Utilities : Spain: is a financial regulation of gas and electricity networks on the cards?

In Spain , in a double circular published at the end of last month, CNMC mentioned the possible introduction of recommended credit ratios for the operators of regulated infrastructures in the gas and electricity sector . To determine these credit ratios, the competition authority applied a two- pronged scenario: ( i ) setting an implicit credit rating target (single-A category) for the companies concerned ; and (ii) extrapolating upper and lower limit values from the observation of the ratios achieved by the different regulated operators in the gas and electricity sectors, derived from the overall average within each sector and a 75% average of values for the sample considered. While not providing details about individual issuers (mainly REE and the distribution subsidiaries of Endesa , Iberdrola and Naturgy in the electricity sector, Enagas , Madrilena Red de Gas (MRG), Nortegas , Redexis and the subsidiary of Naturgy in the gas sector), CNMC has highlighted a situation that is more strained in the gas sector than in the electricity sector , average credit ratios being of inferior quality and, especially, average levels (based on a 75% average of values for the sample considered) that in some instances exceed recommended levels. It seemed timely to assess the individual situation of the main operators of regulated gas and electricity infrastructures in Spain based on net debt-to-EBITDA ratios at end-2017. Whereas Endesa’s electricity distribution subsidiary and REE present moderate ratios (1.6x and 3.2x, respectively), Enagas is the only entity in the gas sector with a ratio that is in line with the CNMC recommended level (≤6x) . All other gas distribution network operators, namely MRG, Nortegas and Redexis , have leverage ratios in excess of 6x. It is no coincidence that these three operators should be controlled by financial investors. By contrast, transmission systems operators Enagas and REE are listed, with the Spanish State having retained minority stakes (5% and 20%, respectively). At this stage, the circulars published by CNMC, which are the object of a public consultation that runs until 25 February, h ave no regulatory weight . Our understanding of the documents made public is that CNMC is not looking to introduce any binding regulation. However, one can wonder what might be CNMC’s real intentions . From this perspective, the release of these circulars and the launch of a public consultation could be seen as CNMC sounding out stakeholders, with the possibility the next step could be a recommendation to the government with a view to the enactment of specific regulation or legislation. In this event, Spain would be following in the footsteps of the United Kingdom by introducing financial regulation in the gas and electricity sectors designed to ensure resources are available to fund the maintenance and investments needed for the proper functioning of these networks. If that is the path that is taken, this would be beneficial to credit quality in the sector. For the th r ee gas distributors identified above, this change in the regulatory framework would imply specific measures, including a redefinition of the dividend policy and/or a capital injection.