Business and Other Risks
The ENEOS Holdings Group (hereinafter, the 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 28, June, 2016.
RISKS AFFECTING THE ENTIRE ENEOS GROUP
(1) Country risks relating to sources of raw material supplies
The ENEOS Group procures large quantities of raw materials outside Japan. In particular, it is almost entirely 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, deterioration in economic conditions, or changes in laws or policies-may have an impact on the ENEOS Group's performance.
(2) Risks relating to business operations in China and other East Asian countries
Sales of such products as refined copper, chemicals, and electronic materials made by the ENEOS Group depend heavily on demand in Asian countries, notably China, and the ENEOS Group is expected to undertake further business expansion in those countries.
In the event that for whatever reason there is a decline or other changes in demand for the ENEOS Group's products in these areas, it may have an impact on the ENEOS Group's financial position and business performance.
(3) Risks relating to foreign exchange rate fluctuations
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 consolidated subsidiaries or affiliates accounted for by the equity method are converted into yen.
(4) 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.
(5) 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 special 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.
(6) Risks relating to capital expenditures, investments, and loans
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.
(7) 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; however, the competition in obtaining top-quality personnel is becoming extremely intense in this industry. Therefore, in the event that the ENEOS Group is unable to recruit enough topquality personnel, this may result in the loss of profit-making opportunities and a decline in competitiveness.
(8) 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.
The ENEOS Group's operations give rise to considerable quantities of wastewater, gas emissions, and waste materials, and unforeseen circumstances may cause the volumes of these discharges to rise above their permitted levels. 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.
(9) 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.
(10) Risks relating to intellectual property rights
In the execution of its businesses, the ENEOS Group owns patents and other intellectual property rights of various kinds, 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, or that owing to the speed of technical progress, the protection afforded by intellectual property rights becomes 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, the ENEOS Group's business performance may be affected.
(11) 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.
(12) Risks relating to the write-down of inventories owing to decreased profitability
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.
(13) Risks relating to the impairment of fixed assets
The ENEOS Group has substantial fixed assets. In the future, if such factors as changes in the business environment cause the profitability of fixed assets to decline and make it unlikely that funds invested can be recovered, 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 information systems
Information systems may become inoperative as a result of an earthquake or other natural disaster or an accident, 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.
(15) 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.
(16) Risks relating to the management of personal information
The ENEOS Group manages personal information in relation to such services as petroleum product sales and periodic precious metal investment plans. The implementation of measures necessary to protect that information may require considerable expenses going forward. Furthermore, the leakage or misuse of customers' personal information may have an impact on the aforementioned business activities.
RISKS BY SEGMENT
(1) Risks relating to fluctuations in margins in the Petroleum Refining and Marketing business
The margins for petroleum products are determined by factors beyond the control of the ENEOS Group, largely due to the difference between crude oil prices and the 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), and global demand for crude oil. Factors that influence the prices of petroleum products include 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 worsen considerably depending on crude oil prices or the market trend of petroleum products, and this may have an impact on the ENEOS Group's financial position and business performance.
Furthermore, margins for chemicals are affected by the difference between prices for crude oil and major raw materials, such as naphtha, and prices for chemicals. These margins are determined by factors beyond the control of the ENEOS Group. Chemical 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. Owing to weak market conditions, it may be difficult to pass on cost increases stemming from higher crude oil and other raw materials prices to product prices. This may have an impact on the ENEOS Group's financial position and business performance.
(2) Risks relating to demand fluctuations and competition in the domestic petroleum business
Mainly in the industrialized countries, initiatives related to the Earth's environment have been stepped up, with the aim of accelerating the development of a "low carbon society." These initiatives include making reductions in greenhouse gas emissions and promoting the saving of energy and natural resources. Amid these developments, 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. In the event that this decline in domestic demand continues or accelerates, this may have an impact on the ENEOS Group's financial position and business performance. Moreover, in the domestic Petroleum Refining and Marketing business, competition among industry participants at present is intense, and there is a possibility that the trend toward lower demand in the domestic market may accelerate such competition. More-intense competition may have an impact on the ENEOS Group's financial position and business performance.
(3) Risks relating to sources of procurement of crude oil and petroleum products
The ENEOS Group procures all its crude oil from overseas, primarily from the Middle East, and some petroleum products are procured abroad and in Japan. Such factors as changes in the political situation in oil-producing countries, and changes in the supply and demand balance for petroleum products in Japan and abroad, may hamper the procurement of crude oil and petroleum products. Inability to secure an appropriate alternative supply source may have an impact on the ENEOS Group's financial position and business performance.
(4) Risks relating to inventory valuation
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.
Oil and Natural Gas E&P Business
(1) Risks relating to crude oil and gas prices and currency exchange rate fluctuations in the Oil and Natural Gas E&P business
Sales in the Oil and Natural Gas E&P business fluctuate along with changes in crude oil and gas prices and movements in foreign currency exchange rates. When crude oil and gas prices are rising and the value of the yen is declining, sales in yen terms increase. When the crude oil and gas prices are falling and the yen is appreciating, sales in yen terms decrease. Therefore, during times when crude oil and gas prices move downward and the yen is appreciating, the performance of the ENEOS Group is adversely affected because of the decline in sales in yen terms.
