Risks relating to Neste's business
In the pursuit of its objectives and targets, Neste is exposed to different risk factors that stem from the external environment, internal decision making, operating processes and systems in use. The most significant risk factors relate to the areas mentioned below. Any one of the risks, either singly or in the aggregate, may have a material adverse effect on Neste’s business, financial condition, operating results and future prospects.
External risks – Economic conditions, Geopolitics, Pandemic
Year 2022 was marked with slowing economic growth and several crises - war in Ukraine, rising inflation and exceptional price hikes in the energy market. Following the war in Ukraine, major European refiners not connected to the Druzhba pipeline shifted away from using Russian crudes. This combined with the OPEC+ supply control measures has strongly supported non-Russian crude prices this year. Russia will likely curtail its crude production upon the introduction of the G7 price cap and the EU’s embargo on Russian oil trading. Especially if the price cap is set at a too low level, additional cuts to Russian crude oil production are expected. Meanwhile, China’s Covid policies and economic fundamentals could cast uncertainties towards the other direction.
Oil refining margins in 2022 were impacted by a hike in operating costs. This is due to a combination of overall heightened oil supply risks, and the significant increase in refineries’ utility costs. The latter was primarily driven by skyrocketing natural gas prices in Europe caused by Russia’s substantial reduction of natural gas exports to Europe.
With an embargo on Russian oil products coming into force in the EU in early February 2023, uncertainties related to the oil product availability, subsequent cost development for natural gas in Europe and macroeconomic developments impacting demand make the exact direction for refining margins going forward difficult to predict.
The renewable fuel market in 2022 was also impacted by the war in Ukraine, in two major ways. Firstly, by driving up prices for vegetable oils, and in turn other waste and residue feedstocks, in the months after the start of the war. Price levels have meanwhile declined substantially from their peak in early summer. Secondly, through driving up the cost of fossil transport fuels, which led a few EU member states, including Finland and Sweden, to freeze or even lower their biofuel blending obligations in 2022 and the following years. However, the impact on biofuel demand was overall limited, as demand continued to grow in many markets in the EU, North America and around the world.
External risks – Environment
Neste’s strategic ambition is to be the global leader in renewable and circular solutions. Growing pressure to combat climate change and reduce greenhouse gas emissions is therefore primarily a positive driver for Neste’s business. However, political and societal focus on the low-carbon transition and the energy sector’s carbon footprint also create risks. Indirect economic and political consequences of climate change may contribute to the general uncertainty in the business environment and hence have an adverse effect on Neste’s business. In addition, changes in carbon emission trading schemes or similar initiatives on EU-, US- or individual Member State-level may have a significant effect on Neste’s business.
External risks – Laws and regulation
Changing regulation presents both an opportunity and a threat to Neste’s business. Neste’s refining operations and products are subject to extensive regulation (incl. environmental, health and safety, sustainability). General regulatory requirements in areas like commodity trading and data protection have also contributed to the formalization of operating procedures.
Neste’s business units mainly benefit from increased support for biofuels and renewable fuels (for example requirements that relate to renewable content in diesel and gasoline). However, changes in regulation especially in the European Union and the United States also create uncertainties as these may influence the speed at which the demand for renewable products develops, and new raw materials sources are brought into use. For the renewable products, a significant source of uncertainty is fragmented regulation around the acceptability and use of waste and residue feedstock.
Risks relating to strategic choices and strategy implementation
The majority of strategic risks relate to the viability of strategic choices and risks in strategy implementation. Opportunities and threats may arise from changes in the competitive landscape or from internal decision making and use of technology.
Neste’s competitive position in the selected key markets is good. Neste’s proprietary NEXBTL production technology is a proven technology for producing high-quality diesel from renewable raw materials. However, there is no assurance that this competitive position will continue as new players enter the market, current competitors develop their technologies or customer preferences for clean mobility change. In addition to the development of alternative feedstocks and production technologies for liquid fuels, the evolution of engine technologies and introduction of alternative powertrains can be faster than expected.
Staying ahead of competition requires continuous improvement, the ability to challenge current business models and a strong focus on innovations such as new production technology and feedstock platforms. In addition, Neste’s products and services must continuously meet customer requirements relating e.g. to product quality and sustainability. Evolving customer requirements together with more complex sourcing and logistics networks and production methods increase the exposure to quality risks that need to be managed well in order to maintain the high-quality brand image. As risk mitigation, Neste has implemented systematic quality management measures both in its own operations and in partner networks.
Strong governance practices and the continued contributions of Neste’s senior management, personnel and partners are vital for the company’s success. Due to fierce competition for talent, there is a risk that Neste may not be able to recruit and retain the highly skilled employees that are needed for strategy deployment and successful operations in the future. There is also a risk that Neste will not be able to build and manage strategic partnerships that contribute to future success.
