After the "dark" (or perhaps, more properly "confused") years of the post-referendum, the water sector is experiencing a renaissance which could actually lead to a broad relaunch with positive impacts on Italian industry, consumers and the country in the complex. The following notes are intended to arouse a debate on the Journal where qualified contributions aimed at effectively relaunching the system will be hosted.
After many years of discussions and political confrontations, too often unproductive and which in any case had the main effect of slowing down, if not freezing everything for several decades, it is probable that we are now moving towards a new period of growth and modernization in which a series of new enabling technologies could play an important role. Consider, for example, the use of ICT - Information and Communication Technologies - in network control systems and programming in the management of water services in the various phases.
The theme of water is certainly not new for ours Magazine; see the articles in the appendix. The magazine has contributed to the debate by advocating in unsuspecting periods – see for example the editorial in number 3/2009 entitled “Reform of water services. Note for discussion” – the need to assign the AEEG the task of regulating the sector, significantly modifying the ineffective architecture of the government system built following the Galli law. Not that the objectives of the Galli Law were contemptible, on the contrary. Its application has been uncertain and contradictory: for about twenty years the sector has been characterized by an unclear regulatory framework, largely based on the role of local administrations and on the AATOs which in many cases have not been as efficient as hoped. Added to this is the never resolved lack of transparency in the sector, until a few years ago even unknown for about 30%; and the cheerful managements that have put many companies in serious economic-financial difficulty.
The 2011 Referendum created an even worse condition, if ever possible, above all by canceling the possibility of remunerating investments and, consequently, alienating private investors but also putting public operators in difficulty. Let's not forget that the financing model for works based on resources drawn from taxation has been greatly contracted for years due to the burdening or instability of the Italian public accounts (but the phenomenon is not isolated in our country) and today it is in practice punishable only in limited circumstances.
But when it seemed to have reached the bottom, and perhaps thanks to this apparently lethal blow, the forces emerged to revive the system. The situation was unblocked in 2011 by the Monti government: the decisive decision was to proceed with the desired extension of the regulatory power of the Electricity and Gas Authority (AEEG) to water as well – a much appreciated and respected body also at an international level – providing as well as updating the name to AEEGSI where SI stands for Water System.
From that decision to date, the Authority has taken many important steps, first of all by organizing itself appropriately, then increasing the transparency of the sector and then introducing new tariff principles to encourage investments and better management. After an experimentation period which developed between 2012 and 2015, a new, very delicate and significant regulatory period will begin in 2016 which will profoundly influence the future trend of the sector. In August 2015 the consultation document on this issue was issued which appears to address the challenges in a coherent way.
A new wave of investment?
Will all this make it possible to restart the much-desired investments? Water companies are planning to invest several billion euros (4 or 5) in infrastructure in the short term to modernize and extend the sector's plant and infrastructure capabilities and performance. A significant role will be played by new technologies. Over the next 25/30 years, an overall requirement of around 70 billion euros is estimated. The effective implementation of this huge plan will be largely determined by the choices and decisions of the Authority even if there must then be the corresponding ability of the companies to effectively and concretely carry out the works without dispersion or waste of resources as has too often happened (it think of unfinished purifiers or new networks that have not been used for years). But there is one specific issue that interests us here: the considerable prospective financial investments require corresponding funds which must come mainly from private sources since, as mentioned, the public administration will not have sufficient resources. Although it is evolving, our informal survey shows that national and international investors are still skeptical of the Italian water system and tend to prefer other opportunities such as those in the United Kingdom. They admit that the AEEGSI is highly credible and has a reputation commensurate with the situation, but they also recognize the existence of a series of aspects which today limit the potential for intervention.
We list some of them below, emphasizing how they have both a regulatory nature and refer to structural elements of the sector. 1. The return on invested capital. The substantial solution to the problem generated by the aforementioned Referendum certainly helps. It is evident that a clear, transparent and incentive remuneration system for capital employed is a fundamental prerequisite for national and international debt investors to begin to consider the opportunity. 2. Regulatory profiles. What matters to the investor. However, the regulatory system is central.
