Fortum Oyj Corp Ord

Welcome to the Fortum Half-Year Financial Report 2022 conference call. For the first part of the conference call, the participants will be in listen-only mode. During the questions and answers session, participants are able to ask questions by dialing star 5 on their telephone keypad. Now I will hand the conference over to the speakers. Please go ahead.

Good morning everyone and welcome to Fortum's webcast and news conference on our first half results for 2022. My name is Pauliina Vuosio and I'm head of executive communications at Fortum. This event is being recorded and a replay will be provided on our website later today. Here with me in the studio is our CEO Markus Rauramo and our CFO Bernard Günther. They will then together present Fortum's first half 22 figures and the group's performance. After the presentation, we will open up for Q&A over the teleconference. So with this, I will now hand over to Markus to start.

Thank you very much, Pauliina. Today, I will start with some reflections on our operating environment, which has been unprecedented. As the war continues in Ukraine, it has substantial direct and indirect implications on Fortum Group, especially on our subsidiary Uniper. Uniper has accumulated tens of millions of euros in losses every single day since Gazprom began to curtail gas flows in mid-June. I cannot stress enough how severely this has put Uniper's future at risk and impacted also us at Fortum. Last month was marked by intense negotiations aiming to save Uniper and to protect Fortum as a shareholder. And five weeks ago, the German federal government, Uniper and Fortum agreed on a stabilization package for Uniper that addresses Uniper's losses. I will later run you through what has been agreed. At the same time, we see commodity prices on record highs, also in the Nordics, consuming an unhealthy amount of liquidity in this volatile market environment. This is the way the markets are designed, but the development is a concern to energy-intense industries, households and also to utilities. Given the nature of our low-cost, low-carbon generation portfolio, a high and volatile environment presents significant benefits as well as challenges to Fortum. But we need to think about the market more broadly as well as our own interests. I will address the need for both immediate and long-term solutions to the issue momentarily. I will close with our agenda going forward with the ambition to bring Fortum Group to stable footing. Bernhard will then walk you through the numbers in more detail. But let me now start with a look at the operating environment. As Fortum, we find ourselves at the center of an unprecedented geopolitical crisis in Europe, following Russia's attack on Ukraine and the decision of the Russian government to use energy as a weapon. We must acknowledge that the implications of the Russian invasion have materially hit Fortum Group. Fortum has traditionally had exposure to Russia directly with our investments in mainly gas for generation in the Urals and Western Siberia, as well as in Russian wind and solar. Fortum's business has played an important role in the Russian market, and until recently, we have had constructive relations with all stakeholders there. The attack on Ukraine changed all that. However, we are most exposed to Russia through our investment in Uniper. As you may remember, for Fortum, this was an investment in Nordic CO2-free power generation and an investment into the European energy transition, where Uniper's strong position in natural gas and security of supply would play a key role. Nevertheless, Uniper's global commodities business as a central player in German gas markets has been a major importer of Russian gas into Germany. And now Russia's aggression has turned this strategic choice into a liability we must turn around. Today, we are also affected by the extreme prices and volatility that increasing supply fears drive on the continent and in the Nordics. The situation is challenging to consumers and politics, and unfortunately, it is only expected to intensify towards winter, as low Russian gas flows could cause severe demand rationing in Europe. The skyrocketing commodity prices are also affecting the Nordics, where increasing power prices are now prevalent, not only in the spot markets, but also in forward prices across the curve. As high prices are a concern to all societies, governments are discussing ways to soften the impact. The measures under consideration mainly include price caps, tax rebates and direct subsidies. In some countries, however, political interventions like additional taxes on the profits of energy producers have been introduced. So far, these so-called windfall profit taxes are not on the agenda of Nordic governments. At Fortum, these challenging times underline our responsibility for security of supply and the clean energy transition. In this respect, our priority in the short term is to maintain the high availability, efficiency and safety of our Nordic Fleet, and to continue to play a key role in delivering low-carbon electricity to the region. We look forward to the start of regular production of O3 nuclear power