Business and Other Risks

The ENEOS Holdings Group (hereinafter, the ENEOS Group) develops and operates an “Enterprise Risk Management (ERM) system" to respond appropriately to risks related to group management. Specifically, the ENEOS Group identifies risk events every fiscal year that may have a significant impact on group management, selects “priority risk events," implements countermeasures, and reports on their status to the meetings of the Executive Council and the Board of Directors.

ENEOS Group faces a variety of risks that may have an important impact on its business performance. The principal risks are those outlined below. Please note that forward-looking statements made in this section are, unless otherwise stated, judgments made by ENEOS Holdings, Inc., as of June 25, 2020.

In addition to the matters described below, restrictions on economic activities due to the spread of COVID-19 have had a significant impact on the Group's business. Because the impact of COVID-19 going forward is still unclear, the ENEOS Group's financial position and business performance may be affected in ways that cannot be assumed at this time.

(1) Market risk

Commodity price risk

In the ordinary course of business, ENEOS Group sells products such as petroleum, petrochemicals, and metal products and purchases raw materials such as crude oil and copper concentrates, and is accordingly exposed to commodity price fluctuation risk arising from fluctuation of sales and purchase prices.

(Energy Segment)

The margins for petroleum products in Japan are determined by factors beyond the control of the ENEOS Group, largely due to the difference between crude oil prices and the domestic market prices of petroleum products. Factors influencing crude oil prices include the Japanese yen to U.S. dollar exchange rate, the political situation in oil-producing regions, production adjustments by the Organization of the Petroleum Exporting Countries (OPEC), production trend of shale oil, and global demand for crude oil. Factors that influence the prices of petroleum products include domestic demand for petroleum products, overseas petroleum product market conditions, domestic petroleum-refining capacity and capacity utilization ratios, and the total number of service stations in Japan. The ENEOS Group determines petroleum product prices by appropriately reflecting the supply and demand conditions or market trends of petroleum products; however, margins may fluctuates considerably depending on crude oil prices or the market trend of petroleum products. Furthermore, margins for petrochemicals are affected by the difference between prices for crude oil and major raw materials, such as naphtha, and prices for petrochemicals. These margins are determined by factors beyond the control of the ENEOS Group. Petrochemical prices are affected by such factors as increases in supply capacity through the construction of new production facilities or the expansion of existing facilities and demand trends for apparel, automobiles, home electronics, and other goods. It may be difficult to pass on cost increases stemming from higher crude oil and other raw materials prices to product prices if supply and demand conditions are unfavorable. Accordingly, fluctuations in the prices of crude oil, petroleum products, and petrochemicals may have an impact on the ENEOS Group’s financial position and business performance.

(Oil and Natural Gas E&P Segment)

In the Oil and Natural Gas E&P business, sales increase when crude oil and natural gas prices rise, but decrease when crude oil and natural gas prices fall. Accordingly, fluctuations in crude oil and natural gas prices may have an impact on the ENEOS Group’s financial position and business performance.

(Metals Segment)

The ENEOS Group’s copper business mainly derives profit from its overseas copper development business, investments in overseas copper mines, copper smelting and refining business, and functional materials and thin film materials business, and it is affected by factors including copper concentrate prices, smelting and refining margins, sales premiums, and other metal market conditions. The ENEOS Group’s copper smelting and refining business operates as a custom smelter that purchases copper concentrate from overseas copper mines and produces and sells refined copper. The gross margin mainly comprises smelting and refining margins and sales premiums. In the overseas copper development business and investments in overseas copper mines, the ENEOS Group is also exposed to the risk of decrease in sales should there be any fall in international prices of refined copper, since prices of copper concentrate sold by the mines in which the ENEOS Group has invested are based on international prices of refined copper. Smelting and refining margins are determined by negotiations with copper mines, and could decline due to factors such as a lower concentrate grade or the emergence of an oligopoly of mining majors. Sales premiums, which are added to the international refined copper price, are determined through negotiations with customers in consideration of a variety of factors, such as transportation costs and product quality. Depending on the outcome of such talks, sales premiums could be adversely affected. The prices of the raw materials used in the functional materials and thin film materials business fluctuate in accordance with the market prices of metals and other materials. If increases in the costs of these raw materials cannot be passed on in product prices or if there is a significant decline in the market value of inventories compared with the corresponding book value at the beginning of the fiscal period, profit or loss could worsen. Accordingly, fluctuations in factors including copper concentrate prices, smelting and refining margins, sales premiums, and other metal market conditions may have an impact on the ENEOS Group’s financial position and business performance.

