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Note 39: 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. This risk management strategy assumes that the electricity wholesale market that currently operates will continue to do so in the future. There is a possibility that future regulatory intervention may fundamentally alter the structure of the wholesale electricity market. The likelihood and potential impact of such a change is unquantifiable. However, such an occurrence would likely necessitate a change to the Group's electricity price risk management policies and require a review of assets and liabilities held at fair value where electricity price is a key assumption in their value.

The aggregate notional volume of the outstanding electricity derivatives at 31 March 2013 was 1,275GWh (31 March 2012: 639GWh).

The hedged anticipated electricity purchase transactions are expected to occur continuously throughout the next three 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 2013 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
 
2013
$000
2012
$000
2013
$000
2012
$000
Increase/(decrease) to profit of a 10% increase in electricity forward price 447 (3,706) 447 (3,706)
Increase/(decrease) to profit of a 10% decrease in electricity forward price (447) 3,706 (447) 3,706
Increase/(decrease) to equity of a 10% increase in electricity forward price 9,011 5,062 9,011 5,062
Increase/(decrease) to equity of a 10% decrease in electricity forward price (9,011) (5,062) (9,011) (5,062)

(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 2013 was $877,803,000 (31 March 2012: $489,459,000).

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

Weighted average interest rates for the Parent and the Group are disclosed in note 26.

Sensitivity analysis

At 31 March 2013, 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
 
2013
$000
2012
$000
2013
$000
2012
$000
Increase/(decrease) to profit of a 100 basis point decrease in interest rates (19,873) (10,752) (5,790) (6,587)
Increase/(decrease) to profit of a 100 basis point increase in interest rates 19,058 10,336 5,484 6,195
Increase/(decrease) to equity of a 100 basis point decrease in interest rates (20,168) (11,235) (6,085) (7,070)
Increase/(decrease) to equity of a 100 basis point increase in interest rates 19,344 10,800 5,770 6,659

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 2013 was $247,476,000 (31 March 2012: $11,076,000).

The hedged anticipated transactions denominated in foreign currency are expected to occur at various dates between one month and one year 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 2013 will be recycled to revenue from the sale of carbon credits when the credits are sold or to cost of property, plant and equipment when the assets are purchased.

Sensitivity analysis

At 31 March 2013, if the functional currency of the entities holding the forward foreign exchange contracts 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 different.

Other components of equity would have been $24,145,000/$(24,145,000) higher/(lower) (31 March 2012: $(768,000)/$768,000 (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 (2012: 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. Collateral is customer bond deposits held as cash - refer to note 25. This collateral reduces the exposure to credit risk by its nominal amount. As shown in note 19, the reported accounts receivable balance includes a provision for doubtful debts of $1,700,000 (2012: $1,800,000).

The Group has around 206,000 customers (2012: 209,000), only four (2012: 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 (2012: 4 per cent) of the Group's total accounts receivable.

Included in other accounts payable and accruals is $861,000 (2012: $1,349,000) of bonds collected from customers who do not meet certain credit criteria.

As of 31 March 2013, trade receivables relating to the Group and the Parent of $3,955,000 (2012: $4,652,000) were past due but not impaired. The ageing analysis of these trade receivables is as follows:

GROUP PARENT
 
2013
$000
2012
$000
2013
$000
2012
$000
Up to 3 months 3,955 4,652 3,955 4,652
3,955 4,652 3,955 4,652

As of 31 March 2013, trade receivables relating to the Group and the Parent of $1,700,000 (2012: $1,800,000) were past due and impaired. The ageing analysis of these trade receivables is as follows:

GROUP PARENT
 
2013
$000
2012
$000
2013
$000
2012
$000
Up to 3 months 11 493 11 493
Over 3 months 1,689 1,307 1,689 1,307
1,700 1,800 1,700 1,800

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
  Note 2013
$000
2012
$000
2013
$000
2012
$000
Opening balance 1,800 1,800 1,800 1,800
Provision for receivables impairment 1,492 1,515 1,492 1,515
Bad debts written off (1,592) (1,515) (1,592) (1,515)
Closing balance 1,700 1,800 1,700 1,800

