eurochem-annual-report-2011

Business review
Risk management report
Risk management
Our ambitious strategic targets require us to pursue opportunities that involve
a multitude of risks. Evaluating these risks and understanding how they relate
to each other allows us to optimise our risk management system and thereby
limit uncertainties. EuroChem’s risk management strategy and system are
integrated throughout the Group’s business activities.
Risk management is a continuous process which aims to reveal the operational,
financial and strategic risks arising within our business. Risks to our reputation
are as important, but widely viewed as a derivative of the other three types of
risks. To mitigate these risks, our risk management system models, evaluates,
and prioritises every risk by its degree of likelihood and the severity of its
potential impact.
Our key risks are detailed below and illustrated in our strategic risk maps
on pages 64-65.
Operational risks
Unplanned production shutdowns or equipment failures
Our operational performance and financial results are directly related to our
ability to manufacture, and ultimately sell, our products. Any unplanned
equipment failure or capacity shutdown at one of our facilities could result in
disruptions to production and have a negative effect on the Group’s profitability.
We address these risks through a combination of regular preventative
maintenance and repair work and continuous employee technical training
programmes coupled with equipment and business interruption insurance.
Health, safety and environment (HSE)
We have deployed and actively implement environmental management and
other safety systems certified to ISO 9001, ISO 14001, and OHSAS 18001
at all our production subsidiaries. We regularly review our HSE procedures,
including on-site emergency plans with a particular focus on potential
emergency situations involving hazardous chemicals and other dangerous
items. Starting from this year, as part of our drive to promote accountability
in health, safety and the environment, we have introduced HSE components
within our management KPI system.
Logistics
With up to 5 MMT of main raw materials needed to be delivered to our plants,
and up to 15 MMT of final product to be shipped to our customers by rail and
sea every year in a timely way, logistic functions are essential to the success
of our business model. We employ various techniques, from daily planning
to insurance, in order to reduce the probability and possible impact of potential
events adversely affecting our ability to supply our plants and customers.
Fraud and bribery
We expect everyone within the Group to display the highest standards of ethical
behaviour and the sound corporate governance practice we have developed
over the years plays a vital role by setting the tone at the top. In addition to
having preventive and detective controls, which include transaction monitoring
procedures, we have also installed dedicated insider trading whistleblower
services. To further mitigate these risks, our Internal Affairs and Internal Audit
units regularly evaluate the integrity of our internal control systems.
Construction risks
Delays in the construction of new production lines or facilities could result in
non-compliance with our set strategic targets and lead to the erosion of our
competitiveness and significant losses of benefits. To minimize these risks
we have recruited experienced personnel and leading contractors and have also
taken out insurance policies covering mining, logistics, property, and business
interruption risks.
62 EuroChem Annual Report and Accounts 2011
Financial risks
Our revenues are mostly derived from the sale of products which can generally
be classified as commodities. Because prices for nitrogen and phosphate
fertilizers, and iron ore concentrate, are largely determined by supply and
demand factors they are subject to relatively high volatility. Overall, the supply
and demand environment is multi-dimensional and can be affected by factors
ranging from raw material curtailments and key input pricing to government
subsidies, farmer economics and financing availability. The main objective of
the financial risk management function at EuroChem is to reduce the volatility,
in a cost-effective manner, of the Group’s likely future cash flows to the extent
necessary for maintaining the desired level of strength of its balance sheet
(across-the-cycle net debt/next 12 months’ EBITDA ratio of between 1.5x
and 2.0x).
Product prices
Fluctuations in fertilizer and iron ore prices significantly impact our cash flows.
Although our ability to mitigate these risks through financial instruments is
limited by liquidity constraints, we also address them by constantly seeking
to improve our competitive advantage and our position on the global cost curve,
which we view as the best protection from price volatility in the longer term.
Over the last few years, we have been investing heavily in increasing the
efficiency of our production processes, expanding our raw material base and
broadening our product offering. Together with the expansion of our sales and
production geographies, these strategic investments have contributed to the
relative stability of margins across our production segments by spreading the
risks associated with the seasonality and cyclicality of product demand.
Foreign currency risk
EuroChem revenues, expenses, capital expenditure, investments, and
borrowings are denominated in different currencies. While a significant portion
of our revenues come from export sales denominated in US dollars, our
expenses, excluding debt servicing, are almost entirely incurred in Russian
roubles. As a result, our profitability and debt burden can be significantly
affected by currency swings. This risk has been exacerbated by the heightened
currency volatility observed in the wake of the financial crisis. We currently
mitigate this risk by matching cash flows and using derivative financial
instruments such as forward currency contracts to limit our exposure to
currency fluctuations.
Interest rate risk
We are exposed to interest rate risk because the majority of our debt portfolio,
apart from rouble bond and Eurobond issues maturing in 2018 and 2012,
respectively, is represented by loans with floating interest rates. Nevertheless,
we consider the impact of rising interest rates on our cash flows to be limited as
periods of rising interest rates tend to overlap with periods of elevated
commodity prices. At the same time, we may occasionally use interest rate
swaps or other derivatives to hedge our exposure to interest rate risk.
Increases in costs
In Russia, we have been facing cost pressures from increases in the prices
paid for freight, natural gas, electricity and rail transportation. To mitigate their
impact we seek to enhance or maintain EuroChem’s position on the global cost
curve through improvements in energy efficiency at our production facilities;
by optimising logistics with our own rail stock, transhipment terminals, and
sea-going vessels; and by reducing dependency on third-party suppliers.
Other financial risks that we continuously monitor include liquidity risk, credit
risk, financial covenants and ratings risks, and material tax risks.