Activity of the LOTOS Group

Commerce organization in the LOTOS Group

The trading activity of the LOTOS Group is conducted both in the parent company and in the subsidiaries. The functional division is as follows:

• Trading services of Grupa LOTOS organise the sales of fuels to key accounts and export and intra-community supplies of oil products, and they buy raw materials, components and goods for resale.
• LOTOS Paliwa runs the retail and wholesale of fuel all over Poland.
• The core business of LOTOS Gaz is LPG trading.
• LOTOS Oil is involved in the production and distribution of lubricating products: finished oils, automotive and industrial lubricants and base oils .
• The operation of LOTOS Asfalt includes both production and trading; the Company’s business covers road and industrial bitumen, as well as bitumen emulsions and glues and heavy fuel oil.
• LOTOS Parafiny produces and sells premium quality paraffin and a wide range of paraffin masses; the Company’s products also include paraffin accessories for the retail market.

Oil procurement

In 2007-2008, Grupa LOTOS aimed at increasing the share of oil transported by sea in the total structure of procurement of this raw material.

In the total volume of oil processed in Gdańsk, the largest share is held by the REBCO blend oil from Russia (89%). As regards the oil delivered by sea, 75% of the total volume is Volve, while the Polish oil is only the Rozewie blend produced by Petrobaltic.

Intra-community imports and procurement

In 2008, a major challenge for the trading services of Grupa LOTOS was the import of oil products. The dynamically growing demand for diesel oil on the domestic market resulted in a record import of medium distillates, mostly diesel oil and components for the production of light fuel oil. Apart from the imports from Scandinavia that started in previous years, in 2008 for the first time, products were imported from Germany on such a large scale by land transport. It provided the further optimization of logistic costs, the growth of Grupa LOTOS on the domestic market and the preparation for increased sales of diesel oil from own production after completing the 10+ Programme.

Sales of oil products

In 2008, the LOTOS Group sold more than 7.5m tonnes of oil products, i.e. recorded a 6% growth compared to 2007.

More than 70% of the sales volume (5.4m tonnes) was liquid fuels: gasoline, diesel oil, light fuel oil, LPG and aviation fuel. A particular sales growth was recorded in diesel oils (by 18%) and aviation fuel (by 11%). It was also the consecutive year of falling sales in light fuel oil and gasoline, which reflected the trends observed on the domestic market.

Diesel oil is the basic product offered by the LOTOS Group, comprising more than 1/3 of total sales. The share of diesel oil in total sales increases annually.

The developing area of the LOTOS Group’s operation is sales of aviation fuel, with the share in total sales significantly growing due to the development of air transport and the short supply of this fuel on the European market.

On the other hand, there is a visible fall in sales of gasoline, as its share fell from 22% in 2006 to 18% in 2008. This is a symptom of the continued popularity of cars with diesel engines.

The share of light fuel oil has also decreased in the sales of Grupa LOTOS, reflecting the global trends that result from interest in other energy sources.

In 2008, the LOTOS Group sold 74% of its total sales on the domestic market. Diesel oil accounted for more than 50% of this figure, with the share increased by 5% compared to 2007. The share of gasoline, as well as light and heavy fuel oils, fell. The share of lubricating oils and aviation fuel was maintained at the same level for two years.

More than 26% of the global production volume in 2008 was exported. As in 2007, a significant share of exported sales involved heavy fuel oil and aviation fuel (in 2008, the total share of these two products exceeded 45%). A high share of sales was maintained also in asphalts, bunkering fuel and gasoline (the total share of these products in 2008 amounted to almost 35%). As regards gasoline, like on the domestic market, there was a drop in sales by 2%.

Fuel sales

On the domestic market, the primary customer groups include:

• retail customers (via the fuel station chain),
• international oil concerns,
• institutional clients,
• agents on the fuel market, and
• station operators.

2008 was another consecutive year of strengthening the market position of the LOTOS station chain and its optimization, aimed at providing improved customer service and the higher values of sales.