(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
At 31 March 2013 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Net settled electricity price derivatives 71 1,019 6,073 10,950
Net settled interest rate derivatives 491 3,579 3,267 19,426
Accounts payable and accruals 116,009 87 104 4,064
Unsecured subordinated bonds - 11,343 65,871 306,768
Unsecured senior bonds - 8,170 8,170 254,235
Unsecured bank loans - 11,042 5,628 452,291
Financial guarantee contracts - - - -
Total 116,571 35,240 89,113 1,047,734
At 31 March 2012 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Net settled electricity price derivatives 463 3,675 2,878 4,319
Net settled interest rate derivatives 347 2,232 2,407 16,288
Accounts payable and accruals 106,160 87 104 4,273
Unsecured subordinated bonds - 119,824 6,472 182,492
Unsecured senior bonds - 8,170 8,170 270,575
Unsecured bank loans - 10,073 5,628 301,172
Financial guarantee contracts 756 - - -
Total 107,726 144,061 25,659 779,119
PARENT
At 31 March 2013 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Net settled electricity price derivatives 71 1,019 6,073 10,950
Net settled interest rate derivatives 298 1,391 1,689 13,046
Accounts payable and accruals 112,609 87 104 4,064
Unsecured subordinated bonds - 11,343 65,871 306,768
Unsecured senior bonds - 8,170 8,170 254,235
Unsecured bank loans - 7,562 5,628 101,082
Financial guarantee contracts - - - -
Total 112,978 29,572 87,535 690,145
At 31 March 2012 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Net settled electricity price derivatives 463 3,675 2,878 4,319
Net settled interest rate derivatives 217 975 1,192 10,967
Accounts payable and accruals 98,617 87 104 4,273
Unsecured subordinated bonds - 119,824 6,472 182,492
Unsecured senior bonds - 8,170 8,170 270,575
Unsecured bank loans - 7,786 5,628 125,432
Financial guarantee contracts 756 - - -
Total 100,053 140,517 24,444 598,058

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
At 31 March 2013 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Foreign currency forward contracts
Inflows 3,882 139,269 77,844 21,923
(Outflows) (2,529) (141,057) (79,793) (22,743)
At 31 March 2012 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Foreign currency forward contracts
Inflows 3,784 - 3,409 3,882
(Outflows) (2,685) - (2,316) (2,685)
PARENT
At 31 March 2013 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Foreign currency forward contracts
Inflows 3,882 - - -
(Outflows) (2,529) - - -
At 31 March 2012 Less than
1 month
$000
1-6
months
$000
6-12
months
$000
Over
1 year
$000
Foreign currency forward contracts
Inflows 3,784 - 3,409 3,882
(Outflows) (2,685) - (2,316) (2,685)

Fair Values

Except for subordinated bonds and senior bonds (see notes 27 and 28), 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 3.8% to 4.3%

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 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
31 March 2013 Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
Assets per the statement of financial position
Interest rate derivative assets - 5,288 - 5,288
Electricity price derivative assets - - 1,488 1,488
Exchange rate derivative assets   - 2,395 - 2,395
  - 7,683 1,488 9,171
Liabilities per the statement of financial position
Interest rate derivative liabilities - 22,628 - 22,628
Electricity price derivative liabilities - - 14,862 14,862
Exchange rate derivative liabilities - 2,237 - 2,237
- 24,865 14,862 39,727
31 March 2012   Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
Assets per the statement of financial position
Interest rate derivative assets - 4,721 - 4,721
Electricity price derivative assets - - 8,357 8,357
Exchange rate derivative assets   - 3,190 - 3,190
    - 7,911 8,357 16,268
Liabilities per the statement of financial position
Interest rate derivative liabilities - 17,199 - 17,199
Electricity price derivative liabilities - - 4,207 4,207
Exchange rate derivative liabilities   - - - -
    - 17,199 4,207 21,406
PARENT
31 March 2013 Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
Assets per the statement of financial position
Interest rate derivative assets - 4,558 - 4,558
Electricity price derivative assets - - 1,488 1,488
Exchange rate derivative assets - 1,346 - 1,346
- 5,904 1,488 7,392
Liabilities per the statement of financial position
Interest rate derivative liabilities - 13,431 - 13,431
Electricity price derivative liabilities - - 14,862 14,862
Exchange rate derivative liabilities - - - -
- 13,431 14,862 28,293
PARENT
31 March 2012 Level 1
$000
Level 2
$000
Level 3
$000
Total
$000
Assets per the statement of financial position
Interest rate derivative assets - 4,689 - 4,689
Electricity price derivative assets - - 8,357 8,357
Exchange rate derivative assets - 3,190 - 3,190
- 7,879 8,357 16,236
Liabilities per the statement of financial position
Interest rate derivative liabilities - 10,378 - 10,378
Electricity price derivative liabilities - - 4,207 4,207
Exchange rate derivative liabilities - - - -
- 10,378 4,207 14,585

