3.2 Impairment tests of goodwill allocated to the Heat Generation segment

On November 30, 2020, impairment tests were carried out. Due to the fact that the goodwill is allocated to the assets of Heat Generation segment, in practice the impairment test involved verification of cash generating units by determining their recoverable values and then comparison these values with fixed assets enlarged by the goodwill.

In practice, it is very difficult to determine a fair value of a very large group of assets which do not have an active market or comparable transactions. With respect to whole cogeneration plants whose value in a local market should be determined, there are no observable fair values. Therefore, the recoverable value of the analysed assets was determined by way of estimating their use value by means of the discounted net cash flows method based on the financial forecasts prepared for the period from December 2020 to the year 2030. In the Group’s opinion, the adoption of financial forecasts for periods longer than five years is justifiable in view of the significant and long-term impact of the estimated changes in the regulatory environment. Thanks to adopting longer-term forecasts, the estimates of recoverable values may be more reliable. In the case of the generation units whose useful economic life extends beyond 2030, the Group determined their residual value for the remaining period of operation. The energy market, and in particular the district heating market, is a regulated market in Poland and as such it is subject to many regulations and cannot be freely shaped based on business decisions alone. The objectives of the Energy Law include taking effective regulatory measures to ensure energy security. This means that the regulatory environment is aimed at ensuring the stable functioning of heat suppliers in a given area so as to satisfy the needs of customers in the long term. According to the provisions of the Energy law, the ERO President may, even in extreme cases, order an energy company to carry out activities covered by the concession (for a period not longer than 2 years), if the public interest so requires. If such activity generates a loss, the energy company is entitled to receive compensation from the State Treasury.

In view of the above, the Company does not assume a finite asset life due to the regulatory environment, which limits the possibility of discontinuing operations. Moreover, what can be observed in the heat generation sector is an extended useful life of equipment (boilers, turbine sets), which is operated much longer than it would appear from the original assumptions. Therefore, the impairment tests included the assumption of continuation of operations (in the form of residual value), with expenditures on the current assets maintained at a replacement level in the long term due to, among others, the public interest in the form of ensuring heat supply. The approach to useful life is consistent with the asset maintenance strategy of the PGE Capital Group.

The key assumptions determining the assessed use value of the tested CGUs include the following:

• recognising the particular branches of PGE EC S.A. as separate CGUs, i.e. Branch No. 1 in Kraków (Kraków CHP Plant), Wybrzeże Branch (Gdańsk CHP Plant, Gdynia CHP Plant), Rzeszów Branch (Rzeszów CHP Plant), Lublin Branch (Lublin Wrotków CHP Plant), Bydgoszcz Branch (Bydgoszcz I CHP Plant, Bydgoszcz II CHP Plant), Gorzów Wielkopolski Branch (CHP Plant in Gorzów Wielkopolski), Zgierz Branch (CHP Plant in Zgierz), Kielce Branch (CHP Plant in Kielce) as separate CGUs;
• recognising the three generation facilities belonging to KOGENERACJA, i.e. Wrocław CHP Plant, Czechnica CHP Plant and Zawidawie CHP Plant as one CGU;
• for the period from 2021 onwards, it was assumed that generators from the PGE Capital Group did not obtain free CO₂ emission allowances for electricity generation;
• the allocation of free CO₂ emission allowances in the period 2021-2030 for district heating and high-efficiency cogeneration was taken into account. The allocation of free allowances for heat generation for the years from 2021 to 2030 is regulated by EU Directive 2018/410 of March 14, 2018 amending Directive 2003/87/EC to strengthen cost-effective emission reductions and low-carbon investments and Decision (EU) 2015/1814. Another regulation clarifying the allocation of free CO₂ emission allowances is the Commission delegated Regulation (EU) 2019/331 of December 19, 2018 determining transitional Union-wide rules for harmonised free allocation of emission allowances pursuant to Article 10a of Directive 2003/87/EC of the European Parliament and of the Council (the so-called FAR – Free Allocation Rules) (entered into force on February 28, 2019 – the Polish version on February 27, 2019). The Directive is reflected in the amended Act of July 4, 2019 amending the Act on the greenhouse gas emission trading scheme and certain other acts. Under Article 10a of the Directive, Member States may apply for an allocation of free CO₂ emission allowances for heat in the amount of 30% in the period from 2021 to 2030, with the 30% value relating to the gas benchmark and supply of heat for municipal purposes;
• adopting the assumption for CHP plants that there is support from the capacity market or its equivalent during the residual period;
• taking into account the support system for high-efficiency cogeneration over the maximum period of 15 years, for gas-fired units for which the statutory period expires after 2030, support is also included in the residual value;
• maintaining generation capacities thanks to asset replacement projects;
• taking into account highly advanced development investment projects and including them in the Company’s investment plan;
• adopting the weighted average cost of capital after taxation for the forecast period at the level of 7%.

Some important regulatory assumptions adopted for the purpose of impairment tests are beyond the control of the PGE Capital Group and their fulfilment in the future is uncertain. This applies in particular to issues relating to the shape of the Polish capacity market after July 1, 2025 or the allocation of free CO₂ emission allowances. In these areas the Group relies on the present assumptions concerning the development of regulatory changes, which are burdened with risk. Future changes in the regulations with respect to the PGE’s present expectations may influence the assessment of the recoverable value of the generation assets in the Heat Generation segment and assign to its goodwill.

Nevertheless, according to the Group, the adoption of the aforementioned assumptions is justified in view of expected changes in the regulatory environment. These assumptions, which were reflected in cash flows, constitute, according to the Group, a realistic scenario for their functioning and effective duration. Nevertheless, it cannot be ruled out that the final shape and duration of such solutions can be very much different from the adopted ones.

As at 30 November 2020, the value of the tested goodwill equalled PLN 189 million. As a result of the performed impairment test, the Group identified a surplus of the value in use of the tested assets over their carrying amount and concluded that there was no need to make an impairment write-down.

In accordance with IAS 36, the Group performed a sensitivity analysis for the generating units of the Heat Generation segment.

The impact of changes in the key assumptions on the value in use of assets as at November 30, 2020 for the Heat Generation segment is presented below.

A 1% drop in the price of electricity would reduce the value in use of the assets by PLN 0.5 billion.

An increase in WACC by 0.5 p.p. would reduce the value in use of the assets by PLN 2.2 billion.