Board of Directors' report

Board of direcotrs

Key developments and strategic direction

Well positioned in an industry with attractive long-term potential

A deeply rooted improvement culture and relentless focus on cost reduction have strengthened Hydro's position among the global leaders in the aluminium industry.

Dedicated improvement programs in all business areas have enabled Hydro to weather an environment of continued low aluminium prices. In 2013 Primary Metal successfully completed its USD 300 improvement program generating roughly NOK 1.5 billion in annual improvements compared to 2009 cost levels. Primary Metal is targeting additional savings of USD 180 per metric ton (mt) for its global portfolio of part-owned smelters. Despite temporary setbacks, Bauxite & Alumina's From B to A program is expected to achieve its overall target by 2015. Rolled Products' Climb program has contributed to significant savings. In total, these programs are expected to generate NOK 3 billion of annual improvements going forward.

On September 1, 2013, Hydro and Orkla completed the Sapa joint venture transaction transforming their respective extrusion businesses. The transaction has improved the global reach of the combined operations and created a stronger foothold in North America and several important emerging markets. It is also expected to generate substantial synergies amounting to roughly NOK 1 billion annually by the end of 2016. Initiatives include optimization of production and sourcing activities, restructuring and rationalization of operations and increasing margins through high grading the product portfolio.

Following several years of challenging market conditions, the global aluminium market balance (excluding China) has improved somewhat. The market is expected to remain balanced in the coming year, based on expected demand growth 2-4 percent which is uncertain.

Pursuing a clear direction in a challenging industrial landscape

The financial crisis and subsequent weak global economic conditions have led to an industry-wide poor financial performance for the past several years. A robust financial position, focus on liquidity and ongoing improvements over and above cost inflation have enabled Hydro to view the industry challenge as an opportunity.

Hydro has succeeded at defining and delivering significant improvements. Going forward, the company intends to increase the robustness of its businesses within all parts of the value chain. Hydro will leverage its strong technological orientation toward innovative solutions in close collaboration with customers. Efforts to increase energy efficiency, enhance product benefits and increase recycling will further lower operating costs, provide market opportunities and further reduce the environmental impact of our operations.

Hydro has the ambition to be among the industry leaders within health, safety, environment and corporate social responsibility. In 2013, Hydro launched a new climate strategy with the aim to become carbon-neutral by 2020. Key strategic goals include reducing direct and indirect emissions, increasing the share of recycled metal in the company's production and delivering more aluminium to markets and products which contribute to CO2 savings.

Operating performance

Underlying EBIT improved to NOK 2,737 million from NOK 1,297 million in 2012, influenced by lower operating costs for Hydro's smelters, improved results for Qatalum and higher product premiums. Positive developments were partly offset by lower realized alumina and aluminium prices together with production disruptions relating to external power outages at Alunorte. Lower alumina production and higher alumina sourcing costs had a negative impact on underlying results for the company's bauxite and alumina operations. Bauxite production declined due to lower off-take by Alunorte. The improvement program From B to A was also affected and Hydro did not achieve the improvements targeted for 2013. However, measures were introduced to restore production and prevent future disruptions lifting average production in the final quarter to an annualized level of 5.8 million mt.

Hydro did not meet its most important target in 2013 following one fatal contractor accident. Although Hydro's safety performance is among the best in the industry, the company also did not meet its improvement target for total recordable injuries (TRI rate). Hydro's climate strategy was strengthened, but the company experienced a setback in its reforestation program in Brazil. A new third-party grievance mechanism was successfully developed in Brazil and training in the company's revised code of conduct was completed according to plan. Implementation of Hydro's enhanced people performance and development system and the company's diversity program were on schedule.

Priorities for 2014

As a resource-rich, global aluminium company, Hydro is aiming to continuously improve the performance and profitability of its business without compromising on safety and compliance. Priorities in 2014 include:

  1. Strengthening performance within health, safety, security and environment (HSE) and corporate social responsibility (CSR)
  2. Providing customers with innovative and differentiated products
  3. Delivering on targeted cost reduction and improvement programs
  4. Pursuing recycling opportunities to improve earnings and reduce environmental impact
  5. Maximizing energy asset potential and strengthen the global support function
  6. Maintaining capital discipline

The ambition of no fatal accidents remains Hydro's top priority, and the company is targeting further improvement of its TRI rate for 2014 based on leadership, employee involvement and defined risk mitigating activities. The biodiversity and reforestation program in Paragominas will be further developed and strengthened.

