Operating internationally and buying commodities denominated in USD the Group is subject to the risk that fluctuations in foreign exchange rates may affect the fair value of some of its assets and liabilities. Although the Group produces and sells mainly in the euro area it is subject to exchange rate risk especially in relation to the British pound, the Brazilian real, the US dollar, the Argentine peso, the Chinese renminbi and the Indian rupee.

The Group uses forward contracts to reduce the risk of fluctuations in the EUR/USD exchange rate. As described in the paragraph on Price risk, in some cases it covers its purchase and sales formulae directly and the price of this cover depends on the EUR/USD exchange rate. By fixing its formulae in euro, the exchange rate is indirectly hedged too.

Regarding the exchange rate risk of translating the financial statements of foreign operations, the operating companies generally have a degree of convergence between their sourcing costs and their sales revenues and this kind of risk is also limited by the fact that the companies operate in their local currencies, are active in their own domestic markets and abroad and, in the event of need, can raise funding locally.

In order to show the potential effect in the financial statements of the exposure to exchange rate risk, a sensitivity analysis was carried out, assuming shifts in the exchange rate. For the purposes of comparison, the results of the analysis at December 31 2009 are also shown.  

Through the activity in the utilities sector of the Sorgenia group, the Group is exposed to the risk of fluctuations in energy commodity prices on the purchase of fuels for its power production plants and on its purchases and sales of gas and electricity (where contracts stipulate specific indexing to baskets of fuels). Moreover since almost all of the commodities in question are priced in US dollars, the Group is also exposed to fluctuations in the EUR/USD exchange rate.

Sorgenia continually monitors this exposure by breaking its contractual formulae down into the underlying risk factors and managing the exposure using a two-stage procedure.

First, taking part in the negotiation of contracts for the purchase of electricity and gas and in the definition of pricing policies enables the Group to verify rates used and thus achieve a high level of natural hedging, minimizing the impact on margins of the factors of uncertainty mentioned above not only at business line level but also at consolidated portfolio level.

Secondly, monitoring net remaining exposure after the action described above. Sorgenia trades derivative instruments with prime financial institutions in order to minimize counterparty risk. The derivatives in question are traded over the counter (OTC), directly with the counterparties, and are mainly fixed to floating swaps or vice versa for commodity price hedges, and outright forwards for exchange rate hedges.

Since 2008, in view of the greater liquidity in the derivatives markets, in order to reduce basis risk on the hedges as far as possible, the group has started negotiating with its financial counterparties contracts where the underlying is the whole formula for the purchase or sale of natural gas or electricity. These hedges make it possible to eliminate the change in costs and revenues due to the commodity risk factor and the exchange rate risk factor by entering into just one contract.

As from this year  these commodity derivative contracts, being entered into exclusively for hedging purposes, are managed according to the rules of hedge accounting as set out in IAS 39. Therefore the effects in terms of profit and loss of the changes in their fair value are recognized directly to a special equity reserve (Cash flow hedge reserve).

Should the effectiveness test show that the hedges have some degree of non-effectiveness, the non-effective part will be recognized immediately to the income statement.

The fair value of derivatives contracts is calculated using market forward prices as of the balance sheet date, when the underlying commodities are traded in markets where there is a forward price structure. Otherwise the fair value is calculated using internal models based on data and information available in the market, supplied by recognized and reliable third party sources.  

Regarding the hierarchical form of classification introduced by the recent Amendment to IFRS 7 which is based on three levels according to the method and the input used to determine fair value, it should be pointed out that the financial instruments used for managing commodity risk belong to level 2 of the fair value hierarchy.

The valuation techniques for derivatives outstanding at the end of the year were the same as those adopted last year.

For commodities the maturity of the swap contracts is generally no longer than 18 months. At December 31 there were no open positions in liquid fuel derivatives; the fair value for this kind of instrument was therefore zero.

There were however open positions in derivatives on price formulae maturing in 2011 and 2012.

In order to measure the exposure to the group to the risk of changes in the prices of commodities and gas and electricity price formulae, a sensitivity analysis was carried out based on the revaluation of the fair value of derivative contracts outstanding at December 31 2010 in the event of shifts in commodity prices.

In order to revalue these financial instruments and quantify the effect on the accounts of shifts in the price curve of liquid fuels, guaranteeing the highest possible degree of accuracy of measurement, the same financial models were used as those used to produce the reports for management showing how exposure is constantly monitored.      

The following chart shows the sensitivity analysis results for commodities:  

  The higher exposure to the risk of changes in commodity prices, which is however offset by physical purchases and sales of fuels on the spot markets, is due to the fact that hedges were put in place using financial contracts over a longer time horizon than in the previous year and that there were more contracts outstanding at December 31 2010 compared to December 31 2008. In fact at that date all the positions were closed. 

As in 2009, in 2010 the Sorgenia group minimized its exposure to the changes in commodity prices thanks to greater opportunities for defining sales formulae consistent with its sourcing formulae and thanks also to having established hedging strategies using financial instruments.

The derivatives  in commodities are in fact entered into for the exclusive purpose of hedging, therefore the changes in the results of the commodity derivatives positions are offset by changes in the results of the underlying physical positions with an impact on the income statement essentially limited to the basis risk in all cases where there is a discrepancy between the commodities of the underlying physical contracts and the liquid commodities traded in the markets, both managed and OTC, on which the derivative instruments are based.

During 2010 the Sorgenia group managed to reduce this remaining risk factor thanks to its ability to negotiate with its financial counterparties both hedges of its sales formulae and less liquid commodities with which the values of the underlying physical contracts are directly correlated.  

As from this year the Sorgenia group also engages in speculative trading activity. This activity is separated out in a special portfolio and the deals done were in the power market, in commodities and foreign exchange. This portfolio is monitored on a daily basis by a special department of the company, has strict limits as to risk (calculated through VAR) and profit and loss (calculated as a stop loss limit on P&L).

In 2010 the area started operating with a daily VAR of 95%. ther average percentage of use of the VAR limit has been 58%, closing at December 31 with a value of approximately € 88,000, while the stop loss limit has not yet been activated.

In ordere to calculate VAR reliably, the Risk Management department of Sorgenia S.p.A. has developed a mixed parametric-simulative method on the basis of which price scenarios are generated which are consistent with the parameters described by historical observations. The Value at Risk is on a daily basis and has a confidence level of 95%. The value of VAR is a function of statistical price distribution and market returns, and also of serial correlations of different products and markets.