Annual Report Management s Review...3. HMN Naturgas I/S and the energy policy agreement Regulation of PSO activities...

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1 Annual Report 2012 CVR nr Contents Management s Review....3 HMN Naturgas I/S and the energy policy agreement Distribution activities Regulation of PSO activities Audit Committee Corporate social responsibility The enterprise s internal control and reporting Special risks Development in group activities and financial conditions Key Figures and Financial Ratios Statement by the Board of Directors and Executive Board Independent Auditor s Report Statement of Comprehensive Income Balance Sheet Cash Flow Statement of the HMN I/S Naturgas group Statement of Changes in Equity Notes Company information

2 What can the gas system be used for? A. Storing wind power. Surplus power from wind turbines is converted into hydrogen, which can be mixed with natural gas and used in the gas system. B. Storing biogas. Surplus biogas can be mixed with natural gas and used in the gas system. C. Regulating electricity production. When it isn t windy, the natural gas can quickly be turned up at the decentralised power plants. Lars Petersen The gas infrastructure will play an important role in the Danish energy system of the future, as far ahead as it is meaningful to comment. However, in future, rather than competing, the energy systems will be cooperating and integrated to form an energy system for the future in which wind power, solar energy, biomass, waste and gas are flexibly integrated.

3 Management s Review In 2012, the HMN Naturgas group generated a profit after tax of DKK million. During the year, the group reduced its net debt in the year by DKK 502 million to DKK 707 million. The Annual Report is presented in accordance with International Financial Reporting Standards (IFRS). This means that the Annual Report 2012 comprises the joint parent Financial Statements of HMN Naturgas I/S and Consolidated Financial Statements in which the parent is consolidated with the following subsidiaries: HMN Gassalg A/S with the subsidiary HMN Gashandel A/S HMN Erhverv A/S and HNG Holding ApS with the subsidiary A/S Strandvejsgasværket The group s earnings from distribution activities are determined by an income limit imposed by the Danish Energy Regulatory Authority for the individual year, taking into account that HMN Naturgas I/S may be able to repay debts established before 1 January 2005 and cover its operating expenses through efficient operation of the company. The group s earnings from natural gas supply activities, which are handled by HMN Gassalg A/S and HMN Gashandel A/S, have been generated by the sale of natural gas to customers in Denmark in competition with other natural gas supply enterprises. All customers are free to choose their own natural gas supplier. Customers in HMN Naturgas distribution area who do not exercise their right to choose a supplier receive supplies from HMN Gassalg A/S PSO activities, the profit of which is regulated by the Danish Energy Regulatory Authority. The other subsidiaries in the group have limited activities that contribute only modestly to the group s consolidated results. HMN Naturgas I/S object is to distribute natural gas as cheaply as possible and at a high safety and service level for the benefit of the customers in the enterprise s distribution area. The customers are offered natural gas on competitive terms via the supply company HMN Gassalg A/S and its subsidiary HMN Gashandel A/S. The object of the HMN Naturgas group is to be the most efficient natural gas distribution company in Denmark and be the customers preferred natural gas supply company. In November 2012, HMN Naturgas I/S Committee of Representatives decided to extend the repayment period for the remaining part of the net debt in the parent company HMN Naturgas I/S by 4 years, thus extending the existing debt repayment period from end-2016 to end This decision was made because HMN Naturgas I/S finds that customers should benefit from the HMN Naturgas group s robust finances by the remaining part of the net debt being repaid at a slower rate. The distribution rate is consequently lowered by 22% on average as from The decision of HMN Naturgas I/S Committee of Representatives is based on the fact that at the end of 2012, repayment of the net debt in the overall HMN Naturgas group will be reduced to the end-2014 level anticipated in the original agreement between HNG I/S and Naturgas Midt-Nord I/S (merged into HMN Naturgas I/S) and the government (the Sankt Hans Agreement). The Sankt Hans Agreement was concluded in HMN Naturgas I/S (57 municipalities) 100% HNG Holding aps HMN Erhverv A/S HMN GASSALG A/S 100% 100% a/s strandvejsgasværket HMN GAShandel A/S 3

4 HMN Naturgas I/S and the energy policy agreement 2012 On 22 March 2012, the parties in the Danish Parliament, except Liberal Alliance, concluded an agreement on Denmark s energy policy for the period With an eight-year framework of agreement and joint policy objectives extending to 2050, HMN Naturgas I/S is of the opinion that a firm political basis has been created for Denmark s sustainable energy system of the future. HMN Naturgas I/S is working actively and determinedly to introduce greener energy while ensuring that the system is coherent and based on a socioeconomic rationale. In a gas perspective, the energy policy agreement contains many interesting elements, including the following: Utilisation of the gas infrastructure In the coming year, an analysis will identify how the gas infrastructure is to be utilised in the future in the transitional phase with continued use of natural gas as well as in the future when biogas and other renewable energy gases will take over. Together with analyses of the role of district heating in the energy sector of the future and sustainable utilisation of biomass resources, the analysis will illustrate the future backbone of the Danish energy system combined heat and power (CHP) production. It is essential for HMN Naturgas I/S to keep the focus on the role of gas-based decentralised CHP production as the most efficient and socioeconomically most expedient way to balance a Danish energy system. Furthermore, the gas infrastructure constitutes a social investment of DKK 50 billion, which will soon be paid, and which will be capable of storing and transporting different gases to most parts of the country for many years to come. We should uphold and utilise this infrastructure. Development in the period until 2020 Despite considerable long-term uncertainty, some development lines can be drawn with reasonable certainty for the period until 2020: Furthermore, continued conversions from natural gas to district heating are expected, particularly in the Greater Copenhagen area. However, in HMN Naturgas I/S assessment, the best projects in socioeconomic and user economic terms are actually being implemented now or have been adopted for implementation. Accordingly, as shown by the most recent project proposals, the socioeconomic and user economic benefits of converting to district heating are deemed to be declining. As a consequence, some local authorities are considering making connection to district heating mandatory to ensure corporate profitability of the projects. Overall, the assessment is that in addition to the already adopted conversion projects, which will lead to a sales reduction of just over 200 million m3 of natural gas for HMN Naturgas I/S, only a modest conversion potential will remain in 2020 based on the present assumptions. In recent years, HMN Naturgas I/S has been a consultee in approx. 80 cases that would cause our gas sales to fall. We agreed in 66 cases and appealed to the Energy Board of Appeal in only 14 cases based on the poor economy of the projects or on violation of legislation in general. The Board decided in our favour in 11 cases, and we lost 3 cases. A decline in natural gas sales in the range of 25-35% is expected compared to A key reason for this is the much higher energy-saving requirements imposed on energy companies. This will have a significant impact on all forms of energy, including natural gas. Thus, HMN Naturgas I/S must realise energy savings corresponding to a total of just over 250 million m³ of natural gas over the period The future sale of natural gas for decentralised CHP is subject to much greater uncertainty. The electricity system of the future will be wind-based, so there will be a need for backup capacity when the weather does not permit wind-based electricity production. Here, the flexible and energy-efficient gas-based decentralised CHP is an obvious solution, but the area does pose some challenges. 4

5 Firstly, the existing subsidy scheme for decentralised CHP the so-called basic amount will be discontinued in It is highly uncertain how many CHP plants will close down, unless a positive solution to the discontinuation of this scheme is found. Secondly, a strengthening of the Danish link-up with electricity grids abroad is being planned. While providing a number of advantages for wind-based production, this also intensifies competition for CHP production at Danish decentralised CHP plants. The intensified competition may result in advantages as well as drawbacks for decentralised electricity production in Denmark. HMN Naturgas I/S estimates that sales will be reduced by between 100 and 200 million m3 of natural gas for this customer segment, which used to be the principal element of efficient and environmentally less harmful Danish energy supply. We also anticipate a reduction in sales to industry, boosted by a special government subsidy earmarked for conversion to biomass and resulting from energy savings. In 2020, the sale of energy for use in industrial production through HMN Naturgas I/S system is estimated at approx. 350 million m3 of natural gas against approx. 500 million m3 today. CO2 reductions Natural gas is a fossil fuel, but it contains approx. 25% less CO2 than oil and approx. 40% less than coal. Hence, conversion to natural gas will in itself lead to an immediate reduction of CO2. This applies particularly to the transport sector and industry where there is a marked absence of other solutions. Finally, the heating sector continues to have potential. In HMN Naturgas I/S area alone there is a remaining potential of approx. 30,000 oil-fired single-family houses. Natural gas provides immediate environmental benefits in the short term. With the introduction of upgraded biogas and other renewable energy gases such as gasification gas and synthesis gas from electrolysis, the reduction of CO2 will be further strengthened in the longer term. Energy efficiency Energy must be used as efficiently as possible. While this implies continued energy savings, it also means that energy already produced must not go to waste. Here, the gas system with its huge storage capacity may be of vital importance to a sustainable energy system. The wind-based electricity system will produce surplus power from time to time. Through electrolysis, this power can be transformed to synthesis gas, which can be stored and subsequently used in the CHP sector for heat and power production when weather conditions prevent wind-based power generation. Finally, the gas-enabled CHP production contributes to reducing total gross energy consumption. Overall, the sale of gas in 2020 through HMN Naturgas I/S system is estimated at approx. 1.2 billion m3 against just under 1.8 billion m3 in Development after 2020 The energy policy agreement from 2012 will run until Subsequent development towards the vision of a fossil-free energy system by 2050 has not been politically described, much less determined at the present time. Flexibility Gas is a highly flexible energy form which can be modulated very quickly as required. Gas-based decentralised CHP is therefore the ideal and necessary back-up facility for a wind-based electricity system. The same applies to the flexibility of gas as a fuel for mid and peak demand supplies for the district heating systems. Finally, the modular gas provides a number of production technology-related and thus financial benefits for the industry. However, there are indications that the energy system of the future should meet three significant criteria: CO2 reductions, energy efficiency and flexibility. At the same time, the electricity, district heating and gas energy systems must work together and consequently should be viewed as a whole to a much larger extent than previously. In this connection, the gas infrastructure may play an important part: Overall, the gas infrastructure will thus have an important part to play in the Danish energy system for the foreseeable future. What is new is that rather than competing with each other in future, the energy systems will have to work together and be synthesised in a future energy system integrating wind power, solar power, biomass, waste and gas in a flexible way. 5

6 6 If gas is introduced in the transport sector, environmental benefits in the form of considerably lower CO 2 emissions will be within sight. A benefit that could grow when biogas ultimately follows suit. The HMN Natural Gas Group is driving developments by establishing gas filling stations and joining forces with municipalities and fleet owners on converting heavy traffic to use gas. Denmark s first 24-hour gas filling station with public access will be opened by HMN Natural Gas in Skive in April. Lars Petersen

7 Biogas in the natural gas grid Under the energy agreement concluded in March 2012, biogas used directly for CHP production and biogas distributed through the natural gas grid were given equal status in terms of grants. This created economic framework conditions under which it is realistic to expect the establishment of biogas production in the coming years with a view to distributing biogas through the existing natural gas grid. The primary purpose of introducing a financial incentive for upgrading and thus for the distribution of biogas is to improve the financial basis for biogas production in order to reduce the environmental impact of animal manure and organic waste. The overall political objective is to substantially increase the annual biogas production in the period until Initial grants for the establishment and extension of biogas production were awarded in Due to considerable interest, it has only been possible to provide grants for 1/3 of the plants that have applied, and there are currently no prospects of further grants being offered. It is uncertain whether the desired growth in biogas production will take place, and it is similarly difficult to estimate the future biogas share of the total gas distribution. HMN Naturgas I/S estimates that half of the biogas produced will eventually be distributed through the natural gas system, while the other half will be sold directly to CHP plants. The statutory implementation of the energy agreement implies that HMN Naturgas I/S is obliged to connect biogas to the natural gas grid, always provided that the costs are covered by the enterprise which is to upgrade biogas to natural gas quality. Like biogas production, upgrading of biogas is to be considered a commercial activity. This means that HMN Naturgas I/S is prevented from getting involved in these activities. HMN Gashandel A/S, on the other hand, has decided that it will be capable of upgrading biogas, while at the same time it has decided that, for the time being, biogas production is not to be one of the company s business areas. Gas for the transport sector The energy agreement of March 2012 also specifies grants for biogas for transport purposes. As a main rule, the biogas to be used for transport purposes is expected to be distributed through the natural gas grid. In practice, this will involve linking certificates to the biogas produced, which may be comprised by separate pricing. The use of biogas will have a marked impact on the transport sector s contribution to the reduction of CO2 emissions. The contribution of natural gas will be limited, but since the technology relating to gas for transport purposes is fully developed and widespread in many countries, natural gas may play an important part during a transitional period. Thanks to the favourable development in natural gas prices, natural gas is close to being competitive with conventional fuels such as petrol and diesel oil. Accordingly, there is a basis for establishing an infrastructure as regards gas for transport purposes. This mainly involves gas filling stations for large fleets, especially public bus companies, where it is easier to ensure the sales necessary to pay interest on the required investments. HMN Naturgas I/S aims to establish a connection model and rating that will help promote the use of gas in the transport sector, while being of benefit to existing customers in HMN Naturgas I/S distribution area. Several projects for the establishment of gas filling stations are currently under way, and gas supplies for 2-3 municipal/ regional bus projects are expected to be established in the course of Together with the Municipality of Skive, HMN Naturgas I/S has launched a demonstration project in which a number of municipal cars will be gas-powered. HMN Naturgas I/S will acquire some of those cars and make them available to the municipality, while HMN Gashandel A/S will establish a public-access gas filling station in the centre of Skive. 7

