Unión Fenosa, S.A. and Subsidiaries composing the Unión Fenosa Group 2005 Consolidated Financial Statements and Directors Report

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3 Unión Fenosa, S.A. and Subsidiaries composing the Unión Fenosa Group 2005 Consolidated Financial Statements and Directors Report Translation of a report originally issued in Spanish based on our work performed in accordance with generally accepted auditing standards in Spain and of consolidated financial statements originally issued in Spanish and prepared in accordance with IFRSs, as adopted by the European Union (see Notes and 37). In the event of a discrepancy, the Spanish-language version prevails.

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5 Translation of consolidated financial statements originally issued in Spanish and prepared in accordance with IFRSs, as adopted by the European Union (see Notes and 37). In the event of a discrepancy, the Spanish-language version prevails. UNION FENOSA, S.A. AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS FOR THE YEARS ENDED 31 DECEMBER () Revenue (Note 5) 6,098,820 4,464,980 Procurements (Note 6) 3,344,372 2,156,282 Staff costs (Note 7) 687, ,071 Other expenses (Note 8) 672, ,870 Capitalised operating expenses (Note 14) 83, ,086 Depreciation and amortisation charge and net impairment losses (Notes 14 and 15) 553, ,718 PROFIT FROM OPERATIONS 923, ,125 Finance costs (Note 9) 522, ,387 Income from financial assets (Note 10) 87, ,158 Share of results of associates (Note 18) 13,540 8,786 Income from non-current non-financial assets (Note 11) 587,785 1,194 PROFIT BEFORE TAXES FROM CONTINUING OPERATIONS 1,091, ,876 Income tax (Note 12) 252, ,924 PROFIT FOR THE YEAR FROM CONTINUING OPERATIONS 838, ,952 PROFIT (LOSS) FROM DISCONTINUED OPERATIONS (Note 20) (3,458) 7,188 PROFIT FOR THE YEAR 834, ,140 Attributable to shareholders of Parent (Note 22.07) 823, ,751 Attributable to minority interests (Note 22) 11,161 21,389 Earnings per share (Note 13) Basic earnings per share Diluted earnings per share The accompanying Notes 1 to 37 are an integral part of the consolidated income statement for

6 Translation of consolidated financial statements originally issued in Spanish and prepared in accordance with IFRSs, as adopted by the European Union (see Notes and 37). In the event of a discrepancy, the Spanish-language version prevails. UNION FENOSA, S.A. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AT 31 DECEMBER () ASSETS 17,730,972 15,269,366 NON-CURRENT ASSETS 14,923,748 13,031,204 Property, plant and equipment (Note 14) 10,829,488 9,502,324 Intangible assets (Note 15) 673, ,414 Goodwill (Note 16) 179, ,836 Non-current financial assets (Note 17) 1,764, ,974 Investments in associates (Note 18) 156, ,030 Deferred tax assets (Note 12) 1,222,221 1,111,627 Other non-current assets (Note 21) 98,488 99,999 CURRENT ASSETS 2,565,885 1,922,717 Inventories (Note 19) 114,318 93,975 Trade and other receivables (Note 21) 1,621,445 1,200,038 Current financial assets (Note 17) 191, ,517 Other current assets (Note 21) 487, ,479 Cash and cash equivalents (Note 21) 151, ,708 ASSETS CLASSIFIED AS HELD FOR SALE (Note 20) 241, ,445 EQUITY AND LIABILITIES 17,730,972 15,269,366 EQUITY (Note 22) 5,066,770 3,318,100 Equity attributable to shareholders of the Parent 3,923,803 2,962,328 Minority interests 1,142, ,772 NON-CURRENT LIABILITIES 8,690,036 8,735,730 Bank borrowings (Note 23) 5,500,562 5,659,363 Long-term provisions (Notes 25 and 26) 1,239, ,492 Other financial liabilities (Note 27) 87, ,484 Deferred tax liabilities (Note 12) 740, ,965 Other non-current liabilities (Note 28) 1,122, ,426 CURRENT LIABILITIES 3,813,170 2,963,215 Bank borrowings (Note 23) 727,275 1,251,825 Short-term provisions (Note 26) 224,789 1,297 Other financial liabilities (Note 27) 59, ,625 Trade and other payables 1,127, ,900 Other current liabilities (Note 28) 1,674, ,568 LIABILITIES ASSOCIATED WITH ASSETS CLASSIFIED AS HELD FOR SALE (Note 20) 160, ,321 The accompanying Notes 1 to 37 are an integral part of the consolidated balance sheet for

