Commodity market risk

As a consequence of the deregulation of the electric power and natural gas markets, companies that operate in the energy sector are facing a steady increase in the risk of fluctuations in the level of their economic results, due to volatility in the markets where the benchmark commodities are traded.

In response to this environment, the Edison Group developed an energy risk management strategy designed to stabilize the operating margins generated by its portfolio of assets and contracts and, using strategic hedging transactions, protect Group EBITDA from fluctuations related to the price risk and foreign exchange rate risk inherent in the commodities it uses. The stabilization of margins also serves the purpose of protecting the value of assets carried on the balance sheet from impairment caused by excessive market price volatility.

The Group’s policy is designed to minimize the use of the financial markets for hedging purposes, choosing instead to emphasize the benefits offered by the vertical and horizontal integration of its diverse portfolio of businesses. Accordingly, the Group maximizes the benefit naturally provided by its overall physical portfolio by means of a netting process: specifically, either directly or through indexing formulas, the same commodities are featured both in its purchasing contracts and its sales contracts and, consequently, the assessment of the exposure to the price risk is performed taking into account all of the positions in the portfolio, netting out for each month opposite positions that provide an internal hedge.

Consistent with this goal, the Group plans how to physically balance the volume of its market sales of physical energy commodities for the various maturities. In addition, it pursues a strategy of homogenizing physical sources and uses, with the objective of building a Group position that is as balanced as possible with regard both to physical volumes and the indexing formulas applied to purchases and sales.

To manage any risk remaining after the netting process is applied to the portfolio of assets and contracts, the Group may use hedges executed in the financial markets in accordance with a cash flow hedging strategy.

The purpose of hedging transactions can be to protect a maximum level of Profit at Risk or a maximum level of exposure, computed centrally for the Group’s total net portfolio (Strategic Hedging). Such transactions may also be used to lock-in the margin of a single transaction or of a limited number of related transactions (Operational Hedging). Strategic Hedging transactions are activated automatically by the Risk Committee when the Group’s net risk exposure, computed in terms of Profit at Risk, exceeds the predetermined economic capital ceiling approved by the Board of Directors. The Economic Capital represents the risk capital, stated in millions of euros, allocated to cover the commodity price risk and the foreign exchange rate risk.

Strategic Hedging is carried out by means of financial hedges that are activated gradually during the year. The gradual approach used in Strategic Hedging minimizes the execution risk, which would be incurred if all of the hedges were executed during an unfavorable market phase, as well as the volume risk, related to the variability of the underlying commodity based on best volume projections, and the operational risk, related to execution errors.