Fortum in European and Russian power markets Mikael Lilius President and CEO Fortum Corporation Fortum Investor/Analyst day 2006 27 November, London
Disclaimer This presentation does not constitute an invitation to underwrite, subscribe for, or otherwise acquire or dispose of any Fortum shares. Past performance is no guide to future performance, and persons needing advice should consult an independent financial adviser. 2
European power markets Russian power markets and Fortum in Russia Supply and demand of electricity in the Nordic market Fortum's investment program Concluding remarks 3
Towards a functioning European power market Today - regional Nordic Tomorrow - European Yesterday - national 1990s Directives: Market liberalisation Strategy: Market integration 2000 - Market-based development Increased competition Increased efficiency 2010 - Benefiting customers and societies 4
Requirements for a functioning European power market A functioning power market = A functioning wholesale market Seamless co-operation between the TSOs Efficient congestion management Regional and European view on grid investments Liquid power exchanges Co-operation of regulators with clear mandates and broader than national obligations Political commitment 5
The Nordic market is a forerunner The Nordic market is the only regional market in the EU today Functioning market design independent TSOs congestion management by implicit auctions liquid and well-functioning regional power exchange regional day-ahead, intra-day and balancing markets high degree of market transparency 6
A result of commitment by all parties politicians, authorities, industry 1960's 1970's Commitment 1980's by all parties: 1990's 2000's Nordel co-operation: Synergies from differences in power production across the Nordic area Technical coordination of the Nordic generating and transmission systems Free access to grid Independent TSOs No cross-border tariffs Free competition Nord Pool power exchange MW 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Denmark Norway Sweden Finland Wind Other thermal Nuclear Hydro 7
DG Competition Sector Inquiry on European electricity markets Preliminary conclusions Markets remain highly concentrated Cross-border trade does not currently reduce incumbents' market power Market participants complain about insufficient unbundling of network and supply More transparency is urgently needed Eurelectric's comments Considerable progress already achieved, but additional work needed in, e.g.: transposition of the Directives into national legislation harmonisation of powers of national regulators application of market-based mechanisms to manage congestion on all interconnectors better co-ordination among TSO's elimination of remaining elements that distort competition (regulated tariffs, etc.) development of regional markets in parallel with the EU internal market Identifying the key issues in the functioning of the European markets is a step in the right direction. The issues will be solved with market based mechanisms 8
EC Energy Policy agenda 2007 Conclusions of the green paper First strategic EU Energy Review Common vision and strategy on energy balancing sustainable development, security of supply and competitiveness More active external policy Re-negotiating the Partnership and Co-operation Agreement between the EU and Russia 3rd liberalization package - further developing the Internal Energy Market Ownership unbundling European regulator to address cross-border transmission Transparency 9
Regional cross-border wholesale power markets are emerging Source: Powernext press release 21 Nov 2006 10
European power markets are developing in the right direction The need for building new generation capacity is identified and generally accepted Wholesale market integration is proceeding price convergence with market based congestion methods and transmission investments EU Commission is pushing for further integration and competitiveness Liquidity of power exchanges is improving Regional cross-border wholesale markets are emerging There continues to be trust in market liberalisation - and a pressure to proceed faster 11
European power markets Russian power markets and Fortum in Russia Supply and demand of electricity in the Nordic market Fortum's investment program Concluding remarks 12
Russia is an emerging opportunity > 4,000 TWh 2000 1500 1000 500 0 US Power generation China Japan Russia India Germany Canada France UK Nordic Brasil TWh 1400 1200 1000 800 600 400 200 0 Power and heat sector reform Need for huge investments Need for efficiency improvement Strong growth potential Electricity production Russian Energy Strategy Demand growth ~300-400+ TWh before 2020 (recently also higher estimates presented) 1990 2000 2010 2020 High Low 13
