Financing challenges facing Europe’s TSOs

World Forum on Energy Regulation VSession “The role of investment in enhancing security of supply”

Quebec City, 15 May 2012

Konstantin Staschus, Ph.D.Secretary-General, ENTSO-E

Overview

• An introduction to European electricity markets and ENTSO-E.

• Europe’s energy policy objectives & ENTSO-E’s role in delivering them.

• The scale of the investment need – Ten-Year Network Development Plan.

• The challenges in delivering that investment.

• The need for action on permitting & finance.

• Concluding remarks.

Financing challenges facing Europe‘s TSOs| K. Staschus | 15 May 2012 | Page 2 of 17

Lisbon Treaty 2008: TITLE XXI – ENERGY - Article 1941. …Union policy on energy shall aim, in a spirit of solidarity between Member

States, to:

EU energy policy and challenges for TSOs – in a nutshell

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Market opening electricity and gas:

– 3 Internal Energy Market legislative packages 1996, 2003, 2009̶0 3rd party access, national regulators, cross-border trading, non-discriminatory TSOs̶0 TSO unbundling, ACER, common rules (network codes)

– Europe-wide wholesale electricity market well established but hampered by congestion and insufficient infrastructure (2014 goals; Infrastructure Package)

– From the outset, (staged) retail market opening part of the packages

– Cross-border M&A and also increasingly direct sales in other countries

Climate action:

– Emissions trading but also:

– 20-20-20 goals for energy efficiency, greenhouse gases, renewable energy

– 2009 RES Directive and National Renewable Energy Action Plans foresee 35 to 38% RES in electricity in 2020 (dominated by wind, solar, hydro)

Variable RES create even bigger challenges for TSOs (balancing) than markets

EU energy policy and challenges for TSOs (2)

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Key activities set out in Regulation 714/2009 (on cross-border electricity trade, part of the 3 rd IEM Package)•Deliver network codes binding to all network users (through ‘Comitology’)•Deliver network plans European / regional view of system needs (“TYNDP”)•Deliver crucial aspects of market integration (“market coupling”)•R&D Plan (fully included in EEGI – European ElectricityGrid Initiative, part of the SET Plan)

Through its members deliver the infrastructure to:• enable markets to function, • secure energy supply, • meet climate change objectives through connecting RES

ENTSO-E has significant role in deliveringEuropean energy and climate change objectives

41 TSOs from 34 countries530 million people, 910 GW gen., 300 000 km transm.

41 TSOs from 34 countries530 million people, 910 GW gen., 300 000 km transm.

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Huge flows all over Europe total

PV

wind

2000

total

PV

wind

2010

total

PV

wind

2020

From a few large plantsThousands of small units

Offshore

Onshore

Today

2020: 230 GW

2030: 400 GW

Wind share of demand: 2010 = 5,3% 2020 = 23% 2030 = 36%

TWh

40 GW

150 GW

190 GW 250 GW

Network planning while Europe experiences a paradigm shift

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And renewable energy booms, as the 2012 ENTSO-E Ten-Year Network Development Plan shows

Drivers for grid development RES effects on investment need

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Which requires huge investment over the next 10 years

Total investments costs for transmission projects of pan-European significance:€ 104 billion until 2022, of which € 23 billion is for subsea cables.

• Financing challenges facing Europe‘s TSOs| K. Staschus | 15 May 2012 | Page 8 of 17

The challenges in delivering infrastructure today

The Energy Infrastructure legislative package proposed

by the European Commission in Oct 2011 and now debated in

Council and Parliament represents a key opportunity to

address these issues

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Financing issues - The basic TSO business model

build and operate grid infrastructure

attract investors

charge all customers rates approved by

the regulator

The TSO business model Increasing demand for (long-distance) transmission

- Technological challenges - Permitting and authorization

Capital Acquisition - Investor confidence - Regulatory framework

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But regulatory regimes differ, and asset base expansions cannot be part of normal incentive regulation

Period 1 TimePeriod 2 Period 3

Revenue

Return

Cost

Revenue

Cost based regulation

€

Time

Incentive regulation

Efficiency targets

Cost

-+

Incentive: Cost reduction

-

€

Expansions of the asset base must be regulated outside the classic incentives !

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Regulation is exceptionally important to attracting investment:e.g. institutional investors looking for low risk and long-term.

Broad Rating Factors Weight Rating sub-factor Weight

Regulatory Environment & Asset Ownership Model

40% Stability & predictability of regulatory regime 15

Asset Ownership Model 10

Cost & investment recovery 10

Revenue Risk 5

Efficiency & Execution Risk

10% Cost Efficiency 6

Scale & Efficiency of capital program 4

Stability of business model & financial structure.

10% Ability & willingness to pursue opportunistic corporate activity

3.33

Ability & willingness to increase leverage 3.33

Targeted Proportion of Operating Profit Outside Core Regulated Activities

3.33

Key Credit Metrics 40% Adjusted ICR (or FFO Interest Cover) 15

Net Debt/RAV (or Fixed Assets) 15

FFO/Net Debt 5

RCF/CAPEX 5

Source: Moody’s global infrastructure financeSource: Moody’s global infrastructure financeFinancing challenges facing Europe‘s TSOs| K. Staschus | 15 May 2012 | Page 12 of 17

The TSO financing challenges in Europe today

Unstable regulatory regimes can deter investor confidence. Unstable regulatory regimes can deter investor confidence.

Large investment need, risks increasing, competition for funds:

finding the volume of investment needed to meet Europe’s needs is a real challenge.

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Some recent developments address these concerns

• Great Britain: review of the regulatory mechanism

(RIIO Revenue = Incentives + Innovation + Outputs)

• Italy: Additional rewards for delivering investments more quickly.

• USA: inter state investment incentives based on “Adders”

• European Commission: European Infrastructure Package (?)

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The Priority Premium concept

Investment [Mio. €]

Impact in Italy

Investment [Mio. €]

Impact in the US (1 ISO)

Introduction

Introduction

Announcement

• Goal: incentivise TSOs to push Projects of Common Interest forward (attract investors)

• Possible implementation: establish a non deductible return premium

• Effect: similar schemes have kick- started investment internationally

• Leverage effect: moderate premiums can incentivise relatively large investments

Source: Roland Berger study commissioned by the EChttp://ec.europa.eu/energy/infrastructure/studies/doc/2011_ten_e_financing_report.pdf

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How EU regulation could support investment

• Risks can be decreased through increasing regulatory stability,

making allowances for riskier projects, increasing transparency.

• By creating incentives to focus attention.

• By specifying a consistent framework to align domestic regulation

and EU policy objectives via the Energy Infrastructure Package.– Example: Common description of risk – priority premium relationship.

• By making financing contributions to target specific risks.

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Concluding remarks

The European energy sector is changing very fast.

• ENTSO-E is at the heart of that change.

• But significant challenges remain and need to be addressed.

• In too many cases important projects are delayed by fragmented or overly complex planning processes.

Regulatory regimes need to adapt to deliver what Europe‘s customers require.

• And ensure that the huge investment volumes can be financed.

• In order to ensure security of supply, creating genuinely competitive markets and decarbonise the sector.

• Decisive action from the EU and from regulators is needed.

Infrastructure Package (3-year time limit, incentives) + regulatory stability.

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