8 Based on foreign experience with gas vehicles, the establishment of a market for gas vehicles is likely to be slow. But in the long term, when a substantial part of the natural gas must be expected to be replaced by green gases, there is reason to believe that the transport sector will make up a significant part of the gas market. Energy-saving efforts Together with the other Danish grid and distribution companies, HMN Naturgas I/S is committed to realising energy savings that would not be realised without the participation of those companies. This commitment is rooted in the agreement between the Minister for Climate, Energy and Building and the companies. As seen from the table below, HMN Naturgas I/S exceeded its obligation to realise energy savings among its customers. Furthermore, this was achieved at lower unit costs than originally anticipated for the period in the agreement between the Minister for Climate, Energy and Building and the grid and distribution companies. HMN Naturgas I/S has chosen a strategy according to which it is clear what the company offers individual categories of end users in terms of supporting their energy-saving efforts. The strategy ensures that all end-user categories are offered assistance from HMN Naturgas I/S with realising their energy savings. At the same time it has been decided that most of HMN Naturgas I/S efforts in terms of realising energy savings are to be implemented via specific partnerships with external players. Hence, HMN Naturgas I/S has chosen a role where the company s own employees perform a minor part of the specific advisory tasks. In addition, HMN Naturgas I/S performs quality assurance activities concerning its overall energysaving efforts to ensure that its activities and results meet the obligations and requirements following from the agreement between the Minister for Climate, Energy and Building and the companies. In mid-2012, the Danish Energy Agency completed an evaluation of the energy-saving scheme. The evaluation concluded that the customers are generally very satisfied with the scheme. The external players, including consultancy and installation firms among others, also expressed satisfaction with the scheme and the wish to continue cooperating with HMN Naturgas I/S on the implementation of energy-saving measures in the future. In November 2012, a revised agreement was concluded between the Minister for Climate, Energy and Building and the grid and distribution companies. The revised agreement increases the grid and distribution companies obligation to realise energy savings by 75% in 2013 and In the period , the obligation will be increased by 100% relative to the annual obligations in the period An ambitious target for the companies efforts, but HMN Naturgas I/S estimates that it will be able to realise its share of the increased targets. In addition to the increased obligation, the revised agreement contains a number of clarifications and imposes stricter standards, which will lead to a greater degree of transparency in the grid and distribution companies energy-saving efforts, higher-quality documentation of realised energy savings, and continued focus on market orientation and the involvement of external players. The revised agreement and the increased obligation will not result in immediate changes in HMN Naturgas I/S energysaving efforts nor in HMN Naturgas I/S staffing up to perform the task. On the other hand, cooperation with external players and large energy-intensive enterprises will be strengthened. Obligation Result Accumulated transfer Year MWh MWh MWh , ,727 61, , ,586 93, , , , , , ,171 8

9 Regulation of distribution activities The parent company HMN Naturgas I/S is in charge of the group s natural gas distribution activities. The parent company s financial affairs are mainly regulated by the Danish Executive Order on Income Limits and Opening Balance Sheets for Natural Gas Distribution Companies. According to the Executive Order, the Danish Energy Regulatory Authority sets the annual limits for the income the companies are authorised to collect for the operation of the companies the costs the companies are authorised to include in their prices. The income limit period is four years and the current 4-year period covers In the autumn of 2013, the Danish Energy Regulatory Authority will set the preliminary income limit for the period The Danish Energy Regulatory Authority will also lay down efficiency requirements for the same period. The income limit is the annual cap on the income that the distribution company is authorised to collect from its customers, and the income limit is fixed for the purpose of repaying and paying interest on the distribution company s historical debt, of covering operating expenses through efficient operation and of earning a return on and writing off new investments over the useful lives of the assets. Interest on and repayments of debt as at 1 January 2005 total approx. 50% of the income limit for HMN Naturgas in The decision of the Committee of Representatives to extend the repayment period regarding historical debt until 2020 means that as from 2013 interest on and repayments of debt will constitute approx. 40% of a new and lower income limit. Under the Executive Order on Income Limits, costs related to the operation and maintenance of the distribution system have been fixed so as to ensure that these costs cannot exceed the average annual costs realised in the period Furthermore, the Danish Energy Regulatory Authority has imposed efficiency requirements of 0.75% p.a. on the company for each year in the period The actual costs relating to these tasks may be included in the prices charged to the consumers by the companies. Extraordinary efficiency gains In the event that the efficiency-adjusted costs or the actual interest expenses in respect of net debt for a year are lower than the limits set by the Danish Energy Regulatory Authority for such costs, this constitutes an extraordinary efficiency gain under the Executive Order on Income Limits. At least 50% of this gain is to be refunded to the consumers through a lower future distribution rate, while the remainder may be allocated to the return on the contributed capital, among other things. In December 2012, the Danish Energy Regulatory Authority determined the final income limit for 2011 for HMN Naturgas I/S distribution activities. At the same time, the Danish Energy Regulatory Authority calculated HMN Naturgas I/S extraordinary efficiency gain for that year at DKK 89.2 million. The Danish Energy Regulatory Authority will not determine the final income limit for 2012 until Q Accordingly, Financial Statements will not be presented pursuant to the Executive Order in this Annual Report, but the efficiency gain for 2012 will be included in the Financial Statements for Distribution rate In addition to adjustment for extraordinary efficiency gains, adjustment is also made for excess/deficient cover relative to the income limit. The realised sales will to a greater or lesser extent deviate from the budgeted sales which are used as the basis for determining the distribution rates. A preliminary computation shows a residual accumulated deficient cover of approx. DKK 105 million arisen in the years Deficient cover is adjusted over the distribution rate in the period The deficient cover was planned, as HMN Naturgas strives to keep the companies distribution rates measured in fixed prices fairly constant from year to year. The principles in the Executive Order on Income Limits mean that the company must reduce its distribution rate considerably at the end of the debt repayment period in Costs relating to security tasks imposed on the distribution companies under the Gas Regulations are not comprised by the Danish Energy Regulatory Authority s efficiency requirements. 9

10 Regulation of PSO activities HMN Gassalg A/S was previously in charge of the HMN Naturgas group s PSO natural gas activities. The supply obligation used to comprise customers who did not choose another commercial natural gas supplier. The PSO activities are subject to regulation from the Danish Energy Regulatory Authority, which determines the maximum surplus individual PSO natural gas suppliers are entitled to earn in a single year. Natural gas legislation will be amended as from The amendment implies, among other things, that the Danish Energy Agency will invite tenders for the PSO task in individual distribution areas. In principle, the PSO task will be granted to the company that is able to offer customers the lowest overhead charge on an exchange price of natural gas specified in the tender documents. However, the Danish Energy Regulatory Authority did not determine the size of the surplus HMN Gassalg A/S is entitled to keep for each of the years until December Seen over this period as a whole, the Danish Energy Regulatory Authority s decision entails a result that was expected by HMN Gassalg A/S and which led HMN Gassalg to lower the price of natural gas for customers in both 2011 and HMN Gassalg A/S had the lowest natural gas prices for customers who received natural gas on PSO terms over the entire period. In future, the primary recipients of natural gas on the new PSO terms will be customers who actively choose the PSO product and customers who are unable to be supplied by a commercial natural gas company. The Danish Energy Agency s invitation for tenders for the PSO task in early 2013 includes a licence period from 1 May 2013 to 30 April Audit Committee In accordance with the implementation in Danish legislation of the Eighth Company Law Directive of the EU, HMN Naturgas I/S has set up an Audit Committee to monitor the financial reporting process. The Audit Committee of the HMN Naturgas group is identical to the Board of Directors of HMN Naturgas I/S. This was found to be most expedient, as regulatory requirements related to the work of the Audit Committee already constitute a significant part of the Board of Directors responsibilities. The most important task of the Audit Committee in 2012 was to monitor the financial reporting process of the companies in the HMN Naturgas group and to monitor the group s risk management and internal control. 10

11 Corporate social responsibility Climate and environment HMN Naturgas I/S supports the development towards increased use of renewable energy while the use of fossil fuels, including natural gas, is phased out. However, this change in energy supply will happen gradually, and therefore natural gas will continue to be an important element in Denmark s energy supply in the coming years, as natural gas is an environmentally efficient "bridge builder" to the future of renewable energy. gas grid, a few of which are expected to be implemented in the course of 2013 and Natural gas leaks Natural gas consists of hydrocarbons (mainly methane) which are extremely aggressive greenhouse gases as compared to CO2. Therefore, HMN Naturgas I/S is making every effort to limit emissions. HMN Naturgas I/S will continue to focus on ensuring as efficient use of natural gas as possible, while working towards developing the interaction between renewable energy and natural gas. Development activities HMN Naturgas I/S is a co-owner of DGC (Danish Gas Technical Centre) which is responsible for the company s research and development activities subject to the licence. HMN Naturgas owns 40% of DGC and annually contributes approx. DKK 8 million to its operations. DGC has formulated a strategy with focus on the transition to renewable energy and how the natural gas system can support this transition. The long-term perspective is for natural gas to be replaced by renewable energy gases which are CO2 neutral. These are biogas, artificial natural gas and gas produced from the gasification of biomass. The strategy will be implemented in specific research and development activities. Distribution of biogas For the past few years, HMN Naturgas I/S has focused on developing the possibility of distributing biogas. Using waste from agricultural production etc. for energy purposes generates major environmental benefits and, hence, using the natural gas grid for the distribution of biogas offers significant prospects. In 2012, political framework conditions for the distribution of biogas in the natural gas grid were laid down. The framework conditions are expected to be approved in the EU during the spring/summer of In the second half of 2012, HMN received a number of applications for connection of biogas plants to the natural The natural gas grid is regularly examined for leaks. In reality, however, there are no leaks in the natural gas grid. Therefore, the most likely cause of natural gas leaks is if the pipelines are damaged during digging work. To prevent this from happening during digging work, HMN Naturgas I/S provides online information on the position of pipelines, and furthermore has considerable emergency response measures in place to reduce the effect of such damage. Employees with the required expertise must be present within one hour after damage to a pipeline during digging work. In practice, employees are present at the scene of the damage within approx. 30 minutes. For all planned grid interventions, the pipelines are blown down using flaring to avoid the emission of methane to the atmosphere to the widest possible extent. To prevent accidents in gas consumers homes, HMN Naturgas I/S carries out random safety checks of new and existing customer installations. In the event that a suspected gas leak in a consumer s home is reported, an employee with the required expertise must be present within one hour of the leak being reported. Normally, the employee will be present at the scene within approx. 30 minutes. Social responsibility Social responsibility is considered to be an important aspect of retaining HMN Naturgas I/S position as an attractive place to work with satisfied employees. HMN Naturgas I/S s corporate social responsibility policy and the specific efforts are discussed on an annual basis as part of the company s staff policy discussions with the participation of the management and employee representatives. The company addresses both internal and external social responsibility. 11

