Statkraft AS. Annual update. CREDIT OPINION 15 June Update. Summary Rating Rationale. Credit Strengths

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1 CREDIT OPINION Statkraft AS Annual update Update Summary Rating Rationale RATINGS Statkraft AS Domicile Norway Long Term Rating Baa1 Type LT Issuer Rating - Fgn Curr Outlook Stable Please see the ratings section at the end of this report for more information.the ratings and outlook shown reflect information as of the publication date. Statkraft's Baa1/P-2 ratings are underpinned by the company's strong market position as Norway's leading power generator, with a large proportion of low marginal cost hydropower production. Whilst Statkraft has earnings volatility associated with Nordic power prices and volatile hydro output this is partially mitigated through the company's control over many of the country's reservoirs and the majority of the company's long-term contracts with powerintensive Nordic industries, running through 2020 and representing around 40% of annual mean Nordic hydropower production, at prices above current market levels. We expect that the pace and scale of the investment programme will be managed to protect credit quality in light of the continued weak power price environment. Exhibit 1 Earnings down but European flexible generation still profitable despite very low power prices Analyst Contacts Philip Cope Analyst philip.cope@moodys.com Helen Francis VP-Sr Credit Officer helen.francis@moodys.com Neil Griffiths Lambeth Associate Managing Director neil.griffiths-lambeth@moodys.com 'Full cost including depreciation' includes property tax and depreciation but excludes sales costs, overhead, net financial items and tax. Values based on normal production from power prices under Statkraft's management in Norway, Sweden, Germany and the UK. The vast majority of Statkraft's output from its European flexible generation fleet is sold in Norway. Source: Annual reports Statkraft's ratings also factor in a two-notch uplift versus the standalone credit profile (baseline credit assessment or BCA under Moody's methodology for Government Related Issuers). This reflects Statkraft 100% ownership by the Norwegian government and our belief there is a strong likelihood that the government would support the company in case of extraordinary need. Credit Strengths Leading European low marginal cost hydro generator Contracted generation provides degree of earning stability through 2020

2 Some flexibility to manage pace and scale of investment programme to protect credit quality We believe that there is a strong likelihood that the Norwegian State government would support Statkraft in case of extraordinary need Credit Challenges Material exposure to power prices reflecting (1) the fixed, albeit low, cost nature of its generation fleet; and (2) the estimated 35TWh per annum of unhedged output from its European operations in a typical year Increased earnings volatility post 2020 unless existing long-term contracts, c20twh, are replaced as they mature Rating Outlook The outlook is stable, reflecting our expectation that the company will manage the pace and scale of its investment programme such that it meets the guidance for the current rating: FFO interest coverage of over 4x; Funds From Operation (FFO) / Net Debt at least in the high teens in percentage terms; and RCF / Net Debt comfortably in the low double digits in percentage terms. Factors that Could Lead to an Upgrade Upward rating pressure would likely require a material and sustained recovery in power prices in Norway, which we do not currently anticipate before the end of this decade. However, positive pressure could develop on the Baa1 ratings in the longer term if: the company achieved FFO/net debt comfortably in the mid twenties and RCF/net debt in the high teens, both in percentage terms, on a sustainable basis; OR there was a significant increase in government support for the company, although this seems unlikely in the foreseeable future. Factors that Could Lead to a Downgrade Negative pressure could develop if: the company's financial profile were to deteriorate such that metrics fell below the guidance for the current rating where, for example, lower revenues as a result of a reduction in achieved prices were not mitigated by cuts in the investment programme the government were to significantly reduce its ongoing support for Statkraft We note, however, that the current rating could accommodate a limited fall in the Norwegian government's rating. Key Indicators Exhibit 2 Key Indicators All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Source: Moody's Financial Metrics This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 Detailed Rating Considerations Contracted generation provides degree of earning stability through 2020 Absent a significant recovery in power prices, we estimate that contracted generation will account for around half of Statkraft's EBITDA over the next few years. A material proportion of earnings comes from around TWh of long-term market contracts with power-intensive Nordic industries. The majority of these contracts, which run through 2020 and account for up to c.40% of annual mean Nordic hydropower production, were put on at the start of the decade when prevailing power prices were significantly higher. Statkraft's small but growing international business, which accounted for 6% of 2015 output, also benefits from the majority of volumes having long-term power purchase agreements (PPAs), Exhibit 3 Contracted generation expected to account for around half of Statkraft's EBITDA over next few years; majority from long-term contracts with power-intensive Nordic industries Source: Statkraft Whilst prevailing hydrological conditions in the Nordics will create year-to-year volatility in Statkraft's metrics, with years of particularly high inflow and hydropower production in the Nordics, as was seen in 2015, placing acute pressure on metrics, Statkraft's ability to store water for up to three years in some reservoirs, allied to the long-term contracts, means it is better placed than some peers to manage this risk. Also, with Europe's largest reservoir capacity (~40TWh), Statkraft is able to optimise production relative to power prices and water inflows and achieve higher average prices over time. For example, the group held back Nordic hydropower 3

