At first blush the landscape of the Italian power market has altered dramatically within the last two months. More than four years since the enactment of Law 79/99, the Italian electricity market was finally launched on 1 April 2004, over three years behind schedule. A bill of law before Parliament has been partially approved, allowing the unification of the ownership and operation of the grid. And a united authorisation decree that should quicken the time needed to construct plants has been agreed in principle.

Yet these measures are unlikely to have a significant immediate affect on investment in power, despite being generally welcomed for creating a greater transparency and stability that will attract investors over time. "It would have been difficult for Italy to continue without a market, as most countries in Europe have an energy exchange," says William Hartert, associate at CMS Adonnino Ascoli & Cavasola Scamoni, Rome. "The air of uncertainty endured for over three years, with the start of the market continually said to be in two or three months' time, has ended, and the functioning market, which has previously not been dynamic and therefore stable, is very good for Italy. There is a lot more transparency for eligible clients, since in the past the market did not get a clear view of prices in bilateral agreements. There is more confidence and more interest in investment."

The PPA's decline

The future of long-term bilateral power purchase agreements (PPAs) has caused a perennial headache for the Energy and Gas Authority, which has tried to balance the need for less risky streams of revenue, upon which project financing can be pinned, against an aversion to long-term binding agreements. Before Law 79/99 many power plant financings were grounded on a PPA, but after May 1999, when the Energy and Gas Authority introduced a mandatory termination clause - via Resolution 78/99 - that allowed the off-taker to withdraw without penalty from a contract with a mere six months' notice, PPAs became a far less attractive basis for project financing, and dried up. After determined lobbying by the Italian Bankers Association (ABI) and the industrialist association, Confindustria, the ban on long-term agreements was lifted in July 2003 through Resolution 123/03. However, there has not been a wholesale reversion to PPAs because projects have stagnated in the permitting and authorisation process and because the pending launch of the electricity exchange made it more difficult to tie in offtakers to long-term agreements with the market price of electricity and market volatility unknown.

"Project financing was easier in the early nineties under the CIP6 regime," said Hari Iyengar, the global energy corporate and project finance head at Deloitte. "The agreements were made at an attractive unit price, with secure margins."

Now the aggressive liberalisation, beginning with the curbing of ENEL's power and, most recently, the inception of the electricity exchange, sponsors and their advisers are looking to other types of revenue streams as a basis for financing. This is not to say that long-term power purchase agreements are unlawful, only that under the new regime the Italian energy regulator must clear bilateral agreements in advance. The criteria for approval have not been set down yet, and it is unclear whether this will be done pro forma or on a case-by-case basis. If the authority refuses an application, it must give notice to the European Commission.

Merchant menace

In place of project financing based on long-term purchase agreements, sponsors have been broadly faced with three funding alternatives: to offer financing on a merchant basis, via a tolling agreement, or shun non-recourse debt altogether and raise balance sheet capital.

The first power plant to be financed using solely a merchant credit was Termoli. CIR and Verbund sponsor the project, an 800MW combined-cycle gas-fired plant located near Campobasso in the Biferno Valley of Termoli, in the Molise region. Project company Energia Molise raised Eu260 million ($326 million) from CIR relationship bank Banca Monte dei Paschi di Siena, as well as a Eu65 million VAT facility. The total cost of the plant is Eu400 million, and the project is the first permit to be issued by the Ministry of Production Activities under the new simplified procedure introduced by decree 7/2002 of 9 April 2002 (the sblocca centrale, or power plant unblocking decree) which was subsequently converted into law (no. 55/2002). It follows Energia's involvement in the Tirreno Power (formerly Interpower) deal - the first merchant deal in Italy. Tirreno, however, was for a portfolio - this plant has concentrated merchant risk, and will rely on Energia's sales to large Italian corporates to make it viable. Even so, such leverage will make it an aggressive benchmark in a market set to see a slew of new plants chasing financing, including several more from Energia. Pricing on the deal is not public, but is understood to be 200bp over Euribor, largely as a result of a relationship bank's involvement, and without syndication pressure.

Termoli seems destined to be an exception; leverage is likely to be the limiting factor with merchant deals, both for the cost of borrowing and the price the sponsor is able to charge the customer. One banker said that equity would have to be close to 50% to make a purely merchant deal viable. A more risk-averse alternative is a financing based on a tolling agreement. The financing and operation of power plants in Italy is thus gradually moving towards the use of tolling structures, as it did in North America.

