Against the backdrop of the largest IPO of 1999 (the Eu15 billion sale of stock in Italian electricity utility ENEL of which Eu6 billion has still to be sold to institutional investors), a vast ENEL decommissioning program and a wave of IPP's due for refinancing, the potential grandfathering of revised tariffs legislation to deals originally agreed under CIP6 could significantly hurt power project financing.

Ninety percent of Italian project finance is in power. The decision in 1992 to subsidize energy tariffs under CIP6 made Italian and foreign sponsors eager for project finance and kicked off the participation of both local and international banks. Compared to other markets in Europe most players agree that Italian power is second only to the UK - albeit by a long way.

The first power deal to reach the market was the financing of the $466 million Rosen project in Tuscany which closed in May 1996. Sponsors were Belgium's Tractebel and Solvay. Deutsche Bank and Meccanica Finanziaria the arrangers. Other projects followed quickly including financing for ISAB, Falconara, Sarlux, Teverola, Serene and Elettra power plants built across the Italian territory.

Local and international sponsors and financiers have fought hard against a cultural background of traditionally risk-adverse Italian banks with little experience of structured deals. According to one Italian sponsor: "CIP6 has created a mechanism for project finance in Italy. Project finance has been an occasion for local sponsors to gain higher degrees of both responsibility and visibility in their deals and in their partnership with the financiers."

So why is the Italian government considering hammering CIP6 benefits at a time when a swathe of state utility ENEL's output is about to be decommissioned and many sponsors are looking for refinancing of plant,s built under the original CIP6, that are becoming operational? Because, according to Diego Gavagnin, spokesperson for the independent body in Milan, "there is no reason why Italian consumers should subsidize the profits of US banks. Foreign sponsors thought of Italy as a soft spot where easy money could be made. The authority had to stop this."

In June 1999 an independent body created by the Italian government in 1995 to supervise the competitiveness of both the gas and electricity sectors ruled that CIP6 was to end due to its high costs and limited advantage to the consumers. The ruling is to affect new plants but also existing plants built under CIP6. The counsel of state is to give a final decision on the authority's recommendations by the end of November.

Gavagnin claims sponsors deliberately delayed construction of plants to the late 1990s in order to benefit from both cheaper technological improvements and previously agreed subsidies on tariffs. "It should be an acceptable conclusion that a change of profit revenues for developers from 7%-8% to 14% needs a change in subsidies as well," claims Gavagnin.

Outraged project sponsors and financiers have taken legal advice. One lawyer in Milan says: "The authority made a mistake driven by arrogance. A review of CIP6 tariffs was both reasonable and expected, but there was no need to touch on existing projects. This has jeopardized the positive image Italy had to the eyes of both local and foreign sponsors interested to do deals."

Pressure on the Italian government continues to mount with the Italian banking association and a number of embassies (lobbying on behalf of foreign sponsors) being pulled into the fray. Even US president Bill Clinton has had CIP6 talks with Italian Prime Minister Massimo D'Alema.

Some sponsors have moved quickly and already tapped the refinancing markets. Syndication for the $680 million refinancing for API Energia closed oversubscribed at the end of September this year. Sponsor of API Energia is an international consortium combining API, Texaco and ABB. Arrangers for the financing are Mediocredito Centrale, ABN Amro, Banca Nazionale del Lavoro and Greenwich Natwest. Banca Intesa, Dresdner Kleinwort Benson, Mediobanca, Paribas and UniCredito Italiano are the co-arrangers.

Conversely, local and foreign sponsors agree that the legal limbo created by the authority has slowed the power-dominated project finance market in Italy for the last four months. Unless a decision comes soon, a number of operations are at risk due to the the lack of clarity. As Antonino Lo Bianco, partner at Babcock & Brown in Milan, says: "Much of the optimism I had for the future of Italian project finance two years ago is now gone. Today's picture is rather gloomy."

But depression is not universal. For the banks, tariff revision means more restructuring and more business. Nicoletta Zappatini, head of project finance at Citibank in Rome, remains positive about the future of project finance in Italy and looks at macro trends. She says: "The ice has been broken: what we are facing now in Italy is a condition of open market. Despite the number of legal intricacies, the Italian market is one of the most promising in Europe after the UK."

