Natural disasters Decommissioning obligations arise when an entity is required to dismantle or remove an asset at the end of its useful life and to restore the site on which it has been located, for example, when an oil rig or nuclear power station reaches the end of its economic life. Natural disasters Decommissioning obligations
Rather than allowing an entity to build up a provision for the required costs over the life of the facility, IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that the liability is recognised as soon as the obligation arises, which will normally be at commencement of operations. Similarly, IAS 16 Property, plant and equipment requires the initial cost of an item of property, plant and equipment to include an estimate of the amount of the costs to dismantle and remove the item and restore the site on which it is located.
IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities applies to any decommissioning, restoration or similar liability that has been both included as part of the cost of an asset measured in accordance with IAS 16 and recognised as a liability in accordance with IAS 37. Any new obligations resulting from a natural disaster, other than the existing decommissioning obligations, would not fall into scope of IFRIC 1 and would be recorded as expenses because these relate to new events and not the original decommissioning obligation.
A natural disaster can significantly change the timing and amount of the estimated cash flows required to settle the decommissioning, restoration or similar liability. IFRIC 1 addresses how the effect of the following events that change the measurement of an existing decommissioning, restoration or similar liability are accounted for: Natural disasters Decommissioning obligations
A change in the estimated outflow of resources embodying economic benefits (e.g., cash flows) required to settle the obligation.
If the related asset is measured using the cost model, the change in the liability is added to, or deducted from, the cost of the asset to which it relates. Where the change gives rise to an addition to cost, the entity considers the need to test the new carrying value for impairment. Because of the nature of natural disasters, impairment of any increase in the value of the related asset may be a very real possibility. Conversely, reductions over and above the remaining carrying value of the asset are recognised immediately in profit or loss. The adjusted depreciable amount of the asset is then depreciated prospectively over its remaining useful life.
A change in the current market-based discount rate (this includes changes in the time value of money and the risks specific to the liability).
An increase that reflects the passage of time (also referred to as the unwinding of the discount).
The periodic unwinding of the discount is recognised in profit or loss as a finance cost as it occurs.
Reduction in the economic life of an asset Natural disasters Decommissioning obligations
After a natural disaster, it is determined that a power plant will have to be closed earlier than previously expected. The entity determines that the remaining useful economic life of the asset has reduced from 35 years to 10 years. Natural disasters Decommissioning obligations
Accordingly, in the absence of other changes, the present value of the decommissioning liability will increase because of the shorter period over which cash flows are discounted (flows). This increase is added to the carrying value of the asset, which is tested for impairment. The remaining carrying value is depreciated prospectively over the following 10 years.
If the related asset is measured using the revaluation model, changes in the liability alter the revaluation surplus or deficit previously recognised for that asset. Changes to the provision are recognised in other comprehensive income and they increase or decrease the value of the revaluation surplus in respect of the asset, except to the extent that:
- A decrease in the provision reverses a previous revaluation deficit on that asset that was recognised in profit or loss
- A decrease in the provision exceeds the carrying amount of the asset that would have been recognised under the cost model
Or Natural disasters Decommissioning obligations
An increase in the provision exceeds the previous revaluation surplus relating to that asset
Disclosure example Premier Oil plc AR 2018
Critical accounting judgements
- the application of the going concern basis of accounting (basis of preparation section above); Natural disasters Decommissioning obligations
- carrying value of intangible exploration and evaluation assets (note 9 on page 140), in relation to whether commercial determination of an exploration prospect had been reached;
- carrying value of property, plant and equipment (note 10 on page 142) regarding assessing assets for indicators of impairment;
- decommissioning costs (note 17 on page 146), relating to the timing of when decommissioning would occur; and
- tax and recognition of deferred tax assets (note 19 on page 152), relating to the extent to which future cash flows are included.