Taking the toll

Under these arrangements the toller supplies fuel to the processor, which operates the plant and delivers power back to the toller, which pays a tolling fee. The toller is therefore in direct control of the availability of generation capacity, fuel availability and at the mercy of fuel price volatility.

The first single asset financing based upon a tolling agreement was the Novel 100MW gas-fired combined-cycle cogeneration plant in Novara, northern Italy, which signed on 24 January 2004. The project is sponsored by Atel (51%), a Swiss utility, and Radici (49%), an Italian textiles group - both will be tolling the plant in proportion to their shareholding with Radici purchasing steam for its nearby works.

Financing comes from a Eu85.4 million debt package put in place by lead arrangers WestLB and Bancaperta. The transaction comprises three tranches: a Eu66 million, 10-year loan, a Eu14.4 million VAT facility and a Eu5 million standby facility. Since the arrangers have been tight-lipped about the structure, it is unclear what kind of a benchmark Novel sets for future deals.

The refinancing of Edipower was, however, a landmark deal that used tolling agreements, on the back of which financing was placed, being the first hybrid multi-asset refinancing of its type in Italy. Edipower is a 7,000MW genco, Eurogen, sold to a consortium led by Edison as part of Enel's enforced divestiture of capacity brought about by the Bersani Decree (decree 79/99). The decree imposed a maximum 50% market share on Enel, which it met by selling three gencos, Eurogen, Elettrogen, Interpower, accounting for 15,000MW of generation capacity.

The Eu2.3 billion Edipower project deal refinanced the Eu3.8 billion acquisition debt. The financing was a complex hybrid of recourse and non-recourse tranches, comprising a Eu1.6 billion non-recourse loan, a Eu600 million loan guaranteed by the sponsors, Edison, Aem Milano, Aem Torino and Atel, and a Eu100 million revolver. The tolling agreements initially cover 6,000MW of capacity, rising to 8,000MW over an eight-year period as new plants come on line. Deloitte acted as adviser to a consortium that put together a multi-fuel, multi-plant built business and financing model.

The refinancing was arranged by a pool of banks headed by Banca Intesa and Royal Bank of Scotland and joined by Barclays Capital, BNP Paribas, Commerzbank, Credit Agricole Indosuez, HSBC, Interbanca, MCC, Mediobanca, Societe Generale, Unicredit Banca Mobiliare and WestLB. General syndication closed oversubscribed on 11 November 2003.

The Eu1.6 billion loan matures 21 November 2008 and steps up incrementally from 150bp over Euribor to 195bp. Both the stand-by facility and sponsor-guaranteed loan share the same pricing structure.

Unblocking the market

The Italian government's decision to push through the sblocca centrali decree could cause a sense of déjà vu. In 2002 the government passed a decree of the same name without the intended effect of quickening the process to construction. Most bankers agree that the latest decree, which will incorporate a united authorization procedure involving all competent parties, should facilitate the application process but are sceptical that it will make a significant impact.

"The issue will be solved once conflicts with intermediate local powers are overcome," says Monica Mariani, an analyst at Standard & Poor's. "It's an aspect of constitutional law that energy is ruled by the government and regions, and this causes an inherent strain in the system. A regime of incentives resulting in lower power prices for those local authorities that accept power plants in their region might go in the direction to reduce opposition. Everyone accepts we need more power but no one wants to live near a plant."

Those sponsors who have had most success under the first decree are most likely to gain. Iyengar at Deloitte singles out established players as the best at getting plants authorised.

"Two factors seem crucial in getting a project across the line: one, possessing brownfield sites, and two, having a secure supply of gas," he says.

It is often claimed that some 12,000MW of capacity was the subject of applications under the decree, but only around 2,000MW are works in progress.

The application process seems certain to remain a highly political issue. Hartert at CMS says that although by letter of the law sponsors could force through an application for a plant or pipeline, they may be reluctant to do so for political and publicity reasons. Outside investors are likely to be more brazen in their approach.

As a mark of good practice and to avoid unnecessary delay, sponsors are now looking to get agreement from regional authorities and local landowners before investing. Sponsors and their advisers will look to resolve the financial problem of royalties and compensation at a conventionally less advanced stage, before memoranda of understanding are distributed.

Renewed interest

Not to be accused of inconsistency, the bureaucratic overhaul in Italian power has extended to renewables. An important precedent was set with the financing of the 176MW IVPC2000 wind project - the first deal to be based on the new green certificates scheme. Under the scheme renewable generators receive the pool price for their power and a premium by selling certificates matching that amount of power to utilities that do not have the requisite renewable capacity as set down by the government. The target is currently set at 2% of output, and will rise to 12% over time.