Russian power industry reform plan includes both restructuring and liberalisation A Nordic/Western analogy Unbundling of businesses by type of activity Competitive businesses Regulated monopolies A new structure in generation ownership Other standalone co's and stations 7% Krasnoyarskaya GES 3% Irkutskenergo 6% Rosenergoatom 11% RAO UES 73% Generation Sales Transmission Distribution Market liberalisation in competitive businesses Pricing model reform from tariff regulation to competitive pricing Rosenergoatom 11% Other standalone co's and stations 20% Krasnoyarskaya GES 3% Irkutskenergo 6% 1 hydro WGC 10% 6 thermal WGCs 24% 14 TGCs 26% 14
Competitive market model launched A model was launched on 1 September 2006 Implicit price cap was removed Regulated vesting agreements function as financial hedges the volume will be reduced annually by 5-15% (100% of physical sales go through power exchange) the price will be adjusted based on inflation and fuel prices starting from 2008 (cost plus -pricing removed) Key benefits of the new model launched Signal of political commitment to the reform First market-based price level indications received Indexation of vesting agreements motivates generators on efficiency improvements (unlike in the cost-plus tariff set-up) Market rules tested in practice, (feed-back for the continuing development work) 100 % Price [RUB/MWh] 75 % 50 % 25 % 0 % 900 800 700 600 500 400 300 Share of vesting agreements Free market Vesting agreements Daily average prices European Part of Russia 200 1.1. 1.2. 1.3. 1.4. 1.5. 1.6. 1.7. 1.8. 1.9. 1.10.1.11. 15
Some specific considerations to take into account in the current Russian context Supply tightness, large amount of investments needed Potential increases in electricity price need to be managed for selected customer groups - new support mechanisms to be created? Major benefits to be gained from ensuring efficient use of resources - significant improvement potential Adjustments to market rules are likely to be needed as experience accumulates Short-term actions must be balanced with long-term ambitions The key principles of liberalization should not be compromised 16
Developing the market further Establishing a functioning wholesale market with free price formation is the single most important factor in securing reform success Today there is an excellent platform to start with Some short-term action could strengthen the current path Some additional long-term action could take the market towards further liberalization Short-term action Ensure transparency of market rules and information Ensure a regulatory body that can make fast and consistent decisions Long-term action Demand and supply flexibility fully reflected Financial derivatives market Continue liberalisation of retail market 17
Fortum's current operations in Russia ~25% stake in Territorial Generating Company No. 1(TGC-1) based on the stake in St. Petersburg Generating Company (Lenenergo generation) ~1/3 stake in other companies spun off from Lenenergo earlier the largest utility in northwest Russia Operation & maintenance services Electricity imports Nuclear fuel and coal imports TGC-1 Electricity production capacity ~6,070 MW (of which hydro 2,874 MW) Production volume of electricity ~22 TWh and heat ~29TWh Third largest TGC Started operation on 1 October 2005 based on a leasing model Merger on 1 November 2006 On TGC-1's Board of Directors Fortum has 3 representatives out of a total of 11 members Owners of TGC-1: RAO UES ~56% Fortum ~25% Norilsk Nickel ~7% Others ~12% 18
New opportunities for investments in Russia October 06 - the first IPO of a generating company in Russia Fortum participated in the additional share issue of Wholesale Generating Company No.5 (WGC-5) WGC-5 is the first company to be spun off from RAO UES (Q2/07) Konak 2 400 MW Nevinn. 1 290 MW Progress of the power sector reform in Russia opens various opportunities for strategic investments Reftins. 3 800 MW Sredne. 1 170 MW WGC-5 Electricity production capacity ~ 8,660 MW One of the largest in Russia 4 power stations located in the economically strong regions Annual generation of electricity ~ 35 TWh and heat ~ 8.2 TWh Balanced fuel supply: 56% - gas 44% - coal Plan to sell over 25% to a strategic investor 19
Stable investment environment is important to secure long term investments into generation Political commitment to the reform and its timetable Stable and predictable regulation Equal treatment of both domestic and foreign actors Transparent and free price formation in the wholesale power market - no mechanisms that distort the market Market based capacity investments should be engouraged 20
European power markets Russian power markets and Fortum in Russia Supply and demand of electricity in the Nordic market Fortum's investment program Concluding remarks 21
