Fortum Oyj (FOJCF) CEO Pekka Lundmark on Q4 2018 Results - Earnings Call Transcript

Fortum Oyj (OTCPK:FOJCF) Q4 2018 Results Conference Call February 1, 2018 4:00 AM ET

Company Participants

Måns Holmberg - IR

Pekka Lundmark - CEO

Markus Rauramo - CFO

Conference Call Participants

Artem Beletski - SEB

Wanda Weirzbicka - Credit Suisse

Lueder Schumacher - Societe Generale

Vincent Ayral - JPMorgan

James Brand - Deutsche Bank

Lars Polson - Bloomberg News

Måns Holmberg

Hello, and welcome everybody to Fortum's full year 2018 results web conference, both you here in Keilaniemi in our headquarters and everybody online. Please note that this event will be recorded and you can see a recording afterwards on Fortum's Web site.

Today we have Pekka Lundmark, our CEO and our CFO, Markus Rauramo, presenting our full year results. And after that presentation, you will be able to ask questions, both directly here in the audience by raising your hand or then through the chat online or by telephone. But please, Pekka, the stage is yours.

Pekka Lundmark

Thank you very much, Måns. And good morning investors, media and whoever might be watching, either over the network or here in Espoo. Welcome to this event where we go through our full year results. And I would like to say that we are overall pleased with the results a solid quarter ended, a year that was quite eventful.

Of course, we had a key event in the fourth quarter our Capital Market Day where we updated our strategy, we presented our four priorities going forward, which I will not go into today but they will of course be guiding our work in the coming years. The most significant event during the whole year was obviously the investments in Uniper. And I’d like to briefly reflect on the current situation because this is of course such an important matter that is still ongoing.

First of all, since the closing of the offer, we have increased our shareholding to 49.9% of Uniper shares and voting rights. And we have done so through further secure Fortum's floating position in any future general meeting of Uniper. This is a shareholding, but let me take one step back. When we first announced our interest in Uniper I said that together we could not only create value for all stakeholders but we could also together accelerate the European energy transition even more. And I strongly continue to believe in this. We have a clear vision for how Fortum and Uniper could jointly build what we would like to call the utility of the future, and we want to work with a company to explore how to best, make this vision a reality for the benefits of all shareholders and stakeholders of both companies.

However, over the last six months, we have made only little progress and that is disappointing, not only for us at Fortum but also for shareholders of both companies, and surely also for the employees. But we are continuing our talks with the company, both with the management board and with the supervisory board, and we are not walking away, because there is so much value to be created. So let us see where this will take us.

Then when it comes to other matters of the year, of course the year was characterized by higher Nordic power price during the year, which supported our results. The year was very dry, hydro inflows, the reservoir levels are still lower than normal. A very important thing during the year was obviously the commodity and CO2 price development. CO2 price tripled during the year, which means that the emission trading system that Europe has is now starting to work, which is of course a very good thing.

Finally, the year was a good one. We reported 19% increase in comparable EBITDA and 22% increase in comparable operating profit. Then when it comes to both EPS and cash flow, there's lot of items affecting a lot of things and Markus has promised to take us through it later through all this specific items in detail. What I will say though is that obviously the balance sheet discipline, which is extremely important when it comes to our credit-rating among other things that will continue to be in focus, and we are going to be very disciplined when it comes to new investment and CapEx decisions.

And as you probably already have seen, the board of directors proposed an unchanged dividend of €1.1 per share, which means that the goal that we set for ourselves a year ago that we would not need to temporarily cut the dividend, we have during this year been successful with that goal.

Then couple of highlights about the fourth quarter. The power price increase is really quite remarkable the Nordic price in Q4 compared to the Q4 a year before was up 56%. As I already mentioned, hydro inflows and reservoir levels are low, volatile commodity and CO2 prices and result of this is improvement of 12% in EBITDA and 13% on operating profit on a comparable basis. And the same comment when it comes to Q4 that there's a lot of items that Markus will go through.

Couple of other highlights around Q4. We are progressing quite fast now on our wind investments. We commissioned 50 megawatt wind farm in Ånstadblåheia in Norway. We started actually I think it's official in the 1st of January this year, the operations through our joint venture in Russia of a 50 megawatt wind at Ulyanovsk site. We already before this had a fully 100% Fortum-owned 35 megawatt wind operation in Ulyanovsk. And as earlier announced, these projects together with our partner in Russia will continue. We have decisions to build further 250 and 100 megawatts of wind to be taken into use in 2020.

