Annual Report 2013 | Suomeksi |

CEO’s review

In 2013, the economic recession in Europe and uncertainty over how long it would persist influenced energy prices and demand. The downturn also slowed economic growth in Russia.

In the recent years, the inflow of heavily subsidised renewable energy with grid priority has changed the operating environment in Europe significantly. Market-driven energy production is struggling with weakened profitability, reducing the ability of companies to invest. Furthermore, the rapid growth in distributed production poses big challenges for market functionality and security of supply.

Wholesale prices decreased as consumer prices rose

The rapid entry of shale gas into the US market has increased the use of gas, improved the country’s energy self-sufficiency and reduced the consumption of coal. In the meanwhile, Europe has received a steady stream of more economically priced coal and its use has increased. This trend, coupled with the rock-bottom prices of emission allowances and more expensive gas has eroded the profitability of energy produced

with natural gas in Europe. Brand-new gas-fired power plants have been shut down due to unprofitability. Despite the lower wholesale prices, subsidies to renewable energy have significantly hiked the consumers' electricity bills.

Compared to coal-fired power generation, natural gas-based power has a much lower environmental impact. Power from natural gas is also necessary for balancing the fluctuation of renewable energy production in areas where hydropower is unavailable. In fact, discussions on the introduction of capacity payments to support traditional energy production have taken place in several European countries during the year. All the while, governments are already spending considerable sums on subsidising energy production.

Making carbon dioxide emission reductions the energy policy’s main goal

Debate on the direction of Europe’s energy and climate policy remained lively throughout 2013. An increasingly topical issue was how to maintain Europe’s competitiveness amidst rising consumer prices.

An increasingly topical issue in the debate on the direction of Europe's energy and climate policy was how to maintain competitiveness amidst rising consumer prices.

At the beginning of 2014, the European Commission published its proposal on Europe’s climate and energy policy

for 2020 to 2030. The proposal placed a sharper focus on reducing greenhouse gas emissions, recommending a target of a 40 per cent reduction in line with the commonly agreed targets set by the EU for 2050.

The Commission also proposed getting rid of the binding, national renewable energy targets and setting a binding, EU-level target to increase the share of renewable energy to 27 per cent. While this is a step in the right direction, it still overlaps with the carbon dioxide emissions reduction target. Overlapping targets and steering mechanisms increase the energy and climate policy price tag and, ultimately, the consumers’ electricity bill.

A positive development in the Commission’s proposal was a market stability reserve mechanism for emissions trading. The mechanism may be useful in addressing the central weakness of the emissions trading scheme, which is its inability to cope

with strong fluctuations in demand or oversupply. Advance agreement on the arrangements controlling the scheme will reduce political risk and improve the predictability required for energy sector investments.

For Europe to remain competitive, it is essential that efforts to create an integrated electricity market continue. Shifting the energy policy’s focus from national interests to common energy production solutions that leverage the region’s strengths will eventually provide the most sustainable and cost-effective results for consumers, industry and the climate. In an integrated European electricity market the use of production capacity will be optimised and investment signals market-driven.

Increased speed and flexiblility in 2013

Despite a challenging operating environment, 2013 was a

satisfactory year for Fortum. Although our comparable operating profit decreased, the operative cash flow was very strong, and we continued to implement our investment projects in Europe and Russia with determination.

In 2012, we set a goal for Fortum’s efficiency programme, which was to improve the company’s speed and flexibility by strengthening cash flow by at least one billion euros in total by the end of 2014. The programme has progressed as planned, lightening our cost structure throughout our operating areas. Furthermore, we have divested non-core assets and improved our working capital efficiency.

Towards emissions-free energy production in line with the strategy

Regardless of the economic recession, steps must be taken

to mitigate climate change. The latest report by the Intergovernmental Panel on Climate Change (IPCC) sent a strong scientific message to decision-makers: Emissions must be clearly reduced before 2020 and must be cut in half by 2050. The transition to a Solar Economy where energy production is based on renewable energy sources may be gradual, but it is inevitable.

The cornerstones of Fortum's strategy are our strong expertise in CO2-free hydro and nuclear power production, our efficient combined heat and power (CHP) production, and know-how in operating in the energy markets. Alongside electricity production based on renewable energy sources, our strength, the energy-efficient CHP production, flexibly responds to fluxuating demand.

In 2013, we inaugurated five new production facilities in Europe. New waste-fired CHP plants were inaugurated in

Klaipeda, Lithuania, and Brista, Sweden, and new biomass-fuelled CHP plants in Jelgava, Latvia, and Järvenpää, Finland. Additionally, bio-oil production using pyrolysis technology commenced at Fortum’s Joensuu CHP plant. This unique technology may offer significant future business potential, for example, in the area of traffic fuels. In fact, the Joensuu project is the first of its kind in the world and was recognised for innovation at the Global District Energy Climate Awards in autumn 2013.

The transition to a Solar Economy where energy production is based on renewable energy sources may be gradual, but it is inevitable.

In addition to increasing CHP capacity, we also continued our

annual hydropower refurbishments and strengthened the prerequisites for nuclear power production particularly at our co-owned power plants in Sweden. Fortum's fully-owned Loviisa nuclear power plant in Finland had once again a good production year. The plant’s load factor of 92.5% was excellent by international standards. We have also established our position in growth markets through our expert services business during the year.

Fortum's Russian investment programme progressed to the final large units

In Russia, our investment programme is progressing, and in 2013 two new power plant units were commissioned in Nyagan, in Western Siberia. Out of the programme's eight production units, the three last, large ones are under construction. Our new gas-fired power plants in Russia are very energy-efficient.

