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Electricity network tariff regulation Electricity network tariff regulation The Italian experienceThe Italian experience

Claudia Malandra - Emma Putzu Claudia Malandra - Emma Putzu Tariffs department Tariffs department

Milan, 4Milan, 4thth march 2010 march 2010

Autorità per l’energia elettrica e il gas – Tariffs Department

Autorità per l’energia elettrica e il gasAutorità per l’energia elettrica e il gas

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Summary• Introductory notes

– Electricity network industry in Italy• Transmission• Distribution• Metering

– Tariffs department main tasks

• General questions related to network tariffs regulation– Criteria for tariffs regulation: the Italian legal framework– Criteria for tariffs regulation: the AEEG objectives

• Tariffs setting process– Determination of the allowed costs– Cost allocation to customers groups– Tariffs setting

• Domestic tariffs and vulnerable customers protection scheme

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Transmission – From vertical integration to ownership unbundling

– 1962: nationalization of electricity industry: ENEL owns more than 90% of National Electricity Transmission Network

– 1993: beginning of privatization process (ENEL Spa)– 1999: reorganization of electricity sector - a separated

company is constituted as independent system operator (ISO) under National Decree n. 79/99: property and management of National Transmission Network have to been separated

– 2004: from ISO to TSO – re-unification of ISO and ownership into a new independent electricity grid company (TERNA Spa) independent from ENEL – full ownership unbundlingTransmission assets are owned by: Terna Spa ( 98%), companies owned by municipalities, Railroad and other private companies

Progressive acquisition of assets from other owners

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Transmission – Key Figures– Length of the lines:

• 380 kV about 11.000 km• 220 kV about 11.000 km• 150-120 kV about 40.000 km

– Trafo station: • 380 kV N. 131• 220 kV N. 148• 150/132 kV N. 100

– Number of transporters:• 7 but … 98,23% of the network is owned by TERNA

– Regulatory asset value or Rate Asset Base (RAB) (2008):• 6.000 million Euro

– Allowed operating costs (2008):• 340 million Euro

– Allowed capital costs (2008):• 710 million Euro Remuneration of net invested capital

Total installed capacity: 119 GVA

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Distribution – From vertical integration to legal and functional unbundling

– 1962: nationalization of electricity industry (ENEL)– Beside ENEL survived local distribution companies,

owned by municipalities, small distribution companies operating in small non interconnected islands and a few other small companies (mutual companies)

– In general all the companies were vertical integrated– 1993: beginning of privatization process (ENEL Spa)– 1999: reorganization of electricity sector – ENEL and companies

serving more than 100.000 final customers have to create a separate company for distribution and supply (legal unbundling)ENEL Distribuzione Spa is constituted2007: legal and functional unbundling of distribution and supply for companies serving more than 100.000 final customerscompanies serving less than 100.000 final customers have to guarantee accounting unbundling of distribution and supplydistribution companies are also responsible for metering activities

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Distribution – Key Figures– Length of the lines (31 December 2008):

• High and very high voltage (km) 20,061• Medium Voltage (km) 372,239• Low Voltage (km) 815,041

– Numbers of distributors:• 143

– Regulatory Asset Base (RAB) (2008): 21,000 million Euro

– Allowed operating costs (2008): 2,000 million Euro

– Allowed capital costs (2008): 2,500 million Euro

– Commercial costs of distribution 630 million Euro

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Metering – Key Figures

– Regulatory asset value or Rate Asset Base (RAB) (2008): 3,200 million Euro

– Allowed operating costs (2008): 260 million Euro

– Allowed capital costs (2008): 520 million Euro

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Tariff department main tasks– Criteria for regulating tariffs of regulated infrastructures

(electricity and gas)• Focus on non-competitive activities: • Electricity: transmission (HV), distribution (MV, LV) and metering

– Tariffs setting and periodical revisions– Unbundling criteria and monitoring unbundling

implementation• Functional unbundling (focus on infrastructural companies governance)• Transparency of accounts

