5.1 RISK MANAGEMENT POLICY
The Company’s risk management strategy is designed to safeguard the stability and sustainability of AES Gener and its subsidiaries at all times, under both normal and exceptional circumstances in relation to all relevant components of financial uncertainty. The Company’s risk management is aligned with the general guidelines defined by its controlling shareholder, the AES Corporation.
“Financial risk events” refer to situations in which there is exposure to conditions that indicate financial uncertainty, and are classified based on the source of the uncertainty and associated sources. The responsible and effective management of these uncertainties is viewed by the Company as strategic from the standpoint of value creation.
The following aspects of financial risk management are most important:
· Providing transparency, establishing and managing risk tolerances and determining guidelines in order to develop strategies to limit significant exposure to risk.
· Providing a disciplined and formal process for assessing risk and carrying out the commercial aspects of the business.
Financial risk management involves the identification, analysis, quantification, measurement and control of these events. It is management’s responsibility, particularly the financial and commercial management teams, to constantly assess and manage financial risk.
5.2 RISK FACTORS
(A) MARKET RISK
Market risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of a change in market prices. Market prices comprise of three types of risk: Foreign Currency risk, Interest Rate Risk and Commodity Price Risk.
(i) Foreign Currency Risk
With the exception of operations in Colombia, the Company’s functional currency is the US dollars given that its revenue, expenses and inves- tments in equipment are mainly determined using the US dollars. Also, the Company is authorized to declare and pay its taxes in US dollars. Foreign currency risk is associated with any revenue, expenses, investments and debt denominated in any currency other than US dollars. The main concepts denominated in Chilean pesos are contract energy sales and tax credits mainly associated with VAT. As of December 31, 2012, Gener maintained several currency derivative instruments to cover its exposure to Chilean peso variations. As of December 31, 2012, the impact of a 10% variation in the exchange rate of the Chilean peso with respect to the US dollars could have generated a negative impact of approximately ThUS$2,266 in the Group’s net income, holding all other variables held constant. During the same period, approximately 85.8% of operating revenue and 92.0% of the Company’s expenses were in US dollars, while during the year ended December 31, 2011, approxima- tely 85.6% of operating revenue and 91.6% of the Company’s expenses were denominated in US dollars.
In relation to the foreign subsidiaries, Chivor’s functional currency is the Colombian peso, since the majority of the subsidiary’s revenue, parti- cularly contract sales and operating costs are linked to the Colombian peso. As of December 31, 2012, sales in Colombian pesos represented 10.7% of the Company’s consolidated operating revenue. For the year ended December 31, 2011, 12.0% if sakes were in denominated in Colombian pesos. Additionally, Chivor dividends are determined in Colombian pesos, although financial hedge instruments are used to fix the amount to be distributed in US dollars. Furthermore, spot prices in the Argentinean market are denominated in Argentinean pesos. Ar- gentinean peso denominated sales represented just 3.6% of the Company’s consolidated operating revenue, as of December 31, 2012, while
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during the same period ended in 2011, this amount was 2.4%. It A variation of 10% in the foreign exchange rate between the US dollar and the Argentine Peso would have a negative impact of ThUS$6,000.
In addition, the majority of investments in new plants and maintenance of equipment are denominated in US dollars. The majority of short term investments for cash management purposes are also in US dollars. As of December 31, 2012, 75.0% of short term investments were in US dollars, 8.70% in Chilean pesos, 13.0% in Colombian pesos and 3.30% in Argentinean pesos. The balances in Cash and Cash Equivalents that are denominated in Argentine Pesos are subject to exchange restrictions and volatility in the foreign currency exchange rate. At December 31, 2012, 82.0% of the investments are denominated in US dollars, 15.1% in Chilean Pesos, 2.20% in Colombian Pesos and 0.70% in Argentine Pesos.
With respect to debt denominated in currencies other than the US dollars, Gener has entered into currency swaps to eliminate the majority of the exchange rate risk. For the UF denominated bonds issued in 2007 for approximately ThUS$219,527, AES Gener has a cross currency swap for the duration of the debt. As of December 31, 2011, 97.5% of the Company’s debt is denominated in US dollars, including the bonds mentioned above. The following table shows the composition of debt by currency as of December 31, 2012 and 2011:
CURRENCY DECEMBER 31,2012% DECEMBER 31,2011%
US$ 97.5 98.1
UF 2.1 1.9
Col$ 0.4 0.0
(ii) Interest Rate Risk
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Group’s exposure to the risk of changes in market interest rates relates primarily to the Group’s long term debt obligations with floating interest rates.
