Risks and sensitivities

Fortum’s financial results are exposed to a number of financial, operational, strategic, and sustainability-related risks. Fortum is exposed to these risks both directly and indirectly through its subsidiaries, associated companies, and joint ventures.

Risk update Q1 2020

Key drivers and risks

Fortum’s financial results are exposed to a number of financial, operational, strategic, and sustainability-related risks. Fortum is exposed to these risks both directly and indirectly through its subsidiaries, associated companies, and joint ventures. The most relevant companies are Uniper SE, Teollisuuden Voima Oyj (TVO), OKG AB, Forsmarks Kraftgrupp AB, Kemijoki Oy, TGC-1, and Stockholm Exergi AB. For more information about the risk exposures, please see each respective company’s annual report.

On 26 March 2020, Fortum became the majority shareholder of Uniper. Fortum consolidated Uniper into Fortum’s balance
sheet as of 31 March 2020. From the second quarter of 2020, Fortum will consolidate Uniper’s results into its income
statement. However, Uniper remains a separate company, listed in Germany, and therefore has its own risk management
systems, risk governance framework, and a separate disclosure of its material risks and uncertainties. As Uniper now is a subsidiary of Fortum, Fortum and Uniper have initiated discussions on risk management systems and frameworks to
ensure continued compliance with corporate governance codes, relevant disclosure requirements, and regulations.

Uniper’s business is predominantly exposed to the following four risk categories: market risk, credit risk, operational risk, and financial risk. Market risk comprises risks from market price movements (commodity, interest rates, and foreign exchange rates), as well as from the market environment. Operational risk includes risks related to Uniper’s asset operations, asset projects, IT, political & regulatory environment, legal proceedings, as well as people and process-related risks. Financial risks comprise margining risks, tax risks, and risks from unforeseeable non-periodic financial results. As per the end of the first quarter 2020, the categories credit risk, commodity price risk, foreign exchange rate risk and interest rate risk, legal risk, financial risk, as well as asset project risk are the major source of uncertainty for Uniper’s financial performance. For more information on the risk exposure, please see Uniper’s annual report and first-quarter 2020 financial results report.

One of the key factors influencing Fortum’s business performance is the Nordic electricity wholesale price. The key shortterm drivers behind the electricity wholesale price development in the Nordic region are commodity prices, such as coal and gas, European electricity wholesale prices, prices for CO2 emission allowances, the hydrological situation, temperatures, and the electricity import-export balance. In the longer term, global economic growth and changes to energy policy and regulations impact commodity and CO2 emission allowance prices, which, in turn, impact the Nordic wholesale price of electricity. In addition, increased volatility in exchange rates could have both translation and transaction effects on Fortum’s financials, especially through the Russian rouble and Swedish krona.

Operational risks resulting from failed internal processes or systems or from external events can have a negative impact
on Fortum’s results. In all regions, fuel prices and power plant availability also impact profitability.

Changes in the regulatory and fiscal environment create risks and opportunities for the energy and environmental
management business. 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 analyses and assesses a
number of future market and regulation scenarios, including the impact of these on different generation forms and
technologies. As a result, Fortum’s strategy includes broadening of the revenue base and diversification into new
businesses, technologies, and markets. The environmental management business is based on the framework and
opportunities created by environmental regulation. Being able to respond to customer needs created by the tightening
regulation is a key success factor.

For Fortum’s Russian business, the key drivers are economic growth, the rouble exchange rate, regulation of the heat
business, and the further development of the electricity and capacity markets. A key profitability driver is the received capacity payments based on the CSA contracts and CCS auctions. The main part of Fortum’s generation capacity built after 2007 is entitled to CSA payments for approximately 10 years after commissioning of each new unit (approximately 15 years for renewable generation). The received capacity payments vary, depending on the age, location, type, and size of the plant, as well as on seasonality and availability. The CSA payments are adjusted for, among other factors, the weighted average cost of capital (WACC), the consumer price index (CPI), and re-examination of earnings from the electricity-only (spot) market (done every three and six years after commissioning of a unit). In addition, thermal power plants are entitled to clearly higher CSA payments starting approximately six years after commissioning.