4 production in late 2015, when the NordPool average system price in Q3 was 13.3/MWh due primarily to extreme hydrological conditions, and then delivered record high hydropower production in Q (18.6TWh, a 3.7TWh quarter-on-quarter change) when the average system price was higher, 24/MWh. Material power price exposure remains however Despite the high levels of contracted generation Statkraft remains exposed to prevailing power prices; particularly given its predominantly fixed, albeit low cost, generation fleet. Indeed, with around 35-40TWh of unhedged European output in a typical year, we estimate a 1/MWh change in European power prices equates to a cnok350 million change in group EBITDA, around 3% of reported underlying earnings in recent years. This material exposure to lower commodity prices, accentuated by the abnormal hydrological conditions, was illustrated by the NOK1.5 billion fall in 2015 EBITDA from European flexible generation and market operations in 2015, which has accounted for over 80% of group underlying reported EBITDA in recent years. Exhibit 4 Reported underlying EBITDA primarily driven by European flexible generation; low power prices impacts this segment Underlying EBITDA adjusts for unrealised changes in value on energy contracts and significant non-recurring items. Following the business segment reclassification effective from Q1 2016, the sum of European flexible generation and market operations is analogous to the sum of Nordic hydropower and continental trading. From Q1 2016, share of profit from associated companies and JVs is included in EBITDA. To aid comparison this is excluded in EBITDA would have NOK684 million under the new reporting criteria, with the associates in international hydropower, wind power and industrial ownership and 2012 EBITDA was restated (NOK29 million and NOK287 million higher post restatements) but originally reported EBITDA is shown to provide a divisional split Source: Annual reports Although a return to more normal hydrological conditions will help, we expect earnings from Statkraft's largest business segment to remain under pressure. Even with the recent rebound in commodity prices, current one-year forward baseload prices in the Nordics are only around the low EUR20s/MWh, still 25% below early 2015 levels. With (1) commodity prices expected to remain weak for the remainder of the decade; (2) anaemic demand growth from traditional surplus; (3) a growing Nordic power surplus as more renewables come online; and (4) the anticipated doubling of Nordic export capacity, reducing the power surplus, over the next ten years mainly to be felt post 2020 when new interconnectors come online, we do not anticipate a material recovery in power prices this decade. We note the impact on Statkraft's cash flows based metrics, such as FFO and, in particular, RCF, is substantially lower than the change in EBITDA from a EUR1/MWh change in the realised price of the unhedged European output. This reflects the very high marginal tax rate on Norwegian hydropower output (58%) and the group's 85% dividend payout. Taking these two factors together, at a group level, we estimate that the change in RCF is less than 10% of the change in EBITDA. Pace and scale of investment programme expected to be managed to protect credit quality Over the past few years, Statkraft has sought to diversify cash flows through an ambitious expansion strategy outside of the Nordics, primarily in international hydropower (48% of 2015 capex). Statkraft has always stated this investment ambition is subject to financial capacity and maintaining current ratings. Although the company has already cut its investment ambition for once, by 15% in December 2015 following the reversal of the planned dividend cut by the government, we view the company as still having significant financial flexibility in this area. Over half 4