12 The internal focus is on maintaining and promoting a good and inspiring physical and psychosocial working environment. This is ensured by, among other things, providing a good framework for the employees, allowing them to make healthy choices in terms of food and exercise, and rules have been laid down for the care of and support to employees in the event of illness. HMN Naturgas I/S has a separate social responsibility policy in connection with illness. The social responsibility in relation to the surrounding world mainly means that meaningful employment is offered to employees requiring special terms (flexible jobs and light jobs) or undergoing work test assessments. In 2012, HMN Naturgas has five employees on special terms, and eight persons have gone through work test assessments. Trainees from primary and lower secondary schools and other educational institutions are regularly taken in, and HMN Naturgas I/S is committed to permanently having eight students in education or training. In 2012, the number of students in education or training was six. Human rights and anticorruption HMN Naturgas I/S supports the United Nation s human rights and anticorruption policies, but the company has not laid down any policies of its own in this area, as it only to a very limited extent has transactions of goods with other countries. Therefore, the company finds that it can only to a very limited extent exert any influence in these areas. The enterprise s internal control and reporting The Audit Committee, comprising the Parent Company s Board of Directors, determines the group s overall guidelines on risk management, internal control and reporting. The implementation of these guidelines is performed by the day-to-day management. The purpose of the guidelines for the group s risk management and internal control is to manage rather than eliminate the risk of errors and omissions in connection with financial reporting. The internal control systems in the group and the guidelines laid down are continuously evaluated, and any significant deviations from and changes to these guidelines are addressed by the Audit Committee. The Board of Directors lays down the overall guidelines for risk management in connection with the group s financing, volume and price risk in connection with the purchase and sale of natural gas and price and counterparty risk in connection with hedging in the financial market. The day-to-day management responsibility and competences in relation to the Board of Directors are laid down in the Articles of Association of HMN Naturgas I/S. The day-to-day management lays down/approves policies and guidelines in areas that are important to the operation and day-to-day financial management of the companies, including: Customer credit and loan policy Investment policy Depreciation and amortisation policy Guidelines for financial reporting items based on estimates or generated through complex procedures. 12

13 Control activities and reporting The day-to-day management is responsible for ensuring that the internal control systems are adequate to ensure correct financial reporting in the HMN Naturgas group. The internal control systems to ensure correct financial reporting are divided into two categories: 1. Controls in connection with registration, approvals and reconciliation 2. Controls in connection with periodic reporting Controls in connection with registration, approvals and reconciliation Procedures and systems are organised to ensure the required separation of functions in the finance function. The organisational structure and internal guidelines constitute the control environment. Descriptions of financial reporting and reporting procedures are updated as needed and reviewed at least once a year. Policies, descriptions of procedures, internal guidelines, including accounting rules relevant to the internal control in respect of financial reporting are available to the relevant employees. Controls in connection with periodic reporting As part of the internal control, periodic reports are prepared at the end of each quarter. Periodic reports are handled by the Board of Directors of the individual companies. Periodic reports include a statement of the company s current situation in the most important risk areas in which the Board of Directors has laid down/approved policies and guidelines. Any additional risks identified are assessed and reported. Appropriations Upon the recommendation of the Board of Directors and in accordance with the company s Articles of Association, the company s Committee of Representatives approves the parent company s budget for the coming year by 15 November, at the latest. The appropriations for the coming year form part of the budget approval and comprise: Appropriation for revenue. Appropriation for operating expenses and other operating income. Appropriation for interest and other financing expenses. Appropriation for amount available for investments. The appropriations are granted upon the Committee of Representatives approval of the budget. The Board of Directors may decide that investment activities are to be subject to special approval by the Board of Directors. Based on quarterly reports, the Board of Directors checks that the appropriation amounts are complied with and makes recommendations to the Committee of Representatives in the event that appropriation corrections are needed. External audit The company s Financial Statements are audited by an external auditor appointed by HMN Naturgas I/S Committee of Representatives. In this connection, the auditor also considers the company s financial reporting and internal controls. The auditor represents the interests of the owner municipalities as well as public interests. The auditor reports material financial reporting matters or material weaknesses in the internal control environment to the Board of Directors via the Audit Committee and in the long-form audit report to the Board of Directors. As part of the preparation of periodic reports including the Annual Report the central items included in the financial results for the period are subject to a probability test to ensure that they are recognised in the correct periods. 13

14 Special risks Distribution income Distribution income in the parent company is subject to regulation under the Danish Natural Gas Supply Act (lov om naturgasforsyning). According to the Act, the natural gas distribution company may have repaid its historical debt by 2014 at the earliest. In the autumn of 2012, HMN Naturgas I/S decided to extend the repayment of its historical debt from the end of 2016 to the end of This entails a lowering of the level of distribution income for each year in the period by approx. 20% compared to the distribution income in Derivative financial instruments HMN Gashandel A/S offers customers agreements in which the selling price of natural gas is determined on the basis of different combinations of fuel and gas oil prices, exchange prices of natural gas and the US dollar and euro rates. Similarly, HMN Gashandel A/S enters into purchase agreements, in which the purchase price of natural gas is fixed on the basis of different exchange prices or combinations of fuel and gas oil prices and the US dollar and euro rates. Inadequate distribution income in individual years may be taken into account when determining future distribution rates. Income from natural gas supply The HMN Gassalg group s income mainly derives from a minor amount per m³ sold added to expected natural gas purchase prices and a fixed contribution per customer. In a warm year, the group s gross profit will decrease owing to reduced sales and any take-or-pay terms. This risk has been mitigated by purchasing some of the natural gas quantities on flexible terms supplemented by quantities that can immediately be resold on the international market. The flexibility is estimated to be adequate to cope with normal temperature fluctuations and normal market share losses to other suppliers or customers choosing other forms of energy supply. To the extent that the customers choose other natural gas suppliers than HMN Gassalg A/S or HMN Gashandel A/S, the HMN Naturgas group s income basis is reduced. In its transactions, the group has allowed for any loss of market shares in the HMN Gassalg group. Competitive strength The market price of natural gas varies to a considerable extent with the development in natural gas prices on the European gas exchanges and to a declining extent with the development in oil prices. The purchased natural gas quantities and the sales agreements concluded primarily follow or are hedged in relation to those exchange prices. Imbalances between natural gas quantities purchased and sold can thus be realised on current market terms. On entering into such agreements, HMN Gashandel A/S accepts a price and foreign-exchange risk as the purchase and selling prices of the gas are fixed on a different basis. HMN Gassalg A/S and HMN Gashandel A/S hedge these oil price and foreign-exchange risks by using derivative financial instruments, including swaps and, to a limited extent, call and put options, so that HMN Gashandel A/S has only a minimal risk in connection with the purchase and sales agreements concluded. There is a risk that a time difference will occur between the actual delivery to customers and the financial hedging of the delivery in question. The financial hedging of the price products means that there is a potential risk that the financial counterparty will not be able to meet the obligations in the agreements concluded with HMN Gashandel A/S. This risk is sought to be hedged through solvency requirements for the counterparty combined with a limitation of outstanding accounts with the individual counterparty. Ordering and nominations It will have financial implications if the company s ordering and nominations of natural gas for the next 24 hours are outside the margins laid down in the rules governing the use of the transmission system. During recent years, the group has built up considerable knowledge in this area while at the same time automating the routines in the company s nomination system. The nominations have been hampered by the increasing impact of electricity prices on the customers gas consumption. Unforeseen fluctuations, particularly in large customers consumption of natural gas may result in the forced sale or forced purchase of gas quantities from the system operators. 14

15 Loans to customers HMN Naturgas I/S offers loan financing of, in particular, private customers shift to natural gas or replacement of natural gas installation. The loans are based on a specific credit assessment of the individual customer. Loans are granted on commercial terms, meaning that the interest rate is fixed based on an assessment of the overall credit risk on the loan portfolio. Loss on bad debts In the wake of the financial crisis, the company has experienced an increase in its losses on bad debts. This is reflected in higher provisions for losses. The loss risk is sought to be reduced by specifying customers terms of payment and closely following up on receivables due. Development in group activities and financial conditions Results 2012 HMN Naturgas I/S Financial Statements for 2012 show a profit for the group of DKK million after interest, depreciation and amortisation and tax. In 2011, the net profit totalled DKK million. The parent company, comprising the distribution activities in HMN Naturgas I/S, generated a profit of DKK million after interest and depreciation and amortisation, compared with a profit in 2011 of DKK million. Due to its corporate form, the parent company is not liable to taxation. Distribution of natural gas In 2012, HMN Naturgas I/S gross profit from distribution activities amounted to DKK million against DKK million in The gross profit for 2012 reflects that the distribution rate was lowered by 3%, effective from 1 January 2012, corresponding to approx. DKK 25 million. Furthermore, the distributed natural gas volume was lower in 2012 than in 2011, due particularly to lower electricity production at decentralised CHP plants. Natural gas supply In 2012, the group s gross profit from natural gas supply activities was DKK 77.2 million, down from DKK million in The gross profit for 2012 was negatively affected by a refund of approx. DKK 50 million in 2012 to PSO customers due to a higher profit in 2011 and previous years than is expected to be approved by the Danish Energy Regulatory Authority in early 2012 for those years. In December 2012, the Danish Energy Regulatory Authority decided that only DKK 30 million was to be refunded to consumers. Other operating income Other operating income in the group totalled DKK million in 2012 against DKK 78.4 million in Other operating income comprises income from service schemes offered to small natural gas customers and changes in the fair value of financial instruments used in connection with the purchase and sale of natural gas and other operating income. 15

16 Other external costs and staff costs Total operating expenses in the group amounted to DKK million in 2012 against DKK million in In 2012, staff costs totalled DKK million, and other operating expenses were DKK million. The corresponding figures for 2011 were DKK million and DKK million, respectively. Other external operating expenses include expenses for service schemes offered to small natural gas customers. Depreciation and amortisation In 2012, depreciation and amortisation amounted to DKK million in the parent company and DKK million in the group against DKK million in 2011 in the parent company and DKK million in the group. Financing costs The group s net financing costs totalled DKK 12.7 million in 2012 against DKK 30.7 million in The parent company s net financing costs totalled DKK 12.0 million in 2012 against DKK 32.7 million in Of the net financing costs in 2012, revaluation of provisions for abandonment in terms of return amounted to DKK 9.3 million. In 2011, this revaluation was DKK 11.7 million. Development in the group s net debt The group s net debt totalled DKK million at the end of 2012 against DKK 1,208.7 million at the end of Equity The group s equity increased to DKK 1,844.3 million at the end of 2012 against DKK 1,709.9 million at the end of Events occurring after the end of the financial year No events of material importance to the evaluation of the Annual Report have occurred after the end of the financial year. Outlook The customers switch to other forms of energy supply including conversion to district heating as well as general reductions in the consumption of energy may lead to increasing distribution rates. Therefore, it is essential to keep distribution rates at a level ensuring that the overall end price of natural gas remains competitive with that of alternative fuels. In 2013, the distribution rate will be reduced by 23% on average, and it will be further reduced once the historical debt has been repaid. The historical debt is planned to be repaid by The overall HMN Naturgas group expects to be able to maintain its position as an efficient enterprise offering customers competitive prices and a high service level. Overall, the group expects a slightly lower profit in 2013 than in

17 Key Figures and Financial Ratios for the HMN Naturgas group Finances DKK million Revenue ,247 5,468 5,723 Gross profit , Operating income Operating expenses Depreciation and amortisation/writedown Operating profit Special items Profit in associates Net financials Profit/loss before tax Income tax Net profit/loss for the year Financial ratios Investments in property, plant and equipment Equity ,574 1,710 1,844 Balance sheet total 5,012 5,025 6,993 6,202 6,024 Non-current liabilities, gross 4,348 4,314 4,164 3,233 2,833 Net debt 2,042 1,678 1,713 1, Contributed capital and interest accrued Net cost on liabilities % Inflation %, net price index, Dec Gross margin Profit ratio Rate of return "Return on equity Equity ratio, solvency Statistics Distribution, million m ,173 1,858 1,740 Connected, number of customers 183, , , , ,663 Distribution network, km ,268 1,268 1,268 Distribution system, km 4,362 4,370 8,450 8,483 8,495 Number of persons employed Key figures and financial ratios for 2010 to 2012 are stated for the HMN Naturgas group, whereas the comparative years 2008 and 2009 comprise figures for HNG I/S. The Financial Statements for 2012 are presented in accordance with IFRS, and comparative figures for 2009 to 2011 are stated according to the same standards. Comparative figures for 2008 have not been restated to IFRS. 17

