Due to the termination of long-term contracts for sale of capacity and electricity (“LTC”), pursuant to the LTC Act, power generating units who once served as parties to such contracts have acquired the right to compensations for the coverage of the so-called stranded costs. Stranded costs are the expenses of the power generating units, borne until May 1, 2004 for property, plant and equipment related to the production of electricity, uncovered by revenue from the sales of the electricity produced, capacity reserves and system services on the competitive market, after the premature termination of the long-term contract. The LTC Act limits the total resources which can be paid out to all power generating units to cover stranded costs discounted as of January 1, 2007 to the sum of PLN 11.6 billion, with PLN 6.3 billion attributable to PGE.

Basic data for Group power generating units assumed with the LTC Act.

Within the term stipulated by the LTC Act, i.e. until December 31, 2007, PGE S.A. signed contracts terminating its long-term capacity and electricity sales contracts with power generating units who once served as parties to the then effective LTC. Therefore, the power generating units have gained the right to receive funds to cover stranded costs.

Decisions of the President of the Energy Regulatory Office related to realisation of the LTC Act

Some generating entities, currently branches of PGE GiEK S.A., became entitled to receive funds to cover stranded costs (so-called "LTC compensation") pursuant to the LTC Act. The LTC Act is ambiguous in many points and raise important questions of interpretation. The calculation of the estimated results of each entity and resulting compensations, annual adjustments of stranded costs and final adjustments as well as resulting revenues recognized in the statement of comprehensive income was performed by the Group with the best of its knowledge in this area and with support of external experts.

Until the date of preparation of these financial statements, producers from the PGE Group received decisions on annual adjustments of stranded costs and costs generated in gas-fired units for the years 2008-2015. In part, these decisions were unfavourable for the particular units, and, in the opinion of the Group, were issued in violation of the LTC Act. In consequence, since 2009, a number of proceedings have been pending before the District Court in Warsaw - Competition and Consumer Protection Court ("CCP Court") and before the Court of Appeals, regarding appeals of power generating units from the PGE Group against the Decision of the President of the Energy Regulatory Office (“ERO President”). The value of disputes in all matters relating to the years 2008 – 2012 amounts to PLN 1,660 million, including the value of disputes favourably resolved for the PGE Group by the Court of Appeals and a favourable final judgment by the CCP Court of PLN 1,489 million. As at the date of preparation of these financial statements, majority of the proceedings are conducted before the Supreme Court.

During 2016 the following events took place regarding annual adjustments of stranded costs and costs generated in gas-fired units for the years 2008-2015:

¡  On April 7, 2016 the court case was conducted before the Supreme Court, during which a cassation  appeal of the ERO President was examined concerning the determination of annual adjustment of costs arising in gas-fired units at PGE GiEK S.A. Branch Lublin - Wrotków Heat and Power Plant for 2009. The Supreme Court overruled the contested judgment of the Court of Appeals in Warsaw in its entirety and dismissed the appeal of PGE GiEK S.A. The claimed amount in this case was nearly PLN 7 million. As a consequence of the verdict, the company paid that amount to the account of Zarządca Rozliczeń S.A.

• On April 7, 2016 the Supreme Court refused to accept for examination the cassation submitted by PGE GiEK S.A appeal concerning the determination of annual adjustment of costs arising in gas-fired units at PGE GiEK S.A. Branch Lublin – Wrotków Heat and Power Plant and Branch Rzeszów Heat and Power Plant for 2010. The ruling ends the proceedings, meaning that rulings by the CCP Court and the Court of Appeals are binding. The claimed amount in this case was PLN 4 million.
• On April 14, 2016 the court case was conducted before the Court of Appeals concerning the determining of annual adjustment of stranded costs due to GiEK S.A. Branch Opole Power Plant for 2010. The court allowed the appeal of the PGE Group and at the same time dismissed the appeal of the ERO President. The above means that the court changed the contested decision as requested by the appeal of the PGE Group. The judgement is binding. The ERO President did not file a cassation appeal. The claimed amount in this case was approx. PLN 142 million. Zarządca Rozliczeń S.A. transferred that amount to the PGE GIEK S.A.’s account.
• On May 12, 2016 the court case was conducted before the Court of Appeals concerning the determination of annual adjustment of costs arising in gas-fired units at Branch Rzeszów Heat and Power Plant for 2012. The Court of Appeals issued a judgment in which changed the verdict of the CCP Court in its entirety and dismissed the company’s appeal. The claimed amount in this case is approx. PLN 7 million.
• On May 12, 2016 the Supreme Court refused to accept for examination the cassation appeal of PGE GIEK S.A. concerning determination of annual adjustment of costs arising in gas-fired units at Branch Rzeszów Heat and Power  Plant for 2009 and 2011. The claimed amount in both cases is to approx. PLN 10 million.
• On August 8, 2016 PGE GiEK S.A. received administrative decision of the ERO President regarding the annual adjustment of the stranded costs for the year 2015. The amount of the annual adjustment of stranded costs in power generating units: Branch Turów Power Plant and Brach Opole Power Plant for 2015 is approx. PLN (+) 326 million. The company does not dispute this amount. The advances collected in 2015 amounted to PLN 251 million.
• On September 14, 2016, the PGE Group appealed against the ruling of the District Court in Warsaw regarding the compensation claimed by the company from the State Treasury – the ERO President for lost benefits incurred by the Group due unfavourable decisions of the ERO President regarding stranded costs for 2008. The claimed amount in this case is PLN 57 million.