Then perhaps result wise in the short term, a smaller thing but basically very important. We made a decision to install in Sweden, Nordics biggest battery system, a 5 megawatt battery that will be installed in connection with our hydro power plant, and that will be acting in the same way as a corresponding slightly smaller battery in Finland, working on the balancing market, frequency regulation market together with TSO's in the respective countries.

Valo Ventures, as part of our strategic priority number four, we are building seats for new business is in the long term. And an important step here was the launch together with that former co-founder of Google Capital, a new venture capital fund of €150 million that we'll invest in the intersection of digital and certain for us relevant mega trends, such as de-carbonization, climate change, circular economy and urbanization.

And then last but not least quite an important milestone when it comes to one of our most significant assets, which is Loviisa nuclear power plant. The digital atomization project which ran there for several years has now been successfully completed. I already commented the low hydro reservoirs. They were actually quite close to the normal level in the beginning of the year, but then they declined to quite low levels during summer due to very dry weather. Then in august September, they were record drains in Norway that increased the water reservoirs rapidly. You can see the development of this picture, its 2018 it's indicated with an orange color. And here now also we shed a little bit more light on the Nordic reservoir structure. As you can see, this is clearly dominated by the reservoirs in Norway. We are not in Norwegian hydro we are in Finland and Sweden, which are of course both important but in relative terms smaller than Norway.

The reservoir levels were at the end of the year 9 terawatt hours below the normal and 12 terawatt below last year. And the dryness has continued during January at the moment, the latest situation is roughly 11 terawatt hours to low normal, and 9 terawatt hours below the situation a year ago.

Some quick comments on commodities, coal price moments where heavily China dependent with the early part of the year characterized by a positive macro economic outlook, strong demand growth and lagging domestic coal production. Towards the end of the year, the coal prices were driven by the wider commodity complex that turned quite varies in October. And this coupled with weak imports into China's power utilities and the additional building we saw given slightly weaker price towards the end of the year.

Gas market throughout the year was very tight because of the cold winter in '17 and '18 leading to high storage injections during the summer. And then one thing that started to affect the market balance towards the end of the year where strong LNG imports that bought prices down from October onwards.

CO2, I already commented earlier that it's actually did triple during 2018, mainly due to the market now pricing in the tightening effect of the market stability reserve, which started now in the beginning of January 2019. And now the EUA, the emission allowance price, has recently at level that has now started to indicate more coal to gas switching in the coming years, which is of course what this mechanism is supposed to deliver. We have put into the investor package quite substantial information about how all this works. I am not going to go through all the details now, but we thought that it would be -- because this is such an important driver now for power prices that we would give investors a summary of the most relevant facts around the whole ETS directive and market stability reserve.

One note though, if you look at the graph on the right hand side of the picture. The green color indicates the so called coal to gas switching range, which of course depends on coal prices, gas prices and then the efficiencies that you use, low efficiency and high efficiency. We have here taken quite a narrow band between low efficiency and high efficiency and with today's emission allowance prices, you can see the black line. We are now well within the switching range, which is indicating that the market is pricing in quite much more switching now for 2019 than what was the case in 2018. And this is quite an interesting development to note for several operations.

Couple of other things on the regulatory side, the second bullet point is significant. As you know, Fortum supports ambitious climate goals. European commission has started the climate strategy 2050 work through a long-term framework discussion. They have presented different scenarios, and Fortum in its work with the commission, has made it very clear together with some other Nordic power companies and actually some industry and other associations now recently that we are ready to support the most ambitious target, which would be CO2 neutrality for Europe by 2050. And we would encourage the commission to take actions to develop the policy measures that would drive in a transparent and market driven way the emissions to neutrality by 2050; meaning that, if there are emissions left, they should then be compensated by carbon sinks.

The other thing I wanted to comment about regulatory update. Obviously, it's very important piece of news regarding the German coal commission, which handed over its proposal to the government and most of you I guess have seen the details that 12.5 gigawatts in total would be shut down, including the earlier made decisions would be shut down by 2022 out of the comparison level of 42.5 gigawatts of coal capacity that German had in the reference year 2017, and additional 13 gigawatts would be shut down by 2030, and then the rest by 2038.

We at Fortum, we welcome the report. First of all, it's a responsible and holistic approach to phasing out coal and it is in line with our vision for a cleaner world. Enforcement will require difficult decisions but we believe that there will be also significant opportunities. And now we hope that the German government will decide the further actions as soon as possible, and start preparing respective laws and regulations chiefly. Because further clarity and detailed rules on compensation is necessary for the operators to make decisions of their capabilities is really, really important, so that we get more clarity around whole situations.