18 Statement by the Board of Directors and Executive Board The Board of Directors and the Executive Board have today reviewed and approved the Annual Report of HMN Naturgas I/S for the financial year 1 January 31 December The Consolidated Financial Statements and the Parent Company Financial Statements are prepared in accordance with International Financial Reporting Standards as adopted by the EU. Furthermore, the Consolidated Financial Statements, the Parent Company Financial Statements and the Management s Review are prepared in accordance with additional disclosure requirements of the Danish Financial Statements Act (årsregnskabsloven). In our opinion, the Consolidated Financial Statements and the Parent Company Financial Statements give a true and fair view of the group s and the company s assets, liabilities and equity and financial position at 31 December 2012 and of the results of the group s and the company s operations and cash flows for In our opinion, the Management s Review includes a fair review of developments in the group s and the company s operations and financial affairs, the profit or loss for the year and the group s and the company s financial position as well as a description of the key risks and uncertainties facing the group and the company. The Annual Report is submitted for the adoption by the Committee of Representatives. Gladsaxe, 14 March 2013 Susanne Juhl Managing Director, CEO Board of Directors' meeting, 14 March 2013 Jens Grønlund (Chairman) Ole Bjørstorp (Vice chairman) Ove E. Dalsgaard Willy R. Eliasen Elvin J. Hansen Jens Arne Hedegaard Jens Vestergaard Jensen Erik Lund Jørgen Nørby Finn Stengel Petersen Tina Tving Stauning Jørgen H. Sørensen Hans Toft 18

19 Independent Auditor s Report To the partners of HMN Naturgas I/S Report on the Consolidated Financial Statements and the Parent Company Financial Statements We have audited the Consolidated Financial Statements and the Parent Company Financial Statements of HMN Naturgas I/S for the financial year 1 January to 31 December 2012, which comprise the statement of comprehensive income, balance sheet, statement of changes in equity, cash flow statement and notes, including summary of significant accounting policies, for the group as well as for the parent company. The Consolidated Financial Statements and the Parent Company Financial Statements are prepared in accordance with International Financial Reporting Standards as adopted by the EU and additional disclosure requirements in the Danish Financial Statements Act. Management s responsibility for the Consolidated Financial Statements and the Parent Company Financial Statements Management is responsible for the preparation of Consolidated Financial Statements and Parent Company Financial Statements that give a true and fair view in accordance with International Financial Reporting Standards as adopted by the EU and additional disclosure requirements in the Danish Financial Statements Act, and for such internal control as Management determines is necessary to enable the preparation of Consolidated Financial Statements and Parent Company Financial Statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on the Consolidated Financial Statements and the Parent Company Financial Statements based on our audit. We conducted our audit in accordance with International Standards on Auditing and additional requirements under Danish audit regulation. This requires that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance as to whether the Consolidated Financial Statements and Parent Company Financial Statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the Consolidated Financial Statements and Parent Company Financial Statements. The procedures selected depend on the auditor s judgement, including the assessment of the risks of material misstatement of the Consolidated Financial Statements and the Parent Company Financial Statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the company s preparation of Consolidated Financial Statements and Parent Company Financial Statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by Management, as well as evaluating the overall presentation of the Consolidated Financial Statements and the Parent Company Financial Statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. The audit has not resulted in any qualification. Opinion In our opinion, the Consolidated Financial Statements and the Parent Company Financial Statements give a true and fair view of the group s and the Parent Company s financial position at 31 December 2012 and of the results of the group and the Parent Company s operations and cash flows for the financial year 1 January to 31 December 2012 in accordance with International Financial Reporting Standards as adopted by the EU and additional disclosure requirements in the Danish Financial Statements Act. Statement on the Management s Review We have read the Management s Review in accordance with the Danish Financial Statements Act. We have not performed any procedures additional to the audit of the Consolidated Financial Statements and the Parent Company Financial Statements. On this basis, in our opinion, the information provided in the Management s Review is consistent with the Consolidated Financial Statements and the Parent Company Financial Statements. Per H. Jensen State Authorised Public Accountant Hellerup, 14 March 2013 PricewaterhouseCoopers Statsautoriseret Revisionspartnerselskab Rasmus Juul Pihl State Authorised Public Accountant 19

20 HMN Natural Gas helps house owners and companies to save energy by providing advice and subsidies. HMN Natural Gas bases its energy-saving activities on achieving savings that would not otherwise be carried out. Lars Petersen

21 Comprehensive Income Income Statement HMN I/S HMN group DKK million note Revenue 1 5, , Cost of sales -4, , Gross profit Other operating income Other external expenses Staff costs Depreciation and amortisation 9, Operating profit Profit in associates Financial income Financial expenses Profit before tax Income tax Net profit for the year Statement of Comprehensive Income HMN I/S HMN group DKK million note Net profit for the year Other comprehensive income in the year: Fair value adjustments of hedging instruments Other comprehensive income Total comprehensive income for the year

22 Balance Sheet Assets HMN I/S HMN group DKK million note Assets Customer relations Goodwill Intangible assets Land and buildings , ,492.2 Distribution system 1, , Fixtures and fittings, tools and equipment Plant in progress , ,998.3 Property, plant and equipment 8 2, , Non-current receivables from subsidiary , ,162.4 Investments in subsidiary Investments in associates Financial receivables , ,447.5 Investments Deferred tax asset , ,508.8 Non-current assets 2, , Inventories Trade receivables 10 1, , Receivables from group enterprises Receivable income tax Other receivables Prepayments Receivables 1, , Securities Cash 1, , ,752.4 Current assets 3, , , ,261.2 Assets 6, ,

23 Balance Sheet Liabilities and equity HMN I/S HMN group DKK million note Liabilities and equity Contributed capital Reserve for revaluation at fair value Fair value adjustment of loans and hedging instruments Extraordinary efficiency gain Provision for price reduction Reserve for price adjustment Retained earnings 1, , , ,772.7 Equity 1, , , ,046.0 Bond loans , , Abandonment liabilities Other provisions , ,435.0 Non-current liabilities other than provisions 1, , , ,397.9 Current portion of non-current payables , , Trade payables Payables to group enterprises Prepayments received from customers Other payables Current portion of provisions , ,053.5 Current liabilities other than provisions 2, , , ,488.5 Liabilities other than provisions 4, , , ,261.2 Liabilities and equity 6, ,202.1 Contingent liabilities and other liabilities 17 Related parties 18 Purchase obligations and guarantees 19 Excess/deficient cover 20 Subsequent events 21 Accounting policies 22 Accounting estimates and judgements 23 23

24 Cash Flow Statement HMN I/S HMN group DKK million Cash flow from operating activities: Operating profit Adjustment for hedging instruments in comprehensive income Reversal of other operating income Reversal of depreciation and amortisation Financial income Financial expenses Income tax paid Changes in working capital: Changes in receivables, inventories etc Changes in trade payables etc Total cash flow from operating activities Cash flow from investing activities: Capital investments Adjustment for abandonment liabilities Total cash flow from investing activities Cash flow from financing activities: ,414.4 Repayments of current and non-current payables -1, ,145.0 Short- and long-term loans 1, Total cash flow from financing activities Total increase/decrease in cash and cash equivalents , Cash and cash equivalents, beginning of year 1, , Cash and cash equivalents, end of year 1, ,326.3 Cash and cash equivalents, end of year: Cash 1, Securities Cash and cash equivalents, end of year 1, ,326.3 All securities fall due within three months and are consequently classified as cash and cash equivalents in the Cash Flow Statement. 24

25 Statement of Changes in Equity parent company Extraordinary efficiency gain Reserve for Fair value of and gain relating Contributed revaluation at hedging to return on Provision for Retained DKK million capital fair value instruments net debt price reduction earnings Total Equity at 1 January ,604.3 Interest for the year 0.0 Comprehensive income for the year Reserve for price reduction from efficiency gain on operating expenses Reserve for price reduction from efficiency gain on financing costs Reversed provision relating to price reduction Equity at 31 December ,772.7 Equity at 1 January ,445.8 Interest for the year 0.0 Comprehensive income for the year Reserve for price reduction from efficiency gain on operating expenses Reserve for price reduction from efficiency gain on financing costs Reversed provision relating to price reduction Equity at 31 December ,604.3 group Extraordinary efficiency gain Reserve for Fair value of and gain relating Contributed revaluation at hedging to return on Provision for Retained DKK million capital fair value instruments net debt price reduction earnings Total Equity at 1 January , ,709.9 PSO adjustment 0.0 Interest for the year 0.0 Comprehensive income for the year Reserve for price reduction from efficiency gain on operating expenses Reserve for price reduction from efficiency gain on financing costs Reversed provision relating to price reduction Equity at 31 December , ,844.3 Equity at 1 January , ,573.5 PSO adjustment Interest for the year 0.0 Comprehensive income for the year Reserve for price reduction from efficiency gain on operating expenses Reserve for price reduction from efficiency gain on financing costs Reversed provision relating to price reduction Equity at 31 December , ,

26 Lars Petersen Natural gas or district heating? This is a hot topic in many areas of Denmark, and district heating will certainly gain a larger market share in the future. However, HMN Natural Gas believes that the most economic projects in terms of society and users are either already being carried out or the decision has been made to implement them. The most recent project proposals concerning converting to district heating are therefore believed to demonstrate ever-decreasing economic benefits for society and users. Consequently, some municipalities have begun introducing mandatory connection to district heating on the grounds that otherwise the projects do not add up for the companies involved. 26

27 Notes Note 1 Segment information The management has defined the group's operating segments based on the reporting to the group management that forms the basis of decisions. The group management manages activities based on a division of the distribution and sale of gas. The sale of gas is furthermore divided into regulated and non-regulated sale. Accordingly, the segments to be reported are: Distribution of gas comprises operation of the distribution system in the Greater Copenhagen Region and central and northern Jutland. Gas transactions, regulated, comprises the activities subject to the licence in connection with the sale of gas comprised by the Danish Energy Regulatory Authority's regulation. Gas transactions, not regulated, comprises the sale of natural gas on individually negotiated terms. Activities are not subject to any regulation from the Danish Energy Regulatory Authority. Information on business segments is based on the group's return and risks and on the internal financial management. Internal transactions and allocation between segments are performed on an arm's length basis. Gas transactions, Gas transactions Activities 2012 DKK million Distribution regulated not regulated Other Eliminations Group total Extra-group revenue , , ,723.2 Intra-group revenue , , Revenue , , , ,723.2 Operating profit/loss Net financials Income tax Net profit for the year Additions of property, plant and equipment Depreciation, property, plant and equipment Amortisation, intangible assets Non-current assets 3, ,821.8 Current assets 1, , ,201.9 Assets 5, , , ,023.7 Equity 1, ,844.3 Liabilities other than provisions 3, ,179.4 Liabilities and equity 5, , , ,

28 Note 1 continued Gas transactions, Gas transactions Activities 2011 DKK million Distribution regulated not regulated Other Eliminations Group total Extra-group revenue , , ,467.9 Intra-group revenue , , Revenue , , , ,467.9 Operating profit/loss Net financials Income tax Net profit for the year Additions of property, plant and equipment Depreciation, property, plant and equipment Amortisation, intangible assets Non-current assets 3, ,191.3 Current assets 1, , ,010.9 Assets 5, , , ,202.1 Equity 1, ,709.8 Liabilities other than provisions 4, ,492.3 Liabilities and equity 5, , , ,202.1 HMN I/S HMN GROUP Note 2 Other operating income DKK million Income from service schemes Income from digging work/re-laying Income from service agreements with subsidiaries Costs from fair value adjustment of derivatives Other income Other operating income HMN I/S HMN group Note 3 Auditors' fee DKK million Total fees for the past financial year for the auditors appointed by the Committee of Representatives can be specified as follows: Fees for statutory audit Auditors' fee for PwC Other services Total fee during the financial year

