The sanctions that have hit Russia since it invaded Ukraine have significant repercussions for companies operating in the country, particularly in fossil fuels. TotalEnergies had bet big on Russia, in particular via the Yamal and LNG and Arctic LNG 2 projects, or the Kharyaga and Termokarstovoye deposits.
Arctic LNG 2
But let’s take a closer look at Arctic LNG 2. The French major and its partners launched the investment decision in 2019. The project, located on the Gydan peninsula in Russia, is characterized by a liquefied gas production capacity of 19.8 million tons per year. The first LNG cargo ship Arctic LNG 2 was to set sail in 2023. TotalEnergies holds a 10% direct stake in the project, to which is added an 11.6% indirect stake through its presence in the capital of Novatek, the main operator of Arctic LNG 2. TTE’s overall economic stake in Arctic LNG 2 is therefore 21.6%.
Given the new geopolitical context, TotalEnergies took advantage of the closing of its accounts on 1er quarter of 2022 to provision an amount of $4.1 billion. This amount is very high, even if it does not reach the $25.5 billion announced by BP Plc, which has chosen to completely cut ties with Russia. But what exactly does it correspond to?
To understand this, let’s start with slide n°5 of the March 24, 2022 presentation (Strategy, Sustainability & Climate). We understand that the direct participation of TotalEnergies in Arctic LNG 2 translates into $2.5 billion in capital employed. Beyond this exposure of $2.5 billion, TotalEnergies has granted guarantees in its capacity as shareholder for the benefit of the lenders to cover its share of the debt within the framework of the financing of the project. On Arctic LNG, this exposure amounts to approximately $800 million.
TotalEnergies exhibition in Russia (source: slide n°5 presentation March 23, 2022)
This presentation slide is relatively important since it allows shareholders to understand at what levels the group is exposed in Russia. It is these various shareholdings and commitments that have been the subject of impairments and provisions.
Distinguish provision for depreciation and provision for risks and charges
Provisions for depreciation in assets (most often called “Depreciation”) record an accidental and non-definitive loss in value of an asset. They differ in particular from depreciation, which recognizes an irreversible depreciation. Moreover, while only fixed assets can be depreciated, all assets are susceptible to accidental depreciation and can therefore be subject to provisions for depreciation.
Provisions for risks and charges are intended to cover identified and real risks relating to the company’s activity, but the amount and timing of which are uncertain. See it as a reserve intended to anticipate more or less well-evaluated future charges.
Accounting treatments
- Money always present in the accounts
These two types of allocations to provisions result in an expense item in the income statement and reduce the company’s results (thus for TTE the net income group share goes from $8,977 million to $4,944 million) while factually the money has not yet left the group’s accounts (without effect on the cash flow).
- The balance sheet must remain balanced
Knowing that the company’s net profit (reduced by the presence of provisions) slides, at the end of the financial year, at the level of shareholders’ equity in the balance sheet, it is necessary to balance it. The mechanism is different if it is a depreciation or a provision for risks and charges:
- In the case of a provision for depreciationbalance is achieved by the fact that the asset is reduced by the same amount as the provision recorded under expenses.
- In the case of a provision for risks and chargesthe assets do not move, it is only in the liabilities that the balancing takes place: the provision must be perceived as a new resource and comes to increase the liabilities of the company, which has the effect of neutralizing the difference between the adjusted net result and the actual net result recorded at the end of the financial year at the level of shareholders’ equity.
Recovery of provisions
What is important to remember is that the depreciations record a loss of value which is not final and that the provisions for risks and charges may be poorly calibrated. The context that led the company to make these provisions may change and it will therefore have to act accordingly, i.e. partially or totally take back the provision or increase it if the probability that the risk materializes increased.
For example, in the case of provisions for risks and charges, it must be clearly understood that the provision is made when the risk is highly probable, but the amount that the company will have to spend to face this risk is only estimated, it is not clearly defined. The maturity date of this risk is not known either. At the end of the year, if we assume that the risk no longer exists, we will take back the money that is in the liabilities and consider that it is a product in the income statement. The provision will disappear from the balance sheet. If the anticipated charges are indeed recognized over one or more subsequent years, then the recovery of the provisions made in 2021 by TTE will neutralize the corresponding charges which will therefore have no impact on the results of the years in question.
The case of the TotalEnergies provision
In its publication, when TotalEnergies speaks of a provision of $4.1 billion, it is actually a mix between depreciation and provisions for risks and charges. The exact detail of what has been taken into account is however very difficult to obtain, especially since this $4.1 billion does not only concern the activities of Arctic LNG 2 but also other Russian assets to which the group is exposed.
Basically, the accounting maneuver carried out by TTE consists in assuming on the one hand the loss of value of its participation in the project (depreciation) and on the other hand the expenses which did not take place during the quarter but which great chances of being observed in the years to come. The key point is that TTE recorded these provisions over a particularly good quarter (which occasionally reduces its tax base) and wrapped this accounting maneuver in a nice communication operation. The group will be able to use this new line of resources created to potentially absorb heavy costs over a financial year that could be less good.
The same kind of accounting maneuvers can be carried out when there is a restructuring of a group. This news is generally well received by the market when the group manages to append it to a nice publication, while it is nevertheless a question of signaling to the shareholders that risks unforeseen at the start are in the process of materializing.