One important thing to note is that the report enforces the importance of gas during the transmission towards the fully de-carbonized energy system. When Germany shuts down, nuclear and simultaneously with that starts shutting down coal, it automatically increases the importance of gas. Because it is the fact that the wind will not always blow and the sun will now always shine. Of course then when it comes to specific assets then the companies operating in Germany and in our case, of course the interest is in Uniper. They are the ones who will need to then make comments about specific assets and then practice directly in this discussion with the German government.

And one further point, the coal commissions' suggestion to cancel the CO2 allowance is in order to mitigate its national decisions impact on the EU ETS system is absolutely the correct one. We strongly support this position that the coal commission has taken.

Nordic power price development as was already mentioned has been strong. Here you see that the trend changed in 2015. Nordic average system price for the year was €44, which was almost €15 higher than the year before. The spot price increase was mainly due to clearly higher cost of coal condensed production as a result of the carbon price EU, or emission price increasing as well as higher coal price. So it's a combination of these two. And then of course the power price was further supported by dry hydrology.

There has been quite much discussion in earlier events about the German Nordic spread. So we thought that we would also put that information now here. In 2018, the spread in the spot price, which of course is a totally different thing than the spread in the forward price was actually very narrow. Historically, the spread in spot price has varied between minus €1 and plus €15 on an annual level. And 2018 was clearly at the lower end of this range that spread was €0.50 per megawatt hour. Those price spread have been influenced by not only the supply demand fundamentals, but then also things of course they are also in a way fundamentals, but the Nordic hydrological situation typically affects this spread a lot.

Then the financial market, the forward price. As you can see, it is expecting the German Nordic spreads to increase. And it has varied a little bit during the year. This is the forward price for the year 2020. It was quite wide in the beginning of the fourth quarter and now it has narrowed a little bit.

Supply demand balance in the Nordic area and the Continental Europe will always have an effect on this price spread. And looking at the things that are changing, increasing interconnected capacity between the Nordic and the Central Europe should contribute to a lower price spread. But at the same time, wind production in the Nordic is estimated to increase, which is working then to the other tracks. And there are other variables in this of course going then forward into the 2020 is the German nuclear shutdown will definitely have an effect, the new German coal shutdowns and the continued renewable investments in Germany will also have an effect. So this is a complicated picture overall.

Here you see -- on the next slide, you are seeing a graphical form of the power price development. Once again, Q4 spot price in the Nordic is up 56% from the year before. Of course, we are hedging significant parts of our production but despite that, we also then did get an increase in our achieved price which was plus 16% compared to a year-ago. So this is of course development that from our point of view is going to the right direction.

In Russia, spot price was up 6%, but then when we take our achieved price in euros, then mainly because of the weaker ruble, we are looking at the results, which is minus 4% compared to the year before. And then before Markus continues, I will make a few quick comments on each division's performance. Generation first overall because of the dry hydrology, the 19.1 terawatt hours hydro production that generation had in the year was one of the lowest in our history. Q4 in relative terms, compared to the year before, was a little bit better than in Q3 but also Q4 was almost 1 terawatt hour lower in production than last year. In Q3, the difference was around 2 terawatt hours. So it is shrinking a little bit but still behind.

Nuclear production again was higher last year, which supported the result and then higher achieved power prices and lower taxes in Sweden supported the result. And of course on the annual level compatibly with DA going from 6.03 to 7.62 is a good result than the same can be seen in compatible profit, operating profit as well and comparable return on net assets grew to 11.2%.

CD solutions did improve the result slightly Q4 from 110 to 113 in EBITDA and comparable operating profit from €61 million to €68 million. So this is going to the right direction but our ambition level is clearly higher. We are not yet happy with this result that we have actions ongoing, both in Hafslund integration, but also in several other fronts where our goal is to improve the result from this level. This is now, as I said, developing to the right direction but fairly slowly you can see some signs of improvement but we want to go higher.

The same comment about consumer solutions. We have in EBITDA a strong improvement in reported comparable EBITDA from €57 million to €110 million. But just for transparency, I want to highlight here that that includes an accounting change coming from IFRS15, which had a positive effect of €32 million. And it has to do with the capitalization of sales commissions that had to be reported to be compliant with IFRS. So this affects comparable EBITDA in a positive way. But of course even without that EBITDA would have improved, mainly because of Hafslund.

