CEO’s Business Review 2018

Dear stakeholders, 

2018 was an eventful year for Fortum. We continued our strategy implementation with the integration and development of our Hafslund and Ekokem acquisitions, further investments in renewables, and most significantly; closing the Uniper tender offer. Our long-term belief in the need for large-scale decarbonisation took a leap forward with the decision to strengthen the Market Stability Reserve and subsequent tripling of emission allowance prices, having a clear positive impact on power prices.

Determined strategy implementation and updated strategy

Driving the change for a cleaner world is at the heart of Fortum’s strategy and our role is to accelerate this change by reshaping the energy system, improving resource efficiency, and providing smart solutions.

Over the previous years we have worked hard to deliver on our strategy announced in early 2016. As a result, we now have a portfolio of businesses with good profit potential for coming years. After taking significant steps in the capital redeployment that began in 2016, we updated Fortum’s strategy in November 2018. The updated strategy is a natural continuation of the previous one and builds on four priorities.

Our first strategic priority is to pursue operational excellence and increased flexibility in order to ensure benchmark performance of our existing businesses and improve our long-term competitiveness. After the large investments done during previous years it is only natural that the second priority is to ensure value creation from these investments. We will also continue to optimise our business portfolio, considering the ongoing transformation and decarbonisation of the sector. As our third priority, we will continue to drive focused growth in the power value chain. We will build on our long-standing expertise with the strategic focus on CO₂-free power generation – For a cleaner world. Foreseeing the market development towards the end of the 2020s will be increasingly challenging, but we believe that the uncertainty will also provide new business opportunities. Consequently, as our fourth priority, we aim to build on our existing competences and emerging technologies to create new businesses, independent of power prices, that have the potential for sizeable profit contribution. One example of initiatives in this area is our commitment to invest in Valo Ventures, a new global venture capital fund. Valo Ventures invests in digital startups focusing on key global megatrends that are central to Fortum’s strategy. Fortum launched Valo Ventures together with Scott Tierney, former Google Capital co-founder.

The operating environment in 2018

The urgent need to decarbonise society is perhaps the greatest challenge of our time. The EU Commission published its long-term climate vision in November. Fortum supports the net zero emission target for 2050, as proposed in the most ambitious scenario. Cost-efficient emission reduction pathways should be established for all sectors. The EU emission trading scheme currently covers less than half of EU’s CO₂ emissions. Therefore, strengthening and broadening the scope of the EU ETS to e.g. heating, cooling, and transport should be a key tool to drive decarbonisation. Fortum also supports the UN Global Compact and Caring for Climate initiatives, and is committed to the principles of these initiatives.

The market conditions in 2018 were characterised by the increasing CO₂ emission allowance price, volatile commodity and power prices, as well as the dry Nordic hydrology. Following the decision in late 2017 to strengthen the EU emission trading scheme by increasing the linear reduction factor and introducing the market stability reserve, the CO₂ price increased from EUR 8 per tonne in the beginning of 2018. The CO₂ price was volatile during the year was at EUR 25 per tonne at the end of the year, more than three times higher than a year earlier. This resulted in 50% higher power prices than a year earlier and the average system spot price for 2018 was EUR 44 per megawatt-hour.

The Nordic water reservoirs were slightly above the long-term average in the beginning of the year and decreased to very low levels in the third quarter, which reduced Fortum’s third quarter hydropower production to historically low levels. The year ended at 9 terawatt-hours below average.

Strong financial performance

The impact of the higher power prices is reflected in our full-year comparable operating profit, which increased by 22%. The investment in Uniper only had a marginal effect on Fortum’s 2018 results, as they include only Fortum’s share of Uniper’s third-quarter results. In the future, Uniper’s profit and dividends will contribute to Fortum’s earnings per share and cash flow.