7 Translation of consolidated financial statements originally issued in Spanish and prepared in accordance with IFRSs, as adopted by the European Union (see Notes and 37). In the event of a discrepancy, the Spanish-language version prevails. UNIÓN FENOSA, S.A. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF RECOGNISED INCOME AND EXPENSES FOR THE YEARS ENDED 31 DECEMBER () Of the Parent Of Minority Interests Total Of the Parent Of Minority Interests Total Net profit recognised directly in equity 338,859 95, ,881 82,973 53, ,862 In retained earnings (56,229) 1,032 (55,197) (44,833) 673 (44,160) - Actuarial (losses) and gains on pension plans (56,229) 1,032 (55,197) (44,833) 673 (44,160) In asset and liability revaluation reserves 238,442 18, ,903 84,769 20, ,006 - Change in value of cash flow hedging derivatives 13,548 13,548 (4,902) (4,902) - Change in value of non-current assets in Colombia 42,242 18,461 60,703 43,183 20,237 63,420 - Change in value of available-for-sale investments 182, ,652 46,488 46,488 In translation differences 156,646 75, ,175 43,037 32,979 76,016 Profit for the year 823,728 11, , ,751 21, ,140 TOTAL INCOME AND EXPENSES RECOGNISED IN THE YEAR 1,162, ,183 1,268, ,724 75, ,002 The accompanying Notes 1 to 37 are an integral part of the consolidated statement of recognised income and expenses for

8 Translation of consolidated financial statements originally issued in Spanish and prepared in accordance with IFRSs, as adopted by the European Union (see Notes and 37). In the event of a discrepancy the Spanish-language version prevails. UNION FENOSA, S.A. AND SUBSIDIARIES CONSOLIDATED CASH FLOW STATEMENTS FOR THE YEAR ENDED 31 DECEMBER () Profit attributable to the Parent 823, ,751 Adjustments to attributable profit to determine the profit from operations 100, ,374 Finance costs 522, ,387 Income from financial assets (87,922) (126,158) Share of results of associates (13,540) (8,786) Income from non-current non financial assets (587,785) (1,194) (Profit) Loss from discontinued operations 3,458 (7,188) Profit attributable to minority interests 11,161 21,389 Income tax expense 252, ,924 Profit from operations 923, ,125 Adjustments to expenses and income that do not give rise to cash flows 671, ,131 Depreciation and amortisation charge 553, ,718 Net change in provisions 201,365 51,499 Capitalised operating expenses (83,395) (103,086) Payments to fund post-employment benefits (91,637) (42,272) Changes in working capital 203, ,538 Net cash from operating activities before income tax 1,706,927 1,297,522 Income taxes paid (249,440) (22,582) NET CASH FLOWS FROM OPERATING ACTIVITIES 1,457,487 1,274,940 Investments in property, plant and equipment and intangible assets (1,141,892) (773,127) Disposals of property, plant and equipment and intangible assets 60,332 43,370 Disposals of other non-current non-financial assets 1,287,565 88,033 Proceeds from financial assets 91, ,656 Dividends received at associates 17,735 15,954 Contribution to shortfall in revenues from regulated activities (295,084) Change in assets classified as held for sale and associated liabilities and discontinued operatio (20,664) (55,954) Other changes in investing activities 70,797 (232,935) Change in government grants and other deferred income 21,375 9,336 NET CASH FLOWS FROM INVESTING ACTIVITIES 91,648 (781,667) Net cash flows from equity instruments 687,076 Change in bank borrowings and other financial liabilities (1,353,605) 90,940 Finance costs (504,862) (413,337) Dividends paid (180,963) (167,345) Other changes due to financing activities (274,229) 84,273 NET CASH FLOWS FROM FINANCING ACTIVITIES (1,626,583) (405,469) NET CASH AND CASH EQUIVALENTS GENERATED IN THE PERIOD (77,448) 87,804 Net increase / (decrease) in cash and cash equivalents (77,448) 87,804 Cash inflows / (outflows) due to foreign exchange rate changes and changes in the scope o 28,844 (4,869) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 199, ,773 CASH AND CASH EQUIVALENTS AT END OF YEAR 151, ,708 The accompanying Notes 1 to 37 are an integral part of the consolidated cash flow statement for The consolidated cash flow statement for 2004 is presented for information purposes only. -6-

