London, 20 November 2012 -- Moody's Investors Service has today downgraded the issuer rating of Polskie Gornictwo Naftowe i Gazownictwo S.A. (PGNiG) and the senior unsecured rating of its guaranteed subsidiary PGNiG Finance AB (publ) to Baa2 from Baa1. Concurrently, Moody's has downgraded the provisional, long-term senior unsecured rating on the EUR1.2 billion euro medium-term note programme of PGNiG Finance AB (publ) to (P)Baa2 from (P)Baa1. The outlook assigned to the ratings is negative. This concludes the review for downgrade initiated by Moody's on 4 September 2012.

RATINGS RATIONALE

Today's rating action reflects the sharp deterioration in PGNiG's credit metrics from the solid levels achieved in 2011.

Moody's notes that PGNiG is taking measures to improve its operational efficiency and has reached an agreement with OJSC Gazprom over the gas price it will pay under its long-term contract for natural gas imported from Russia. However, the positive impact of these actions is unlikely to be sufficient to offset the negative pressures on the group's earnings in the context of its evolving business risk profile, coupled with the changing operating environment in Poland.

PGNiG's results for 9M 2012 reflected wide-ranging pressures on its earnings and included a 44% decline in EBITDA to PLN1.4 billion (EUR345 million) from PLN2.6 billion (EUR621 million) in 9M 2011. Much of the deterioration in PGNiG's operating performance was due to the negative gas margin in its trade operations. Lower cash flow generation on the back of the group's investments and its acquisition of Vattenfall Heat Poland S.A. resulted in PGNiG's debt increasing to PLN10.3 billion (EUR2.5 billion) at 30 September 2012.

Moody's notes that the agreement with Gazprom cuts the price PGNiG would pay for Russian gas and furthermore includes retroactive payments by Gazprom. This will boost PGNiG's EBITDA by approximately PLN2.5-3 billion (EUR600-720 million) this year and strengthen its cash flows in 2012 and 2013. However, the rating agency also notes that the scale of future benefits from the lower price will be limited by the extent to which such reduction is passed through to final customers.

PGNiG falls under Moody's rating methodology for Government-Related Issuers (GRIs) given its 72.4% ownership by the Government of Poland (A2 stable). PGNiG's Baa2 rating incorporates uplift for potential government support to the group's standalone credit quality, which is expressed by Moody's as a baseline credit assessment (BCA), which the rating agency has revised downwards to baa3 from baa2 as part of this rating action.

NEGATIVE OUTLOOK

The negative outlook on the ratings reflects the evolving nature of the gas market in Poland and uncertainty around PGNiG's ability to adapt to these changes in the context of (1) its long-term take-or-pay contracts with Gazprom and other suppliers, (2) growing exploration and production activities, (3) volatile cash flows, and (4) high debt levels.

The Polish gas market is currently regulated by the Energy Regulatory Office. Moody's notes the proposed regulatory reforms to the country's gas sector which aims to introduce a competitive market through a gas trading obligation. At this stage, the extent and timing of a change in the gas market setup in Poland, where PGNiG has the dominant position, is uncertain. However, the rating agency believes that given increasing interconnector capacity and the virtual reverse flow on the Yamal-Europe pipeline (a procedure enabling buyers of Russian gas in Germany to sell it back to buyers in Poland), the Polish gas incumbent could gradually lose significant market share compared to its current 90%+ market share over the medium term. This is exacerbated by PGNiG's take-or-pay obligations under its long-term contracts, which may exert pressure on the group's earnings in the event of lower gas spot prices in western European countries.

Unregulated activities account for approximately 20% of PGNiG's revenues and will increase when the Skarv offshore project in Norway, in which PGNiG has a 12% stake, and the group's fully owned onshore Lubiatow-Miedzychod-Grotow (LMG) project in Poland become fully operational in 2013, more than doubling PGNiG's crude oil output from 0.48 to 1.1 million tonnes. Further growth in the exploration and production segment is a key element of PGNiG's strategy. PGNiG will direct part of this investment towards shale gas exploration and has already entered into cooperation agreements with several Polish energy groups interested in exploiting the potential gas reserves. However, Moody's notes that progress in this area has been slow. The complex planning and permits process and other potential delays, combined with uncertainty surrounding the possible taxation of oil and gas, mean that PGNiG's actual spending may fall some way below the amounts assumed in the group's strategy.

Moody's considers that growth in the area of exploration and production represents both a material increase in the level of PGNiG's activity and a diversification away from its core regulated business. In addition, the rating agency notes that the profitability of this segment of operations will be dependent on the future taxation regime, details of which are currently being prepared by the government.

WHAT COULD CHANGE THE RATING UP/DOWN

Given the current negative outlook, Moody's considers an upgrade to be unlikely at this stage. However, the outlook on the Baa2 ratings could be stabilised if PGNiG's retained cash flow (RCF)/debt ratio were sustainably above 30% and there were more clarity regarding the evolution of the group in the changing operating environment.

PGNiG's ratings could come under downward pressure if the group's RCF/debt ratio were below 30% on a sustained basis or liquidity concerns arise. In addition, negative pressure on PGNiG's ratings could develop as a result of (1) material adverse changes in the operating environment in Poland, including the regulatory framework; (2) a substantial debt-financed M&A transaction; (3) significant expenditure on exploration and production activities that prove less successful than anticipated; or (4) a deterioration in the credit quality of the Government of Poland and/or a reduction in the support assumptions currently incorporated in Moody's assessment.

PRINCIPAL METHODOLOGIES

The methodologies used in these ratings were Regulated Electric and Gas Utilities, published August 2009, and Government- Related Issuers: Methodology Update, published July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Polskie Gornictwo Naftowe i Gazownictwo S.A. is a holding company for a vertically integrated gas group in Poland. The company is majority-owned (72.4%) by the Government of Poland, with the remaining 27.6% of shares listed on the Warsaw Stock Exchange. PGNiG is the dominant player in the Polish natural gas market, covering the whole gas stream (excluding transmission), from oil and gas field development, hydrocarbon production, natural gas importation, storage and distribution to supply to consumers. Following its acquisition of Vattenfall Heat Poland S.A. in early 2012, the group is now also present in the power and heat generation market.

Domestically, PGNiG produces approximately 30% of total Polish natural gas sales (total sales of 14.4 billion cubic metres (bcm) in 2011), operates more than 117,000 km of distribution pipelines and supplies gas to approximately 194,000 commercial customers and almost 6.6 million households. PGNiG's revenues amounted to PLN23 billion (EUR5.5 billion) as at 31 December 2011.

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