Risk management

EuroChem’s management assesses risks on a regular basis.

Over the past years, we have made progress in formalizing our risk management processes and further developing the corporate risk management function – as a result, we now have a more robust internal framework for timely risk identification, assessment, response and control, at both strategic and operational levels.

EuroChem classifies risks in three broad categories: strategic, financial and operational. The fourth important element – risks to our reputation – is viewed mostly as a derivative of the other three risk groups. Key risks as seen by EuroChem today are listed below.

Strategic risks

Our key strategic risks relate to the Potash, Nitrogen, Phosphate and Distribution segments. In addition, currently we also monitor regulatory and demand-related strategic risks as shown on the strategic map below.

Financial risks

While EuroChem is exposed to various financial risks, we assess and manage those risks in terms of their aggregate impact on our cash flows, including the likely correlations between the key variables.

Product prices. Out of all risk factors, declines in fertilizer/iron ore prices typically have the largest impact on our cash flows. Our ability to mitigate these risks through financial instruments is limited by liquidity constraints, however we assess their use on an ongoing basis.

Foreign currency risk. EuroChem is exposed to currency risk given its incoming and outgoing cash flows are denominated in different currencies. Substantial appreciation of the ruble against the US dollar may have negative effects on our cash flows. The level of EuroChem’s risk from foreign exchange fluctuations is reduced by the fact that the ruble tends to strengthen in times of strong commodity prices, which typically coincides with strong fertilizer and iron ore prices.

Interest rate risk. EuroChem’s cash flows are exposed to volatility from rising interest rates due to the fact that at the end of the reporting period all of our debt was floating rate. Liquid instruments are available for hedging against this volatility, but we estimate that the impact of rising interest rates on our cash flows would not be significant because the periods of rising interest rates tend to overlap with the periods of elevated commodity prices.

Increases in costs. Increases in freight costs, as well as certain other major costs items (natural gas, electricity, rail transport), at a rate outpacing increases on global markets could have a negative impact on EuroChem’s position on the global cost curve. We seek to reduce the impact of rising prices and tariffs by increasing energy efficiency, optimization of logistics and reducing reliance on outside supply whenever practical.

Other financial risks which are being managed on an ongoing basis include liquidity, investments in securities, financial covenants and risks linked to our credit rating. A discussion of our credit risk management is available in note 33 to the audited IFRS financial statements included in this report.

Operational risks

Loss of physical property and business interruption. Equipment failure or breakdowns at our plants or mines could lead to disruptions in production. We seek to mitigate these risks through a program of current maintenance and repairs, as well as a long-term program of capital investments and renovations. We are also evaluating the effectiveness of insurance products for physical property and business interruption.

Health, safety and environment. We regularly review our HSE procedures, including those that apply in emergency situations. The robustness of our systems in the area is evidenced by our ISO certifications for quality management, environmental management and health and safety management. Starting in 2010, we began to offer employee accident insurance. We are also evaluating the use of voluntary third-party liability and extended environmental insurance policies.

Sub-optimal sales. These risks emanate from losses due to counterparty risks or foregone revenues due to a sub-optimal sales process. We mitigate these risks by, among other things, diversifying our customer base and expanding our finished goods storage capacity.

Fraud. EuroChem seeks to build its business processes in such a way that fraud risks are minimized. The Company’s Internal affairs and Internal audit units regularly evaluate the integrity of our internal control systems.

Construction risks. Delays in the construction of key production facilities can lead to significant losses of benefits and non-compliance with our strategic goals. To reduce these risks, we carefully select our contractors and ensure that project management is organized such that the procurement and construction risks are controlled. To mitigate construction risks we are also considering different insurance options covering heavy machinery transport logistics, shaft construction risks, physical property damage, and business interruption risks during active production.

Achievements in 2010

Strategic risks

We have formalized the way we identify, assess and respond to strategic risks. Management uses a risk map (below) and key performance indicators to track previously identified risks. Regular strategic reviews for our business segments allow us to identify new threats and take advantage of opportunities.

Financial risks

We have also formalized our approach to financial risk management. We evaluate financial risks over a 12-month horizon in terms of their contribution to the volatility of our cash flows – such volatility has a cost as it reduces our debt capacity, forcing us to substitute debt with more expensive equity. This volatility, however, may be reduced or eliminated by hedging, and it makes sense to do so for as long as the cost of hedging is below the cost of substituting debt with equity. We review the dynamics of cash flow volatility, the contribution of various risk factors to it, taking into account their historic correlation with each other, and the cost of hedging it, on a monthly basis.

Reputational risks

We have further advanced our reputational risk management by implementing a crisis communications system, which aims to prevent/ restrict damage our reputation and the value of our public securities by ensuring that a situation is dealt with publicly in an open, timely, transparent and proactive manner.

Plans for the future

Our top priorities are a comprehensive review of our operating risks, as well as a review of different insurance strategies as a risk management tool.

Strategic risk map

Circles represent estimated current risk positions; incoming arrows reflect changes in risk position over the past 12 months (yellow – an increase in risk, gray – a decrease); outgoing arrows reflect the risks estimated direction over the next 12 months. Absence of arrows implies no changes in risk perceptions. For more details on our strategic risks management, see this page.