I said in the beginning of last year that 2018 would be a challenging year from profitability point of view, which was of course exactly what happened, but the same comment that’s about CD solutions that now the synergy effects through Hafslund integration, which are on track towards the 2020 targets that we have published. They will start to deliver results as we expect during 2019.

Russia had again a good year. We suffered from currency headwinds on annual level. It was quite a lot actually. When we report in euros, we suffered €32 million altogether. That's why our comparable operating profit for the year was €271 million compared to €296 million for the year before. The other reason why this was slightly behind was what we also reported earlier. There were some bad debt provisions, mainly dealing with the bankruptcy of one of the electricity retailers in the country and the combined effect of that and then the weaker ruble, offset the very good operational development in CSA payments in operating new power production capacity this time mainly in renewables. But overall, despite currency headwinds, operationally a very good year in Russia, we are pleased with our development there.

And now, I would ask Markus to continue from here.

Markus Rauramo

Okay, thank you, Pekka. So, I will start with a recap of the fourth quarter. Q4 compared to last year was up €38 million; and that was driven by the better prices and lower taxes in generation; higher power sales volume and prices and seasonal heat pricing in CD solutions; and in Russia higher CSA payments and the contribution from the new production units, even despite the mentioned FX headwind.

If we have the same look at the full year up year-on-year €176 million; in generation, higher prices, lower taxes, are somewhat offset by the lower hydro and lower nuclear volumes; both in CD solution and consumer solutions, the consolidation of now Fortum Oslo Varme and Hafslund markets had a positive impact even if they were partly offset by the weaker result in recycling and waste business and on the other hand, lower sales margins in consumer solutions and the negative impact from the ended service agreements that we have been supplying.

Russia improved operationally quite significantly actually; but then on the comparison basis, the positive impact from bad debt recovery in 2017; and the negative FX impact of €32 million mean that in euros, the comparable number went down €25 million; but operationally, the underlying number actually is better; and then finally, other €23 million improvement year-on-year, driven by the profit of selling the 54% share of our Indian solar power plant.

Then I move over to the key financials. On this slide, I will only comment shortly that as we discussed already before, sales improved both in Q4 and for the full year, EBITDA up and comparable operating profit up. Then for the rest, there are many items impacting the profit before tax and cash from operating activities. And I will open these up on the next two pages.

I will focus here now on the line items affecting comparability, share of profit of associates and joint ventures and the finance costs. So I start with the items affecting comparability in Q4. In the most recent quarter in the items affecting comparability, we had a nuclear fund adjustment impact for Loviisa liabilities, negative around €20 million. So that was the main item. But actually -- and we open up this in our report. It is due to that the anticipated costs for Loviisa liabilities are reduced, that means that we reduced our provision. And thus, we can recognize less of the overfunded assets. So we actually have to take the asset down, so positive thing looks negative here on this line. We are still about €250 million overfunded for the Loviisa liability but which we cannot recognize here, but this we open up in the report.

On the other hand for Q4 2017, we had impairment reversals, capital gains and fair valuations that all amounted up to the €20 million positive. For the full year, if you look at items affecting comparability for 2018 full year, we have there the Hafslund production sales gain about €100 million, fair values about €100 million and then our nuclear fund adjustment relating to the same issues. And these all total -- that was a negative item. And these all total the number of 151. Correspondingly for 2017, the biggest item there as we have seen in many quarters is to gain from the Hafslund restructuring of €326 million and then some smaller fair value positives adding up to €347 million.

And if I go to the next line profits from associates there and you can find in the report the associated company results. Total Oskarshamn is around €60 million. And the biggest part of that is changes in our nuclear accounting assumptions. This bigger part is then offset by the changes in nuclear assumptions in the finance costs, which is also disclosed in the report, which is around €50 million. And the rest is done impacted and also the comparable operating profit. The nuclear assumption changes net out to be very close to zero.

Part of the Oskarshamn result is also relating to the increased decommissioning costs that Oskarshamn has assessed. So this is then separate from the changes in assumptions. And then other associates were about €20 million positive. On the hand, in 2017 fourth quarter and profits from associates, the associated result was somewhat stronger. So year-on-year there is a negative impact from somewhat weaker result from other associates and then the big part is the Oskarshamn.

For the full year 2018, we have the same impact as I just described for the fourth quarter. And then Stockholm Exergi result, which is the biggest contributor in associates, was somewhat weaker than in '17. TGC-1 share of profit was on the other hand a little bit stronger. But all-in-all leading to that, the profit from associates for 2018 was €38 million versus the €148 million from the previous year. And of course the one item that is not included anymore in 2018 is our share of the Hafslund profit, which now shows-up in the comparable operating profit and EBITDA.