The Group manages its interest rate risk by having a balanced portfolio of fixed and variable rate loans. Additionally, the Company has entered into interest rate swaps to mitigate interest rate risk for long term obligations. Currently, the Group has interest rate swaps for an important part of the debt associated with subsidiaries Ventanas and Angamos. The following table shows the composition of debt by type of interest rate as of December 31, 2012 and 2011:
RATE DECEMBER 31, 2012% DECEMBER 31, 2011%
Fixed rate 89.8 90.1
Variable rate 10.2 9.9
(iii) Commodity Price Risk
The Group is affected by the volatility of certain commodities. The fuels used by the Company, mainly coal, diesel and liquid natural gas (LNG), are commodities with international prices set by market factors outside of the Company’s control. Specifically, diesel and LNG are bought based on international oil prices through bilateral local supply agreements. Commodity price risk is related to fluctuations in these prices.
The price of fuel is a key factor in plant dispatch and spot prices both in Chile and Colombia. Price variations for fuels such as coal, diesel and natural gas can change the composition of the Company’s costs through variations in marginal cost. Since AES Gener is a company with based mainly on thermal generation, fuel costs represent a significant portion of the cost of sales.
Currently the majority of Gener’s energy sales contracts incorporate an indexation that adjusts the energy sales price to the variations in coal prices, according to the indexes and schedules contained in each contract. In addition, the Company has created a coal acquisition strategy that consists of maintaining a portion of purchases at both fixed and variable prices in order to align its generation costs with its contracted energy sales.
Currently, diesel purchases and LNG are not hedged. Given that the Company has a policy of physically backing up its contract sales with efficient generation, it is expected that diesel fired or LNG units will operate for only for spot sales in rare circumstances such as drought conditions in the SIC. Given those conditions and the fact that Sociedad Eléctrica Santiago S.A. (“ESSA”) plant used LNG for its generation this period, it is estimated that a 10% increase in diesel cost would have caused a negative impact in the Company’s consolidated gross margin of ThUS$18,338 during 2012, while a 10% decrease would have caused a positive impact in the same magnitude. It is worth noting that Nueva Renca’s unit within the subsidiary of ESSA can use either diesel or LNG and is able to acquire the necessary LNG volumes using short term contracts when the LNG price is more competitive than diesel.
(B) CREDIT RISK
Credit risk is related to the credit rating of the parties with whom AES Gener and its subsidiaries do business. The Company is exposed to credit risk primarily from its operating activities related to trade receivables and from its financing activities including deposits with banks and financial institutions and other financial instruments.
With regard to accounts receivable, AES Gener’s counterparties in Chile are principally distribution companies and industrial customers of elevated solvency and over 90% of these customers have local and/or international investment grade credit ratings. Sales made by the AES Ge- ner group companies in the spot market are obligatorily made to other generators, members of the CDEC, in accordance with the economic dispatch determined by this entity. It should be noted that one generator participant of the CDEC was declared in bankruptcy in September 2011 as a result of the financial losses caused by the dry hydrological conditions experienced in the SIC. In the proceedings, Gener and Eléctrica Santiago presented evidence of the outstanding debt owed by such generator, equal to ThUS$70 and ThUS$2,937 plus applicable interest. To date, of this amount outstanding, ThUS$1,169 has been paid and based on management’s estimation no further payments will occur and thereby the remaning amounts have been written down.
In Colombia, AES Chivor performs risk assessments of its counterparties based on an internal credit quality evaluation, which in some cases may include guarantees. In 2010, also in dry hydrological conditions, AES Chivor suffered collection problems with an energy trader and eventually registered a loss of ThUS$1,300. In this case, the trader was suspended from participating in the Bolsa or spot market and AES Chivor presented actions to recover the outstanding amount. Meanwhile, it has been determined that Termoandes is not exposed to major credit risks given that the commercial counterparty is CAMMESA (“Compañía Administradora del Mercado Mayorista Eléctrico S.A., which is the administrator of the wholesale electricity market in Argentina and its non-regulated customers operate under the Energy-Plus scheme.