Below is a list that is by no means exhaustive but merely illustrative of some aspects that will influence the investment choices of financial operators or, in other words, that affect the bankability of development projects. What follows is based on the opinion expressed by some primary financial operators; it must be said that the Authority has moved very effectively in recent months, in constant liaison with businesses in order to enact rules that are effective in practice.
to. It is important to focus on the standard agreement (or agreements) which clarifies the relationship between the grantor and the concessionaire, i.e. the manager, in all aspects. It is clear that this agreement is essential for a correct profiling of the various types of risk by the lenders. The AEEGSI has already issued two consultation documents and will have to set the general criteria that the EGATOs (Government Bodies of the ATOs that replace the AATOs) will have to follow. Some relevant topics are set out below and include questions already addressed in recent months regarding the methods of application of the Tariffs. As the Authority is well aware, the tariff obligations must (together with other factors, such as the quality of the service) be well integrated into the standard agreements.
b. A point that requires a definitive launch is the limit of the object of the water activities included in the regulation, recalling for example that for post-meter services and rainwater there are some residual uncertainties.
c. For investors, it is important to limit exposure to demand risk (referring to a possible drop in water volumes). But also important are both an effective automatic updating of the RAB and Opex on the basis of an adequate inflation index, and a clear, suitable and unbureaucratic mechanism for the selection and approval of investments for the purpose of recognition in the RAB.
d. Many also underline the issue of the valuation of assets in the event of takeover and, more generally, of the takeover process at the conclusion of the concessions. The Authority is devoting much attention to the issue and will also have to set the criteria for determining the residual value of the assets. Here a clear and fair-minded approach is essential, which is what has actually been proposed.
And. Not irrelevant is also the existence and the size of the "profit sharing" mechanisms that allow operators to take advantage of the efficiencies they achieved in a specific regulatory period also in subsequent periods. This affects profitability but also the ability to repay loans.
f. The introduction of rewards/punishments systems with respect to the achievement of objectives also appears to be important, including the reduction of losses or the adoption of enabling technologies. On this point, a leading international operator informs us that in the new regulatory period in England a system of "rewards/penalties" is envisaged referring to the achievement of certain objectives: penalties introduce an element of potential downside to the regulatory WACC, reducing the visibility of flows of cash. This approach is, I believe, applicable right now to the Italian case; in fact, the AEEGSI provides for it, perhaps leaving too much space for the EGATOs, while common reference guidelines would perhaps be useful. In short, the phase is delicate and the consultation document on the next regulatory period summarizes all the critical points on which work has been done in recent months. But of course, from the lender's point of view, good regulation is not enough: in fact, the structural profiles of the sector and the behavioral profiles of companies emerge.
Structural profiles: the growth of company size is important Another issue from the perspective of the investor, certainly not separated from the regulatory one also for the regulations that encourage aggregation processes, concerns the structure of the water sector. It is characterized by the coexistence of: the four large multi-utility companies (A2A, Iren, Acea and Hera) present in the water sector in different but nonetheless significant ways; of some medium-large mono-utility operators (for example: AQP, Abbanoa, Cap or Smat) with distinct histories and genesis but all strongly focused on the sector in question; and a large number of minor operators, some of which are active in very particular areas (think, for example, of operators in mountain areas which often have excellent quality water resources at very low costs), but others which are certainly undersized for efficient management. With regard to access to the financial markets, there are no problems for the large multi-utility companies: they have a history, size and cash flows that allow them to operate nationally and internationally. The latter are gearing up to raise financial resources at competitive costs (for example, AQP and Smat have been resorting to ratings for some time now). Lastly, smaller operators certainly have greater difficulty in accessing the financial markets even if some interesting collaboration initiatives between smaller operators such as that of Viveracqua should be noted (see: Trolese, F., “Viveracqua: an innovative project for the integration of management of the integrated water service in Veneto", in Management of Utilities and Infrastructures, 02/2015). Collaborations between large and small operators are also to be seen positively: the latter would have the possibility of increasing their capabilities without losing the margins of autonomy.