29 HMN I/S HMN group Note 4 Staff costs DKK million T total staff costs can be specified as follows: Wages and salaries Pensions Other social security costs Payroll costs capitalised as non-current assets Total staff costs Of this amount, remuneration for the Executive Board, the Board of Directors and the Committee of Representatives totals: Wages and salaries to the Executive Board Pensions for the Executive Board Board of Directors Committee of Representatives Total Executive Board, Board of Directors and Committee of Representatives Total employees Wages and salaries for the Executive Board in 2011 comprise salaries for two managing directors and termination benefits of DKK 1.5 million. HMN I/S HMN group Note 5 Net financials DKK million Financial income Interest income on cash funds from operations Interest income on financial receivables Fair value adjustments Exchange rate adjustment, net Interest income from group enterprises Total financial income Financial expenses Interest expenses for group enterprises Interest expenses on loans Discount effect of provisions Fair value adjustments Exchange rate adjustment, net Other financial expenses Total financial expenses Net financials

30 HMN I/S HMN group Note 6 Tax on profit/loss for the year DKK million Current tax for the year Deferred tax for previous years Regulation for previous years Deferred tax for the year Total tax for the year comprising: Tax on profit for the year Tax on changes in equity Total tax for the year T tax on profit/loss for the year comprises: Income tax rate 25.0% 25.0% Tax effect of: Loss, previous years 0.0% 0.0% Amortisation of goodwill for tax purposes 0.0% 0.0% Profit on tax-free activities 0.0% 0.0% 0.0% 0.0% Other tax adjustments -22.3% % 0.0% 0.0% Effective tax rate 2.7% -92.2% T tax asset comprises: Loss carry-over Other time differences Total tax asset HMN Gassalg A/S is taxed jointly with its subsidiary HMN Gashandel A/S. HNG Holding ApS is taxed jointly with its subsidiary A/S Strandvejsgasværket. The income tax is subject to joint liability. Management expects that profits liable to taxation will be generated in the coming years, thereby utilising the loss carryforward. 30

31 Note 7 Intangible assets DKK million p a r e n t c o m p a n y Customer relations Goodwill Total Cost at 1 January Additions Disposals Cost at 31 December Amortisation at 1 January Amortisation Amortisation at 31 December Carrying amount at 31 December Cost at 1 January Additions Disposals Cost at 31 December Amortisation 1 January Amortisation Amortisation at 31 December Carrying amount at 31 December G R O U P Customer relations Goodwill Total Cost at 1 January Additions Disposals Cost at 31 December Amortisation at 1 January Amortisation Amortisation at 31 December Carrying amount at 31 December Cost at 1 January Additions Disposals Cost at 31 December Amortisation at 1 January Amortisation Amortisation at 31 December Carrying amount at 31 December The value of goodwill and customer relations determined in connection with the merger of HNG I/S and Naturgas Midt-Nord I/S is based on a specific assessment of possible sales over the next few years and a budget period until Customer relations determined in connection with the merger comprise the value of the customers to whom the group sells gas, regulated as well as non-regulated. The valuation of distribution activities and PSO activities is based on applicable legislation on the regulation of these activities. Expected free cash flows are discounted at a real interest rate of 3 4% p.a. Goodwill has been allocated to the following segments: DKK million Distribution 63.0 Gas transactions Goodwill relating to distribution is mainly attributable to high operating efficiency. Goodwill relating to trade is attributable to expectations of increased activities. Goodwill cannot be amortised for tax purposes. 31

32 Note 8 Property, plant and equipment DKK million parent company Land Distribution Fixtures and fittings, Plant in and buildings system tools and equipment progress Total Cost at 1 January , , ,487.5 Transfer Cost at 1 January 2012 upon transfer , , ,487.5 Additions Disposals Cost at 31 December , , ,541.3 Depreciation at 1 January , ,141.3 Depreciation Depreciation at 31 December , ,543.0 Carrying amount at 31 December , ,998.3 Cost at 1 January , , ,431.8 Transfer Cost at 1 January 2011 upon transfer , , ,431.8 Additions Disposals Cost at 31 December , , ,487.5 Depreciation at 1 January , ,738.1 Depreciation Depreciation at 31 December , ,141.3 Carrying amount at 31 December , ,346.1 GROUP Land Distribution Fixtures and fittings, Plant in and buildings system tools and equipment progress Total Cost at 1 January , , ,493.8 Transfer Cost at 1 January 2012 upon transfer , , ,493.8 Additions Disposals Cost at 31 December , , ,547.3 Depreciation at 1 January , ,142.1 Depreciation Depreciation at 31 December , ,544.3 Carrying amount at 31 December , ,003.0 Cost at 1 January , , ,436.6 Transfer Cost at 1 January 2011 upon transfer , , ,436.6 Additions Disposals Cost at 31 December , , ,493.8 Depreciation at 1 January , ,738.5 Depreciation Depreciation at 31 December , ,142.1 Carrying amount at 31 December , ,351.7 Construction interest is included in the addition to the distribution system by DKK 1.3 million (2011 = 1.3 million), based on a capitalisation interest rate of 4.95% p.a. (2011 = 4.95% p.a.). Interest is calculated as a WACC based on the CIBOR interest rate plus a risk premium. The interest rate is set by the Danish Energy Regulatory Authority and is fixed throughout the income limit period up to and including HMN Naturgas I/S has received compensation for conversion of property, plant and equipment totalling DKK 11.8 million (2011: DKK 0.0 million). The company has received no other form of support, and the agreement contains no unmet requirements. 32

33 Note 9 Investments DKK million parent company SUBSIDIARY Investments in Financial Total Receivables Investments associates receivables investments Cost at 1 January , ,573.9 Additions Disposals Cost at 31 December , ,447.5 Revaluations at 1 January Value adjustment for the year Revaluations at 31 December Carrying amount at 31 December , ,447.5 Cost at 1 January , ,572.5 Additions Disposals Cost at 31 December , ,573.9 Revaluations at 1 January Value adjustment for the year Revaluations at 31 December Carrying amount at 31 December , ,573.9 group Investments Cost at 1 January Additions Disposals Cost at 31 December Carrying amount at 31 December Cost at 1 January Additions 67.3 Disposals Cost at 31 December Carrying amount at 31 December Investments in group enterprises and associates comprise: Ownership share Equity Group enterprises HNG Holding ApS, Gladsaxe, Denmark 100% 22.4 HNG Holding ApS, owner: Strandvejsgasværket A/S, Gladsaxe, Denmark 100% HMN Erhverv A/S, Viborg, Denmark 100% 24.5 HMN Gassalg A/S, Viborg, Denmark 100% HMN Gassalg A/S owner: HMN Gashandel A/S, Viborg, Denmark 100% Associates Danish Gas Technical Centre, Hørsholm, Denmark 40%

34 HMN I/S HMN GROUP Note 10 Provision for loss on bad debts DKK million Provision for loss on bad debts at 1 January Ascertained losses Reversal of provisions for expected losses Provision for expected losses for the year Provision for loss on bad debts at 31 December Trade receivables and financial receivables have the following maturity profile: Not due 1, , Less than one month More than one month Total trade receivables and financial receivables 1, ,349.9 Trade receivables fall due within one year, while financial receivables have a longer maturity profile. HMN I/S HMN GROUP Note 11 Other receivables DKK million Market value of derivatives to hedge loans Market value of derivatives to hedge purchase and sales contracts Service contracts VAT and duties receivable Other receivables Total other receivables All receivables other than fair value of derivative financial instruments are current and fall due within one year of the end of the financial year. The term to maturity for derivative financial instruments appears from note 13. All receivables other than fair value of derivative financial instruments are with counterparties that have not been credit-rated by an external rating agency. HMN I/S HMN GROUP Note 12 Liabilities other than provisions DKK million Non-current liabilities other than provisions 1, ,033.2 Bond loans (long-term) 1, , Market value of derivatives to hedge loans (long-term) Provisions (non-current) , ,435.0 Non-current liabilities other than provisions 1, ,682.2 Current liabilities other than provisions 1, ,389.3 Bond loans (short-term) 1, , Market value of derivatives to hedge loans (short-term) Collateral received Trade payables Payables to group enterprises Prepayments received from customers VAT and duties payable Holiday pay transferred Other payables (e.g. collateral) Current portion of provisions , ,053.4 Current liabilities other than provisions at 31 December 2, , , ,488.5 Total liabilities other than provisions at 31 December 4, ,

35 Note 12 continued Maturities of financial liabilities, including interest payments DKK million Carrying Payment PARENT COMPANY 2012 amount obligation After 2015 Bond loans 2, , , Bond loans, payments from swaps Trade payables Payables to group enterprises , , , Carrying Payment 2011 amount obligation After 2014 Bond loans 2, , , Bond loans, payments from swaps Trade payables Payables to group enterprises , , , The distribution of maturities is based on undiscounted cash flows on financial liabilities. Carrying Payment group 2012 amount obligation After 2015 Bond loans 2, , , Bond loans, payments from swaps Trade payables , , , Carrying Payment 2011 amount obligation After 2014 Bond loans 2, , , Bond loans, payments from swaps Trade payables , , , The distribution of maturities is based on undiscounted cash flows on financial liabilities. HMN Naturgas is seeking to spread the burden of repayments over time so that only a minor part of the debt needs to be refinanced in a single year. HNG makes sure to have enough available funds to be able to stay away from the loan market for six months. 35

36 Note 13 Business risks Risks related to the group s financing, volume and price risk in connection with the purchase and sales contracts for natural gas could be the following: Financing risks: HMN Naturgas I/S distribution activities will for a number of years continue to be funded by loan capital. Based on a consideration of costs, the loans will generally comprise a mix of variable-rate and fixed-rate loans and may be obtained in foreign currency. HMN Naturgas I/S uses hedge accounting and has converted the following fixed-rate loans to variable-rate loans over their remaining term using interest rate swaps: EMTN loan, nom. JPY 5,000 million, maturity The loan has been converted to variable EUR interest rate. The fair value of the swaps totals DKK 193 million as at 31 December 2012 (31 December 2011: DKK 325 million). The fair value of the loans totals DKK -205 million as at 31 December 2012 (31 December 2011: DKK -344 million). Inefficiency recognised in the Income Statement totals DKK 4.8 million (2011: DKK million). The Danish Executive Order on Income Limits and Opening Balance Sheets for Natural Gas Distribution Companies (Executive Order no of 14 December 2009, reprinted on 30 December 2009) stipulates that if the annual financing costs of the natural gas distribution company are higher than what follows from the interest rate set by the Danish Energy Regulatory Authority, the company must bear the loss itself. If, on the other hand, the company s financing costs are lower than what follows from the interest rate set by the Danish Energy Regulatory Authority, at least half of this gain must be refunded to the customers through a lower distribution rate. HMN Naturgas I/S has laid down a financing policy with guidelines on the raising and conversion of loans including the use of financial instruments and allocation of available funds to ensure that the company incurs the lowest possible costs without running significant risks. Sensitivity analysis In the event of a change in the interest rate of 100 basis points (change of the entire yield curve), the earnings impact will be DKK 10.2 million (2011: DKK 28.5 million). This impact is due to changes in the market value of loans measured at fair value and swaps due to an interest rate change. Price change Estimated earnings impact Interest rate bp +10,2 +28,5 For the past years, the group s debt has been significantly reduced, and the plan is to repay debt relating to the distribution activities raised before 1 January 2005 by The debt relates to major investments in the company s infrastructure. The debt is sought to be hedged at an interest rate corresponding to, as a maximum, the terms in the income framework regulation for the distribution activities. It is important to maintain the company s high credit rating to ensure low financing costs. A lower credit rating may result in higher financing costs that, subject to the approval of the Danish Energy Regulatory Authority, could be included in the distribution rate. Credit risks on swaps and options HMN Naturgas I/S uses swaps and options for the purpose of hedging risks on loans. Swaps and options are solely used for hedging purposes. The market value of swaps and options is computed on the basis of current exchange rates and interest rates. The market value reflects the replacement value of the swap or option, meaning the size of the loss if the counterparty can no longer meet his obligations. HMN Naturgas I/S credit risk on swaps and options consists of the risk of a counterparty becoming insolvent and failing to meet his obligations. More swaps and options with the same counterparty are attached to a Master Agreement (framework agreement), and it is usually possible to mutually offset the outstanding accounts on all swaps and options. 36

