- We see the possibility of a tariff deficit reappearing this year in Spain's regulated electricity system because of the dramatic fall in power demand due to economic shocks from the coronavirus lockdown.
- Past tariff deficits in Spain have weighed on the electricity sector and have largely penalized the financial performance of players.
- This time, because of the new regulatory framework, we anticipate the potential shortfall to be manageable and temporary for Spanish utilities and renewables, though the adjustment tools remain untested.
- Overall, our assessment of the regulatory framework for power transmission and distribution networks in Spain continues to be strong/adequate and assumes the country's energy plan (PNIEC) will not create any new structural tariff deficit.
Given the decline in electricity consumption during Spain's lockdown, S&P Global Ratings believes it is possible the country could once again see a tariff deficit for 2019 and 2020. However, whether that actually happens depends on how fast the Spanish economy rebounds for the rest of the year. The national lockdown began March 14, 2020, and has been gradually easing this month. We preliminarily expect that electricity consumption will decline roughly 6%-8% this year, depending on the speed of recovery, which will also determine consumption in 2021.
Tariff deficits--shortfalls of electricity system revenue (see box below)--lead to lower collections that companies need to finance as with any other working capital, which they generally recover in one or two years. In other words, such deficits usually generate a limited and temporary need for working capital. Spain saw a large accumulation of tariff deficits between 2000 and 2013, which weakened the financial standing of market players and cast a shadow over Spanish energy infrastructure investments for years. With the reform of the electricity market in 2013, the regulator sought to avoid such shortfalls, provide increased visibility, and restore investor confidence. Yet with the economic disruption that the coronavirus pandemic has unleashed, once again it appears that the Spanish electricity system faces a tariff deficit. If that should happen, S&P Global Ratings believes this time will be different. Our view is notably supported by the Royal Decree of June 24, 2020, that allows the use of the system surplus generated from 2014 to 2018 to mitigate any potential tariff deficit for 2019 and 2020.
Tariff Deficits Explained
A tariff deficit is basically a shortfall of electricity system revenue, which arises when tariffs for regulated components of the retail electricity price--the access tolls--are set below the corresponding costs borne by energy companies on their regulated assets and other energy policy costs also covered by access tolls. The shortfall would be treated as a receivable to be paid by the electricity system, but like other working capital movements, it may be temporarily financed. Prior to 2013, it was financed by utilities. However, all companies receiving revenues from the electricity sector, including renewable plants receiving subsidies, would be liable for financing tariff deficits.
The Accumulated Surplus Should Offset A Potential Tariff Deficit In 2019
We believe a tariff deficit in 2019 is likely, given the latest data from the CNMC (the National Commission on Markets and Competition; see below). However, we understand that the surplus of about €1 billion accumulated since 2013 would be used to offset any potential tariff deficit in 2019, as confirmed by approval of the Royal Decree on June 24.
Whether the system has generated a tariff deficit for 2019 should be known by around the end of 2020. The Spanish electricity system has 14 settlements for each year; 10 usually within the same year, with four additional settlements and the final calculation of the tariff deficit or surplus in the following year. For 2019, the CNMC published the 14th settlement on April 30, 2020, showing a €1.202 billion provisional tariff deficit, with the final settlement expected for December 2020 (see table 1). The 14th settlement is missing some system revenues, such as the tax on hydroelectric plants, the islands 2015 compensation, and some income related to the 7% tax on generation. Therefore, an initial preliminary number will deviate from the final calculation. The 2018 settlement process reported an initial tariff deficit of €243 million on the 14th settlement but a €96 million surplus according to the final calculation. Therefore, it is too soon to draw conclusions, but we expect the final calculation to result in a lower deficit than indicated by the 14th settlement, which would be compensated by the accumulated surplus.