Key sources of estimation uncertainty Natural disasters Decommissioning obligations
Details of the Group’s critical accounting estimates are set out in these financial statements and are considered to be:
- carrying value of property, plant and equipment (note 10 on page 141), where the key assumptions relate to oil and gas prices expected to be realised, 2P production profiles and estimated future costs; Natural disasters Decommissioning obligations
- decommissioning costs (note 17 on page 146, where the key assumptions relate to the discount and inflation rates applied, applicable rig rates and expected timing of COP from each field;
- estimating the fair value of the equity and synthetic warrants recognised in the year (note 18 on page 149), where key assumptions relate to expected timing of exercise and future share price volatility; and, Natural disasters Decommissioning obligations
- tax and recognition of deferred tax assets (note 19 on page 152), where key assumptions relate to oil and gas prices expected to be realised, 2P production profiles and estimated future costs.
Oil and gas assets Natural disasters Decommissioning obligations
The Company applies the successful efforts method of accounting for exploration and evaluation (‘E&E’) costs, having regard to the requirements of IFRS 6 Exploration for and Evaluation of Mineral Resources. Natural disasters Decommissioning obligations
(a) Exploration and evaluation assets Natural disasters Decommissioning obligations
Under the successful efforts method of accounting, all licence acquisition, exploration and appraisal costs are initially capitalised in well, field or specific exploration cost centres as appropriate, pending determination. Expenditure incurred during the various exploration and appraisal phases is then written off unless commercial reserves have been established or the determination process has not been completed.
Pre-licence costs Natural disasters Decommissioning obligations
Costs incurred prior to having obtained the legal rights to explore an area are expensed as they are incurred.
Exploration and evaluation costs Natural disasters Decommissioning obligations
Costs of E&E are initially capitalised as E&E assets. Payments to acquire the legal right to explore, costs of technical services and studies, seismic acquisition, exploratory drilling and testing are capitalised as intangible E&E assets. Natural disasters Decommissioning obligations
Tangible assets used in E&E activities (such as the Group’s vehicles, drilling rigs, seismic equipment and other property, plant and equipment used by the Company’s Exploration Function) are classified as property, plant and equipment. However, to the extent that such a tangible asset is consumed in developing an intangible E&E asset, the amount reflecting that consumption is recorded as part of the cost of the intangible asset. Natural disasters Decommissioning obligations
Such intangible costs include directly attributable overhead, including the depreciation of property, plant and equipment utilised in E&E activities, together with the cost of other materials consumed during the exploration and evaluation phases. E&E costs are not amortised prior to the conclusion of appraisal activities.
Treatment of E&E assets at conclusion of appraisal activities Natural disasters Decommissioning obligations
Intangible E&E assets related to each exploration licence/prospect are carried forward until the existence (or otherwise) of commercial reserves has been determined subject to certain limitations, including review for indications of impairment. Natural disasters Decommissioning obligations
If commercial reserves have been discovered, the carrying value, after any impairment loss, of the relevant E&E assets, is then reclassified as development and production assets, once the project is deemed to be justified for development. If, however, commercial reserves have not been found, the capitalised costs are charged to expense after conclusion of appraisal activities.
(b) Oil and gas properties Natural disasters Decommissioning obligations
Oil and gas properties are accumulated generally on a field-by-field basis and represent the cost of developing the commercial reserves discovered and bringing them into production, together with the E&E expenditures incurred in finding commercial reserves transferred from intangible E&E assets, as outlined in accounting policy (a) above.
The cost of oil and gas properties also includes the cost of acquisitions and purchases of such assets, directly attributable overheads, finance costs capitalised, and the cost of recognising provision for future restoration and decommissioning. Natural disasters Decommissioning obligations
Depreciation of producing assets Natural disasters Decommissioning obligations
The net book values of producing assets (including pipelines) are depreciated generally on a field-by-field basis using the unit-of-production method by reference to the ratio of production in the year and the related commercial (proved and probable) reserves of the field, taking into account future development expenditures necessary to bring those reserves into production.