– Tariffs setting for levies (system charges) applied in order to finance activities of general interest (financing of R&D, decommissioning of old nuclear power plants, incentives to renewable energy)

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Prices and electricity tariffs in the III regulatory period

Generation

Transmission costs Transmission Transport Tariff (TRAS c€/kWh)

Distribution Distribution Tariff

Distribution costs

Fuel and dispatching costs

Metering costs Metering

Metering tariff (MIS1 MIS3)

Supply Supply costs

Costs

Dispatching

Price/Tariff

Price

Price

FOCUS ON

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Incidence of regulated activities on the final average customer bill (first quarter 2010)

(A) Production costs63,8%

Taxes14,0% (B) System charges

8%

Infrastructures cost and metering15,4 %

(A) Production costs are inclusive of fuel costs, fixed generation costs dispaching costs. Production-capacity and interruptibility service, service remunerations and UC1 UC6 and PPE components

(B) System charges are inclusive of all components, plus component Uc4 and component MCT

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Criteria for tariffs regulation: legal framework

• Law no. 481/95 – Transparency– Use of pre-determined criteria– Safeguard the interest of users and consumers– Reconcile the economic and financial objectives of electricity

companies with general social objectives, environmental protection and efficient use of resources

– Single tariff, by class of customers, at national level – Use of price-cap formula to increase efficiency

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Criteria for tariffs regulation: AEEG objectives

Incentive to efficiency: price-cap & profit-sharing

Transparency: separated transparent tariffs for different activities (transmission, distribution etc.), set in advance in order to avoid cross-subsidies between regulated and non-regulated activities

Simplicity: clear and simple tariffs for regulated activities facilitate the possibility to compare the non-regulated part of the final price (supply) and, therefore, competition in liberalised segments

Stability of regulation: reduce regulatory risks and, as a consequence, cost of capital

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The allowed costs

DEPRECIATION Standard life

CAPITAL REMUNERATIO

NRegulatory asset base

OPERATING COSTS Profit sharingPrice cap

+

+

Efficiency incentives

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The operating costs

Operating costs or costs of external resources (personnel, procurement of materials and services) have to be reported in separate accounts and have to be documented

Annual revision by price cap mechanism + Profit sharing

Any operating cost reduction achieved in the first regulatory period, as a result of productivity gain over the 4% per-year target, has been shared between electricity companies and customers.

The companies’ share of the extra-gains was set at 50% in the last price control review.

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CAPEX RAB =

+ net asset value + circulating capital- Trust fund recovery

CAPITAL REMUNERATION

Rate of return

Historical revalued cost

WACC

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Equity cost:CAPM

Debt cost:Risk free rate(*) +

spread over (depending from real

cost of regulated companies

WACC

Capital remuneration is calculated as weighted average of cost of equity and debt cost Weighted Average Cost of Capital (WACC)(*) Risk free rate is calculated using the 12 month average of gross returns on the 10-years Treasury bond (BTP) benchmark taken by Bank of Italy

Capital remuneration (WACC)

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The WACC formula (1)

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)(*

)1()1(*

)(*

)1( 1

) (

rpiDE

DTtcKd

DEE

TKe

taxpreWACC

Where:Ke is the return allowed on equityT is the tax rateE is the equityD is the debtKd is the debt ratetc is the tax shieldrpi is the expected average inflation rate 

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The WACC formula (2)

The allowed return on equity has been calculated according to the CAPM methodology. CAPM is a model describing the relationship between risk and expected return that is used in the pricing of risky securities. CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium.

