Key drivers and risks
Fortum's financial results are exposed to a number of strategic, political, financial and operational risks. The key factor influencing Fortum's business performance is the wholesale price of electricity in the Nordic region. The key drivers behind the wholesale price development in the Nordic region are the supply-demand balance, fuel and CO2 emissions allowance prices as well as the hydrological situation. The completion of Fortum’s investment programme in Russia is also one key driver to the company’s
result growth, due to the increase in production volumes.
The continued global economic uncertainty and Europe's sovereign-debt crisis has kept the outlook for economic growth unpredictable. The overall economic uncertainty impacts commodity and CO2 emissions allowance prices, and this could maintain downward pressure on the Nordic wholesale price for electricity in the short term. In the Russian business, the key factors are the regulation around the heat business and further development of electricity and capacity markets. Operational risks related to the investment projects in the current investment programme are still valid. In all regions, fuel prices and power plant availability also impact profitability. In addition, increased volatility in exchange rates due to financial turbulence could have both translation and transaction effects on Fortum's financials, especially through the SEK and RUB. In the Nordic countries, also the regulatory and fiscal environment for the energy sector has added risks for utility companies.
Despite macroeconomic uncertainty, electricity will continue to gain a higher share of the total energy consumption. Fortum currently expects the average annual growth rate in electricity consumption to be 0.5%, while the growth rate for the nearest years will largely be determined by macroeconomic development in Europe and especially in the Nordic countries. The new 650-MW Estlink-2 interconnector between Finland and Estonia increases market coupling between the Nordic and Baltic countries.
During the fourth quarter of 2013, the price of oil improved, whereas coal and EUA ended close to their opening levels.
The price of electricity for the upcoming twelve months clearly decreased in the Nordic area, whereas in Germany it was largely unchanged.
In late January 2014, the future quotation for coal (ICE Rotterdam) for the rest of 2014 was around USD 81 per tonne, and the price for CO2 for 2014 was about EUR 6 per tonne.
In late January 2014, the electricity forward price in Nord Pool for the rest of 2014 was around EUR 32 per MWh. For 2015 the price was around EUR 33 per MWh, and for 2016 around EUR 33 per MWh. In Germany, the electricity forward price for the rest of 2014 was around EUR 36 per MWh and for 2015 EUR 37 per MWh.
In late January 2014, Nordic water reservoirs were about 1 TWh above the long-term average and 1 TWh above the corresponding level of 2013.
The Power Division's Nordic power price typically depends on such factors as hedge ratios, hedge prices, spot prices, availability and utilisation of Fortum's flexible production portfolio, and currency fluctuations. Excluding the potential effects from the changes in the power generation mix, a 1 EUR/MWh change in the Power Division’s Nordic power sales (achieved) price will result in an approximately EUR 45 million change in Fortum's annual comparable operating profit. In addition, the comparable operating profit of the Power Division will be affected by the possible thermal power generation volumes and its profits.
The on-going multi-year Swedish nuclear investment programmes are expected to enhance safety, improve availability and increase the capacity of the current nuclear fleet. The implementation of the investment programmes could, however, affect availability.
Fortum’s power procurement costs from co-owned nuclear companies are affected by these investment programmes through increased depreciation and finance costs of associated companies.
The generation capacity built after 2007 under the Russian Government's Capacity Supply Agreements (CSA – “new capacity”) receives guaranteed capacity payments for a period of 10 years. Prices for capacity under CSA are defined in order to ensure a sufficient return on investments.
Capacity not under CSA competes in the competitive capacity selection (CCS – “old capacity”). The capacity selection for 2014 was held in September 2013. In the selection auction, the majority of Fortum’s power plants were selected. The volume of Fortum’s installed
capacity not selected in the auction totalled 132 MW, which is approximately 4.6% of Fortum’s total installed capacity. All of Fortum’s capacity was allowed to participate in the selection for 2014.
The Russia Division's new capacity will be a key driver for earnings growth in Russia as it will bring income from new volumes sold and also receive considerably higher capacity payments than the old capacity. However, the received capacity payment will differ depending on the age, location, size and type of the plants as well as seasonality and availability. The return on the new capacity is guaranteed, as regulated in the CSA. The regulator will review the earnings from the electricity-only market three years and six years after the commissioning of a unit and could revise the CSA payments accordingly. CSA payments can vary somewhat annually because they are linked to Russian Government long-term bonds with 8 to 10 years maturity.
Fortum estimates that the commissioning of the Nyagan unit 3 will be finalised by the end of 2014. The capacity payments for Nyagan unit 3 will start as of 1 January 2015, one year earlier than originally planned in 2008. In accordance with the CSA terms, no penalties for unit 3 can start to run before 1 January 2016.
The last two units of Fortum's Russian investment programme are being built in Chelyabinsk instead of Tyumen, as originally planned. The units constructed at the Chelyabinsk GRES power plant, originally planned to be commissioned by the end of 2014, have been slightly delayed and are scheduled to be finalised during the first half of 2015 mainly due to extensive groundwork at the brownfield site. The delay will not cause any penalties. In addition, Fortum plans to modernise and upgrade the existing equipment of the power plant.