And then finally on the finance costs. When we look at the past quarter Q4 of '18, our interest costs have come down somewhat. So interests are lower than the corresponding item in '17. Then we had loan and investment write-downs into start-up and venture businesses that was a negative, and then a big positive from the change of the nuclear assumptions, and this will add up to minus €4 million. In Q4 '17, interest was somewhat higher and other net was very small, so the total is €49 million. For the full year 2018, interest cost has come down, that is the biggest item than interest income was at the same level as 2017. And the nuclear related bookings are somewhat positive and they were little bit more negative in 2017.

So if I try to summarize this time and boil this down to a simple explanation, the changes in the nuclear assumptions that we are describing in the report, they are net zero. Then we have the adjustment in the Loviisa share of the nuclear, funds relating to the liabilities, negative here but positive in the actual costs.

Oskarshamn decommissioning provision increase is an actual negative as well, and it is relating to that we have the different funding rates in the Swedish and Finnish funds. And then on the other items of 2018, the biggest item in the gains was the Hafslund production and Hafslund restructuring very big gain in 2017. So I hope that this opens-up a little bit. We have tried to disclose all of this well in the report and the different notes there.

Then I move over to the cash flow statements. So if we start from the top EBITDA, clearly stronger. So our business has been improving year-on-year both for the quarter and for the full year. On the realized FX, there is positive item, positive transport for the quarter and for the year. This is due to the weaker Ruble and weaker Swedish krona. That means that when we roll over our internal loans actually when rate, the FX rate is moving this way and cash is released, and that was €314 million compared to full-year '17.

In working capital, we have a big negative swing, both in the quarter and in the full year. And this is due to two factors that we have opened-up a little bit more here. Part is due to that more cash is tied into the cash settled futures, which is €226 million in Q4, but this is a good thing for us. That means that prices go up and we have to post more cash settlement for the futures, in the long run positive thing. Other working capital same issue more sales, higher prices, which mean more receivables. And of course eventually as we go on these positions, we will unwind and cash will come back.

CapEx is down €80 million from 2017, and we ended up even slightly under our guidance. That was due to the fact that some tens of millions rolled over from 2018 to 2019, and I'll come back to the guidance in a minute. And then the big items on acquisitions and divestments of shares; 2018, the biggest part of cost was Uniper also then impacting Q4 of '18; and then in 2017, both on the acquisitions and divestments, the Hafslund restructuring; and 2018 also Hafslund production, sale and sale of the solar business.

And then I move over to the key ratios and there we can see that that EBITDA increased to €1.5 billion, a healthy increase from '17. Net debt increased to 5.5, of course, mainly due to the Uniper acquisition but also because of the mentioned working capital increase that I described on the previous page. And this means that our net debt EBITDA stood at 3.6 times at the end of the year. Our net debt EBITDA target is 2.5 times, and we believe that we will de-lever rather fast towards this target, driven by the business performance, driven by the working capital relief eventually. But also what we mentioned here on the slide prioritizing of our CapEx, improving our business through the operational excellence, increasing the flexibility and optimizing the business portfolio.

Liquidity is very good. We have €600 million in cash and €1.8 billion in undrawn committed credit lines. One thing that's good to note here is that there is no Uniper EBITDA, no proportionate share of Uniper EBITDA consolidated in these numbers. Just as a calculation exercise, you can think that we would release the working capital and include our share of the Uniper EBITDA, we would be actually very close to this 2.5 target. But nonetheless, we are working the actual reported number also down.

And then to the outlook, on the demand side, we do expect that electricity demand will continue to grow at around 0.5% on average. Hedges both for 2019 and 2020 are up 10 percentage points and €1. Meaning that for this year, we are 75% hedged at €31 per megawatt hour and for 2020, we're hedged 45% at €29. The CapEx guidance for this year stands at the same level as we reported earlier €600 million to €650 million, and this is including maintenance but excluding acquisitions. And then if and when we are successful with capital recycling, of course, we then have to look at how this number is then treated. But it is the basis for this year.

The targeted cost synergies for Hafslund stand at the same level, so readily materializing in 2019, 2020 €15 million to €20 million. And finally, the tax rate guidance for this year is at 19% to 21%, so the same guidance as for last year but likely on the higher end of the scale. And then finally the board has called for our AGM to be on the 26th of March, and the board also proposed the dividend unchanged at €1.1.

Thank you for listening for this part. And now, we’re ready for Q&A with Pekka.

