3.2 Description of assumptions for the District Heating segment

The impairment tests were performed as at November 30, 2019 with respect to cash-generating units by determining their recoverable amount. Determination of fair value for very large groups of assets for which there is no active market and a small number of comparable transactions is very difficult in practice. In the case of CHP plants for which a value on the local market should be determined, there are no observable fair values. Therefore, the recoverable amount of the analysed assets was determined based on value in use estimated using the discounted net cash flow method, based on financial projections prepared for the period from December 2019 to 2030. According to the Group, financial projections longer than five years are justified due to significant and long-term effects of projected changes in the regulatory environment. With longer projections, the recoverable amount can be determined in a more reliable manner. For generating units with expected periods of economic useful lives beyond 2030, a residual value was determined for the remaining service time. The energy market, and in particular the heating market, is a regulated market in Poland and as such is subject to many regulations and cannot be freely shaped solely on the basis of business decisions. The objectives of the Energy Law include, among others, taking effective regulatory actions aimed at ensuring energy security. This means that the regulatory environment aims at stable operation of heat suppliers in a given area in order to meet the long-term needs of consumers.  According to the provisions of the Energy Law, the President of the ERO may even, in extreme cases, order an energy company to carry out activities covered by a concession (for a period not longer than 2 years) if the public interest so requires. If such activities cause a loss to the energy company, the losses should be covered by the State Treasury.

Therefore, the Company does not assume the end of life of assets due to the regulatory environment, which limits the possibility of discontinuation of operations. Moreover, in the heating sector, we can observe an extended service life of equipment (boilers, turbine sets), which is operated much longer than it would result from the original assumptions. In view of the above, the impairment tests assume the continuation of operations (in the form of residual value) while maintaining expenditures at the replacement level on current assets in the long term, due to, among other things, the public interest in the form of heat supplies. The life cycle approach is in line with the PGE Group’s asset maintenance strategy.

Detailed assumptions regarding the segment

Presented below are the key assumptions having impact on estimates of the value in use of the tested CGUs:

• Recognition individual branches of PGE Energia Ciepła S.A. as separate CGUs: Rybnik Branch (Elektrownia Rybnik), Branch No 1 in Kraków (Elektrociepłownia Kraków), Wybrzeże Branch (Elektrociepłownia Gdańsk, Elektrociepłownia Gdynia), Reszów Branch (Elektrociepłownia Rzeszów), Lublin Branch (Elektrociepłownia w Lublinie Wrotków),  Bydgoszcz Branch (Elektrociepłownia Bydgoszcz I, Elektrociepłownia Bydgoszcz II), Gorzów Wielkopolski Branch (Elektrociepłownia w Gorzowie Wielkopolskim),  Zgierz Branch (Elektrociepłownia w Zgierzu), Kielce Branch (Elektrociepłownia w Kielcach). Elektrownia Rybnik (Rybnik Power Plant) belonging to PGE Energia Ciepła S.A. is tested in the Conventional Generation segment.
• Recognition of three production facilities of KOGENERACJA, i.e. Elektrociepłownia Wrocław, Elektrociepłownia Czechnica, Elektrociepłownia Zawidawie, as a single CGU.
• Assumption of a quantity of free-of-charge CO₂ emission allowances for the purposes of electricity generation for 2019-2020 for specific CGUs in accordance with Poland’s application for a transition allocation of free emission allowances for the modernisation of electricity generation activities pursuant to Article 10c(5) of directive 2003/87/EC of the European Parliament and the Council (derogation application), which meets the requirements of Commission Decision of July 13, 2012. As regards heat generation, free-of-charge allowances were taken into account in accordance with the list of quantities of CO₂ emission allowances allocated for heat for 2013-2020, published by the Environment Ministry.
• Taking into account the allocation of free CO₂ emission allowances in 2021-2030 only for system district heating and high-efficiency , based on the 2020 level and assuming annual reduction.
• Assumption for CHP plants that during the residual period there will be support from the capacity market or equivalent, only for units that meet the emission criterion of 550 g of CO₂ of electricity produced.
• Taking into account the support system for high-efficiency over the maximum period of 15 years, for gas units for which the statutory period expires after 2030, the support also included in the residual value.
• Maintaining production capacities as a result of replacement-type investments.
• Taking into account highly advanced development investments, including tenders in progress.
• Assumption of the adjusted weighted average cost of capital after tax (WACC) over the projection period of 7.0%.

Some important regulatory assumptions made for impairment tests are beyond the control of PGE Group and their materialization in the future is uncertain. This concerns in particular issues related to the shape of the Polish capacity market after July 1, 2025 or allocation of free CO₂ emission allowances after 2020. In these areas, the Group relies on current assumptions about developments in regulations, which are subject to risk. Future changes to these regulations, compared to PGE’s current expectations, may have an impact on the assessment of the recoverable amount of generation assets in the District Heating segment.

Nevertheless, the Group believes that such assumptions are justified in view of the expected changes in the regulatory environment. These assumptions, which have been reflected in cash flows, form, in the Group’s opinion, a realistic scenario and will remain valid in the period they have been made for. However, it cannot be ruled out that the final shape and term of validity of these arrangements may differ significantly from those assumed.

Impairment tests for the District Heating segment were performed in respect of generation assets owned by PGE EC S.A. and its subsidiaries, excluding Elektrownia Rybnik presented in the Conventional Generation segment. As a result of the acquisition of EDF assets in 2017, goodwill was allocated to the acquired district heating assets.

As at November 30, 2019, the value of tested property, plant and equipment and intangible assets of PGE EC S.A. amounted to PLN 5,959 million. Based on the impairment test, the Group estimated the excess of the value in use of the tested assets over their carrying amount, and therefore found no need to recognize or reverse impairment losses on these assets. The Group also found that it was not necessary to reverse the impairment losses recognised in previous reporting periods with respect to selected CGUs.

Sensitivity analysis

In accordance with IAS 36, the Group performed a sensitivity analysis for generation units in the District Heating segment.

The estimated effect of the change of key assumptions on the value in use of assets as at November 30, 2019 for the District Heating segment is presented below.

A 1% decrease in electricity price would decrease the value in use by PLN 0.5 billion.

A 0.5 p.p. increase WACC would decrease the value in use by PLN 1.6 billion.

A lack of support for high-efficiency would decrease the value in use by PLN 2.3 billion.