  Ke = rf + i (rm – rf) Where : rf risk free rate systematic risk of the activity rm expected market return

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The WACC formula (3)

Parameters and rates used to fix WACC for 2008-2011 period

Parameter Description Transmission Distribution Metering

rf Risk free rate 4,45% 4,45% 4,45%

b levered Sistematic risk of the activity 0,58 0,60 0,67

Ke Equity rate 6,75% 6,85% 7,13%Kd Debt rate 4,90% 4,90% 4,90%

D/(E+D) Gearing 44% 44% 44%T Tax rate (%) 40% 40% 40%tc Tax shield (%) 33% 33% 33%

Rpi Expected inflation rate 1,70% 1,70% 1,70%

WACC % Real Pre tax 6,9% 7,0% 7,2%

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Capital remuneration: more incentives for new investments

Adequate incentives for new strategic investments Price-cap regulation needs quality regulation in order to avoid risks of lack of investments and bad technical performance Quality regulation may not be sufficient: specific incentives for new investments (extra remuneration for some strategic investments crucial to facilitate competition)

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From the allowed costs …to the cost allocation matrix

Transmission Grid

HV – Distribution Grid

MV - Distribution Grid

LV - Distribution Grid

Metering

Billing & Co.

LV - Customers HV - Customers

MV - Customers

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Cost allocation to different customer groups

MV - Customers

Street lighting

Other uses

Household

Street lighting

Other uses

HV - Customers

LV - Customers

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Cost allocation criteria 1/1

Meshed network –

shared resource

Peak demand of customer

groups

• Fix costs of transmission and distribution are allocated to different type of users on the basis of the load profile (in different hours of the day there is a different congestion so different costs)

• Tariff component is calculated as energy consumption in each price period of each customer group weighted by prices per unit where prices are set following a peak load pricing approach

Transmission Grid

HV – Distribution Grid

Network features

Cost allocation criteria

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Cost allocation criteria 2/2

Mostly radial network – only partially shared

resource

Costs are independent from the peak demandMaximum subscribed demand of power (MV) customers/Maximum subscribed demand of power corrected by a contemporary factor for LV customers

Radial network/Mostly dedicated

resource

Costs are independent from the peak demand;Effective demand of power

Partially dedicated/Partiall

y shared resources

Contractual average complexity of customer groups/ Costs of dedicated equipmentSubscribed demand

MV - Distribution Grid

LV - Distribution Grid

Metering

Billing & Co.

Network features Costs allocation criteria

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Balancing stability and cost reflectivity

StabilityCost

reflectivity

The allocation criteria are the same from 1999In order to balance the two potentially conflicting objectives of tariff stability and cost reflectivity, for the second and third regulatory periods the Italian Regulator, has decided only to adjust the vector of tariff constraints at the beginning of each regulatory period in function of the total allowed cost variations, keeping steady the cost allocation weights

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Transmission and Distribution Services: Tariffs by Customer Types (€c/kWh)

TRANSMISSION AND DISTRIBUTION DIFFERENCE 2008 2009 2009-2008

LV – domestic uses 3.417 3.505 0.088 LV – public lighting 1.706 1.751 0.045 LV – other uses 2.726 2.798 0.072 MV – public lighting 1.072 1.104 0.032 MV – other uses 1.133 1.166 0.033 HV 0.446 0.465 0.019 VHV > 220 kV 0.405 0.424 0.019

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The tariff system evolution1997 – First tariff reform (del. 70/97)

2000 – 2003: First regulatory period

2004 – 2007: del. n.5/04Second regulatory period

2008 – 2011: del. n. 348/07Third regulatory period

Pool (1/4/2004)

Supply full opening(1/7/2007)

First code of tariff regulation (2001)

Social protection for vulnerable clients (2008-

2009)

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Relevant features of the tariff structure before the regulatory intervention

• Tariffs did not reflect cost structure by customer class– Tariffs were higher than costs for non-residential

low- voltage customers– Tariffs were lower than costs for high-voltage

customers– Special tariff regime for State Railways, aluminium

smelters and energy-intensive industries

• Tariffs did not reflect cost of services (No unbundling between generation, transmission and distribution costs)

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Relevant features of the tariff structure in the first and in the second regulatory period

• Four yearly revision of tariff criteria (duration of regulatory period)

• Tariffs were more cost reflective for different class of consumers

• Unbundling of different costs of transmission, distribution and generation

• The Regulator set the constraint on revenues and companies set tariffs

• Distributors propose and the regulator approves tariffs options. Tariff options have to comply with constraints V1 and V2 set by the Regulator