Question-and-Answer Session

Operator

So we will now start the Q&A session, and we will start with questions here in Keilaniemi [Operator Instructions].

Artem Beletski

Artem Beletski from SEB. Actually, I have two market based questions. So the first one is relating to what you present on Page Number 18, the material relating to switch from coal to gas. It indeed seems that based on CO2 prices and fuel prices, we should be seeing more switch happening right now. Is it really something what we have seen onto market right now? And clearly, there are some elements like CO2 hedges of some producers, which are basically preventing this shift on that front. And the other question relates to Nordic and German price differentials what comes to forward. I know that there are many moving parts. But do you have any let's say few directionally versus kind of quite widespread what we're in right now should be maybe becoming a bit smaller going forward.

Pekka Lundmark

Well, the second question is extremely hard to answer without revealing what our expectations are on power prices. So we do not comment that. We just explained what the different variables are and to what direction everything else equal they would affect. But of course, when you look at now what the market is pricing in for 2020, they are expecting that the spread would be higher than what it was in the realization during 2018. And then the first question was switch. There is now more switching going on. There was very little during 2018. We had actually an estimate but these are very rough estimates that in 2018 something like 20 million to 30 million tons of CO2 was in a way switched or avoided through switching.

If we take the whole switching channel according to the calculation that we had in the paper, that could be 150 million to 200 million tons of CO2, which would indicate that about maybe 20% of the European power generation and heat production CO2 emissions could be reduced through switching. But then I mean this is highly volatile, because the coal and gas prices affected. But when you look at where we currently are, we are well within that range now and it is starting to happen now.

Markus Rauramo

I guess a few comments on the operational side that you’re exactly spot on with actually the second part of your question. So, whatever you have contracted, either our gas or coal or CO2, that will have an impact on the running. But eventually of course, this will flow through. So the daily decisions on let's say if you can choose what you are running like we can at our Oslo Varme plant and it's very operational decision based on what inputs you actually have available at that time.

A - Måns Holmberg

Do we have any further questions here from the audience? If not then operator, we are ready for questions from the lines.

Operator

[Operator Instructions] Our first question comes from the line of Wanda Weirzbicka from Credit Suisse. Please go ahead.

Wanda Weirzbicka

Two questions from me, the first one on the coal commission in Germany. As the larger shareholder in Uniper, do you agree that that going forward shouldn’t go online in the future given that it's probably will be more efficient the operating coal pipelines now in Germany? And my second question would be on the solar investments in India. Given the cancellation of the auction results which you announced last week or this week, have you changed your view on the investments in India and solar going forward?

Pekka Lundmark

When it comes to the coal commissions' reports, consequences and ramifications on the individual assets, obviously, Uniper is the one that needs to comment. But what I can say on a general level is this that we understand quite well and support Uniper's stated position on this one that since it seems to be a fact now that according to the current plan, Germany would continue to run some coal until 2038, so wouldn't it made much better to then run environmentally more friendly and at least in relative terms less emitting assets than old and dirty assets. So from that point of view, the answer is yes. We think it should run since coal will continue to run anyhow until 2038. But more into details I do not want to get into. Please discuss this with Uniper.

Then when it comes to solar India, the cancellation was of course an unfortunate event. We do not change our strategy. We believe that we have a good position in India. We were able to show through the previous, what we call recycling, i.e. divesting part of our earlier investments that we are able to create value and we will definitely continue, but not at any cost. I mean there will be new auctions. And we will have very strict limiters to the profitability that we are expecting. And assuming that they can be met, we are definitely interested to continue. But once again through the so-called recycling model where we extract value from building assets commissioning them and then partially divesting assets they are commissioned.

Markus Rauramo

And I guess if I can add that the reason for the cancellation as has been stated was that the higher or high solar box fees from the government led to actually high tariffs, which was then ultimately apparently not the desire of the government. So then they have gone back. We thought the solar park fees and as far as I understand, they intent to come back with the new auction.

Operator

Thank you. Our next question comes from the line of Lueder Schumacher from SocGen. Please go ahead. Your line is now open.

Lueder Schumacher

Number of questions on my side, the first one is on Uniper. Talks have now not been progressing for a rather long time. You mentioned six months are to be let's say maybe even the year. Would it be safe to conclude that there just won't be any corporation? And if that is the case, what exactly is the stumbling block in the negotiations? Because I would've thought lifting synergies even if they are limited, should be in both shareholders' interest. And that's my first question. The second one is on your leverage target. You did mentioned just now that if you were to take the proportionate EBITDA of Uniper into account, you already be at your leverage target at 2.5 times. And can I just confirm that this leverage target of 2.5 times is actually for Fortum in its present form, i.e. without consolidating any part of Uniper and also when roughly. What is the aim, how fast should you de-lever. So is there a target that's feasible over the next two to three years? And lastly, I didn't quite get Pekka's numbers on the fuel switching capacity across the range. If you could just repeat those numbers and that would be fantastic.