5 of its investment ambition (NOK21 billion) is either reserved or the company purportedly has full flexibility over. We also note that the company is considering other measures in 2016 and has pulled out of new investments in offshore wind. Given the low current power price environment, the stable outlook incorporates our expectation that Statkraft will utilise this financial flexibility to maintain its credit quality, although the deferral of some international hydro projects will reduce anticipated earnings growth in medium term and reduce the modest cash flow diversification provided. However, even with utilising financial flexibility, we expect financial metrics to remain weakly positioned in 2016, and to a lesser extent in 2017, against ratio guidance, absent a material recovery in power prices. OWNERSHIP BY THE GOVERNMENT OF NORWAY PROVIDES RATINGS UPLIFT Statkraft's Baa1 ratings incorporate two notches of uplift from its baa3 BCA under Moody's Government-Related Issuers (GRI) Methodology, published in October We view the likelihood of the Norwegian government providing Statkraft with support as strong. This reflects the strong indication of support and a general alignment of consensus between the major political parties that the company will remain 100% government owned, evidenced by a June 2014 White Paper on state ownership. We also note that under the Norwegian Industrial Licencing Act, only majority (two-thirds) publicly owned companies can own power plants or waterfall rights and hold their licence in perpetuity, to ensure that hydropower resources are managed in the best interests of the general public. Although the government reversed the planned NOK5 billion dividend cut over accounting years in December 2015, we viewed this as principally affecting Statkraft's financial flexibility rather than a change in support for Statkraft's strategy. This reflects that the government had already provided in December 2014 a NOK5 billion direct capital injection in support of the investment plan and the current dividend payout ratio (85% of net income) remains unaltered and in line with historical levels (75-100%). Under our GRI methodology we view the level of dependence as moderate, reflecting the moderate degree to which Statkraft and the government depend on the same customer base, and the low level of common credit risks that could cause a default. Liquidity Analysis Statkraft's liquidity is strong. Following a 200 million (NOK1.9 billion) bond issuance in March 2016, the group had cash and marketable securities of NOK10.7 billion at 31 March 2016 and an undrawn NOK12.0 billion revolving credit facility which doesn t mature until January 2018 and contains no financial covenants. These along with operating cash flows, expected to be around NOK7-8 billion in 2016, comfortably cover immediate calls on Statkraft s liquidity during the next 12 months represented by (1) debt maturities totalling around NOK5.5 billion; and (2) an investment programme that is expected to average NOK8 billion per annum or less over the coming five years. No dividend payment is scheduled in 2016 given the 2015 net income result. Corporate Profile Statkraft AS is the largest generator of hydro-powered electricity in Europe and the second-largest power producer in the Nordic region. In 2015, Statkraft produced 56.3 terawatt hours (TWh) of electricity from its 16.8 gigawatts of installed capacity. The company generates the majority of its EBITDA from its Nordic electricity production and sales but also benefits from its industrial holdings as well as the consolidation of its 66.6% ownership in Skagerak Energi, a regional utility active in the generation, networks and district heating sectors in Norway. Statkraft is expected to continue its expansion into renewable energy projects in Europe and international emerging markets. Statkraft AS is wholly owned by Statkraft SF, which in turn is wholly owned by the Norwegian state. 5

6 Exhibit 5 Nordic hydropower accounts for majority of 2015 total production Power production and heat production Power production includes share of consolidated companies 43.5TWh of European flexible generation output was Nordic hydropower Source: Annual report Rating Methodology and Scorecard Factors The BCA of baa3 is derived from Moody's methodology for Unregulated Utilities and Power Companies (October 2014), under which we assess Statkraft as a power company. Based on the company's three-year average historic financial metrics, the grid-indicated BCA is baa3, in line with the assigned BCA. 6

7 Exhibit 6 Statkraft AS - Rating Factor Grid [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments fro Non-Financial Corporations. [2] As of 31/12/2015. [3] This represents Moody's forward view, not the view of the issuer, and unless noted in the text, does not incorporate significant acquisitions and divestures. Source: Moody's Financial Metrics Ratings Exhibit 7 Category STATKRAFT AS Outlook Issuer Rating Senior Unsecured Other Short Term Moody's Rating Stable Baa1 Baa1 (P)P-2 Source: Moody's Investors Service 7

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