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Transmission and distribution tariff (not for domestic users) (del. no. 348/07)

Transmission tariff – Single tariff, by class of customers, at national level (energy

tariff expressed in euro cent per kWh, flat without variation according to consumption level), yearly revision

Distribution tariff – Single tariff, by class of customers, at national level– Compulsory tariff for all distributors joint with a compensation

mechanism in order to guarantee costs recover– Yearly revision – Three parts tariff

• Flat component expressed in euro cent per customer per year • Power component expressed in euro cent per kW per year • Energy component expressed in euro cent per kWh

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Metering tariff (not for domestic users) (del. no. 348/07)

Metering service

– Meter installation, maintenance, meter riding and billing. Metering tariff

– Single tariff, by class of customers, at national level– Yearly revision– Flat tariff

• MIS1: Power component expressed in euro cent per customer per year

• MIS3: Energy component expressed in euro cent per kWh (only for street lighting)

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The tariffs revision method

Tariffs component are fixed at the beginning of the regulatory period (four years) and yearly revised:

Capex component (non subjected to price cap):The tariff components covering the allowed costs for the return on invested capital are adjusted annually by reviewing the capital itself using the average annual change in the gross fixed investment deflator measured by the National Statistics Office, and taking into account: any net investments carried out by companies the previous year; the incremental remuneration for new strategic investments, and the energy variation

Operating cost are subjected to price cap and revised yearly : In the third regulatory period has been set a target productivity gain (X-factor) of 2.3% for transmission, 1.9% for distribution and 5% for metering.

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Domestic tariffsThree domestic tariffs: D1, D2 and D3 • D1 tariff is a reference tariff for domestic customers. It is a cost reflective tariff but it is not applied to the customers• D2 tariff is for domestic customers in their place of residence,

with contractual power till 3.3 kW (about 80% of domestic customers).

• D3 tariffs is for:– domestic customers in their place of residence with contractual power over

3.3 kW and– domestic consumers in their spare homes (about 20% of domestic

customers).Tariffs D2 and D3 are set on the basis of the level of D1 tariff.

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D1 structure

D1 is a three parts tariff: • Flat component: expressed in euro cent per

customer per year;• Power component: expressed in euro cent

per kW per year; • Energy component: expressed in euro cent

per kWh, (flat, without variations according to consumption level)

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D2 and D3 structure D2 and D3 are three parts tariffs:• Flat component• Power component• Energy component: increasing when the

consumption level increases

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D2 and D3 as transitory tariffsD2 and D3 cross-subsidies are relevant

- low-consuming customers with D2 pay less than high-consuming ones with D2 and customers with D3

- For example, single men could pay less than low income families with a lot of children

• Tariffs D2 and D3 are considered transitory tariffs moving towards D1 tariff.

• Subsidies removal have to be gradual and linked to the implementation of a special tariff for vulnerable customers (the so-called “social tariff”).

.

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D2 convergence towards D1

0

100

200

300

400

500

600

700

800

900

1.000

0 1.000 2.000 3.000 4.000 5.000Annual Consumption (kWh)

Annu

al E

xpen

ditu

re (E

uro)

D1 08D2 08D2 09

Total Expenditure for residential customers(taxes not included)

Autorità per l’energia elettrica e il gas

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D3 convergence towards D1Total Expenditure for non-residential customers

(taxes not included)

0

100

200

300

400

500

600

700

800

900

1.000

1.100

0 1.000 2.000 3.000 4.000 5.000Annual Consumption (kWh)

Annu

al E

xpen

ditu

re (E

uro)

D1 08D3 08D3 09

Autorità per l’energia elettrica e il gas

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Social tariff and vulnerable customers

Social tariff is based on a political decision from the Parliament and Government

