12.12 Information on the impact of Covid-19 and the war in Ukraine on the Company’s and Group’s operations

in PLN millions, unless otherwise stated

The greatest impact on the operations and results of the KGHM Polska Miedź S.A. Group is from the Parent Entity and, to a lesser extent, the KGHM INTERNATIONAL LTD. Group.

The most significant risk factors related to the COVID-19 pandemic and the war in Ukraine impacting the Company’s and Group’s activities are:

• increased absenteeism amongst employees of the core production line as a result of subsequent waves of infection by the SARS-CoV-2 virus,
• further increase in the prices of fuels and energy carriers,
• interruptions in the supply chain and the availability of materials (e.g. steel), fuels and energy on international markets,
• interruptions and logistical restrictions as regards international transport,
• restrictions in certain sales markets, a drop in demand and optimisation of inventories of raw materials and finished products amongst customers,
• the global economic slowdown,
• potential exceptional legal changes,
• volatility in copper, silver and molybdenum prices,
• volatility in molybdenum prices,
• volatility in the USD/PLN exchange rate,
• volatility in electrolytic copper production costs, including in particular due to the minerals extraction tax, changes in the value of purchased copper-bearing materials consumed and volatility in prices of energy carriers and electricity,
• the increase in prices of materials and services due to the observed high inflation, and
• the general uncertainty on financial markets and the economic effects of the crisis.

Evaluation of the key categories of risk which are impacted by the coronavirus pandemic and the war in Ukraine is performed by the on-going monitoring of selected information in the areas of production, sales, supply chains, personnel management and finance, in order to support the verification and assessment process of the current financial and operating situation of KGHM Polska Miedź S.A.

From the Group’s point of view, an effect of the COVID-19 pandemic and the war in Ukraine is an increase in market risk related to volatility in metals prices and market indices. The Company’s share price at the end of 2022 increased by 45% compared to the price at the end of the third quarter of 2022, decreased by 9% compared to the end of 2021 and at the close of trading on 30 December 2022 amounted to PLN 126.75. During the same periods the WIG index increased by 14% and fell by 17%, while the WIG20 index increased by 30% and fell by 21%. As a result of changes in the share price of KGHM, the Company’s capitalisation decreased from PLN 27.88 billion at the end of 2021 to PLN 25.35 billion at the end of 2022.

After a stable first half of 2022, when the average price of copper amounted to 9 761 USD/t, the price decreased by 18.6% compared to the average price of copper in the second quarter of 2022. From November 2022, an upward trend was recorded and in the fourth quarter of 2022 the average price of copper increased by 3.3.% compared to the average price of copper in the third quarter of 2022. The average price of copper in 2022 amounted to 8 797 USD/t, which was at the level assumed in the budget.

The potential continuation of increases in prices of fuels and energy carriers may still be the main factor generating a further increase in the cost of sales, selling costs and administrative expenses.

While individual deviations have been observed in the availability of raw and other materials, at present the KGHM Polska Miedź S.A. Group is still not experiencing a substantial negative impact of these fluctuations on its operations. Taking into consideration the continuity of supply of energy carriers (natural gas, coal, coke), at present the KGHM Polska Miedź S.A. Group is not experiencing any negative impact from the suspension of Russian natural gas, coal and coke deliveries, and is fully capable of maintaining the continuity of the core production business and other production processes.

KGHM Polska Miedź S.A., as one of the largest electricity consumers in the country, has been diversifying its demand for electricity for many years according to an effective strategy developed over the years, which includes self-generation. The purchase is realised under bilateral contracts, framework agreements with many suppliers and on the Polish Power Exchange (these contracts are not financial instruments under IFRS). The policy for the purchase of electricity and gaseous fuel has been advanced for years under the Standing Commission for the purchase of electricity, gaseous fuel and property rights.

Nevertheless, regardless of the lack of a significantly negative impact of the aforementioned limitations on the Group’s activities, the Parent Entity recorded a negative impact of the price increases on the fuels and energy carriers market, which ultimately resulted in deviations from budget targets for 2022, on the cost side of KGHM Polska Miedź S.A. Details on the results of the operating segments may be found in sections 8-11 of the Management Board’s report on the activities of KGHM Polska Miedź S.A. and of the KGHM Polska Miedź S.A. Group in 2022.

The increased number of patients with the SARS-CoV-2 virus omicron variant recorded at the start of 2022, and in subsequent months the war in Ukraine, caused a temporary decline in the number of reservations and customer stays in the spa facilities. Nonetheless, beginning at the turn of April and May 2022, the situation systematically improved and stabilised. Starting from 16 May 2022, the state of pandemic was rescinded and was replaced by the state of pandemic threat, which remains in force until rescinded. In the fourth quarter of 2022 no direct negative impact of COVID-19 was recorded on the functioning of the market in which these companies operate. Therefore, the financial forecasts of these companies for 2023 and subsequent years do not assume restrictions of their operations or any temporary suspensions in the operations of their spa facilities.

The spa companies involved in curative activities, which are financed from public funds, take advantage of the protection arising from the law on particular solutions aimed at protecting consumers of natural gas due to the situation on the natural gas market. The protection provided by this law will be in force to the end of 2023. The financial obligations of the spas to their creditors and lessors in the fourth quarter of 2022 were regulated on time, while the improved results, despite the higher-than-expected costs of electricity, natural gas and debt servicing, had a positive impact on meeting the conditions included in the investment loan agreement with the bank Pekao S.A.

