The following outlook was published in accordance with Fortum's January-June Interim Report on 20 July 2016.
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, as well as 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 further development of 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 sector has also added risks for utility companies.
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-June 2016, oil and coal prices increased, while the price of CO2 emission allowances (EUA) declined. The price of electricity for the upcoming twelve months appreciated in the Nordic area as well as in Germany, but both are still on lower levels than at the end of the second quarter of 2015.
In mid-July 2016 the quotation for coal (ICE Rotterdam) for the remainder of 2016 was around USD 61 per tonne, and for CO2 emission allowances for 2016 around EUR 5 per tonne. The Nordic system electricity forward price in Nasdaq Commodities for the rest of 2016 was around EUR 26 per MWh and for 2017 around EUR 23 per MWh. In Germany, the electricity forward price for the rest of 2016 was around EUR 29 per MWh and for 2017 around EUR 28 per MWh. Nordic water reservoirs were about 3 TWh below the long-term average and 8 TWh above the corresponding level in 2015.
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, as well as on 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 the possible thermal power generation volumes and its profits.
In Finland, the technical plan and cost estimates for nuclear waste management are updated every third year. The new technical plan was published in 2015 and related cost estimates were updated during the second quarter of 2016. The update had a minor positive impact on Fortum which is included in the result for the second quarter of 2016.
As a result of the nuclear stress tests in the EU, the Swedish nuclear safety authority (SSM) has decided to propose new regulations for Swedish nuclear reactors. The process is ongoing. Fortum emphasises that maintaining a high level of nuclear safety is the highest priority, but considers EU-level harmonisation of nuclear safety requirements to be of continued importance.
In 2015, the Swedish Government increased the nuclear waste fund fee from approximately 0.022 to approximately 0.04 SEK/kWh for the 2015-2017 period. The estimated impact on Fortum is approximately EUR 25 million annually. The process to review the Swedish nuclear waste fees is done in a three-year cycle. However, as a result of the decision on early closure of nuclear power plants, the Swedish Radiation Safety Authority, SSM, recalculated the waste fees for the Oskarshamn and Ringhals power plants. The political energy agreement made in June 2016 stated that the regulatory framework for the nuclear waste fund will be reformed in order to enhance yield and the lifetime in the waste fee calculation would possibly be extended from 40 to 50 years.
It was also decided in the energy agreement that the tax on installed nuclear capacity will be phased out over two years starting in 2017. The tax was previously increased by 17% as of 1 August 2015 and will hence have an estimated impact on Fortum totalling approximately EUR 15 million in 2016, albeit corporate tax-deductible.
In addition, the hydropower real estate tax was decided to be decreased over a four-year period starting in 2017, from todays 2.8% to 0.5% and the process for renewing existing hydro permits will be reformed, in order to safeguard small hydro in particular.
OKG AB decided in 2015 to permanently discontinue electricity production at Oskarshamn unit 1 and start decommissioning after permission for service operation has been granted by the relevant Swedish authorities. The first two stages of the decommissioning process were approved in June 2016. The date for discontinued production and the start of decommissioning has been set to 30 June 2017. Oskarshamn unit 2, which has been out of operation since June 2013 due to an extensive safety modernisation, will stay out of operation. The closing processes are estimated to take several years.
In May, 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.
The Russia segment's new capacity generation built after 2007 under the Russian Government's 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. The regulation related to the time frame (10 vs.15 years) regarding the calculation of capacity payments was finally approved in June 2016. The decision was to keep the current 10 year time frame, and Fortum will hence 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.
According to rules approved by the Russian Government in 2015, the competitive capacity selection for generation built prior to 2008 (CCS, without capacity supply agreements) takes place annually. At the end of 2015, the CCS for 2016 and the long-term CCS for 2017-2019 were held. The majority of Fortum’s plants were selected. The volume of Fortum’s installed "old" capacity not selected in the auction totalled 195 MW (out of 2,257 MW), for which Fortum has obtained forced mode status, i.e. it will receive payments for the capacity. In 2016, the CCS for year 2020 will take place.
In 2014, the new heat market model roadmap proposed by the Ministry of Energy was approved by the Russian Government. If implemented, the reform should provide heat market liberalisation by 2020 or, in some specific areas, by 2023. In May 2016, the draft law on the heat reform was submitted by the Russian Government to the state Duma (Parliament). The law still requires the consent of the regional and local authorities before starting the reform in certain pilot regions. The Parliament hearings will begin in the autumn of 2016.
The targeted operating profit (EBIT) level of RUB 18.2 billion in the Russia segment is expected to be reached during 2017-2018. The segment’s profits are impacted by changes in power demand, gas prices and other regulatory developments. Economic sanctions, the currency crisis, oil prices and the surge in inflation have impacted overall demand. As a result, gas prices and electricity prices have not developed favourably as expected. As forecasted by the Russian Ministry of Economic Development, the Russian annual average gas price growth is estimated to be 4.9% in 2016.
The euro-denominated result level will be volatile due to the translation effect. The income statements of non-euro subsidiaries are translated into the Group reporting currency using average exchange rates. The Russia segment's result is also impacted by seasonal volatility caused by the nature of the heat business, with the first and last quarter being clearly the strongest.
Restructuring of TGC-1 according to strategy in Russia
In December 2014, Fortum, Gazprom Energoholding LLC and Rosatom State Corporation signed a protocol to start a restructuring process of the ownership of TGC-1 in Russia. The discussions have not yet come to a conclusion. It is not possible to estimate the timetable.
Capital expenditure and divestments
Fortum currently expects its capital expenditure, excluding acquisitions, for its continuing operations in 2016 to be approximately EUR 650 million. The annual maintenance capital expenditure is estimated to be about EUR 300-350 million in 2016, below the level of depreciation.
The effective corporate income tax rate for Fortum in 2016 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 June 2016 approximately 75% of Generation's estimated Nordic power sales volume was hedged at approximately EUR 29 per MWh for the remainder of 2016. The corresponding figures for the 2017 calendar year were approximately 45% at approximately EUR 27 per MWh.
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.