Risk management deals with all aspects of value creation, including strategy, finance, commercial matters, organization, HSE, reputation, corporate responsibility, regulatory and legal matters. Hydro’s Board of Directors regularly reviews and evaluates the overall risk management systems and environment within Hydro.
Hydro faces many risks and uncertainties within the global marketplace. Changes in competitive and market conditions affect margin, price and volume developments. Following a period of extreme financial turmoil and unprecedented market decline towards the end 2008, we face a seriously oversupplied aluminium market and low aluminium prices. Input costs are falling but many are anticipated to remain high in the short-term. We face challenges in securing adequate financing and a higher risk of counterparty default in an environment of limited availability of risk mitigating instruments. Price volatility can have a significant impact on our reported and operating results. Our reported operating results and competitive position are influenced by developments in currency exchange rates and in particular the U.S. dollar, Euro and Norwegian krone. China is encouraging the production of more labor intensive semi-fabricated and fabricated products increasing the exposure of our downstream businesses. Our primary smelting operations are highly dependent on securing substantial amounts of energy at competitive prices. We are exposed to increasingly onerous legislation on CO2 emissions directly impacting Hydro relating to aluminium production and indirectly through higher power prices. Repositioning and restructuring activities are important in determining the viability of our future aluminium operations. It is challenging to complete large upstream projects on time and within budgets. Major accidents, legal proceedings or criminal investigations could have a serious impact on our reputation. Our business expansion is expected to take place increasingly in emerging and transitioning market areas heightening the risk related to unforeseen changes in the overall operating framework.
Risk management in Hydro is based on the principle that risk evaluation is an integral part of all business activities. The main responsibility for risk management is therefore placed with the business areas and coordinated by staff units at the corporate level. Policies and procedures have been established to manage risk.
Financial position
Hydro’s main strategy for mitigating risk related to volatility in cash flows is to maintain a solid financial position and strong credit-worthiness. To achieve this, Hydro targets, over the cycle, to keep its adjusted net interest bearing debt/equity ratio below 0.55 and to maintain a ratio of funds from operations to adjusted net interest bearing debt above a level of 0.40. In addition, Hydro has established guidelines for liquidity reserves and for the profile of instalment payments on debt in order to secure its financial position. At the end of 2008, our financial position was within these ratios and guidelines.
Liquidity risk
The challenging market conditions toward the end of 2008 have led to an increased focus and attention on credit and liquidity risk throughout our entire organization. Planned capital expenditures have been reduced and we have and will continue to implement initiatives to cut costs.
Hydro is taking proactive approach towards customers to reduce credit risk. We are also monitoring the financial performance of key suppliers in order to reduce the risk of default on operations and key projects.
Prices and currency
Hydro’s operating results are primarily affected by price developments of its main products, aluminium and power, in addition to foreign currency fluctuation of the most significant currencies, the U.S. dollar and the Euro, against the Norwegian krone. Hydro’s main risk management strategy for its upstream operations is to accept exposure to aluminium and energy price movements, while focusing on reducing the average cost position of its smelters.
Downstream and other margin-based operations are to a certain extent hedged to protect processing and manufacturing margins against raw material price fluctuations. Hydro has an operational hedging system in place to protect commercial contracts from aluminium price fluctuations. In order to mitigate part of its exposure to U.S. dollar currency fluctuations, Hydro has been utilizing currency forward contracts selling the U.S. dollar mainly against the Norwegian krone. This program is currently being reduced to reflect lower exposures due to falling LME prices and an increasing amount of U.S. dollar denominated debt. During 2008, Hydro has to a limited extent entered into forward contracts in other currencies to hedge revenue and cost positions.
