Can Italy strike twice?

By Stefania Belisario and Massimo Schiavo, Contributors

Italy’s National Energy Strategy aims to increase wind and solar power’s share of gross final energy consumption by 2030. The country boasts a track record of meeting past renewables targets, but can it be successful once more? Stefania Belisario, associate director, Infrastructure, S&P Global Ratings, assesses the factors either driving or impeding progress

Italy’s power market is on the cusp of significant change. According to the National Energy and Climate Plan submitted to the European Commission earlier this year, by 2030, solar capacity is forecast to increase from 21 gigawatts (GW) at end-2018 to 50.9 GW. Wind capacity is set to undergo similar proliferation – from 11 GW to 18.4 GW.  

Unsurprisingly, the feasibility of meeting such ambitious targets has garnered significant interest. Italy’s historical success in surpassing renewable targets has set the bar high, but the generous government subsidies and resultant capital investment that boosted past levels are both lacking. In the absence of subsidies, projects are largely exposed to volatile merchant prices – a key credit risk when financing new projects. 

As such, meeting these targets, though possible, comes with considerable hurdles. With the size of auctions through to 2021 estimated at 7GW, Italy will require levers beyond the upcoming auctions to meet its lofty 2030 targets. 

Can Italy repeat past success?

Nonetheless, the country is taking steps to promote its new energy targets: seven auctions are to be held from 2019 to 2021, with a contract for difference mechanism that will remove all exposure to market risk by ensuring a unitary tariff; a reference price for larger plants that is closer to market price than under previous incentive plans, reducing the risk of retroactive changes in the regulatory framework; and incentives that assist smaller plants. 

One mustn’t forget that Italy has a successful track record in meeting renewable targets. The country reached its 2020 energy strategy target of 17% of renewables in gross energy consumption in 2014 – not only six years ahead of the 2020 deadline, but also with stronger performance than other EU countries. This previous success came during a period of generous government subsidies, which spurred exceptional growth in renewable investment in the country, particularly in solar photovoltaics (PV) and onshore wind between 2010-2013. 

Times, however, have changed. While the cost of renewable investments and maintenance has fallen significantly over the last years, feed-in tariffs for PV ended in 2013 in Italy. In the absence of subsidies, projects are largely exposed to the volatility of merchant prices, which, in the long term, makes the predictability of cash flow relatively uncertain, representing a key credit risk for financing new projects. Hence, these latest targets must be met under different circumstances. 

Long-term purchase agreements (PPAs), which set fixed prices, reduce the uncertainty about market volatility. While Italy has announced its intention to create a platform to negotiate long-term energy contracts, the Renewables Decree for the upcoming auctions provides no immediate measures to facilitate this. 

Some authorization risk remains, too.  There have been a number of cases under previous feed-in tariffs where irregularities were found in plants’ authorizations after some years of operation. Assets, therefore, remain exposed to the risk of incentive revocation during their lifetime and also, potentially, to risk of clawback. 

This means the Gestore dei Servizi Energetici (GSE; the state-owned entity responsible for granting renewable incentives) may claim the reimbursement of all incentives already received by the project if authorization irregularities are found – at any time during the life of the project. While large portfolios can mitigate risk through geographical diversification, this exposes single assets to high-impact risk.

Some reasons for optimism

Likely to go some way to promoting renewable investment and helping Italy reach its 2030 targets are the seven competitive auctions to be held between 2019 and 2021, which include up to 4.8 GW in new PV and wind power plants, as well as 140 megawatts (MW) of hydro, biomass, and geothermal plants, and 490 MW repowering investments. What’s more, a further 1.49 GW will be auctioned for smaller plants. 

The proposed incentive of contracts for difference (CFD) – an established mechanism in other European countries, but a novelty for Italy – may make all the difference in insulating solar and wind plants from merchant risk. Stipulating that projects selected at auction will sell energy to the GSE at a “strike price,” fixed on a nominal basis for 20 years, and that the parties will exchange the difference between the strike price and market price at contract time, a CFD removes all project exposure to market risk. 

While this removes potential upside for sponsors, it also removes all project exposure to market risk, increasing the predictability of cash flow. The CFD mechanism also means that for the first time, auctions may generate revenue for the GSE – reducing the risk of retroactive changes in the regulatory framework, compared to the 8% cut in the feed-in tariff applied in 2014 to reduce the tax burden on final consumers. This is further supported by the fact that the reference price in the auctions for plants above 1MW is closer to the market price than under previous incentive plans, reducing the risk of the plan becoming unsustainable. 

Wind and PV projects will be competing for the same incentive, which is a novelty under the Italian framework, with project selection to be based on discount offered. We believe that the similar levelized cost of wind and solar in the country may ensure a fair competition between the two technologies. 

Of course, outside the opportunities offered by the auctions, all’s not lost. Renewable investments without any form of subsidies are not impossible: the U.S., for example, has developed a market for long-term PPA that reduces uncertainty about future market prices. Some transactions relying on PPA are starting to emerge in Europe as well and Italy is not an exception. Upcoming actions, therefore, are only the beginning of a longer path to reach the ambitious targets that Italy has set itself for 2030.

Stefania is an associate within the Infrastructure team at S&P Global Ratings where she is responsible for a portfolio of corporate and project finance credits. On the corporate side, she has experience in the rail, toll road and car park sectors across Europe, while her expertise in project finance covers student accommodation, hospitals and renewable projects. Prior to joining S&P in 2015, Stefania was an assistant manager in the project finance team at PwC in Rome. She has a Master’s degree in Economics and Management from Bocconi University, Milan, and speaks English, Italian and French.

Massimo is an Associate Director within the Infrastructure Ratings Group of S&P Global Ratings.
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