In the premium station segment, there were 139 stations as at the end of December. The LOTOS Family Trading Partnership network encompassed 79 stations at the end of 2008. The number of LOTOS patronage stations (DODO) decreased as planned, as a result of the Concern’s policy concerning LOTOS fuel stations. The DODO stations that fulfil the required conditions and quality criteria can join the partnership (DOFO) system.

The number and structure of the LOTOS station chain

	2006	2007	2008
CODO stations	132	133	139
DOFO stations	57	71	79
DODO stations	209	175	137
TOTAL	398	379	355

The whole chain of LOTOS stations has recorded a significant and continued growth in fuel sales. In 2008, the generated sales were higher by 13% than in 2007. The increase in the daily average sales at LOTOS-owned (CODO) stations amounted to 15% (December to December). According to the market trends, diesel oil accounted for most of the growth, of which sales in 2008 were more than 25% higher than in 2007.

Apart from the standard fuel products, LOTOS stations offer LOTOS Dynamic fuels that are characterised by top quality parameters. LOTOS Dynamic fuels feature a unique production formula. They contain special additions that reduce friction in the engine, have a positive impact on the engine dynamic, reaction time and the use of its power. They protect engines against the formation of sedimentation on valves and in the injection system. Moreover, they protect tanks and fuel systems against corrosion. The LOTOS Dynamic diesel oil guarantees the maintenance of high technical quality parameters even at -33°C. The LOTOS Dynamic fuels are appreciated by experts and users, which has been confirmed by many awards and distinctions.

Promotional campaigns definitely increased the sales of fuels. In 2008, apart from the image promotion, advertising campaigns for LOTOS Dynamic and the Navigator programme were conducted.

The promotion of the Dynamic fuels in 2008 included the participation of the brand in the KIA LOTOS Cup races.

The loyalty Navigator programme at LOTOS stations encourages customers to purchase premium products at attractive prices. In the first edition of the programme, almost one million magnetic Navigator cards were distributed. Regular promotions of goods are conducted at LOTOS stations, supported with additional points in the Navigator programme. It is expected that these programmes will increase the dynamic of non-fuel goods sales to about 10% (year to year).

A supplement to the offer of the petrol stations is the service of fleet cards for corporate customers, including the special fleet card of the LOTOS Business programme and cards of other card operators (DKV, UTA, WOG, ESSO and MAGISTRAL). In 2008, the sales to corporate customers featured:

• exceeding sales projections by 30%,
• launching commercial operations in Lithuania, Latvia and Estonia, and
• developing cooperation with domestic transport associations.

Together with the segmentation of the retail market, the importance of the non-fuel offer is increasing. It constitutes an important element of the offer and has a major impact on the perception of the station chain. The year 2008 witnessed significant changes in this regard at the stations:

• modern coffee corners were installed,
• the mini-catering facilities were upgraded,
• the Dynamic power drink was launched, and
• car cosmetic products were introduced as bonuses in the Navigator loyalty programme.

An important event in 2008 for the development of the LOTOS station network was winning the tender for the construction and operation of Service Areas for six out of fourteen complexes located on motorways (two stations on the A2 and four on the A4). Apart from the fuel stations with the necessary infrastructure (utilities, car parks and landscaping), there will be six McDonald’s restaurants and two hotels erected at the Service Areas.

The comprehensive offer for institutional customers includes: a large selection of products (diesel oil, gasoline, light fuel oil and AdBlue), as well as the investment-trading cooperation concept (LOTOS Diesel Service). The sales take place in three market segments:

1. Key accounts
• companies in the road construction business,
• entities involved in industrial building, and
• other firms operating on the whole domestic market.
2. Tender customers purchasing fuel in public procurement procedures
• municipal communication plants,
• inter-city communication enterprises, and
• other industrial businesses supplied under tender procedures.
3. Other end customers
• buyers of diesel oil and other engine oils used in the operation of own fleets (transport, industry and agriculture), and
• buyers of light fuel oil used for heating or production (industry, services and farms).

