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Utilities, investors urge rethink of Spanish grid return cuts

Spanish utilities and their investors are pushing back against proposals to tighten the allowed returns for electricity and gas networks during the next regulatory period, arguing that the cuts would cripple investment and could undermine the country's plans to leverage its booming renewables market for its decarbonization efforts.

Spain's competition regulator, the Comisión Nacional de los Mercados y la Competencia, or CNMC, last month unveiled a consultation that proposes to cut the regulated revenue for electricity distribution and transmission networks by around 7% to 8% and slash returns for gas distribution and transmission networks by 18% to 22% for the period from 2021 to 2026. The new tariff mechanisms, which also apply to gas storage and LNG terminals, would involve lowering the rates of remuneration and tightening cost allowances, as well as phasing out payments for older grid infrastructure.

Some of the country's largest utilities, including Iberdrola SA and Naturgy Energy Group SA, have voiced strong opposition to the proposals, saying they go against the government's own targets to transform Spain's energy system.

"The proposed rate of return is not sufficient ... to mobilize the necessary investment in networks in order to reach the goals of [the government's] national integrated energy and climate plan," Iberdrola Chairman and CEO Ignacio Galán said on a July 24 earnings call. "Meeting these decarbonization targets will require additional incentives to power grids in order to promote a quick electrification of the economy."

According to Moody's, the regulator estimates that lost revenues would expand gradually over the course of the six-year regulatory period, ultimately reaching an aggregate €325 million for the gas transport and re-gasification sector, and €453 million for gas distribution. That represents roughly a third of total regulated revenues for both sectors.

Investors in some of the affected companies have also raised alarm. The Financial Times reported that a group of private equity firms and pension funds, including CVC Capital Partners Ltd. and Global Infrastructure Partners, have written to the CNMC to warn that the changes would harm investment in Spain's gas sector, in particular.

Gas sector hit hardest

Enagas SA, which operates most of Spain's gas transportation network, could potentially see its 2018 EBITDA trimmed by 22% as a result of the cuts, Moody's calculates. By contrast, Naturgy and electricity transmission operator Red Electrica de Espana S.A.U. could see earnings cut by only 7% and 10%, respectively.

On July 25, S&P Global Ratings revised its outlook for Enagas, as well as gas distribution operators Madrilena Red de Gas II, S.A.U. and Nortegas Energía Distribución S.A.U., to negative as a result of the proposal. The companies would be hit hardest by the phaseout of payments for amortized assets, S&P said.

Utilities said they are now preparing detailed arguments against the proposals, which are still open for consultation. But Francisco Reynés, Naturgy's chairman and CEO, also raised the possibility of legal action if the CNMC fails to be convinced.

"Of course, allegations is not the only way we have to defend the interest of all of the shareholders," he told analysts on a July 24 earnings call, adding that the company is considering "judicial alternatives." Companies could pursue claims in domestic courts or seek international arbitration through their foreign investors, according to David Diez, a partner at the law firm Watson Farley & Williams in Madrid.

Despite the fact that it operates the majority of Spain's gas distribution network, its more diversified overall business would make Naturgy less exposed to the cuts than some of its peers, according to S&P.

New powers

Spain isn't the only country tightening the screws on network companies. Grid operators in the U.K. have been sparring with Ofgem, the British energy watchdog, over its own proposal to lower the allowed rate of return.

But in Spain, the state recently handed extra powers to the regulator, meaning the CNMC now has ultimate authority to approve the new framework. Diez said the current proposals could provoke a showdown with the government, which still has oversight of network planning and may oppose the plans if it sees grid expansion under threat. The energy ministry is expected to call a special commission to arbitrate the matter in the coming weeks.

Although the CNMC could simply disregard the commission's opinion, Diez said precedent suggests that the regulator may be open to amending its proposal enough to placate the utilities. He also said it's unlikely the CNMC will let things come to a head with the government.

"My experience is that the regulator is not absolutely strict, in the sense that they are open to analyzing proposals and allegations made during the process," Diez added. "It would create a bad regulatory atmosphere if there is a public conflict."

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.