and diversification of available financing sources,
• internal control processes and organisational efficiency facilitating prompt contingency response.

Contractual maturities of financial liabilities as at December 31st 2012 and December 31st 2011:

Maturity structure of derivative financial instruments as at December 31st 2012 and December 31st 2011:

33.6 Credit risk

Management of credit risk related to counterparties in financial transactions consists in the verification of creditworthiness of the current and potential counterparties and monitoring of credit exposure against the granted limits. The counterparties must have an appropriate credit rating assigned by leading rating agencies, or hold guarantees from institutions meeting the minimum rating requirement. The Group enters into financial transactions with reputable firms with sound credit standing, and diversifies the group of institutions with which it cooperates.

As at December 31st 2012, the concentration of credit risk with respect to any single counterparty in financial transactions did not exceed PLN 26,073 thousand (0.13% of the Group's balance-sheet total). As at December 31st 2011, the concentration of credit risk with respect to any single counterparty in financial transactions did not exceed PLN 3,063 thousand (0,015% of the Group's balance-sheet total).

As regards management of counterparty risk in non-financial transactions, all customers who request trading on credit terms are subject to credit assessment, whose results determine the level of possible credit limits. The Parent defines guidelines for the management of counterparty risk in non-financial transactions with a view to maintaining appropriate credit analysis standards and operating safety across the Group.

Credit risk is measured by the maximum exposure to risk of individual classes of financial assets. Carrying amounts of financial assets represent the maximum credit risk exposure.

Maximum exposure to credit risk arising from financial assets as at the last day of the reporting period:

In the Management Board’s opinion, the risk related to non-performing financial assets is reflected in the recognised impairment losses. For more information on impairment losses on financial assets, see Notes 9.2 ; 9.6  and 18.1 .

For discussion of concentration of credit risk related to trade receivables as at December 31st 2012 and December 31st 2011, see Note 18.

For age analysis of receivables which are past due but not impaired, as at December 31st 2012 and December 31st 2011, see Note 18.1.