37 HMN Naturgas I/S enters into transactions only with counterparties with good credit standing and furthermore uses agreements on continuous collateral security in the form of pledge to minimise the credit risk. Thus, HMN Naturgas I/S has concluded an agreement with Nordea on collateral security. Nordea is to provide collateral security for the market value of swaps and options exceeding EUR 25 million, corresponding to DKK 186 million. HMN Naturgas I/S has similar agreements with Society General, BNP Paribas and Merrill Lynch International. HMN Naturgas I/S and these counterparties provide mutual collateral security for the current market value of outstanding financial contracts. HMN Naturgas I/S credit risk is primarily related to receivables, securities and derivative financial instruments. The below tables illustrate the counterparty risk on the market value of financial instruments, as at the balance sheet date, based on the counterparty s rating at Moody s Standard & Poor. Credit risks HMN Naturgas I/S credit risk mainly relates to receivables, securities and derivative financial instruments. The tables below illustrate the counterparty risk on marked value of financial instruments as at the balance sheet date based on the counterparty's rating with Moody's og Standard & Poor Moody's Standard & Poor DKK million Nordea Aa3 AA- 74 Merrill Lynch International Baa2 A- 0 Danske Bank Baa1 A Moody's Standard & Poor DKK million Nordea Aa2 AA- 198 Merrill Lynch International A2 A 0 Danske Bank A2 A 0 The credit risk on receivables arises where the HMN Naturgas I/S group s sales of natural gas, distribution and loans to customers are not effected by prepayment, or where customers ability to pay is not covered by guarantees etc. Depositing of cash at banks is subject to a specific credit assessment of the banks used. Requirements for equity and an individually determined maximum amount for each bank have been laid down. Exchange rate risks HMN Naturgas I/S income base is in Danish kroner. At the end of 2012, HMN Naturgas I/S debt portfolio is solely in Danish kroner and EUR. The table below shows the conversion of the company s debt by means of swaps. Part of the debt has been raised in JPY and converted into EUR through a swap agreement. Currency risk and financial instruments DKK million Nominal gross debt by currency 2012 DKK million Loans Swap from Swap to Debt after swap EUR DKK 1, ,995.8 JPY Total 2, ,217.5 Nominal gross debt by currency 2011 DKK million Loans Swap from Swap to Debt after swap EUR DKK 2, ,266.0 JPY Total 2, ,

38 Volume risks in purchase and sales contracts for natural gas The terms governing natural gas purchased on the wholesale market include take-or-pay terms. Take-or-pay terms mean that the supply companies must pay for the contracted quantity of natural gas, regardless of whether or not it is possible for the HMN Gassalg group to receive the gas. Prices for natural gas purchased on the wholesale market with flexibility of supply are higher than prices for the purchase of fixed quantities delivered regularly over a specified period such as a number of hours, days or months. The HMN Gassalg group s quantity risk for natural gas arises when there is no connection between the quantities delivered to the companies for a period of time, including the use of reserved natural gas storage, and the quantities purchased by the company s customers in the same period. Many customers consumption of natural gas is closely linked to the weather. With a view to overcoming the above risks, a risk management policy has been established, ensuring that the long-term purchase agreements are concluded at spot prices enabling the companies to sell surplus gas or purchase lacking gas daily on the spot market at prices corresponding to the purchase agreement. In addition, part of the natural gas purchase includes volume flexibility which, together with the reserved natural gas storage, can be used to manage fluctuations in the customers current natural gas consumption and the current purchase or sale on the wholesale market. Price risks in relation to the conclusion of purchase and sales contracts for natural gas Prices for large commercial customers in particular are determined via negotiation, and a number of these customers want special price adjustment formulas, which may include different weighting of the price development in various oil products, exchange prices for natural gas and exchange rates or that the sale is effected at fixed prices. Correspondingly, the HMN Gassalg group purchases natural gas at different prices adjusted by the price development in various oil products, gas exchange prices and exchange rates or the natural gas purchase is effected at fixed prices. The risk for the HMN Gassalg group arises when the quantities purchased and sold on the same price adjustment terms are not completely identical, and when delivery is not effected at the exact same time. Therefore, the HMN Gassalg group engages in significant hedging activities on the financial market. This makes it possible to manage and minimise the risk that occurs when the price adjustment terms for the purchase and sale of natural gas are not identical. The company hedges price and foreign-exchange risks relating to binding agreements on future purchases and sales of gas using swaps and to a limited extent call options and put options. The provisions on hedge accounting are not used. Gas contracts and price derivatives The price derivatives that are based on oil prices, natural gas prices and exchange rates have a net fair value at 31 December 2012 of DKK 9.7 million. (2011: DKK 18.5 million). A sensitivity analysis of the financial portfolio shows the effects of a 10% change in oil prices, natural gas prices and the USD exchange rate. Estimated earnings impact Risk Price change Change in oil price and USD exchange rate 10 % Change in oil price and USD exchange rate -10 % To counter the credit risk on counterparties by entering into these financial agreements, the HMN Gassalg group has concluded Master Agreements (framework agreements), thereby ensuring that it is usually possible to mutually offset outstanding accounts with the same counterparty. The HMN Gassalg group assesses the credit standing of counterparties on a regular basis and enters into transactions only with counterparties with good credit standing. Furthermore, the companies use agreements on continuous collateral security in the form of pledge to minimise the credit risk. 38

39 Note 14 Categorisation of financial instruments and information on fair values DKK million Fair value Parent company 2012 Carrying amount Niveau 1 Niveau 2 Niveau 3 Financial assets - fair value over the Income Statement Market value of derivatives to hedge loans Securities Total financial assets - fair value over the Income Statement Financial liabilities - fair value over the Income Statement Liabilities other than provisions - derivatives to hedge loans Financial liabilities - attributable to fair value over the Income Statement Bond loans 1, Bond loans - short-term portion 1, ,389.3 Total financial liabilities - attributable to fair value over the Income Statement 2,422.5 Fair value Parent company 2011 Carrying amount Niveau 1 Niveau 2 Niveau 3 Financial assets - fair value over the Income Statement Market value of derivatives to hedge loans Securities Total financial assets - fair value over the Income Statement Financial liabilities - fair value over the Income Statement Liabilities other than provisions - derivatives to hedge loans Financial liabilities - attributable to fair value over the Income Statement Bond loans 1, Bond loans - short-term portion 1, ,550.2 Total financial liabilities - attributable to fair value over the Income Statement 2,830.8 Financial instruments measured at fair value are subsequently distributed by the following measurement hierarchy: Level 1: Quoted prices of identical instruments Level 2: Quoted prices of comparable instruments or materially based on observable market data Level 3: Non-observable market data Financial risks are described in Note

40 Note 14 continued Categorisation of financial instruments and information on fair values DKK million Fair value group 2012 Carrying amount Niveau 1 Niveau 2 Niveau 3 Financial assets - fair value over the Income Statement Other receivables - derivatives to hedge loans Other receivables - derivatives to hedge gas contracts Securities Total financial assets - fair value over the Income Statement Financial liabilities - fair value over the Income Statement Liabilities other than provisions - derivatives to hedge loans Liabilities other than provisions - derivatives to hedge gas contracts Total financial liabilities - fair value over the Income Statement 76.0 Financial liabilities - attributable to fair value over the Income Statement Bond loans 1, Bond loans - short-term portion 1, ,389.3 Total financial liabilities - attributable to fair value over the Income Statement 2,422.5 Fair value group 2011 Carrying amount Niveau 1 Niveau 2 Niveau 3 Financial assets - fair value over the Income Statement Other receivables - derivatives to hedge loans Other receivables - derivatives to hedge gas contracts Securities Total financial assets - fair value over the Income Statement Financial liabilities - fair value over the Income Statement Liabilities other than provisions - derivatives to hedge loans Liabilities other than provisions - derivatives to hedge gas contracts Total financial liabilities - fair value over the Income Statement 26.4 Financial liabilities - attributable to fair value over the Income Statement Bond loans 1, Bond loans - short-term portion 1, ,550.2 Total financial liabilities - attributable to fair value over the Income Statement 2,830.9 Financial instruments measured at fair value are subsequently distributed by the following measurement hierarchy: Level 1: Quoted prices of identical instruments Level 2: Quoted prices of comparable instruments or materially based on observable market data Level 3: Non-observable market data Financial risks are described in Note

41 HMN I/S HMN group Note 15 Abandonment liabilities DKK million Abandonment liabilities at 1 January Addition discount effect of beginning of year Addition liability on investments for the year Abandonment liabilities at 31 December Abandonment liabilities comprise expected future costs incidental to shutdown and removal of distribution systems and technical plant. The abandonment liability is measured at discounted present value based on a real interest rate of 1%. The abandonment liability is adjusted over net financials in the Income Statement. Reference is made to note 22 on significant accounting estimates regarding a description of the uncertainty over the size of the liability and the time placing. HMN I/S HMN group Note 16 Other payables DKK million VAT and duties Holiday pay obligations Accrued interest on loans Market value of derivatives to hedge purchase and sales contracts Collateral received Other items Total other payables Note 17 Contingent liabilities and other financial liabilities HMN Naturgas I/S has an obligation to HMN Gassalg A/S to inject subordinated loan capital of DKK 125 million. The group companies are jointly and severally liable for tax on the group's jointly taxed income etc. The total amount appears from the Annual Report of HMN Naturgas I/S, which is the administration company in relation to the joint taxation. Note 18 Related parties HMN Naturgas I/S has no related parties with controlling interest. The company's management has significant influence. The company's remuneration of the management etc. is stated in note 4. HMN Naturgas I/S has provided various administrative services to the subsidiaries HMN Gassalg A/S, HMN Gashandel A/S and HMN Erhverv A/S for DKK 46.0 million (2011: DKK 43.9 million). HMN Naturgas I/S sells gas to the owner municipalities. None of these parties has significant individual influence in HMN Naturgas I/S. In 2011 and 2012, HMN Gassalg A/S made a fixed-term deposit of DKK million with HMN Naturgas I/S. This was solely for business purposes since HMN Naturgas I/S has a higher credit rating than any bank in Denmark, and the risk was assessed to be lower than for a bank deposit. The fixed-term deposit expired at 31 December

42 Note 19 Purchase obligations and guarantees The group has entered into binding agreements on the purchase of natural gas totalling DKK 3,367 million (2011: DKK 3,820 million) on take-or-pay terms. The term of the agreements is up to and including The purchase obligations have been concluded jointly with the HMN Gassalg group. Nordea has furnished guarantees of a total of 238 million (2011: DKK 86 million) for the HMN Gassalg group. Note 20 Excess/deficient cover Parent Company and Consolidated Financial Statements For the financial year 2012, a preliminary excess cover of approx. DKK 49 million has been calculated for the parent company HMN Naturgas I/S. The excess cover for 2012 will be finally determined by the Danish Energy Regulatory Authority at the end of The excess cover in 2012 is set off against the accumulated deficient cover at the end of 2011 so that the calculated deficient cover totalled approx. DKK 105 million at the end of 2012 (2011: approx. DKK 200 million). Subject to the Danish Energy Regulatory Authority s approval, the company aims at making up for the deficient cover in the period , but this depends on the natural gas sales in the individual years. At the end of 2012, the subsidiary HMN Gassalg A/S had calculated a preliminary accumulated deficient cover of approx. DKK 15 million. The deficient cover is not included in the Financial Statements as the extent to which this will be collected from the customers is uncertain. The final deficient cover is determined by the Danish Energy Regulatory Authority on the basis of benchmarking of earnings and costs in the three PSO companies (DONG Energy Forsyning, Naturgas Fyn Forsyning and HMN Gassalg) on the Danish market. Note 21 Subsequent events As from 1 May 2013, HMN Gassalg A/S will no longer be a PSO company in HMN Naturgas distribution area, as this right and obligation will be transferred to another supplier from that date. All HMN Gassalg A/S existing customers will remain with the company unless they actively choose another gas supplier. Note 22 Accounting policies Basis of accounting The Annual Report is presented in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU and additional Danish disclosure requirements concerning annual reports for reporting class D, cf. the Danish Executive Order on IFRS Adoption issued in pursuance of the Danish Financial Statements Act. The Annual Report also complies with IFRS issued by the International Accounting Standards Board (IASB). The Annual Report comprises Consolidated Financial Statements for the company and its subsidiaries as well as separate Financial Statements for the parent company. New accounting policies and disclosures for 2012 The accounting policies applied are unchanged from last year. New accounting standards not yet effective At the time of the presentation of the Annual Report 2012, IASB and the EU have approved various new standards and interpretations which will apply to financial years beginning on or after 31 December Therefore, these standards have not been applied in the preparation of this annual report. 42

