Key drivers and risks
Fortum's financial results are exposed to a number of economic, strategic, political, financial and operational risks.
One of the key factors influencing Fortum's business performance is the wholesale price of electricity in the Nordic region. The key drivers behind the wholesale price development in the Nordic region are the supply-demand balance, the prices of fuel and CO2 emissions allowances, and the hydrological situation.
The continued uncertainty in the global and European economies has kept the outlook for economic growth unpredictable. The overall economic uncertainty impacts commodity and CO2 emissions allowance prices, and this could maintain downward pressure on the Nordic wholesale price of electricity. In Fortum's Russian business, the key drivers are economic growth, the rouble exchange rate, regulation around the heat business, and the further development of the electricity and capacity markets. In all regions, fuel prices and power plant availability also impact profitability. In addition, increased volatility in exchange rates due to financial turbulence could have both translation and transaction effects on Fortum's financials, especially through the Russian rouble and Swedish krona.
In the Nordic countries, the regulatory and fiscal environment for the energy and environmental management sectors has also added risks for companies. The main strategic risk is that the regulatory and market environment develops in a way that we have not been able to foresee and prepare for. In response to these uncertainties, Fortum has analysed and assessed a number of future energy market and regulation scenarios, including the impact of these on different generation forms and technologies. As a result, Fortum’s strategy was renewed in 2016 to include broadening the base of revenues and diversification into new businesses, technologies and markets. The environmental management business is based on the framework and opportunities created by the environmental regulation. Being able to respond to the customer needs created by the tightening regulation is a key success factor.
Despite macroeconomic uncertainty, electricity is expected to continue to gain a higher share of total energy consumption. Electricity demand in the Nordic countries is expected to grow by approximately 0.5% on average, while the growth rate for the next few years will largely be determined by macroeconomic developments in Europe, and especially in the Nordic countries.
During January-March 2017, the oil price continued to increase, the coal price stayed fairly stable, and the price of CO2 emission allowances (EUA) declined. The price of electricity for the upcoming twelve months decreased in the Nordic area as well as in Germany.
In mid-April 2017, the quotation for coal (ICE Rotterdam) for the remainder of 2017 was around USD 71 per tonne and for CO2 emission allowances for 2017 around EUR 5 per tonne. The Nordic system electricity forward price in Nasdaq Commodities for the rest of 2017 was around EUR 26 per MWh and for 2018 around EUR 23 per MWh. In Germany, the electricity forward price for the rest of 2017 was around EUR 33 per MWh and for 2018 around EUR 30 per MWh. Nordic water reservoirs were about 2 TWh below the long-term average and 8 TWh below the corresponding level in 2016.
The Generation segment’s achieved Nordic power price typically depends on such factors as the hedge ratios, hedge prices, spot prices, availability and utilisation of Fortum's flexible production portfolio, and currency fluctuations. Excluding the potential effects from changes in the power generation mix, a 1 EUR/MWh change in the Generation segment’s Nordic power sales achieved price will result in an approximately EUR 45 million change in Fortum's annual comparable operating profit. In addition, the comparable operating profit of the Generation segment will be affected by possible thermal power generation volumes and its profits.
As a result of the nuclear stress tests in the EU, the Swedish Radiation Safety Authority (SSM) has decided on new regulations for Swedish nuclear reactors. For the operators, this means safety investments that should be in place no later than 2020.
The process to review the Swedish nuclear waste fees is done in a three-year cycle. The Swedish Nuclear Fuel and Waste Management Co (SKB) has updated the new technical plan for the SSM to review. The final decision on the new nuclear waste fees will be made by the Swedish government in December 2017. However, as a result of the decision on early closure of nuclear power plants, SSM recalculated the waste fees for the Oskarshamn and Ringhals power plants.
In April 2017, the Swedish government announced that during the second quarter they will submit a proposal to the parliament regarding the calculations of nuclear waste fees and the investment of the nuclear waste fund. According to the announcement the operating time for calculating the waste fee would be 50 years, as opposed to the current 40 years. The fund would also be allowed to invest in other financial instruments than government bonds. The proposed changes are expected to reduce the nuclear waste fees.
In September 2016, the Swedish government presented the budget proposal for the coming years. One of the key elements was the proposal that taxation of different energy production forms should be more equal and the tax burden of nuclear and hydro should be taken to the level of other production technologies. The budget states that the nuclear capacity tax will be reduced to 1,500 SEK/MW per month from 1 July 2017 and abolished on 1 January 2018. In 2017, the tax for Fortum is estimated to decrease by approximately EUR 32 million to EUR 52 million due to the tax decrease and by another EUR 5 million due to the premature closure of Oskarshamn 1 in the middle of the year. In 2018, there is no capacity tax.
