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EDP Renewables 2013 Annual Report

Internal Control and Risk Management II

3. FINANCING

I.VI. RISKS RELATED TO FINANCIAL MARKET EXPOSURE

EDPR finances its wind farms through project finance or corporate debt. In both cases, a variable interest rate would imply fluctuations in interest payments.
On the other hand, EDPR’s presence in several countries implies revenues denominated in different currencies. Consequently, exchange rate fluctuations may have a material adverse effect on financial results.

MANAGEMENT OF FINANCIAL RISKS

The evolution of the financial markets is analysed on an on-going basis in accordance to EDP Group’s risk management policy approved by the EDPR`s Executive Committee.

Taking into account risk management policy and approved exposure limits, the Finance team identifies, evaluates, and submits the financial strategy appropriate to each project/location for the Executive Committee’s approval. Global Risk Area supports the Finance team in exchange rate hedging decisions.

I.VI.2. INTEREST RATE RISK

Given the policies adopted by EDPR Group, current exposure to variable interest rate is not significant and financial cash flows are substantially independent from the fluctuation of interest rates.

MANAGEMENT OF INTEREST RATE RISK

The purpose of the interest rate risk management policies is to reduce the exposure of long term debt cash flows to market fluctuations, mainly by contracting long term debt with a fixed rate. When long term debt is issued with floating rates, EDPR settles derivative financial instruments to swap from floating rate to fixed rate.

EDPR has a portfolio of interest-rate derivatives with maturities of up to 13 years. Sensitivity analyses of the fair value of financial instruments to interest-rate fluctuations are periodically performed.

I.VI.3 EXCHANGE RATE RISK

EDPR has international operations and is exposed to the exchange-rate risk resulting from investments in foreign subsidiaries. Currently, the main currency exposure is to U.S. dollar/euro exchange rate that results from EDPR’s operations in the US. With the increasing capacity in non-euro geographies, EDPR is increasing its exposure to currencies other than the euro in Poland, Romania, Brazil, United Kingdom and Canada.

MANAGEMENT OF EXCHANGE RATE RISK

EDPR’s general foreign exchange policy is the natural hedging in order to match currency cash flows, minimizing the impact of fluctuations of exchange rates in the Income Statement and preserving value. The essence of this approach is to create financial foreign currency outflows to match equivalent foreign currency inflows.

EDPR hedges risk against currency fluctuations by financing in the same currency as the revenues of the project. When local financing is not available, EDPR hedges debt cash flows though cross interest rate swaps. EDPR also contracts foreign exchange forwards to hedge the risk in specific transactions (procurement, etc.)

EDPR’s hedging efforts minimize exchange rate volatility, but do not eliminate completely this risk due to high costs associated to hedging FX in certain situations.

I.VI.4. COUNTERPARTY CREDIT RISK

Counterparty credit risk is the risk that the counterparty to a transaction could default before the final settlement of the transaction’s cash flows. If the transactions or portfolio of transactions with the counterparty has a positive economic value at the time of default, an economic loss would occur.

During 2013, EDPR introduced a new Global Counterparty Credit Risk Policy, which has already been implemented across the Company. Basel Standards were used as a reference for EDPR’S approach to counterparty credit risk.

From a credit risk perspective, EDPR classifies its counterparties in three different groups:

  • Energy off-takers: Counterparties of EDPR in PPAs (energy and green certificates purchase agreements) and energy hedges
  • Suppliers: Developers, partners, WTG suppliers and O&M suppliers
  • Financial institutions: Counterparties of EDPR in foreign exchange forward contracts, interest rate swaps and bank deposits

MANAGEMENT OF COUNTERPARTY CREDIT RISK

To control credit risk at EDPR, thresholds of Expected Loss and Unexpected Loss are established as defined in Basel Standards. Expected Loss and Unexpected Loss from counterparty credit exposure are re-evaluated monthly. If threshold is surpassed by any counterparty or by the Company as a whole, mitigation measures are implemented in order to remain within the pre-established limit.

I.VI.5. LIQUIDITY RISK

Liquidity risk is the risk of EDPR not meeting its financial obligations.

MANAGEMENT OF LIQUIDITY RISK

EDPR’s strategy to manage liquidity risk is to ensure that its liquidity is sufficient to meet financial liabilities when due, under both normal and stressed conditions, and without incurring unacceptable losses or risking damage to EDPR’s reputation.

EDPR uses a financial model to forecast liquidity risk in the medium and long term to meet strategic targets previously set (EBITDA, debt ratio and others).

4. WIND TURBINE CONTRACTS

The wind turbine generator (WTG) is a key element in the development of EDPR’s wind-related energy projects, as the shortfall or an unexpected sharp increase in WTG prices can dramatically affect development of new projects and their profitability.

WTG represents on average 70 to 80% of an onshore wind farm capital expenditure

I.VI.7. WIND TURBINE SUPPLY RISK

The demand for new wind farms may offset the offer of turbines by WTG manufacturers. Currently, the local component requirement in some geographies (Ex: Brazil) creates this shortfall situation.

MANAGEMENT OF WIND TURBINE SUPPLY RISK

EDPR faces limited risk to the availability and price increase of WTG ́s due to the framework agreements with major global wind turbines suppliers. The Company uses a large mix of turbines suppliers in order to diversify the wind turbine supply risk.

For geographies with specific requirements of local component, EDPR does not engage in a project before securing the supply of wind turbines.

WIND TURBINE PRICE RISK

Price of wind turbines is affected, not only by market fluctuations of the materials used in the turbines, but also by the demand.

MANAGEMENT OF WIND TURBINE PRICE RISK

For every new project, EDPR secures the demand risk that might increase price of the turbines.
With regards to market risk of the materials used to manufacture wind turbines, an escalation formula is negotiated with wind turbine manufacturers. EDPR might hedge some of the market exposure of this escalation formula if exposure is above a pre-established limit and the market is liquid.

5. PIPELINE DEVELOPMENT

I.VII.1. PERMITTING RISK

Wind farms are subject to strict regulations at different authority levels (international, national, state, regional and local) relating to the development, construction, grid interconnection and operation of power plants. Among other things, these laws regulate landscape and environmental aspects, building licenses, land use and land securing and access to the grid issues.

While level of exigency might be different depending on the geographies, EDPR acknowledges a trend for legislations to align towards concentrating the most restrictive rules and development risks on the consenting (environmental and urban permissions) and interconnection (connection of the wind farm to the national grid).

In this context, EDPR’s experience gathered in different countries is useful to anticipate and deal with similar situations in other countries.

MANAGEMENT OF PERMITTING RISK

During the development and design phase, EDPR focuses on the optimization of its projects. By mastering the variables, such as choice of locations, lay-out, etc., the objective is to make our projects more resilient to permitting risks.

Additionally, EDPR mitigates execution risk by generating optionality, with development activities in 11 different countries (Spain, Portugal, France, Belgium, Poland, Romania, UK, Italy, US, Canada and Brazil) and a portfolio of projects in several stages of maturity. EDPR has a large pipeline of projects that provide a “buffer” to overcome potential delays in the development of prioritized projects, ensuring growth targets and being able to compensate permitting delays in some geographies.