The LOTOS Group also sells fuels to B2B customers who are not end consumers. The receivers are independent fuel stations and agents. The customer portfolio in this segment is diversified in terms of certainty and volumes so as to achieve the most beneficial margins. In this distribution channel, Grupa LOTOS has several dozen strategic customers and a great many independent stations and wholesale intermediaries operating all over Poland.

National Index Target implementation

2008 was the first year of fulfilling the obligation related to the National Index Target , resulting from the Act of 25 August 2006 on biocomponents and liquid fuels. It obliges fuel producers to add biocomponents to fuels sold or used for own needs. The Cabinet of the Republic of Poland determined the value of the index at 3.45% of the minimum biocomponent content in liquid fuels, expressed in energy values as specified in separate regulations.

Grupa LOTOS achieves the National Index Target by maximising the sales of fuels with biocomponents, maintaining a 5% threshold of acceptable ethanol or ethyl ether content in gasoline or fatty acids methyl esters in diesel oil.

Biocomponents are purchased from domestic producers or on the inter-community market. An important event was the launch of the FAME production system in May 2008. The system was constructed in Czechowice-Dziedzice with the infrastructure and potential of the LOTOS Group companies operating there. The system, which features solutions that guarantee the quality of production, the use of basic raw materials, power supplies, profitability and the application of state-of-the-art production technologies, may produce 100 thousand tonnes of esters per year.

LPG

LPG trading in the LOTOS Group focuses on supplies to LOTOS-owned stations, because LPG fuel is a substitute for gasoline and the interest in LPG is falling with the increasing demand for diesel oil and the falling average age of used personal cars.

In 2008, LPG came from the refinery in Gdańsk, imports, inter-community supplies and from domestic suppliers. An additional factor that had a major impact on liquid petroleum gas trading was the unstable price situation as well as temporal limitations in the product’s availability from Eastern markets.

Aviation fuel

The sales of aviation fuels on the domestic market have growing importance for the operation of the LOTOS Group. Owing to the modern MEROX system, the refinery in Gdańsk may produce major amounts of aviation fuel. The systems and equipment created in the 10+ Programme will increase the aviation fuel throughput to approximately one million tonnes per year, which will provide better profits (owing to the higher refining margin) and the strengthened market position in Europe and on the domestic market.

The share of aviation fuel in the sales volume of the LOTOS Group in 2008 amounted to 6.5%, including 17% sold in Poland. The supplies were provided to entities with own loading terminals, to intermediaries and directly to end customers.

According to a decision of the European Commission, at least two fuel suppliers have to operate at all airports that serve more than 2 million passengers per year. For Polish airports, where there is usually one fuel operator, this regulation necessitates the introduction of a competitive fuel operator. The entrance of Grupa LOTOS on the airport market will increase the volume of aviation fuel sold and provide better control of the margin in the whole chain of supplies. In mid 2008, a decision was taken to construct a fuel depot at the airport in Gdańsk-Rębiechowo as part of the ‘Gdańsk Airport’ project.

The LOTOS Group intends to participate actively in the European aviation fuel market by searching for new suppliers. The aim of trading services is to increase the market share systematically with a simultaneous maximization of margins. The LOTOS Group intends to establish its position on the confidence and support of customers gained in Poland.

In 2008, almost 90% of the JET A1 aviation fuel volume exported by Grupa LOTOS was sold in Sweden, Finland and Denmark.

Lubricating oils

The flagship product of the LOTOS Group in lubricating oils is the LOTOS engine oil family.

According to the survey of Moto Scan conducted by Qualifact in 2008, the strongest market position was held by the LOTOS Semi-synthetic and LOTOS Mineral oils, while the LOTOS oil brand enjoyed the greatest loyalty among customers out of all brands.

The LOTOS Group produces oils for industry, in particular for the power industry, the steel works, mining and machinery industries. It offers hydraulic and transmission oils and produces small volumes of specialist lubricants.

