History   

The RWE Group has a groupwide risk management system for the early identification as well as standardized reporting, assessment, control and monitoring of risks. We have formed risk-management boards both at the Group and divisional levels. They are responsible for the risk management system’s continued development and establish rules for the risk-management process. The basis for this is provided by a groupwide risk management guideline.

Our risk-management activities are designed to obtain information on risks and their financial impact as early as possible, in order to be able to counteract them with suitable measures. Moreover, the planning and controlling process also aims to identify and make use of opportunities as well as associated earning potential. We evaluate risks according to their probability of occurrence as well as damage potential and aggregate them at the business unit, divisional and Group levels. The damage potential is defined against the operating result and equity of the business unit concerned and the Group as a whole. We can thus ensure a systematic and uniform analysis of our current situation throughout the Group, on the basis of which specific risk-control initiatives can be developed. Our risk reporting scheme is fully integrated in our standardized planning and controlling process. The RWE Group’s management and supervisory bodies are regularly informed of the current risk situation. The efficiency and effectiveness of our risk management system are monitored internally.

We break down major risks and opportunities into the following categories:

  • Volatility of commodity and product prices: Risks and opportunities arise from our electricity generation business. The latter is significantly influenced by the development of market prices for electricity, fossil fuels — especially hard coal and gas — as well as by the development of the price of CO2 certificates. A risk arises, e. g., if higher commodity prices cannot be passed on by increasing electricity prices. Opportunities stem from the rising margins between electricity prices and prices for fossil fuels. Additional risks and opportunities result from our oil and gas production operations. The impact of unexpected disadvantageous changes in price in this area is minimized through the strategic use of derivative hedges. In addition to production, supply operations are also exposed to risks. Such risks arise, e. g., as a result of unexpected fluctuations in demand owing to changes in temperature. Our price risks on purchasing and sales markets are determined using special evaluation models, while taking current forward prices and expected price volatility into account. Among other things, we use financial and commodity derivatives to mitigate risks associated with sales and procurement.

    Our electricity and gas businesses face the price and sales risks as well as marketing opportunities resulting from the deregulation of Europe’s electricity and gas markets. We address these risks with differentiated pricing strategies and appropriate marketing policies as well as with effective measures to cut costs. Earnings risks can also arise from the loss of concessions in the grid business.

    On the one hand, our trading division business functions as a central platform for hedging commodity price risks throughout the RWE Group. This enables us to create a stable basis of planning for our company. On the other hand, while staying within trading limits, we conclude trades in order to take targeted advantage of changes in prices on energy markets. This leads to risks from unexpected price fluctuations. The RWE Group’s integrated trading and risk management system for the energy trading business is firmly aligned with best practice as applied to the trading business. Specific benchmarks for price risks are established on a daily basis. The Executive Board of RWE AG sets risk limits that are continuously monitored. Among other things, we calculate the Value at Risk (VaR) to quantify price risks associated with energy trading. The central risk controlling parameter is the Global Value at Risk, which limits trading activities conducted by RWE Supply & Trading and may amount to no more than € 40 million. The VaR figures within the RWE Group are generally based on a confidence interval of 95 % and a holding period of one day. RWE Supply & Trading’s Global VaR thus provides a cap for the maximum daily loss, which is not exceeded with a probability of 95 %. In the first three quarters of 2008, RWE Supply & Trading’s Global VaR averaged € 13 million, and the daily maximum was € 17 million. The Global VaR did not exceed € 16 million in the first half of October, although that month was characterized by high volatility.
  • Volatility of financial prices: Within the scope of our operations, we are also exposed to currency, interest-rate and share-price risks. Due to our international presence, currency risk management is very important. Group companies are generally obliged to hedge all currency risks via RWE AG. The parent company determines the net financial position for each currency and hedges it with external market partners if necessary. The Value at Risk is used to measure and mitigate risks. In the period under review, the average VaR for the foreign currency position of RWE AG’s ledger was less than € 1 million, as was the maximum VaR. The same applies to October, despite the high volatility.

