UPM annual report 2015

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IN BRIEF

STRATEGY

BUSINESSES

STAKEHOLDERS

GOVERNANCE

ACCOUNTS

Business performance Operating profit decreased due to clearly lower average electricity prices. Significantly higher hydropower generation volumes reduced production costs, and thanks to good water availability and increased price volatility, profit opportunities improved from optimal use of the adjustable hydropower capacity. Return on capital employed met Mitigating market challenges The year 2015 was characterised by a challenging market environment. Electricity prices decreased and the competitive market situation remained distorted. Mild temperatures caused decrease in demand and electricity prices also decreased thanks to exceptionally good hydrology. The competitive market situation was impacted by non-market driven issues such as regulation, taxes and support schemes, benefitting renewable energy generation. Meanwhile other generation forms, including emission-free hydropower and cost competitive nuclear generation, suffered fromweak profitability and generally rising taxes and environmental regulation. Current low electricity prices and the distorted competitive market situation prevent market-based modernisation or new investments in low-emission generation technologies. The full potential of all sustainable alternatives may not be fully utilised. The challenging market conditions are laying the groundwork for industry restruc- turing, e.g. by mothballing coal condensing and decommissioning nuclear power capacity before the originally projected life span. Market situations may also call for structural changes in the industry and UPMEnergy, as a large producer, can be an active participant. The share of weather-dependent (wind and solar) power production is growing. This increases price volatility and also the need for flexible balancing power genera- tion to compensate for the variations in the production and consumption of electric- ity. Hydropower is an efficient way to produce this balancing power and it is needed to mitigate climate change. With its competencies and optimal use of its hydropower assets, UPMEnergy is well positioned to generate good profitability and create additional value from the increased electricity price volatility in the market. In 2015, UPMEnergy proceeded with its hydropower production asset upgrades. Through its ownership of Länsi-Suomen Voima Oy, UPMEnergy is participating in the expansion of the Harjavalta hydropower plant. The project covers a newmachine unit and refurbishment of the existing two turbines. When completed in 2017, the project will improve the efficiency, control and environmental safety of the plant, while also responding to the increasing demand for flexible capacity. The total power output of the plant will increase from 72 MW to 110MW. The largest ongoing project is at Teollisuuden Voima Oyj (TVO), which involves building a third nuclear power reactor, OL3, at Olkiluoto, Finland. The new unit will have an annual nuclear power generation capacity of approximately 1,600MW. long-term financial targets. Business development

UPM Energy

HYDROPOWER IS SUPERIOR BALANCING POWER

OUR DIRECTION • Create value in electricity generation and physical and financial trading • Profitable growth on the Nordic CO 2 emission-free electricity market OUR STRENGTHs • Cost competitive, low-emission electricity generation portfolio • Versatile asset base – nuclear power as base load capacity, hydropower as flexible capacity and condensing power as reliable peak load capacity • Strong competencies and value creation track record in physical and financial electricity trading • Proven capabilities in energy management services to both generating and consuming customers

As the use of renewable energy based on the forces of nature increases, also the need for balancing power grows to maintain the stable operation of the power grid. If there is no wind or sunlight, the electricity generated by windfarms and solar power plants has to be replaced by other energy sources. Balancing power is also needed for evening out the fluctuations in energy consumption. Hydropower is an excellent solution for producing balancing power. The electricity production of a hydropower plant can be adjusted very quickly by controlling water flow and the operation of the turbines. Unlike wind and sunlight, water can also be stored for future needs. By using reservoirs, electricity can be generated when it is needed. Autumn rainfall can for instance be used to generate electricity during the cold winter months.

Through Pohjolan Voima Oy (PVO), UPM is entitled to approximately 500MWof capacity. According to the plant supplier’s schedule, regular electricity production is scheduled to start at OL3 towards the end of the year 2018. In June 2013, UPM announced that it is participating in the share issue from Pohjolan Voima Oy to finance the Olkiluoto 3 nuclear power plant project. UPM’s share of the issue is EUR 119 million, of which EUR 31 million was paid in Q4 2015, EUR 31 million in Q4 2014 and EUR 31 million in Q2 2013. The remaining part of the share issue will be imple- mented in the coming years based on the financing needs of the project. In June 2015, Teollisuuden Voima Oyj decided not to apply for a building permit for the Olkiluoto 4 nuclear power plant unit, resulting in a charge of EUR 19 million related to UPM’s participation in the tendering and planning phase of the project. Markets and drivers • Electricity consumption in the Nordic countries is expected to remain stable. Demand is driven by household consumption, the commercial sector and industrial activity, and it is heavily dependent on temperatures. • In 2015, electricity consumption in the Nordic countries decreased slightly, primarily due to weather that was warmer than usual. • New capacity investments in the Nordic countries are driven by economics and influ- enced by regulatory policies and support schemes Therefore, capacity is mainly growing in subsidised renewables. • Due to current market conditions, existing generation capacity is decommissioned before the originally projected life span, e.g. it has been announced that Swedish nuclear capacity will be decommissioned earlier than expected. • Hydrological balance and wind in the Nordic countries impacts electricity supply and, therefore, electricity prices and price spreads between different price areas. • In the Nordic countries there are several different price areas; UPMEnergy’s assets are located in the Finnish price area only. Power markets across Europe are becoming more integrated due to new transmission lines.