Foreign exchange risk

Portions of the ENEOS Group’s receipts and payments arise from business transactions denominated in foreign currencies, and the ENEOS Group also has substantial assets and liabilities denominated in foreign currencies. Consequently, fluctuations in foreign exchange rates may affect the value of assets, liabilities, receipts, and payments when converted into yen. In addition, fluctuations in foreign exchange rates may have an impact when the financial statements of overseas subsidiaries, affiliates accounted for using the equity method, joint operations, and joint ventures are converted into yen.

(2) Risks relating to environmental regulations

The ENEOS Group’s businesses are subject to a wide range of environmental regulations. These regulations impose expenses for environmental cleanups, and, if environmental pollution were to occur, the payment of fines and compensation would be required, making it difficult for the ENEOS Group to continue its operations. It is also possible that in the future environmental regulations may be tightened. The obligations and burdens imposed on the ENEOS Group by these environmental regulations and standards may have an impact on the ENEOS Group’s financial position and business performance.

(3) Risks relating to climate change

Efforts are being made to reduce emissions of greenhouse gases, which are believed to be the cause of climate change and global warming, amidst the growing global concern over climate change, and if the trend toward a low-carbon society, as evidenced by the Paris Agreement, accelerates and countries tighten their climate change policies or change or introduce new environmental laws and regulations, demand for petroleum products may decrease faster than expected. In that case, it may have an impact on the ENEOS Group’s financial position and business performance, as a corporate group engaged in petroleum refining and marketing and oil and natural gas E&P as its main business.

(4) Risks relating to operations

Businesses of the ENEOS Group are exposed to a variety of risks relating to its operations, such as risks of fire, explosions, accidents, import or export restrictions, natural disasters, mine collapses, climatic or other natural phenomena, labor disputes, and restrictions on the transportation of raw materials or products. If such accidents or disasters were to occur, considerable losses may ensue. The ENEOS Group obtains insurance coverage for accidents, disasters, and other contingencies to the possible and appropriate extent, but it is possible that compensation may not cover the full cost of any damages that occur.

(5) Risks relating to fluctuating demand

Demand for the products and services of the ENEOS Group is strongly influenced by the economic and social conditions in the countries and regions where they are provided. The demand for petroleum products in Japan is expected to continue to decline along with the trends toward the wider use of fuel-efficient automobiles and the transition toward other energy sources, such as gas and electricity, with the aim of accelerating the development of a low carbon society. Sales of petrochemicals depend heavily on demand in Asian countries, and fluctuations in demand in these regions may have a significant impact on the demand for the ENEOS Group’s products. There is a limited number of customers for products such as functional materials and thin film materials and titanium, and the operating environment of specific customers may have a significant impact on demand for the ENEOS Group’s products. For the construction business, declines in public investment and private sector capital investment, including residential investment may have an impact on demand in the ENEOS Group’s construction business. Although the ENEOS Group works to accurately forecast these fluctuations in demand to take necessary measures, the ENEOS Group’s financial position and business performance may be affected by sudden fluctuations that exceed forecasts.

(6) Risks relating to competition

The ENEOS Group is exposed to intense competition in various markets. In the domestic Petroleum Refining and Marketing business, competition among industry participants is intense, and there is a possibility that the trend toward lower demand in the domestic market may accelerate such competition. Additionally, the functional materials and thin film materials business is exposed to constant competition from competitors in a business environment characterized by technical innovation and rapid changes in customer needs. More-intense competition may have an impact on the ENEOS Group’s financial position and business performance.

(7) Country risks relating to sources of raw material supplies

The ENEOS Group procures large quantities of raw materials outside Japan. In particular, it is significantly dependent on limited crude oil reserves in the Middle East as well as on limited copper concentrate sources in South America, Southeast Asia, and Australia. Country risks in those countries or regions-for example, involving political instability, social unrest, labor disputes, deterioration in economic conditions, or changes in laws or policies may have an impact on the ENEOS Group’s financial position and business performance.