9 Notes to 2005 Consolidated Financial Statements Contents 01. General description of the Group Basis of presentation of the consolidated financial statements and comparative information Industry regulation Accounting policies Revenue Procurements Staff costs Other expenses Finance costs Income from financial assets Income from non-current non-financial assets Tax matters Earnings per share Property, plant and equipment Intangible assets Goodwill Financial assets Investments in associates Inventories Assets classified as held for sale and discontinued operations Other assets Equity Bank borrowings Financial risk management Post-employment benefit obligations Other provisions Other financial liabilities Other liabilities Guarantee commitments to third parties Segment reporting Related party transactions Other disclosures concerning the Parent s Board of Directors Events subsequent to year-end Subsidiaries Joint ventures Associates Explanation added for translation to English

10 Translation of consolidated financial statements originally issued in Spanish and prepared in accordance with IFRSs, as adopted by the European Union (see Notes and 37). In the event of a discrepancy, the Spanish-language version prevails. -8-

11 01. General description of the Group The Unión Fenosa Group s Parent was incorporated for an indefinite period of time in Spain through a public deed on 10 February Its registered office is at Avenida de San Luis, nº 77, Madrid. Unión Fenosa, S.A. and its subsidiaries ( the Group ) engage mainly in the following business activities: a) The production, sale and use of electric power and of other energy sources and the performance of studies relating thereto and the production, exploration, sale and use of all manner of solid, liquid or gaseous primary energy resources, including specifically all forms and kinds of oil and natural, liquefied or any other type of gas. b) The design, development, implementation and provision of services relating to corporate information, management and organisation (consulting) and the research, development and use of new technologies. c) Energy planning and rationalization of the use of energy and combined heat and power generation. d) The research, development and exploitation of communications and information technologies in all their facets. The provision of industrial services, in particular relating to electricity, telecommunications, water, gas and oil. e) The management, development and operation of properties. f) The development, promotion, presentation, performance, acquisition, sale and provision of services in the fields of art, culture and leisure, in their different activities, forms, expressions and styles. g) Management of the corporate Group made up of equity interests in other companies. As established in the bylaws, these activities which make up its corporate purpose may be carried on by the Company in Spain or abroad directly or indirectly through the ownership of shares or of other equity interests in companies with identical or similar corporate purposes. Due to the considerable growth in the business activities carried on by the Unión Fenosa Group, and in order to facilitate the management of all the activities, the Group has been structured into business divisions which group together the various businesses by type, all of which share common management. The holding company, Unión Fenosa, S.A., is responsible for establishing strategies and policies and for controlling all the Group s activities. The business segments are as follows: the energy business in Spain, which includes the gas generation and distribution activities; the international electricity business in the following geographical areas: Mexico, Colombia, Central America and other countries; professional services (Soluziona); and corporate structure and other businesses not included in the aforementioned segments (see Note 30). 02. Basis of presentation of the consolidated financial statements and comparative information General considerations The accompanying consolidated financial statements for the year ended 31 December 2005, and the related comparative information was prepared in accordance with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) and adopted by the European Commission, in conformity with Regulation (EC) no. 1606/2002 of the European Parliament and of the Council and subsequent amendments thereto. The disclosures required by IFRS 1 First-Time Adoption of International Financial Reporting Standards, referring to the transition to IFRS, are detailed in Note The accompanying consolidated financial statements were prepared from the accounting records as of 31 December 2005 and 2004, of Unión Fenosa, S.A. and of each of the consolidated subsidiaries, incorporating the adjustments necessary to adapt these accounting records to the requirements stipulated in the International Financial Reporting Standards. The 2005 consolidated financial statements of the Unión Fenosa Group, and the individual financial statements of Unión Fenosa, S.A., which were prepared on 29 March 2006 by the Parent s Board of Directors, and both these financial statements and those of the other companies included in the scope of consolidation have not yet been approved by the respective Shareholders Meetings. However, the Board of Directors of Unión Fenosa, S.A. considers that these financial statements will be approved without any changes. The Unión Fenosa Group s 2004 consolidated financial statements, were approved by the Parent s Shareholders Meeting on 6 May

