Manage the commodity market risks area
Within Risk Management activities and considering the fact that the Edison Group is exposed to the risk of price fluctuations for all energy commodities used by its businesses (mainly electric power, natural gas, petroleum products, environmental securities) and to the foreign exchange risk for energy commodities denominated in foreign currencies, the Company has adopted for some time an Energy Risk Policy.
This policy, which defines the governance, monitoring and control environment for these risks, calls for the adoption of specific risk limits in term of Economic Capital, based on the entire portfolio of Group assets and contracts (the “Industrial Portfolio”), measured periodically through the Profit at Risk (statistical measurement of the maximum potential negative variance expected in the event of unfavorable market moves for a given time horizon and confidence interval). Financial derivatives may be used to contain the exposure to the commodity risk within the approved economic capital limits.
Within the framework of its core activities, the Edison Group also engages in trading in physical and financial commodities.
These activities must be carried in accordance with special procedures and must be segregated in special portfolios (the “Trading Portfolios”), separate from the Industrial Portfolio, which are monitored based on strict risk limits. In this case as well, a maximum limit of Economic Capital is established, measured through the Value at Risk (a statistical measurement of the maximum potential negative variance in the portfolio’s fair value in response to unfavorable markets moves, within a given time horizon and confidence interval) and a stop loss limit.
The Board of Directors, based on the mapping of the main business risks, determines each year, when it approves the annual budget, the maximum limit of the Economic Capital both for the Industrial Portfolio and the Trading Portfolios.
Objectives
One of the objectives of the Group’s risk management activity is to stabilize the cash flows generated by the existing portfolio of assets and contracts and use strategic hedging to protect the Group’s industrial margins from fluctuations caused by the effect of the price risk and the foreign exchange risk on the commodities used.
Strategic hedging is carried out by means of financial hedges that are activated gradually during the year, based on market trends and changes in projections of the volumes of physical buy and sell contracts and the production of the Group’s assets.
The gradual implementation of strategic hedging helps minimize the execution risk, which refers to the possibility that all hedges will be activated during an unfavorable market phase, the volume risk, which is related to the variability of the underlying items that require hedging based on the best volume projections, and the operational risk, which is related to implementation errors.
Moreover, the Group’s policy is designed to minimize the use of financial markets for hedging purposes by maximizing the benefits of the vertical and horizontal integration of its different business segments.
Accordingly, the Group makes it a planning priority to physically balance the volumes of physical energy commodities that it will sell in the market on the different due dates, using for this purpose the production assets it owns and its portfolio of medium/long-term contracts and spot contracts.
In addition, through the vertical and horizontal integration of the different business segments, the Group pursues a strategy designed to homogenize sources and physical uses, so that the formulas and indexing mechanisms that determine the revenues generated by the sale of energy commodities reflect as much as possible the formulas and indexing mechanisms that govern the costs that the Group incurs to purchase energy commodities in market transactions and to supply its production assets.
To manage the price and foreign exchange risk on the remaining exposure of its portfolio of assets and contracts, the Group can use structured hedges executed in the financial markets in accordance with a cash flow hedging strategy.
Financial hedges can also be established in response to specific requests by individual business units to lock in, with operational hedging, the margin earned on a single transaction or a limited number of related transactions.