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Retrieving Data

Note 38

For the Year Ended 31 March 2011

FINANCIAL RISK MANAGEMENT

Financial Risk Management Objectives

TrustPower's activities expose it to a variety of financial risks: electricity price risk, interest rate risk, exchange rate risk, liquidity risk and credit risk. The Group's overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group's financial performance. The Group uses derivative financial instruments to hedge certain risk exposures. Risk management is carried out under policies approved by the Board.

(a) Electricity Price Risk

The Group typically sells more electricity at fixed prices than it generates. As a result the Group is required to purchase a percentage of its electricity sold off the electricity spot market. This leaves the Group exposed to fluctuations in the spot price of electricity where it sells electricity at a fixed price. The Group operates under an energy trading policy which limits the exposure the Group may have in any future period. Future exposure is estimated based on expected fixed price sales and generation output. The Group has entered into a number of electricity hedge contracts to reduce the commodity price risk from price fluctuations on the electricity spot market. These hedge contracts establish the price at which future specified quantities of electricity are purchased. Any resulting differential to be paid or received is recognised as a component of energy costs through the term of the contract. The Group has elected to apply cash flow hedge accounting to those instruments it deems material and which qualify as cash flow hedges while immaterial contracts are not hedge accounted.

The aggregate notional volume of the outstanding electricity derivatives at 31 March 2011 was 900GWh (31 March 2010: 1,146GWh).

The hedged anticipated electricity purchase transactions are expected to occur continuously throughout the next five years from the end of the reporting period consistent with the Group's forecast electricity generation and retail electricity sales. Gains and losses recognised in the cash flow hedge reserve on electricity derivatives as of 31 March 2011 will be continuously released to the income statement in each period in which the underlying purchase transactions are recognised in the income statement.

Sensitivity analysis

The following tables summarise the impact of increases/decreases of the relevant forward electricity prices on the Group's post-tax profit for the year and on other components of equity. The sensitivity analysis is based on the assumption that the relevant forward electricity prices had increased/decreased with all other variables held constant as a result of the fair value change in electricity price derivatives.

 
GROUP PARENT
2011 2010 2011 2010
$000 $000 $000 $000
Increase/(decrease) to profit of a 10% increase in electricity forward price (609) (1,532) (609) (1,532)
Increase/(decrease) to profit of a 10% decrease in electricity forward price 609 1,532 609 1,532
Increase/(decrease) to equity of a 10% increase in electricity forward price 5,369 9,768 5,369 9,768
Increase/(decrease) to equity of a 10% decrease in electricity forward price (5,369) (9,768) (5,369) (9,768)
         

(b) Interest Rate Risk

The Group's bank borrowings are all on floating interest rates exposing it to the risk that rising interest rates will increase the Group's interest expense and, hence, reduce its profitability. The Group operates under a treasury policy which prescribes the proportion of fixed interest rate cover the Group must hold in relation to its future borrowings. This proportion is calculated based on the actual fixed rate cover held and the forecast debt levels of the Group. The Group has various interest rate financial instruments to manage exposure to fluctuations in interest rates. Any resulting differential to be paid or received on the instruments is recognised as a component of interest paid. The Group has elected to hedge account only a limited number of these instruments.

The aggregate notional principal amounts of the outstanding interest rate derivative instruments at
31 March 2011 was $440,415,000 (31 March 2010: $563,197,000).

Interest payment transactions are expected to occur at various dates between one month and nine years from the end of the reporting period consistent with the Group's forecast total borrowings.

Effective interest rates for the Parent and the Group are disclosed in note 25.

Sensitivity analysis

At 31 March 2011, if interest rates at that date had been 100 basis points higher/lower with all other variables held constant, post-tax profit for the year and other components of equity would have been adjusted by the amounts in the table below, as a result of the fair value change in interest rate derivative instruments.

