- We believe the regulatory framework that governs Norwegian electricity distribution and transmission networks is very transparent and predictable, and we view the regulator as independent.
- We assess the framework as strong, because it is very predictable and has proven to provide operators with long-term visibility despite the lack of fixed regulatory periods.
- We think Norwegian utilities face lower transition risks (and lower investment needs) than most of their European peers but face larger operations risk because of environmental challenges.
- As a result, we believe the vast majority of Norwegian power networks would be eligible for an excellent business risk profile assessment, provided there is no operating underperformance.
- We view as a relative weakness of the framework assets under construction not being added to the regulatory asset base until the project enter operations.
|Norway--Electricity TSO And DSO Regulatory Framework|
|Regulator||Norwegian Water Resources and Energy Directorate (NVE)|
|Key players||Statnett--electricity TSO|
|Tariff-setting methodology||Revenue cap model|
|40% cost base, 60% cost norm|
|Rate of return:|
|2020: 5.43% (preliminary)|
|Regulatory period||No set periods; adjustments lasts for at least five years.|
|TSO--Transmission system operator. DSO--Distribution system operator.|
In Norway (AAA/Stable/A-1+), the regulator is The Norwegian Energy Regulatory Authority (NVE-RME).It sets allowed review for both transmission system operator (TSO) and distribution system operator (DSO) activities, covering about 120 companies. The transmission network length is about 11,000 kilometers (km), and regional and high-voltage distributions grids cover about 19,000 km and 100,000 km, respectively. The Norwegian electricity sector has been deregulated since 1991.
The vast majority (95%) of generation stems from hydro power, with production at about 140 terawatt-hours annually and the country being a net exporter to the Nordic region. Furthermore, hydro production facilities are spread out across the country, which lowers the risks for transmission of capacity over longer distances compared with neighboring countries. While Norway announced some large projects in offshore wind, the already-largely decarbonized electricity mix does not need a major transformation compared with many other European markets, which means no significant capital expenditure requirements for network operators (interconnecting cables excluded). In addition, the country's GDP is among the highest in Europe and affordability risks regarding energy bills are less prominent in the political debate. Nevertheless, more rapid demand growth, likely powered by the transportation and oil and gas sectors, could change the domestic demand-supply situation in the next few years and trigger increased need for investment in the network. The Norwegian operating landscape, dominated by mountain, costal, and cold, are typically more challenging than that of European peers. Statnett SF (A+/Stable/A-1) is a state-owned TSO, with about 97% of all transmission lines, including interconnectors. We do not rate any companies with DSO activities.
Regulatory stability: Very robust
We assess the stability of the regulatory framework as very robust, because it is very predictable, has historically provided good cost recovery and prudent return on invested capital, and is inflation-linked. The system remuneration also includes a clear and achievable operating efficiency incentive component, whereby operators can retain efficiency gains, but also be penalized for less than average efficiency. We believe this primarily benefits larger operators, due to economies of scale.
The Norwegian framework does not have regulatory periods like many of its neighboring countries, such as Sweden or Finland. Any changes to the framework are instead communicated in advance, typically about two years ahead, via a referral process including with a clear, public, and transparent consultation process including all affected parties. Key factors of the regulatory framework then take effect for five years. The latest changes to the model were in January 2019, meaning no changes to the weighted average cost of capital (WACC) parameters until 2023 at the earliest. Historical changes have not materially affected compensation, nor our assessment of the framework.
The model has both fixed and variable parameters (see table 2). The variable parameters are updated annually, resulting in a different WACC each year, which the regulator communicates to the market in November for the upcoming year. However, these parameters come from other authorities, and could easily be monitored by the industry throughout the year, hence our expectation of each year's WACC being transparent and predictable (see chart 1).
|Trajectory Of The WACC Parameters Shows A Declining Rate Of Return|
|Risk-free rate (f)||2.5||2.5||2.5||2.5||2.5||2.5||1.5||1.5|
|Inflation rate (v)||1.70||2.18||2.25||2.53||2.33||1.98||2.23||2.13|
|Equity beta* (f)||0.875||0.875||0.875||0.875||0.875||0.875||0.875||0.875|
|Market risk premium (f)||5||5||5||5||5||5||5||5|
|Tax rate (v)||28||27||27||25||24||23||22||22|
|Cost of equity (nominal, post-tax)||8.58||9.06||9.13||9.41||9.21||8.86||8.11||8.01|
|Swap rate (v)||2.59||2.19||1.44||1.18||1.48||1.87||1.79||1.13|
|Credit risk premium (v)||0.97||0.56||0.75||1.00||0.65||0.63||0.77||1.09|
|Cost of debt (nominal, pre-tax)||3.56||2.75||2.19||2.18||2.13||2.50||2.56||2.22|
|WACC (nominal, pre-tax)||6.90||6.61||6.32||6.32||6.12||6.10||5.69||5.43|
|*Equity beta is a constant value, not in percent. WACC--Weighted-average cost of capital. f--Fixed. v--Variable.|
Tariff setting: Efficiency pays off
NVE determines how much revenues each DSO and TSO can collect from its customers through tariffs. It determines allowed income (the revenue cap). Each company then sets its rates based on this. Actual revenue from tariffs might not always equal allowed revenue, leading to excess revenue or even a deficit. The excess revenue must be reimbursed to customers, with interest; deficit revenues should be recovered in a timely manner.