Vulnerability is defined according to economic or health conditions: People with economic disadvantages Customers in weak health conditions,

requiring specific electrical appliances in order to survive

Additionality of benefits for customers in both conditions

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Social tariffAim To guarantee an average saving of 20% in

electricity expenditure The system is fully compatible with competitive

energy marketsCompensation Lump sum varying with the number of family

members Applied as a discount in the billingBurden recovery “Ad hoc” tariff component charged to all final users

of the electric system, based on electricity consumption

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Access to social tariff Based on existing indicators of family’s

economic conditions (ISEE), already in use for TLC, schools, etc

ISEE is an indicator of poverty, not of “fuel poverty”

Application form ahs to be processed by local authorities (Municipalities)

Local authorities send relevant information to distributors through a computer system

Local authorities and distributors make controls Activation of the discount in the billing Yearly renovation required with new ISEE

Autorità per l’energia elettrica e il gas

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Figures

Social tariff system has been working since 2009

Families which apply before February 2009 received the compensation for 2008 too.

More than 1 million people were admitted to the compensation in 2009 (about 90% for economic disadvantages; less than 10% for weak health conditions)

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Customers’ savings

Family membe

rs

Estimated annual

consumption

(kWh)

2008 bonus (euro)

2009 bonus(euro)

2010 bonus(euro)

1-2 members

2200 60 58 56

3-4 members

2700 78 75 72

More than 4 members

4000 135 130 124

Yearly revision according to D2 trend

Economic disadvantages

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Customers’ savings

2008 bonus (euro)

2009 bonus(euro)

2010 bonus(euro)

150 144 138

Yearly revision according to D2 trend

Weak health conditions

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Characteristics of the regulated pricing system for

domestic consumers Convergence towards cost-reflective tariff Protection more focused on really

vulnerable customers Neutrality with respect to the liberalisation

process Promotion of efficient use of resources Coherence with EU Directive

Autorità per l’energia elettrica e il gas

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Thank you

Questions?

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Back up

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THE WACC FORMULA (4)

Parameters and rates used to fix WACC for 2004-2007 period

Parameter Description Transmission Distribution Metring

rf Risk free rate 4,25% 4,25% 4.25% levered Sistematic risk of the

activity 0.55 0.6 1.0

Pr Market premium (%) 4% 4% 4%

Kd (nominale) Debt rate 4,66% 4,66% 4,66%

T Tax rate (%) 40% 40% 40%

Tc Tax shield (%) 33% 33% 33%

Rpi Expected inflation rate 1.7% 1.7% 1,7%

WACC Weighted Average Cost of Capital 6,7% 6,8% 8,4%

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X factor

Planned productivity gains (X-factor) for the annual updating of operating costs

ActivityRegulatory

period

Transmission Distribution Metering

2000-2003 4.0% 4.0% 4.0%

2004-2007 2.5% 3.5% 3.5%

2008-2011 2.3% 1.9% 5.0%

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II REGULATORY PERIOD - DISTRIBUTION TARIFF OPTIONS FOR FINAL NON-RESIDENTIAL CUSTOMERS

CONSTRAINTS V1 AND V2 & TARIFF OPTIONS

CONSTRAINT V1Maximum total annual revenue which can be obtained by the distributor from a single customer category (verified ex-post). It is calculated on the basis of TV1 option.CONSTRAINT V2Maximum price, related to a standard quality service, which determines the maximum expense for each customer (verified ex-ante). It is calculated on the basis of TV2 option.TARIFF OPTIONSDistributors propose and the regulator approves tariffs options. Tariff options have to comply with constraints V1 and V2.

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Protected –Tariff Service - Reference Prices for Average Consumers (with an annual Consumption of

2,700 kWh and a Power Capacity of 3 kW)

taxesgeneral system charges (components A, UC4 and MCT)supply costs (including components UC1, UC5 and PPE)network costs (including components UC3 and UC6)

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The equalization mechanism – del. no. 348/07

– Law no. 481/95 fix single tariff at nation level and the introduction of equalization mechanisms between operators that have different costs of service.

– Single tariff at national level imply that tariff components are set on the basis of average costs of users network but costs of services depend on users served and land features

– The equalization mechanism guarantee the operators to recover allowed costs