Producing assets are generally grouped with other assets that are dedicated to serving the same reserves for depreciation purposes, but are depreciated separately from producing assets that serve other reserves. Natural disasters Decommissioning obligations
(c) Impairment of oil and gas properties’ assets Natural disasters Decommissioning obligations
An impairment test is performed whenever events and circumstances arising during the development or production phase indicate that the carrying value of an oil and gas property may exceed its recoverable amount. Natural disasters Decommissioning obligations
The carrying value is compared against the expected recoverable amount of the asset, generally by reference to the present value of the future net cash flows expected to be derived from production of commercial reserves. The cash-generating unit applied for impairment test purposes is generally the field, except that a number of field interests may be grouped as a single cash-generating unit where the cash inflows of each field are interdependent. Natural disasters Decommissioning obligations
Any impairment identified is charged to the income statement. Where conditions giving rise to impairment subsequently reverse, the effect of the impairment charge is also reversed as a credit to the income statement, net of any depreciation that would have been charged since the impairment.
(d) Acquisitions, asset purchases and disposals Natural disasters Decommissioning obligations
Acquisitions of oil and gas properties are accounted for using the acquisition method when the assets acquired and liabilities assumed constitute a business.
Transactions involving the purchase of an individual field interest, or a group of field interests, that do not constitute a business, are treated as asset purchases irrespective of whether the specific transactions involve the transfer of the field interests directly or the transfer of an incorporated entity. Accordingly, no goodwill and no deferred tax gross up arises, and the consideration is allocated to the assets and liabilities purchased on an appropriate basis. Natural disasters Decommissioning obligations
Proceeds on disposal are applied to the carrying amount of the specific intangible asset or oil and gas properties disposed of and any surplus is recorded as a gain on disposal in the income statement.
(e) Decommissioning Natural disasters Decommissioning obligations
Provision for decommissioning is recognised in full when the related facilities are installed. The amount recognised is the present value of the estimated future expenditure. A corresponding amount equivalent to the provision is also recognised as part of the cost of the related oil and gas property.
This is subsequently depreciated as part of the capital costs of the production facilities. Any change in the present value of the estimated expenditure is dealt with from the start of the financial year as an adjustment to the opening provision and the oil and gas property. The unwinding of the discount is included as a finance cost.
10. Property, plant and equipment continued
Impairment charge Natural disasters Decommissioning obligations
The impairment charge in the current year relates entirely to the Huntington asset in the UK. The impairment charge of US$20.5 million was calculated by comparing the future discounted pre-tax cash flows expected to be derived from production of commercial reserves (the value-in-use) against the carrying value of the asset.
The future cash flows were estimated using the following oil price assumption: Natural disasters Decommissioning obligations
US$60/bbl in 2019, US$65/bbl in 2020,US$70/bbl in 2021 and US$75/bbl in ‘real’ terms thereafter (2017: two years at forward curve, year three at US$70/bbl followed by a long-term price of US$75/bbl (real)) and were discounted using a pre-tax discount rate of 9 per cent for the UK assets (2017: 9 per cent) and 12.5 per cent for the non-UK assets (2017: 12.5 per cent).
Assumptions involved in impairment measurement include estimates of commercial reserves and production volumes, future oil and gas prices, discount rates and the level and timing of expenditures, all of which are inherently uncertain. Natural disasters Decommissioning obligations
The principal cause of the impairment charge being recognised in the year was as a result of an increase in the expected decommissioning costs attributed to the asset. The prior year impairment charge was principally driven by a downgrade in 2P reserves on the Solan asset. Natural disasters Decommissioning obligations
Reversal of previously recognised impairment charges Natural disasters Decommissioning obligations
Under the requirements of IAS 36, if there is an indication that a factor that resulted in an impairment charge may have changed or been reversed, then the previously recognised impairment charge may no longer exist or may have decreased. Natural disasters Decommissioning obligations
For a number of assets, due to an increase in the near-term oil price assumption (based on the Dated Brent forward curve), we have reassessed the recoverable amount of the asset to assess whether an increase in the recoverable amount (value-in-use) is indicative of a reversal of a previously recognised impairment charge.
The future cash flows were determined using the same assumptions as those used for the impairment charge outlined above.
A reversal of impairment of US$55.7 million has been credited to the income statement for the year, which has been partially offset by the impairment charge recognised.
The impairment reversal relates entirely to Solan in the UK as a result of a reduction in the expected gross decommissioning cost attributed to the asset. The recoverable amount of Solan at 31 December 2018 was US$171.4 million. The prior year reversal of impairment was driven by a one year extension of COP on the Huntington asset.