    Interest rate management is also ascribed significant importance. Our interest-rate risks primarily stem from our financial debt and interest-bearing investments. Negative changes in value caused by unexpected interest rate movements are hedged with non-derivative and derivative financial transactions. The VaR for interest-rate risks associated with our financial debt and related hedges averaged € 125 million in the period under review and € 127 million in October. The VaR from interest-bearing investments including hedges amounted to € 54 million and € 51 million, respectively. The VaR for our share-price risks was € 16 million and € 46 million, respectively.

    Opportunities and risks from changes in the value of securities are controlled by a professional fund management system. The Group’s financial transactions are recorded using centralized risk management software and monitored by RWE AG. This enables the balancing of risks across individual companies. Range of action, responsibilities and controls are set forth in internal guidelines to which our Group companies are obliged to adhere.
  • Liquidity: Liquidity risk defines the potential for failure to meet financial obligations on time due to insufficient cash and cash equivalents. At RWE, these obligations consist of the repayment of financial liabilities that come due. In addition, we are obliged to put up cash collateral for our counterparties within the scope of our trading activities, in order to hedge negative market values. Despite the current financial crisis, we consider our liquidity risk exposure to be low. Our robust financing provides the basis for this. We have strong cash flows from operating activities and substantial cash and cash equivalents (also see commentary).
  • Creditworthiness of business partners: Most of the credit transactions performed by our finance and trading departments are with banks and business partners of good creditworthiness. We mitigate credit risks from these activities by establishing and adapting limits in a timely manner. If necessary, we request cash collaterals or bank guarantees. We also mitigate credit risk through credit insurance policies. Credit limits are issued in compliance with an internal credit risk guideline. Our customers’ creditworthiness is determined using an internal rating method that has been supplemented by an early warning indicator in light of the current crisis on financial markets. Credit risks are monitored daily for both energy trading and finance transactions. In our supply business, we are exposed to credit risks due to the possibility that customers may fail to meet their financial and purchase commitments. These credit risks are limited by internal caps on the basis of regular creditworthiness checks. Bank guarantees, cash collateral and credit insurance policies are used to further reduce our credit risks.
  • Continuity of business activities: We operate technologically complex and interconnected production plants all along our value chain. Earnings risks can arise from uninsured damage to our lignite mining equipment, production plants, power plant components or grids. There is an increasing risk of outages in power plants due to the ageing of their components. Our grid business is exposed to the risk of facilities being destroyed by force majeure such as severe weather conditions. We address these risks through high safety standards as well as regular audit, maintenance and servicing work. As appropriate, insurance policies also limit possible effects of damage.
  • Regulation: The RWE Group’s exposure to the constant change in the political, legal and social environment in which it does business can be expected to have an impact on earnings. Lignite and hard coal power plants account for a significant portion of our electricity generation portfolio. Therefore, we are exposed to a risk due to the EU-wide CO2 emissions trading system. Risks can arise from unexpected increases in the cost of procuring CO2 certificates. Therefore, CO2 risk management is an integral component of our centralized risk-management system. The European Commission adopted a new set of climate-protection measures for the period from 2013 to 2020. They include binding goals for all EU member states regarding the reduction of greenhouse gas emissions and the share of electricity consumption accounted for by renewable energy. The European Commission’s proposals are currently the subject of controversial discussions at the European Parliament and the European Council. RWE anticipates that CO2 costs will be much higher than in the current trading period, which will last until 2012. We intend to continue reducing CO2 emissions and make our power generation portfolio more flexible through our current power plant projects. Furthermore, we limit CO2 risks through climate protection projects in developing and newly industrializing countries within the scope of the Kyoto “Clean Development Mechanism” and “Joint Implementation.”