The weakened industrial and economic growth indicators reported in Russia at the end of the year indicate that not even this market area is immune to the uncertainty in the global economy. The Russian government decided to postpone and reduce the previously planned annual gas price increases in its domestic markets. As a result, the new and efficient plants will not have as significant a competitive advantage as previously estimated. Due to this development and the weakened exchange rate for the rouble, it will be more challenging to achieve an operating profit level (EBIT) of EUR 500 million run rate in 2015. However, we will not abandon this target. Instead, we will strive to actively develop our operations and find ways to reach it.

Russia will be an important growth area for Fortum in the upcoming years. The reform of the Russian wholesale market has proceeded completely according to plan, and we expect the same consistent progress in the reform of the heating

sector as it gets underway. Russia has the potential to significantly increase the efficiency of its heat production, a fact that offers interesting prospects for Fortum’s heat business and CHP expertise.

Next generation solutions

Along with emissions-free hydro and nuclear power and resource-efficient CHP production, we are developing the use of waste and biomass-based fuels as well as researching opportunities in solar and wave power. These are all building blocks of the future energy system based on the sun's energy.

In India, we invested in a 5-megawatt solar power plant in order to gain experience in solar energy technologies and to enhance our understanding of the country’s electricity market. If the operating requisites develop positively, I believe that in regions that are favourable for production, unsubsidised solar energy will be able to compete with other energy sources even within this decade.

We are also continuously developing new tools and services to help our business and private customers monitor and

lower their energy consumption. A smart grid and products that complement it, such as Fortum Fiksu, play an increasingly important role in the interaction between the energy producer and the consumer. We are also developing open, two-way solutions that enable customers to sell the surplus electricity or heat they produce to Fortum.

In 2013, we inaugurated five new production facilities in Europe.

Our concerted efforts to cater to the evolving needs of our customer are also reflected in our annual stakeholder satisfaction survey results. For several consecutives years, customers have indicated their increasing satisfaction with Fortum and in 2013, the survey results improved again. At the same time, the number of customers we serve has increased.

At the end of 2013, Fortum had more retail customers in the Nordic countries than ever before.

Electricity distribution business in Finland to be divested

In December 2013, we completed the assessment of future alternatives for our electricity distribution business. After a thorough analysis, we concluded that divesting the electricity distribution business is the best alternative for Fortum’s shareholders and for the business itself. The decision gives Fortum the opportunity to focus on efficient and low-carbon electricity and heat production as well as on its activities in the integrating energy markets. It also provides the company with strategic freedom and increases shareholder value. I firmly believe that it is also a good solution from the perspective of our distribution customers and society at large

because it will enable the development of the network business purely from its own standpoint.

Accordingly, we signed an agreement to sell the electricity distribution business in Finland to Suomi Power Networks Oy in December. Its shareholders are a consortium of the Finnish pension funds Keva and LocalTapiola Pension and the international infrastructure investors First State Investments and Borealis Infrastructure. We expect to finalise the sale during the first quarter of 2014.

The decision has no effect on our electricity retail customers to whom will continue to offer smart products and services that improve the efficiency of their energy consumption and decrease their costs. Our new products, like solar panels and heating solutions that take advantage of the power market's lowest hourly prices, have been well received by customers. I am very pleased with the continuous improvement in

customer satisfaction in all our divisions. Fortum’s reputation among other key groups also continued to strengthen.

Sustainability as an integral part of strategy

Sustainability is a key success factor for Fortum, and we are committed to the principles of the UN Global Compact. We adopted new sustainability indicators at the beginning of 2013 and have met the customer satisfaction and reputation targets we set for them. However, because of the heavy storms at the end of the year, we did not reach our target with regard to the security of supply for electricity. The average outage time per customer was 220 minutes during the entire year.

We will persist in our efforts to achieve our environmental targets. Fortum gained significant recognition for its work towards emissions-free energy production and climate change

mitigation in autumn 2013 when the Carbon Disclosure Project (CDP), which represents institutional investors, ranked us as the best company in the Nordic Climate Disclosure Leadership Index * with a maximum score of one hundred points.

The occupational safety of Fortum’s own personnel further improved in 2013 and the number of injuries resulting in absences reached an all-time low. On the other hand, there is room for improvement in the development of the occupational safety culture of our contractors. In 2013, an accident resulted in the death of a contractor employee at our construction site in Russia and in February 2014, an accident took the life of a contractor employee working on our distribution network in Sweden. I would like to express my sincere condolences to the families and colleagues of the victims. Our goal is to avoid all serious accidents. For this reason, improving occupational safety must become integral to the daily routines of every Fortum employee.

Ready to seize opportunities in the changing energy markets

In difficult times it is good to be at the helm of a company that can boldly shape its own future. We will continue our efficiency programme as planned, enhance our flexibility, and decisively and systematically build new business opportunities. Only a company on stable financial footing such as Fortum can leverage the opportunities presented by the rapidly changing sector. We will carefully manage our current business and build the future in line with our strategy.

In difficult times it is good to be at the helm of a company that can boldly shape its own future.

To conclude, I extend my sincerest gratitude to Fortum’s personnel in all our operating countries for the work they have done towards achieving our shared goals in the past year. I also wish to acknowledge Sari Baldauf, our Chairman of the Board, who for a period of months assumed a greater responsibility in advancing Fortum’s interests while I was on sick leave. I also thank our CFO Markus Rauramo, who successfully served as my deputy. And, finally, I would like to thank our customers and our broadening shareholder roster for your trust. We will continue to work to increase the company’s value also in 2014.

Tapio Kuula

*The name of the index has been corrected on March 26, 2014.

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