Market and business conditions

Hafslund’s business is impacted by public regulation in the form of legislation, regulations and licences. This is seen most clearly in grid regulation, which establishes frameworks for the grid companies’ revenue levels and financial results. Other parts of the business, including power production and electricity sales, operate in a competitive market without correspondingly stringent regulations. The Heat business, both as a market operator and owner of infrastructure, falls in between the two categories.

The power market

At an overarching level the power market in Norway is split into a wholesale and an end user market. Physical wholesale trading takes place via the Nordic power exchange Nord Pool Spot, where the price for power delivery is established on a daily basis, primarily based on notifications from sellers and buyers. The main players on Nord Pool Spot are power producers and power sale companies. Financial power contracts (derivatives) are primarily traded via Nasdaq OMX Commodities. Power sales to individual end customers are made in the end user market, which is a competitive market characterised by a large number of players, several different types of agreement, marked price pressure and low margins.

Fundamental issues

The Norwegian power market is dominated by hydropower and is primarily impacted by climatic conditions such as temperatures and precipitation, but also by access to imported power, competition with other energy carriers and power prices on the European market. The Nordic power market is essentially impacted by price developments on Nord Pool Spot, but also by periods of major regional price differences due to bottlenecks and varying resource access in the regions.

At the end of 2011 Norwegian reservoir levels were around 43 percent, approximately 26 percentage points below the median value. Winter 2010/2011 was extremely cold, and electricity consumption reached record high levels. At 18 percent, the lowest reservoir levels were recorded in Week 13. Then followed a period of mild weather and a rapid snowmelt, which helped to return reservoirs to higher levels at an earlier time than normal. The summer and autumn were significantly wetter than normal in most parts of Norway, and reservoir levels peaked in October at 88 percent, which was on a par with the median. At the end of the year reservoir levels were around 80 percent.

The summer and autumn of 2011 were significantly wetter than normal in most parts of Norway, and reservoir levels peaked in October at 88 percent.

Price areas

To boost security of supply, Statnett in January 2011 increased the number of price areas in Norway from three to four, and a month later a fifth price area was introduced. At the time access to resources in parts of Norway varied significantly, while transmission capacity between different parts of the country was limited. The division into five price areas remained in force during the year.

On 1 November Sweden was split into four price areas. The intention was to promote more secure operation of the Swedish power system and power supplies in southern Sweden, and to ensure higher power imports to southern Sweden and southern Norway in times of high consumption. The switch to four price areas instead of one reduced the difficulties involved in exchanging power between Sweden and neighbouring countries due to internal restrictions in the Swedish grid.

Power prices in 2011

Having started the year at NOK/MWh 620.8 in Week 1, the system price in 2011 fell until Week 40, when it reached a low for the year of NOK/MWh 78.3. Subsequently, the system price rallied slightly, before falling again towards the end of the year, when it closed at NOK/MWh 220.6. The average system price in 2011 was NOK/MWh 376.2. The average system price in 2010 was a record high of NOK/MWh 425.2.

The area price for NO1 (Østlandet) in the first quarter of the year was slightly higher than the system price due to weak hydro resources, while for the remainder of the year it was as much as 7 NOK/MWh lower than the system price due to high reservoir levels.

Hafslund’s power production

In 2011 Hafslund continued its strategy of selling its own electricity on the spot market without any significant degree of price hedging. The risk to which Hafslund is exposed in the power market is regulated by the Group’s risk frameworks. The average achieved power price for the Group’s power production in 2011 was NOK/MWh 316.2, 19.0 percent down on 2010. Annual production was 3,135 GWh, 1.1 percent higher than in a normal year.

Hafslund’ s power plant rights were acquired before the establishment of the current scheme for reversion to state ownership, meaning that the Group’s own power plants may not be returned to state ownership.

End user sales

The market for power sales to end users comprises around 100 suppliers and is characterised by strong price pressure and low margins.

The market for power sales to end users comprises around 100 suppliers and is characterised by strong price pressure and low margins

Hafslund is Norway’s largest electricity supplier with 878,000 customers at the end of 2011, of which 696,000 were in Norway and 182,000 in Sweden and Finland.

The power companies offer different power agreements, which primarily mirror price developments on the Nord Pool Spot power exchange. As a result of low wholesale prices from spring through the rest of the year, the average electricity price to end users in 2011 significantly trailed prices in 2010. However, the average electricity price to end users in the first half of 2011 still came in at a record high.

A joint Norwegian-Swedish certificate market for renewable electricity entered into force on 1 January 2012. The scheme will deliver 26 TWh of renewable electricity production under a mandatory certification system that is expected to promote new renewable electricity production. The electricity customers finance the scheme in that the electricity companies add the certification cost to the electricity price.

Networks

Through laws, regulations and licence conditions Hafslund Nett is subject to a series of provisions and requirements that govern the company’s business and resource utilisation.

Revenue ceiling system

The grid companies have a monopoly on the transfer of electrical energy, for which they are allocated licences. To prevent the grid companies exploiting their monopolistic position they are regulated by the Norwegian Water Resources and Energy Directorate (NVE) in various areas, including financially through the establishment of annual revenue ceilings. The revenue ceiling sets an upper limit for how much the grid company can receive in payment for the transmission of electrical power.

The revenue ceiling sets an upper limit for how much the grid company can receive in payment for the transmission of electrical power.

The NVE establishes the revenue ceiling based on financial and technical reporting that the grid companies are obliged to submit to the authority each year. Over time the revenue ceiling shall cover the costs of operation and depreciation of the grid, and provide a reasonable return on capital invested given efficient grid operation, utilisation and development.