Apart from industrial oils based on classic basic mineral oils, the LOTOS Group’s offer includes new products based on modified ingredients, i.e. synthetic oils.

Quality and technology

In 2008, LOTOS Oil signed a trading contract with Lubrizol, thus obtaining access to state-of-the-art lubricating additions. The contract does not only provide for preferential trading conditions, but also for marketing cooperation and rendering production services and training for employees.

Lubrizol is a leader on the market of additions for lubricating products. It produces additions for oils and lubricants for the motor sector, industry and processing liquids. It is one of the most important long-term suppliers of the LOTOS Group that is actively involved in the development of oil products.

The year of services

The oil service of LOTOS Oil is an important element of building a competitive advantage and a strong market position in the segment of lubricating products.

Specialists of LOTOS Oil provide continuous monitoring of oils and machines. It is possible to streamline machinery operation with the collected data. The main aim of such controls is the early detection and removal of any potential causes of costly failures. Experts of the Oil Service provide services to international companies operating in Poland.

Cooperation with KIA

The presence of the LOTOS brand on the Authorised Service Stations of KIA Motors Polska confirms its prestige and strengthens the image of high margin oil products of LOTOS.

A supplement to the cooperation with KIA was the participation of the LOTOS brand as the titular sponsor in the KIA LOTOS CUP motor racing cycle in 2007. The Cup is an international event with eliminations held in Poland, the Czech Republic, Hungary and Slovakia.

Growing role of exports

LOTOS Oil is one of the most important producers of engine oils sold in Central Europe. The high and stable quality of oils obtained with advanced production technology and the best upgrading additions makes their sales increase every year.

Outside Poland, the key markets include: Russia, Ukraine, Byelorussia, the Czech Republic, Slovakia, the Baltic States and the Black Sea region. LOTOS Oil is also establishing successful commercial contacts in Asia and Western Europe.

Bitumen and heavy fuel oil

The LOTOS Group successfully sells road and industrial bitumen, bitumen emulsions and glues as well as heavy fuel oils. These products are made in three production centres: Gdańsk, Jasło and Czechowice. Heavy products of the LOTOS Group are sold mostly on the road market (bitumen) and to the power sector (heavy fuel oil). Work is also being carried out on launching the production and sales of hydro-insulation materials.

In 2008, bitumen were delivered mostly to road construction sites in Poland, including the constructions of the A1, A2 and A4 motorways. Large volumes of top quality modified bitumen (MODBIT) were delivered for the construction of the A1 motorway section. In 2008, a major 10% growth in modified bitumen sales was recorded compared to 2007.

In 2008, the list of countries that buy bitumen from the LOTOS Group was extended with Croatia and Switzerland. The operation on the Lithuanian market was intensified, where an approximately 70% increase in sales was recorded compared to the previous year. The LOTOS Group sells bitumen also to customers in Sweden, Lithuania, Latvia, Estonia, the Czech Republic, Slovakia, Ukraine, Austria, Hungary, Germany, Russia and Romania.

After the construction of the 10+ Programme systems, the sales of bitumen will exceed one million tonnes per year. The performance of these premises complies with the plan of developing the road infrastructure in Poland, government strategy and the ‘National Road Construction Programme 2008-2012’.

Paraffin

In spite of a lower volume of sales, the restructuring of paraffin product sales in the LOTOS Capital Group provided a major improvement in sales efficiency (by 4.1% in 2008 compared to 2007). This higher sales efficiency had a positive impact on the return on capital. In the assortment sales, as in previous years, candle paraffin dominated (its total share in sales amounted to 63%).

In order to increase sales, in 2008 commercial contacts and cooperation were established with companies operating on the paraffin emulsion market.

In 2008, the share of domestic sales increased slightly in the paraffin structure sales (by 2% compared to 2007). Paraffin exports constituted 26% of total sales. Foreign paraffin customers include mostly companies from Germany, Slovenia, the Czech Republic and the Netherlands.

