Commodity market and fuel risks
Fortum’s business is exposed to fluctuations in prices and availability 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 approved Hedging Guidelines and Mandates. For further information on hedge ratios, exposures, sensitivities and outstanding derivatives contracts, see Note 4 Financial risk management.
Electricity price and volume risks
In competitive electricity markets, such as the Nordpool spot market exchange in the Nordic region, the wholesale price of electricity 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, wind, CO2 allowance prices, fuel prices, economic development, transmission capacity and the import/export situation.
Electricity price risks are mainly hedged by entering into electricity derivatives contracts on the Nasdaq Commodities exchange. The ability to implement hedging strategies is dependent on a well-functioning and liquid derivatives market. There is a risk of decreasing liquidity on the Nasdaq Commodities exchange, and alternatives including use of OTC derivative contracts and proxy products traded on other exchanges are used to mitigate this risk. Hedging strategies are continuously evaluated as electricity and other commodity market prices, the hydrological balance and other relevant parameters change. Hedging of the Generation segment’s power sales is performed in EUR on a Nordic level covering both Finland and Sweden, and the currency component of these hedges in the Swedish entity is currently not hedged. In Russia, electricity prices and capacity sales are the main sources of market risk. The electricity price is highly correlated with the gas price. Exposure is partly mitigated through regulated fixed-price bilateral agreements, but the majority of electricity sales is exposed to spot price risk. 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 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 factors influencing the prices of CO2 allowances and other environmental values are political decisions and the supply and demand balance. Fortum hedges its exposure to these prices and volumes through the use of CO2 futures 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, there are also risks related to imported fuels from Russia.
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. 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.
Fortum's sensitivity to electricity market price is dependent on the hedge level for a given time period. As per 31 December 2018, approximately 75% of the Generation segment's estimated Nordic power sales volume was hedged for the calendar year 2019 with a price 31 EUR/MWh and approximately 45% for the calendar year 2020 with a price 29 EUR/MWh. Assuming no changes in generation volumes, hedge ratios or cost structure a 1 EUR/MWh change in the market price of electricity would affect Fortum's 2019 comparable operating profit by approximately EUR 11 million and for 2020 by approximately EUR 25 million. The volume used in this sensitivity analysis is 45 TWh which includes the electricity generation sold to the spot market in Sweden and Finland in the Generation segment without minority owner's shares of electricity or other passthrough sales, and excluding the volume of Fortum's coal-condensing generation. This volume is heavily dependent on price level, the hydrological situation, the length of annual maintenance periods and availability of power plants. Sensitivity is calculated only for electricity market price movements. Hydrological conditions, temperature, wind, CO2 allowance prices, fuel prices, economic development, transmission capacity and the import/export situation all affect the electricity price on short-term basis and effects of individual factors cannot be separated.
Sensitivity according to IFRS 7
Sensitivity analysis shows the sensitivity arising from financial electricity derivatives as defined in IFRS 7. These derivatives are used for hedging purposes within Fortum. Sensitivities are calculated based on 31 December 2018 (31 December 2017) position. Positions are actively managed in the day-to-day business operations and therefore the sensitivities vary from time to time. Sensitivity analysis includes only the market risks arising from derivatives i.e. the underlying physical electricity sales and purchases are not included. Sensitivity is calculated with the assumption that electricity forward quotations in Nasdaq Commodities and in EEX would change 1 EUR/MWh for the period Fortum has derivatives.
|+/- 1 EUR/MWh change in electricity forward quotations, EUR million||Effect||2018||2017|
|Effect on profit before income tax||+/-||1||27|
|Effect on equity||+/-||56||28|
Liquidity and refinancing risks
Fortum's business is capital intensive and there is a regular need to raise financing. Fortum maintains a diversified financing structure in terms of debt maturity profile, debt instruments and geographical markets. Liquidity and refinancing risks are managed through a combination of cash positions and committed credit facility agreements with its core banks. The credit risk of cash positions has been mitigated by diversifying the deposits to high-credit quality financial institutions and issuers of corporate debt.
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 material transaction exposures should be hedged while translation exposures are not hedged, or are hedged selectively. An exception is the Generation segment’s hedging of power sales in Sweden where the currency component is currently not hedged. The main translation exposures toward the EUR/RUB, EUR/SEK and EUR/NOK are monitored continuously. Changes in these currency rates affect Fortum’s profit level and equity when translating results and net assets to euros.
Counterparty & credit risks
Fortum is exposed to counterparty risk whenever there is a contractual arrangement with an external counterparty including customers, suppliers, partners, banks, clearing houses and trading counterparties.
Credit risk exposures relating to financial derivative instruments are often volatile. The majority of commodity derivatives are exchange-traded and cleared through clearing houses such as Nasdaq Clearing AB or through clearing banks. The recent default of a trader active on Nasdaq Commodities has shown that there is also credit risk toward clearing houses. The trend toward more use of futures contracts instead of forward contracts is decreasing the credit exposure toward clearing houses. Derivatives contracts are also entered into directly with external counterparties and 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. The majority of the exposure is toward Fortum's key relationship banks, which are highly creditworthy institutions, but also 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.
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 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.
More detailed information about Fortum's financial risk management is described in the company's Financial Statements and Operating and Financial Review.