Revenue ceiling regulation establishes the total revenue ceiling for the industry. In accordance with this the NVE makes comparable efficiency analyses to determine how cost-effective the individual grid company is operating its business. If a grid company performs better than the industry average it can achieve a return higher than the normal return for the industry, and vice versa.

The grid companies’ revenue ceiling also depends on the quality of their deliveries. Grid outages have a direct impact on the grid companies’ annual results.

The prevailing regulation model started in 2007 and the industry has raised major objections to the current model. The main misgivings relate to inadequate investment incentives and predictability, and general over-complexity. The NVE is working on changes to the applicable model for all grid levels and has indicated that any changes will apply from 2013. The exact implications for the industry are not currently known.

The EU and grid levels

Through the EEA agreement Norway obliged to incorporate EU Electricity Directives into Norwegian legislation. The Third Energy Market Package was adopted in the EU in 2009, but has still not been implemented into Norwegian law, mainly due to issues relating to operational responsibility, ownership and regulation of the regional and central grid.

In Europe the industry operates on two grid levels – “distribution” and “transmission”. In Norway there are three grid levels – the central grid, regional grid and distribution grid. It is unclear what should be characterised as “distribution” and “transmission” in Norway, and thus which requirements should apply. Hafslund Nett is an important regional grid owner, and is waiting to see how the Norwegian authorities will implement the Third Energy Market Package and to what extent this will result in changes in ownership or operation of the transmission grid at central and regional grid level.

Competence regulation

The regulation on requirements for competence for site and area licences (the competence regulation) was established by the Norwegian Ministry of Petroleum and Energy on 10 March 2011. The agreement entered into force on 1 July 2011. The purpose of the regulation is to help ensure that all parties who have site and/or area licences in accordance with the Norwegian Energy Act have suitable competence to, in normal operations, perform the tasks pursuant to the Norwegian Energy Act and its related provisions and licence measures. A transitional regulation applies until 1 July 2013 governing competence in grid companies with revenue ceilings.

In 2011 Hafslund Nett started work to enable the business to satisfy the remaining requirements of the competence regulation.

Automatic metering systems (AMS)

By the end of 2016 advanced metering systems (AMS) shall be installed at all Norwegian customers.

The NVE has established frameworks for the introduction of AMS in Norway, and set deadlines for its mandatory introduction. By the end of 2015, AMS shall be installed for 80 percent of all grid customers and for all customers by the end of 2016. AMS is based on the Regulation adopted on 24 June 2011 on changes in metering, settlement and coordination of electricity trading and invoicing of network services (the Settlement Regulation).

AMS covers the actual meters, associated equipment used for communication and management at customers’ premises, communication solutions between customers and the grid company and equipment and systems required to receive, store and process meter data in the AMS system.

In 2011 Hafslund Nett established a project with the mandate of commencing implementation of AMS in Hafslund Nett’s distribution area. At the end of the pre-qualification stage the tender documentation was sent to ten companies with a tender deadline of 1 March 2012. A contract will be entered into with a prime supplier in the third quarter of 2012.

Heat

Through its espousal of the EU’s Renewables Directive, Norway has undertaken to significantly boost renewable energy production. Hafslund believes that both a heightened focus on research and an appropriate support scheme for renewable energy will be required to make this possible. It will be particularly important to develop appropriate support schemes for renewable heat production similar to the electrical certificates scheme for renewable electricity power production.

The waste situation

High prices, a scarcity of waste and varying fuel quality once again proved to be significant problems for Norwegian waste-to-energy plants in 2011. Differences in prices of fuel and energy, and in charges in Norway and Sweden, make it profitable to transport residual waste over long distances to Swedish incineration plants. The final waste treatment fee was abolished in October 2010 in order not to further exacerbate the market situation. However, in practice this did not result in any immediate improvement in the framework conditions for the Norwegian plants. Swedish companies continue to enjoy better framework conditions as a result of a long-term environmental policy, strong dividends and greater ability to pay for energy.

Differences in prices of fuel and energy, and in charges, make it profitable to transport residual Norwegian waste over long distances to Swedish incineration plants.

Healthy industry development and the promotion of opportunities to secure a reasonable return in relation to risk require more equal competitive terms for the private and public sectors and within the EEA/EU system with regard to areas including import/export terms, charges and support schemes.

In 2011 Hafslund continued to actively contribute to work to secure equal framework conditions with respect to export restrictions and prices of waste.

District heating

Following the revision of the Norwegian Planning and Building Act it is now a legal requirement to connect newbuilds in areas covered by district heating licences. In addition to the main rule on the obligation to connect, there is also an exemption provision which allows local authorities to exempt buildings from this obligation if they can offer a more environmentally friendly heating solution.

The City of Oslo is currently reviewing an exemption application under the Norwegian Planning and Building Act for district heating. Since this is the first exemption application under the new legislation, the City of Oslo is taking steps to establish a technical basis for assessing such applications.

Pellets

Hafslund’s pellets factory BioWood Norway, which is located at Averøya in Møre og Romsdal, produces wood pellets for industrial purposes. The raw material is imported woodchips. The main market is power-intensive industry, district heating plants and modern coal-fired power plants located near harbours in northern Europe and the UK.

At the start of the 2010/2011 heating season there was undercapacity in the global pellets market and a limited amount of pellets in stores. The year started with pellet prices at around EUR 120 per tonne. As a result of the cold winter and undercapacity, prices climbed throughout the season to reach around EUR 135 per tonne at the end of the year.

There continues to be a shortage of pellets for major industrial consumers in the European market. As a result, coal is being used to a greater extent than expected and is therefore compensating for the fall in pellets consumption. There is no clear explanation of why pellets production is roughly half of the installed capacity globally, but limited raw material access fuelled by the downturn in the global economy and technical challenges at some of the largest pellets producers go some way to accounting for the situation.