Integrated Annual Report 2018
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Reduction of CO2 emissions and expansion of renewable energy

The Paris Agreement (2015 XXI UnitedNations Climate Change Conference, or COP21) seeks to minimise the impact of climate change, entailing a reduction in emissions that is only possible if there is a long-term transformation in energy. This energy transformation may be an opportunity, since it will require increased investment, but it will also reshape the appeal of businesses and investments alike.

Although there is no single path to achieving the climate goals, the most ambitious scenarios pose significant challenges for fossil fuels.

Due to falling capital costs, renewables are consolidating their leadership and will be the fastest-growing primary energy source in the medium and long term. Renewables are expected to expand from 2% of primary energy demand in 2016 to 6% by 2040.

Natural gas is expected to account for 20% of the primary energy mix in 2040, as it is the main energy source that is compatible with the climate commitments.

Renewables are expected to expand
2%
·····>
6%
2016
 
2040

Growing electricity demand and energy efficiency

In terms of final energy consumption, electricity will expand by 62%, from total worldwide demand of 21,000 TWh in 2016 to 34,000 TWh in 2040. Development of the emerging economies will require increased use of electrical applications (motors, cooling systems, information technology, etc.), while greater electrification of homes and transportation, coupled with digitalisation, will drive growth of electricity as a final energy source.

Electricity's share of total energy demand is expected to rise from 19% in 2016 to 23% in 2040.

Electricity's share of total energy
19%
·····>
23%
2016
 
2040

Big data and data analytics

Digitalisation in the energy sector, such as the development of applications and services that transform the relationship with customers due to greater connectivity, will enable demand management to be optimised (smart devices) and the portfolio of products and services to be expanded

The number of connected devices is expected to increase by 27 billion between 2017 and 2020. Sales via digital channels are expected to increase by over USD 1 trillion in the same period.

Number of connected devices
27 billion
2017-2020

Risks

Risk management model

Naturgy's risk management model seeks to ensure that the company's performance is predictable in all aspects that are of relevance to its stakeholders. This requires establishing the risk tolerance by setting limits for the main risk categories. In this way, the company can anticipate the consequences of certain risks and be perceived in the market as a sound, stable company, with all the benefits that entails.

Naturgy has a framework integrating the vision of governance, risks and compliance so as to provide a 360º view of the group's processes, existing controls and the associated risks.

Risk management bodies

Guaranteeing the predictability and sustainability of the company's operational and financial performance is a key aspects of risk management at Naturgy, and is supported by a number of bodies with clearly identified areas of responsibility.

Business, Corporate and Project units
Businesses
Risk Control Units
Risk Committee
Audit Committee

Audit Committee

Supervises the company's internal control and risk management systems. Its function is to identify the various types of risk and the measures implemented to mitigate them, and to address them in the event that they materialise in the form of actual damage.

Risk Committee

Entrusted with determining and reviewing the company's target risk profile. It ensures that the risk profile is aligned with the company's strategic position and it also safeguards stakeholders' interests. It also exercises oversight to ensure that the entire organisation understands and accepts its responsibility for identifying, assessing and managing the main risks.

Risk Control Units

In charge of monitoring and reporting risks and ensuring that they fall within the limits defined in the target risk profile by the Risks Committee. Three units in particular stand out:

  • Risks and Insurance: Identifies, monitors and tracks the Group's overall risk profile based on a definition of policies and metrics in coordination with the business units. Supports the Risk Committee in determining and monitoring the overall risk profile.
  • Gas & Power Risks: Oversees and proposes measures to mitigate risks on the basis of Group policy, reducing volatility to achieve the target rate of return.
  • Internal audit:Reviews and tracks the internal control system established by Senior Management and evaluates the operational risks linked to the processes. Supports the Audit Committee in its supervisory functions.

Businesses

In charge of managing risk in all their areas of action. They identify trends and positions that may entail risk and report them to the Risk Units. They also apply the guidelines and criteria established by the Risk Units.

Business, Corporate and Project units

Responsible for applying the general principles established in the Risk Control and Management Policy and for risk management in their areas of responsibility, observing, reporting, managing and mitigating risks.

Risk categories

Each business unit has specific information on the main types of risk that may affect it. The goal is to facilitate decision-making, which is positive for the company since it enhances profitability, predictability and efficiency.

The system addresses basically three categories of risk:

  • Market risk: understood as the uncertainty related to commodity prices, exchange rates and interest rates, which may impact the company's balance sheet, its procurement costs or its ability to raise funding in the capital markets. It is measured using two yardsticks: in the short term, focused on the income statement, and in the long term, focused on enterprise value, including the capacity to generate cash flow and its stability, variations in the funding structure, and volatility in the applicable discount rates.
  • Credit risk: i.e. the risk to the financial solvency of the company's receivables. It also incorporates the short-term measurement of returns on placing cash surpluses with financial institutions, the aim being to select the most efficient portfolios.
  • Operating risk: i.e. the possibility offinancial losses as a result of failures in processes, internal systems or other factors. It enables risk to be measured objectively, which is decisive for raising awareness within the company and for improving management of exposure, all of which have an essential impact on the reinsurance market's perception of Naturgy's operational excellence.