As a result of the funds received from the 2.0 Shield for Large Enterprises from the Polish Development Fund (PDF, Polski Fundusz Rozwoju S.A.) for periods in which the operations were shut down, in August 2022 Uzdrowisko Połczyn Grupa PGU S.A. and Uzdrowiska Kłodzkie S.A. – Grupa PGU settled the obtained support and received permission for remission of the loan. Other companies which received subsidies under the PDF’s Financial Shield program for the small and medium-sized enterprises sector are awaiting the decision of the PDF as to the settlement of the support.

The pandemic situation caused by COVID-19 did not have a significant impact on the operations of the Group. At the date of publication of this report the Management Board of the Parent Entity estimates the risk of loss of going concern caused by COVID-19 to still be low.

The geopolitical situation associated with the direct aggression of Russia against Ukraine and the implemented system of sanctions does not currently limit the operations of the Group, while the risk of interruptions to the operational continuity of the Group in this regard continues to be considered as low.

Despite the high inflation observed in the global economy, resulting in the tightening of the monetary policy, the demand for the Group‘s key products did not deteriorate significantly in the fourth quarter of 2022. The metal prices were characterised by an upward dynamic resulting, among others, from the depreciation of the US dollar. In addition, the easing of the „zero COVID” policy by the Chinese authorities gave rise to the expectation of increased consumption of metals in China in 2023, which also had a positive impact on the increase in metal prices at the end of 2022.

In the following year, the main sources of risk for economic development will be the high level of inflation and Russia’s aggression against Ukraine, which may result in an economic slowdown in key industries for metal consumption (e.g. construction). Currently, it is not possible to estimate the impact of these factors on the potential net result, however the situation is continuously being monitored and simultaneously possible mitigation measures are being used.

In terms of the availability of capital and the level of debt, the Group holds no bank loans drawn from institutions threatened with sanctions.

With respect to exchange differences (the measurement of balance sheet items denominated in foreign currencies), a weakening of the PLN may increase foreign exchange gains (unrealised) due to the fact that the amount of the loans granted by KGHM in USD is higher than the amount of borrowings in USD.

With regard to other companies of the KGHM Polska Miedź S.A. Group, the situation in Ukraine in 2022 did not have a significant impact on the operating results generated by these entities.

In KGHM Polska Miedź S.A. as well as in all international mines of the KGHM Polska Miedź S.A. Group and Sierra Gorda S.C.M., thanks to the implementation of a variety of preventative measures there were no production stoppages which would have been directly attributable to the pandemic and the war in Ukraine. As a result, the Group’s production of copper, silver and molybdenum in 2022 was higher than the level assumed in the budget. 

For years, KGHM Polska Miedź S.A. has applied procedures related to the monitoring of repayment of receivables. The timeliness of payments by customers is subject to daily reporting, while any recorded interruptions in cash flows from customers are immediately explained. In terms of sales, currently the majority of customers do not report significantly negative impact from the previous waves of the pandemic on their activities, thanks to which the trade receivables towards the Parent Entity are paid on time, while deliveries are sent to customers without major interruptions.  

The strategy of diversification of suppliers applied by the entire KGHM Polska Miedź S.A. Group and the use of alternative solutions at the present time effectively mitigate the risk of interruptions in the supply chains of raw and other materials. 

The Group is fully capable of meeting its financial obligations. The financial resources held by the Group and the obtained borrowings guarantee its continued financial liquidity. The financing structure of the Group on the level of the Parent Entity based on long-term and diversified sources of financing, provided the Company and the Group with long-term financial stability by maintaining a stable spread of debt maturities and optimising its cost. 

Due to the centralisation of the process of obtaining external financing for the needs of the entire Group, in order
to transfer liquidity within the Group, a debt instrument in the form of owners loans is used to support the investment process, and the Group uses local and international cash pooling to service its daily operations. 

Currently, the Parent Entity does not identify a significant risk of a breach in the financial terms (so-called “covenants”) contained in external financing agreements, related to the COVID-19 pandemic and the war in Ukraine. 

The Group continues to advance its investment projects in accordance with established schedules and therefore does not identify any increase in risk related to their continuation due to the effects of the coronavirus pandemic and the war in Ukraine. 

During the reporting period there were no interruptions in the continuity of the Group’s operations caused by infections of this virus amongst the employees and no substantially higher level of absenteeism amongst employees was recorded. 

In the Company, the process continued of implementing a comprehensive business continuity management system, which also enables a detailed breakdown of the scope of actions undertaken as regards managing corporate risk in terms of the risk of a catastrophic impact and the small probability of their occurrence. 

Taking into consideration the risk of appearance of new mutations of the SARS-CoV-2 virus and the next wave of the COVID-19 pandemic observed in China, there is still uncertainty as to the potential development of the pandemic situation in the world, in particular as to the consequence of its impact on the economic and social situation in Poland and globally. From the start of the COVID-19 pandemic, China maintained a restrictive “zero covid” policy, and in the fourth quarter of 2022 it decided to lift most of the restrictions. The expected economic recovery, given the improved pandemic situation so far, was slowed down by the Russia’s aggression against Ukraine with an impact on food security, high prices of energy and the Producer Price Index, as well as problems with access to synthetic fertilizers. With respect to stability and the continuity of energy carriers supply chains, the directions of energy-climate geopolitics will be of importance, especially in the context of gaining independence by European countries from Russian deliveries of natural gas and coal and the effects of the plan adopted by the EU Member States to reduce natural gas consumption in winter. The Parent Entity continuously monitors the international economic situation in order to assess its potential negative impact on the KGHM Polska Miedź S.A. Group and to take anticipative actions to mitigate this impact.