According to a comparative study of the European power sector made by Citibank, Italy ranks ahead of countries such as France and Spain and is on a par with Germany. The prospects are there, and Citibank is confident there will be enough to keep sponsors busy for the next few years.

In 1997 Citibank arranged the financing of $1.1 billion ISAB Energy together with local Mediocredito Centrale, BZW, Societe Generale, IMI, Dai-Ichi Kangyo Bank and Barclays. ISAB will start operations in the second week of November this year when the plant will be operational.

This year's review of CIP6 is not worrying Zappatini. She is already working on the refinancing for ISAB, a deal that should hit the market as soon as an announcement over the future of grandfathering is made. Most of the optimism comes from international sponsors and financiers that with greater confidence in comparison with their local partners look at the project finance market in Italy.

But Vittorio Semeraro, head of project finance at Societe Generale in Milan warns of the dangers in changing the CIP6 subsidies for existing structures. "The risk is default in the payments' schedules. It is a word nobody wants to use but it is what sponsors will face." Societe Generale has a good experience of the Italian market with ISAB. It is now behind the financing of two other projects worth $300 million sponsored by ABB in southern Italy.

Semeraro is also interested in funding a waste-to-energy plant in Calabria sponsored by Foster Wheeler Italiana. He wishes the Italian authorities will join efforts for the creation of a sounder and stronger legal environment to support project finance activities across all sectors: "Italy should follow the positive examples of Australia and the UK without too much compromising for an Italian solution to project finance."

The most exciting potential rests in the developments of new plants. Franco Baseotto, head of project finance at Foster Wheeler Italiana, believes there are good prospects for the development of greenfields for the year 2000. Foster Wheeler Italiana has a strong presence in Italy. At the end of 1998 it sponsored the development of the $194 million Lomellina waste-to-energy plant in northern Italy. It also sponsored the construction of two power plants in association with a local partner: the $155 million Teverola power plant in southern Italy and the $153 million Ferrara power plant in the north. Both transactions are coming to market for a $300 million refinancing. Paribas is arranging the deal. Close is forecast for 2000 and co-arrangers to be nominated in the coming weeks.

Jacques Prost, head of project finance at Paribas in Milan is bullish: "Italy is the first market for the bank's project finance activities in Europe. More is to come with the decommissioning of some 15,000MW worth of generating capacity from Italy's electric state utility ENEL." The decommissioning is not expected before the second half of 2000 but it represents the most attractive immediate prospect for business in Italy.

International sponsors have already made contacts to establish the time framework for the privatization of ENEL. The Italian government has not confirmed the exact size of the final deal but has indicated that up to 30% of ENEL's equity could go at a price of between Eu3.9 billion and Eu 4.3 billion.

And with ENEL chief executive Franco Tato embarking on an ambitious program of diversification into water and telecoms - bankers are also looking forward to a spate of non-power ENEL project financings.

Most sponsors claim a strong belief in the future of merchant power plants in the Italy - despite the current CIP6 furore. And Italian developers are touting co-operation as the way forward. "The presence of international heavyweights is the best way to get Italian financiers signing a project finance deal. But the best way for international heavyweights to get access to the Italian market is with the presence of a local sponsor with a good knowledge of the legal environment."

Opinions over the role Italian banks can play in project finance are not as bullish. One Rome-based international sponsor claims: "Italian sponsors and financiers are beginning to move ahead and understand project finance. But my view on Italian banks is still tragic."

Traditionally cautious, Italian banks have been playing catch-up in the project finance business. Few Italian banks, with the exceptions of Mediocredito Centrale in Rome and Turin-based IMI San Paolo, have the capacity to arranger a project financing on their own. Most of the other banks tend to play minor roles at syndication level.

But the biggest hurdle is lack of legislative clarity. If the Italian government does grandfather the new potential tariff system it will send a clear message to the domestic and international project finance business - that there is no such thing as a concrete risk/reward equation in Italy.