Origin Energy Limited (2011)
Notes to the Financial Statements [extract]
27.Financial Instruments [extract]
(c)Financial Risk Management
Financial risk factors
The consolidated entity’s activities expose it to a variety of financial risks: market risk (including foreign exchange risk, interest rate risk and commodity price risk), credit risk and liquidity risk. The consolidated entity’s overall risk management programme focuses on the unpredictability of financial and commodity markets and seeks to minimise potential adverse effects on the consolidated entity’s financial performance. The consolidated entity uses a range of derivative financial instruments to hedge these risk exposures.
Risk management is carried out under policies approved by the Board of Directors. Financial risks are identified, evaluated and hedged in close co-operation with the consolidated entity’s operating units. The consolidated entity has written policies covering specific areas, such as foreign exchange risk, interest rate risk, electricity price risk, oil price risk, credit risk, use of derivative financial instruments and non-derivative financial instruments, and the investment of excess liquidity.
(i) Market risk
Foreign exchange risk
The consolidated entity operates internationally and is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the New Zealand dollar, US dollar and Euro. Foreign exchange risk arises from future commercial transactions (including interest payments on long-term borrowings, the sale of oil, the sale and purchase of LPG and the purchase of capital equipment), recognised assets and liabilities (including foreign receivables and borrowings) and net investments in foreign operations.
To manage the foreign exchange risk arising from future commercial transactions, the consolidated entity uses forward foreign exchange contracts. To manage the foreign exchange risk arising from the future principal and interest payments required on foreign currency denominated long-term borrowings, the consolidated entity uses cross currency interest rate swaps (both fixed to fixed and fixed to floating) which convert the foreign currency denominated future principal and interest payments into the functional currency for the relevant entity for the full term of the underlying borrowings. In certain circumstances borrowings are left in the foreign currencies, or hedged from one foreign currency to another to match payments of interest and principal against expected future business cash flows in that foreign currency.
Each subsidiary designates internal derivatives as fair value hedges or cash flow hedges, as appropriate with the relevant underlying transaction. External derivative contracts are designated at the consolidated entity level as hedges of foreign exchange risk on specific assets, liabilities or future transactions on a gross basis.
The consolidated entity has certain investments in foreign operations whose net assets are exposed to foreign currency translation risk. Currency exposure arising from the net assets of the consolidated entity’s foreign operations is managed primarily through borrowings denominated in the relevant foreign currencies.
Price risk
The consolidated entity is exposed to commodity price risk from a number of commodities, including electricity, oil, gas and related commodities associated with the purchase and/or sale of these commodities. To manage its commodity price risks in respect to electricity and oil, the consolidated entity utilises a range of derivative instruments including fixed priced swaps, options and futures. The consolidated entity’s equity investments subject to price risk are all publicly traded.
The consolidated entity’s risk management policy for commodity price risk is to hedge forecast future transactions for up to 18 years into the future. The consolidated entity has a risk management policy framework that manages the exposure arising from its commodity-based activities. The policy permits the active hedging of price and volume exposure arising from the retailing, generation and portfolio management activities, within prescribed risk capacity limits. The policy prescribes the maximum risk exposures permissible over prescribed periods for each commodity within the portfolio, under defined worse case scenarios. The full portfolio is subject to ongoing testing against these limits at prescribed intervals, and reported monthly to management.
The consolidated entity is also exposed to equity securities price risk because of investments held by the consolidated entity and classified on the statement of financial position as available-for-sale and fair value through profit or loss.
(ii) Credit risk
The consolidated entity manages its exposure to credit risk via credit risk management policies which allocate credit limits based on the overall financial and competitive strength of the counterparty. Publicly available credit information from recognised providers is utilised for this purpose where available. Credit policies cover exposures generated from the sale of products and the use of derivative instruments. Derivative counterparties are limited to high-credit-quality financial institutions and other organisations in the relevant industry. The consolidated entity has Board approved policies that limit the amount of credit exposure to each financial institution and derivate counterparty. The consolidated entity also utilises ISDA agreements with all derivative counterparties in order to limit exposure to credit risk through the netting of amounts receivable from amounts payable to individual counterparties.
The carrying amounts of financial assets recognised in the statement of financial position, and disclosed in more detail in notes 6 and 9 best represents the consolidated entity’s maximum exposure to credit risk at the reporting date. In respect of those financial assets and the credit risk embodied within them, the consolidated entity holds no significant collateral as security and there are no other significant credit enhancements in respect of these assets. The credit quality of all financial assets that are neither past due nor impaired is appropriate and is constantly monitored in order to identify any potential adverse changes in the credit quality. There are no significant financial assets that have had renegotiated terms that would otherwise, without that renegotiation, have been past due or impaired.
(iii) Liquidity risk
Prudent liquidity risk management implies maintaining sufficient cash and marketable securities, the availability of funding through an adequate amount of committed credit facilities and the ability to close out market positions. Due to the dynamic nature of the underlying businesses, the consolidated entity aims to maintain flexibility in funding by keeping committed credit lines available. Certain of the consolidated entity’s interest-bearing liability obligations are subject to change in control provisions under the agreements with third-party lenders. As at 30 June 2011 those provisions were not triggered.
(iv) Interest rate risk (cash flow and fair value)
The consolidated entity’s income and operating cash flows are substantially independent of changes in market interest rates. The consolidated entity’s interest rate risk arises from long-term borrowings. Borrowings issued at variable rates expose the consolidated entity to cash flow interest rate risk. Borrowings issued at fixed rates expose the consolidated entity to fair value interest rate risk. The consolidated entity’s risk management policy is to manage interest rate exposures using Profit at Risk and Value at Risk methodologies using 95 per cent statistical confidence levels. Exposure limits are set to ensure that the consolidated entity is not exposed to excess risk from interest rate volatility. The consolidated entity manages its cash flow interest rate risk by using floating-to-fixed interest rate swaps. Such interest rate swaps have the economic effect of converting borrowings from floating rates to fixed rates.
Under the interest rate swaps, the consolidated entity agrees with other parties to exchange, at specified intervals (mainly quarterly), the difference between fixed contract rates and floating rate interest amounts calculated by reference to the agreed notional principal amounts.