The impacts of reasonably possible changes in commodity prices on profit and equity, both after taxation, based on the assumptions set out above are as follows:
2014 2013
Energy prices Base price(i)
Reasonably possible change
in variable % (ii) Base price(i)
Reasonably possible change in variable % (ii) UK gas (p/therm) 50 +/–6 66 +/–6 UK power (£/MWh) 47 +/–5 55 +/–4 UK coal (US$/tonne) 67 +/–6 88 +/–7 UK emissions (€/tonne) 8 +/–1 5 +/–1 UK oil (US$/bbl) 69 +/–14 102 +/–8
North American gas (US cents/therm) 21 +/–4 41 +/–3
North American power (US$/MWh) 41 +/–6 50 +/–4
2014 2013 Incremental profit/(loss) Impact on profit (ii) £m Impact on profit (ii) £m
UK energy prices (combined) – increase/(decrease) 114/(94) 90/(97)
North American energy prices (combined) – increase/(decrease) 109/(111) 71/(71)
(i) The base price represents the average forward market price over the duration of the active market curve used in the sensitivity analysis provided. (ii) The reasonably possible change in variable and the impact on profit are calculated using both the active and inactive market curves for all UK energy prices.
The impact on equity of such price changes is immaterial.
Credit risk management
Credit risk is the risk of loss associated with a counterparty’s inability or failure to discharge its obligations under a contract. The Group continues to be vigilant in managing counterparty risks in accordance with its financial risk management policies. In 2014 there have been fewer credit rating downgrades of financial institutions and European energy majors, than in 2013. The Group continually reviews its rating thresholds for counterparty credit limits, and updates these as necessary based on a consistent set of principles. It continues to operate within its limits. In the US and Europe, ongoing regulatory changes are increasing trading over exchanges or via zero threshold margined contracts. This helps to reduce counterparty credit risk, but carries increased liquidity requirements. The fall in oil prices towards the end of 2014, if sustained, may add financial pressure to certain counterparties which may in turn have a detrimental impact on their financial strength and resulting credit risk profile. These pressures will be taken into account in counterparty credit reviews.
The Group is exposed to credit risk in its treasury, trading, energy procurement and downstream activities. Credit risk from financial assets is measured by counterparty credit rating as follows:
2014 2013
Derivative financial instruments with positive fair values £m
Receivables from treasury, trading and energy procurement counterparties £m
Cash and cash equivalents
£m
Derivative financial instruments with positive fair values £m
Receivables from treasury, trading and energy procurement counterparties £m
Cash and cash equivalents £m AAA to AA 9 27 282 1 33 358 AA– to A– 530 643 296 533 576 349 BBB+ to BBB– 282 314 24 251 405 2 BB+ to BB– 37 87 4 5 140 1 B or lower 4 114 – 3 16 – Unrated (i) 68 226 15 7 140 9 930 1,411 621 800 1,310 719
(i) The unrated counterparty receivables primarily comprise amounts due from subsidiaries of rated entities, exchanges or clearing houses.
Details of how credit risk is managed across the asset categories are provided below.
(a) Treasury, trading and energy procurement activities
Wholesale counterparty credit exposures are monitored by individual counterparty and by category of credit rating, and are subject to approved limits. The Group uses master netting agreements to reduce credit risk and net settles payments with counterparties where net settlement provisions exist (see S6 ‘Financial assets and liabilities subject to offsetting, master netting arrangements and similar arrangements’ for details of amounts offset). In addition, the Group employs a variety of other methods to mitigate credit risk: margining, various forms of bank and parent company guarantees and letters of credit. See note 24(c) for details of cash posted or received under margin or collateral agreements.
Centrica plc Annual Report and Accounts 2014
NOTES TO THE FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
S3. Financial risk management
It is the Group’s policy to hedge material transactional exposures using forward contracts to fix the functional currency value of non-functional currency cash flows, except where there is an economic hedge inherent in the transaction. At 31 December 2014, there were no material unhedged non-functional currency monetary assets or liabilities, firm commitments or probable forecast transactions (2013: nil), other than transactions which have an inherent economic hedge and foreign currency borrowings used to hedge translational exposures.