    Risks still exist in our German electricity and gas grid business as a result of regulatory intervention. We have already received all of the notifications for 2008 from the German Federal Network Agency. Risks arise primarily due to the incentive-based regulation that will take effect from 2009. This places high demands on German grid operators, which must achieve ambitious efficiency goals in a short period of time. In addition, major details remain to be clarified. For instance, how the grid operators’ energy procurement costs can be taken into account in a timely manner is yet to be determined. Another open issue is a reasonable return on debt. We intend to partially offset some of the negative effects stemming from the regulation by taking measures to cut costs and enhance efficiencies throughout RWE Energy.

    In Germany, risks can also arise from the stricter monitoring of anti-competitive pricing practices, which entered into force at the end of 2007. Based on the new legal situation, in March 2008, the German Federal Cartel Office began to review the end customer prices of numerous gas utilities, including four RWE subsidiaries. The results of these reviews have since been furnished. But they are still preliminary. We are assessing the economic impact they may have. Depending on the remaining course of the proceedings, we may be faced with burdens.
  • Capital expenditure and divestments: Decisions approving acquisitions and capital expenditure on property, plant and equipment must take into account both the opportunities and risks associated with tying up capital for extensive periods of time. At RWE, such decisions are prepared and implemented in adherence with specific accountability rules and approval processes. The same applies to divestments such as the sale of our North American water activities.
  • Legal procedures: Some RWE Group companies are involved in litigations and arbitration proceedings connected with their operations. In addition, out-of-court claims have been filed against individual Group companies in connection with sales of companies. However, we do not expect any major negative repercussions for the RWE Group’s economic or financial position. Furthermore, Group companies are directly involved in various procedures with public authorities or are at least affected by their results.

    In the end customer business, we are affected by lawsuits in Germany and by investigations conducted by the regulator in the UK dealing with the effectiveness of price mechanisms in Germany and the admissibility of specific sales-related measures in the UK. This may result in burdens for us.

    Raw materials production and power generation activities might be curtailed by risks arising from approval processes for our opencast mines and nuclear power plants. Furthermore, there is a risk of financial loss when capital is spent on the construction of power plants in the run-up to local planning decisions made by public authorities. We take precautionary measures against this by preparing our applications for approval with great care and ensuring that approval processes are handled competently. In light of our extensive growth programme and numerous investments in replacement plants, the number of our ongoing approval processes is especially high at present.

    Outside shareholders initiated several legal proceedings to examine the appropriateness of the conversion ratios and the amount of cash paid in compensation in connection with company restructurings pursuant to company law. The conversion ratios and cash compensation have been calculated on the basis of expert opinions and verified by auditors. If the legally enforceable decisions come up with a different result, the compensation will be carried out by making an additional cash payment to the affected shareholders, including those who are not involved in the conciliation proceedings.

    The EU Commission conducted follow-up inquiries at several European power utilities in May and December of 2006. This also affected RWE AG and other RWE Group companies in Germany. Afterwards, the EU Commission filed requests with companies including RWE for information on individual energy market issues.

    In early May 2007, the EU Commission initiated an abuse procedure against RWE. It suspects that we hindered access to the natural gas transmission system located in Germany in order to attain a purportedly market-dominating position in the gas supply business. At the end of May, we reached an agreement with the EU Commission on a solution to the antitrust abuse proceedings against RWE Transportnetz Gas GmbH, which have been ongoing since April 2007. We will commit to selling our German gas transmission grid to a third party which is independent from RWE. In exchange, the EU would stop the proceedings. The envisioned settlement is not an admission of guilt. We remain convinced that we have complied with the statutory regulations in the gas business, but we want to avoid protracted litigation. We are currently working on the details of our proposed settlement. The next step will involve the EU Commission soliciting the opinions of major market participants regarding the solution. Subsequently, it is expected to declare the commitment binding and stop the proceedings. The gas transmission grid for sale has a length of approximately 4,100 kilometres. In 2008, we expect to generate about € 170 million in total annual revenue from it.

We have included additional information on opportunities and risk management of our 2007 annual report.


 

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