Investing in the Lithuanian Energy Sector

Lietuvos Energetikos Konferencija 2013

10.10.2013 Vilnius

Jaakko Vähä-Piikkiö, Vice President, Baltic Region

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Our geographical presence today

TGC-1 (~25%)Power generation ~7 TWhHeat sales ~8 TWh

OAO Fortum Power generation 19.2 TWhHeat sales 26.4 TWh

Russia

PolandPower generation 0.8 TWhHeat sales 4.3 TWh

Baltic countriesPower generation 0.4 TWhHeat sales 0.9 TWh

Nordic countriesPower generation 51.6 TWh

Heat sales 14.5 TWh

Distribution customers 1.6 million

Electricity customers 1.2 million

Nr 3 Power generation

Electricity sales

Nr 2

Nr 1 Heat

Distribution Nr 1

Key figures 2012Sales EUR 6.2 bnOperating profit EUR 1.9 bnBalance sheet EUR 25 bn Personnel 10,400

Great BritainPower generation 1.1 TWhHeat sales 1.8 TWh

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Fortum's carbon exposure among the lowest in Europe

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200

400

600

800

1000

1200

88

g CO2/kWh electricity, 2011

201268% of Fortum's total power generation CO2-free93% of Fortum’s power generation in the EU CO2-free

Close to 100% of the ongoing investment programme in the EU CO2-free

Average 338 g/kWh

192

Note:Fortum’s specific emission of the power generation in 2012 in the EU were 42 g/kWh and in total 171 g/kWh.Only European generation except “Fortum total“ which includes Russia.

Source: PWC & Enerpresse, Novembre 2012Changement climatique et Électricité, Fortum

Fortum’s investment programme – Nordic region and Baltic countries

Project Electricity, MW Heat, MW Commissioned

Olkiluoto 3, Finland 400

Swedish nuclear upgrades 290

Refurbishing of hydro power 10 annually

Additional electricity capacity around 870 MW 100% CO2-free

Total ~870 ~380

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Blaiken, Sweden, wind power 30 Q1 2013

Brista, Sweden (waste CHP)

20 57 Q4 2013

23Järvenpää, Finland, biomass CHP 63 Q2 2013

Jelgava, Latvia(biomass CHP)

23 45 Q3 2013

Värtan, Sweden(biomass CHP)

130 280 Q2 2016

20Klaipeda, Lithuania, waste CHP 60 Q2 2013

Already commissioned:

New electricity capacity will require over 60 €/MWh power price

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Estimated lifetime average cost in nominal 2014 terms.Large variations in cost of new hydro and wind due to location and conditions.

Gas Nuclear Hydro Wind Cleancoal

EUR/MWh

0

10

20

30

40

50

60

70

80

90

100

110

Other costs ( variation)

CO2 cost

Coal0

10

20

30

40

50

60

70

80

90

100

110

Source: Nord Pool spot, NASDAQ OMX Commodities Europe

EUR/MWh

Futures2 September 2013

1995 2013 2023

Competitiveness of energy efficient CHP will increase driven by fuel prices and by need to reduce emissions

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• CHP is local, smaller scale production

– Resource efficiency compensates scale

– Possibility to use local fuels (bio, waste)

• CHP covers about 10% of world electricity supply with significant growth potential globally

• CO2 issue will increase CHP’s competitiveness

• EU’s Industrial Emissions Directive to drive new CHP investment potential further

• Synergy opportunities in the growing bio energy and bio fuel markets

• Organic growth potential in emerging markets

>100

Global new CHP potential 1,350 TWhe

From 2,000 TWhe up to total 3,350 TWhe by 2020

>250

>500

>500

Small scale CHP

Desalination

Industrial CHP

District heating

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Investments in Waste-to-Energy solution to many challenges

• Increases domestic electricity production

• Reduces heat prices to competitive level

• Resolves problem to comply with EU Landfill Directive

• Reduces CO2 emissions

• Replaces imported fuel and contributes to security of supply of energy

• Resolves a remarkable part of EU energy efficiency targets for district heating in Lithuania

Circular Economy

Heat regulation regimes vary across Europe – transition towards competitive heat markets and pricing

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Source: Fortum analysis based on benchmarking selected DH/CHP markets in Europe. KPMG survey 2012,

Alternative-based heat pricing as main pricing principle to promote DH against

other heating solutions

DH company sets competitive prices while authorities monitor pricing based on

competition law

Heavy-touch ex-ante price control based on established methodology and approval

of autonomous regulator

Heavy-touch ex-ante price control based on multi-level approval by state, regional

and local authorities

• Norway and Netherlands

• Sweden, Finland, Denmark, Germany, Austria, Belgium, France and UK

• Estonia, Latvia, Lithuania, Poland, Czech Republic, Slovakia, Hungary, Bulgaria and Macedonia