Logistics

2008 was another year of systematic logistics development at Grupa LOTOS in order to prepare this area for growing trading activity and the launch of new products following the 10+ Programme’s execution.

The methods and directions of fulfilling the growing demands in transhipping, transport and storage, both in terms of primary and secondary logistics, were based on economic premises and taking account of the complete safety of product distribution and supply and compliance with formal and legal requirements.

In 2008, the LOTOS Group carried out an optimization of the logistic assets (including own storage bases) and their adaptation to needs resulting from trade-related tasks. The aim of the optimization process was also to fulfil the requirements concerning the creation and maintenance of obligatory reserves of oil and oil products and the execution of the National Index Target.

The new legal conditions related to the higher required volumes of biocomponents than in the previous years were one of the major challenges in the area of logistics and necessitated close supervision of the logistic chain in order to provide the suitable quality of ready products and the fulfilment of all formal requirements.

Storage depots

In 2008, the storage depot network continued optimization in order to provide top services of trading tasks. Grupa LOTOS systematically increased the role of own fuel depots and transhipping terminals, especially in Gdańsk, Czechowice, Jasło, Piotrków Trybunalski and Rypin. The number of used external storage depots, as well as the volume and type of fuels distributed by independent operators were adapted to the market demand and the new supply sources.

Rail transport

In order to optimise the use of own assets and provide the most economic, efficient and safe distribution of own products, the LOTOS Group contracts transport services from its subsidiary, LOTOS Kolej.

In 2008, the transport services rendered by LOTOS Kolej increased by more than 41%. This resulted from the growing sales of the LOTOS Group products and from railway transport to customers outside the LOTOS Group, higher by 15%. The dynamic growth of LOTOS Kolej increased its market share in the transport of goods. In 2008, it grew to 4.4% (from 3.1% in 2007).

Sea logistics

Sea logistics are an important element in the logistic chain of Grupa LOTOS. The pipeline connection of the refinery in Gdańsk with the liquid fuel transhipping base in the Northern Port provides a significant logistic advantage. In 2008, more than 250 tankers with oil and oil products called at the transhipping terminals of Naftoport and the Northern Port. Some of the tankers shipped exported oil products.

The Northern Port enables the transhipment of tankers with a draught up to 15m and loading capacities of 150 thousand tonnes of oil or oil products. Therefore, Grupa LOTOS exports the surplus of its production by locating it on the markets of Scandinavia and North-West Europe. The direct connection with the port facilitates the organization of the supplementary import of oil products, primarily of diesel oil.

The location of the Grupa LOTOS refinery near the sea terminal of oil transhipment enables the performance of the strategy of diversifying raw material supplies, and deliveries of petroleum from own fields on the Baltic Sea and, in the near future, also from the North Sea.

In 2008, investments were continued aimed at increasing the capacity of the tanks at the refinery in Gdańsk and at improving the transit capacities of the pipeline system connecting the refinery with the Port. The execution of these investments will increase the export potential resulting from higher production capacities after the performance of the 10+ Programme. It will also facilitate and accelerate the transhipment of growing volumes of oil delivered by sea.

Grupa LOTOS has been consistently working on taking over the transport functions in sea deliveries. It provides better control and improves the process of transhipment planning in sea ports, and minimizes the periods of demurrage and related costs. Approximately 60% of tankers carrying cargo to and from the refinery in Gdańsk in 2008 were chartered by the logistic services of Grupa LOTOS.

Obligatory stocks

Higher sales of fuel by the LOTOS Group require a systematic increase in maintained obligatory stocks.

In 2008, the maintenance of obligatory stocks (crude oil, components and finished products) was mostly provided by the own capacities of depots owned by the LOTOS Group. In order to limit dependence on external providers of storage services, a modern tank for 32 thousand m3 was constructed in Czechowice. At the same time Grupa LOTOS gained incomes from so-called ticket services, by offering customers a maintenance of surplus gasoline or heavy fuel oil as obligatory stocks of fuels.