(ii) Translational currency risk
The Group is exposed to translational currency risk as a result of its net investments in North America and Europe. The risk is that the pounds sterling value of the net assets of foreign operations will decrease with changes in foreign exchange rates. The Group’s policy is to protect the pounds sterling book value of its net investments in foreign operations where appropriate, subject to certain parameters monitored by the GFRMC, by holding foreign currency debt, entering into foreign currency derivatives, or a mixture of both.
The Group manages translational currency risk taking into consideration the cash impact of any hedging activity as well as the risk to the net asset numbers in the Group’s Financial Statements. The translation hedging programme including the potential cash impact is monitored by the GFRMC.
(c) Interest rate risk management
In the normal course of business the Group borrows to finance its operations. The Group is exposed to interest rate risk because the fair value of fixed rate borrowings and the cash flows associated with floating rate borrowings will fluctuate with changes in interest rates. The Group’s policy is to manage the interest rate risk on long-term borrowings by ensuring the exposure to floating interest rates remains within a 30% to 70% range, including the impact of interest rate derivatives.
(d) Sensitivity analysis
IFRS 7 requires disclosure of a sensitivity analysis that is intended to illustrate the sensitivity of the Group’s financial position and performance to changes in market variables (commodity prices, foreign exchange rates and interest rates) as a result of changes in the fair value or cash flows associated with the Group’s financial instruments. The sensitivity analysis provided discloses the effect on profit or loss and equity at 31 December 2014, assuming that a reasonably possible change in the relevant risk variable had occurred at 31 December 2014, and been applied to the risk exposures in existence at that date to show the effects of reasonably possible changes in price on profit or loss and equity to the next annual reporting date. Reasonably possible changes in market variables used in the sensitivity analysis are based on implied volatilities, where available, or historical data for energy prices and foreign exchange rates. Reasonably possible changes in interest rates are based on management judgement and historical experience.
The sensitivity analysis has been prepared based on 31 December 2014 balances and on the basis that the balances, the ratio of fixed to floating rates of debt and derivatives, the proportion of energy contracts that are financial instruments, the proportion of financial instruments in foreign currencies and the hedge designations in place at 31 December 2014 are all constant. Excluded from this analysis are all non-financial assets and liabilities and energy contracts that are not financial instruments under IAS 39. The sensitivity to foreign exchange rates relates only to monetary assets and liabilities denominated in a currency other than the functional currency of the commercial operation transacting, and excludes
the translation of the net assets of foreign operations to pounds sterling, but includes the corresponding impact of financial instruments used in net investment hedges.
The sensitivity analysis provided is hypothetical only and should be used with caution as the impacts provided are not necessarily indicative
of the actual impacts that would be experienced because the Group’s actual exposure to market rates is changing constantly as the Group’s portfolio of commodity, debt and foreign currency contracts changes. Changes in fair values or cash flows based on a variation in a market variable cannot be extrapolated because the relationship between the change in market variable and the change in fair value or cash flows may not be linear. In addition, the effect of a change in a particular market variable on fair values or cash flows is calculated without considering interrelationships between the various market rates or mitigating actions that would be taken by the Group. The sensitivity analysis provided excludes the impact of proprietary energy trading assets and liabilities because the VaR associated with the Group’s proprietary energy trading activities is less than £5 million.
(i) Transactional currency risk
The Group has performed an analysis of the sensitivity of the Group’s financial position and performance to changes in the fair value or future cash flows of foreign currency denominated financial instruments. The Group deems 10% movements to US dollar, Canadian dollar and euro currency rates relative to pounds sterling to be reasonably possible. The impact of such movements on profit and equity, both after taxation, is immaterial to the Group.
(ii) Interest rate risk
The Group has performed an analysis of the sensitivity of the Group’s financial position and performance to changes in interest rates. The Group deems 1% movements to UK, US and euro interest rates to be reasonably possible. The impact of such movements on profit and equity, both after taxation, is immaterial to the Group.
