Vattenfall Nordic Electricity Trading IAS 39 in practice

1
Vattenfall Nordic Electricity TradingIAS 39 in
practice

• NAET Seminar
• Oslo, January 29, 2004

Fredrik Adolfson, Vattenfall Patrik Bernhard,
Atos Consulting
2
Why is IAS 39 important to Vattenfall?

• Owner has decided that all state-owned companies
  should apply International Accounting Standards
• Vattenfall has very large volumes of external
  derivatives
• Electricity Trading
• (Vattenfall Treasury)
• Effects on P/L and equity could potentially be
  substantial
• Need to assist large customers in adapting to IAS
  39

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Starting the project up

• Put a broad project organisation together
• Think carefully about
• the grouping of freestanding derivatives
• how to make the inventory embedded derivatives
• Start thinking early about
• solutions on a high level
• the need for systems support
• External consultants
• Internal project management and resources
• External expertise

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High-level project plan

Analysis High Level Solutions design
Detailed solutions design
Implementation
Phase 1 Phase
2 Phase 3 30 April
30 June
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Phase 1
Objectives

• Full picture of potential P/L implications
  without hedge accounting
• High-level picture of possible solutions
  available to achieve hedge accounting

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Phase 1
Detailed project plan

• Inventory of external derivatives
• Grouping of derivatives
• Sensitivity analysis
• High-level solutions design
• Review of other requirements
• Recommendation

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Phase 1
Vattenfall Business Model

Production
Sales
Supply Trading
VPM
NordPool
OTC
Customers
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Phase 1
Inventory of external derivatives

• Germany not included
• Hedging of future production
• Hedging of future sales
• All customer contracts
• Trading
• Vattenfall Portfolio Management
• Other contracts
• Electricity certificates and emission rights
• Weather derivatives

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Phase 1
Inventory Result

• 3 main categories of external derivatives
• Derivatives related to Vattenfall net position
  of future production and future sales
• Derivatives related to trading
• Derivatives related to Vattenfall Power
  Managements customers
• Electricity certificates and emission rights not
  to be considered as financial instruments
• Supported by Finansinspektionen (Sw FSA)
• Weather derivatives relatively marginal

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Phase 1
Sensitivity Analysis

• Simple analysis
• Outstanding balances as at 2003-03-07
• Electricity Price 50 SEK/MWh
• Currency Exposure excluded
• Included in Treasury analysis
• Not a worst-case scenario
• No probability assumption

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Phase 1
Conclusions of Sensitivity Analysis

• P/L volatility risk far too high to be
  acceptable
• Hedge accounting should be achieved for all
  freestanding derivatives

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Phase 1
High-level solutions

• Hedge Accounting to be achieved through matching
  against forecasts (cash flow hedges)
• Production and/or Sales forecasts?
• Gross volumes of sold/bought derivatives will be
  the decisive factor
• Length of time periods?
• Quarters to be used as working hypothesis
• Basis risk might cause problems
• FX and Price Area risks
• Hedge Accounting solution to developed in detail
  in phase 2

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Nordic Electricity Trading
Systems support

• A special hedge accounting module will probably
  not be needed in order to handle the hedge
  accounting solutions efficiently
• Murex is developing a hedge accounting module
• For a financial sector client
• Adaptions may be required to adjust to the needs
  of Vattenfall

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IASB and EU Timeplan IAS 32 39

• May 2003 IAS 32 39 not endorsed
• Sept 2003 New Exposure Draft from
  IASB
• March 2004 Finalised version from IASB
• Q2/Q3 2004 EU endorsement?
• 1 Jan 2005 IAS 39 effective? No comparative
  figures needed
• Discussed changes not relevant for
  Vattenfall

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High level project plan

Analysis High Level Solutions design
Detailed solutions design
Implementation
Phase 1 Phase
2 Phase 3 30 April
30 June
31 December
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Phase 2
Starting point Q1 2004 (dummy figures)

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Phase 2
Alternative A Minimize hedge accounting

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Phase 2
Alternative B Maximize hedge accounting

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Phase 2
Alternative C Separate trading Maximize hedge
accounting

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Phase 2
Evaluation of hedge accounting alternatives

• Alternative C seemed like the best alternative
• Trading contracts marked-to-market
• Hedge accounting for hedging contracts
• Hedge Accounting to be achieved through matching
  hedging contracts against forecasts
• Derivative sales contracts vs forecasts of
  future production
• Derivative purchase contracts vs forecasts of
  future sales

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Detailed evaluation of alternative C
Derivatives

FX

• Pros
• Perfect hedge (critical terms)
• No composed hedging
• instruments
• Cons
• Can high probability really be achieved?
  (NOKSYS forecasts)
• Will two-way forecasts be accepted?
• Requires separation of the FX component

CFD
Forecasts (Prod/Sales)
NOK SYS
P/L
NOK SYS
NOK SYS
Electricity price
FXComponent
Need to develop alternative D
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Phase 2
Alternative D (AC) Separate trading Minimize
hedge accounting Step 1 Separate trading

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Phase 2
Alternative D (AC) Separate trading Minimize
hedge accounting Step 2 Minimize hedge
accounting

Hedge accounting 5 TWh
M-t-M 6 TWh
11 TWh
6 TWh
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Detailed evaluation of alternative D
Forecast (Production)
Derivatives

FX
STO SEK

• Pros
• Perfect hedge (critical terms)
• One-way forecasts
• No separation of FX component required
• High probability no problem (forecast
  denominated in STOSEK)
• Follows the business logics
• Cons
• Composed hedging instruments (requires very
  good matching)
• Is there enough volume of hedging instruments
  available?
• May require fall-back solution

CFD
NOK SYS
STOSEK
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Fall-back solution for alternative D
Derivatives

Need to develop alternative E
CFD
P/L
Forecast
FX
STO SEK
NOK SYS
Ineffectiveness(basis risk)
SEKSYS
EffectivenessTesting
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Phase 2
Alternative E 1. Separate trading 2. Minimize
hedge accounting 3. Make external STOSEK
contracts to replace present NOKSYS hedging
contracts

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Phase 2
Alternative E 1. Separate trading 2. Minimize
hedge accounting 3. Make external STOSEK
contracts to replace present NOKSYS hedging
contracts

Hedge accounting 5 TWh

• Trading
• M-t-M
• 6 TWh

11 TWh
6 TWh
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Detailed evaluation af alternative E

Forecast (Production)
Derivatives
STO SEK
STO SEK

• Pros
• Perfect hedge (critical terms)
• One-way forecasts
• No separation of FX component required
• High probability no problem (STOSEK vs
  STOSEK)
• Follows the business logics
• No composed hedging instruments
• Cons
• Requires new external transactions
• Availability?
• Transaction costs?

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Alternative E
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Phase 3
Next steps

• Decide on main alternative
• Auditors acceptance
• Roll-out in Germany
• Develop procedures
• Parallell run
• Implementation
• January 1, 2005