Allowed revenue for each company builds on the cost base and cost norm, with a weighting of 40% and 60%, respectively, although this will change starting 2023 to 30% and 70%, respectively.
The cost base is the company's individual costs of operations and maintenance related to the grid. But it also includes:
- Cost of energy not supplied plus values of lost load;
- Network losses: measured in megawatt-hours multiplied by the price of energy;
- Depreciation of the regulatory asset base (RAB); and
- Return on assets: RAB multiplied by rate of return (WACC).
The cost norm represents what costs would be had the electricity grid been maintained, developed, and operated at average efficiency. The cost norm is based on the cost base factor adjusted for how efficient each company is. From a credit perspective, we view this as positive, because well organized and effective companies are allowed to higher returns and the system is transparent concerning the function. The cost norm compares all regulated entities, and gives entities incentive to continuously work on efficiency to receive a high efficiency score, thereby avoiding a deduction to its revenue cap.
Efficiency Score Determination
- The TSO efficiency score is done separately with a European benchmark, because Statnett is the only TSO operator in Norway. In the most recent assessment, the company came out below 100%, but the regulator adjusted this to 100% because the benchmark report did not capture Norwegian price developments compared with rest of Europe, or the company's unique environmental issues. Statnett was assessed as at least average in the previous review in 2012, leading to a 100% efficiency score for its allowed regulated-return calculation.
- Each DSO's efficiency score is assessed annually, and gives companies incentive under the framework to improve their efficiency. The benchmark is a ranking process, which measures DSOs' comparative cost bases and adjusts for environmental factors. We view this as a positive feature of the framework, because these factors could vary significantly in Norway. The efficiency score exercise is divided into three steps:
- --Calculate efficiency scores with data envelopment analysis, which provides a mathematical programming method of estimating best practice production levels and evaluating the relative efficiency of different entities;
- --Adjust efficiency scores for environmental factors. The calculation considers the specific entity's environmental factors for its grid, such as geological issues; and
- --Calculation of the cost norm. This calculation includes the difference between the cost base and cost norm, multiplied by the individual company's share of the total RAB in Norway. Overall, the sum of cost bases for all involved companies equals the sum of cost norms, resulting in the calibration mechanism ensuring that the industry as a whole gets the regulatory rate of return.
Financial stability: Strong, based on full cost recovery and a healthy operating environment
Companies under the regulatory framework, with a WACC of 5%-7%, can usually recover about 50% of their investment after five years, which we deem in line with that of other regulated frameworks we assess as strong. In addition, neither DSOs nor TSOs have significant volume risk, because the risk captured as a pass-through, albeit with a two-year lag. We view as a relative weakness of the framework that assets under construction not being added to the regulatory asset base until the project being taken into operation. Although, interest cost related to this is allowed for capitalization, and additional 1% is added to RAB to cover assets under construction.
The Norwegian economy is among the strongest in Europe, underpinned by a stable and largely predictable policymaking environment. It is re-enforced by high wealth levels, and large external and fiscal net asset positions from accumulated petroleum revenue. This lowers the risk of any sudden and unfavorable changes of the regulating framework, in our view. We estimate the country's GDP per capita at $71,100 in 2020, among the highest of all sovereigns we rate. Norway has a history of prudent policymaking, reflected in its fiscal rule and the creation and management of its very large sovereign wealth fund, the Government Pension Fund Global, set up to save and channel oil revenue into the economy.
Regulator independence: High level of independence
NVE is the independent regulatory authority in Norway. It is responsible for the regulation of DSOs and Statnett. We consider NVE independent based on Norway's stable political base as well as no track record of government interference.
- Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013
- Nordic Utilities Are Suffering From Low Power Prices And Structural Changes, Oct. 15, 2020
- The Quality Of Eastern European Regulatory Frameworks For Utilities Varies, Reports Show, Oct. 6, 2020
- Statnett SF 'A+' Rating Affirmed With A Stable Outlook, Feb. 26, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Daniel Annas, Stockholm +46 (8) 4405925;|
|Secondary Contacts:||Per Karlsson, Stockholm (46) 8-440-5927;|
|Pierre Georges, Paris (33) 1-4420-6735;|
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