News Article

The Italian Renewable Power Market


The Italian power market will undergo significant
changes in the next few years as its fuel mix undergoes a
transformation, with more renewables and a decline in coal. Meanwhile,
an increasing number of interconnections among Italy and its neighbours
means that major structural changes in the German, French, and other
markets will have implications for the Italian power sector. But,
despite a substantial tightening in the power market in Germany from
early next decade as a result of its nuclear and coal closure program,
S&P Global Platts Analytics expects Italy to retain its position as
the premium market in terms of power prices in Western Europe to 2025,
and for prices to rise consistently in real terms between 2020 and 2025.
This is partly due to Italy's large gas capacity, which makes its power
prices heavily dependent on PSV ("punto di scambio virtuale" or virtual
trading point) gas prices, which are also consistently above those of
other European hubs. S&P Global Platts Analytics forecasts PSV gas
prices to fall from 2018 levels, when they were at about 25€/MWh, until
the end of the decade to below 20€/MWh but to recover from 2021 as a
reduction in liquefied natural gas (LNG) imports and lower European gas
production reduce the competitive pressure on Russian gas.

coal phaseout, which is set to end by 2025 in the National Energy
Strategy, translates into a forecast reduction of 2GW in coal capacity
by 2024 and by a further 6GW in the following year, according to S&P
Global Platts Analytics. Coal closures will be skewed toward the end of
the period due in part to the regulated nature of some coal capacity,
which is in receipt of nonmarket revenue for system security reasons.

closures mean that gas will remain the dominant technology in Italy in
the foreseeable future. As such, prices are heavily dependent on PSV gas
prices. Imported natural gas enters the national network through eight
entry points. In 2018, Italy's major suppliers were Russia (41%),
Algeria (24%), and Libya (6%), while pipeline imports from northwest
Europe and LNG accounted for 11% and 12% of Italian supply,

Edison SpA's announcement in early March that it would invest in a new 0.8GW combined cycle gas
turbines plant at Marghera represents the first large addition to the
Italian thermal fleet since 2013. But overall, new additions of large
gas capacity to 2025 are expected to be limited, shifting the focus on
renewables and imports to balance the system. By 2023, Italian
interconnector capacity will expand by 1.2GW with mainland France and
1.0GW with Switzerland, from 3.2GW and 4.2GW today, but increased flows
have a limited impact on the robust margins of domestic thermal plants.
As a result, Italy is expected to reinforce its position as the premium
power market in Europe (even as Germany becomes increasingly tight in
the next decade as a result of its coal and nuclear closure programs).

wind and solar capacity are both forecast to more than double by 2030
from 2018 levels, while neighbouring France is also expected to see
robust increases. The anticipated growth in renewables to 2030 adds
downward pressure on wholesale power market prices, but this will be
offset by continued coal and nuclear closures in France, Germany, and
elsewhere as well as upside in demand from the electrification of
transport, and, to a lesser extent, heating.

has been historically strong in hydro production, which has represented
the bulk of renewables production in the country. In 2018, hydro output
was 49TWh, which was 9TWh more than reported solar and wind generation
combined. However, the potential for growth in hydro capacity--currently
at around 12GW for large scale and 22GW in total--is limited, while
solar photovoltaic capacity in the country increased rapidly from 3GW in
2010 to approximately 21GW by the start of 2019, and is forecast to
increase further to 27GW by 2025. Similarly, wind, whose total installed
capacity in 2010 was 6GW, increased to 10.3GW by the start of 2019 and
is forecast to increase to 14GW by 2025.

Can Italy Do It Again?

will Italy reach its ambitious goals to increase renewables in the
energy mix by 2030? The country has proposed to increase its solar and
wind installed capacity to 50.9GW and 18.4GW by 2030, from 21GW and 11GW
as of end-2018, according to the National Energy and Climate Plan the
government submitted to the European Commission on Jan. 8, 2019.

plan would go a long way to meeting the National Energy Strategy (NES)
approved in November 2017, with the ambitious goal of increasing the
share of energy from renewable sources in gross final consumption to 30%
by 2030, from 18.3% in 2017 and 17.5% in 2015.

has a successful track record in achieving renewable targets as its
2020 energy strategy target of 17% of renewables in gross energy
consumption was reached in 2014, six years ahead of the deadline,
performing better than other EU countries. We note that in 2018 power
represented 55% of energy consumption.

achievement of past targets, however, reflects exceptional growth in
renewable investment in Italy, particularly in solar photovoltaics (PV)
and onshore wind between 2010 and 2013, boosted by generous subsidies.
Feed-in tariffs for solar PV halted in 2013 in Italy, while other
renewable sources (mainly onshore wind) continued to be promoted through
auctions, the latest of which was in December 2016.