Main risks

Risk type Description Management approach Metric   Trend
Market risks          
Commodity prices Gas Volatility in the international markets that set gas prices.

Physical and financialhedges. Portfolio management.

Stochastic Decoupling of long-term contracts from hub prices.hubs.
Electricity Volatility in the Spanish and Portuguese electricity markets. CPhysical and financial hedges. Optimisation of the power generating fleet. Stochastic Penetration by renewables with zero marginal cost and intermittent production.
Volume Gas Mismatch between gas supply and demand. Optimisation of contracts and assets worldwide.

Deterministic

  Aggregate demand pressure in Spain in a context of energy efficiency.
Electricity Reduction of the available thermal gap. Uncertainty about volume of hydroelectric output.
Optimisation of the balance between supply and generation. Stochastic Aggregate demand pressure in Spain in a context of energy efficiency.
Regulatory   Exposure to regulatory review of the criteria and returns recognised for regulated activities. Heightened intensity of communication with regulatory bodies.
Adjusting efficiencies and investments to recognised rates.
Scenarios Different business units at different stages of maturity.
Exchange rate Volatility in international
currency markets.
Geographic
diversification.
Hedging via local
currency funding and
derivatives. Monitoring
of the net position.
Stochastic   Uncertainty about
growth prospects in Latin
America.
Interest rate and credit
spread
Volatility in funding rates. Financial hedges.
Diversification of
funding sources.
Stochastic   Uncertainty about the
interest rate scenario.
Tax Ambiguity or subjectivity
in the interpretation of
current tax regulations,
or due to a material
amendment of same.
Queries to a
independent expert
bodies.
Engagement of top
level advisory firms.
Adoption of the Code
of Best Tax Practices.
Recognition of
provisions on a
prudential basis.
Scenarios   Different business units
at different stages of
maturity.
Credit risk
Credit Uncertainty about
performance of bad debt
ratios as a result of the
economic cycle.
Analysis of customer
solvency to define
specific contractual
conditions.
Debt collection
process.
Stochastic   Pursues efficiency in debt
collection.
Operational risk
Operational: insurable risks Accidents, damage
and non-availability of
Naturgy assets.
Continuous
improvement plans.
Optimisation of total
cost of risk and of
hedges.
Stochastic Growing tension in
the insurance market
in the face of natural
catastrophes.
Operational: image and
reputation
Impaired perception of
Naturgy by stakeholders.
Identification and
tracking of potential
reputational events.
Transparency in
communication.
Scenarios   Stabilisation of MERCO
index score.
Operational:
environment
Harm to the natural
and/or social
environment. Evolution of
environmental regulation.
Emergency plans at
facilities with risk
of environmental
accident.
Specific insurance
policies.
End-to-end
environmental
management.
Scenarios Implementation of an
Integrated Management
System that is audited
and certified each year byo
AENOR.
Operational:
climate change
Changes in environmental
factors as a result of
climate change.
Regulation aimed at
combating it.
Corporate positioning
vis-à-vis climate
change.
Stochastic/
Scenarios
Uncertainty about
policy developments
to encourage energy
efficiency.
Metrics used:
Stochastic:production of trend lines for the main magnitudes, taking the maximum deviation from the benchmark scenario to be the risk, within a pre-set confidence interval. Those magnitudes are generally Ebitda, earnings after taxes, cash flow and value.
Scenarios:analysis of the impact with respect to the benchmark scenario of a limited number of possible incidents.Financial risks - interest rates, exchange rates, price of raw materials or commodities, credit risk, liquidity risk- are explained in Note 18 of the Consolidated Annual Report.

Opportunities

Naturgy's main opportunities are as follows:

Renewable generation

Renewable generation: Increase renewable capacity internationally, given that renewable energies are costcompetitive and considering Naturgy's presence in growth markets.

Generation mix

Generation mix: Naturgy's generating fleet, which is dominated by CCGTs, has the necessary flexibility to adapt to different market situations and is a valuable asset for seizing opportunities related to volatility in prices and demand volume in the gas and electricity markets.

Portfolio of natural gas and LNG procurements

Portfolio of natural gas and LNG procurements: Management of gas pipelines, stakes in plants and the fleet of LNG carriers make it possible to meet the needs of the Group's various businesses in a flexible, diversified way by optimising for different energy scenarios. Naturgy is one of the world's leading LNG operators and a key player in the Atlantic and Mediterranean basin.

A balanced structural position

A balanced structural position: in businesses and regions, many of them with stable flows that are independent of commodity prices, making it possible to optimise the capture of energy demand growth and maximise new business opportunities in new markets.

Technological development and innovation

Technological development and innovation: Naturgy focuses on research, development and innovation as a means of generating a reliable, sustainable energy supply. 

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