 
GROUP PARENT
2011 2010 2011 2010
$000 $000 $000 $000
Increase/(decrease) to profit of a 100 basis point decrease in interest rates (8,994) (7,297) (3,774) (3,447)
Increase/(decrease) to profit of a 100 basis point increase in interest rates 8,713 7,119 3,647 3,301
Increase/(decrease) to equity of a 100 basis point decrease in interest rates (9,601) (8,085) (4,381) (4,235)
Increase/(decrease) to equity of a 100 basis point increase in interest rates 9,361 7,900 4,295 4,082
         

(c) Exchange Rate Risk

During the course of business the Group may enter into contracts for the construction of generation assets and the sale of carbon credits to be settled in a foreign currency in the future. This exposes the Group to movements in foreign exchange rates. The Group operates under a treasury policy which requires all foreign currency transactions over certain limits to be 100% hedged. Compliance with this policy is measured by forecasting future foreign currency transactions and ensuring that the exchange rate has been fixed. The Group enters into forward exchange contracts to reduce the risk from price fluctuations of foreign currency costs associated with the construction of property, plant and equipment or income associated with the sale of carbon credits. Any resulting differential to be paid or received is recognised as a component of the cost of the project for the construction of generation assets and as a part of revenue for the sale of carbon credits. The Group has elected to apply cash flow hedge accounting to these instruments.

The aggregate notional principal amounts of the outstanding forward foreign exchange contracts at
31 March 2011 was $20,689,000 (31 March 2010: $25,062,000).

The hedged anticipated transactions denominated in foreign currency are expected to occur at various dates between one month and two years from the end of the reporting period. Gains and losses recognised in the cash flow hedge reserve in equity on forward foreign exchange contracts as at 31 March 2011 will be recycled to revenue from the sale of carbon credits when the credits are sold.

Sensitivity analysis

At 31 March 2011, if the New Zealand dollar had weakened/strengthened by 10 per cent against the currencies with which the Group has foreign currency risk with all other variables held constant, post-tax profit for the year would not have been materially different.

Other components of equity would have been $(1,387,000)/$1,458,000 (lower)/higher (31 March 2010: $(2,248,000)/$2,041,000 (lower)/higher), arising from foreign exchange gains/losses on revaluation of foreign exchange contracts in a cash flow hedge relationship.

(d) Credit Risk

The Group has no significant concentrations of credit risk (2010: none). It has policies in place to ensure that sales are made to customers with an appropriate credit history. Where a potential customer does not have a suitable credit history a bond is required before the customer is accepted. Derivative counterparties and cash transactions are limited to high credit quality financial institutions with a minimum Standard & Poor's long-term credit rating of A+ and other large electricity market participants (all have a Standard & Poor's long-term credit rating of at least BBB). Where a potential counterparty does not meet these credit criteria the maximum level of credit exposure is set individually by the Board. The Group has policies that limit the amount of credit exposure to any counterparty.

The carrying amounts of financial assets recognised in the statement of financial position best represents the Group's maximum exposure to credit risk at the reporting date without taking account of the value of any collateral obtained. As shown in note 19, the reported accounts receivable balance includes a provision for doubtful debts of $1,800,000 (2010: $2,000,000).

The Group has around 221,000 customers (2010: 225,000), only four (2010: four) of which make up more than one per cent of the Group's total accounts receivable balance. The largest of these customers accounts for 4 per cent (2010: 7 per cent) of the Group's total accounts receivable.

As of 31 March 2011, trade receivables relating to the Group and the Parent of $3,589,000
(2010: $4,447,000) were past due but not impaired. The ageing analysis of these trade receivables
is as follows:

 
GROUP PARENT
2011 2010 2011 2010
$000 $000 $000 $000
Up to 3 months 3,589 3,984 3,589 3,984
3 to 6 months - 463 - 463
3,589 4,447 3,589 4,447
       

As of 31 March 2011, trade receivables relating to the Group and the Parent of $1,800,000 (2010: $2,000,000) were past due and impaired.

The ageing analysis of these trade receivables is as follows:

   
GROUP PARENT
2010 2009 2010 2009
$000 $000 $000 $000
Up to 3 months 96 - 96 -
3 to 6 months 873 977 873 977
6 to 12 months 453 603 453 603
Over 12 months 378 420 378 420
1,800 2,000 1,800 2,000
       

For details of the receivables considered impaired refer to note 2.4.

