RISK MANAGEMENT AND SENSITIVITY ANALYSIS

Billerud’s products are generally dependent on the business cycle in terms of both price trends and delivery volumes. Market pulp, which accounts for around 20% of Billerud’s sales, is considerably more sensitive to the business cycle than packaging paper is. Variations in the market prices of Billerud’s products can influence Billerud’s profit or loss unless the price variations are related to changes in Billerud’s costs. Demand for Billerud’s products is influenced by the behaviours and attitudes of Billerud’s customers and end-customers.

There are various pricing models for packaging paper, the most common being interim pricing. Fixed price contracts extending over a long period only occur to a limited extent.

The price of market pulp is determined by the current market price. Billerud’s mills have higher capacity for production of sulphate pulp than it requires to produce packaging paper. To produce in a cost-effective way, Billerud is largely dependent on being able to sell surplus sulphate pulp as market pulp.

Billerud works continually on its process efficiency to adapt its costs, to counter the negative influence that lower market prices have on Billerud’s operating profit.

Nearly all sales are based on framework agreements specifying general delivery conditions and planned delivery volumes. A minor portion of sales consists of spot sales, that is, sales not subject to a framework agreement. Spot prices may be higher or lower than framework agreement prices, and such sales occur above all in the market pulp sector.

Billerud works continuously to increase product differentiation based on customers’ needs and to boost the proportion of sales to consumer-related industries, for example to reduce cyclical fluctuations.

During 2010, Billerud increased prices on packaging paper in line with the market with the purpose of restoring prices to the level prevailing before the recession. Thus average prices for Billerud’s packaging paper segment rose 15% in local currency, compared to the average prices in 2009 in local currency.

The market price of market pulp increased, from USD 800 per ton at the end of 2009, to USD 950 per ton at the end of 2010.

During 2010, a customer survey and numerous other activities were carried out to further improve our insight into customers. The product launches done during the year were the result of in-depth dialogue with customers about what kinds of products they demand.

Billerud has three production facilities that operate round the clock, every day of the year. The only planned shutdown is the periodic maintenance shutdown at each mill. Continual operation means high efficiency in the utilisation of capital, but it also raises sensitivity to unplanned disruptions to production. If disruptions in operations occur that lead to major production losses, they may result in loss of income to Billerud.

Extensive effort is devoted to developing production plant so as to ensure operational reliability. This is in addition to structured work on documentation, skills development for employees, a well thought-out approach to preventive maintenance and careful follow-up and analysis of deviations. To protect Billerud in the event of serious breakdowns or other production problems, the facilities are insured against disruptions. For disruptions that result from serious breakdowns or other damage, such as a fire, power failure, water damage, Billerud will be compensated by the insurance company for damages beyond the excess. Billerud is also insured for property up to replacement costs.

During 2010, a strike occurred at Billerud’s Swedish mills which adversely affected production at two mills. During the year, Billerud was fully compensated for these strike-related costs by the Confederation of Swedish Enterprise.

Supplies of fresh fibre are vital to Billerud’s production of paper. Billerud does not own any forest; it buys all its wood raw materials on the timber market.

These purchases are made from a small number of major suppliers, such as Stora Enso, Holmen and Sveaskog, as well as from a larger number of private landowners in northern Sweden. In addition, about 25% of the company’s timber requirements are imported, mainly from the Baltic states. Billerud’s assessment is that its partnership with the major suppliers will account for the main share of wood raw material deliveries for the foreseeable future.

In 2010, the wood market was in balance.

Energy costs represent a major component of the manufacturing costs. Billerud consumes electricity, biofuel, oil and smaller amounts of other types of energy. Higher energy prices could result in higher operating expenses for the Group and have a negative effect on operating earnings.

The biofuel-based portion of Billerud’s electricity generation capacity entitles the Company to “electricity certificates”, sold on an ongoing basis. A change in the system for electricity certificates and the price of electricity certificates could lead to changed expenses for Billerud.

In 2005 and 2006, Billerud carried out a comprehensive investment programme in the energy sector that has reduced the amount of electricity it needed to purchase, from 1.2 TWh, to approximately 0.8 TWh since the start of 2007. Thus Billerud’s self-sufficiency in electricity is around 60% at full output. In May 2007, Billerud signed a 10-year supply agreement for electricity at fixed prices with Vattenfall. The agreement covers basic power requirements of around 0.4 TWh per year for the period 2008–2017. Through this agreement and its own power generation capacity, Billerud has secured, since the beginning of 2008, approximately 80% of its electricity energy requirement in a satisfactory manner, with a balanced combination of in-house generated electricity and long-term supply agreements. The remainder of the external energy requirement will be bought on the spot market or reduced by further energy savings.

In 2010, total electricity consumption was about 1.5 TWh, of which about 48% was generated in-house, about 29% was basic power purchased from Vattenfall at fixed prices and about 23% was purchased in the spot market.

Besides wood and energy, many other inputs are used in the manufacture of Billerud’s products. Market prices for these inputs vary over time, which can affect Billerud’s earnings.

Certain process chemicals are by-products from chemical processes and their price can therefore vary significantly between years. Prices for other chemicals have been much more stable. Overall, however, chemical price trends have been stable.

