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 Q3 2022
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, Kemijoki Oy and TGC-1. For more information, please see Fortum’s annual report.
Russia’s attack on Ukraine on 24 February 2022 has severely impacted Fortum’s current and future businesses. The likelihood of a number of existing geopolitical risks that could negatively impact Fortum’s current business has increased, and in some cases, such as Uniper, risks have fully or partly realised. Russia’s counter sanctions on the EU have significantly affected the energy market, especially through the gas curtailments. A further widening of sanctions against Russia, and possible countermeasures, may impact current or future business relations. Continued curtailment on the physical supply of gas, coal, oil and other fuels from Russia could have follow-on implications, e.g. on the availability of Fortum's power plants.
On 21 September 2022, Fortum announced that the company, the German Government and Uniper had signed an agreement in principle for a long-term solution according to which Fortum will fully divest Uniper to the German State.
The completion of the transaction mitigates the risks related to the material uncertainty of Uniper’s liquidity and financial situation that also affects Fortum. The financial distress for Uniper or, ultimately, its insolvency, as a result of the failure of the agreed transaction, or otherwise, could be detrimental for Fortum and have serious consequences, not only for Fortum’s financial arrangements, but also for the Nordic and possibly European energy markets.
The closing of the agreed transaction remains subject to various regulatory approvals and eventually approval by an Extraordinary General Meeting of Uniper, currently planned to take place in the second half of December 2022. However, there is always a risk that the transaction is delayed or will not be completed due to political, regulatory or legal reasons. For more information on the agreement, please see ‘Uniper divestment‘ in this interim report.
The total loss from the Uniper divestment in the legal Fortum entity owning the Uniper shares will be slightly below EUR 6 billion, which is the net effect from the investments in Uniper SE shares of approximately EUR 7.2 billion, the sales proceeds of EUR 0.5 billion to be received and dividends of approximately EUR 0.9 billion received during the Uniper ownership. The divestment will negatively impact the parent company Fortum Oyj’s equity; however, Fortum has assessed that the equity remains at a sufficient level and does not require additional capital injections.
The unpredictable nature of sanctions and possible countermeasures by Russia continue to pose a significant risk for Fortum. The EU, US and UK have already implemented several sanctions towards Russia, targeting, for example, the financial and energy sectors. The sanctions imposed so far restrict the possibility to make cross-border payments from Fortum’s Russian units, which may affect repatriation of future dividends from the Russian operations, Fortum internal loan repayments and interest rate payments. Fortum has announced that no further investments will be made in Russia and that existing contracts will not be renewed when they expire. The company is also pursuing a controlled exit from the Russian market with a divestment of its Russian operations as the preferred path. This process will take its time and is subject to approvals by both the Russian Government Commission and the Russian President.
Since Russia’s invasion of Ukraine, owning and operating a profitable power and heat generation business in Russia has become challenging. For Fortum’s Russian businesses, the key drivers are economic growth, the rouble exchange rate, interest rates (which also impact capacity payments), and the regulation of the power and heat business. The current key challenges in the Russian businesses are related to the foreign suppliers’ lack of interest to supply spare parts. Risks relating to these drivers are all partly being realised, driven by the deterioration of the overall economic and business environment including GDP growth and rising interest rates. The profitability of Fortum’s Russian businesses in euro terms has not been negatively impacted by the current geopolitical situation. However, there is an increasing risk of countermeasures aimed at enabling nationalisation of foreign-owned assets in Russia in retaliation for Western sanctions. Such countermeasures could result in loss of control or a risk of delay in divestment of the Russian business, or it may negatively impact the value of the Russian business in the sales process or, in the extreme case, expropriation of Fortum’s Russian assets. Fortum is preparing for such a scenario by ensuring the Russian businesses are able to operate independently and in compliance with applicable laws, regulations and sanctions.
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 the Ukraine drove commodity prices to new record levels and further increased price volatility. As a consequence, the EU is taking action with temporary market interventions (e.g. price caps and windfall taxation). These market interventions may pose a risk for business performance, if becoming permanent. The value of the Fortum outright power generation portfolio has increased in January−September 2022, which is generally positive for future earnings. However, the higher value combined with increased price volatility has led to an increase in the commodity price risk. An economic downturn 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 the Group’s business operations, including margining and collaterals issued for commercial activities. Following the elevated prices, increased volatility and the EU EMIR (European Market Infrastructure Regulation), the margining requirements from Fortum’s hedges concluded via exchanges increased in the third quarter of 2022. In order to mitigate this risk, Fortum agreed on a bridge financing arrangement with its majority owner, the Finnish State, in the third quarter of 2022. With the arrangement, the company aims to ensure access to sufficient liquidity resources if power prices − and, with it, collateral requirements − continue to rise significantly in particular on the Nordic commodities exchange Nasdaq. For more information on the agreement, please see ‘Solidium's bridge financing loan to Fortum and directed share issue without payment to Solidium‘ in this interim report.