NOTES TO THE FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
S3. Financial risk management
(iii) Commodity price risk
The impacts of reasonably possible changes in commodity prices on profit and equity, both after taxation, based on the assumptions set out above are as follows:
2014 2013
Energy prices Base price(i)
Reasonably possible change
in variable % (ii) Base price(i)
Reasonably possible change in variable % (ii) UK gas (p/therm) 50 +/–6 66 +/–6 UK power (£/MWh) 47 +/–5 55 +/–4 UK coal (US$/tonne) 67 +/–6 88 +/–7 UK emissions (€/tonne) 8 +/–1 5 +/–1 UK oil (US$/bbl) 69 +/–14 102 +/–8
North American gas (US cents/therm) 21 +/–4 41 +/–3
North American power (US$/MWh) 41 +/–6 50 +/–4
2014 2013 Incremental profit/(loss) Impact on profit (ii) £m Impact on profit (ii) £m
UK energy prices (combined) – increase/(decrease) 114/(94) 90/(97)
North American energy prices (combined) – increase/(decrease) 109/(111) 71/(71)
(i) The base price represents the average forward market price over the duration of the active market curve used in the sensitivity analysis provided. (ii) The reasonably possible change in variable and the impact on profit are calculated using both the active and inactive market curves for all UK energy prices.
The impact on equity of such price changes is immaterial.
Credit risk management
Credit risk is the risk of loss associated with a counterparty’s inability or failure to discharge its obligations under a contract. The Group continues to be vigilant in managing counterparty risks in accordance with its financial risk management policies. In 2014 there have been fewer credit rating downgrades of financial institutions and European energy majors, than in 2013. The Group continually reviews its rating thresholds for counterparty credit limits, and updates these as necessary based on a consistent set of principles. It continues to operate within its limits. In the US and Europe, ongoing regulatory changes are increasing trading over exchanges or via zero threshold margined contracts. This helps to reduce counterparty credit risk, but carries increased liquidity requirements. The fall in oil prices towards the end of 2014, if sustained, may add financial pressure to certain counterparties which may in turn have a detrimental impact on their financial strength and resulting credit risk profile. These pressures will be taken into account in counterparty credit reviews.
The Group is exposed to credit risk in its treasury, trading, energy procurement and downstream activities. Credit risk from financial assets is measured by counterparty credit rating as follows:
2014 2013
Derivative financial instruments with positive fair values £m
Receivables from treasury, trading and energy procurement counterparties £m
Cash and cash equivalents
£m
Derivative financial instruments with positive fair values £m
Receivables from treasury, trading and energy procurement counterparties £m
Cash and cash equivalents £m AAA to AA 9 27 282 1 33 358 AA– to A– 530 643 296 533 576 349 BBB+ to BBB– 282 314 24 251 405 2 BB+ to BB– 37 87 4 5 140 1 B or lower 4 114 – 3 16 – Unrated (i) 68 226 15 7 140 9 930 1,411 621 800 1,310 719
(i) The unrated counterparty receivables primarily comprise amounts due from subsidiaries of rated entities, exchanges or clearing houses.
Details of how credit risk is managed across the asset categories are provided below.
(a) Treasury, trading and energy procurement activities
Wholesale counterparty credit exposures are monitored by individual counterparty and by category of credit rating, and are subject to approved limits. The Group uses master netting agreements to reduce credit risk and net settles payments with counterparties where net settlement provisions exist (see S6 ‘Financial assets and liabilities subject to offsetting, master netting arrangements and similar arrangements’ for details of amounts offset). In addition, the Group employs a variety of other methods to mitigate credit risk: margining, various forms of bank and parent company guarantees and letters of credit. See note 24(c) for details of cash posted or received under margin or collateral agreements.
Centrica plc Annual Report and Accounts 2014
NOTES TO THE FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
S3. Financial risk management
100% of the Group’s credit risk associated with its treasury, trading and energy procurement activities is with counterparties in related energy industries or with financial institutions.
IFRS 7 requires disclosure of information about the exposure to credit risk arising from financial instruments only. Only certain of the Group’s energy procurement contracts constitute financial instruments under IAS 39. As a result, whilst the Group manages the credit risk associated with both financial and non-financial energy procurement contracts, it is the carrying value of financial assets within the scope of IAS 39 (note S6) that represents the maximum exposure to credit risk in accordance with IFRS 7.