The hydropower real-estate tax will decrease over a four-year period beginning in 2017, from todays 2.8% to 0.5%. The real-estate tax on hydro will, as stated in the government’s budget, be reduced in four steps: in January 2017 to 2.2%; in January 2018 to 1.6%; in January 2019 to 1.0%; and in January 2020 to 0.5%. In 2017, the tax for Fortum is estimated to decrease by approximately EUR 20 million to approximately EUR 95 million.
In addition to the decrease in the tax rate, the hydropower real-estate tax values, which are linked to electricity prices, will be updated in 2019. The real-estate tax values are updated every six years. With the current low electricity prices, the tax values in 2019 will be clearly lower than today. The process for renewing existing hydro permits will also be reformed.
In October 2016, the Swedish Energy Agency presented a concrete proposal on how to increase the production of renewable electricity by 18 TWh in 2020-2030 within the electricity certificate system, as part of the Energy Agreement. In April 2017, the Swedish government decided that the increase will be carried out in a linear manner.
In 2015, Swedish OKG AB decided to permanently discontinue electricity production at Oskarhamn’s nuclear plant unit 1 and 2. The discontinuing of production and start of decommissioning has been set to 30 June 2017 in unit 1. Unit 2, which has been out of operation since June 2013, will stay out of operation. The closing processes for both units are estimated to take several years.
In City Solutions steady growth, cash flow and earnings are achieved through investments in new plants and through acquisitions. Fuel cost, availability, flexibility and efficiency as well as gate fees are key drivers in profitability, but also power supply/demand balance, electricity price and the weather affect the profitability.
In May 2016, the Finnish government decided to increase the tax on heating fuels by EUR 90 million annually from 2017 onwards. The negative impact on Fortum is estimated to be approximately EUR 5 million per year.
In the Consumer Solutions profitability is achieved by competitive product offerings, efficient operations, scale benefits in systems and operations as well as prudent risk management. As the Consumer Solutions segment hedges most of the market risk exposure it is typically more exposed to short-term variations in power prices and demand than long-term price trends. Short-term volatility, often caused by temperature, can have a substantial impact on power prices as well as power demand. The competitive environment effects the Consumer Solutions segment both through the sales margins of the products sold as well as the size of the customer base.
The Russia segment's new capacity generation built after 2007 under the Russian Capacity Supply Agreement (CSA) is a key driver for earnings growth in Russia, as it is expected to bring income from new volumes sold and also to receive considerably higher capacity payments than the old capacity. Fortum will receive guaranteed capacity payments for a period of 10 years from the commissioning of a plant. The received CSA payment will vary depending on the age, location, size and type of the plants, as well as on seasonality and availability. CSA payments can vary somewhat annually because they are linked to Russian Government long-term bonds with 8 to 10 years maturity. In addition, the regulator will review the earnings from the electricity-only market three years and six years after the commissioning of a unit and could revise the CSA payments accordingly.
The long-term Competitive Capacity Selection (CCS) for the years 2017-2019 was held at the end of 2015, and the long-term CCS for year 2020 was held in September 2016. The majority of Fortum’s plants were selected. The volume of Fortum’s installed "old" capacity not selected in the auctions totalled 195 MW (out of 2,214 MW), for which Fortum has obtained forced mode status, i.e. it will receive payments for the capacity.
The Russian annual average gas price growth was 3.6% in 2016. Fortum estimates the Russian annual average gas price growth to be 2.0% in 2017.
Capital expenditure and divestments
Fortum currently expects its capital expenditure, excluding acquisitions, to be approximately EUR 800 million in 2017. The annual maintenance capital expenditure is estimated to be below EUR 300 million in 2017, well below the level of depreciation.
The effective corporate income tax rate for Fortum in 2017 is estimated to be 19-21%, excluding the impact of the share of profits of associated companies and joint ventures, non-taxable capital gains and non-recurring items.
At the end of March 2017, approximately 55% of Generation's estimated Nordic power sales volume was hedged at EUR 29 per MWh for the rest of 2017 and approximately 45% at EUR 27 per MWh for 2018.
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 electricity derivatives quoted on Nasdaq Commodities.
Text from Fortum January-March 2017 Interim Report