Successful projects play a key role in Neste’s strategy deployment, operational development and the digitization of processes. Significant delays in project planning or execution may reduce operational efficiency or impair Neste’s ability to secure its competitive position.
Business continuity risks
During the last few years, widespread implications from Covid-19 pandemic have pushed many industries and companies towards more systematic continuity management practices. While the pandemic still continues to restrict economic activity in some areas, more significant pressures for contingency planning during 2022 have come from geopolitical tensions, energy market volatility and high inflation rates. While governments have shifted attention towards mitigation of higher cost of living, the market has seen temporary reductions in climate ambition and targets as well as slowed down implementation of climate policies that would also support demand for Neste’s solutions. Neste has continued implementation of strategic and operational business continuity measures. On the company level also scenario work has played an important role.
On the operational level Neste’s business performance is very much dependent on the continuous reliability of refining activities in Finland (Porvoo), Singapore and the Netherlands (Rotterdam). In addition to the planned maintenance turnarounds, for example disruptions in the supply of utilities or breakdown of critical machinery could cause unexpected shutdowns that would affect Neste’s ability to fulfill demand for end products.
The vessels chartered to Neste or owned by Neste are subject to inherent risks like maritime disaster, damage to the environment and loss of or damage to cargo and property. Such events can be caused by multiple factors, such as adverse weather conditions or mechanical failures.
Neste has insurance in place to reduce the financial impact of property damage, business interruption, and maritime disasters. However, insurance does not cover all potential losses and Neste could therefore be seriously harmed by operational catastrophes or deliberate sabotage.
In 2022, the oil and energy market as a whole experienced unforeseen hikes in energy and utility prices. Despite market stabilization there is a continuing risk of market volatility and increasing prices. This could have direct impacts on Neste’s operating and project costs. In addition, high inflation could also have an indirect impact on the demand for Neste’s products as governments try to balance the cost of climate actions with the need to manage the generally increased cost of living. On the feedstock side, it is expected that the high demand and high pricing for different waste and residue feedstock streams continues as competitors are increasing their production capacity for renewable products.
The financial results of Neste are primarily affected by the price differential, or margin, between refined petroleum and renewable product prices; and the prices for crude oil, different vegetable oils and other feedstock used. Historically, refining margins have been volatile and they are likely to continue to be so in the future. The main factors that may affect the refining margins include:
- Changes in aggregate demand for and supply of raw materials and products;
- Changes in demand for and supply of specific raw materials and products;
- Raw materials and product price fluctuations; and
- Evolution of worldwide refining capacity, and in particular development of refining capacity that relates to petroleum and renewable products similar to Neste.
As a part of risk management, Neste uses derivative instruments to protect its position against fluctuations in commodity prices.
Neste is exposed to foreign exchange risks because most of the sales are denominated in US dollars, whereas operating expenses (except the purchase of raw materials) are recorded in euros. Neste limits the uncertainties relating to changes in foreign exchange rates by hedging its currency risks in contracted and forecasted cash flows and balance sheet exposures.
More information on market risks can be found in the Financial Statements Note 3 section of the Annual Report.
Counterparty and credit risk
Counterparty risk arises from all business relationships, where Neste is exposed to the counterparty’s failure to perform according to Neste’s requirements and contractual commitments. The extent of counterparty risk has increased along the continued diversification of Neste’s supply base and customer segments. In order to manage the risk, Neste has implemented systematic controls for counterparty screening and monitoring.
Especially on the sales side, Neste is also exposed to credit risk i.e. the potential failure of a counterparty to meet its contractual payment obligations. Risk magnitude is dependent on the size of the exposure concerned and counterparty’s creditworthiness, which is assessed systematically both during onboarding and during the relationship.
The most significant sustainability risks that relate to Neste’s own operations or to the extended enterprise have been reported in line with the requirements of the Non-Financial Reporting Directive as a part of the review by the Board of Directors.
ICT and cyber risks
Digitalization and emerging technologies (for example the use of artificial intelligence and robotics) offer opportunities to automate dangerous or error-prone tasks and increase the efficiency of operations. At the same time, the increasing sophistication of cyber threats and generally rising frequency of attacks targeted at oil and gas companies is also a concern for Neste. Cyber risks multiply the impact of other risks and as individual risks could also have a major negative impact on Neste’s reputation or continuity of business operations.
The reliability of the key IT systems and partnerships is essential for continuous business operations. Prolonged disruption in the availability of the key systems, data or interfaces could limit Neste’s ability to conduct its business operations in a profitable, efficient and controlled manner.