Due to the ongoing Covid-19 pandemic, the exposure to risk and uncertainty in all risk categories has increased
compared to the year-end situation. Specifically, market prices for Nordic electricity prices have fallen due to lower
commodity and CO2 prices and European demand as well as the extremely wet, warm, and windy winter in the Nordics.
Fortum’s hedges, especially for the remainder of 2020, will offer some protection against short-term fluctuations in Nordic electricity and other commodity market prices, but if the Covid-19 pandemic continues longer than expected or results in a more severe economic downturn than anticipated, results will be negatively impacted, as the hedge level for future years is lower.

Additionally, there is an increased risk of credit defaults caused by the abrupt shut-down of society in many parts of the world. Fortum hedges the majority of its Nordic power production through exchanges where contracts are cleared through clearing houses, such as Nasdaq Clearing AB, thus limiting credit exposure. However, Fortum also has retail electricity and heat sales to businesses and households primarily in the Nordics, Poland, and Russia as well as exposure towards customers in the recycling and waste solutions business. Credit defaults have not yet had a significant impact, but if the pandemic continues for a longer period of time without sufficient support schemes for affected businesses, we expect to see increased default rates and delayed payments from customers, especially in the small and medium businesses in high-risk sectors.

Operational risks have also increased due to the pandemic. Travel restrictions, risk of prolonged absences of key
personnel, and difficulties in obtaining key materials, parts, and resources from our suppliers increase the risk of
operational incidents or prolonged maintenance periods. So far, the risks have been mitigated through activation of
business continuity plans and a review of the timing and prioritisation of maintenance work. However, the longer the
Covid-19 pandemic continues, the higher the risk of such incidents in the future.

Fortum has established a pandemic task force that is closely monitoring the development of the pandemic and its effects
on our operations so that we can quickly respond to changes and continue to ensure safe and reliable delivery of
electricity, heat and related services.

Financial risk management in Fortum

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.

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 emission 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 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. In 2019, the models used for evaluating hedging strategies and reporting risk were developed to
cover more parameters and improve the use of especially hydrological data. 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 and capacity prices are the main source of market risk. Electricity price exposure is partly mitigated through regulated fixed-price bilateral agreements, but the majority of electricity sales is exposed to spot price risk. Capacity from newer units is sold under capacity supply agreements where the price is set by the Russian Federation to ensure the return on investments. Capacity from old units has been sold until 2024 via capacity supply auctions which have already been conducted.

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. However, Russia has announced intentions to comply with the Paris Agreement, but there is uncertainty related to how and when a possible carbon market could be implemented.

The main factors influencing the prices of CO2 emission 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 derivatives 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, e.g. increased demand growth in developing countries, natural disasters or supply constraints in countries experiencing political or social unrest. For fuels that are sourced on local or regional 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 current sanctions, 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 which is partially regulated limiting the price risk exposure.

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 2019 (31 December 2018) 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 and futures 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 2019 2018
Effect on profit before income tax +/- 4 1
Effect on equity +/- 49 56

 

Liquidity and refinancing risks

Fortum's business is capital intensive and there is a constant need to ensure efficient 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. The credit risk of cash positions has been mitigated by diversifying the deposits to high-credit quality financial institutions and
issuers of corporate debt.

Fortum’s access to and cost of financing is dependent on having an investment-grade rating. The current investment in Uniper has increased Fortum’s leverage, and with the announced increase in ownership, there is an increased risk of downgrade in the credit rating which could negatively impact Fortum’s access to cost-efficient financing. After the
closing of transaction, through which an additional minimum of 20.5% share in Uniper will be acquired, Fortum’s key objective is to maintain an investment-grade rating and to strengthening its financial profile longer term. Fortum maintains an active dialogue with credit rating agencies to ensure understanding of Fortum’s strategy and planned measures which
target to achieve a financial and business profile that supports a solid investment grade rating.

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. During 2019, Nasdaq Clearing AB has continued implementation of its risk management enhancement program in order to reduce the risk of member defaults. In addition, 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 toward a number of banks and financial institutions. The majority of the exposure is to 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 risks and risk management is described in the company's Financial Statements and Operating and Financial Review 2019 on pages 25 and 48 as well as in Corporate Governance Statement 2019 on page 11.

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