At the beginning of August 2022, both the S&P Global Ratings and Fitch rating agencies affirmed Fortum’s BBB rating on Negative Outlook. Following the announcement in September that Fortum will fully divest Uniper to the German State, the rating agencies have commented that the divestment of the Uniper stake was regarded as credit positive for Fortum as it will improve the company’s financial and risk profile. However, the rating agencies concluded that it is premature to determine the full effect of the Uniper divestment on Fortum’s rating. The rating agencies are expected to update their ratings after the completion of the transaction and once Fortum publishes its new strategy. A lowering of the credit ratings, in particular to below investment-grade level (BB+ or below), would trigger counterparties’ rights to demand additional cash or non-cash collateral. In addition, a downgrade could negatively affect access to the capital markets and increase the cost of new financing. Fortum targets to have a solid investment grade-rating of at least BBB. Fortum continues to constantly monitor all rating-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.
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 sale of energy products. The main exposure is toward electricity and gas prices and volumes, prices and volumes of emission allowances, and prices and availability of fuels. Fortum hedges its exposure to commodity market risks in order to reduce volatility in cash flow, and to increase the predictability of future results.
Sensitivity according to IFRS 7
Sensitivity analysis shows the sensitivity arising from financial commodity derivatives as defined in IFRS 7. Sensitivities are presented with most descriptive measure about the risk management and usage of derivatives in Uniper segment and Fortum’s other segments.
Fortum, excluding Uniper
In Fortum, excluding Uniper, 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, excluding Uniper, has derivatives.
|+/- 1 EUR/MWh change in electricity forward quotations, EUR million||Effect||2021||2020|
|Effect on profit before income tax||+/-||1||1|
|Effect on equity||+/-||57||58|
In Uniper segment, derivatives are used mainly for hedging, but also for proprietary trading purposes.
Commodity price risks in Uniper segment are measured based on a value-at-risk approach with 95% confidence interval and take into account the amount of open position as well as the prices, their volatility and the liquidity on the respective markets. Value-at-risk figures are supplemented by stop-loss and volume based indicators. When necessary, additional portfolio-specific restrictions are set.
Based on the current Uniper portfolio, as of December 2021, the calendar year based weighted value-at-risk, which takes market liquidities into account and ignores correlations between years, was EUR 1,422 million (2020: 463) for financial and physical commodity contracts covering next three years.
Electricity price and volume risks
Fortum is exposed to electricity market price movements and volume changes mainly through its power and heat generation.
In the Nordics and central European countries, market prices and, consequently, the amount of profitable production exhibit significant variation, for instance due to weather conditions, outage patterns in production and transmission lines, CO2 allowance prices, fuel prices, as well as the amount of electricity demand. Electricity price risks in the Nordics and central European markets are mainly hedged by entering electricity derivatives contracts on exchanges such as the Nasdaq Commodities or the European Energy Exchange, as well as directly with counterparties active in the energy markets. The ability to efficiently implement hedging strategies is dependent on a well-functioning and liquid derivatives market. There is a risk of decreasing liquidity of especially Nordic electricity derivatives on the Nasdaq Commodities, and decreasing the price variance and difference in the liquidity in various price areas. Alternatives, including the use of OTC derivative contracts and correlated products traded on other exchanges, are used to mitigate this risk. The Generation segment and the Uniper segment have separate hedging strategies covering several years in the short- to medium-term. 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. Uniper segment’s Nordic power hedging is performed only in Sweden, and the currency component of these hedges in the Swedish entity is hedged.
In Russia, electricity and capacity prices are the main source of market 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 2025 via capacity supply auctions which have already been conducted.
Electricity price exposure is partly mitigated through regulated fixed-price bilateral agreements, but the majority of electricity sales is exposed to spot price risk. In the short-term, electricity prices and volumes are mainly impacted by changes in industrial demand, gas prices and weather-driven demand changes.
Emission and environmental value risks
The EU and the United Kingdom have emissions trading schemes to reduce the amount of CO2 emissions. In addition to the emissions trading schemes, 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 and gas prices 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 biofuels, 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. The increasing geopolitical tensions and further escalation could, e.g., lead to curtailments of physical gas deliveries to Uniper, which may require Uniper to source gas in the market at higher prices. Both Fortum and Uniper continue to monitor the situation closely and prepare constantly adapted mitigation measures to minimise the impact of an escalation to Fortum Group.
The 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. Long-term gas supply contracts are concluded with gas suppliers to ensure gas availability for power plants.
