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.
Key drivers and risks Q1 2023
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 principal associated companies and joint ventures are Teollisuuden Voima Oyj, Forsmarks Kraftgrupp AB, OKG AB and Kemijoki Oy. For more information, please see Fortum’s annual report.
Russia’s attack on Ukraine in February 2022 has severely impacted Fortum’s current and future businesses. A number of geopolitical risks that negatively impact Fortum’s businesses have realised, while other risks remain on an elevated level as a result of the war. Due to the Presidential decree (No. 302 of 25 April 2023), the Russian authorities seized control of Fortum’s Russian assets in April. Following the loss of control, Fortum will deconsolidate the Russia segment and will record an impairment of the remaining EUR 1.7 billion book value of the Russian assets in the second quarter of 2023. The continued lack of supply of Russian pipeline gas and other fuels from Russia to Europe could have follow-on implications for Nordic power prices and volatility, especially in case of a cold winter or disturbances to other sources of gas supply. A further escalation of the war could have severe implication, such as an increased risk of sabotage or direct attacks on, for example, energy infrastructure in Fortum’s operating countries.
The unpredictable nature of sanctions and possible countermeasures by Russia continue to pose a significant risk for Fortum. The EU, US and UK are implementing a various range of sanctions towards Russia, targeting, for example, the financial and energy sectors. Despite having lost control of the Russian business, the sanction risk remains for Fortum’s other businesses.
One of the key factors influencing Fortum’s business performance is the Nordic electricity wholesale price. In the Nordics, power prices exhibit significant short- and long-term variations on the back of several factors, including, but not limited to, weather conditions, outage patterns in production and transmission lines, CO2 emission allowance prices, commodity prices and the supply-demand balance. The Russian invasion of Ukraine drove commodity prices to new record levels and further increased price volatility. As a consequence, the EU and its member states have taken action with temporary market interventions (e.g. price caps and windfall taxation). If made permanent, these market interventions may pose a risk to business performance. Commodity prices decreased during January–March compared to year-end 2022 while price volatility continues to keep the commodity market at a high level.
However, the higher value combined with increased price volatility has led to a higher commodity price risk. An economic downturn, lower commodity prices, warm weather or wet hydrology could lead to significantly lower Nordic power prices, which would negatively impact earnings from Fortum’s outright power production. Fortum hedges its exposure to commodity market prices and reports on the hedging levels and hedged prices of its outright power on a quarterly basis. For more information, please see ‘Outlook’ in this Interim Report.
Fortum is exposed to liquidity and refinancing risks primarily through the need to finance its business operations, including margining and collaterals issued for commercial activities. Higher and more volatile commodity prices increase the net margining payments toward clearing houses and clearing banks, mainly settled in cash. Fortum mitigates this risk by entering into OTC derivatives contracts directly with bilateral counterparties without margining requirements. Consequently, credit exposure from hedges with OTC counterparties has increased. In general, due to Fortum’s net short position in Nordic power hedges the credit exposure tends to increase with the value of hedges if Nordic power prices decrease.
In March 2023, both S&P Global Ratings and Fitch rating agencies affirmed Fortum’s BBB rating and revised the outlook to stable. A lowering of the credit ratings, in particular to below investment-grade level (BB+ or below), could trigger counterparties’ rights to demand additional cash or non-cash collateral. Fortum targets to have a solid investment grade-rating of at least BBB. Fortum continues to constantly monitor all ratings-related developments and to regularly exchange information with the rating agencies.
Fortum’s business activities include energy generation, storage, distribution, and control of operations, as well as the construction, modernisation, maintenance and decommissioning of power plants or other energy industry facilities. Any unwanted operational event (which could be caused by e.g., technical failure, human or process error, natural disaster, sabotage, failure of key suppliers, or terrorist attack) can endanger personal safety or lead to environmental or physical damage, business interruptions, project delays and possible third-party liability. The associated costs can be high, especially in Fortum’s largest units and projects.
