RU

INTEGRATED REPORT 2016

Improving Risk Management

Paul OSTLING
Chairman of the Audit Committee

In today’s world, where new challenges are constantly arising, an important condition for the successful development of any company is the ability to manage its risks, in particular, identify them, take measures to mitigate them, and have a clear action plan in case of risk occurrence. Such work should be carried out in the company on a systematic basis and at all levels, with the understanding that decisions in the field of risk management should be carefully thought out and balanced as much as possible.

An effective risk management and internal control system remains one of the Company’s priorities. As part of these activities, at all levels, measures are taken to reduce the likelihood of negative consequences that may result from certain events. In 2016, the Company continued its risk management activities as part of COSO ERM, an integrated risk management concept, and ISO 31000 Standard.

Key risk factors

This section describes only the major and most significant risk factors, which may have a considerable impact on the financial and operating performance of Uralkali. All estimates and forecasts contained herein should only be viewed taking these risks into account.

Other risks, of which Uralkali is unaware or which are not currently deemed significant, may become material in the future and have a considerable adverse effect on the Group’s commercial, financial and operating performance.

The Integrated Report does not aim to give an exhaustive description of all risks that may impact the Company. Uralkali will disclose any necessary information in a timely manner according to the applicable laws.

Our risk management approach is based on an understanding of our current risk exposure, risk probability and impact, appetite and dynamics.

Activities completed in 2016

  1. Further introduction of a corruption prevention system and a compliance system at foreign subsidiaries.

  2. Further integration of risk management in operational management.

  3. Improvement of the internal control system in the foreign trader’s work.

Plans for 2017

  1. Further monitoring of risk management practices and their implementation in the Company’s operations.

  2. Completing introduction of corruption prevention policies and procedures in key foreign subsidiaries.

  3. Further improvement of the risk management and internal control system inthe foreign trader’s work, as well as foreign subsidiaries of Uralkali Group, and foreign investment management, including partial automation of internal controls.

I. STRATEGIC RISKS 1. Failure to meet targets set for investment projects
2. Change in the supply and demand balance on the main potash markets
II. OPERATING RISKS 3. Reduction in production/capacity
4. Lack of qualified employees
5. Non-fulfilment of obligations by contractors or suppliers
6. Expenditure increase
III. FINANCIAL RISKS 7. Inflation and currency fluctuations
IV. ENVIRONMENTAL RISKS 8. Environmental risks and risks related to mining operations
9. Risks related to the incidents at Berezniki-1 and Solikamsk-2
10. Non-compliance with environmental and health and safety regulations
V. MARKETING RISKS 11. Potash demand decline
12. Potash price decrease
13. Loss of market share on specific markets
14. Lack of specific products
VI. POLITICAL AND LEGAL RISKS 15. Risks, connected with the licensing of use of natural resources
16. Political and regulatory risks
17. Compliance with applicable legislation and internal policies
Risk Description Risk level Dynamics Comments Risk minimisation measures
STRATEGIC RISKS
Failure to meet targets set for investment projects Expansion CAPEX, costs associated with productivity increase and other investment costs of Uralkali are an important part of the Company’s expenditure budget. There are risks that investment projects’ timeframes and budgets will be exceeded, and risks that the projects’ technical parameters will not be achieved, or risks of project termination taking into account current factors and forecasts.
 
