Uniper Continues to Raise the Temperature at Fortum

Uniper SE, the fossil fuel giant that is majority-owned by Fortum Oy, that itself is majority-owned by the Finnish government, has just borrowed €10 billion – €8 billion from Fortum and €2 billion from the German government-owned bank KfW. 

Uniper’s margin calls have been huge because the market price of gas has increased by four to five times this last year. 

These large price increases are the result of three main reasons:

  1. Russia is holding back the supply of gas
  2. Germany decided to close down nuclear plants, and
  3. Gas storage in Europe has not been sufficient to cover the demand for gas.

Uniper needs this huge cash infusion to cover margin calls on future trades of gas and power contracts. There is nothing strange about this – traders, banks and other short term investors are often required to make such payments when they have entered into fixed price contracts to sell products at some future date. These margin calls are returned to the seller when the contracted product is delivered on the due date.

These payments, which are called “margin calls”, must be made if the current market price of the same product increases above what is the agreed price of the product to be sold at the future date. 

Here is an example: If Uniper has agreed on January 1st to sell one unit of gas at €50 for delivery and payment on June 1st, and the market price of the gas suddenly goes to €100 on January 30th, then the buyer will want to have sufficient cash from the seller to cover this extra cost today to be sure he can buy that one unit if the seller fails to deliver this unit on June 1st.

Uniper purchases most of the gas they need from Russia’s Gazprom – another government-owned company. It appears that Uniper uses long-term contracts with Gazprom that attempt to fix prices and volumes for current and future deliveries because they need to sell gas and power to their customers in Europe at fixed prices. 

However, Uniper appears to be sitting in the middle of a pricing dilemma according to the following document from Fortum. It states that both price and volumes of deliveries from Russia are not fixed and may vary in ways which are described as “detrimental” for Uniper. This makes hedging extremely difficult, or put another way, Uniper has a source of risk that can defy normal hedging or make hedging expensive.

“Long-term gas supply contracts of Uniper generally include the possibility for the customer and the supplier to adapt contractual terms to changed market conditions. This entails the major risk for Uniper that suppliers will impose conditions that are detrimental. In order to limit the risk, negotiations are conducted by the most experienced employees utilizing all available internal and external expertise.”

The contracts with the Russians appear to contain high levels of uncertainty and will therefore to create an increased need for hedging and margin calls will increase relatively more when the market price of gas increases rapidly as we have seen this last year. 

This is clearly challenging for Fortum to manage and thus we see unusually large loans for €10 billion which have been announced this week. It is worth noting that the money was not raised from private banks but from internal and German government-owned sources. The German government is obviously concerned that Uniper should continue its gas and power activities without any hiccups. In some sense one can regard this financing package to resemble a state bailout of a sticky situation.  

Why Fortum wanted to buy a fossil fuel company like Uniper with the proceeds from selling rather cheaply a highly profitable transmission company to private equity groups is one of the biggest mysteries of corporate finance? Fortum would have done better to have invested the proceeds in renewables rather than getting involved in even more expensive Russian deals. Their appetite for such risk appears to be insatiable since they have also taken a slice of the next nuclear plant deal to be delivered by the Russians here in Finland. This plant has yet to receive planning permission from the nuclear safety authorities here after years of failed attempts. Even my grandmother, bless her soul, knows that asking Russians to build a safe nuclear plant is asking for trouble… Building any nuclear plant is tough today. The latest one built by the French for TVO was over 10 years late, and cost many times more than what was agreed!

Illustration: Alice at the Mad Hatter’s tea party — Illustration to the fifth chapter of Alice in Wonderland by John Tenniel. Wood-engraving by Thomas Dalzie

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