|Spanish Electricity System Settlement Calculations Published By The CNMC|
|13th settlement||14th settlement||Final settlement|
|Source: Comisión Nacional de la Competencia (CNMC).|
A Tariff Deficit In 2020 Seems Even More Likely
As we have mentioned above, we now see a risk of a tariff deficit as more likely for 2020. That's because the CNMC revises the tariffs charged to end-consumers based on expectations of electricity consumption and the number of clients, among other variables. And, as we have stated, electricity consumption will likely be lower than the regulator initially expected in 2020 because of potentially lower collections due to the 7% tax on generation and because some end-consumers may have lowered contracted capacity. In addition, we anticipate lower income for the system from the sale of CO2 allowances because of a decline in prices this year. We believe that the system's lower expenses will only partly offset the fall in electricity consumption and other income, following the lower remuneration of regulated assets under the new regulatory period that began in January 2020. In addition, we understand the Royal Decree 11/2020 considers potential compensation from the government budget to cover the reduction of the contracted capacity as exceptionally allowed during the state of alarm period.
Regulation To Cover Such Risk Is In Place But Remains Untested
If the system generates tariff deficits for 2019 or 2020, we expect them to be temporary and addressed by adjustment mechanisms in the 2013 regulatory framework. However, although such tariff deficits would temporarily increase the need for working capital, we nevertheless expect that would be manageable for our rated companies. The impact on working capital would take effect in 2020 and 2021, therefore allowing companies to prepare. All of the companies we rate have strong balance sheets and access to a variety of credit-protective measures, which would allow them to absorb temporary impacts arising from changes in market conditions. For example, if the tariff deficit is 2% of system revenues and financed over five years with interest, that would mean about a €350 million impact in working capital for the companies receiving regulated income or subsidies from the electricity sector, considering the numbers of 2019 as a reference.
If the tariff deficit falls above 2%, we expect, under the current law, tariffs to be adjusted on the following year, in line with how other electricity markets work. Yet, we recognize that the deficit-adjustment mechanism remains untested, and will assess how the regulator reacts to tariff deficits as part of our analysis of system sustainability. Prior to 2013, the utilities absorbed the tariff deficit, but after 2013 all companies receiving settlements from the electricity system, including the renewable plants that receive subsidies, would need to finance it. The automatic mechanism introduced in 2013 to adjust for potential tariff deficits treats those that fall below 2% of annual revenue differently than those above the 2%:
Potential tariff deficits below 2% of annual revenue. In this case, companies receiving settlements from the electricity system do not collect their revenues in full and therefore working capital would take a hit equivalent to the percentage size of the tariff deficit compared to total revenues of the system. The receivables would be spread over five years and include market interest. In the example for 2020, the receivables would increase in 2020 and 2021. The final tariff deficit is calculated by December 2021, and it would paid from 2022 to 2026 with market interest.
Potential tariff deficits above 2% the system's accumulated balance. For the amount exceeding the threshold only, the CNMC would automatically increase access tolls and charges the following year to make up for the deficit. For example, a potential tariff deficit in 2020 would be reported as part of the final settlement in December 2021 and compensated throughout 2022. This would be in line with how the framework works in most European countries.
Past Tariff Deficits Were A Key Weakness In Spanish Regulation
Behind the material tariff deficit from 2005 to 2013 were large subsidies that Spain extended to foster the penetration of renewables. That was well before renewables reached the grid parity they enjoy today because of a massive scale-up in production, which was indeed thanks to the government subsidies.
The renewables subsidies were too large to be charged into the system, which led to a €28.7 billion structural tariff deficit by 2013. This deficit was a receivable for distribution and transmission companies, which in most cases securitized it to maintain their credit metrics, but threatened the sustainability of the system. It was at that time that the Spanish government reformed the electricity system, which led to lower remuneration for regulated assets and for renewables. Since 2014, there have been no further deficits; instead, a surplus of €1.0 billion-€1.1 billion has accumulated. What's more, the pre-2013 tariff deficit has gradually declined and was €16.6 billion in 2019, a reduction that we view as one of the main elements underpinning the sustainability of the Spanish electricity system. The pre-2013 tariff deficit is expected to be fully repaid by 2028.