Movements on the provision for impairment of trade receivables are as follows:

GROUP PARENT
2011 2010 2011 2010
Note $000 $000 $000 $000
Opening balance 2,000 1,600 2,000 1,600
Provision for receivables impairment 7 1,708 2,374 1,708 2,374
Bad debts written off (1,908) (1,974) (1,908) (1,974)
Closing balance 19 1,800 2,000 1,800 2,000
           

(e) Liquidity Risk

The Group's ability to readily attract cost effective funding is largely driven by its credit standing.

Prudent liquidity risk management implies maintaining sufficient cash and marketable securities, the availability of funding through an adequate amount of committed credit facilities and the spreading of debt maturities. The Group operates under a treasury policy which dictates the level of available committed facility to be maintained to provide cover for reasonably conceivable adverse conditions. This is measured by forecasting debt levels under various adverse scenarios and comparing this to committed facility levels. The treasury policy also requires a spread of debt maturities which is measured by the proportion of debt maturing in various time bands.

The tables below analyse the Group's and the Parent's financial liabilities excluding gross settled derivative financial liabilities into relevant maturity groupings based on the remaining period to the earliest possible contractual maturity date at the period end date. The amounts in the tables are contractual undiscounted cash flows.

 
GROUP Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2011
Net settled electricity price derivatives 2,151 7,522 5,802 4,103
Net settled interest rate derivatives 30 979 1,008 6,628
Accounts payable and accruals 86,807 - - -
Unsecured subordinated bonds - 11,232 11,110 308,788
Unsecured senior bonds - 8,179 8,090 270,228
Unsecured bank loans 35 3,994 - 340,959
Financial guarantee contracts 756 - - -
106,550 31,906 26,010 930,706
Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2010
Net settled electricity price derivatives 234 787 2,342 830
Net settled interest rate derivatives 300 3,366 2,414 993
Accounts payable and accruals 99,413 - - -
Unsecured subordinated bonds - 11,232 11,049 331,130
Unsecured senior bonds - 5,495 5,405 191,356
Unsecured bank loans 123 196,752 - 142,943
Financial guarantee contracts 756 - - -
100,826 217,632 21,210 667,252
PARENT Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2011
Net settled electricity price derivatives 2,151 7,522 5,802 4,103
Net settled interest rate derivatives 30 471 501 5,461
Accounts payable and accruals 86,027 - - -
Unsecured subordinated bonds - 11,232 11,110 308,788
Unsecured senior bonds - 8,179 8,090 270,228
Unsecured bank loans 35 1,707 - 137,332
Financial guarantee contracts 756 - - -
105,770 29,111 25,503 725,912
Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2010
Net settled electricity price derivatives 234 787 2,342 830
Net settled interest rate derivatives 300 2,096 1,632 449
Accounts payable and accruals 98,452 - - -
Unsecured subordinated bonds - 11,232 11,049 331,130
Unsecured senior bonds - 5,495 5,405 191,356
Unsecured bank loans 123 1,465 - 142,943
Financial guarantee contracts 756 - - -
99,865 21,075 20,428 666,708
       
The tables below analyse the Group's and the Parent's derivative financial instruments that will be settled on a gross basis into relevant maturity groupings based on the remaining period to the contractual maturity date at the period end date. The amounts disclosed in the tables are the contractual undiscounted cash flows.
GROUP Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2011
Foreign currency forward contracts
Inflows 3,720 2,553 3,340 11,076
(Outflows) (3,063) (2,599) (2,642) (8,768)
Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2010
Foreign currency forward contracts
Inflows 3,654 - 3,270 18,137
(Outflows) (3,121) - (2,692) (14,750)
PARENT Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2011
Foreign currency forward contracts
Inflows 3,720 2,553 3,340 11,076
(Outflows) (3,063) (2,599) (2,642) (8,768)
Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
At 31 March 2010
Foreign currency forward contracts
Inflows 3,654 - 3,270 18,137
(Outflows) (3,121) - (2,692) (14,750)
         

Fair Values

Except for subordinated bonds and senior bonds (see notes 26 and 27), the carrying amount of financial assets and financial liabilities recorded in the financial statements approximates their fair values.