Mitigating climate change, adapting to it and driving the transition to a lower-carbon economy is an integral part of Fortum’s strategy. The revised strategy contains tightened sustainability and decarbonisation ambitions with updated targets to reach carbon neutrality already by 2030, coal exit by the end of 2027, target for specific emissions and commitment to SBTi (1.5°C) and biodiversity targets. Fortum’s climate-related risks are divided into two categories in accordance with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations: transition risks and physical risks. The transition to a low-carbon economy poses a number of strategic and operative risks related to changes in energy and climate policy and regulation, technology development and the business environment in which Fortum operates. Related to physical risks, Fortum’s entities are required to identify and assess their assets’ resilience towards different acute and chronic physical climate-related risks within different Intergovernmental Panel on Climate Change (IPCC) climate scenarios, and create adaptation plans for the most material risks. Fortum is a supporter of the TCFD, and physical climate-related risks are reported accordingly in Fortum’s TCFD report in the Sustainability 2022 report.
Financial risk management at Fortum
Commodity market and fuel risks
Fortum’s business is exposed to fluctuations in prices and availability of commodities used in the production, transmission and sales of energy products. The main exposure is toward electricity prices and volumes, prices of emissions, and price and availability of fuels. Fortum hedges its exposure to commodity market risks in order to improve the predictability of the future result by reducing volatility in earnings while ensuring cash flow risk is at an acceptable level.
Risk management for commodity hedging activities is based on general standards in the industry and involves the segregation of duties, as well as daily calculation, monitoring and reporting of results, positions and risks. Controls are in place to ensure exposures are kept within approved limits and mandates. Hedging involves the use of derivative financial instruments, as well as fixed-price physical delivery contracts.
Sensitivity according to IFRS 7
Sensitivity analysis shows the sensitivity arising from financial commodity derivatives as defined in IFRS 7.
These derivatives are used for hedging purposes with hedge accounting applied to most hedging strategies. Sensitivities in the table below are calculated based on the electricity position as of 31 December. 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 would change 1 EUR/MWh for the period Fortum has derivatives.
|+/- 1 EUR/MWh change in electricity forward quotations, EUR million||Effect||2022||2021|
|Effect on profit before income tax||+/-||2||1|
|Effect on equity||+/-||47||57|
Electricity price and volume risks
The exposure to Nordic electricity prices and normal volume fluctuations (e.g. due to weather-driven demand and supply changes) is the largest commodity market risk exposure for Fortum in terms of impact to earnings. The exposure arising from outright power production (hydro and nuclear production assets) is mainly hedged by entering into electricity derivatives contracts on exchanges such as Nasdaq Commodities or the European Energy Exchange, as well as directly with counterparties active in the energy and financial markets. The main objective of hedging is to reduce the effect of electricity price volatility in earnings while ensuring the cash flow risk is at an acceptable level, and to increase the predictability of future results.
The Generation segment’s hedging strategies cover several years in the short- to medium-term. These hedging strategies are executed within approved mandates and are continuously evaluated as electricity and other commodity market prices, the hydrological balance and other relevant parameters change.
Liquidity and refinancing risks
Fortum's business is exposed to liquidity and refinancing risks primarily through the need to finance the Group’s business operations including margining and collaterals issued for hedging activities. Trading derivative financial instruments exposes the Group to a liquidity risk associated with having to provide financial collaterals like cash or bank guarantees. A downgrade in rating could trigger counterparties’ right to demand additional collateral, which would need to be provided via cash or bank guarantees.
The derivative instruments used by the Group are traded via exchanges and over-the-counter with selected counterparties based on bilateral agreements. Trading through exchanges requires the exchange of cash to cover credit risks (margining payments). Since the second half of 2021, the very volatile commodity markets with unprecedently high prices have required significantly high net margining payments. During the third quarter 2022, as Nordic power prices followed the very high Continental European power and gas prices, Fortum’s standalone (excl. Uniper) collateral requirements increased to a record-high level peaking at around EUR 5 billion. Fortum has arranged new financing to meet the demands.