plant, expected in December, and the construction of Finland's first floating LNG terminal at our Inco harbour. To sum it up, the geopolitical crisis is an unprecedented challenge for our modern European societies and our customers. It has created an unprecedented level of risk for Fortum Group. We had to act fast and in the best interest of our group, which we have done. Given the gravity of the situation, let me recap the major developments that led to this predicament and why we made the choices we did already last winter. In August last year, Europe was coming out of COVID and commodity prices were supported by the rapid economic recovery and there was tightness in the gas supplies to Europe. At the same time, our collaboration with Uniper was on a good track under Uniper's new management. Our focus was on defining our joint path towards closer integration and the execution of our strategy, rooted on clean power and increasingly clean gas. Was proceeding well. We announced that our Russia division would exit coal at the end of 2022 and that we had accelerated the coal phase-out both in the UK and in Germany. There was much to be pleased about. As the fall came, volatility and prices in the gas markets increased, and with that, Uniper's collateral and margining needs increased as well. All the while, Uniper's gas business was making excellent profits, which prompted Uniper to increase their full year guidance. Fortum Group's financial position had improved following the closing of a series of divestments, and our credit metrics were rock solid. All in all, we were in a good place financially, strategically and operationally. Then at Christmas time, the gas prices peaked at around 200 euros per megawatt hour and Uniper was in an acute liquidity crisis. The collateral and margining needs of the company stood at over 10 billion euros. And we were faced with the very real concern that Uniper might not make it. Uniper's default would have meant in all likelihood collapse of the European gas markets, and it would have had severe impacts also on Fortum and the Nordic markets. We could not let that happen. It was not in our interest, nor anyone else's, to let that happen. Over Christmas and the new year, we then agreed on a financing package for Uniper, together with the German state-owned KfW Bank. Fortum gave a €4 billion loan and a €4 billion parent company guarantee. The KfW bank gave a €2 billion loan. Now, it is very important to note that at that time, Gazprom was delivering all the contracted gas volumes to Uniper. All of them, like they had done for the previous 50 years. So this was not an energy supply crisis, it was a liquidity crisis. Uniper needed capital to cover the collateral and margining needs, and these funds would be returned as the gas contracts went into delivery later in the coming months and years. Based on the information available, there did not appear to be any risk of Fortum not getting the loan back. Then in late February, Russia invaded Ukraine and started a brutal war. This decision by President Putin fundamentally and irrevocably changed our relationship with Russia. We stopped our investments in Russia, started searching for alternative fuel sources and began preparing for an exit from Russia. I'm sure you all remember that time. A couple of weeks after the war started, we published our highest ever results, 2.5 billion euros of comparable operating profit, half of which came from Uniper. Throughout the spring, while Gazprom continued the contracted deliveries of gas as before, EU countries started making preparations to secure supply in the event of a gas curtailment. Floating LNG terminals were chartered to increase imports, Gas storage filling level requirements were set and legislation was passed to deal with different levels of emergency. As the parent company of the biggest importer of Russian gas, we faced heavy criticism of Uniper's continued imports from Russia despite the war. Our explanation that we could not discontinue these imports because the consequences to the German economy would be grave did not land well. Then came mid-June, and Gazprom significantly curtailed their gas deliveries. Uniper, on the other hand, was still contractually obliged to deliver gas to its customers and had to procure the missing volumes from the market at much higher prices. This crystallized significant losses, and the spiral of reduced gas from Russia and increased prices resulted in those losses increasing. Germany had a law in place for exactly this kind of situation. It was intended for a gas provider to pass through the extra cost from having to buy the missing volumes from the market to customers. The German government, however, did not take this part of the law into use, thereby making it impossible for Uniper to pass through the higher costs. This left Uniper in an acute financial crisis. Unlike at year end, This time the cause was a gas supply crisis resulting in extreme losses, not a lack of liquidity. With funds depleting and fears of the gas curtailment being prolonged or even escalated, Uniper called on the German government to help. And finally, on the 22nd of July, after intense