Financial investments by AES Gener and its subsidiaries such as mutual funds, time deposits and derivatives, are executed with local and foreign financial institutions which have national and/or international credit ratings greater than or equal to “A” under the S&P and Fitch scale and “A2” under the Moody’s scale. Similarly, derivative instruments are executed with highly rated international entities. The Company has cash, investment and treasury policies to guide its cash management and minimize credit risk.
The maximum credit exposure at the date of this report is the accounting value for each kind of financial assets referred in Note 10 Financial Instruments. The Company does not maintain any guarantees for those financial assets.
(C) LIQUIDITY RISK
Liquidity risk relates to the ability to meet payment obligations. The Company’s objective is to maintain a balance between fund continuity and financial flexibility through normal operating cash flows, bank loans, public bonds, short term investments and both committed and uncommitted credit lines. As of December 31, 2012, AES Gener had available liquid resources of ThUS$405,504, that included cash and cash equivalents of ThUS$397,204, time deposits and short term US dollars mutual funds for a total of ThUS$8,300, recorded in Other Current Financial Assets. As of December 31, 2011, the total cash balance was ThUS$537,778, which included cash and cash equivalents of ThUS$409,157 and time deposits and short term US dollars mutual funds of ThUS$128,621. Cash and Cash Equivalents include cash, time deposits with original maturities of less than three months, marketable securities, US dollars available-for-sale mutual funds, repurchase agreements and fiduciary rights.
As of December 31, 2012, AES Gener holds committed and unused lines of credit for close to ThUS$285,533, in addition to uncommitted and unused lines of credit for close to ThUS$255,163.
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In relation to debt maturities, Gener has no significant maturities during 2013. The debt amount originally maturing in 2014 was significantly reduced from ThUS$628,344 as of June 30, 2011 to ThUS$379,567 as of December 31, 2011due to the refinancing process held in August 2011. This process, part of the active debt management of the Company, was performed in order to extend the maturity term of an significant part of the corporate debt. The refi- nancing process included the exchange and voluntary tender of approximately 63% on the ThUS$400,000 Senior Notes due in 2014, and the voluntary tender of approximately 48% of the Serie Q Chilean Bond of ThUS$196,000 due in 2019 and the issuance of New Notes for a total of ThUS$401,682 due in 2021 with an interest rate of 5.25%. The graphic and table below shows the maturity profile, based on actual debt, in millions of US dollars as of December 31, 2011:
DEBT MATURITY PROFILE
0 millon US$ 200 2013 66 380 113 63 77 104 214 120 1,142 2014 2015 2016 2017 2018 2019 2020 2021+ 400 600 800 1,000 1,200 AS OF DECEMBER 31, 2012 AVERAGE INTEREST RATE
EXPECTED CONTRACTUAL MATURITY DATE (IN MILLION US$)
2013 2014 2015 2016 2017 +
FIXED RATE
(UF Swapped to U.S.$) 5.50% - - 47.0 - - (UF Swapped to U.S.$) 7.34% - - - - 172.3
(U.S.$) 7.50% - 147.1 - - - (U.S.$) 5.25% - - - - 401.7 (U.S.$) 8.00% - - - - 102.2 (UF) 7.50% 1.0 1.1 1.2 1.3 42.9 (U.S.$) 9.75% - 170.0 - - - (U.S.$) 6.95% 6.0 3.0 - - - VARIABLE RATE
(US$) LIBOR + Spread 22.5 25.5 25.9 30.4 251.3 (US$) LIBOR + Spread 36.6 33.0 39.1 31.3 676.1 (Col$) DTF(1) + Spread - - - 0.3 9.6
TOTAL 66.1 379.7 113.2 63.4 1,656.0
5.3 RISK MEASUREMENT
The Company has developed methods to measure the efficiency and effectiveness of risk strategies, both prospectively and a retrospectively.
For those analyses, different market methods for risk quantification are used, such as regression methods, risk bearing capacity and maximum risk expo- sure, which allow the Company to adjust risk strategies and mitigation methods and assess their impact.