Long-term gas supply contracts of Uniper generally include the possibility for the customer and the supplier to adapt contractual terms to changed market conditions. This entails the major risk for Uniper that suppliers will impose conditions that are detrimental. In order to limit the risk, negotiations are conducted by the most experienced employees utilising all available internal and external expertise.
A deterioration in the economic situation or upheavals in the market for LNG could lead to a lower than planned utilisation of the long-term capacity booked in the regasification plants in Uniper’s LNG business, and make it necessary to set up provisions for onerous contracts over the entire remaining booking period. Uniper strives to further increase the utilisation of this booked capacity, and thus improve the revenue situation.
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 trading and hedging activities. Higher commodity prices increase the net margining payments which are mainly settled in cash. 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 Corporation is currently rated BBB with a stable outlook by both Fitch and S&P Global Ratings rating agencies. The key risk factors which could lead to a weakening credit metrics and potentially trigger rating downgrade include a persistent decline in European and Russian power prices, lower-than-expected amounts received from planned divestments, increase in leverage, deterioration of the geopolitical situation or high market volatility. A lowering of credit ratings, in particular to below investment grade level (BB+ or below) could affect access to the capital markets and increase the cost of new financing.
Uniper, a separate listed company operating under German laws and regulations, is currently also rated BBB with a stable outlook by S&P Global Ratings. The stable outlook on Uniper’s rating reflects the outlook on the BBB rating of Fortum, which serves as a cap for Uniper’s rating. A downgrade of Fortum’s rating could lead to a corresponding downgrade of Uniper’s rating. A downgrade from the current BBB investment grade rating to BBB- or below could negatively affect Uniper’s liquidity as it would trigger counterparties’, particularly in the trading business, right to demand additional collateral which would need to be provided via liquid assets or bank guarantees. The related risk is measured, monitored and managed against a given limit.
Fortum is targeting to maintain at least its current rating, and to strengthen its financial profile and to improve its business risk profile. Fortum and Uniper maintain an active dialogue with credit rating agencies to ensure understanding of Fortum and Uniper’s aligned strategy and planned measures which target to achieve a financial and business profile that supports the current 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 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. Additionally changes in general interest rate levels may have an impact on discount rates of various provisions like pension provisions and asset retirement obligations causing changes in the amount of interest-bearing debt and financial costs, but without a cash flow impact. Fortum manages the interest rate exposure through a duration mandate of the loan portfolio excluding leasing 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 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 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 translation exposure is toward EUR/Russian Rouble (RUB), EUR/Swedish Krona (SEK) and EUR/British Pound Sterling (GBP), arising from Fortum's extensive operations in Russia, Sweden and the United Kingdom. Fluctuations of the RUB, SEK and the GBP against the EUR could have an adverse effect on future results and equity when consolidating and translating results and net assets in Russian, Swedish and UK affiliates into euros. Translation exposures in the Fortum Group are generally not hedged as the majority of these assets are considered to be long-term strategic holdings.
Transaction exposure arises mainly from physical and financial trading of commodities, existing and new investments, external and internal financing and shareholder loans within the Group. Fortum hedges major transaction exposures on a local level in the reporting currency of each legal entity in order to avoid exchange differences in the profit and loss statement. An exception is the Generation segment’s hedging of power sales in Sweden where the currency component is currently not hedged.
Centralised treasury functions in Uniper and the Fortum Corporation separately coordinate currency risk management and execute external hedges consisting of currency derivative contracts, which are matched against the underlying future cash flow according to maturity. Derivatives are used exclusively to hedge existing foreign exchange risks, not for proprietary trading.
Counterparty and 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. Following increasing geopolitical tensions, counterparties of the Fortum Group could become subject to sanctions, which may impact current or future business relations. Fortum actively monitors the situation in order to ensure continued compliance with prevailing rules and applicable sanctions laws.
Credit risk exposures-related hedging and trading arise through the use of physical delivery contracts, and to financial derivative instruments. The credit risk exposures are 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 OTC derivative contracts are concluded directly with a number of different counterparties, including energy wholesalers and retailers, utilities, trading companies, industrial end-users and financial institutions active in the financial and energy 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 toward Fortum's key relationship banks, which are highly creditworthy institutions. Fortum also has 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 as well as affiliates of the key relationship banks.
Credit risk exposures relating to customers and suppliers are 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 risk of credit losses in the electricity and heat sales business in Russia is deemed higher than in Fortum’s other operating countries.
Fortum has routines and processes to identify, assess and control exposure. Credit checks are performed before entering or renewing commercial obligations and exposure limits are set for larger individual counterparties as well as for counterparty groups. 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 contract 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 2021.