43 IASB has published the following new financial reporting standards and interpretations that are deemed to be of relevance to HMN Naturgas I/S: Amendment to IFRS 7 Disclosures in the notes on offsetting financial assets and liabilities. IFRS 10 Clarification of the definition of control of another entity Control exists when the following applies: Power over an investee Exposure, or rights, to variable returns Ability to exert power to affect the entity s return IFRS 12 Disclosure requirements for interests in other entities, including subsidiaries. IFRS 13 Standard on fair value measurement. Amendment to IAS 1 The amendment implies a requirement for the presentation of items of other comprehensive income to be reclassified ( recycled ) to the Income Statement separately from items that are not to be recycled. Amendment to IAS 19 All actuarial gains and losses are recognised in other comprehensive income, and the return element is determined based on the net liability. Amendment to IAS 27 The consolidation rules are replaced by IFRS 10, and the standard then comprises the rules governing parent company financial statements from the current IAS 27. Amendment to IAS 32 Further guidance on when financial assets and liabilities can be offset. HMN Naturgas I/S expects to implement the new standards and interpretations when their use becomes compulsory. The Annual Report is presented in DKK million. Recognition and measurement The financial statements are presented on the basis of the historical cost principle, modified for measurement of certain financial instruments at fair value. Furthermore, investments in subsidiaries in connection with the merger as at 1 January 2010 are recognised at market value in the Parent Company Financial Statements at the time of the merger. Income is recognised in the Income Statement as earned. Furthermore, all costs incurred to generate the income for the year, including depreciation, amortisation, impairment losses and provisions, are recognised in the Income Statement. Translation of foreign currency Transactions in foreign currency are translated to the functional currency (DKK) at the exchange rates at the transaction date. Foreign currency gains and losses from the settlement of these transactions and from the translation of monetary assets and liabilities in foreign currency to the exchange rates at the balance sheet date are recognised in the Income Statement. Consolidated Financial Statements The Consolidated Financial Statements comprise HMN Naturgas I/S and the subsidiaries HMN Gassalg A/S, with its subsidiary HMN Gashandel A/S (the HMN Gassalg group), HMN Erhverv A/S, HNG Holding Aps with its subsidiary A/S Strandvejsgasværket. The Consolidated Financial Statements are prepared on the basis of the Financial Statements of HMN Naturgas I/S with subsidiaries. The Consolidated Financial Statements are prepared by combining items of uniform nature. On consolidation, intra-group income and expenses, intra-group balances and dividends as well as gains and losses on transactions between the consolidated companies are eliminated. The Financial Statements used in the consolidation are prepared in accordance with the group s accounting policies. Business combinations Newly acquired or newly established enterprises are recognised in the Consolidated Financial Statements from the acquisition date. Disposed or discontinued enterprises are recognised until the date of disposal. Profit or loss on the disposal of subsidiaries and associates is determined as the difference between the disposal consideration and the carrying amount of net assets at the time of the sale, including remaining goodwill and expected selling or discontinuation costs. 43

44 For the purchase of subsidiaries and associates, the purchase method is used, meaning that, upon initial recognition, the assets and liabilities and equity of newly acquired enterprises are measured at fair value at the acquisition date. Subsequently, these are measured at cost. Positive balances (goodwill) between the acquisition cost and fair value of acquired assets and liabilities and equity are recognised in the Balance Sheet. Amortisation is not provided for such positive balances, but regular impairment tests are performed. Cost is determined as the cash payment plus the fair value of issued shares. Transaction costs are recognised as costs as incurred. In the event of control of an enterprise that was previously an associate, the previous ownership share is deemed to have been sold and repurchased at fair value. The difference between the carrying amount and the fair value is recognised in the Income Statement under special items. Derivative financial instruments The HMN Natural Gas group uses derivative financial instruments for the purpose of hedging price and volume risks in connection with the purchase and sale of gas and to hedge interest rate risks. On initial recognition, the derivative financial instruments are measured at the fair value of the remuneration paid or received. Subsequent to initial recognition, the derivative financial instruments are measured at the fair value as at the balance sheet date. Changes in the fair value of derivative financial instruments, classified as and complying with the requirements for hedging of the fair value of a recognised asset or liability, are recognised in the Income Statement together with changes in the fair value of the asset or liability attributable to the hedged risk. Changes in the fair value of derivative financial instruments not complying with the requirements for hedge accounting are recognised in the Income Statement. Changes in the fair value of derivatives purchased for the purpose of hedging price risks related to gas are recognised in other operating income, and changes in the fair value of derivatives used to hedge interest rate risks are recognised in net financials. Cash flow hedging Changes in the fair value of financial instruments classified as and meeting the conditions of hedging of expected future transactions are recognised in other comprehensive income for the effective part of the hedge and classified as a separate reserve in equity. The ineffective part is recognised in the Income Statement. If the hedged transaction results in income or costs, the amount deferred under equity is recognised in the Income Statement and set off against other comprehensive income in the period in which the hedged transaction is recognised. The amount is recognised in the same item as the hedged transaction. INCOME STATEMENT Revenue Revenue on the sale of goods and services is recognised in the Income Statement provided that delivery has been effected and risk has passed to the buyer before the end of the year and provided that income can be determined reliably and is expected to be received. Revenue is measured at fair value of the agreed payment exclusive of VAT and duties charged on behalf of a third party. All forms of discounts rendered are recognised in revenue. Revenue in the parent company includes the distribution of natural gas via HMN Naturgas I/S distribution system. The individual consumer pays for the distribution via distribution rates. Expenses for system differences stated according to the market rules for the natural gas area are also included. Revenue also includes energy savings implemented in accordance with the energy savings agreement between the distribution companies and the Minister for Climate, Energy and Building. 44

45 Revenue in the subsidiary, the HMN Gassalg group, comprises the sale of natural gas less discounts. Revenue is recognised in step with delivery of distribution services or gas. Income from customers paying on account has been calculated for the period after the latest annual statement of account. Cost of sales Cost of goods used to generate the revenue for the year. Other operating income Other operating income includes, e.g. income from service schemes offered to small natural gas customers. Other external expenses Other external expenses include expenses incidental to maintenance of the distribution system, settlement and customer service costs, safety-related costs, communication costs, consulting services, other administrative expenses, etc. Staff costs Staff costs such as wages, social security contributions, holidays and absence due to illness, bonus and non-monetary benefits are recognised in the financial year in which the group s employees have performed the related work. In connection with the group s long-term employee benefits, costs are accrued and recognised, as the relevant employees perform their work. Net financials Net financials include interest income and interest expenses, realised and unrealised exchange gains and losses as well as amortisation added/deducted pertaining to loans and the discount effect on the abandonment liability. Taxes The Parent Company Financial Statements do not include any current or deferred tax owing to the corporate form. In the parent company s subsidiaries, the HMN Gassalg group and HMN Erhverv and HNG Holding ApS and its subsidiary A/S Strandvejsgasværket, tax for the year comprises current tax for the year and any change in deferred tax. Current tax payable and receivable is recognised in the Balance Sheet as tax computed on the taxable income for the year, adjusted for tax prepaid. Deferred tax is recognised and measured according to the balance sheet liability method providing for all temporary differences between the carrying amounts of assets and liabilities and the amounts used for taxation purposes. The computation of the tax value of the assets is based on the planned use of each asset. Deferred tax is measured based on the tax rules and tax rates applicable under the legislation in force on the balance sheet date when the deferred tax is expected to crystallise as current tax. Changes in deferred tax owing to changes in tax rates are recognised in the Income Statement. Deferred tax assets, including the tax value of losses available for carry-over for tax purposes, are recognised in the balance sheet at the value at which the asset is expected to be realised, either through set-off against deferred tax liabilities or as net tax assets. HMN Gassalg A/S is taxed jointly with the subsidiary HMN Gashandel A/S. The current Danish income tax is divided between the jointly taxed companies in proportion to their taxable incomes (full allocation with refund concerning tax losses). BALANCE SHEET Intangible fixed assets Customer relations and goodwill arose in connection with the merger between HNG I/S and Naturgas Midt-Nord I/S on 1 January 2010 as revaluation at market value of the acquired company and revaluation at market value of the jointly owned subsidiary. The value of acquired customer relations is measured at cost less accumulated amortisation and impairment losses. The value of the acquired customer relations is amortised on a straight-line basis over the expected lifetime which is 12 years. 45

46 Goodwill is the amount at which the cost of an acquired enterprise exceeds the fair value of the acquired assets and liabilities at the acquisition date. Goodwill is recognised as an asset and attributed to cash flow-generating units corresponding to the level at which the management monitors the investment. Goodwill is recognised as an asset and is not amortised, but the carrying amount of goodwill is subjected to an impairment test at least once a year. Goodwill is written down to recoverable amount, provided that the carrying amount of the cash flow-generating unit s net assets exceeds the higher of net selling price and value in use, corresponding to the present value of expected future cash flows from the unit. Any impairment loss is recognised in the net profit or loss for the year and is not reversed. The carrying amount of goodwill is tested for impairment on an annual basis. The impairment test of intangible assets is based on the expected earnings from the sale of natural gas for the next years, assuming increasing competition and a subsequent loss of market share and future earnings. The impairment test is based on future cash flows discounted on the basis of real interest rates. Property, plant and equipment Land and buildings, plant and machinery as well as other fixtures and fittings, tools and equipment are measured at cost less accumulated depreciation and impairment loss. The cost of acquisitions incurred after 1 January 2005 includes the purchase price and costs incidental to the acquisition until the time when the asset is ready for use as well as estimated abandonment costs. For self-constructed assets, cost comprises direct and indirect costs of materials, components, sub-suppliers and wages until the time when the asset is ready for use as well as estimated abandonment costs. For investments for the year in new natural gas installations, construction interest is accrued corresponding to six months interest. The interest rate is determined by the Danish Energy Regulatory Authority as the interest rate that may be included, cf. the income limit, as interest on investments made from (and including) Depreciation of assets coming into use after January 2005 is effected according to the following useful lives: Buildings 50 years Distribution network, distribution system and service pipes 30 years Meter/regulator stations (including land and buildings) Meters Cars, equipment and other operating equipment Sirius IT project Other IT systems 15 years 15 years 5 years 8 years 3 years Upon planned replacements of existing installations it is assessed whether costs of labour and materials are to be capitalised. Profit and loss from the sale of property, plant and equipment are computed as the difference between the selling price less selling costs and the carrying amount at the time of sale. Profit or loss is recognised under other operating income to the extent that the selling price exceeds the original cost. The abandonment liability is included in the determination of cost. The amount at the beginning of the year for the abandonment liability in 2005 is written off over 12 years. Subsequently, the useful lives stated above are used. Compensation on conversion of property, plant and equipment The compensation is recognised when general conditions for recognition and the conditions associated with the grant are met. Compensation provided to cover investments is deducted from the cost of the asset. Impairment test The carrying amount of property, plant and equipment is assessed on an annual basis to determine whether indication of impairment exists. If such indication of impairment exists, an impairment test is performed. 46