On September 15, 2016, the Court of Justice of the European Union issued a ruling regarding prejudicial questions concerning the group in the meaning of the LTC Act.

The above question concerned two issues:

• whether national courts are competent to examine issues related to LTCs?

The Court ruled that the national bodies and courts are not authorised to verify whether national laws that are considered to be an authorised state aid are in compliance with the assumptions listed in the Announcement of the Commission relating to the methodology for analysing state aid linked to stranded costs;

• whether entities in a group should be defined based on the group structure reflected in Annex 7 to the LTC Act or based on the current structure in each year covered by the programme?

The Court ruled that when determining annual adjustments of compensations for stranded costs to be paid to a power generating untit belonging to a group, the companies should take into account the group’s structure and consequently the group’s financial results at the time when the adjustment is made, and not the group structure reflected in Annex 7 to the LTC Act.

• In connection with the above, a cassation hearing before the Supreme Court took place on November 10, 2016 regarding the cassation appeal of the ERO President against judgment of the Court of Appeals in respect of calculation of the annual adjustment of stranded costs at the Branch Dolna Odra Power Plant Complex for 2009. The Supreme Court overruled the judgement of the Court of Appeals in its entirety and changed the judgement of the CCP Court by replacing the annual adjustment for 2009 in the amount of PLN (+) 117 million with the amount of PLN (+) 51 million. As a result of this judgement, PGE GiEK S.A. paid PLN 66 milion to the account of Zarządca Rozliczeń S.A. on November 30, 2016.
• On December 8, 2016 conciliatory meeting was held, involving PGE GiEK S.A. as a petitioner and the ERO President as a defendant. The meeting concerned the payment of PLN 107 million as a compensation for PGE GiEK S.A. for lost benefits resulting from unfavorable decisions for the year 2009. Agreement has not been reached.

Additionally, starting from January 1, 2017 until the date of preparation of these financial statements, the following events took place related to adjustments of stranded costs and costs generated in gas-fired units for the years 2008-2015:

• On January 10, 2017 the Supreme Court:
• refused to accept for examination the cassation appeal of PGE GiEK S.A. against the judgement of the Court of Appeals concerning the determination of annual adjustment of stranded costs for Branch Dolna Odra Power Plant Complex for 2008.
• overruled judgement of the Court of Appeals in Warsaw regarding the determination of annual adjustment of stranded costs for Branch Gorzów Heat and Power Plant for 2009. The case was submitted for reexamination by the Court of Appeals.
• On January 26, 2017 the Supreme Court issued an alter decision concerning:
• the annual adjustment of stranded costs for Branch Lublin Wrotków Heat and Power Plant for 2008 in which it determined its value at approx. PLN (+) 9 million. As a result, PGE GiEK S.A. will return to Zarządca Rozliczeń S.A. the amount of approx. PLN 1 million.
• the annual adjustment for stranded costs for Branch Rzeszów Heat and Power Plant for 2009, in which it determined its value at PLN 0. As a result, PGE GiEK S.A. will return to Zarządca Rozliczeń S.A. the amount of approx. PLN 7 million.

Effect on the financial statements for the period ended December 31, 2016

In the financial statements for the period ended December 31, 2016, the PGE Group recognized revenues from LTC compensations of PLN 520 million in sales revenues.

The verdict of the Court of Appeals concerning the determination of annual adjustment of stranded costs for GiEK S.A. Branch Opole Power Plant for 2010 resulted in an adjustment of LTC settlements of approx. PLN (+) 173 million that was recognized in the financial statements for the period ended December  31, 2016.

Moreover, refusal to accept for examination the cassation appeal of PGE GIEK S.A. concerning annual adjustment of costs arising in gas-fired units at PGE GiEK S.A. Branch Lublin-Wrotków Heat and Power Plant and Branch Rzeszów Heat and Power Plant for 2010 and unfavourable ruling of the Supreme Court in case of the annual adjustment of costs arising in gas-fired units at PGE GiEK S.A. Branch Lublin - Wrotków Heat and Power Plant for 2009 caused an adjustment of LTC settlements of PLN (-) 25 million that was recognized in the financial statements for the period ended December 31, 2016.

The above adjustments are presented in net amount in the statement of comprehensive income in other operating revenues.

In the period from 2008 till December 31, 2016 the PGE Group recognised revenues from LTC compensations in total amount of PLN 7,755 million