  • The Company continues to implement its investment programme
  • The Company continuously monitors and controls the implementation of its investment programme.
  • The Company makes investment decisions based on market outlook; it selects the most economically efficient projects, based on its financial abilities, and determines optimal implementation periods.
  • The Company uses project management principles.
  • Major investments are made after the design stage activities have been completed and after the timeframe, costs and feasibility of the projects have been confirmed.
Change in the supply and demand balance on the main potash markets Change in the supply and demand balance on the main potash markets, inter alia, because of a decrease in demand and price of potash due to both political and economic factors, may have a negative impact on the Company’s operations. The desire of potash producers to achieve high capacity utilisation in the context of insufficient demand can lead to potash oversupply and thereby to a reduction in global prices. All this may affect revenues and result in a decrease in the Company’s profits.
The demand for potash on major sales markets does not match the level of supply, which leads to price reduction, a decrease in the Company’s revenues and affects the ability to meet assumed obligations.
  • Uralkali’s management is developing a marketing strategy to promote potash.
  • The Company actively supports agricultural producers (e.g. by updating farmers’ calculators).
  • The Company maintains a flexible production strategy, increasing or decreasing production depending on current demand and market forecasts.
OPERATING RISKS     
Reduction in production/capacity External and internal factors, including accidents, downtime, a general decline in potash demand, can affect potash production.
Production capacity decreased in connection with the accident at Solikamsk-2.
  • The Company continues to expand its production capacity and replace retired assets, maintaining them in working order.
  • Uralkali sets production plans taking into account the current market situation and the adopted strategy.
Lack of qualified employees The Company’s business implies in-depth professional training and high qualification of its employees, in particular, in the field of production, mining, geology. Uralkali may face the difficulty of attracting and retaining staff with sufficient qualifications and the need for additional time and material resources to train and develop its employees. All this can negatively affect the Company’s timely achievement of its goals.
In the context of the planned launch and development of a number of mining projects in the Perm and neighbouring regions by other companies in the coming years, retention of qualified personnel is becoming one of the main tasks for the Company.
  • The Company constantly monitors the labour market and takes measures to retain personnel, mainly production, including through surveys to determine the degree of personnel engagement and monitoring the reasons for resignation.
  • The Company has implemented a system for personnel assessment and training. In 2016, new initiatives were launched for this purpose, for example, the Corporate University, licensed for training according to 250 programmes; a distance learning system; the Talent Pool programme for key positions in the production unit.
Non-fulfilment of obligations by contractors or suppliers The failure of key partners, relations with whom are strategically important, to meet their contractual obligations may adversely affect Uralkali’s performance.
The Company’s activities depend on monopolistic energy suppliers and the Russian railways. In the context of macroeconomic instability, suppliers and contractors can raise the price of their products and services. Timely fulfilment by suppliers, contractors and buyers of their obligations related to the implementation of the Company’s investment projects is critical in order to ensure compliance with deadlines within the approved financial investments.
  • The Company strives to ensure alternative suppliers and contractors are available for all its needs.
  • Uralkali is working towards enhancing contractual discipline to ensure the obligations undertaken by the parties are fulfilled on time and in full, including monitoring compliance with the terms of contracts through the introduction of additional controls (including KYC, credit policy development and risk assessment model) to improve the quality of documentation.
Expenditure increase Production costs may increase due to the wearand- tear of production equipment, utilisation of obsolete technologies, inefficient spending on operating activities or energy appreciation.
The Company is implementing programmes to increase productivity and reduce operating expenditures.
  • The Company is engaged in thorough budgeting and planning activities, ensures continuous monitoring and control of expenses of its bodies and officials.
  • The Company constantly improves performance discipline and implements additional controls that allow it to stay on budget and keep costs at an approved level.
FINANCIAL RISKS     
Inflation and currency fluctuations Inflation processes and currency fluctuations, as a result of which the Company’s costs increase due to the rise in price of materials, resources and services used (for example, transportation services), may lead to a decrease in the Company’s net profit.
Part of the Company’s loan portfolio consists of loans with floating interest rates and is denominated in foreign currency. The bulk of the Company’s expenses are denominated in roubles, while the main export revenues are denominated in US dollars. The Company minimizes the risks of currency fluctuations and the risk of a significant increase in the floating interest rate by hedging its interest and currency risks.
ENVIRONMENTAL RISKS     
Environmental risks and risks related to mining operations Uralkali’s activities related to the extraction of minerals and production are subject to risks associated with the geological structure of the Verkhnekamskoye field, and exploration, extraction and processing of minerals. The risks include possible flooding, fires and other accidents that can lead to unforeseen costs and a general decline in the efficiency of the Company’s operations.
