29. Financial instruments and related risk management
Cameco is exposed in varying degrees to a variety of risks from its use of financial instruments. Management and the board of directors, both separately and together, discuss the principal risks of our businesses. The board sets policies for the implementation of systems to manage, monitor and mitigate identifiable risks. Cameco’s risk management objective in relation to these instruments is to protect and minimize volatility in cash flow. The types of risks Cameco is exposed to, the source of risk exposure and how each is managed, is outlined below.
Market risk
Market risk is the risk that changes in market prices, such as commodity prices, foreign currency exchange rates and interest rates, will affect the Company’s earnings or the fair value of its financial instruments. Cameco engages in various business activities which expose the Company to market risk. As part of its overall risk management strategy, Cameco uses derivatives to manage some of its exposures to market risk that result from these activities.
Derivative instruments may include financial and physical forward contracts. Such contracts may be used to establish a fixed price for a commodity, an interest-bearing obligation or a cash flow denominated in a foreign currency. Market risks are monitored regularly against defined risk limits and tolerances.
Cameco’s actual exposure to these market risks is constantly changing as the Company’s portfolios of foreign currency and commodity contracts change. Changes in fair value or cash flows based on market variable fluctuations cannot be extrapolated as the relationship between the change in the market variable and the change in fair value or cash flow may not be linear.
The types of market risk exposure and the way in which such exposure is managed are as follows:
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A. Commodity price risk
As a significant producer and supplier of uranium, nuclear fuel processing and electricity, Cameco bears significant exposure to changes in prices for these products. A substantial change in prices will affect the Company’s net earnings and operating cash flows. Prices for Cameco’s products are volatile and are influenced by numerous factors beyond the Company’s control, such as supply and demand fundamentals, geopolitical events and, in the case of electricity prices, weather.
Cameco’s sales contracting strategy focuses on reducing the volatility in future earnings and cash flow, while providing both protection against decreases in market price and retention of exposure to future market price increases. To mitigate the risks associated with the fluctuations in the market price for uranium products, Cameco seeks to maintain a portfolio of uranium product sales contracts with a variety of delivery dates and pricing mechanisms that provide a degree of protection from pricing volatility.
To mitigate risks associated with fluctuations in the market price for electricity, BPLP enters into various fixed price energy sales contracts that qualify as cash flow hedges. These instruments have terms ranging from 2013 to 2017. The periods in which the cash flows associated with these cash flow hedges are expected to occur and when they are expected to impact earnings are as follows:
Cash flows Earnings impact 2013 $6,101 $4,074 2014 556 - 2015 94 - 2016 4 - 2017 - - Total $6,755 $4,074 The maximum length of time BPLP is hedging its exposure to the variability in future cash flows related to electricity prices on anticipated transactions is six years. For the year ended December 31, 2012, a net unrealized loss of $2,058,000 (2011 - $3,141,000) was recognized for the ineffective portion of cash flow hedges.
At December 31, 2012, the effect of a $1/MWh increase in the market price for electricity would be a decrease of $149,000 in net earnings and a decrease in other comprehensive income of $154,000 for 2012.
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B. Foreign Exchange Risk
The relationship between the Canadian and US dollar affects financial results of the uranium business as well as the fuel services business. Sales of uranium product, conversion and fuel manufacturing services are routinely denominated in US dollars while production costs are largely denominated in Canadian dollars.
Cameco attempts to provide some protection against exchange rate fluctuations by planned hedging activity designed to smooth volatility. To mitigate risks associated with foreign currency, Cameco enters into forward sales contracts to establish a price for future delivery of the foreign currency. These forward sales contracts are not designated as hedges and are recorded at fair value with changes in fair value recognized in earnings. Cameco also has a natural hedge against US currency fluctuations because a portion of its annual cash outlays, including purchases of uranium and conversion services, is denominated in US dollars.
At December 31, 2012, the effect of a $0.01 increase in the US to Canadian dollar exchange rate on our portfolio of currency hedges and other US denominated exposures would have been a decrease of $10,200,000 in net earnings for 2012.
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C. Interest Rate Risk
Cameco is exposed to interest rate risk through its interest rate swap contracts whereby fixed rate payments on a notional amount of $155,000,000 of the Series C senior unsecured debentures were swapped for variable rate payments. The swaps terminate on March 16, 2015. Under the terms of the swaps, Cameco makes interest payments based on the three-month Canada Dealer Offered Rate plus an average margin of 1.83% and receives fixed interest payments of 4.7%. To mitigate this risk, Cameco entered into interest rate cap arrangements, effective March 18, 2013, whereby the three-month Canada Dealer Offered Rate was capped at 5.0% such that total variable payments will not exceed, on average, 6.83%. At December 31, 2012, the fair value of Cameco’s interest rate swaps and caps was $5,453,000 (2011 - $8,647,000).