Estimation of Fair Values

The fair values of financial assets and financial liabilities are determined as follows:

• The fair value of financial assets and liabilities with standard terms and conditions and traded on active liquid markets are determined with reference to quoted market prices.

• The fair value of other financial assets and liabilities are calculated using discounted cash flow analysis based on market-quoted rates.

• The fair value of derivative financial instruments are calculated using quoted prices. Where such prices are not available, use is made of discounted cash flow analysis using the applicable yield curve or available forward price data for the duration of the instruments.

Where the fair value of a derivative is calculated as the present value of the estimated future cash flows of the instrument, the two key types of variables used by the valuation techniques are:

• forward price curve (as described below); and

• discount rates.

 
Valuation Input Source
Interest rate forward price curve Published market swap rates
Foreign exchange forward prices Published spot foreign exchange rates and interest rate differentials
Electricity forward price curve Market quoted prices where available and management’s best estimate based on its view of the long run marginal cost of new generation where no market quoted prices are available.
Discount rate for valuing interest rate derivatives Published market interest rates as applicable to the remaining life of the instrument.
Discount rate for valuing forward foreign exchange contracts Published market interest rates as applicable to the remaining life of the instrument.
Discount rate for valuing electricity price derivatives Assumed counterparty cost of funds ranging from 4.0% to 4.9%
   

The selection of variables requires significant judgement and therefore there is a range of reasonably possible assumptions in respect of these variables that could be used in estimating the fair value of these derivatives. Maximum use is made of observable market data when selecting variables and developing assumptions for the valuation techniques. See earlier in this note for sensitivity analysis.

NZ IFRS 7 requires that financial instruments that are measured in the statement of financial position at fair value, this requires disclosure of fair value measurements by level of the following fair value measurement hierarchy:

• Quoted prices (unadjusted) in active markets for identical assets or liabilities (level 1)

• Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices) (level 2)

• Inputs for the asset or liability that are not based on observable market data (that is, unobservable inputs) (level 3).

The following tables present the Group's and Parent's financial assets and liabilities that are measured at fair value.

 
GROUP
Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
31 March 2011
Assets per the statement of financial position
Interest rate derivative assets - 3,635 - 3,635
Electricity price derivative assets - - 1,763 1,763
Exchange rate derivative assets - 3,307 - 3,307
- 6,942 1,763 8,705
Liabilities per the statement of financial position
Interest rate derivative liabilities - 6,297 - 6,297
Electricity price derivative liabilities - - 18,503 18,503
Exchange rate derivative liabilities - - - -
- 6,297 18,503 24,800
Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
31 March 2010
Assets per the statement of financial position
Interest rate derivative assets - 3,918 - 3,918
Electricity price derivative assets - - 18,466 18,466
Exchange rate derivative assets - 3,138 - 3,138
- 7,056 18,466 25,522
Liabilities per the statement of financial position
Interest rate derivative liabilities - 6,582 - 6,582
Electricity price derivative liabilities - - 2,066 2,066
Exchange rate derivative liabilities - - - -
- 6,582 2,066 8,648
PARENT
Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
31 March 2011
Assets per the statement of financial position
Interest rate derivative assets - 3,344 - 3,344
Electricity price derivative assets - - 1,763 1,763
Exchange rate derivative assets - 3,307 - 3,307
- 6,651 1,763 8,414
Liabilities per the statement of financial position
Interest rate derivative liabilities - 4,805 - 4,805
Electricity price derivative liabilities - - 18,503 18,503
Exchange rate derivative liabilities - - - -
- 4,805 18,503 23,308
Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
31 March 2010
Assets per the statement of financial position
Interest rate derivative assets - 3,077 - 3,077
Electricity price derivative assets - - 18,466 18,466
Exchange rate derivative assets - 3,138 - 3,138
- 6,215 18,466 24,681
Liabilities per the statement of financial position
Interest rate derivative liabilities - 4,158 - 4,158
Electricity price derivative liabilities - - 2,066 2,066
Exchange rate derivative liabilities - - - -
- 4,158 2,066 6,224
       
