Risk management
In its business operations, Nuon recognises risks that can affect the company’s development and results, as well as the forecasts that Nuon issues on the basis of current insights and judgement.
An overview of the most important operational and financial risks that may arise based on current insights and judgement:
- Enterprise Risk Management
- Changes in the economic climate
- Regulation of activities
- Law on Independent Grid Management
- Competitive pressure
- US cross border leases
- Security of supply
- Operational processes
- ICT risks
- Allocation and reconciliation
- Production and distribution
- Commodity markets
- CO2 emission rights
- Volatility of the results as a result of the application of IFRS
- Changing prices for financing instruments
- Legal risks
- Pensions
- Taxation
- Health and safety risks
- Enterprise Risk Management
In 2006, Nuon devoted further attention to the development of Enterprise Risk Management and its Business Control Framework, leading to improved insight into operational and financial risks. On a quarterly basis, all business units report the risks they have identified as potentially having a significant impact on their business. Subsequently, the risks are assessed at group level by the Management Board, resulting in risk overviews that are discussed with the Audit Committee and the Supervisory Board. It cannot be ruled out that deficiencies in the current approach or inadequacies from the past will have repercussions for operational and/or financial results or related balance sheet positions. The section ‘Internal Risk Management and Control System’ deals in greater detail with these issues and the opinion of the Management Board concerning the effectiveness of the business controls during the reporting year.
- Changes in the economic climate
Nuon’s core markets are the Netherlands, Belgium and Germany. The development of the economy, regulation, the business cycle in general and in Nuon’s core markets, and in the European and other international markets have an impact on the development of Nuon’s results. These developments may have a significant impact on Nuon’s operational and financial performance.
- Regulation of activities
A significant part of Nuon’s activities is regulated. These mainly concern the grid management operations which have been placed within Continuon Netbeheer, a group company that operates more independently within Nuon due to legal requirements. Certain activities related to non-regulated tasks have also been attributed to Continuon Netbeheer. Energy supervision in the Netherlands has been entrusted to NMa/DTe (Netherlands Competition Authority/Office of Energy Regulation). In the past years, the supervision over Dutch business and industry, including the energy companies, has been intensified and the enforcement policy tightened up. A trend towards increased regulation and further scrutiny cannot be ruled out, which may affect future results. In the second half of 2006, DTe started an investigation into the results and the risk of crosssubsidising of the four larger energy companies in the Netherlands, including Nuon. The outcome of this investigation is still pending but could possibly affect Nuon’s future results or operations.
- Law on Independent Grid Management
The Minister of Economic Affairs has presented proposals to the Lower Chamber of Parliament to unbundle the Dutch energy companies into strictly separated grid companies and supply/production companies. The Lower Chamber approved the Act on Independent Grid Management in April 2006. In November 2006 however, the Upper Chamber only approved this unbundling act after it was amended, following the proposals thereto by members Doek and Sylvester. The amended act prescribes that integrated energy companies cannot be forced to unbundle their activities unless eu regulations oblige companies to do so or when foreign activities endanger the independence of grid operators in the Netherlands or if market circumstances make unbundling necessary. Dutch integrated energy companies are required to transfer the economic ownership of the grids to their independent grid operator. The management of high-voltage grids in excess of 110 kV are to be transferred to TenneT prior to 1 January 2008. The Independent Grid Management Act and a potential forced unbundling could possibly lead to lower credit ratings which would result in higher interest costs for Nuon.
- Competitive pressure
The markets in which Nuon operates are becoming more competitive resulting in pressure on prices and margins and, as a consequence, possibly leading to a loss of market share, revenues and/or margins.