At December 31, 2012, the effect of a 1% increase in the three-month bankers’ acceptance rate would be a decrease in net earnings of $2,770,000.
Counterparty credit risk
Counterparty credit risk is associated with the ability of counterparties to satisfy their contractual obligations to Cameco, including both payment and performance. Cameco’s sales of uranium product, conversion and fuel manufacturing services expose the Company to the risk of non-payment.
Cameco manages the risk of non-payment by monitoring the credit worthiness of our customers and seeking pre-payment or other forms of payment security from customers with an unacceptable level of credit risk. To mitigate risks associated with certain financial assets, Cameco will hold positions with a variety of large creditworthy institutions.
Cameco is exposed to credit risk on its cash and cash equivalents, short-term investments, accounts receivable and derivative assets. The maximum exposure to credit risk, as represented by the carrying amount of the financial assets at December 31 was:
2012 2011 Cash and cash equivalents $749,824 $398,084 Short-term investments 49,535 804,141 Accounts receivable 532,754 595,140 Derivative assets 42,633 71,579 At December 31, 2012, there were no significant concentrations of credit risk and no amounts were held as collateral. Historically, Cameco has experienced minimal customer defaults and, as a result, considers the credit quality of its accounts receivable to be high. All accounts receivable at the reporting date are neither past due nor impaired.
Liquidity risk
Financial liquidity represents Cameco’s ability to fund future operating activities and investments. Cameco ensures that there is sufficient capital in order to meet short-term business requirements, after taking into account cash flows from operations and the Company’s holdings of cash and cash equivalents. The Company believes that these sources will be sufficient to cover the likely short-term and long-term cash requirements.
The table below outlines the Company’s available debt facilities at December 31, 2012:
Total Amount Outstanding and Committed Amount Available - (a) The amount outstanding and committed includes $39,500,000 relating to working capital and $6,320,000 of operational letters of credit.
Unsecured revolving credit facility $1,250,000 $ - $1,250,000 Letter of credit facility 698,814 698,814 - Inkai revolving credit facility (Cameco's share) 11,939 - 11,939 BPLP working capital and operational letter of credit facility (Cameco's share) (a) 47,400 45,820 1,580 BPLP letter of credit facilities (Cameco's share) 154,524 154,524 - The tables below present a maturity analysis of Cameco’s financial liabilities, including principal and interest, based on the expected cash flows from the reporting date to the contractual maturity date.
Carrying Amount Contractual Cash Flows Due in less than 1 year Due in 1-3 years Due in 3-5 years Due after 5 years Accounts payable and accrued liabilities $468,776 $468,776 $468,776 $ - $ - $ - Short-term debt 106,590 106,606 106,606 - - - Long-term debt 1,292,440 1,300,000 - 300,000 - 1,000,000 BPLP lease 131,013 131,013 16,337 38,552 48,190 27,934 Energy and sales contracts 8,294 8,294 6,957 1,106 231 - Foreign currency contracts 1,954 1,954 1,954 - - - Total contractual repayments $2,009,067 $2,016,643 $600,630 $339,658 $48,421 $1,027,934 Total Due in less than 1 year Due in 1-3 years Due in 3-5 years Due after 5 years Interest on short-term debt $1,567 $1,567 $ - $ - $ - Interest on long-term debt 543,450 62,540 125,080 96,880 258,950 Interest on BPLP lease 32,991 9,259 14,536 8,058 1,138 Total interest payments $578,008 $73,366 $ 139,616 $ 104,938 $ 260,088 Fair value
All financial instruments measured at fair value are categorized into one of three hierarchy levels, described below, for disclosure purposes. Each level is based on the transparency of the inputs used to measure the fair values of assets and liabilities:
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Level 1 – Values based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities.
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Level 2 – Values based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability.
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Level 3 – Values based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.
When the inputs used to measure fair value fall within more than one level of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measure in its entirety.
Except as otherwise disclosed, the fair market value of Cameco’s financial assets and liabilities approximates the carrying amount as a result of the short-term nature of the instruments, or the variable interest rate associated with the instruments, or the fixed interest rate of the instruments being similar to market rates.
The fair value of Cameco’s privately held available-for-sale securities, as described in note 12, has not been disclosed because of the unavailability of a quoted market price in an active market. Cameco does not currently have plans to dispose of this investment.
The following tables present Cameco’s fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis.