Contracts for Difference May Make A Difference

country expects to hold seven competitive auctions featuring contracts
for difference (CFD) this year through 2021 to promote renewable
investments in Italy, which may go some way to helping the country reach
its 2030 targets. They include up to 4.8GW in new PV and wind power
plants, together with 140MW of hydro, biomass, and geothermoelectric
plants, and 490MW repowering investments.

final version of the decree authorizing the auctions has not yet been
approved, and the first auction, which was first to be in October 2018,
then on Jan. 31, 2019, has been further delayed. Overall, we expect the
Northern League-Five Star Movement coalition government established in
June 2018 to continue supporting decarbonization and renewables growth
(see "Will The Momentum Build For Green Finance In Italy?" published on
Aug. 2, 2018), in line with the content of the coalition government
contract. Indeed, the draft Renewables Decree circulated in September
2018 is much the same as the draft prepared by the previous government.

proposed incentive of the new auctions is a novelty in Italy but
largely mirrors the mechanism of CFD already launched in other European
countries. A CFD stipulates that the electricity generator will sell
energy to the buyer at a fixed price ("strike price") and the parties
will exchange the difference between the strike price and market price
at contract time. According to the current version of the Renewables
Decree, the reference price for the first auction is set at 70€/MWh for
solar PV and wind projects, with a 70% maximum discount.

means that bidders will submit to the Gestore dei Servizi Energetici
(GSE), which is the state-owned entity responsible for granting
renewable incentives in Italy, their offer expressed as a percentage
discount to the reference price. Successful bidders will be selected
based on the highest discount and, in case of parity, based on their
rating on legal aspects (as stated under European Directive No.
27/2012), followed by their location (for example, plants on dump,
mining or contaminated sites will rank first) and, finally, by the
earliest date of their offer submission.

plants with installed capacity of less than 1MW are excluded from the
auctions but will also be offered incentives through dedicated
registers, to support about 1.49GW of new capacity. These auctions have a
higher reference price with a 30% maximum discount (see table 2).

the reference price for plants above 1MW is closer to the market price
than under previous incentive plans, in our view this reduces the risk
that this plan may become unsustainable and require retroactive changes.

2014, for example, a retroactive change was introduced (see Decree No.
91/2014, the so-called "Spalma Incentivi") to reduce the amount of
subsidies ultimately borne by final consumers. Among three different
available options, most Italian PV plants opted for an immediate
reduction of the feed-in tariff by 8% over the remaining life of the

However, the level of unitary
feed-in tariff granted to solar PV was significantly higher than the
reference price of the envisaged auctions.

the upcoming auctions, the projects that are selected will be entitled
to receive a certain "strike price" fixed on a nominal basis for 20
years. When the "strike price" is higher than the regional market price,
the GSE will pay the project the difference between the "strike price"
and the market price. Vice versa, when the regional market price is
higher than the "strike price," the project will pay the GSE the
difference between market price and the "strike price,"

means that for the first time, auctions may also generate revenues for
the GSE in case future market prices are higher than strike prices. This
further reduces the risk of retroactive changes.

a credit perspective, the CFD mechanism of the proposed auctions
removes all project exposure to market risk by ensuring a unitary
tariff, which remains flat for 20 years, irrespective of merchant
prices. This mechanism reduces potential upside for sponsors but
increases the predictability of project cash flows for lenders and,
therefore, provides better visibility on debt-service coverage ratios.
However, as renewable projects are starting to come online fully exposed
to merchant risk, are CFD the most cost-effective way to stimulate
renewable investments, while keeping the tax burden at a minimum?

How Can Italy Meet The 2030 Targets?

size of the expected auctions (overall slightly less than 7GW of
installed capacity) is lower than the ambitious goal of the proposed
National Energy and Climate Plan, which aims at increasing solar PV and
wind installed capacity by about 37.3 GW by 2030 in total.

are not selected during the auctions will not have access to potential
subsidies, therefore remaining exposed to merchant risk. However, the
absence of subsidies per se is not obstructing investments in the
sector. Capital investment has fallen dramatically over the past decade,
and there is now greater transparency about technology performance (see
"Shining Light On The Key Rating Assumptions For Our Solar Photovoltaic
Project Portfolio," published on April 10, 2018, on the key rating
assumptions for our solar PV project portfolio). Therefore, we
understand that renewables can be competitive without subsidies under
certain conditions.

However, the key concern
for financing new renewable assets in the absence of public support is
the exposure to the volatility of merchant prices, which makes the
predictability of cash flow relatively uncertain in the long term.

price purchase agreements (PPAs) are an alternative to public subsidies
as they set fixed prices and reduce uncertainty about market
volatility. They typically represent bilateral sale agreements
where the off-taker (purchaser), which can be a corporate entity,
typically a utility, or simply a trader, buys future energy production
at a certain price from the producer.

