Revenue structure and regulatory framework

In 2011, the Terna Group’s revenues from continuing activities amounted to 1,636 million euro. Most of this (nearly 94%) derived from activities subject to remuneration as established by the Electricity and Gas Authority (AEEG) and only 6% regards other activities, which consist mainly of the provision of specialized services by Terna Group to other companies, such as HV plant maintenance belonging to other owners, plant engineering, maintenance of the fiber optics grid owned by third parties, housing TLC equipment, and other consultancy activities in the transmission field.

Regulated revenues

Regulated revenues are generated by different tariff components – the most important of which is the transmission fee – paid to Terna by different categories of companies in the electricity industry (distributors, wholesalers), based on specific allocation drivers established by the AEEG (energy quantity, available power, number of injection/withdrawal points)

The AEEG annually determines the unit sum of the tariff components on the basis of rules established at the beginning of every four-year regulatory period. The contributing factors are, on the one hand, costs including margins that are recognized to Terna, and on the other, the reference quantities (forecast) of the above-mentioned allocation drivers. The cost components considered for determining the transmission tariffs mainly belong to three categories:

  • remuneration of the RAB. The value of the RAB (Regulated Asset Base) is annually revalued on the basis of the Istat number on the change in the gross-fixed-investment deflator and updated on the basis of Terna’s net investments. These investments are for both the construction of electricity infrastructures (lines and stations) to renovate or develop the grid (work included in the Grid Development Plan) or of a different nature (i.e., IT systems or technologies aimed at improving the security of the electricity system). The RAB is remunerated by the AEEG at a rate of return linked to the market one, which was established at 6.9% up to 2011, and at 8.4% as of 2012. This rate is increased for a limited number of years for categories of development investment that are considered to be of particular strategic importance. In 2011, remuneration of the RAB represented nearly 47% of Terna’s recognized costs.
  • amortization. Provision is made for the annual adjustment of the amortization recorded because of the effect of new investments, divestments, the termination of the useful life of assets, and the revaluation based on the change in the deflator of gross fixed investment. The share of amortization remuneration represented in 2011 approximately 27% of the total recognized costs.
  • operating costs. These are the costs regarding the activities of transmission, dispatching, and metering: in general, the costs of labor and the procurement of goods and services that do not represent an investment. The component covering these costs, which in 2011 amounted to nearly 26%, is revalued annually on the basis of inflation and it is subject to a price cap mechanism, i.e. reduced yearly by an efficiency factor. At the end of the previous regulatory periods, the efficiency increase achieved exceeding the pre-established efficiency factor was equally divided between Terna and end users in terms of tariff reduction.

Once the unit amounts of the different tariff components have been established, Terna’s revenues will depend on the actual trends of the allocation drivers of recognized costs, particularly, of transferred energy: in effect, because of the volume effect, they can be higher or lower than expected. The sharp business contraction that began in the second half of 2008 together with the increased energy injected into distribution grids (that “locally” meets part of the demand and consequently reduces the energy transmitted along the transmission grid) made the trend of transmitted energy more uncertain and led the AEEG to confirm only for 2012 the mechanism of partial neutralization of the volume effect introduced with its Resolution ARG/Elt 188/08. This mechanism provides for the AEEG to:

  • supplement Terna’s remuneration regarding the volume share exceeding the maximum limit of 0.5% if the final volume is smaller than the one used for the tariffs;
  • require Terna to return the increased earnings regarding the volume share exceeding the maximum limit 0.5% if the final volume is larger than the one used for the tariffs.

As of 2013, the transmission tariff will become binomial, i.e. based on two allocation drivers: approximately 95% of the recognized transmission costs, currently allocated on the basis of transmitted energy, will be divided based on available power in the interconnection points between the transmission grid and the distribution grids, while the remaining part will be allocated according to transferred energy; this should guarantee a greater stability of the tariff revenue and will eliminate the need for the neutralization mechanism of the volume effect.

Pass-through items

To keep the electricity system in a balanced condition, the Parent Company Terna has to regulate it. This involves transactions for buying and selling energy in particular on the Market for Dispatching Services (MDS). Rules require that the economic balance of these transactions be zero for Terna: they are pass-through items that do not influence the net income in the Terna Group’s Income Statement. These items also include the remuneration that Terna receives from distributors and pays to other owners of segments that are part of the National Transmission Grid.

In 2011, the Terna Group’s pass-through revenues and expenses totaled 5,026 million euro (4,831 million euro in 2010). Valued by the application of specific tariff payments, these items are regulated by Terna with the industry companies. An important pass-through item is the so-called uplift, a payment covering the net expenses incurred to procure resources on the MDS, which for 2011 amounted to nearly 1,261 million euro (nearly 1,153 million euro in 2010). The uplift is included in the user’s bill. Even if it does not influence Terna’s profitability, pass-through revenue – among other things, also owing to its size – has important repercussions on its relation with the industry companies with regard to the commercial and administrative management of contracts and receivable and payable billing. 