Our Assessment Of The Spanish Regulatory Framework Remains Strong/Adequate Following The 2020 Reset
After a yearlong review that ended in December 2019, the regulator published the final remuneration scheme for Spain's electricity regulated assets, which was in line with our expectations, in a process that was much smoother than for regulated gas assets. The new remuneration scheme became effective January 2020 and lasts until 2025, providing six years of full visibility for the remuneration of regulated assets, which we view as positive for the credit quality of network operators.
The allowed rate of return will decline to 5.6% until the next regulatory review in 2025 from the current 6.5%. However, the annual rate of reduction will be limited to 50 basis points (bps) for 2020, so remuneration would fall to about 6.003% in 2020 and 42 bps to 5.58% from 2021-2025. As a result, overall remuneration of distribution networks would decline 1.5% in 2025 in nominal terms compared with 2019. We expect this decrease to be manageable for companies we rate, and offset or diluted by, for example, financial policy, increased efficiencies, and diversification into other activities.
Our view of the Spanish regulatory regime is supported by the following:
- The Spanish electricity and gas networks benefit from stable remuneration schemes, confirmed by the CNMC in the most recent regulatory review. The tariff structure is stable and allows companies to recover their costs and earn fair returns.
- Remuneration for electricity and gas transmission is based on RAB (regulated asset base) and the WACC (weighted average cost of capital), while gas distribution remuneration is based on a parametric formula, allowing for market-based growth.
- Six-year regulatory periods provide predictability and transparency.
- We see the appointment of the CNMC as an independent regulator in January 2019 as positive, although we do not have yet a track record to assess its independence.
- Spain benefits from the long-term vision, targets, and directives on energy policy defined at the EU level.
Our view of the Spanish regulatory regime is limited by the following weakness:
- A cumulative tariff deficit of €16.6 billion for electricity as of Dec. 31, 2019, and €960 million for gas as of Dec. 31, 2018;
- A limited track record regarding revision of the six-year regulatory periods, particularly in light of the disruptive process for gas remuneration;
- The methodology to review the process for a reasonable rate of return for electricity networks for the next regulatory period, although based on a WACC calculation, can be limited by a discretional cap set by law;
- By law, tariffs for gas and electricity TSOs (transmission system operators) and DSOs (distribution system operators) not being linked to the consumer price index;
- Limited sensitivity of gas distribution operators to gas volumes; and
- Capital in progress not being remunerated, which adds volatility to the debt metrics of those investing in large regulated assets.
We view diverging long-term prospects for Spain's gas and electricity grids because the role of electricity amid the Spanish Energy Plan provides substantial stimulus for electrification and grid investments, which are RAB-based. We believe that investments in gas transmission will become more selective, although there is some room for grid saturation at the distribution level. On the other hand, the electricity system has a large, accumulated pre-2013 tariff deficit that we view as a key weakness, while the gas market is almost in balance.
We view the investments required for the energy transition (under the Spanish National Energy and Climate Plan (PNIEC)) as relevant over the long term for the tariff deficit and hence the long-term sustainability of the sector. The total investment needed to transform the energy sector is more than €241 billion--including €91.7 billion for renewables and €58.5 billion for electrification and networks from 2021 to 2030, according to PNIEC estimates. We will monitor carefully whether PNIEC's implementation of the plan does not lead to further tariff deficits. Should a structural tariff deficit emerge again, the risk for cuts in regulated revenues--or the need for an increase on access tolls charged within the retail price--would increase proportionally, raising uncertainties about the deployment of regulated investments.
Appendix: Coverage Coefficient
The collections of the electricity tariffs are seasonal. That's because electricity consumption is paid by end-consumers with a delay of one to two months. In addition, the collection of certain taxes that are a source of revenue for the electricity system varies throughout the year. The coverage coefficient ratio published by the CNMC with the reports of each settlement represents the percentage of costs paid with available income.
Writer: Rose Marie Burke
This report does not constitute a rating action.
|Primary Credit Analyst:||Gonzalo Cantabrana Fernandez, Madrid (34) 91 389 6955;|
|Secondary Contacts:||Pierre Georges, Paris (33) 1-4420-6735;|
|Claire Mauduit-Le Clercq, Paris + 33 14 420 7201;|
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