(2) Risks relating to securing reserves
As a result of international competition for resources, competitive conditions for the ENEOS Group to secure reserves have become substantially more challenging. The future oil and gas output of the ENEOS Group will depend on the extent to which 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.
(3) 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. 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.
(1) Risks relating to fluctuations in market conditions in the copper business
The ENEOS Group's copper business mainly derives profit from its copper smelting and refining business and investments in overseas copper mines. Any changes in related market prices, as listed below, could have an impact on the financial position and business performance of the ENEOS Group.
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.
Smelting and refining margins are determined by negotiations with copper mines. If the supply of copper concentrate to the market is inadequate owing to such factors as a lower concentrate grade, the emergence of an oligopoly of mining majors, or increased demand in China, India, and other countries, smelting and refining margins could decline. In addition, the smelting and refining margins have been concluded in U.S. dollars. As a result, in the event that the yen appreciates, the smelting and refining margins will decline.
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 importation costs and product quality. Depending on the outcome of such talks, sales premiums could be adversely affected.
The ENEOS Group is also exposed to the risk of decrease in investment return 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.
(2) Risks relating to the stable procurement of copper concentrate
In view of the tight supply and demand conditions for copper concentrate, the ENEOS Group has been investing in and financing overseas copper mines with the objective of securing stable supplies of copper concentrate. However, if the ENEOS Group is unable to procure the copper concentrate its smelting and refining business needs at the appropriate time, owing to any disruption of operations of the overseas copper mines, which are the ENEOS Group's procurement sources, including those in which the ENEOS Group has invested, the financial position and business performance of the ENEOS Group could be affected.
(3) Risks relating to such factors as demand fluctuations and technical innovation in the electronic materials business
Many customers of the electronic materials business are in the IT-related products, consumer electronics, and automotive industries. Consequently, such factors as supply and demand situations and price movements in those industries may have an impact on the ENEOS Group's business performance. Additionally, the electronic materials business is in the midst of intense competition. Therefore, if the ENEOS Group is unable to respond appropriately to rapid technical innovation or changes in customer needs, this may have an impact on the ENEOS Group's financial position and business performance.
(4) Risks relating to fluctuations in procurement prices of raw materials in the electronic materials business
The prices of the raw materials used in electronic materials 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 the product prices, or if there is some extent of decline in the market value of inventories compared with the corresponding book value at the beginning of the fiscal period, there may be an impact on the ENEOS Group's business performance.
(5) Risks relating to fluctuations in market conditions in the recycling and environmental services business
Margins for the recycling and environmental services business are affected by fluctuations in such factors as metal prices and foreign exchange rates. Therefore, in the event that metal prices decline or the yen appreciates, this may have an impact on the ENEOS Group's business performance.
(6) Risks relating to the procurement of raw materials for the recycling and environmental services business
In the collection of raw materials for recycling in the recycling and environmental services business, competition is becoming intense because primary suppliers, including electronic device parts manufacturers, are shifting from Japan to overseas and entering the recycling business. The ENEOS Group is taking steps in response to this situation, such as expanding overseas procurement. However, in the event that the ENEOS Group is unable to procure the raw materials for recycling that are necessary for its recycling and environmental services business, this may have an impact on the ENEOS Group's business performance.
(7) Risks relating to fluctuating demand in the titanium business
The demand for titanium metals (titanium sponge and titanium ingots) is linked primarily to demand for specific purposes, such as for aircraft, electric power plants, chemical plants, and seawater desalination plants. Moreover, their use in catalysts is almost entirely confined to propylene polymerization.
If demand for titanium metals in these specific applications fluctuates substantially, due to changes in domestic or overseas political and economic conditions, or due to major changes in related consuming industries, it may have an impact on the ENEOS Group's business performance, since such fluctuations in demand tend to have a substantial impact on the sales volume and prices of titanium products.
(8) Risks relating to environmental issues surrounding Gould Electronics, Inc. (a U.S. subsidiary)
In relation to environmental problems that arose in the past in its business activities, Gould Electronics, Inc., a U.S.-based subsidiary, is a potential responsible party with regard to specific designated areas within the United States under U.S. environmental laws, such as the Superfund Act. The ultimate financial burden the subsidiary will bear may depend on numerous factors, including the quantity of the substance and its toxicity for which the areas were designated, the total number of other potential responsible parties and their financial position, and remedial methods and technologies.
In relation to this matter, Gould Electronics, Inc., is providing reserves that it considers appropriate, but owing to the factors referred to above the actual amount of the burden may exceed these reserves, in which case the ENEOS Group's business performance may be affected.
(1) Risks relating to fluctuating demand in the construction business
The ENEOS Group's construction business relies heavily on demand for contracted paving, civil engineering, and construction projects. Therefore, declines in public investment and privatesector capital investment, including residential investment, may have an impact on the ENEOS Group's construction business.