Financial risk management in Fortum
Fortum’s business is exposed to fluctuations in prices andavailability of commodities used in the production and sales of energy products. The main exposure is toward electricity prices and volumes, prices of emissions and prices and availability of fuels. Fortum hedges its exposure to commodity market risks in accordance with annually approved Hedging Guidelines, Strategies and Mandates.
Electricity price risks
In competitive markets, such as in the Nordic region, the price is determined as the balance between supply and demand. The short-term factors affecting electricity prices and volumes on the Nordic market include hydrological conditions, temperature, CO2 allowance prices, fuel prices, economic development and the import/export situation.
Electricity price risks are hedged by entering into electricity derivatives contracts, primarily on the Nasdaq Commodities power exchange. Hedging strategies are continuously evaluated as electricity and other commodity market prices, the hydrological balance and other relevant parameters change. In Russia, electricity prices and capacity sales are the main sources of market risk. The electricity price is highly correlated with the gas price and prices are fixed through bilateral agreements limiting exposure. In India, the electricity price received from solar production are fixed through long term power-purchasing agreements.
Emission and environmental value risks
The European Union has established an emissions trading scheme to reduce the amount of CO2 emissions. In addition to the emissions trading scheme, there are other trading schemes in environmental values in place in Sweden, Norway and Poland. Part of Fortum’s power and heat generation is subject to requirements of these schemes. There is currently no trading scheme in Russia for emissions or other environmental values.
The main factor influencing the prices of CO2 allowances and other environmental values is the supply and demand balance. Fortum hedges its exposure to these prices and volumes through the use of CO2 forwards and environmental certificates.
Fuel price and volume risks
Power and heat generation requires use of fuels that are purchased on global or local markets. The main fuels used by Fortum are natural gas, uranium, coal, various biomass-based fuels and waste. The main risk factor for fuels that are traded on global markets such as coal and natural gas, is the uncertainty in price. Prices are largely affected by demand and supply imbalances that can be caused by, for example, increased demand growth in developing countries, natural disasters or supply constraints in countries experiencing political or social unrest. For fuels traded on local markets, such as bio-fuels, the volume risk in terms of availability of the raw material of appropriate quality is more significant as there may be a limited number of suppliers. Due to the sanctions and economic development in Russia, the risks related to imported fuels from Russia have increased.
In the Nordic market, exposure to fuel prices is limited due to Fortum’s flexible generation capacity which allows for switching between different fuels according to prevailing market conditions. In some cases, the fuel price risk can be transferred to the customer. The remaining exposure to fuel price risk is mitigated through fixed- price physical delivery contracts or derivative contracts. The main fuel source for heat and power generation in Russia is natural gas. Natural gas prices are partially regulated, so the price risk exposure is limited.
Liquidity and refinancing risks
The power and heat business is capital intensive and Fortum has a regular need to raise financing. Fortum maintains a diversified financing structure in terms of debt maturity profile, debt instruments and geographical markets. Fortum manages liquidity and refinancing risks through a combination of cash positions and committed credit facility agreements with its core banks.
After the Distribution divestments, Fortum has a large cash position. The credit risk of this position has been mitigated by diversifying the deposits to high-credit quality financial institutions and issuers of corporate bonds.
Currency and interest rate risks
Fortum’s debt portfolio consists of interest-bearing liabilities and derivatives on a fixed- and floating-rate basis with differing maturity profiles. Fortum manages the duration of the debt portfolio through use of different types of financing contracts and interest rate derivative contracts such as interest rate swaps.
Fortum’s currency exposures are divided into transaction exposures (foreign exchange exposures relating to contracted cash flows and balance sheet items where changes in exchange rates will have an impact on earnings and cash flows) and translation exposure (foreign exchange exposure that arises when profits and balance sheets in foreign entities are consolidated at the Group level). The main principle is that all material transaction exposures should be hedged while translation exposures are not hedged, or are hedged selectively. The main translation exposures toward the EUR/RUB and EUR/SEK are monitored continuously. When these currencies are weak they affect Fortum’s profit level and equity when translating results and net assets to euros.
Fortum is exposed to counterparty risk whenever there is a contractual arrangement with an external counterparty including customers, suppliers, partners, banks and trading counterparties.
Credit risk exposures relating to financial derivative instruments are often volatile. Although the majority of commodity derivatives are cleared through exchanges, derivatives contracts are also entered into directly with external counterparties. Such contracts are limited to high-credit-quality counterparties active on the financial or commodity markets.
Due to the financing needs and management of liquidity, Fortum has counterparty credit exposure to a number of banks and financial institutions. This includes exposure to the Russian financial sector in terms of deposits with financial institutions as well as to banks that provide guarantees for suppliers and contracting parties. Deposits in Russia have been concentrated to the most creditworthy state-owned or controlled banks. Limits with banks and financial institutions are monitored so that exposures can be adjusted as ratings or the financial situation changes, and Fortum is following the development of economic sanctions against Russia as part of the monitoring process.
Credit risk exposures relating to customers is spread across a wide range of industrial counterparties, small businesses and private individuals over a range of geographic regions. The majority of exposure is to the Nordic market, Poland and Russia. The risk of non-payment in the electricity and heat sales business in Russia is higher than in the Nordic market.
In order to manage counterparty credit risk, Fortum has routines and processes to identify, assess and control exposure. Credit checks are performed before entering into commercial obligations and exposure limits are set for all larger individual counterparties. Creditworthiness is monitored through the use of internal and external sources so that mitigating actions can be taken when needed. Mitigating actions include demanding collateral, such as guarantees, managing payment terms and contract length, and the use of netting agreements.
At the end of 2016, approximately 60% of the Generation segment's estimated Nordic power sales volume was hedged at EUR 30 per MWh for the 2017 calendar year and approximately 35% at EUR 26 per MWh for the 2018 calendar year.
The reported hedge ratios may vary significantly, depending on Fortum's actions on the electricity derivatives markets. Hedges are mainly financial contracts, most of them Nasdaq Commodities forwards.