12 Changes in accounting policies and transition to International Financial Reporting Standards (IFRS) The Unión Fenosa Group s consolidated financial statements for the year ended 31 December 2005 are the first to be prepared under IFRS (see Note 02.01), since until 2005 the financial statements were prepared in accordance with Spanish accounting methods and GAAP ( PGC ). The amounts included in these financial statements for the year ended 31 December 2004 were reconciled in accordance with the same principles and methods applicable to the 2005 financial statements. The translation to IFRS of the financial statements prepared in accordance with Spanish GAAP involves the retrospective application of the related accounting principles and valuation standards. The Unión Fenosa Group applied all the standards since the date of transition to IFRS i.e. 1 January 2004, including IASs 32 and 39. In the case of the application of IAS 39, in accordance with the fair value option, at the transition date the Group opted to measure certain financial liabilities and derivatives at fair value and to recognize changes therein in profit and loss. Following the exemptions applied by the Unión Fenosa Group are described: - The Group opted not to retroactively reconstruct business combinations prior to 1 January 2004, maintaining the value of the goodwill existing under PGC. - The Group also opted to treat the amount of the property, plant and equipment revalued under PGC, either on the transition date or previously, as a cost attributed to these assets, since it considers that the revaluations that have been made in accordance with the legislation in force in the various countries in which the Unión Fenosa Group companies operate reflect the fair value of the aforementioned assets. - The translation differences generated before 1 January 2004 were transferred to reserves. The loss or gain for foreign businesses subsequently disposed of or abandoned will exclude the translation differences which arose before the date of transition to IFRS, and will include the translation differences which arose after that date (see Note 04.01). - In relation to pension obligations, the Group opted to recognise all actuarial gains and losses at the transition date in equity. The reconciliation of equity at 1 January 2004, in accordance with Spanish GAAP and IFRS is as follows: RECONCILIATION OF EQUITY SPANISH GAAP-IFRS at 1 January 2004 Capital, Reserves and Translation Differences Minority Shareholders Equity 1 January 2004 Spanish GAAP 3,061,452 3,061,452 Inclusion of minority shareholders 1,015,308 1,015,308 Non-current assets (146,500) (146,500) Post-employment benefit obligations (106,332) (106,332) Liabilities relating to other provisions and financial instruments (97,624) (97,624) Preference shares (609,245) (609,245) Deferred tax assets (92,502) (92,502) Available-for-sale investments 129, ,116 Other adjustments and reclassifications and allocation to minority interests (20,100) (72,186) (92,286) 1 January 2004 IFRS 2,727, ,877 3,061,387 The reconciliation of equity at 31 December 2004, in accordance with Spanish GAAP and IFRS is as follows: -10-