47 In an impairment test, the recoverable amount of the tested asset is compared with the carrying amount of the asset. An impairment loss is recognised when the carrying amount of an assets or a cash flow-generating unit (CGU) exceeds the recoverable amount of the asset or the cash flow-generating unit. The recoverable amount of tangible assets is the higher of the fair value of the asset less expected costs of disposal and the present value of future net cash flows. Investments Investments in subsidiaries are recognised at cost in the Parent Company Financial Statements. The fair value at 1 January 2010 of former associates which became subsidiaries upon the merger of HNG and Naturgas Midt Nord I/S is deemed to be the calculated cost in the subsequent measurement at cost. In the event of indications of impairment, an impairment test is performed as described in the Accounting policies section under Impairment test. In the event that the carrying amount exceeds the recoverable amount, investments are written down to this lower value. Associates Investments in associates are recognised according to the equity method at the proportionate share of these enterprises carrying amount determined in accordance with the group s accounting policies. Goodwill relating to associates is recognised in Investments in associates. Inventories Inventories are measured at cost, determined at the lower of weighted average prices and net realisable value. The net realisable value of inventories is determined as the expected selling price less costs incurred to effect the sale. Receivables Receivables, including financial receivables from customers and other financial receivables, are measured at amortised cost less impairment for bad debt. Impairment for bad debt is based on an individual assessment of each receivable. Price agreements with customers containing a price formula that differs from the list price are separated from the supply agreement and recognised as derivative financial instruments. Other receivables and prepayments Other receivables, including other financial receivables, are measured at amortised cost, which is usually equal to the nominal value. Prepayments recognised under assets include expenses incurred concerning subsequent reporting periods. Prepayments are measured at amortised cost, which usually corresponds to nominal value. Under Danish legislation, distribution companies are obliged to carry out energy-saving projects with the consumers over a number of years, representing certain savings stated in MWh. Any excess savings can be sold to other distribution companies, and failure to meet the savings requirement must be set off by purchasing excess savings from other distribution companies. Excess savings attributable to the financial year and previous years are recognised as prepayments under assets and measured at the lower of actual costs incurred and their estimated selling value. Inadequate savings attributable to the financial year and previous years are recognised as provisions and measured at the lower of estimated costs to carry out the inadequate savings and their estimated acquisition price from other distribution companies. Securities Securities are recognised upon their acquisition at fair value on the trade date. For subsequent periods, securities are recognised at fair value. Fair value adjustment is recognised in the Income Statement under net financials. Contributed capital The parent company is a partnership. Return on the capital contribution is deducted from the distributable reserves and is transferred to a separate reserve under equity. The enterprise s local authority partners are jointly and severally liable for the enterprise s debt. 47

48 Equity reserves Provision and reserve for the reduction of prices are the amounts to be repaid to the consumers via future lower prices based on the Danish Energy Regulatory Authority s regulation of distribution activities and PSO activities. Extraordinary efficiency gain and gain relating to return on net debt are the efficiency gains approved by the Danish Energy Regulatory Authority as extraordinary return on contributed capital. Reserve for accrual of interest is the ordinary return on contributed capital approved by the Danish Energy Regulatory Authority. Reserve for revaluation at fair value in connection with business combinations is a tied reserve in the parent company. Abandonment liability Abandonment liabilities comprise expected future costs incidental to shutdown and removal of distribution systems and technical plant. The abandonment liability is measured at discounted present value based on a real interest rate of 1%. The abandonment liability is adjusted over net financials in the Income Statement. Other provisions Other provisions are recognised and measured as the best estimate of the costs necessary to settle the liabilities at the balance sheet date. Provisions with an estimated due date more than one year from the balance sheet date are measured at discounted present value. Change in the net present value is included under net financials. Prepayments Prepayments include costs incurred for energy savings that are covered by future energy-saving contributions from customers in the subsequent financial year. Prepayments are measured at amortised cost, which usually corresponds to nominal value. Deferred income Deferred income recognised under liabilities comprises income received to be recognised in the Income Statement of the subsequent financial year. Deferred income is measured at net realisable value, which is usually equal to nominal value. Loans In connection with the raising of loans, loans are recognised at the proceeds received less transaction costs incurred. In subsequent periods, financial liabilities are recognised at fair value, with the interest rate being based on the development in a share index or similar, as the liability contains an embedded derivative financial instrument. Fair value adjustment is recognised in the Income Statement under net financials. Other financial liabilities are measured at amortised cost, equal to the capitalised value, by using the effective interest rate so that the difference between the proceeds and the nominal value is recognised in the Income Statement over the term of the loan. For fixed-rate loans effectively hedged against changes in fair value, the value is adjusted for changes in the fair value that are attributable to interest rate changes. Hedge accounting The group uses interest rate swaps and currency swaps to hedge expected transactions, assets and liabilities in accordance with the provisions of IAS 39 Financial Instruments: Recognition and Measurement. Upon the conclusion of the contract, the group classifies each derivative financial instrument that complies with the definition of a hedging instrument as follows: hedging of the fair value of recognised assets, liabilities or binding commitments (hedging of fair value) or hedging of the fair value of an expected financial transaction (hedging of cash flows) 48

49 All contracts are initially recognised at fair value and subsequently at fair value based on applicable purchase prices at the balance sheet date. Forward exchange contracts and currency swaps used to hedge assets or liabilities in foreign currencies are determined at fair value at the balance sheet date. Value adjustments are recognised in the Income Statement with any adjustment of the value of the hedged asset or hedged liability relating to the hedged risk. Value adjustments of forward exchange contracts and currency swaps used to hedge expected transactions are recognised directly in other comprehensive income, provided that the hedge is effective. Accumulated value adjustments of these contracts are moved from other comprehensive income to financial income or financial costs in the Income Statement when the hedged transaction is recognised in the Income Statement. The fair value of financial assets and liabilities is determined on the basis of quoted market prices of financial instruments traded in an active market. If an active market exists, the fair value is determined on the basis of the most recently observed market price at the balance sheet date. Other financial liabilities Financial liabilities are recognised at amortised cost, which is usually equal to nominal value. Segment information Revenue is stated on business segments. Information on business segments is based on the group s return and risk and on the internal financial management. Cash Flow Statement The company s Cash Flow Statement is presented according to the indirect method showing cash flows from operating, investing and financing activities and the company s cash and cash equivalents at the beginning and end of the year. Cash flows from operating activities are made up as operating profit or loss adjusted for non-cash operating items and changes in working capital. Cash flows from investing activities include payments in connection with the purchase and sale of enterprises and activities as well as the purchase and sale of intangible assets, property, plant and equipment as well as investments. Cash flows from financing activities include changes in the amount or composition of the contributed capital and costs incidental hereto as well as the raising of loans, repayments on interest-bearing debt and distribution to the partners (group) or owners (subsidiaries). Cash and cash equivalents include cash and short-term securities with negligible price risk less short-term bank debt. Financial ratios The financial ratios have been computed as follows: Gross margin = Gross profit x 100 / Revenue Profit ratio = Operating profit x 100 / Revenue Rate of return = Operating profit x 100 / Balance sheet total Return on equity = Profit for the year x 100 / Average equity Equity ratio = Equity x 100 / Balance sheet total Net debt = Liabilities other than provisions less current assets and financial receivables 49

50 Note 23 Accounting estimates and judgements When preparing the Consolidated Financial Statements in accordance with IFRS as issued by the IASB and IFRS and adopted by the EU, it is necessary to make certain reasonable estimates. The management makes estimates and assumptions that affect the accounting policies and the reported values of assets, liabilities, revenue, costs, cash flows and relevant information at the balance sheet date. The management prepares its estimates based on the results of previous years and various other assumptions deemed to be reasonable by the management under the circumstances. These estimates form the basis of assessments of the reported financial position, results and cash flows that are not immediately derived from other sources. The actual results may differ from these estimates. The management s estimates and assumptions are reassessed on a regular basis and, if necessary, the changes are recognised in the period in which the reassessed estimates were made. Estimates that are significant to the financial reporting are made, e.g. by determining provisions for restoration obligations, assessing the useful lives of property, plant and equipment, valuating derivative instruments that are not traded in an active market, excess and deficient cover of energy-saving activities and impairment tests. The accounting estimates and judgements deemed by the management to be most significant for the preparation of the Consolidated Financial Statements are described below. Assessment of useful lives of property, plant and equipment As from 1 January 2005, the Danish Executive Order on Income Limits and Opening Balance Sheets for Natural Gas Distribution Companies entered into force. The Executive Order and announcements from the Danish Energy Regulatory Authority lay down the principles of how the future income limits of the natural gas distribution companies are to be defined and, accordingly, the cost of distribution systems acquired before 1 January 2005 is now computed on the basis of an assumption that the distribution system will be financially written off in If the former useful lives had been used, depreciation would have been approx. DKK 175 million higher, and the profit for the year would have been reduced by the same amount. For new installations, the Danish Energy Regulatory Authority has laid down standard useful lives which HMN Naturgas I/S uses. These useful lives are shown in the section on property, plant and equipment. Provision for restoration obligations (abandonment) Provision for restoration obligations comprise expected costs incidental to the shutdown and removal of natural gas distribution systems and the restoration of the physical environment. Determining the costs incidental thereto requires knowledge of how large a share of the portfolio must actually be shut down as well as of the cost incidental to the removal/shutdown of each unit. As this is uncertain, the determination will also be uncertain. The provision is measured at the present value of the future obligations relating to the restoration and removal estimated at the balance sheet date. In 2012, provisions totalled DKK million, up from DKK million in Valuation of derivative financial instruments not traded in an active market The HMN Gassalg group hedges commodity and currency risks. These hedging transactions relate to future income from sale and costs in connection with the purchase of natural gas. Besides, customer contracts include a price index which is treated as separate derivative financial instruments, see below. The fair value of derivatives used to hedge commodity risks and derivatives incorporated in customer contracts is based on valuation models using prices derived from transactions in markets that are less liquid than for instance fixed-income markets. Thus, the valuation is subject to some uncertainty. 50

51 On 31 December 2012, the carrying amount of derivative financial instruments used to hedge commodity risks and derivatives incorporated in customer agreements totalled DKK 64.4 million under assets and DKK 54.6 million under liabilities. The corresponding amounts for 2011 were DKK 22.3 million under assets and DKK 3.8 million under liabilities. Excess and deficient cover of energy-saving activities The carrying amount of excess and deficient cover on energy-saving activities has an estimated uncertainty due to the uncertainty over the sales price of an excess saving and over the costs of carrying out inadequate savings. As at 31 December 2012, an asset of DKK 43.2 million has been recognised. As at 31 December 2011, an asset of DKK 25.9 million was recognised. Impairment test In the annual impairment test of goodwill, it is estimated how the part of the enterprise (cash flow-generating units) to which the goodwill is related will be able to generate sufficient positive cash flows in future to support the value of goodwill and other net assets in the relevant enterprise. Cash flow-generating units are determined on the basis of group structure and mutual cash flows between units. The structure and the determination of cash flow-generating units are assessed on an annual basis. The estimated future free net cash flows (value in use) are based on budgets and projections as well as regulation for the parts of the group subject to regulation. Significant parameters are permitted profits in the regulated parts and the development in the consumption of natural gas. Projections for subsequent years are based on general expectations and risks. The applied cash flows include the effect of future risks related thereto. Therefore, such risks are not included in the applied discount rates. In the budget process and in the day-to-day business activities, potential positive and negative changes in the cash flows for the individual cash flow-generating units are identified. These form part of tests of various scenarios of future possible cash flows. The scenarios reflect various assumptions on market and selling price development as well as the development in gas prices. Budgets and business plans do not include the effect of future restructurings and non-contractual capacity expansions. The discount rate applied in the calculation of the recoverable amount is a real interest rate based on a low risk premium, as the group is in the supply sector, a low risk-free interest rate because of the group s positive credit rating and the development in the net price index. 51

52 Being the customer s company means e.g. being able to offer your customers gas at the lowest possible price. HMN Gashandel trades on the Danish and international gas exchanges, negotiating contracts with many different gas companies to achieve the best prices for its customers. Knud Andersen 52

53 Company information HMN Naturgas I/S Gladsaxe Ringvej 11, DK-2860 Søborg Telefon: CVR no.: EAN no.: Bankers: Nordea Financial year: Calendar year Auditors: PricewaterhouseCoopers Statsautoriseret Revisionspartnerselskab Municipality of domicile: Gladsaxe 53

54 The Board of Directors Jens Grønlund Chairman Ole Bjørstorp Vice chairman Ove E. Dalsgaard Willy R. Eliasen Jens Arne Hedegaard Jørgen Hammer Sørensen Elvin J. Hansen Jens Vestergaard Jensen Erik Lund Jørgen Nørby Finn Stengel Petersen Tina Tving Stauning Hans Toft Susanne Juhl Managing Director, CEO 54