The modification of the structure of the sector in the sense of the aggregation of operators is in any case a relevant issue for the purpose of financing but also for overall efficiency. Dimensional growth, now taken for granted, has an impact on economies of scale and scope. This concentration could take place through a forced consolidation at the level of EGATO. The Thatcherite model was based on just such an action that gave birth to a dozen large companies, which were then privatized. It would not seem foolish from many points of view to imagine the presence in our country of about fifteen medium-large or large water companies even if something similar seems unlikely today in our context. For some time, among other things, we have supported the need for our country to develop an operator with such capacity and size as to expand into international markets where the demand for the services in question is growing significantly (see for example: Gilardoni, A ., "A National Champion in water? Growth strategies between industrial logic and referendum: the word to Paolo Romano", in Management of Utilities, 02/2012). The AEEGSI follows the aggregation dynamics of the sector. In the 2014 annual report presented in July 2015, he indicated updates about the changes in the EGATO but which, in our opinion, should be more significant and extensive. On the other hand, the provisions of the 2015 Stability Law which offer a series of incentives (extension of concessions, exemption from the stability pact, priority allocations of public funds, streamlining of approval procedures by the Municipalities) do not seem particularly effective to others that have had modest application (for example, the systematically rejected request to the Regions to indicate the basins with economically efficient dimensions). In short, this static nature with respect to objectively significant measures leads some to invoke coercive actions (for example the Thatcher model) which however seem to be easily opposable and in any case not effective.
management profiles
Finally, a word on the management aspects. An excellent regulation can be frustrated by inadequate or irresponsible management, or even governed or, better, influenced by organized crime. From the investor's point of view, the ability of companies to manage investment processes matters a lot (are our companies adequate in this sense?) but also the ability to collect and, in any case, the entire management of the active cycle (from measurement of consumption, issuing correct invoices, timely collection, etc.). Even non-small companies have serious deficiencies from these points of view, explained but not justified, also by the high complexity of the processes. Often absent, due to the substantial monopoly position, are marketing skills, including the provision of better and new services to customers, especially post-counter; even water should move along the path traced by electricity where the effort to change by companies has been and is certainly significant. But even all the maintenance of the networks is often carried out in a very expensive and uncontrolled way, just as patronage recruitments and appointments to top leaders of political exponents without any management skills are still too frequent. Here too a change is underway but it must be accelerated and spread throughout the territory. For investors, what has been said is important and is often one of the reasons that pushes loud requests for privatization in the belief that management not conditioned by the political system can manage better. We know that this is not true and that, indeed, there are very effective public managements, but certainly the proof of having progressed in the aspects of management is undoubtedly fundamental.
Conclusions
In conclusion, the new renaissance of the Italian water sector seems within reach above all for the work of the AEEGSI but not only. It is now a question of continuing with determination, also by promoting investments in the sector by international operators with appropriate marketing actions. Adjustment and dimensional scaling are the two central factors. If the mechanism is launched, spaces will also open up for innovative and low-cost financing operations such as for example the one created in the UK for the financing of the Thames Water Tunnel (London's new super-sewer), in which infrastructure investors participate both on the debt side what equity; the RAB is also remunerated during the construction phase; timing and size of the investment are guaranteed by the contractors (selected with an auction mechanism) and the Government guarantees in the event of default. Or even more complex financing structures such as the HoldCo-OpCo structure, Whole Business Securitization which make it possible to reach higher levels of leverage (90-95% Net Debt/RAB to maximize financial efficiencies exceeding the regulatory WACC) which would not seem applicable remaining the shareholding structures held by local administrations.