13 RECONCILIATION OF EQUITY SPANISH GAAP-IFRS at 31 December 2004 Capital, Reserves and Translation Differences Attributable Profit Minority Shareholders 31 December 2004 GAAP 2,892, ,453 3,290,114 Inclusion of minority shareholders 1,001,112 1,001,112 Non-current assets (108,069) (20,603) (128,672) Post-employment benefit obligations (108,256) 71,975 (36,281) Liabilities relating to other provisions and financial instruments (146,765) (20,475) (167,240) Preference shares (25,443) (586,946) (612,389) Deferred tax assets (92,850) 3,325 (89,525) Available-for-sale investments 224,498 (32,741) 191,757 Other adjustments and reclassifications and allocation to minority interests (75,642) 3,260 (58,394) (130,776) 31 December 2004 IFRS 2,585, , ,772 3,318,100 Equity Inclusion of minority shareholders: The total equity under Spanish GAAP is composed solely of equity relating to shareholders of the Parent, unlike equity as defined in IFRS which includes both the equity attributable to the Parent and to the minority shareholders. The effect of the allocation to minority interests of each of the adjustment is included in the item Other Adjustments and Reclassifications and Allocation to Minority Interests in the Spanish GAAP IFRS equity reconciliations at 31 December 2004 and 1 January 2004 included in this Note. Non-current assets: The application of IFRS has mainly had the following implications: - In accordance with IFRS, certain expenses which do not meet the requirements for treatment as assets may not be capitalized. Accordingly, all the start-up expenses, research expenses and other deferred charges which were recorded under Spanish GAAP are derecognized. The deferred debt arrangement and interest expenses, which were presented as deferred charges under Spanish GAAP, are presented as a deduction from the related liabilities under IFRS. - The treasury shares and gains or losses arising from transactions with these shares are deducted from equity, whereas under Spanish GAAP these items were recorded at the lower of cost or market and recorded as fixed assets. - In accordance with Spanish GAAP certain revalued assets of the Colombian electricity utilities, were recognized through the income statement in Under IFRS this revaluation is recorded directly in reserves. Post-employment benefit obligations: The Unión Fenosa Group decided to adopt the methods established in the amendments to IAS 19 published in the Official Journal of the European Communities on 24 November 2005, recording directly in equity the actuarial differences due to the change of assumption which arose in the valuation of the post-employment benefit obligations. In accordance with Spanish GAAP the aforementioned actuarial differences are recognized as profit or loss for the year. Liabilities related to other provisions and financial instruments: - Provision for the dismantling of assets: as established by IFRS, in cases in which it is considered that at the end of the useful life of an asset it will be necessary to incur dismantling expenses, the appropriate estimates were made to increase the carrying amount of the asset by the present value of these expenses and record the related provision, reconstructing the cost and the accumulated depreciation of the assets from the date on which they became operational. In accordance with Spanish GAAP the aforementioned provisions are recorded by the accrual method based on the best estimate of the cost of dismantling the assets. - Provision for major repairs: under Spanish GAAP the cost relating to the scheduled periodic maintenance of generating facilities must be provisioned so that when the overhauls are carried out the cost thereof has already been recognised in the income statement. Under IFRS it is not permitted to recognise expenses early or to recognise future liabilities and, therefore the provisions recognised for this purpose under Spanish GAAP have been derecognised and the aforementioned costs are recognised in income on an accrual basis. - In relation to other provisions, under IFRS in order to be able to recognise a provision a past event must have occurred which could give rise to an outflow of resources and it must be possible to reasonably quantify the risk. Under Spanish -11-

