Key drivers and risks
Fortum's financial results are exposed to a number of economic, strategic, political, financial and operational risks. One of the key factors 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 and CSA payments.
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 Fortum's Russian business, the key factors are economic growth, the rouble exchange rate, 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 and the Russian rouble (RUB) and Swedish krona (SEK). In the Nordic countries, also the regulatory and fiscal environment for the energy sector has added risks for utility companies.
Despite macroeconomic uncertainty, electricity is expected to continue to gain a higher share of the total energy consumption. Fortum continues to expect the annual growth rate in electricity consumption to be on average approximately 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.
During 2014, the price of European Union emissions allowances (EUA) appreciated, whereas the oil and coal prices declined. The price of electricity for the upcoming twelve months declined in the Nordic area as well as in Germany.
In late January 2015, the future quotation for coal
(ICE Rotterdam) for the rest of 2015 was around USD 58 per tonne, and the price for CO2 emission allowances for 2015 was about EUR 7 per tonne. The electricity forward price in Nord Pool for the rest of 2015 was around EUR 28 per MWh and for 2016 around EUR 29 per MWh. In Germany, the electricity forward price for the rest of 2015 was around EUR 32 per MWh and for 2016 around EUR 32 per MWh. Nordic water reservoirs were about 1 TWh below the long-term average and 1 TWh below the corresponding level of 2014.
Restructuring according to strategy in Russia
In December, Fortum and Gazprom Energoholding signed a protocol to start a restructuring process of their ownership of TGC-1, a Territorial Generating Company in Russia. TGC-1 owns and operates hydro and thermal power plants in north-western Russia as well as heat distribution networks in St. Petersburg. Currently, Gazprom Energoholding owns 51.8% of the TGC-1 shares and Fortum 29.5%.
As part of the restructuring, Fortum will establish a company together with Rosatom to own the hydro assets of TGC-1, while Gazprom Energoholding continues with the heat and thermal power businesses of TGC-1. By utilising its present stake in TGC-1, Fortum would obtain a more than 75% ownership in the hydro power company. Rosatom would have a less than 25% minority holding in the hydro power company. The company would be consolidated to Fortum Group as a subsidiary.
Provided that Fortum obtains a more than 75% ownership in TGC-1 hydro assets, Fortum would be ready to participate with a minority stake (max. 15%) in the Finnish Fennovoima nuclear power project on the same terms and conditions as the other Finnish companies currently participating in the project.
Power and Technology
The Power and Technology Segments Nordic power price
typically depends on factors such as hedge ratios, hedge prices, spot prices, availability and utilisation of Fortum's flexible production portfolio, and currency fluctuations. Excluding the potential effects from changes in the power generation mix, a 1 EUR/MWh change in the Power and Technology Segment’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 and Technology Segment will be affected by the possible thermal power generation volumes and its profits.
The ongoing, multi-year Swedish nuclear investment programmes are expected to enhance safety, improve long term 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
As a result of the nuclear stress tests in the EU, the Swedish nuclear safety authority (SSM) has decided to propose new regulations for Swedish nuclear reactors. The process is ongoing. Fortum emphasises that maintaining a high level of nuclear safety is the highest priority, but considers EU-level harmonisation of nuclear safety requirements to be of utmost importance.
In 2014, the Swedish Government decided to increase the nuclear waste fund fee from approximately 0.022 to approximately 0.04 SEK/kWh for the period 2015 to 2017. The estimated impact on Fortum would be approximately EUR 25 million annually. The process to review the Swedish nuclear waste fees is done in a three-year cycle.
The previously announced Swedish Government state budget proposal to increase the tax on the installed effect in nuclear power plants by 17 % iscurrently on hold.
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. The issue of prolonged CSA payments from 10 to 15 years has been under discussion in the Russian Government; however, no official decisions have yet been made.
The capacity selection for generation built prior to 2008 (CCS – “old capacity”) for 2015 was held in September 2014. All of Fortum’s capacity was allowed to participate in the selection for 2015, and the majority of Fortum’s plants were also selected. The volume of Fortum’s installed capacity not selected in the auction totalled 195 MW (approximately 3.7% of Fortum’s total old capacity in Russia) for which Fortum plans to obtain forced mode status.
The Russia Segment's new capacity will be a key driver for earnings growth in Russia, as it is expected to bring income from new volumes sold and to also receive considerably higher capacity payments than the old capacity. The received capacity payment will differ depending on the age, location, size and type of the plants as well as on seasonality and availability. The return on the new capacity is guaranteed, as regulated in the CSA. CSA payments can vary somewhat annually because they are linked to Russian Government long-term bonds with 8 to 10 years maturity. In addition, 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.