and constructive negotiations, we were able to announce the stabilization package negotiated between Fortum, Uniper and the German government, with the help of the Finnish government, to provide financial relief to Uniper. Now, before I recap what was agreed, I would like to point out that although we have an agreement to stabilize Uniper, we still have to agree on the terms of its implementation. get regulatory approvals, in particular from the EU Commission, and seal the agreement in an extraordinary general meeting of UNIPER. As a result of the agreed measures, the German state will invest equity to hold a 30% stake in UNIPER. Fortum's current stake in UNIPER will be diluted to 56% on the initial injection. As Uniper's majority shareholder, we acted to share the burden with the German government, knowing that Uniper's rescue was needed urgently and in the interest of Fortum and the Finnish state. Our initial proposal to ring-fence Uniper's German business into their own federal state-owned entity was not viable in this situation. We met our most critical requirement to stop the massive losses and cash bleeding at Uniper. mainly by the agreement to introduce the levy from 1st of October, which will cover 90% of the losses. It was also important for us that Fortum does not have to contribute any additional capital beyond the 8 billion euros in financial support that we already provided. This would have been politically and commercially unacceptable in Finland. All through the process, the support of the Finnish state as Fortum's majority shareholder has been particularly invaluable. In consideration of our liquidity support to Uniper, Fortum will have the right to exchange the existing 4 billion shareholder loan into the convertible instrument, which would let us increase our stake on the same terms as the German government. This would protect us from further dilution and is an option that we can consider. If we do not exchange our shareholder loan, it will stay in place. With regard to the guarantees of 4 billion euros that we provided to Uniper, let me highlight that they are not going to result in cash leaving Fortum unless Uniper defaults, which in context of the stabilization package and the reaffirmed investment grade rating is much less likely. In addition, we have agreed to work with Uniper and the German government on a long term solution to reform the wholesale gas contract architecture. We also agreed that the German government stands ready to provide further support if Uniper's losses due to continuing gas curtailments exceed a total aggregate amount of seven billion euros. This so-called backstop was another point that was very important to us and the Finnish state in the negotiations. The rating agencies confirmed Uniper's BBB minus rating and Fortum's BBB flat long-term credit rating in the light of the stabilization package. In a nutshell, this is what we agreed. The outcome is by no means perfect, but it is an outcome that ensures immediate stabilization of the situation at Uniper. It is a compromise that all parties could live with. Now over to the financial impact that we see in the first half year result. This has been a highly challenging year for us at Fortum Group, and the crisis is far from over yet. Uniper will accumulate and report substantial losses over the coming quarters as a consequence of the Russian gas curtailment. The amount of these losses will depend on the level of the curtailments, which, as you know, is going to 100% again at the end of the month. On the top row, you see that the Uniper segment is negative in absolute terms with the comparable operating profit of minus 570 million. This includes 403 million of gas curtailment losses from mid-June 22 onwards, but also intra-year earnings shifts into later quarters through the well-known carbon phasing effect and the shift due to gas storage optimization that we highlighted in Q1. When it comes to the reported operating profit, the unit per segment is impacted by 12 billion euros of items affecting comparability. This reflects three things. The anticipated gas curtailment losses until October of more than 6 billion euros. Most of this is expected to settle in Q3 and affect comparable operating profit. Number two, changes in fair values of non-hedge accounted derivatives. And thirdly, impairments for fixed assets from the Uniper segment's Russian subsidiary Unipro. Bernhard will provide more insights on this shortly. On the bottom row, you see that the Fortum segments, excluding Uniper, deliver solid results. The generation segment profits from strong physical optimization and from the increasing price environment, even after allowing for a prudent hedging strategy. In a nutshell, Fortum Standalone is prospering and performing. Having said that, I move to the next slide. Now, in the context of what we have seen in the first six months of the year, let me highlight a very important topic. the current state of futures traded markets. The rise of the Nordic future prices to the current unprecedented levels has caused the collateral and margining requirements of market participants to increase rapidly. This is the case irrespectively