Huge need for new capacity... Globally...... European wide...... and in Russia TWh 30 000 TWh 3 500 25 000 20 000 15 000 10 000 5 000 0 2004 1 2010E 2020E ~10 000 TWh 3 000 2 500 2 000 1 500 1 000 500 0 2000 2005 2010E 2015E2020E 900 TWh Demand growth ~300-400+ TWh before 2020 Source: IEA World Energy Outlook 2006, reference scenario for generation 1 Production 2004: 17 408 TWh/IEA 2006 Existing/remaining capacity Demand Source: Eurprog 2005; Europe: EU25 Source: Ministry of Energy; Russian Energy Strategy 2020 22
...also in the Nordic market Demand and capacity development in the Nordic market TWh 500 400 80 TWh Electricity demand is expected to increase by around 50 TWh by 2020 compared to 2005 Estimated retirement approx. 30 TWh 300 200 100 0 2000 2005 2010 2015 2020 Demand Existing / remaining generation Committed projects Total need for investments roughly 80 TWh approximately 40 TWh already committed another 40 TWh still needed 23
New capacity will require an EUR 40+ power price EUR/MWh 80 70 60 50 40 30 20 10 Futures 23 Nov 2006 EUR/MWh 80 70 60 50 40 30 20 10 CO 2 cost 15 /ton Fuel costs Fixed costs ( variation) 0 1995-97 -99-01 -03-05 -07-09 2011 Source: Nord Pool, Fortum 0 Coal Gas Nuclear Hydro Wind Source: IEA "World Energy Outlook 2006"; Elforsk "El från nya anläggningar", 2003. Adjusted to indicate nominal costs year 2011. Large variations in cost of new hydro and wind due to location and conditions 24
Wholesale prices for electricity EUR/MWh Spot prices Forward prices 100 90 80 70 60 50 40 UK German Nordic 30 20 10 0 November 17, 2006 2004 2005 2006 2007 2008 2009 Source: 25
European power markets Russian power markets and Fortum in Russia Supply and demand of electricity in the Nordic market Fortum's investment program Concluding remarks 26
Fortum a pure power and heat company with focused market areas Nordic Generation 51.2 TWh Electricity sales 58.2 TWh Distribution cust. 1.6 mill. Electricity cust. 1.3 mill. Heat sales 19.4 TWh NW Russia (share in associated company) Generation ~5 TWh Heat production ~7 TWh Poland Heat sales 3.9 TWh Electricity sales 20 GWh Baltic countries Heat sales 1.2 TWh Distribution cust. 22,000 27
Fortum towards non-carbon power generation TWh 60 50 40 Other Peat 30 Gas 20 Coal Nuclear 10 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Biomass Hydro CO2-free generation NOTE: Incl. Fortum's power generation covering own production and shares in Sweden and Finland 28
Carbon exposure European power companies kgco 2 /MWh 1,200 1,000 800 Fortum's goals for carbon intensity: below 200 gco 2 /kwh in any given year below 120 gco 2 /kwh as a floating average over five years 2001 2002 2003 2004 2005 600 400 200 0 DEI Drax RWE Energi E2 EDP Union Fenosa CEZ Edison Endesa Scottish& Southern Essent ENEL E.ON Elsam Vattenfall Electrabel PVO Iberdrola Verbund British Energy EDF Statkraft Fortum/PWC Fortum/ Annual 05 Source: PriceWaterhouseCoopers and Enerpresse, 2005, "Changement climatique et électricité, Facteur carbone européen" Fortum/Annual 05: Fortum annual report 2005 29
Fortum has a remarkable investment program Olkiluoto 3 Swedish nuclear Suomenoja Värtan Refurbishing of existing hydro assets Total ~ 1,200 MW Value of the investment program around EUR 2,700* million In addition Automated meter management (EUR 240 million) Security of supply in distribution (EUR 700 million) * Incl. smaller capacity upgrades and refurbishments in various plants 30
European power markets Russian power markets and Fortum in Russia Supply and demand of electricity in the Nordic market Fortum's investment program Concluding remarks 31
Fortum's compass and key issues going forward Fortum's Compass Vision Strategy Values To be the benchmark power and heat company Fortum focuses on the Nordic and Baltic Rim markets as a platform for profitable growth Become the leading power and heat company Benchmark business performance Excellent performance Co-operative spirit Become the energy supplier of choice Creativity and innovation High ethics 1. Drive growth organic Nordic consolidation Russian and Baltic rim opportunities 2. Become the energy supplier of choice drive customer focus and sales culture make sustainability a success factor 3. Promote a market driven development of the electricity market promote integration towards continental Europe 4. Continue focus on performance - target world class 32
Dividend policy and Capital structure Dividend policy of 50-60% payout on the average for Fortum continuing operations' results In the medium term, allowing the implementation of strategy and the returns of capital, Fortum is committed to reaching a ratio of net debt to EBITDA around 3.0x 33
Fortum is well positioned for 2006 and 2007 Good results in the first nine months Continued focus on the Nordic and Baltic Rim countries Competitive corporate structure, costs and production portfolio Increased hedge prices Favourable market fundamentals Fortum has the foundations for continued good performance 34
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