(8) Risks relating to resource development

The ENEOS Group conducts exploration and development activities related to oil and natural gas fields as well as coal and copper deposits. At present, these activities are in various stages on the way toward full commercial operation. The success of exploration and development is influenced by a wide range of factors, including the choice of areas for exploration and development, the construction cost of equipment, permits that must be received from governments, and fund-raising. In the event that individual projects do not reach the commercial viability stage and funds invested cannot be recovered, this may have an impact on the ENEOS Group’s financial position and business performance. In addition, recruiting personnel with high-level specialized expertise and broad experience is vital to the exploration and development business. Therefore, in the event that the ENEOS Group is unable to recruit enough top-quality personnel, this may result in the loss of profit-making opportunities and a decline in competitiveness.

(9) Risks relating to securing reserves of oil and natural gas

As a result of international competition for resources, competitive conditions for the ENEOS Group to secure reserves of oil and natural gas have become substantially more challenging. The future oil and gas output of the ENEOS Group will depend on how it can secure reserves through exploration, development, and the acquisition of resource rights that make possible production on a commercial basis. In the event that the ENEOS Group cannot supplement its reserves of oil and gas, its production volume may decline in the future, and this may have an impact on the ENEOS Group’s financial position and business performance. Furthermore, estimates of oil and gas reserves are difficult to measure accurately because they involve subjective judgments and decisions based on geological, technical, and economic information, and may require significant revisions based on the application of advancing recovery technologies and new information through production activities. If actual reserves fall below estimates, it may have an impact on the ENEOS Group’s financial position and business performance.

(10) Risks relating to equipment for oil and natural gas E&P

To conduct exploration and the production of oil and natural gas, the ENEOS Group must obtain drilling and other equipment and related services from third parties. When the price of crude oil is rising and in similar circumstances, such equipment and services are in short supply and the prices of equipment and services will increase. In the event that the ENEOS Group cannot obtain such equipment and services with the proper timing and on economical conditions, this may have an impact on the ENEOS Group’s financial position and business performance.

(11) Risks relating to collaboration with third parties and business investments

In a variety of business fields, the ENEOS Group collaborates with third parties through joint ventures and other arrangements and also makes strategic investments in other companies. These partnerships and investments play an important role in the ENEOS Group’s businesses, and, in the event that key joint ventures experience financial difficulties for any reason, or it is not possible to achieve the desired results from collaborative relationships or investments, this may have an impact on the ENEOS Group’s financial position and business performance.

(12) Risks relating to business restructuring

The ENEOS Group is taking steps to reduce costs, concentrate its business activities, and enhance efficiency. However, it is possible that substantial losses related to such restructuring may occur. In the event that the ENEOS Group is unable to execute business restructuring appropriately, or that the restructuring does not achieve the envisaged improvements in the ENEOS Group’s business operations, this may have an impact on the ENEOS Group’s financial position and business performance.

(13) Risks relating to capital expenditures, investments, loans, and impairment losses

Continuing capital expenditures, including investments and loans, are necessary for the ongoing maintenance and growth of the ENEOS Group’s businesses and for the acquisition of new business opportunities. However, it is possible that for such reasons as inadequacy of cash flows, it may become difficult to implement these plans. In addition, due to changes in the external environment or other factors, it is possible that actual investment amounts will greatly exceed projections, or that projected earnings will not materialize. As a result, if it becomes unlikely that funds invested can be recovered with respect to property, plant and equipment, goodwill, and intangible assets owned by the ENEOS Group, their book value will be reduced to reflect the likelihood of recovery, and it will be necessary to post the amount of the reduction as an impairment loss. This may affect the ENEOS Group’s financial position and business performance.

(14) Risks relating to deferred tax assets

The deferred tax assets of the ENEOS Group are recognized to the extent that it is probable that future taxable income will be available against which deductible temporary differences, unused tax credits and unused tax loss carryforwards can be utilized. Although the timing when the future taxable income arises and the amount of such income is determined based on reasonable estimates, the timing and amount of taxable income accrual may be affected by future changes in uncertain economic conditions. Where the actual timing and the amount differ from the estimates, it may have an impact on the ENEOS Group’s financial position and business performance.