The exposure to margining requirements is continuously assessed and monitored so that adequate liquidity is available to cover expected future cash collateral required for margining.
Liquidity and refinancing risks are managed through a combination of cash positions and committed credit and other guarantee facility agreements with the core banks. The maturity profile of loans is monitored to ensure that there is at all times access to adequate liquidity for investments, loan maturities and margining required for commodity trading and hedging activities.
Fortum’s business is capital intensive and it has a diversified loan portfolio. Long-term financing is primarily raised by issuing bonds under Fortum Corporation’s Euro Medium Term Note programme (EMTN), as well as through bilateral and syndicated loan facilities from a variety of different financial institutions.
In Fortum, financing is primarily raised on parent company level and funds are distributed internally through various internal financing arrangements.
Currency and interest rate risks
Interest rate risk
Fortum is exposed to cash flow risk from changes in interest rates mainly from interest-bearing liabilities and derivatives on a fixed- and floating rate basis.
Fortum manages the interest rate exposure through a duration target of the loan portfolio (excluding lease liabilities and provisions), and cash flow at risk limit. Fortum uses different types of financing contracts and interest rate derivative contracts to manage the interest rate exposure, and evaluates and develops the strategies in order to find an optimal balance between risk and financing cost.
Fortum’s policy is to hedge major transaction exposures on a local level in the reporting currency of each legal entity in order to avoid exchange differences in the income statement. An exception is Generation segment’s hedging of power sales in Sweden where the currency component is not hedged. Derivatives are used to hedge existing foreign exchange risks, not for proprietary trading. As a result of sanctions against the Russian Federation followed by low liquidity in RUB and crossborder payment restrictions, hedging of RUB position was stopped during first part of 2022 and existing hedges were unwinded.
Fortum has cash flows, assets and liabilities in currencies other than EUR and is therefore exposed to fluctuations in exchange rates. Currency exposures are divided into transaction exposures (foreign exchange exposures relating to contracted or estimated 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).
Transaction exposures arise mainly from physical and financial trading of commodities, existing and new investments, external and internal financing and shareholder loans. Contracted cash flow exposures are hedged to reduce volatility in future cash flows. These hedges normally consist of currency derivative contracts, which are matched against the underlying future cash flow according to maturity. Fortum has currency cash flow hedges both with and without hedge accounting treatment under IFRS. Those currency cash flow hedges for which hedge accounting is not applied are mainly hedging commodity derivatives and create volatility in operating profit.
Translation exposure position includes net investments in foreign subsidiaries and associated companies. Translation exposures in Fortum are generally not hedged as the majority of these assets are considered to be long-term strategic holdings. In Fortum, this means mainly entities operating in Sweden and Russia, whose base currency is not euro.
Fortum is exposed to counterparty risk whenever there is a contractual arrangement with an external counterparty.
Credit risk exposures relating to financial derivative instruments are often volatile and include both the replacement risk and the settlement risk. Exchange-traded derivatives are cleared through central clearing parties (CCPs) or through clearing banks while over-the-counter (OTC) derivative contracts are concluded directly with a number of different counterparties, including energy wholesalers and retailers, utilities, trading companies, energy companies, industrial end-users and financial institutions active in the financial and energy markets. In order to mitigate the liquidity risk from increased margining requirements toward CCPs, the share of hedges with OTC counterparties without margining requirements has increased.
Credit risk relating to customers, suppliers and trading partners is spread across a wide range of industrial counterparties, energy companies, government and municipal entities, utilities, small businesses, housing associations and private individuals over a range of geographic regions. The majority of exposure is in the form of trade receivables from the sale of electricity, gas and heat in the Nordic market, Poland and Russia. The credit risk in the electricity and heat sales business in Russia is deemed to be higher than in the Nordic and Polish market.
For detailed information on financial risk management at Fortum, see Fortum Financials 2022 publication.