December 31, 2012 Level 1 Level 2 Level 3 Total Derivative instrument assets $ - $42,317 $316 $42,633 Available-for-sale securities [note 7] 49,535 - - 49,535 Derivative instrument liabilities - (10,248) - (10,248) Net $49,535 $32,069 $316 $81,920 December 31, 2011 Level 1 Level 2 Level 3 Total Derivative instrument assets $ - $69,367 $2,212 $71,579 Available-for-sale securities [note 7] 804,141 - - 804,141 Derivative instrument liabilities - (46,317) (316) (46,633) Net $804,141 $23,050 $1,896 $829,087 The fair value of a financial instrument is the amount at which the financial instrument could be exchanged in an arm’s-length transaction between knowledgeable and willing parties under no compulsion to act. Fair values of identical instruments traded in active markets are determined by reference to the last quoted prices, in the most advantageous active market for that instrument. In the absence of an active market, we determine fair values based on quoted prices for instruments with similar characteristics and risk profiles. Fair values of financial instruments determined using valuation models require the use of inputs. In determining those inputs, we look primarily to external, readily observable market inputs, when available, including factors such as interest rate yield curves, currency rates, and price and rate volatilities, as applicable. In some circumstances, we use input parameters that are not based on observable market data. In these cases, we may adjust model values to reflect the valuation uncertainty in order to determine what the fair value would be based on the assumptions that market participants would use in pricing the financial instrument. These adjustments are made in order to determine the fair value of the instruments.
We make valuation adjustments for the credit risk of our derivative portfolios in order to arrive at their fair values. These adjustments take into account the creditworthiness of our counterparties.
Financial instruments classified as available-for-sale comprise actively traded debt and equity securities and are carried at fair value based on available quoted prices.
There were no significant transfers between level 1 and level 2 of the fair value hierarchy. The following table presents a reconciliation of the beginning and ending balances of those financial instruments in level 3 of the fair value hierarchy:
2012 2011 Beginning of year $1,896 $5,056 Losses recognized in earnings 1,580 632 Unrecognized losses previously recognized in other components of equity - 632 Transfers out of level 3 (3,160) (4,424) End of year $316 $1,896 Transfers into level 3 are comprised of BPLP derivative financial instruments with contract terms extending beyond 36 months.
Derivatives
The following tables summarize the fair value of derivatives and classification on the statements of financial position:
For the year ended December 31, 2012 Cameco BPLP Total Non-hedge derivatives: Embedded derivatives - sales contracts $ - $5,126 $5,126 Foreign currency contracts 15,046 - 15,046 Interest rate contracts 5,453 - 5,453 Cash flow hedges: Energy sales contracts - 6,760 6,760 Net $ 20,499 $11,886 $32,385 Classification: Current portion of long-term receivables, investments and other [note 12] $ 17,000 $16,532 $33,532 Long-term receivables, investments and other [note 12] 5,453 3,648 9,101 Current portion of other liabilities [note 18] (1,954) (6,947) (8,901) Other liabilities [note 18] - (1,347) (1,347) Net $ 20,499 $11,886 $32,385 At December 31, 2011 Cameco BPLP Total Non-hedge derivatives: Embedded derivatives - sales contracts $(639) $8,033 $7,394 Foreign currency contracts (17,633) - (17,633) Interest rate contracts 8,647 - 8,647 Cash flow hedges: Energy sales contracts - 26,538 26,538 Net $(9,625) $34,571 $24,946 Classification: Current portion of long-term receivables, investments and other [note 12] $8,922 $42,088 $51,010 Long-term receivables, investments and other [note 12] 8,647 11,922 20,569 Current portion of other liabilities [note 18] (26,555) (16,913) (43,468) Other liabilities [note 18] (639) (2,526) (3,165) Net $(9,625) $34,571 $24,946 The following tables summarize different components of the gains (losses) on derivatives:
For the year ended December 31, 2012 Cameco BPLP Total Non-hedge derivatives: Embedded derivatives - sales contracts $138 $(2) $136 Foreign currency contracts 42,063 - 42,063 Interest rate contracts (785) - (785) Cash flow hedges: Energy sales contracts - (2,058) (2,058) Net $41,416 $(2,060) $39,356 For the year ended December 31, 2012 Cameco BPLP Total Non-hedge derivatives: Embedded derivatives - sales contracts $3,264 $(952) $2,312 Foreign currency contracts (11,586) - (11,586) Interest rate contracts 7,998 - 7,998 Cash flow hedges: Energy sales contracts - (3,141) (3,141) Net $(324) $(4,093) $(4,417)