(15) Risks relating to the write-down of inventories owing to decreased profitability and inventory valuation

The ENEOS Group has large amounts of inventories. In the event that the net market value of inventories at the end of the fiscal period is lower than the corresponding book value owing mainly to declines in market prices of crude oil, petroleum products, and rare metals, the book value must be reduced in line with net market value. The difference between the book value and the net market value must be charged to cost of sales and will result in a decline in profitability. Such write-down of inventories may have an impact on the ENEOS Group’s financial position and business performance. The ENEOS Group values inventories, including crude oil and petroleum products, by the average cost method. During a phase of rising crude oil prices, inventories initially valued at a comparatively low level will act to increase profits by pushing down the cost of sales. However, in a phase of falling crude oil prices, inventories initially valued at a comparatively high level will act to decrease profits by pushing up the cost of sales. This may have an impact on the ENEOS Group’s financial position and business performance.

(16) Risks relating to interest-bearing debt

The large size of its interest-bearing debt may restrict the business activities of the ENEOS Group. In addition, to make repayments of principal and interest relating to this debt, it may be necessary for the ENEOS Group to raise funds through additional borrowings or the sale of assets. However, the ENEOS Group’s ability to conduct such fund-raising may depend upon a variety of factors, such as the state of financial markets, the ENEOS Group’s share price, and whether or not there are buyers for the assets. Additionally, if interest rates rise-either within Japan or overseas-the resultant increase in interest burden may have an impact on the ENEOS Group’s financial position and business performance.

(17) Risks related to defined benefit obligations

ENEOS Group operates retirement benefit plans including defined benefit plans. The present value of retirement benefit obligations to these plans and the related service costs are calculated based on actuarial assumptions. These actuarial assumptions require estimates and judgments on a number of variables such as discount rates. The appropriateness of these actuarial assumptions including these variables may be affected by changes in uncertain future economic conditions, which may have an impact on the ENEOS Group’s financial position.

(18) Risks relating to credit

The ENEOS Group is exposed to credit risk, which is the risk of loss arising from the failure of debtors (counterparties) to meet their obligations related to the financial assets held by the ENEOS Group due to deterioration of creditworthiness or bankruptcy. To mitigate such risk, the ENEOS Group sets the credit limit for each counterparty according to the credit management policy, regularly monitors the financial conditions of the counterparties, and properly manages due dates and balances of receivables due from each counterparty, in order to allow for early detection of receivables which may be uncollectible. Although safeguard measures, such as the holding of collateral or the use of factoring companies, may be adopted as necessary, there is no guarantee that credit risk can be completely avoided. The financial assets held by the ENEOS Group may become unrecoverable due to the deterioration of the creditworthiness of its counterparties, which may have an impact on the ENEOS Group’s financial position and business performance.

(19) Risks relating to intellectual property

In the execution of its businesses, the ENEOS Group owns patents and other intellectual property rights, but, in certain circumstances, it is possible that intellectual property rights may be difficult to obtain or their validity may be contested. It is also possible that the ENEOS Group’s corporate secrets may be disclosed or misused by a third party. Owing to the speed of technical progress, the protection afforded by intellectual property rights may become inadequate with respect to technologies vital to the ENEOS Group’s businesses. In addition, a claim from a third party of infringement of intellectual property rights in regard to the ENEOS Group’s technologies may lead to the payment of substantial royalties or to the prohibition of the use of the relevant technologies. In such cases as those referred to above, in which the ENEOS Group is unable to obtain or make adequate use of intellectual property rights for the conduct of its businesses, it may have an impact on the ENEOS Group’s financial position and business performance.

(20) Risks relating to the establishment of the internal control system

The ENEOS Group is making every effort to enhance compliance, risk management, and other functions as well as strengthen its internal control system, including the internal financial reporting system. In the event that the ENEOS Group’s internal control system does not function effectively and such situations occur as a breach of compliance, the manifestation of risk of loss in a significant amount, or damage to disclosure credibility, there is a risk that confidence among its stakeholders may be significantly impaired, which may affect the financial position and business performance of the ENEOS Group.

(21) Risks relating to information systems

The ENEOS Group uses electronic data related to processes including production, marketing, and accounting through a variety of information systems and networks. Although these information systems have safety measures in place, information systems may unexpectedly become inoperative as a result of an earthquake or other natural disaster or an event such as cyberattack, and business operations may have to be suspended. In such an event, this may disrupt the production and marketing activities of the ENEOS Group and have a serious impact on the operations of business partners.

(22) Risks relating to the management of personal information

The ENEOS Group retains personal information in relation to such services as petroleum product sales, and it has implemented protection measures to manage such information appropriately. The implementation of such measures may require considerable expenses going forward. Furthermore, the leakage or misuse of customers’ personal information may have an impact on the aforementioned business activities going forward.

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