The current market situation is disappointing for all players in the power generation industry, whether they rely upon conventional or renewable sources, be they subsidized or unsubsidized.
Despite poor market performance, however, some actors can still strike a profit in the electricity industry. Consider the role that RAB – Regulatory Asset Base – plays in regulated business. When a business is regulated, it is not so easy to attract private investment, all the more so when the deal involves assets with a very long life cycle, which require huge investments. Over the past couple of decades, we have observed a wide variety of RAB models, which have been instrumental in attracting significant amounts of capital and channel it towards infrastructural projects.
RABs attract capital through a mechanism that reduces investment risks. For investors, the degree to which RABs are successful is primarily related to the quality and predictability of the regulatory framework within which they operate. In the UK, this model has become the major foundation of investor expectations for infrastructure projects, particularly taking into account retrospective “asset-taking” and prospective “asset-stranding”. In very simple terms, RAB means that all regulated investment is made at a pre-determined return for investors, which, in essence, is the Weighted Average Cost of Capital (WACC).
In the Italian electricity system, Terna manages a Regulatory Asset Base that has been instrumental to improve the national grid service, reducing network congestions and the differential between zonal energy prices. Company reports state that over the past decade Terna invested around €9Bn, achieving better grid security, service, integration across zones and markets. Another €3.9Bn will be invested in the coming 5 years to improve the Italian power system further. At the end of this period, Terna’s RAB will amount to €13.4Bn, which will generate a juicy 7.3% WACC. Given that this is the only prospect for profit in the industry, Terna is obliged to invest if it wants to retain happy investors.
Amongst the many investments identified for the next five years, three initiatives raised our attention: the infrastructure that should connect Sicily with continental Italy, the one expected to connect Italy with Montenegro, and the acquisition by Terna of the power line assets from Ferrovie dello Stato (the Italian National Railways).
The power line connecting Sicily to Italy, the so-called “Sorgente–Rizziconi” project, is a €700mln initiative aimed at providing more electricity to the island, this way reducing the spot price for the benefit of all Italian consumers. Despite clear advantages coming from the construction of this new infrastructure, and after more than five years of meetings and project submissions and adaptations, no end is in sight to the permitting procedure. Not-in-my-backyard (NIMBY) bias still rules, and every year since the announcement of the project, Terna has been forced to announce an additional one-year delay.
The Italy–Montenegro power line is a €1Bn / 1GW capacity initiative, which will be remunerated at WACC plus an extra 2%. Its initial rationale was that Italy would have been able to import electricity from hydroelectric generation plants located in Montenegro. Simpler permitting process, less NIMBY. One can argue that this rationale might have been justifiable in the past; however, it is questionable today, given the current overcapacity characterizing the Italian market and the share of renewable generation already in place as of today.
The expected privatisation value of the Italian Railways is the rationale behind Terna’s acquisition of its power line assets. A “no brainer” for a 14.2 thousand kilometres line which will require an estimated investment of €500mln (though some sources say the final cost may be higher). In this case, there is no evident benefit for consumers, or for the market, and upgrading investments will be needed: what is happening is that the government is merely asking one of his companies to purchase an asset owned by another of his companies. “Synergy”, is the term used by the government. “Valuation increase” of Italian Railways is the explicitly stated aim. “System charges” is what customers can read into the deal. Amidst all this, remuneration will in any way guaranteed to Terna and its investors.
Overall, Terna expects to make a €2.2Bn investment, remunerated at an average 8.2% thus yielding around €181mln in revenues per year: RAB is indifferent to actual benefits. Being lucky enough, Italian citizens own part of the company; although for sure, they will anyway have to pay for “system charges” in their electricity bills.
So, to sum it all up, when public consensus is required, the permitting process is a long wrestling match, regardless of the usefulness of the investment. Being obliged to invest to make profits, “RAB companies” are only interested in investing their money, whatever the result. They therefore pursue the least risky initiatives and negotiate incentives: easier initiatives in terms of technical or NIMBY complexity become an inevitable priority, as they will generate profits that might be deferred otherwise.
RAB companies are often unable to complete meaningful initiatives, but are generally free to invest also into less useful projects. RAB is granted either way: even if companies strive to invest into useful initiatives, at the end of the day, they are indifferent to their usefulness or completion. RAB turns measurement of benefits or final commissioning into an irrelevant matter.
In the Country of NIMBY, a regulated monopoly with guaranteed returns is allowed to decide about its own investments. Here, RAB is like having children employed as guards of honour in Mendl’s patisserie.