Pekka Lundmark

If I take questions number one and three, and then Markus will take the leverage question. As I already said, we continue to believe in our investment case. There is a lot of value to be created and we have a strong vision of how these two companies could work together to accelerate the energy transition and create what we would like to call the utility of the future. We are continuing to discuss. And as I said, we are not going to walk away. And we continue to believe that a solution can be found. We will now see where this will take us. Then maybe, Markus take the leverage question?

Markus Rauramo

So the comparable number I mentioned was just for illustration purposes. So yes, I do confirm that it is Fortum in its present form. So from 3.6 we are starting. But this was more to show that there's one block that we are not even calculating in this number. How quickly would we get towards this target, I would say reasonably quickly. We don't give a timeline. But we do observe that when we were downgraded and got the negative outlook, there is certain time to resolve that outlook. The more meaningful number for S&P is the 25% FFO to net debt on an adjusted basis. So that's the other important factor that we are following. So that is one of the key numbers that we are observing. But we are, in our own mind, we are on track with both of these numbers to get to the right level reasonably quickly.

Pekka Lundmark

And then when it comes to the switching channels, one needs to be extremely careful, because there are so many variables and these are not black-and-white things at all. But one variable that when calculating what that switching channel is, you have to you have to make assumptions on the low-end and high-end in terms of the efficiencies of coal and gas. And there is a small print foot note on that chart saying that we have actually used on this chart a very narrow band for whatever its worth. We have assumed that efficient gas would be 49% and low-end non-efficient gas would be 52 -- efficient gas would be 52% efficiency and low end would be 49% efficiency. And then low-end coal would be 34% and high-end coal efficiency would be 36%.

So these are the numbers behind the switching channel that we indicate on that slide. And that would then give a switching channel of 150 to 200 million tons of CO2 this year, which would be about 20% of the European power generation and heat production CO2. And very rough estimate of how much switching took place in 2018 could be 20 million to 30 million tons of CO2, hopefully this clarifies.

Markus Rauramo

It’s in very small print so, use a big screen.

Operator

Thank you. Our next question comes from the line of Vincent Ayral from JPMorgan. Please go ahead.

Vincent Ayral

So we already covered a couple of question on the Uniper. And I will come back to it regarding the coal commission. So obviously, its Uniper will negotiate that. However, the at Fortum would be interested in having your take on how it is engaged regarding compensation, the soft side of the wording and what type of timeline do you see? Do you think there is an option to get that in full open that would be the first question? The second question is related to Russia. So with some bad debt you said there was an operator that went into bankruptcy. I can pick up somewhere that and margins are actually streaming down a little bit. It would be good to have a bit of color there. When I look at next year, I still see potentially a positive effect from CO2 tariff increases and [indiscernible] Unit 2, which would have increased on the second half of this 2018 year. So given this, is it obviously fair to assume still a slight growth on Russia for 2019 in your terms at present. Thank you very much.

Pekka Lundmark

I understand why the first question is very important for you. But unfortunately, I will not be able to go into much details, because this is clearly a Uniper matter. We of course are of the opinion that operators need to get properly compensated and we would hope that the government would then take this recommendation in whatever form they decide and put them into law as quickly as possible, so that the operators would get clarity around the situations, because the important decisions will need to be made. But then when it comes to the times schedule, or money amounts, or names of individual assets or anything like that, that is not for us to comment. So please be in touch with Uniper on this one.

Markus Rauramo

And regarding the Russian bad debt issues and the bankruptcy, one thing I could say there is that what is yet still to come is that this guaranteed supplier business will be auctioned in the market and this has happened many times earlier. So we'll see what our final recovery actually from that is. Typically, the payment for the bad debt has been between 40% and 60%, and we have used this as our assumption also when taking the provision. But that’s subject to the regulator arranging an auction and then companies bidding for this guaranteed supplier.

When it comes to the outlook for 2019 again, our CSA payments are dependent on the consumer price index to government bond yields, the spot realization and then our profile. And it is exactly correct that our profile still has a positive impact, meaning than 15 year step up impact. So everything else alike, yes, results should improve because of that.