The value of the remaining part of the investment programme, calculated at the exchange rates prevailing at the end of December 2014, is estimated to be approximately EUR 0.2 billion, as of December 2014.
The Russian result is impacted by seasonal volatility caused by the nature of the heat business, with the first and last quarter being clearly the strongest.
At the time of the acquisition of the Russian subsidiary OAO Fortum in 2008, the EUR 500 million run-rate level in operating profit (EBIT) target set to be reached during 2015 in the Russia Segment corresponded to approximately RUB 18.2 billion at the then prevailing euro-rouble exchange rates. As earlier communicated, the segment’s profits are mainly impacted by changes in currency exchange rates as well as power demand, gas prices and other regulatory development. Fortum is keeping its rouble-denominated target intact, but, mainly due to the translation effect, the euro-denominated result level will be volatile. The income statements of non-euro subsidiaries are translated into the Group reporting currency using the average exchange rates. Currently, the unfavourable exchange balance converts into a lower profit level in euros. However, every effort to mitigate the negative impacts is continuously being made.
In 2014, the Ministry of Energy proposed a new heat market model (for public discussion), which is supposed to ensure a transition to economically justified heat tariffs by 2020 and attract investments into the heat sector. In September 2014, the heat market reform roadmap was approved by the Russian Government; according to the roadmap, the reform shall give heat market liberalisation by 2020 or, in some specific areas, by 2023.
As forecasted by the Russian Ministry of Economic Development, Russian gas price indexation did not take place in October 2014. However, year-on-year gas price growth is estimated to be 3.5% in 2015.
Fortum continues to prepare and evaluate for a possible sale of the Swedish electricity distribution business.
In Sweden, legal processes are under way concerning the
appeal filed regarding the network income regulatory period 2012-2015. The Administrative Court in Sweden ruled in favour of the network companies in November 2013. The Energy Market Inspectorate decided to appeal the decision to the next final-law court, the Supreme Administrative Court, which still needs to decide on granting a leave to appeal.
The work to define the Swedish network income regulation model for the next regulatory period 2016-2019 is ongoing. In September 2014, the Swedish Government made a decision regarding the capital base ordinance; however, the details will be decided by the Energy Market Inspectorate. Decisions are expected to be made during the spring 2015.
Capital expenditure and divestments
Fortum currently expects its capital expenditure in 2015 to be approximately EUR 0.9 billion, excluding potential acquisitions (including Distribution segment). The annual maintenance capital expenditure (excluding Distribution segment)
is estimated to be about EUR 300-350 million in 2015, below the level of depreciation.
Fortum will gradually decrease its financing to Fortum Värme, the co-owned power and heat company operating in the capital area in Sweden, during 2014-2015. At the end of December 2014, Fortum Värme's remaining interest-bearing liability to Fortum is approximately EUR 0.6 billion.
The effective corporate income tax rate for Fortum in 2015 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.
The Finnish Government decided in June 2014 that it will not, after all, introduce a power plant tax (windfall tax) on nuclear, hydro and wind power built before 2004. The final decision to revoke the tax was made by the Parliament in November
2014, and the revocation entered into force on 1 January 2015.
In August, the Finnish Board of Adjustment of the Large Taxpayers’ Office had unanimously approved Fortum Corporation's appeal of the income tax assessment imposed on Fortum for the year 2007 in December 2013. The Tax Recipients’ Legal Services Unit has appealed in the matter (Note 39). In December 2014, Fortum received a non-taxation decision regarding its financing companies for the remaining years 2008-2011, based on the same audit. This is in line with the Supreme Administrative Court’s (SAC) precedent decision. The Tax Recipients’ Legal Services unit within the tax authorities has the right to appeal the decision.
The new Swedish Government proposed to increase the tax on installed nuclear capacity by 17% as of 2015. This issue is currently on hold. Fortum's position is that the tax issue should be referred to an upcoming parliamentary energy commission in order to get a broadly established view on how
the needs of energy and effect can be resolved. If implemented, the estimated impact on Fortum would be approximately EUR 15 million annually, however corporate tax-deductable.
At the end of December 2014, approximately 50% of Power and Technology's estimated Nordic power sales volume was hedged at approximately EUR 40 per MWh for the calendar year 2015. The corresponding figures for the calendar year 2016 were approximately 10% at approximately EUR 39 per MWh.
The hedge price for Power and Technology'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 segment’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.