- US cross border leases
In the 1990-2000 period various energy companies in the Netherlands, including Nuon, concluded cross-border leases for grids and electricity production facilities. These concern complex financial transactions with long terms which have been structured in such a way that the amounts placed in deposit and invested in securities (including received interest) at the start of the contracts are in principle sufficient to meet the future payment obligations (lease instalments and amounts payable upon the possible exercise of the purchase option). The most important risk consists of an early termination of the transaction as a result of the occurrence of certain events of default or loss as laid down in the documentation, where Nuon is liable to pay the termination value. If the transaction is terminated early, there is a real chance that the amounts set aside and invested at the start of the contracts will be insufficient to pay the termination value. In that case Nuon is liable to pay the difference, known as the strip risk. The risk of the occurrence of events that were unforeseen at the start of the contract is increased by the long-term nature of the leases. Examples of possible events are changes in legislation, such as the recently adopted Independent Grid Management Act, a deterioration of Noun’s creditworthiness, that of the banks involved or the selected investment instruments, or developments elsewhere such as the changed fiscal climate in the us. These factors could diminish investor willingness to co-operate with restructuring requests necessitated by an unbundling, merger or privatisation.
- Security of supply
An important pillar in Nuon’s strategy is the reliability and quality of the grid in order to ensure security of supply to customers. Nuon continues to invest in the quality of its grids, and with some success as is evidenced by the low number of customers affected by power outages, the low average outage time per customer and an exceptionally high grid reliability. However it is possible that Nuon, due to its own fault or due to natural disasters, actions beyond Nuon’s control, including (wilful) actions of third parties, is confronted with extended power outages and is held liable by third parties for any resulting loss or damage due to such outages. Any resulting claims could have an impact on future results.
- Operational processes
Following the recognition that the operational and customer processes of the Dutch energy companies needed improvement, the Office of Energy Regulation (DTe) tightened up its supervision of the sector. In consultation with the sector, the DTe introduced a scorecard for measuring the quality of the services, and the timeliness of the invoicing and supplier switching processes in particular. Since the start of this quarterly measurement in the third quarter of 2005, Nuon regularly ranks as first of the large Dutch energy companies.
- ICT risks
Like any modern-day company, Nuon is increasingly dependent on sophisticated it systems. In almost all aspects of our business, it systems play a key role. Consequently, disruptions in it could have a detrimental impact on performance. For example, disruption in invoicing and collection processes could result in reputation damage, and losses from bad debts and uncollectible receivables.
- Allocation and reconciliation
The allocation process serves to determine the daily produced and delivered quantities of electricity and gas by using an estimation process. In particular, standard annual consumption patterns are used in the allocation process in the consumer and small business market. These estimates are reviewed regularly, and allocated quantities to customers are adjusted for actual quantities obtained through meter readings as part of this process. The legal requirements on reconciliation prescribe the settlement within 17 months after the end of the month of delivery, but with regard to gas, the settlement of volumes can still take place from the year 2002. The expected settlements from these processes have been estimated and recognised in the financial statements as accurately as possible, but the final settlement may affect future results.
- Production and distribution
The production and transport of electricity and gas takes place with the aid of technologically complex and sensitive installations. Strict maintenance schedules are adhered to for these installations. Though these installations are, in general, adequately insured against damage, it cannot be ruled out that occurrences of damage may have severe financial consequences for Nuon.
- Commodity markets
In common with all energy utilities, by virtue of the nature of its business, Nuon has an inherent exposure to the volatile power, fuels and CO2 markets. Although Nuon actively manages this exposure, price developments in these markets may have a significant impact on the financial results of Nuon.
- CO2 emission rights
Since the signing of the Kyoto treaty, CO2 reduction has been high on the social agenda. Changes in the regulatory regime surrounding CO2 or in the methodology by which CO2 emission rights are allocated could have a detrimental impact on the financial performance of Nuon.
- Volatility of the results as a result of the application of IFRS
The application of ifrs could potentially lead to an increase in the volatility of the results, which is caused by the fact that results are more heavily affected by fair value movements than they were in the past. Examples in this case are the accounting for financial instruments (fair value movements and the valuation of derivatives), the valuation of and impairments on goodwill and property, plant and equipment.