The value of the remaining part of the investment programme, calculated at the exchange rates prevailing at the end of December 2013, is estimated to be approximately EUR 0.5 billion, as of January 2014.
After completing the on-going investment programme by mid-2015, Fortum’s goal is to achieve an operating profit level (EBIT) of about EUR 500 million run-rate in its Russia Division during 2015 and to create positive economic added value in Russia. The Russian Government’s earlier target to increase gas prices by 15% annually to reach netback price parity with European prices by 2018 has recently been changed. The forecast by the Russian Ministry of Economic Development now suggests much lower annual increases. The Russia Division’s profits are impacted by possible changes in gas prices, currency exchange rates and other regulations. The suggested gas price development and the weaker Russian rouble make the approximately EUR 500 million operating
profit level (EBIT) goal more challenging for the Division, but the company is making every effort to mitigate the negative impacts.
In 2013, the Ministry of Energy stated that a Heat reform should be developed before changing the current Electricity and Capacity Market model. Therefore, at the end of the year, the Ministry of Energy proposed a new heat market model (for public discussion), which is supposed to ensure transition to economically justified heat tariffs by 2020 and to attract investments into the heat sector. The new regulation concept is at an early stage and expected to be further developed during 2014.
Since the beginning of 2013, wholesale gas prices (except for private household and industrial consumers) have been reviewed quarterly. In February 2013, the Board of Russia's Federal Tariff Service (FTS) adopted a decision according to
which the wholesale gas price for industrial consumers decreased by 3% as of the second quarter 2013, compared to first quarter. As of 1 July 2013, the Russian Government increased gas prices by 15% compared to June 2013, and in October 2013 they were further increased by 1.9% in order to reach the planned total increase of approximately 15% in 2013 compared to 2012. According to a forecast made by the Russian Ministry of Economic Development, Russian gas price indexation will not take place as of July 2014. However, year-on-year gas price growth is estimated to be 7.6% in 2014.
Fortum has disclosed that it has completed the assessment of the future alternatives of its electricity distribution business; the assessment was launched in January 2013. As a result, Fortum is evaluating the possible divestment opportunities country by country.
Fortum's electricity distribution business in Finland is to be sold to Suomi Power Networks Oy. The divestment process is expected to be finalised during the first quarter of 2014 subject to the necessary regulatory approvals as well as customary closing conditions. The total consideration is EUR 2.55 billion on a debt- and cash-free basis. Fortum expects to book a one-time sales gain of EUR 1.8-1.9 billion, corresponding to approximately EUR 2.00 per share in its Electricity Distribution and Sales Division's first quarter 2014 results. A total of 340 employees will transfer with the business at closing.
The work to define the Swedish network income regulation model for the next regulatory period 2016-2019 has been ongoing and a first proposal from the Energy Market Inspectorate is expected to come during the first quarter of 2014.
Capital expenditure and divestments
Fortum currently expects its capital expenditure, excluding Värme in 2014, to be approximately EUR 0.9-1.1 billion, excluding potential acquisitions (including the Finnish distribution business until the end of first quarter 2014). The annual maintenance capital expenditure is estimated to be about EUR 400-500 million in 2014, below the level of depreciation. Capex for electricity distribution in Finland has been approximately EUR 150 million annually.
Fortum will gradually decrease its financing to Värme during 2014-2015. At the end of 2013, Värme's share of debt totalled approximately EUR 1 billion.
The effective corporate tax rate for Fortum in 2014 is estimated to be 19–21%, excluding the impact of the
share of profits of associated companies and joint ventures, non-taxable capital gains and non-recurring items. In Finland, the corporate tax rate was reduced from 24.5% to 20% as of 1 January 2014. In Sweden, the corporate tax rate was decreased from 26.3% to 22% as of 1 January 2013.
The Finnish Parliament approved the power plant tax (previously called windfall tax) in December 2013. It will be enacted later and will be applied from the beginning of 2014, provided that the EU Commission approves it. Fortum has filed a complaint on the tax to the Commission, arguing that it is not in line with general tax principles in Finland and that it constitutes illegal state aid for those plants that are not subject to the tax. If implemented, the estimated impact on Fortum would be approximately EUR 25 million annually.
At the end of December 2013, approximately 60% of the Power Division's estimated Nordic power sales volume was hedged at approximately EUR 43 per MWh for the calendar year 2014. The corresponding figures for the calendar year 2015 were about 20% at approximately EUR 41 per MWh.
The hedge price for the Power Division's Nordic generation excludes hedging of the condensing power margin. In addition, the hedge ratio excludes the financial hedges and physical volume of Fortum's coal-condensing generation as well as the division’s imports from Russia.
The reported hedge ratios may vary significantly, depending on Fortum's actions on the electricity derivatives markets. Hedges are mainly financial contracts, most of them Nord Pool forwards.