During 2014, Hydro intends to increase the momentum of the improvement program From B to A and make significant progress toward reaching the NOK 1 billion target by the end of 2015 compared to 2011 cost levels. The program encompasses all major operating activities focusing on increased production, higher productivity, lower operating costs and lower manning as well as more effective procurement activities and increased commercial earnings. Measures to strengthen safe and sustainable business practices are also planned. Optimizing the company's global bauxite and alumina positions will continue including increased utilization of alumina index pricing.

Continuous improvement of smelter efficiency while constantly addressing cost challenges continues to be a key strategy for Primary Metal. Going forward, the company plans to maintain the improvements achieved and identify new improvement potentials.

Building on the recent success, Primary Metal is targeting additional savings for its global portfolio of part-owned smelters by the end of 2016. These programs are expected to generate annual improvements of roughly NOK 1.2 billion (Hydro's share) compared to 2011 cost levels. In particular, the company will focus on operational improvements at Albras in Brazil together with further streamlining of production and cost optimization at Qatalum in Qatar.

Product premiums have become a relatively larger share of total aluminium metal prices, and optimizing product premium margins will continue to be high on the company's agenda.

Hydro aims to be a leading player in recycled aluminium to pursue opportunities in this growing market segment and reduce the environmental impact of its operations. Recycling is an important element underlying the company’s ambition to become carbon-neutral by 2020. Plans include increasing its capability and capacity to use post-consumed and other types of contaminated scrap and to increase sales of recycling friendly alloys. The most important projects currently include a used beverage can line in Hydro’s Rheinwerk smelter in Neuss, Germany, and increased recycling capacity in the Clervaux, Luxembourg, remelter.

Securing increased returns for Rolled Products continues to be a priority under the Climb improvement program. The goal is to generate revenue and cost improvements of NOK 800 million by 2016 compared to cost levels at the end of 2011. Measures aimed at reducing operating costs and the cost-effective procurement of materials and supplies will continue in the coming years together with efforts to further increase the efficiency of production systems. Hydro intends to improve margins through high-grading its product portfolio and differentiation through innovation, quality and reliability.

Capturing the full value potential from Hydro's Norwegian hydropower assets and using its competence to secure competitive energy sources for the company's global activities is a key element of Energy's Aspiration improvement strategy. Operational excellence will continue to be a priority to secure cost-effective, safe and reliable production.

Hydro aims to provide its shareholders with competitive returns compared to alternative investments in peer companies through ongoing cost reductions, efficiency improvements and product innovation. The company will continue to focus on securing its financial position through exercising strong capital discipline to ensure an optimal level of operating capital, and to maintain a sustainable level of capital expenditures to safeguard its operating portfolio. Strong cash generation and preserving Hydro's investment grade credit rating continue to be key priorities.

Within the CSR area, implementation of the new third-party grievance mechanisms for Hydro's activities in Brazil will be prioritized together with further strengthening supply chain management and a continued strong effort within integrity to ensure the zero-tolerance corruption target. Further implementation of Hydro's people strategy will continue in 2014, emphasizing the revitalized people performance and development process "My Way," diversity roadmaps to achieve long-term ambitions and programs to further develop our leadership pipeline.

Shaping the future

The current industry environment and uncertain global economic conditions represent a significant challenge in obtaining a satisfactory return on capital for the industry as a whole. However, Hydro is well positioned for growth as the global economy evolves.

Hydro's drive for technological leadership will continue in order to raise its cost competitiveness, strengthen environmental standards and support long term growth ambitions. In 2013, the company announced it was evaluating the construction of a 70,000 mt pilot plant at Karmøy with the aim of full scale industrial testing of the world's most energy efficient smelter technology. In February, 2014, Hydro approved the construction of a new production line for aluminium car body sheet with a capacity of 150,000 mt at its rolling mill in Grevenbroich, Germany. Hydro has an attractive project portfolio including a potential new alumina refinery in Barcarena, close to Alunorte; the possible expansion of the Paragominas bauxite mine; the potential of doubling the capacity of the Qatalum smelter and the possibility to expand the Alouette smelter in Canada. Partnerships and joint ventures across the value chain provide the potential for further developing Hydro's asset portfolio. However, investments in these projects will require an improvement in the balance between industry production capacity and market demand.

Hydro is committed to maintaining the viability of the company's global business operations and is working systematically to ensure stable, predictable framework conditions in the countries where it operates.

Updated: October 11, 2016