At present the Italian grid operator GRTN is effectively the price arbiter, issuing certificates against CIP6 renewable contracts transferred to it as an off-taker from ENEL. This is because there is not enough renewable capacity to meet the 2% requirement. To date GRTN has issued small amounts to purposely track the price of green certificates against the subsidised tariff of the CIP6 regime.

The green certificate scheme, which allows for the trade of certificates and effectively taxes pollution, is not unlike the UK ROC system.

Unfortunately for sponsors and the banks, while the GRTN controls the price in the short term, there is a fair deal of uncertainty regarding what the regulator and government will do in the medium to long term.

Nicolas Sush of Dexia Crediop, which worked as a co-arranger on IVPC2000 and structured the 70MW Andretta wind project financing, expects that in four to six year's time the price of green certificates will be driven purely by the forces of demand and supply. He expects prices to fall, but not dramatically. Other predictions are that by 2005 there will be enough renewable capacity to match the 2% requirement, but it is expected the government will up the requirement in advance of certificate oversupply until it reaches the 12% mark.

The Eu170 million club deal backing IVPC2000 signed 12 December 2003 with RBS, BNL, Dexia Crediop, MCC and San Paolo IMI and Banca Verde named mandated lead arrangers. The sponsor is Italian Vento Power Corporation, a subsidiary of US wind developer UPC.

The deal finances five wind farms, and features a complex structure, involving five tranches - one of which is a mezzanine quasi-equity portion - the holding company, IVPC2000, and four operating companies. The deal is structured to ensure eligibility for Law 488 grants, a system in Italy available to small industrial companies that invest in new projects. Energy Finance Advisors provided financial advice to the sponsor. (Search www.projectfinancemagazine.com for the IVPC2000 Deal Analysis.)

The Andretta-Beschia wind project follows in IVPC2000's wake. The Eu80 million project financing will fund development of a 70MW wind farm sponsored by EdF subsidiary SIIF in the Campania region. Dexia structured the debt and is lead arranger, together with MCC and RBS. Tenor on the senior term loan will be 11.5 years and will include an equity bridge and VAT tranche. Like IVPC2000, syndication is expected to be on a club basis, but unlike IVPC, the structure will consist of one holding and one operating company. Syndication will close imminently.

The gathering tide

The latest sblocca centrale hopes to expedite some 20 power plants currently in permitting, which represent around 8,500MW of capacity. Of those, only around a quarter are likely to be viable candidates for single-asset project financing so there are scant pickings for non-recourse lenders.

One such deal close to market is AceaElectrabel's 375MW Voghera development. The CCGT scheme in Lombardy is sponsored by ASM-Voghera, domestic utility Acea and Electrabel of Belgium. The plant was cleared to start construction in February after legal wrangling over permits.

Mirant Italia has two 400MW CCGT plants through the permitting process, one in San Severo and the other in Portogruaro.

Further back in the pipeline E.ON, the German utility is in the midst of making a strategic decision to push ahead with three 800MW gas-fired CCGT plants; Liverno, Santacangelo, and Guidonia.

Entergy Italia currently has three plants in the permitting phase, with the Eu500 million 800MW Filago plant closest to acceptance and likely to go the non-recourse route based on tolling agreements. Entergy's planned 1,200MW Cairo Montenotte has partially run aground on local opposition, but the company is looking to compromise. And a 20MW wind farm between Tuscany and Liguria is also in the permitting stage.

In the more distant future, International Power has a number of key sites throughout Italy and could become a significant player in the coming years.

A one-way bet?

The background against which liberalisation has taken place is the inflated price of electricity on the new exchange, the historical inheritance of a clutch of gas-fired plants, the endemic under-capacity characterised by the paper-thin margin between average and peak capacity and low reserve capacity, and the reliance on imports highlighted by the September 2003 blackout caused by a tree falling on a Swiss interconnector. The price of electricity in the short to medium term is driving new investment in plants but in tension with this is the lack of historical market data and possible price volatility. Still, most agree that the investment will arrive in the short term - held back only by the permitting process.

"We will see new plants from serious developers rather than new entrants - those that have been in Italy for a few years developing a portfolio of assets. Large European players with a number of sites will be well placed," said Paolo Bozzolo, deputy head of project and export finance at MCC.

It would take a particularly strong outside sponsor, with both funds and credibility, to enter Italy with an IPP as a single asset. In turn, banks are taking smaller portions of underwriting risk, indicative of the unknown variables in Italian power.