The following tables present the changes during the year of the level 3 instruments.
GROUP Electricity
price
derivatives
$000
Total
$000
31 March 2011
Assets per the statement of financial position
Opening balance 18,466 18,466
Gains and (losses) recognised in profit or loss (255) (255)
Gains and (losses) recognised in other comprehensive income (16,448) (16,448)
Closing balance 1,763 1,763
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 1,483 1,483
Liabilities per the statement of financial position
Opening balance 2,066 2,066
(Gains) and losses recognised in profit or loss 877 877
(Gains) and losses recognised in other comprehensive income 15,560 15,560
Closing balance 18,503 18,503
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 1,938 1,938
Settlements during the year 26,426 26,426
Electricity
price
derivatives
$000
Total
$000
31 March 2010
Assets per the statement of financial position
Opening balance 3,124 3,124
Gains and (losses) recognised in profit or loss (1,031) (1,031)
Gains and (losses) recognised in other comprehensive income 16,373 16,373
Closing balance 18,466 18,466
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 2,255 2,255
Liabilities per the statement of financial position
Opening balance 3,304 3,304
(Gains) and losses recognised in profit or loss 807 807
(Gains) and losses recognised in other comprehensive income (2,045) (2,045)
Closing balance 2,066 2,066
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 1,327

1,327

Settlements during the year 24,411 24,411
PARENT Electricity
price
derivatives
$000
Total
$000
31 March 2011
Assets per the statement of financial position
Opening balance 18,466 18,466
Gains and (losses) recognised in profit or loss (255) (255)
Gains and (losses) recognised in other comprehensive income (16,448) (16,448)
Closing balance 1,763 1,763
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 1,483 1,483
Liabilities per the statement of financial position
Opening balance 2,066 2,066
(Gains) and losses recognised in profit or loss 877 877
(Gains) and losses recognised in other comprehensive income 15,560 15,560
Closing balance 18,503 18,503
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 1,938 1,938
Settlements during the year 26,426 26,426
Electricity
price
derivatives
$000
Total
$000
31 March 2010
Assets per the statement of financial position
Opening balance 3,124 3,124
Gains and (losses) recognised in profit or loss (1,031) (1,031)
Gains and (losses) recognised in other comprehensive income 16,373 16,373
Closing balance 18,466 18,466
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 2,255 2,255
Liabilities per the statement of financial position
Opening balance 3,304 3,304
(Gains) and losses recognised in profit or loss 807 807
(Gains) and losses recognised in other comprehensive income (2,045) (2,045)
Closing balance 2,066 2,066
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 1,327 1,327
Settlements during the year 24,411 24,411
     

Electricity price derivatives are classified as Level 3 because the assumed location factors which are used to adjust the forward price path are unobservable.

A sensitivity analysis showing the effect on the value of the electricity price derivatives of reasonably possible alternative price path assumptions is shown in section (a) of this note.

Capital Risk Management Objectives

The Group's objectives when managing capital are to safeguard the Group's ability to continue as a going concern so that it can continue to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital.

In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt.

Consistent with others in the industry, the Group monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital.

• Net debt is calculated as total borrowings less short term deposits. Total borrowings are calculated using a value of unsecured bank loans plus unsecured subordinated and senior bonds.

• Total capital funding is calculated as total equity as shown in the statement of financial position, adjusted for the fair value of financial instruments, plus net debt.

The gearing ratio is calculated below:

   
GROUP PARENT
2011 2010 2011 2010
Note $000 $000 $000 $000
Net debt
Unsecured bank debt 25 336,327 336,847 132,700 142,943
Unsecured subordinated bonds 26 261,742 261,206 261,742 261,206
Unsecured senior bonds 27 211,518 137,518 211,518 137,518
Cash at bank / bank overdraft 18 (12,568) (9,492) (1,429) (3,868)
797,019 726,079 604,531 537,799
Equity
Total equity 1,418,491 1,437,146 1,172,978 1,205,255
Remove net effect of fair value of financial instruments after tax 16 7,872 (15,406) 7,872 (15,406)
1,426,363 1,421,740 1,180,850 1,189,849
Total capital funding 2,223,382 2,147,819 1,785,381 1,727,648
Gearing ratio 36% 34% 34% 31%