14 GAAP, and in accordance with the principle of prudence, it is necessary to recognise certain provisions to cover identified risks that exist and even foreseeable risks. - Financial instruments: under Spanish GAAP, the profit or loss from hedging derivatives is allocated in proportion to that from the hedged asset, by the accrual method; non-hedging derivatives must be measured and a provision is recorded in the event that a loss is probable. No accounting entry is recognised if a gain is disclosed. Under IFRS, hedging derivatives are measured at fair value and any change in that value is recognised in equity/or in profit or loss depending on whether the derivative is classified as a hedging derivative or a non-hedging derivative and depending on the type of hedge in question. Also, certain financial assets which under Spanish GAAP are recognised at the lower of cost or market, are carried at fair value under IFRS. Preference shares: Under Spanish GAAP preference shares are classified as minority interests since they are shares of subsidiaries held by third parties. The IFRS establish that preference shares must be classified as liabilities in cases in which the issuing company does not have the capacity to decide whether a dividend is paid on these shares and, accordingly, the related reclassifications were made. Deferred tax assets and liabilities: Under Spanish GAAP deferred tax assets and liabilities are recognized for temporary differences between the carrying amount and the tax base of revenues and expenses. Under Spanish GAAP, in accordance with the principle of prudence deferred tax assets with a foreseeable reversal term of more than ten years are not recognised. Under IFRS any temporary difference between the carrying amount and the tax base of an asset or a liability gives rise to a deferred tax asset or liability that must be recognised and, accordingly, the related adjustments were made. Also, under IFRS deferred tax assets are recognised, with no time limit, provided that their recovery is probable. Available-for-sale investments: Under Spanish GAAP, a significant influence is considered to exist when an entity holds 3% or more of a publicly listed company or 20% or more of an unlisted company. Under IFRS the existence of this significant influence must be demonstrated, which implies, in quantitative terms and for reference purposes, an ownership interest of 20% or more, unless there is rebuttal evidence to the contrary. Consequently, certain investments in publicly listed companies over which a significant influence is not exercised in accordance with IFRS must be classified as available-for-sale investments and recognised at their fair value. The Unión Fenosa Group has used this method to measure the investments in publicly listed companies which under Spanish GAAP had been accounted for using the equity method. Other adjustments and reclassifications: - Exchange gains: under Spanish GAAP exchange gains in general are recognized as income when they are realized, until then they are recorded as deferred income on the liability side of the consolidated balance sheet. The balance for deferred income due to exchange gains was eliminated, since in accordance with IFRS exchange gains and losses are recognised in the income statement when they arise. - Amortisation of consolidation goodwill: consolidation goodwill is amortised systematically over a maximum period of 20 years under Spanish GAAP, since this is considered the average period over which this goodwill will be recovered. Under IFRS goodwill is not amortised; however, an analysis of its impairment or recoverability is performed periodically, at least once a year. - Investments in associates: exchange differences were recognised in equity at consolidated companies accounted for using the equity method due to the effect of the adjustments which these companies made to their equity for adaptation to IFRS. - Changes in scope: as a result of the adaptation to IFRS there were changes in the scope of consolidation derived mainly from: - The recognition of certain investments and transaction lines as assets classified as held for sale and discontinued operations, respectively. - The investments accounted for using the equity method under Spanish GAAP in Barras Eléctricas Galaico Asturianas, S.A., Eléctrica Conquense, S.A. and the EUFER Subgroup, are proportionately consolidated under IFRS, since the requirements established for treatment as joint ventures have been met Changes in the scope of consolidation In 2005 the scope of consolidation changed, due mainly to sales and acquisitions of companies and to mergers and spin-offs in the framework of the Unión Fenosa Group s corporate restructuring plan. The following companies were included in the scope of consolidation of the Unión Fenosa Group in 2005: -12-