Historically, prices for other input materials, such as packaging material and machine covers, have been stable.

In 2010, chemicals accounted for 7% of Billerud’s total operating costs, compared to 8% in 2009. Other inputs accounted for 4%, compared to 4% in 2009.

Billerud purchases services such as freight to customers and maintenance services. Market prices for these services vary over time, which can affect Billerud’s earnings.

Freight costs are fixed annually via agreements. Freight costs are affected by energy prices, wage costs and competition between freight companies.

Other purchased services mainly comprises maintenance services in connection with the annual maintenance shutdowns and regular maintenance. The prices of services are primarily affected by trends in wage costs in Sweden.

In 2010, freight to customers accounted for 11% of Billerud’s total operating costs, compared to 12% in 2009. Shipments by railway accounted for 30% of freight costs incurred by Billerud’s mills, while shipments by sea accounted for 40% and road freight 30%.

In 2010, other purchased services accounted for 5% of Billerud’s total operating costs, compared to 4% in 2009.

Access to skilled and motivated employees and managers is a prerequisite for achieving the goals Billerud has set.

Personnel costs constitute the second largest expense item.

Billerud works continually to manage generational succession and the conversion of skills. So as not to risk losing vital know-how, the Company needs to attract skilled employees. To avoid a skills gap in the years ahead, Billerud is working now to strengthen its brand as an employer.

Wages and salary costs are primarily regulated by collective agreements, payroll taxes and other related legal requirements.

2010 saw the start of the Group’s first graduate training programme with the aim of employing 10 trainees a year over the years to come. In addition, new managers were recruited to all Swedish mills. Billerud also launched its Employer Branding project, which aims to profile Billerud as an employer focusing on sustainability.

In recent years, wage costs have risen through agreements around 3% per year.

Billerud’s operations are governed by extensive environmental legislation and require permits under current legislation. These permits entitle the mills to produce a certain volume of pulp and paper but also stipulate a large number of conditions regarding, for example, emissions into water and the air, as well as noise and waste and chemicals management. Non-compliance with the permits may incur costs of environmental restoration, environmental penalty charges or criminal liability.

In Sweden and internationally, the trend is towards increasingly strict environmental legislation, in which new permits normally stipulate lower thresholds for maximum environmental impact. These rule changes can lead to requirements for major new investment to enable production to continue and requirements under existing legislation being made more stringent.

Even if the Company is meeting legal requirements, there is a risk of negative reactions from the community.

To minimise negative environmental impact, Billerud has established an environmental management system and an energy management system at each mill. The systems are certified under ISO so that environmental and energy aspects are identified and assessed and goals set with the aim of reducing the environmental impact of the operation. Training, supplier assessments and extensive follow-up of environmental activities are also included. Follow-up includes measurements and analyses, periodic audits and an annual evaluation of the management systems.

Operations at the Swedish mills are governed by the Swedish Environmental Code. Permits for conducting operations are obtained from the Swedish Environmental Court. The County Management Board supervises compliance with the environmental permits obtained by each mill. This work is ongoing. If necessary, feasible investments are introduced into the Group’s investment plan.

Billerud works actively to reduce its impact on climate change by reducing energy consumption and emissions of fossil carbon dioxide in production and in transportation. Read more about these efforts in the sustainability report in this annual report.

Environmental efforts were carried out during the year in a satisfactory manner. An application for a new production permit under the Swedish Environmental Code for the mill in Skärblacka was submitted to the Environmental Court.

Financing risk is the risk that Billerud will have difficulty raising new loans. Access to further financing will be affected by a number of factors, including market conditions, the general availability of credit and Billerud’s creditworthiness and credit capacity. In addition, access to further financing will be affected by any negative perceptions that customers, suppliers or lenders may acquire about Billerud’s long and mediumterm financial prospects. Disruptions and uncertainty in the capital and credit markets may also limit availability to the capital needed to operate the business.

To ensure that the Group always has access to external financing, the finance department must ensure that short and long-term credit commitments are available. Maximum cost-efficiency within established limits shall be the goal.

The lender base shall also be reasonably diversified to avoid excessive dependency on individual sources of financing. The repayment structure for loans shall be arranged such that the loan maturity in any particular year is evenly spread over a period.

In 2010, a new seven-year credit facility for SEK 800 million, maturing in 2017, was raised with AB Svensk Exportkredit. At 31 December 2010, outstanding bond loans totalled SEK 825 million. In addition, the credit limit for the syndicated credit facility maturing in 2012, which raised with a consortium of banks, was reduced, from SEK 1 800 million, to SEK 1 200 million. See note 20 for more information.

Billerud’s net debt amounted to SEK 155 million at 31 December 2010, down SEK 997 million from 31 December 2009. The decrease was chiefly attributable to improved cash flow.

Credit risk refers to situations such as when a counterpart in a financial transaction cannot meet commitments. If measures taken by Billerud to minimise credit risk are not sufficient, Billerud’s financial position and results may be adversely affected.

To avoid this, Billerud’s finance policy defines clearly how any excess liquidity may be invested.

When calculating credit risks, the positive effects on earnings of derivative contracts with counterparts are also taken into account. Billerud’s maximum credit risk exposure is equal to the fair value of financial assets, disclosed in note 23.