3.2 Description of assumptions for the District Heating segment

Impairment tests on non-current assets were conducted as of December 31, 2022, on cash generating units basis by establishing their recoverable amounts. Determining fair value for very large groups of assets for which there is no active market and there are few comparable transactions is very difficult in practice. In the case of complete power plants and mines for which a value on the local market should be determined there are no observable fair values. Accordingly, the recoverable amount of the assets analysed was determined based on an estimate of their value in use using the discounted net cash flow method on the basis of financial projections prepared for the period from 2023 to the end of 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. Using longer projections, recoverable amounts may be determined more reliably. For generating units with expected periods of economic useful lives in excess of 2030, a residual value was determined for the remaining service time.

The energy market, and especially the heat market, is a regulated market in Poland and as such is subject to numerous regulations and cannot be freely shaped on the basis of business decisions alone. The Energy Law’s goals include taking effective regulatory action to ensure energy security. This means that the regulatory environment is intended to ensure a stable operation of heat suppliers in a given area to meet the long-term needs of consumers. According to the Energy Law, the Energy Regulatory Office President may, in extreme cases, even 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 this is a loss- making activity, the energy company is entitled to loss coverage from the State Treasury.

As such, the Group does not use a finite CGU lifecycle due to the regulatory environment which limits the possibility of discontinuation. Due to the above, impairment tests assumed the continuation of operations (in the form of residual value), while maintaining expenditures at a replacement level, in the long-term due to, inter alia, social interest in the form of ensuring heat supply. With respect to the generation assets covered by the Decarbonisation Plan, replacement investments relate to the transition of generation capacity (to gas-fired assets) via the use of new low- or zero-carbon generation units, which means that the cash generated by these assets is taken into account in the impairment tests.

The 2050 Decarbonisation Plan for the District Heating segment was adopted at PGE Group in December 2021, aiming to fulfil regulatory requirements in the energy industry and retain the existing generation potential in the long-term in order to meet customer needs. The Decarbonisation Plan operationalises objectives specified directly in PGE Group’s strategy and in the District Heating segment strategy implementation plan. The plan identifies the locations where the transformation of manufacturing assets will take place, the timing of major activities, planned expenditures and effects. Generation capacity transition via new low- or zero-carbon generating units is planned for the 2030 horizon, and climate neutrality for the 2050 horizon.

Presented below are the key assumptions having impact on estimates of the useful value of CGU:

• specific units of PGE EC S.A. being considered as separate CGU Branch no. 1 in Kraków (CHP Kraków), Branch Wybrzeże (CHP Gdańsk, CHP Gdynia), Branch in Rzeszów (CHP Rzeszów), Branch in Lublin (CHP in Lublin Wrotków), Branch in Bydgoszcz (CHP Bydgoszcz I, CHP Bydgoszcz II), Branch in Gorzów Wielkopolski (CHP in Gorzów Wielkopolski), Branch in Zgierz (CHP in Zgierz), Branch in Kielce (CHP in Kielce), Branch in Szczecin (CHP in Szczecin, CHP in Pomorzany, district heating network in Gryfino);
• three production facilities owned by KOGENERACJA S.A. being considered as one CGU: CHP Wrocław, CHP Czechnica, CHP Zawidawie;
• for the period from 2023 it is assumed that PGE Group producers do not receive free-of-charge allocations of CO2 emission allowances for the production of electricity;
• taking account of the allocation of free CO2 emission allowances in the period 2023-2030 for system district heating and high-efficiency cogeneration. Member States may apply for a 30% free allocation of emission allowances for heat in the period from 2022 to 2030, with the 30% value relating to the gas benchmark and district heating supply for municipal purposes,
• assumption for conventional plants that during the residual period there will be support from the capacity market or equivalent;
• take into account the support system for high-efficiency cogeneration in the forecast horizon and in the residual period: for existing units, support was assumed in the form of guaranteed bonus and, if the financing gap condition is met, individual guaranteed bonus; a cogeneration bonus is to be granted to new gas units;
• maintain production capacities as a result of replacement-type investments. For generating assets in respect of which actions have been taken to implement the Decarbonisation Plan, replacement expenditures represent the transition of generation assets to gas-fired assets. The decarbonisation plan encompasses the following locations: Kraków, Gdańsk, Gdynia, Wrocław, Bydgoszcz, Kielce, Zgierz;
• taking into account development investments, for projects with a high level of advancement, minimum inclusion in the Company’s approved investment plan;
• adopt WACC after tax for the projection period at different levels:
  • for 2023-2025: average annual level of 8.30%
  • for 2026-2030: average annual level of 6.73%

As at December 31, 2021, the value of tested property, plant and equipment in the District Heating segment was PLN 4,181 million, and goodwill amounted to PLN 192 million. As a result of an asset impairment test, the Group concluded that there is no need to recognise or reverse impairment losses on these assets.

In accordance with IAS 36 Impairment, the Group carried out a sensitivity analysis for generating units in the District Heating segment.

Presented below is the impact of changes in key assumptions on the useful value of assets in the District Heating segment as at December 31, 2022, using the ceteris paribus principle.

A decline in electricity price by 1% would have caused a PLN 0.7 billion decrease in useful value.

An increase in WACC by 0.5 percentage points would have caused an approx. PLN 2.9 billion decrease in the useful value of assets.

An increase in the price of hard coal by 1% would have caused an approx. PLN 0.7 billion decrease in useful value.

PGE Group’s business environment is characterised by high volatility and is dependent on macroeconomic, market and regulatory conditions, and any changes thereto may have a substantial impact on PGE Group’s financial situation and financial results. This is why the aforementioned assumptions and others used in estimating the useful value of assets are periodically analysed and verified. Any changes will be recognised in future financial statements.