Spanish electricity grid operator Red Eléctrica de Espana (REE) confirmed in November that it was in talks with private equity group CVC Capital Partners to buy the electrical grid assets of Iberdrola. The move followed a deal struck by REE to acquire the grid assets of Endesa and Union Fenosa, and if successful, will lead to REE controlling 98 per cent of Spain’s transmission grid.
Operating data: REE’s acquisition of Endesa and Union Fenosa
REE entered talks with CVC after the Spanish government rejected CVC’s g577m ($562m) purchase of Iberdrola’s grid assets. In November, power utilities Endesa and Iberdrola agreed to sell their grid assets to REE for a combined g1.35bn.
The sale of grid assets by the Spanish utilities marks the unbundling of network ownership from generation and supply under the country’s plan to liberalize its electricity market. The moves by REE to take control of these assets will not only end the fragmented ownership of Spain’s network, but will also make REE a major player in the European power market and position it as a pure transmission system operator.
The government refused to approve the deal between Iberdrola and CVC, reached in July, saying that it would be much more efficient for one company to control the high voltage network. It also took into account the advice of the electricity regulator, CNE, which issued an unfavourable report on the CVC acquisition. CNE’s main concern was over who would be responsible for grid failure, given that under the deal, CVC would own the assets but Iberdrola would operate and maintain the grid for 35 years.
It is clear that the government was keen to see a single independent transmission system operator in control of Spain’s transmission network in order to help promote competition in the market, and it clearly favoured REE for the job. “They were more inclined to see a single company own the transmission grid in its entirety,” commented Daniel Eld, senior analyst with Datamonitor. “Not only does the government own a stake in REE, but with a single operator, you’re more likely to have uniformity in operation of the grid.”
Likewise, REE has been for some time keen to expand its business and it has publicly stated that these deals fulfil its long-term aspiration to become the sole Spanish transmission company. Control of the grid will allow it to take advantage of cost and operational synergies and capitalise on growth opportunities.
Synergies that it has identified include efficiencies in procurement, equipment standardization, and efficiencies in engineering and construction. It foresees that from the Endesa and Union Fenosa asset acquisitions alone, these synergies will increase earnings (EBITDA) margins by two per cent in the short term.
On acquiring the Union Fenosa and Endesa grids, REE will have 15 745 km of 400 kV lines (up from 15 540 km) and 11 186 km of 220 kV lines (up from 4335 km). The Iberdrola assets will add a further 4764 km of lines. Its adjusted turnover will rise from g402m to g570m. In terms of value, it will sit third on the European rankings table, behind RTE of France and National Grid (England and Wales).
However, the acquisition of these grid assets by REE will be entirely debt funded. And while the purchase of the Union Fenosa and Endesa’s assets may be comfortable, analysts believe that the additional strain of buying Iberdrola’s assets may prove too much for REE. In addition, a major strategy shift will be required of REE as electricity network operation becomes its core activity.
“Given its size, REE has had to spend an awful lot of money on purchasing these grid assets and it is questionable whether its going to have the capacity to invest in grid development, which is a really critical issue,” says Eld. “REE will need to borrow up to g1.5bn, inflating its net debt to more than twice its market capitalization, which is likely to bring downgrades from the ratings agencies.
“Although REE is confident that it will not lose its investment-grade status, the debt issue raises serious questions about the company’s ability to maintain investment in grid development.”
The Spanish Energy Infrastructure Plan estimates that investment requirements for the transmission sector between 2002 and 2011 will be g2.7bn. Key areas of investment will be strengthening the transmission grid, connection of new wind and CCGT capacity, the supply of new high speed train connections, and international connections.
“The transmission grid in Spain is probably more important than in many other countries simply because of the shortage of capacity in Spain,” notes Eld. “One of the critical elements of the future development of the Spanish electricity market is the development of interconnector capacity.”
“The grid is one of the most efficient in Europe,” continues Eld, “but it is the interconnectors with France that will need a substantial amount of development to give Spain the electricity it needs to meet demand. You might ask why they don’t just add new generating capacity to the grid, but the stranded cost mechanism, which compensates generators in the liberalized market, effectively distorts the market and makes it far less attractive to build new generating capacity.”
A change in focus and strategy will also be required. “REE will have to scale back its focus on telecoms enormously, requiring the company to overhaul its existing strategy and convince investors of its change of heart” says Eld. “Telecoms, which had been forecast to contribute 40 per cent of earnings growth between 2002 and 2006, will now make up just four per cent.”