The following tables present the changes during the year of the level 3 instruments.

GROUP
31 March 2013     Electricity
price
derivatives
$000
Total $000
Assets per the statement of financial position
Opening balance 8,357 8,357
Gains and (losses) recognised in profit or loss (6,869) (6,869)
Gains and (losses) recognised in other comprehensive income - -
Closing balance 1,488 1,488
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 1,447 1,447

 

Liabilities per the statement of financial position

Opening balance 4,207 4,207
(Gains) and losses recognised in profit or loss (6,395) (6,395)
(Gains) and losses recognised in other comprehensive income 17,050 17,050
Closing balance 14,862 14,862
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 14,383 14,383
Settlements during the year (794) (794)
31 March 2012 Electricity
price
derivatives
$000
Total $000
Assets per the statement of financial position
Opening balance 1,763 1,763
Gains and (losses) recognised in profit or loss (1,986) (1,986)
Gains and (losses) recognised in other comprehensive income 8,580 8,580
Closing balance 8,357 8,357
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 4,316 4,316

 

Liabilities per the statement of financial position

Opening balance 18,503 18,503
(Gains) and losses recognised in profit or loss (22,876) (22,876)
(Gains) and losses recognised in other comprehensive income 8,580 8,580
Closing balance 4,207 4,207
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 6,036 6,036
Settlements during the year 10,110 10,110
PARENT
31 March 2013 Electricity
price
derivatives
$000
Total $000
Assets per the statement of financial position
Opening balance 8,357 8,357
Gains and (losses) recognised in profit or loss (6,869) (6,869)
Gains and (losses) recognised in other comprehensive income - -
Closing balance 1,488 1,488
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 1,447 1,447

 

Liabilities per the statement of financial position

Opening balance 4,207 4,207
(Gains) and losses recognised in profit or loss (6,395) (6,395)
(Gains) and losses recognised in other comprehensive income 17,050 17,050
Closing balance 14,862 14,862
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 14,383 14,383
Settlements during the year (794) (794)
31 March 2012 Electricity
price
derivatives
$000
Total $000
Assets per the statement of financial position
Opening balance 1,763 1,763
Gains and (losses) recognised in profit or loss (1,986) (1,986)
Gains and (losses) recognised in other comprehensive income 8,580 8,580
Closing balance 8,357 8,357
Total gains or (losses) for the period included in profit or loss for assets held at the end of the reporting period 4,316 4,316

 

Liabilities per the statement of financial position

Opening balance 18,503 18,503
(Gains) and losses recognised in profit or loss (22,876) (22,876)
(Gains) and losses recognised in other comprehensive income 8,580 8,580
Closing balance 4,207 4,207
Total (gains) or losses for the period included in profit or loss for liabilities held at the end of the reporting period 6,036 6,036
Settlements during the year 10,110 10,110

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
  Note 2013
$000
2012
$000
2013
$000
2012
$000
Net debt
Unsecured bank debt 460,192 308,440 108,983 119,605
Unsecured subordinated bonds 292,375 262,277 292,375 262,277
Unsecured senior bonds 212,838 212,178 212,838 212,178
Cash and cash equivalents (53,972) (23,142) (31,117) (9,695)
911,433 759,753 583,079 584,365
Equity
Total equity 1,551,763 1,571,331 1,371,900 1,390,234
Remove net effect of fair value of financial instruments after tax 9,390 (5,198) 8,559 (5,198)
1,561,153 1,566,133 1,380,459 1,385,036
Total capital funding 2,472,586 2,325,886 1,963,538 1,969,401
Gearing ratio 37% 33% 30% 30%