whether you run a purely speculative position or whether you are a generator with underlying power production and asset fleet. In general, traded markets provide transparency and liquidity, reduce counterparty risks, and give most efficient hedging possibilities. But in the current environment, margining requirements for the existing deals exceed manifold the potential earnings. Consequently, market participants who do not have enough cash to cover margining requirements have to reduce or even stop trading in the futures market. This reduces marketplaces liquidity and increases volatility as a vicious circle. To illustrate this development, let me give you an example. The Nordic 2023 future system price has increased by 500% since February. At the same time, liquidity on the Nasdaq commodities has reduced by 60%. So while prices The 23 prices have gone up sixfold, and market participants' collateral requirements have followed suit. The liquidity in the market has more than halved. Fortum Group's net margining requirements, including Uniper, at the end of March were approximately €4 billion. At the end of June, they were about €7 billion, and this week they have increased to over €11 billion. Our collateral requirements have not increased as fast as the market prices because we have reduced our positions on Nasdaq. Our hedging policy has not changed, but we are currently mainly hedging through bilaterals, which ensures hedging of our outright position. We are currently managing the liquidity situation, but if the prices continue to rise, there will be a point where we as Fortum stand alone have to increase our liquidity reserves. Our standalone share of the 11 billion euros that I just mentioned is slightly more than 4 billion. Uniper's part is covered by the KFW financing. For Fortum's part, we have started discussions with Finnish state how to manage this liquidity squeeze. It is obvious that the situation is challenging for power producers and consumers alike. Power producers like us cannot hedge in a meaningful way on the market. This means that in case bilateral contracts are not an option, the predictability of the producer's earnings decreases. For industrial customers, electricity sales companies and private consumers, this means increasing exposure to spot prices. And finally, it means that despite highly profitable operations, Power producers' ability to invest may be reduced because capital is tied up in these oversized collaterals. The situation calls for short and long term solutions to make sure that we have a market that functions also under exceptional circumstances. In the short term, I urge our Nordic governments to ensure that working capital financing is available for market participants to cover collateral needs should they need it. The type of facility Germany has implemented through the state-owned KfW bank could be a model for the Nordics too. This would enable power producers to continue hedging and increase the liquidity in the market, which would likely help to curb the high volatility too. The longer-term solution is to look at the EU EMIR regulation, which sets the legal framework for margining requirements. EU processes take time. Therefore, the discussions on how the implementation of the EMIR regulation could be changed should be started immediately. Let me now close with our group priorities for the second half year. In essence, our priorities are divided in three steps. Most importantly, we have to stop the leakage. Firstly, the drain of capital for margining has to come to an end, as I just discussed. Secondly, the negotiations of the details of the stabilization agreement with German government and Uniper have to be finalized to ensure that Fortum and Uniper return to stable footing. In addition, Fortum and Uniper have to work tirelessly to reshape our businesses to respond to the current challenging market conditions. It will require further efforts to turn around particularly Uniper's gas business. To achieve this, it has been agreed that Uniper, with the support of Fortum and the German government, will work on a long-term solution to reform the wholesale gas contract architecture. We know that the situation raises quite some uncertainty for all our employees, especially at Uniper. And we also want a clear perspective for Uniper employees. Everybody wants to know how Uniper should look like in the future. But there will be two major shareholders in the future. And we are just in the beginning of discussing this with the German government and have to learn what their plans are. But also Fortum will have to maintain its standalone competitiveness and to regain the trust of our stakeholders. In addition, we will finalize our exit from the Russian market. We have healthy interest from potential buyers in our businesses there. But as we have already pointed out in May, the outcome will in the end depend on the approval by the Russian government. Finally, we will review our strategy in light of the changed environment to overcome this crisis and forge a path towards a sustainable future. Fortum's CO2 free generation assets are needed more than ever. Having said that, over to Bernhard.