RISKS RELATED TO THE EXTERNAL ENVIRONMENT
Price Risk and Foreign Exchange Risk related to commodity activities
The Edison Group is exposed to the risk of fluctuations in the prices of all of the energy commodities that it handles, including, specifically, electric power, natural gas, coal, petroleum products and environmental securities. These fluctuations affect the Group both directly and indirectly through indexing mechanisms contained in pricing formulas. Moreover, because some of the abovementioned commodity prices are quoted in foreign currency, the Group is also exposed to the resulting foreign exchange rate risk.
The activities required to manage and control these risks are governed by the Energy Risk Policy, which require the adoption of specific risk limits, in terms of economic capital, and the use of financial derivatives that are commonly available in the market for the purpose of containing the risk exposure within preset limits.
Approved activities that are part of the core businesses of the Edison Group include physical and financial commodity trading, which must be carried out in accordance with special procedures and segregated at inception in special trading portfolios. Trading portfolios are monitored by means of strict risk limits and compliance with these limits is verified by an organizational unit independent of those who execute the transactions.
Foreign Exchange Risk not related to commodity
The foreign exchange risk arises from the fact that some of Edison’s activities are carried out in currencies other than the euro or are influenced by changes in foreign exchange rates through indexed contractual components.
The objectives pursued when managing the exchange rate risk are set forth in specific Exchange Risk Policies, depending on the different nature of the risk in question.
Interest Rate Risk
Because it is exposed to fluctuations in interest rates primarily with regard to the measurement of debt service costs, the Edison Group assesses on a regular basis its exposure to the risk of changes in interest rates and uses derivatives to hedge its positions. The Group’s main interest rate exposure is to the Euribor.
The Edison Group operates in the international markets, focusing mainly on the Balkans and Southeast Europe, with some foreign branches that engage in the marketing of electric power. It is also present in Greece, where it produces and markets electric power through a joint venture with Hellenic Petroleum, its Greek partner.
In addition, the Edison Group is active in hydrocarbon exploration and production, with a particularly important presence in Egypt, where it produces natural gas and crude oil as the operator of the Abu Qir offshore concession, and with smaller operations in the Ivory Coast and other countries.
Because of its presence in these international markets, the Group is exposed to the so-called “country risk,” i.e., a whole series of risks deriving mainly from political, economic, social, regulatory and financial differences compared with conditions in the country of origin.
Legislative and Regulatory Risk
A potential source of significant risk for Edison is constant evolution occurring in the reference legislative and regulatory framework, which affects how the market operates, rate plans, required levels of service quality and technical and operational compliance requirements. In this area, Edison is engaged in an ongoing activity to monitor and carry out a constructive dialog with national and local public institutions, so as to develop opportunities for discussing and promptly assessing the impact of regulatory changes, with the aim of minimizing the resulting economic impact.
The credit risk represents Edison’s exposure to potential losses caused by the failure of commercial and financial counterparties to honor the commitments they have undertaken. The Edison Group’s exposure to the credit risk is related to sales of electric power and natural gas, the investment of temporary excess liquidity and financial derivative positions.
The energy markets in which the Group operates are subject to intense competition.
In order to address the risks entailed by its involvement in the domestic electric power market, the Group has been pursuing in recent years lines of action aimed mainly at developing a portfolio of customers in the deregulated segment of the market, consistent with a strategy of gradual downstream integration, geographic diversification, optimization of the production mix, and development of renewable energy sources.
Among the various actions taken to minimize the competitive pressure risk in the hydrocarbon area, a major contractual tool is the enforcement of clauses allowing the renegotiation of prices, based on changes in the benchmark energy scenario and market conditions, which are included in long-term natural gas supply contracts.
Radical changes in the electric power generation technologies currently in use or under development could make certain technologies more competitive than those currently represented in the Group’s production mix. To minimize this risk, Edison monitors on an ongoing basis the development of new technologies both in the electric power and the hydrocarbon sectors.
The main activities are related to the assessment of innovative technologies in the fields of energy efficiency and generation from renewable sources and to subjects linked to the use of Advanced Materials and Fuel Cells.
Demand for Electric Power and Natural Gas
The reduction in the overall level of demand for energy put significant pressure on sales margins due to the negative impact in terms of lower sales volumes of electric power and natural gas by Edison.
The Group monitors both trends in electrical load and natural gas consumption (on a daily basis) and the Italian and international macroeconomic scenario, based on the updates published by major economic and financial forecasting entities.
This information is analyzed in order to spot, as early as possible, potential changes in electric power and natural gas demand trends and optimize the production scenario accordingly. In addition, the adoption of a strategy of commercial diversification makes it possible to counter, up to a point, the effects of an unfavorable market scenario.
Edison’s core businesses include building and managing technologically complex facilities for the production of electric power and hydrocarbons that are interconnected along the entire length of the value chain. The risk of losses or damages can arise from the unexpected unavailability of one or more pieces of equipment or facilities of critical importance for the production process caused by damaging events, including material damages to the equipment or specific components of it, that cannot be fully covered or transferred by means of insurance policies.
Edison pursues an industrial risk management policy that includes risk prevention and control activities, the adoption specific security standards, implementation of the upgrades required by national laws and local entities with regulatory authority over such issues, and frequently scheduled equipment overhauls, contingency planning, inventory management and maintenance activities, an effective industrial insurance and expert evaluation strategy.
The Group’s operations are supported by complex information systems, specifically with regard to the technical, commercial and administrative areas. Risks issues exist with regard to the adequacy of these systems and the integrity and confidentiality of data and information.
With regard to the risk of activity interruption caused by a system fault, Edison has adopted a high reliability hardware and software configuration for those applications that support critical activities.
Lastly, the risk of the occurrence, of ever new types of cyber attacks is being mitigated with the adoption of strict security standards and authentication and profiling systems.
Managing the liquidity risk means addressing the risk that the Company may not have access to sufficient financial resources to meet its financial and commercial obligations in accordance with agreed terms and maturities.
Insofar as the strategic objectives of liquidity risk management are concerned, it should be noted that Edison and its subsidiaries are integrated in the EDF Group.
Inter alia, the system adopted entails a centralized cash management system that will provide Edison with flexibility for its own short-term cash needs and those of its consolidated subsidiaries, while optimizing the management of daily cash surpluses and needs.
As part of this integration process with EDF, the Group developed a medium/long-term refinancing plan that will provide coverage for all the financial needs contemplated in the expenditure plan.
STRATEGY AND PLANNING RISKS
Investments in Development and Acquisitions
The development of the core businesses of the Edison Group must be supported with direct investments (internal growth) and acquisitions, both in the power’s and hydrocarbon’s sector.
As a result of these activities, the Edison Group is exposed to permit risks; risks of delays in the construction and launch of commercial activity of new projects; risk of increases in operating, materials and service costs; risks related to new developments in existing technologies; and risks related to changes in the political and regulatory framework in some of the foreign countries where it operates or plans to operate in the future.
In order to minimize these risks, Edison adopted a series of internal processes to monitor the research and assessment phases of investment initiatives. In addition to requiring the use of appropriate written procedures, these processes require the use of due diligence activities, binding contracts, multilevel internal authorization processes, project risk assessment activities and strict project management and project control activities.