2011 Incentive Schemes

The AEEG has introduced specific bonus and penalty schemes aimed at incentivizing service improvement, both in technical and economic terms. Implicit in the incentive schemes is the assumption that if the objectives are achieved, the benefit for the users of the service will be a multiple of the incentive paid to Terna. In particular, in 2011, incentive based mechanisms were provided for:

  • the quality of the transmission service. For the period 2008-2011, the AEEG’s Resolution 341/07 established a framework of incentives and penalties linked to two indicators: the ENSR (relevant energy not supplied) and the NDU (number of outages per user), measured respectively nationwide and at the level of each Transmission Operating Area (AOT). The bonus/penalty is calculated by multiplying a pre-established sum (15,000 euro per MWh in the case of ENSR) by the difference between the actual value and the target value of the indicator net of an exempted range (+/-10% of the target value in the case of ENSR and +/-5% in the case of NDU). The benchmark levels were determined in 2008 and the first economic effects of the mechanism regulating service quality were generated in 2010;
  • improvement of forecasts regarding energy demand and wind power production (applicable for the 2008-2011 period);
  • reduction of the volume of resources procured on the MDS. The mechanism, originally introduced in 2007 for a four-years duration, was modified by Resolution ARG/elt 213/09 and extended to the whole 2012. The current mechanism provides for a differentiated unitary incentive for each year of the period without a bonus cap;
  • acceleration of investment to develop the NTG. This mechanism was introduced by Resolution ARG/elt 87/10 and provides for a 3% additional incentive for the work in progress on development projects with the most value added for the electricity system (elimination of congestion, increased transfer capacity with other countries), which is conditional on the achievement of a series of milestones agreed on with the AEEG. Beginning in 2012, the application of a mechanism based on bonuses and penalties in the event development works go into operation ahead of or behind schedule.

The bonuses earned for achieving the objectives established as part of the incentive schemes in 2011 are included in Terna’s total regulated revenue. In the case of the incentive for reducing the volume of resources procured on the MDS – Terna in view of the result attained in 2010 amounting to nearly 160 million euro and considering the three-year duration of the incentive mechanism and of its characteristics –recorded 66 million euro revenues in its 2011 Financial Statement (compared to 77 million euro in 2010) as the related fair value adjustment, taking into account the regulatory risks and those connected with the performance of the electricity market.

Incentive mechanisms activated in 2011
Objective Year introduced Period applicable Penalty-bonus range 2011 result
Quality of transmission service 2007
(Resolution 341/07)
2008-2011   Bonus 7.7 million of euro
Improved forecast of wind production 2007
(Resolution 351/07
2008-2011 Penalty maximum
1,5 million euro
Bonus maximum
3 million euro
Bonus 3.0 million euro
Improved forecast of demand 2007
(Resolution 351/07)
2008-2011 Penalty maximum
5 million euro
Bonus maximum
5 million euro
Penalty 2.5 million euro
Reduced volumes of resources procured on the MDS 2009
(Resolution 213/09)
2010-2012 - Bonus 16.7 million euro
Acceleration of investment to develop the NTG 2010
(Resolution 87/10)
2010-2011 as a trial, from 2012 definitively - Bonus 12.9 million euro

The cost of transmission on the final user’s bill

On the basis of the current regulations, most of Terna’s recognized costs (margins) is billed to the end users of the electricity service by the distributor companies. While an official cost breakdown is lacking for the end domestic user that directly indicates the impact of costs deriving from Terna’s activities, on the basis of data published by AEEG, it can be estimated that transmission costs weigh approximately 3% on the electricity bill of a typical domestic user(3). These costs are the main part of Terna’s recognized costs (considering other minor tariff components would have no relevance), net of the let-through items. 

The new regulatory framework

At the end of December 2011, resolutions no. 199/11 and 204/11 of the Electricity and Gas Authority, concluded the review process of the tariff regulation that occurs every four years and that established new tariff regulations applied to Terna’s activities for the 2012-2015 period. These are very important decisions for Terna: over 90% of the Group’s revenues for its continuing core activities depend on the transmission and dispatching service tariffs in Italy.

The review determined a re-establishing of the various tariff components – such as the remuneration of the transfer and dispatching service – and of incentives recognized for various investment categories; this will lead to a consequent adjustment of selection criteria for Terna’s investments. Below the main novelties are listed:

Investments

Returns recognized to Terna increase from 6.9% to 7.4% of the net invested capital, essentially as a consequence of the trend of the market rates. Only for new investments, a remuneration component is introduced equal to 1% of the net invested capital to be used for compensating the delay the investments find for being reflected in the tariffs, while the additional remuneration incentives recognized for 12 years for development investments are reduced; in particular, they decrease from 3% to 2% for interconnections with foreign countries and for works aimed at solving congestions within market areas (category I3 investments) from 3% to 1.5% for works aimed at solving internal congestions within market areas and from 2% to 1.5% for other development works.

As in the past, the recognized amortizations will be determined each year on the basis of investments actually made, while as of 2012, they will no longer reflect the application of the price cap mechanism during the second regulatory period.

Operating costs

The reduction objective – through the price cap system – of the operating costs recognized in real terms increases from 2.3% to 3.0% annually for transmission, to allow the system to gradually reabsorb the extra-efficiency shares obtained during the second and third regulatory period and held by Terna for applying the profit sharing, and is reduced from 1.1% to 0.6% for dispatching.

Incentive mechanisms

The previous bonus/penalty mechanism linked to the quality of the supplied service was simplified. As of 2012, the incentive remuneration will be linked to objectives of service continuity measured only by the reference non-supplied energy indicator.

The bonus/penalty mechanisms are connected to the accuracy of the demand and production forecast from wind power and were not renewed.

The incentive mechanism for accelerating development incentives was re-established following its experimental application in 2010-11. In particular, as of 2012 the reward/penalty mechanism became operational linked to the date of entrance into operation of the works. Moreover, Terna’s participation in the incentive mechanism for accelerating investments (optional with no other consequences until 2011) has become the necessary condition for accessing a 2% extra-remuneration for category I3 investments.

The incentive mechanism linked to reducing the volumes of resources supplied on the Market of Dispatching Services (MDS) will remain active throughout all of 2012, as a last year of validity of a plan that was previously introduced.

 

(3) Ratio between CTRE the gross electricity price for a typical domestic user (a family with 3 kW of power and 2,700 kWh of annual consumption); AEEG data processed by Terna.