- Changing prices for financing instruments
It is in the nature of Nuon’s operations that the company trades on various financial markets. Nuon is sensitive to interest-rate fluctuations. In addition, Nuon makes use of a number of financing instruments and will need to make new financing arrangements for the planned construction of new assets which can possibly not be financed from the cash flow from operating activities. A forced unbundling of the company can cause changes in Nuon’s cash flow or parts thereof, thus leading to significant changes in the costs of the financing arrangements.
- Legal risks
Involvement in legal actions is an inherent part of Nuon’s operations. The outcomes of these actions are partly uncertain. Strict procedures apply to the reporting and handling of legal disputes. The final outcome of legal actions may show that the related costs are higher than foreseen or that the internal assessment of the action in question was insufficient. All this entails that the consequences of the identified risks may not be fully provided for at the time of preparation of the annual report.
- Pensions
Nuon has transferred most of the pension and pre-pension liabilities for the majority of its employees to pension funds. In the Netherlands, the majority of the pension liabilities has been transferred to the pension fund abp. The pension premiums that Nuon pays to the pension funds are based on, among other things, expectations relating to inflation, salary increases, ageing, mortality risks and the returns on the pension fund’s investment portfolio. Actual developments in relation to the aforementioned assumptions may differ from the assumptions used. Furthermore, changes may occur in legislation and regulations on pensions, pre-pensions and collective labour agreements. As a result, pension premiums and/or the related commitments charged to Nuon may be subject to significant fluctuations from year to year. In addition, ias 19 ‘Employee Benefits’ requires that Nuon should recognise a proportionate part of the liabilities and assets of the multi-employer plans in which Nuon participates on its own balance sheet and that a different method for the recognition of pension charges in the income statement is used. Nuon makes use of the exemption in ias 19 to account for the multi-employer plans as defined contribution plans in view of the fact that Nuon’s proportionate part of the assets and liabilities in the multi-employer plans cannot be determined reliably. However, the discussion in the Netherlands on this issue is ongoing and could eventually have a significant impact on the solvency and results of Nuon.
- Taxation
Nuon originates from a number of formerly independent companies, each of which had its own tax position at the time of assimilation into Nuon. Another specific tax issue in the sector concerns the treatment of the Regulating Energy Tax (reb). The valuation of the assets and liabilities in the opening balance sheet as at 1 January 1998 was nearly completed in 2005. The tax returns for the year 1998 are still being dealt with by the Dutch tax authorities. At the time of the preparation of these financial statements, Nuon devoted a lot of attention to assessing all significant tax risks as good as possible, and the current tax position has been reflected in the financial statements to the best of our knowledge. Changing insights may lead to additional charges. In addition, new tax risks may arise. In the valuation of deferred tax assets, notably in the field of tax losses carried forward and deferred tax assets relating to the differences between the carrying amount in the financial statements and the valuation for tax purposes of property, plant and equipment, assumptions are made regarding the extent to, and the term within which these receivables can be realised. This takes place on the basis of business plans, among other things. In addition, the financial statements are prepared using assumptions regarding the temporary and permanent differences between valuations for financial reporting purposes and for tax purposes. The actual situation may differ from the assumptions used in determining deferred tax positions, partly due to disputes with the tax authorities and changes in tax legislation.
- Health and safety risks
Nuon attaches great importance to the prevention of health and safety risks across the spectrum of its business operations and activities. Nuon has large grids at its disposal for the transportation of gas and electricity. Although maintenance standards are high, the assets used contain oil and asbestos. The raw materials used in the generation business include oil, gas and coal. Improper utilisation of assets could cause environmental problems and thus lead to financial damage. In addition, the debate on the possible health hazards of working in a high-voltage environment is continuing. Though Nuon takes health and safety measures on an ongoing basis, the occurrence of health risks due to lack of knowledge, lack of compliance with procedures or insufficient procedures due to current lack of knowledge cannot be ruled out.