In terms
of credit risk, reliance on long-term PPAs exposes the project to the
creditworthiness of the third-party off-taker, unless mitigated by other
public or private entities.

Unlike in the
U.S., Europe has not developed a market of long-term PPAs yet, but some
transactions are starting to emerge--and Italy is not an exception.

draft Renewables Decree for the upcoming auctions fails to provide some
immediate measures to facilitate the development of a PPA market in
Italy, despite the announced intention of creating a platform to
negotiate long-term energy contracts.

We think
utilities with a large customer base, such as Enel SpA, might be more
willing to increase their exposure to merchant risk. Enel is an example
of a utilities giant that can offset merchant risk, in our view, through
its vertical integration, large customer base, and the nature of its
generation mix, given that a large portion still comes from conventional

What Are The Peculiarities Of The Italian Renewable Space?

of the complexities of the Italian market is the presence of six
different regional markets were the energy is traded (Northern Italy,
Center North, Center South, South, Sicily, and Sardinia). This leads to a
material difference in energy prices per region, which in some cases
can reach 10€/MWh. And, the smaller the market, the more difficult to
forecast longer-term prices.

The fact that
solar PV and wind are competing for the same incentive is a novelty of
the upcoming auctions. However, in Italy, their levelized cost of energy
(LCOE; the lifetime costs per energy production) is comparable.
Therefore, we anticipate the two technologies can fairly bid for the
same tariff, which represents an important step toward the achievement
of the grid parity.

Plus, auction participants
should find the amount of subsidies straightforward to forecast in
Italy, compared to, for example, Spain. This is because under the
Italian regulatory framework, unitary incentives remain fixed on a
nominal basis, while Spanish subsidies are periodically reviewed based
on a rate of return that includes interest rates and dynamic floor
prices. We also flagged the risk that the latest renewable projects
auctioned in Spain in 2016 and 2017 may not receive any subsidy and
therefore be completely exposed to merchant risk (see "The End To
Subsidies: The Beginning Of A New Era For Spanish Renewables?" published
on Feb. 7, 2018).

Nevertheless, despite more
predictable incentives than in other countries such as Spain, Italian
renewables remain exposed to a certain authorization risk. There have
been a number of cases in Italy where irregularities were found in
plants' authorizations after some years of operation, and we understand
that assets remain exposed to the risk of incentive revocation due to
permitting or authorization irregularities at any time during the life
of the project. Potential irregularities may expose the project not only
to incentive revocation by the GSE but also to potential clawback,
meaning the GSE may claim the reimbursement of all incentives already
received by the project. To our knowledge, the GSE was not successful in
pursuing such a reimbursement when a number of lawsuits were brought to
court in 2017. Authorization risk remains difficult to assess by
lenders and is based on due diligence carried out by legal advisers
typically at financial close. We recognize the intention of the
legislator to limit the amount of subsidies to be reimbursed in the
range of 20%-80% of total incentives received. Still, this exposes
single assets to high impact risk, which large portfolios can mitigate
through geographical diversification.

Regarding limits to project security packages for lenders, we understand that the Third and Fourth Conto
Energia, which granted feed-in tariff schemes to solar PV projects in
2011-2012, prohibit them from including any pledge over GSE receivables.
This has not prevented banks from financing such projects. However, in
our view, this may jeopardize the legal strength and isolation typical
of project financings, unless strongly mitigated.

have accepted these limits and continue to play a key role in financing
greenfield and brownfield transactions in the Italian renewables
market. A number of large refinancing transactions have closed over the
past few years, mainly aiming at consolidating portfolios in a
fragmented market. If, as a result, refinancing and acquisition
opportunities start shrinking, will market participants or the regulator
find the way to spur investments and achieve the 2030 renewable energy

Previous Incentive Mechanisms

for solar PV have traditionally taken the form of feed-in tariffs.
Solar PV projects that successfully applied to Conto Energia schemes
over 2008-2013 are entitled to receive a unitary tariff, fixed on a
nominal basis over 20 years, on the energy produced (€360/MWh-€100/MWh,
depending on the Conto Energia). Feed-in tariffs for these plants
typically represent about 85% of total revenues as these assets are also
entitled to sell the energy produced.

sources other than PV (mainly onshore wind) have already participated
in competitive auctions, the last one of which launched in December 2016
(800MW). In that case, the amount of bids received was almost double
the size auctioned and since almost all the bidders offered the maximum
discount (40%, corresponding to €66/MWh), the final ranking was
determined by considering the earliest authorizations received. That
type of auction, however, was different to the one to be held in 2019 as
those projects were entitled to retain all of the upside in case market
prices rose higher than the strike price.

Renewable Energy Production In Italy

hydro remains the primary source of renewable electricity generation in
Italy (13% of total gross electricity production in 2018), solar PV and
wind increased their share to about 8% and 6%, respectively.

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