2.4. EQUITY-ACCOUNTED INVESTEES

Joint arrangements

Joint arrangements include:

• Joint operations (see Note 8.7),
• Joint ventures.

As a partner in a joint venture, in the consolidated financial statements the Group recognises its interest in the joint venture as an investment and accounts for that investment with the equity method.

According to the equity method, investments are initially recognised at cost, and subsequently adjusted for the Group’s share in changes of their net assets which occurred in the period from the date joint control was assumed to the reporting date, less impairment. When the Group’s share of losses of a jointly controlled entity exceeds the Group’s interest in that entity, the Group discontinues recognising its share of further losses. Unrealised gains and losses on transactions between the Group and a jointly controlled entity are eliminated on consolidation proportionately to the Group’s interest in the jointly controlled entity.

Impairment of investment in joint venture SGT EUROPOL GAZ S.A.

As at the end of each reporting period, the Parent tests its investment in SGT EUROPOL GAZ S.A. (a jointly controlled entity accounted for with the equity method) for impairment and measures the investment’s value in use using the discounted cash flow (DCF) method. The valuation was based on the Inter-Governmental Protocol of October 29th 2010, which specified the company’s expected net profit.

The company’s value estimated with the DCF method as at December 31st 2019 was PLN 840m.

The calculations were based on the assumption that in each year in 2011−2021 net profit earned by SGT EUROPOL GAZ S.A. (EUROPOL GAZ) will be PLN 21m. The discounted cash flows include all cash flows generated by EUROPOL GAZ, including cash flows related to the servicing of interest-bearing borrowings (interest expense and principal repayments) and other risks known to the issuer. The cash flows were discounted using a discount rate of 5.64% (in real terms).

As at the end of 2019, the value of the Parent’s interest in EUROPOL GAZ determined using the equity method was PLN 917m. Therefore, a PLN 28m impairment loss was recognised in the current reporting period to align the equity method valuation of the interest with the DCF valuation of the interest.

The impairment test result is sensitive to the adopted assumptions regarding future cash flows (which depend on whether the provisions of the Inter-Governmental Protocol with respect to net profit to be earned in each of the years are implemented by the company) and discount rate. Changes in those assumptions following from updates of the company’s financial forecasts and changes in the discount rate due to general or company-specific factors, may have a material effect on the company’s future value.

Impairment of investment in Polska Grupa Górnicza S.A., a joint venture

The PGNiG Group’s joint control of Polska Grupa Górnicza S.A. (PGG), a joint venture, is exercised the equity interest held by PGNiG TERMIKA S.A. (a subsidiary of PGNIG S.A.) in PGG. A test for impairment of PGG shares carried out by PGNiG TERMIKA S.A. at the end of 2019 put the value in use of the shares at PLN 612m. The value in use was determined using the discounted cash flow method. The main reasons for the impairment test were:

• the key assumptions of Poland’s energy policy,
• lower expected future cash flows due to lower coal production forecasts,
• employment at PGG maintained above the originally planned level.

Accordingly, an impairment loss was recognised for the shares in PGG which in the consolidated financial statements of the PGNiG Group are accounted for with the equity method. Taking into account the new value in use of the shares, the investment was impaired down to PLN 612m. For more information on the recognised impairment loss, see Note 2.4.1.

The result of the impairment test is sensitive to the assumptions made with respect to future cash flows (planned coal production levels, correlated with Poland’s energy policy objectives, employment levels and related labour costs) and discount rates. Changes in those assumptions following from updates of the company’s financial forecasts and changes in the discount rate due to general or company-specific factors, may have a material effect on the company’s future value.

Following execution, on February 20th 2020, of an agreement between the PGG Management Board and the company’s trade unions, which provides for a 6% increase in salaries and wages at PGG as of January 1st 2020, PGNiG Termika S.A. initially estimated the potential impact of the increase on the result of the test for impairment of the PGG shares. However, taking into account the written assurance of the PGG that the impact of pay rise will be balanced by savings in other areas of PGG’s business, the PGNiG Group decided to maintain the value in use of PGG shares at PLN 612m.