Our continued investments in wind and solar are starting to have a positive impact on our results. Commissioned in the beginning of 2018 and the first of its kind in Russia, the 35-MW Ulyanovsk wind park is one example of this. The sale of a 54% stake in our 185-MW solar power plants in India freed up capital for further investments, and in June Fortum won a 250-MW auction for an Indian solar park with a fixed tariff for 25 years. Our total wind and solar portfolio has grown substantially during 2018. Together with our associated companies, we have a portfolio of close to three gigawatts of solar and wind parks and development projects in the Nordics, Russia, and India.

Highlight of the year for the Generation division was the clearly improved results, driven by higher market prices. During the year we also finalised the automation modernisation project at the Loviisa nuclear power plant, the biggest single project since the construction of the plant. Following strong improvement in Russia over the past years, the 2018 results in roubles improved slightly. In the City Solutions and Consumer Solutions divisions, 2018 was characterised by the integration of Hafslund, which proceeded well. Unfortunately, the financial results for these two divisions have not yet reached satisfactory levels. We will continue the integration work, and expect the synergies to materialise gradually during 2019 and 2020.

Based on the results of 2018 and the outlook for future years, Fortum’s Board of Directors is proposing an unchanged dividend of EUR 1.10 per share for the calendar year 2018.

The Uniper investment

Closing the offer on Uniper shares in June 2018 was the most significant milestone during the year and at the end of December, Fortum held 49.99% of Uniper shares and voting rights.

The strategic rationale of our investment in Uniper is just as valid today as it was when we launched our offer in 2017. Together Fortum and Uniper have the strategic mix of assets – both clean and secure – as well as the expertise required to successfully and affordably drive Europe’s transition towards a low carbon energy system. Out of Uniper’s 38 GW generation capacity approximately 50% is based on gas, 30% based on coal, and 20% is hydro and nuclear power. While coal-fired generation must be phased out over time, we have a responsibility to ensure security of supply and affordable power and heat for Europeans during the transition and here gas will play a crucial role. Uniper’s declared role as a provider of security of supply is an excellent match with Fortum’s ambition to accelerate the energy transition with increasing renewable generation and innovative solutions.

Building on this base we have a clear vision for how Fortum and Uniper can jointly build ‘The Utility of the Future’, and we want to work with the company to explore how to best make this vision a reality for the benefit of all shareholders and stakeholders of both companies. To our disappointment, talks with Uniper did not proceed as anticipated during 2018. However, in early February 2019, the Chairman of the Supervisory Board of Uniper voiced the need for decisive action to enable a fresh start to the relationship. We are delighted that Uniper is now committed to work with us in order to establish in earnest how the companies can work together strategically and operationally. Clearly, it is in the interest of everybody that we now rapidly advance to create value for the stakeholders of both companies.

Continued focus on decarbonisation

Fortum is one of Europe’s cleanest power producers. Our CO₂-free production capacity has grown substantially over the last few decades and we will continue to focus on increasing it. To the extent we have fossil-based power production, our goal and strategy is, of course, to make it as efficient as possible. In 2018, 96% of our power generation in the European Union was CO₂-free and our specific CO₂ emissions measured by grams of CO₂ per kilowatt-hour produced were 26 gCO₂/kWh. Including the Russian power generation, which is mainly gas-based, and our Indian solar power we are still in the category of one of the cleanest utilities with 57% CO₂-free and specific CO₂ emissions of 186 gCO2/kWh.

Decarbonising the power sector will play an essential role in combatting climate change, but it will not be sufficient in order for the EU to meet the targets of the Paris agreement or the 1.5 degree target of the recent IPCC report. Reaching these targets will require decarbonising transportation, heating, and industry, as well as increasing the use of carbon sinks in order to reach carbon neutrality by 2050. Fortum has focused on this in the updated strategy and will develop new products and services to help our customers reduce their carbon footprint, and by building new energy ventures that we believe will play an important role in the future low-emission energy system.

Finally, I would like to thank all our employees for their commitment and hard work during the year and our customers and all other stakeholders for their continued trust in us.

Pekka Lundmark
President and CEO