One year since the introduction of deregulation and competition in Italy’s electricity market systemic problems remain. Do politicians hold the key to allowing the market to build on the good progress made?

David Bucknall, KWI, UK

The Italian Energy Pool has been in operation for a year now and in that time considerable change and developments have been observed. A case in point is the national blackout that brought almost the entire country grinding to a halt. Since then the industry has been under a worldwide spotlight.

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As the second year of energy trading in Italy begins, the market has reached a point where the issues that have been hidden for so long are now finally being exposed.

The high level of imported energy, such as gas and electricity, and the dominant position of several energy companies, have seen many industry commentators question the success of deregulation. Furthermore, the political influence that still remains within the Italian energy sector continues to cause issues within many quarters. Therefore it has now become clear that the two key themes dominating the Italian energy industry today are the high level of imported energy and competition.

High imports low margins

For some time Italy has been a major importer of gas and electricity, with the main beneficiaries lying just over the other side of the Alps in France and Switzerland. As a relatively large and developed nation, Italy does have the capacity to produce its own energy supplies. However, the margins are not economical to produce the volumes required.

Years of under-investment in plants and facilities by successive governments prior to deregulation has left them with legacy technology that is not sufficient to produce energy as profitably as buying from other countries. The margins the power companies enjoy through cross-border imports are greater.

It was this lack of investment that made Italy’s power supply vulnerable when the unexpected cold weather of 2004 made Italians use more energy than predicted. The subsequent blackout exposed the weakness and lack of adequate resources within Italy. For example, at the time some sources revealed that to help get the country power, trucks and trains were sent into France to bring back gas as the Italian pipeline was insufficient to meet demand.

Figure 1: Italy’s net electricity imports (expressed in GWh) grew in 2003
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To rectify this position utilities are seeking alternative sources of energy, and this has taken the situation into the politicians’ domain.

More of a concern in the long-term, however, is the role coal may play. To cope with the demand in Italy and to reduce the reliance on imports, energy providers have begun to consider redeveloping plants from oil facilities to coal. The concern, therefore, is that as many Western countries seek primary sources of energy, Italy’s consideration of using coal would be a major step back in the evolution of the energy industry. Although it might be argued it is a more environmentally friendly energy source than the oil it replaces, some see it as stepping back into the Dark Ages.

In an effort to reduce imports, cost of energy production and the need for coal, industry commentators have suggested that nuclear energy be considered. The use of nuclear energy in many other countries such as the UK and France has generated widespread condemnation from the media and environmentalists. Furthermore, it has never been fully outside of government hands due to the regular investment packages to support production and survival such as British Energy in the UK. In Italy, even more than most countries, the use of nuclear energy is a political tightrope. The country’s several nuclear plants were all shut down well before the end of their lives at the beginning of the 1990s, following the accident at Chernobyl.

Currently, nuclear energy requires the support of governments to ensure it remains a viable source of power. This will bring calls from politicians, media and industry that nuclear energy producers are not exposed to the market dynamics. However, it is an option that needs to be considered if costs are to be reduced so that Italy can begin to produce higher volumes of power again.

To reduce the reliance on imports from France and Switzerland, not only are alternative sources of energy needed, but the building of new plants and renovation of existing ones is required. Utilizing the latest technologies will reduce the cost of production so that margins can increase, lowering Italy’s dependence on imports. Again, this opportunity for progress meets political hurdles. Local governments have been seen to slow down applications for new plants or renovation due to the environmental impact and, more likely, the loss of votes.

At this point in time the future of Italian energy production lies firmly in the hands of the politicians.

Support for alternative sources of energy, investment in new technologies and infrastructures, and the reduction of local bureaucracy would enable utilities in Italy to begin to produce power at higher margins. It is also hoped that more energy generation and good risk management in Italy itself would reduce the likelihood of a repeat of last year’s complete blackout.

Competition or monopoly

Alongside the reliance on high imports, the Italian energy industry is also challenged by a lack of real competition.

The market was for many years dominated by a couple of major players, namely Enel and Eni. Since the opening of the energy trading market in April 2004, many energy producers have provided more competition. KWI has helped several of these providers, such as Edipower, Tirreno Power and AEM Torino, prepare for energy trading by deploying energy trading and risk management systems and processes for energy trading.

The consensus is that competition has been successful, and the first year of deregulation has seen positive benefits and changes.

The level of foreign investment in Italian energy companies is just one indicator that it is a viable and profitable market. The industry may not be as competitive as the UK or Nordpool, but it is still in its infancy and needs time to mature.

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Nevertheless, there still remains a need for increased competition in Italy and politicians will be required to assist producers in that process. Major players such as Enel have a legacy of government interest and influence over their business. The dominance and influence of a few energy companies is highlighted in their profits, but further magnified when the large dividends paid to the government are considered. The dependency on these dividends as part of the Italian government’s budge should not be underestimated and this vested interest plays a role in the competitive debate.

Take for example, the sale of Enel or Eni. The sale would reduce the influence of politicians in the management of these two major energy players and would more than likely increase competition in the Italian energy sector. However, the Italian government would no longer receive the large dividends, placing ever greater pressure on its debt position. As such, there is competition in the energy sector but the government’s role is still influential.

There is little doubt that the opening of the Italian energy market has seen greater levels of competition and opportunity, but the market has reached a point where the next steps are in the hands of politicians. Unless the role of the government evolves, then the market may be held back. Furthermore, mechanisms need to put in place to drive greater competition.

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It is KWI’s opinion that the influence of a few utilities needs to be reduced if the Italian energy market wishes to develop and build on its successful deregulation. To drive this competition, we believe that market mechanisms such as the implementation of a regulated marketplace for energy derivatives would have a positive impact on the level of competition.

If the politicians establish this exchange, then all producers will be subject to the market dynamics and the energy companies with the best risk managers will be most successful. This is true competition, but again, to reach that point is a political decision.

Where next?

The first year of energy trading has been successful but the issues underlying the market are slowly being exposed. The blackout highlighted the lack of adequate infrastructure in Italy and the reliance on imported power to sustain the country’s energy requirements, while the dominance of a couple of energy companies could stifle long-term competition. The challenges can no longer be hidden and must be addressed.

Politicians must consider the ability of the energy companies to update or build new plants so that the dependence on imports can be reduced. New infrastructures and technology will help utilities increase their margins making energy production on a large scale an even mor profitable business. The potential for nuclear energy is clear but brings its own challenges and the need for more competition is vital to the long-term success of the Italian energy industry.

The Italian energy market has reached a turning point. The utilities can only do so much before political influence and decisions need to be brought to bear to evolve the sector and ensure that the issues in the market are addressed.

Unless these issues are addressed, the positive steps made over the last year will have been made in vain.