Vincent Ayral

I would then like to just follow up on the Uniper situation then on the coal commission. And is it fair to assume that a prudent approach is to wait a bit to get more clarity on competition there before doing anything on Uniper?

Pekka Lundmark

That is the right assumption and once again, you need to discuss that with Uniper. That is not for us to comment.

Vincent Ayral

But not to mix the two things, so the question had the other side…

Markus Rauramo

Vincent, if you would repeat your question please.

Vincent Ayral

Question was that waiting for call commission before doing anything on Uniper?

Pekka Lundmark

Of course, we're following very clearly and closely how the coal commission work and government actions proceed. But there is no direct link per se between that and our other discussions with Uniper.

Operator

Thank you. Our next question comes from the line of James Brand from Deutsche Bank. Please go ahead.

James Brand

I had a question on an investment that was announced back in Q4, but you're highlighting again in the statement, which is to replace the fossil-based production unit for the biofuel units. And not going to pronounce this correctly but [indiscernible]. And I was just wondering if you could explain a little bit more of the rationale for that. Is that something that's been driven by the fossil plant getting to end of the slice or was there an agreement you've come to just to replace the fossil plants there? And is this something that should be driving a step up in profitability, or is it more of a requirement replacing an aging unit? And then also could we see this happening elsewhere for other facilities over the next few years?

Pekka Lundmark

This investment is part of our partnership with City of Espoo. Obviously, decision made on complete the commercial ground is part of the de-carbonization plan that we have for district heating in Espoo. This is a 58 megawatt unit heat only boiler. So from a result point of view, obviously, it is not that significant. But it is one important contributor in making the district heating system here in Espoo renewable.

James Brand

Do you -- is it an expectation that you'd be looking to make other district heating networks renewable as well or this -- is this just Espoo that's moving a step ahead of other cities?

Pekka Lundmark

Absolutely, district hearing is part of our de-carbonization strategy in all places where we operate. I would like to mention Stockholm, which is one of the largest district heating networks in the world seven terawatt hours per year, if I'm not mistaking. And that is already 90% renewable, which is really a remarkable achievement. When we talk about ways to de-carbonize district heating, of course, biomass is one thing. But there are the things, which we are already using in several places, including here in Espoo. And one of the most promising ones is really to work together with large datacenter operators.

If you have a datacenter of say just as a placeholder 100 megawatts that datacenter also produces 100 megawatts of heat, and it absolutely makes sense to connect that into an intelligent directional district heating network that is able to utilize waste heat as much as possible. So I just want to say this that there are -- because the reason that there are multiple ways to de-carbonize district heating, replacing coal with biomass is only one of them.

Operator

Our next question comes from the line of Lars Polson from Bloomberg News.

Lars Polson

Another question on Uniper from me, I'm wondering if you've had any conversations or discussions with Elliott to increase the stake to close to 18% by the end of last year, about the future of Uniper and potentially helping you make any inroads in increasing your stake there.

Pekka Lundmark

Of course we have noted Elliott's increasing stake. But I have the same answer as before that we do not comment any potential discussions with anyone. So my answer to that question is unfortunately no comment.

Lars Polson

And have you got any more -- have you thought any more about how long you are able to tolerate this stalemate in discussions with Uniper? I mean, let's say that there is no progress for another year. And what your situation be then?

Pekka Lundmark

That's an entirely speculative question. We are in this for a long run. We are talking about long-term visions, which means that if needed we can be patient. But of course, we are not as I said not happy with the current situation that we have made only little progress. But as I said in my opening remarks, there are discussions ongoing with both management board and with the supervisory board, and now we need to see where this will take us.

Operator

There are no further questions at this time. So please go ahead speakers.

Måns Holmberg

Okay, thank you. I believe we still have one question from the chat. So you want to go ahead.

Unidentified Company Representative

Thank you. We have a question from Tom Beckman asking that do you anticipate proposing any motions in the upcoming shareholder meeting, AGM of Uniper. If so, what would they be? And separate to that question, will you seek to propose any changes to the compensation of the Uniper supervisory board in the next 12 months?

Pekka Lundmark

When it comes to Uniper's management and what will or will not happen at the shareholders' meeting that is something that we discuss privately with Uniper. We do not comment that in public.

Unidentified Company Representative

Thank you very much, Pekka. Thank you, Markus. If there are still any further questions at all, Ingela and me will be available then. You can send us email or give us a call and we’ll answer them. Some of you I hope to see at our AGM on the 26th of March and the rest of you see you and hear you on the lines on the 26th of April for our Q1 results. Thank you.