11. Receivables Natural disasters Decommissioning obligations
Long-term receivables Natural disasters Decommissioning obligations
Other long-term receivables include US$101.2 million in cash held in escrow accounts for expected future decommissioning expenditure in Indonesia, Vietnam and Mauritania (2017: US$88.1 million). Natural disasters Decommissioning obligations
The decommissioning funding asset relates to the Decommissioning Liability Agreement entered into with E.ON whereby E.ON agreed to part fund Premier’s share of decommissioning the Johnston and Ravenspurn North assets. Under the terms of the agreement, E.ON will reimburse 70 per cent of the decommissioning costs between a range of £40 million to £130 million based on Premier’s net share of the total decommissioning cost of the two assets. Natural disasters Decommissioning obligations
This results in maximum possible funding of £63 million from E.ON. At 31 December 2018, a long-term decommissioning funding asset of US$48.3 million has been recognised utilising the year-end US$/£ exchange rate and underlying assumptions consistent with those used for the corresponding decommissioning provision.
17. Provisions Natural disasters Decommissioning obligations
The decommissioning provision represents the present value of decommissioning costs relating to oil and gas interests in the UK, Indonesia, Vietnam, Pakistan and Mauritania which are expected to be incurred up to 2038. These provisions have been created based on Premier’s internal estimates and, where available, operators estimates. Based on the current economic environment, assumptions have been made which are believed to be a reasonable basis upon which to estimate the future liability.
These estimates are reviewed regularly to take into account any material changes to the assumptions. However, actual decommissioning costs will ultimately depend upon future market prices for the necessary decommissioning works required, which will reflect market conditions at the relevant time. Furthermore, the timing of decommissioning is likely to depend on when the fields cease to produce at economically viable rates. This in turn will depend upon future oil and gas prices, which are inherently uncertain.
A discount rate of 4.6 per cent and an inflation rate of 2.5 per cent have been applied to all decommissioning estimates when determining the net present value of the decommissioning provision. Rig rates used to determine the relevant part of the decommissioning cost estimates are based on a rolling five-year average observed in the market place for similar types of rigs, except where decommissioning is expected to occur in the near-term and then a spot price (or actual price received during a rig tender process) is used.
The oil and gas price assumptions used to determine the field life COP are consistent with those applied for the impairment assessment (see note 10). Decommissioning provisions include expected future obligations for Ravenspurn North and Johnston assets in the UK. The first £63 million of decommissioning expenditure related to these assets is funded via a separate agreement with E.ON, see note 11.
The contingent consideration is the closing year-end fair value of the royalty stream payable to Chrysaor for the acquisition of 40 per cent of the Solan asset in May 2015. The estimate of fair value of this contingent consideration includes unobservable inputs and is level 3 in the IFRS 13 hierarchy and is held at fair value through profit and loss. The movement in fair value for the year was US$1.2 million charge (2017: US$10.7 million income) and has been recognised within other operating costs.
Indonesia unfunded termination benefit provision
In Indonesia, the Group operates a Service, Severance and Compensation pay scheme under a Collective Labour Agreement with the local workforce. In early 2003, the Government of Indonesia introduced a labour law which requires that on dismissal, companies are required to make certain payments to employees that are dependent on numbers of years’ service and salary. The ‘scheme’ effectively provides a termination benefit to employees, but does not represent a defined benefit pension scheme.
The Company operates a defined termination benefit scheme, the cost of providing benefits is determined using the projected unit credit method, with valuations being carried out at each balance sheet date. Gains and losses are recognised immediately. Past service cost is also recognised immediately to the extent that the benefits are already vested, and otherwise is amortised on a straight line basis over the average period until the benefits become vested. The provision recognised in the balance sheet represents the present value of the defined benefit obligation as adjusted for unrecognised past service cost.
23. Capital commitments and guarantees
In addition, the Group had issued letters of credit for future decommissioning liabilities totalling £288.1 million, US$22.6 million held as security for the Mexican letters of credit and a performance bond for the Indonesia Andaman licence of US$0.6 million, totalling US$389.1 million (2017: US$398 million).
Natural disasters Decommissioning obligations
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