Fitch Ratings says that the final tariff proposal for FY2012-2015 for Italian electricity transmission and distribution networks published on 30 December 2011 by the Italian industry regulator, the Authority for Electricity Energy and Gas (AEEG), is broadly rating neutral for network operators rated by Fitch, including Terna Spa ('A'/Negative), Acea Spa ('A'/Rating Watch Negative) and Enel Spa ('A-'/Stable).
Fitch Ratings says that the final tariff proposal for FY2012-2015 for Italian electricity transmission and distribution networks published on 30 December 2011 by the Italian industry regulator, the Authority for Electricity Energy and Gas (AEEG), is broadly rating neutral for network operators rated by Fitch, including Terna Spa ('A'/Negative), Acea Spa ('A'/Rating Watch Negative) and Enel Spa ('A-'/Stable).

The AEEG's price determinations are generally well balanced and, most importantly, based on a methodological continuum with the past that strengthens the regulatory framework's transparency and track record. The determinations have also benefited from significant consultation with the industry during the review process.

The review's main feature is the introduction of an interim re-determination of the risk free rate that is a main factor for the calculation of the weighted averaged cost of capital (WACC). According to the AEEG's final document, the applicable WACC will be reviewed in November 2013, on the basis of a recalculation of the risk free rate, and will be applied to the last two years of this price cycle (2014-2015). The risk free rate is determined based on the average past 12 months yield on Italy 's 10-year treasuries.

Over the second half of 2011 the risk free rate was subject to an unprecedented increase as a result of the sovereign debt crisis in European peripheral countries, including Italy . The gap between the 2008-2011 review's risk free rate and this review's amounts to c. 80 basis points (bps; 4.45% in 2008 and 5.24% in 2011). The interim re-determination underlines the regulation's enhanced flexibility. Whether this will result in an increase of the WACC at the recalculation date is difficult to determine at this stage, but Fitch's view is that it represents a useful adjustment tool in a downside scenario.

The AEEG's final proposal includes a headline real pre-tax WACC of 7.4% for transmission and 7.6% for distribution, an increase of 50bps and 60bps respectively from the previous regulatory cycle (2008-2011). It should be noted that the AEEG's corporate tax rate allowance determination does not include the increased tax rate introduced with the August budget law on Italian energy companies (so called Robin Hood tax) as the charge was not to be passed on to consumers.

The review also establishes the recognition of an additional 1% return allowance on new investments (realised from 2012 and remunerated only from 2014) to compensate for the time difference between completion of investments and the start of their remuneration in the tariff. This item was heavily negotiated with industry players and the final rate achieved represents an improvement on the initial AEEG proposal of 0.7%.

On a more negative note, from 2012 the incentive scheme for strategic investments in transmission has been revised downward to 150bps and 200bps on base WACC depending on the type of investment, from the previous period's 200bps and 300bps. For distribution the incentive scheme was revised to 200bps and 150bps from 200bps on two investments categories and the number of investment categories was widened to five types.

The AEEG has used 2010 as reference year for operating costs allowances. The 50/50 profit sharing was confirmed, while the X-factor (efficiency factor) was increased to 3.0% from 2.3% for transmission and to 2.8% from 1.9% for distribution.

On depreciation allowance for transmission some benefit will stem from the recognition of the first depreciation rate calculated based on the gross investment figure, versus a net investment figure used in the previous regulatory period. The amount of regulatory depreciation in a given price control period is equivalent to the amount of capex that will be funded directly by customers (the balance of the capex will be funded by debt and equity and will be remunerated by the WACC). Therefore, high regulatory depreciation lowers the need to raise debt and equity to fund realised capex.

In distribution, the removal of the price cap on depreciation for assets put into operation prior to 2008, bringing it in line with that already provided by the regulation on depreciation in the third regulatory period (post 2008), will result in a positive contribution.

The volatility of volumes experienced by network operators for the first time in 2009 as a result of the economic downturn and consequent contraction of consumption levels prompted the intervention of the regulator to introduce interim measures to minimize the volume effects on revenues. Those measures have now been introduced in the regulatory framework for transmission and distribution tariffs.

For transmission, in 2013 the tariff will be split in two elements (binomial tariff): one covering the capacity and the second covering volumes. According to the AEEG's document, the exposure to volume effects of transmission revenues should be limited to only 20% of allowed opex, representing c. 4% of total regulated revenues. This is equivalent to 12.5% of volume reduction in comparison to the previous maximum allowance. For distribution a stabilisation system is provided for in the AEEG document but the actual mechanism is yet to be detailed and will be reviewed by Fitch upon its publication.

The final determination assumptions are subject to the details of the technical note to be published by the AEEG. To better appreciate the full impact of the price control proposals it is necessary to assess the building blocks from which the revenue proposals are derived - cost of capital, capex and opex. Fitch will monitor the subsequent documentation and comment where appropriate.

While the price review is broadly credit neutral, Fitch expects to resolve the Negative Outlook on Terna Spa's Long-term IDR in function of final details of the technical note, the management's review of the investment strategy and the dividend policy over the next regulatory period that will be unveiled in the next business plan. The Rating Watch Negative on Acea Spa's rating will be resolved once the legislative vacuum on investment remuneration for water assets has been addressed

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