• Russia, Romania, Belorussia and Ukraine

Regime categories

Prospects for effective competition in local heat markets

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DH/CHPsystem

CO2 trading

Liberalized electricity markets

Heat\cooling

customers

Competitive pressure from

alternative space heating

solutions

Alternative heat production

sources

Competition in fuel supply (RES, waste)

Future CHP products

(eg. Pyrolysis, cooling)

Production Distribution

• Heat pump• Individual gas and coal boiler• Solar collectors

• Industrial waste heat• Existing other DH producers• New entrants based on

RES/CHP subsidy mechanisms

• Customer’s own heat production

• New base load capacity e.g. waste-to-energy

Towards competitive heat markets and pricing

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Fair and effective

competition in local heat

markets between space

heating alternatives and heat producers.

Competitive and value-added DH

through alternative-based heat

pricing.

Attractive, risk-adjusted

returns on refurbishment of privatized

DH assets and on green field

CHP investments.

Effectivecompetition

Competitivepricing

Attractivereturn allowance

Incentives forbenchmark

performance

World-class DHC\CHP

operators can earn higher

than average returns.

Clear responsibility and incentive mechanisms for long-term DH system

optimization.

DH systemoptimization

Position on District Heating and Cooling

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CONTRIBUTION TO SUSTAINABLE DEVELOPMENT

LIBERALIZED HEAT MARKETS

COMPETITIVE PRICING FOR CUSTOMERS

• Renewable and efficient District Heating and Cooling are vital contributors for Europe’s targets for combating climate change and resource efficiency

• DHC are most simple, safe and sustainable ways of providing heating and cooling

• Combined heat and power (CHP) is most energy efficient way of producing heat and electricity

• Utilization of waste heat sources - as an energy otherwise lost - should be highly promoted

• Local heating market where DHC competes with alternative solutions should be deemed as ‘relevant market’.

• Effective competition is the most functional platform to develop the heat market, for customers, suppliers and society

• Customers should have the freedom of choice between different alternatives in heat market

• DHC should be treated as normal, profit making business

• Main steering mechanisms (energy taxation, ETS) should drive behavior towards resource efficiency and combating climate change i.e. sustainable developments

• Competing heat sources such as waste heat should enter heat market on commercial merits

• DHC pricing should be value-added• Competitive towards alternatives• Non-discriminating; equal customers to

be treated equally• Transparent

• Price comparisons of all heating alternatives should reflect full operational and capital costs to give effective and correct signals for customers, suppliers and relevant public stakeholders

• Price comparisons should be transparent, traceable and easily accessible

• When DH prices are being ex-ante approved by regulators or ex-post reviewed by competition authorities, prices should also reflect effectively incurred costs and risk-adjusted return on capital employed so that high efficiency will be incentivized

FORTUM’S POSITION ON DHC IS FULLY ALIGNED WITH EU’S ENERGY POLICY

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Market challenges in district heat sector in LithuaniaEnergy investors expectations

• Relatively high DH prices – heavy-touch regulatory environment – missing long term prospects for the needed heavy investments – natural gas based production as a result

• Heavy-touch regulatory involvement

– District heating sector needs to develop significantly to remain competitive in the future – how does current regulation support these developments?

– Competition between DH and main alternatives will anyhow grow regardless of regulations

• Investors expect high predictability of the long term legal and regulatory framework - possibility to rely on key investment incentives when making the investment decision – no retroactive and sudden changes

Long-term system optimization – targeting improved capacity utilization

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Figure. Annual production curve of a DHC system

Base load

Middle load

Peak load

Cooling load

Condensing mode and new products

i.e. cooling, bio-oils

“Open district heating”

• Optimizing the cost of peak heat load through heat trading between customers having own capacity and DH operator – Fortum is running a pilot program on ‘’Open DH system” in Stockholm, Sweden

• Improving CHP capacity utilization – Fortum will start industrial scale bio-oil production in Joensuu CHP plant, Finland

Waste/biomass/coal/gas

Biomass/coal/gas

Biomass/coal/gas

Gas/oils

DH

system specific priority order

Tartu, Estonia bio/peat CHP 25 MWel/50 MWth in operation since 2009

Pärnu, Estonia bio/peat CHP 23 MWel/45 MWth in operation since 2010

Fortum’s recent investments in the Baltics in local fuel based CHPs

Klaipeda, Lithuania WtE CHP 20 MWel/50 MWth in operation since May 2013

Jelgava, Latvia bio CHP 23 MWel/50 MWth

in operation since September 2013

How to gain public acceptance – the Klaipeda Waste to Energy plantEHP Congress, May 27 – 28 2013, Vienna

Kristian Rehnström

How to gain public acceptance – the Klaipeda Waste to Energy plant

EHP Congress, May 27 – 28 2013, Vienna

Kristian Rehnström

Thank you!