Given unpredictable natural factors associated with mining, the Company takes a conservative approach to mitigating environmental risks.
  • The Company follows its previously developed mining plan, which includes an extensive safety section.
  • The Company regularly audits the effectiveness of measures aimed at minimising mining risks.
Risks related to the incidents at Berezniki-1 and Solikamsk-2 The flooding of Berezniki-1 in October 2006 as well as an accident at Solikamsk-2 in 2014 had a significant impact on the size of mineral reserves and may lead to additional costs, losses and obligations.
The Company adheres to its safety and social responsibility policies and adopts a conservative approach. The Company follows its social responsibility policy, under which it maintains a constructive and consistent relationship with state authorities to respond to any issues in a timely manner.
Non-compliance with environmental and health and safety regulations Uralkali’s operations and the use of its property are governed by various environmental and health and safety laws and regulations. Additional costs and obligations may be incurred by compliance with these laws and regulations.
The Company pays considerable attention to the problems of industrial safety, defining the life and health of people as the most important value and making HSE assurance its main task.
  • The Company has approved and adopted safety standards, including HSE Cardinal Rules, regular training of personnel in safe practices with subsequent attestation, and a number of measures for the prevention of occupational diseases.
  • The Company pays special attention to compliance and improving performance.
MARKETING RISKS     
Potash demand decline Changes in the supply and demand balance on the main potash markets, due to both political and economic factors, may have a negative impact on the Company’s operations.
The growth in demand for potassium chloride does not match the level of supply on the markets. The fall in potash prices in mid-2016 had a significant impact on the Company’s revenue and created a need for cost adjustment.
  • Uralkali’s management is developing a marketing strategy to promote potash and actively supports agricultural producers (e.g. by updating farmers’ calculators).
  • The Company estimates future demand for its products and adjusts production volumes depending on the market environment.
Potash price decrease Producers’ pursuit of high capacity utilisation together with insufficient demand may result in excess supply and a subsequent drop in global potash prices, reducing the Company’s revenue and profit.
In connection with macroeconomic and geopolitical instability, the growth in potash demand does not match the level of supply on the markets, which affects the selling price.
Loss of market share on specific markets Competitors’ activities, commissioning of new production facilities and other events may lead to the loss or reduction of the Company’s share on one or more sales markets. The loss or reduction of its share on specific markets can lead to a decrease in revenue and deterioration of the Company’s financial performance.
↔ When the growth in potash demand does not match the level of supply on the markets, the level of competition may increase. The Company’s management monitors all key markets and is developing a marketing strategy to promote potash.
Lack of specific products With its production capacity fully utilised, the Company may face a deficit of a particular product for a specific market.
Emergencies, as well as possible changes in investment decisions as a result of certain factors, can lead to a deficit of a certain product and the inability to meet the existing demand. The Company retains a flexible production strategy, increasing or decreasing production volumes depending on current demand and market forecasts.
POLITICAL AND LEGAL RISKS     
Risks, connected with the licensing of use of natural resources
  • The Company’s operations depend on the continued validity of its licences and its compliance with licence terms.
  • Legislative changes or decisions by regulators to terminate or restrict the licences may adversely affect the Company’s operations.
In 2016, the Company extended the validity of key licenses for a longer period.
  • The Company has a plan to maintain existing licences.
  • The Company has introduced internal controls to follow up on the plan and respond promptly to any deviations.
Political and regulatory risks
  • Uralkali operates on the Russian market and a number of developing markets that are exposed to higher risks than more developed markets, including significant legal, economic and political risks.
  • The Company could breach applicable laws or regulations on the markets where it operates.
  • Certain measures of governmental bodies or increased regulation could lead to additional costs, as well as affect creditors’ expectations.
  • Risks of additional obligations, costs and restrictions for Uralkali due to audits by tax authorities, the federal health and safety agency (Rostekhnadzor) and other regulators.
Uralkali is registered in Russia and operates in a number of developing markets that are exposed to higher risks than more developed markets, including legal, economic and political risks, i.e. rapidly changing legislation and legal practice.
  • The Company has developed a set of connected measures to ensure its compliance with statutory rules.
  • The Company also monitors any relevant legislative changes in all applicable jurisdictions and liaises with supervisory authorities to promptly adjust its documents and practices. The corporate governance procedures applied to the Company allow the quickest possible adoption of the necessary operational and strategic decisions at different management levels.
Compliance with applicable legislation and internal policies Uralkali is subject to the laws of Russia and other countries of operations, including anti-monopoly ones. Claims, including anti-monopoly claims, may create additional costs for the Company.
Uralkali is subject to special state regulations in various jurisdictions. Due to macroeconomic instability, regulators can increase their requirements. The Company continuously improves its internal control system in order to ensure compliance of its activities with the requirements of applicable law, including anti-monopoly legislation.
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