15 Group companies Joint ventures and associates Instalaciones y Proyectos de Telecomunicaciones, S.A. de C.V. Applus Servicios Tecnológicos, S.L. Socoin México S.A. de C.V. Qalhat LNG S.A.O.C. Arte Contemporáneo y Energía, A.I.E. EUFER Comercializadora, S.L. (1) Energía Empresarial de la Costa, E.S.P. Parque Eólico La Losilla, S.A. (1) Procinsa Ingeniería, S.A. GIBB Portugal Consultores de Engenharia, Gestao e Ambiente, S.A. Instalaciones y Proyectos Integrales de Telecomunicaciones, S.L. Comercializadora Guatemalteca Mayorista de Electricidad, S.A. Compañía de Electricidad de Tulúa, S.A. Unión Fenosa Preferentes, S.A. Auna Operadores de Telecomunicaciones Holding Empresarial 1, S.L. (2) (1) Company in the Enel Unión Fenosa Renovables (Eufer) Subgroup. (2) Holding Company owning the shares in Quiero Televisión, S.A. and Hispasat, S.A., which were spun-off from Auna before the sale of Auna Operadores de Telecomunicaciones, S.A. In 2005 the following companies were excluded from consolidation in the Unión Fenosa Group: Group companies Soluziona Calidad y Medio Ambiente, S.L. Joint ventures and associates Auna Operadores de Telecomunicaciones, S.A. Novotec Consultores, S.A. Norcontrol, S.A. Norcontrol Sweet, S.A. Unión Fenosa Viajes, S.A. Soluziona Telecomunicaciones, S.A.U. Soluziona Consultoría y Tecnología, S.L. Soluziona Ingeniería, S.L. Parque Eólico de Os Corvos, S.A. (1) NET, Tecnología de la Información, A.I.E. NTC, Calidad y Consultoría, S.A. Solutions Reseaux et Securite, S.A. Soluziona Engineering, LTD. The changes in the scope of consolidation as a result of the changes in the consolidation methods applied relate solely to Soluziona Philippines, Inc., which changed from being proportionately consolidated to being fully consolidated, without any changes in the percentage of ownership, in order to correctly represent the Unión Fenosa Group s control over that company. In 2005 there were no significant business combinations that require disclosure of additional information in order to evaluate the nature and financial effects thereof. At 31 December 2005 the investments in Aeropuertos Mexicanos del Pacífico, S.A. de C.V., Instalaciones y Proyectos de Telecomunicaciones, S.A. de C.V. and Socoin México, S.A. de C.V. were recognised as assets classified as held for sale. At 31 December 2004, the investments in Instalaciones y Proyectos Integrales de Telecomunicaciones, S.L., Socoin Ingeniería y Construcción Industrial, S.L.U., Soluziona, S.A. (Bolivia), Egatel, S.L. and Sistemas Integrales de Radiocomunicación, S.A., were similarly classified and continued to be recognised as assets classified as held for sale at 31 December The investment in Soluziona Calidad y Medio Ambiente, S.L. was recognized as an asset classified as held for sale at 31 December

16 03. Industry regulation Energy business in Spain The electricity industry Electricity Industry Law 54/1997 came into force on 29 November The purpose of the Law is to regulate the activities involved in the supply of electricity, i.e. generation, transmission, distribution, retailing and Intra-Community and international exchanges, as well as the economic and technical management of the electricity system. This Law transposed into Spanish legislation the provisions of Directive 96/92/EC of the European Parliament and Council concerning common rules for the internal market in electricity. The Law set up an electricity system that functions in accordance with the principles of objectivity, transparency and free competition, subject to the regulation made necessary by the characteristics of this industry, which include the need for economic and technical coordination of its operations. The Law set a new essentially deregulatory framework, the basic purpose of which is to guarantee electricity supply, supply quality and supply at the lowest possible cost, without overlooking environmental protection. The notion of a public service was replaced by the express guarantee that electricity will be supplied to all consumers demanding the service in Spain. The economic management of the system is based on the decisions of the economic players within the framework of an organized wholesale electricity market. State planning is confined to the transmission facilities. The regulatory framework for the electricity industry established in the aforementioned Law together with the subsequent implementations is based mainly on the following aspects: The right of free installation was recognized with respect to the electricity generation activity, and its functioning is organized in accordance with the free market principle based on a system of supply bids tendered by producers and a system of demand bids made by customers eligible to choose their power supply source. The economic remuneration of this activity is based on the organization of a wholesale market and includes the following aspects: - The power generated is remunerated at the marginal price of the last production facility required to satisfy demand. - The supply guarantee that each production unit effectively provides to the system on the basis of proven availability. - The supplementary services necessary to guarantee an adequate supply to the consumer. The organization and regulation of the electricity generation market were defined and implemented through Royal Decree 2019/1997 of 26 December. Special treatment was reserved for facilities using renewable energy resources or sources, waste and combined heat and power, to foster the development of these facilities through the creation of a favourable special regime, whereby these facilities can opt to sell electricity to the distributor owning the network to which such facilities connect under the regulated rate system or to sell the electricity freely in the market at the price resulting therefrom supplemented by an incentive and a premium. The electricity generation activity, in turn is affected by Royal Decree 1866/2004, of 6 September, amended by Royal Decree 60/2005, of 21 January, which approved the National Plan for the Assignment of Emission Allowances, in compliance with Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading in the European Union. This Plan establishes for the total allowances allocated to the facilities carrying on the activities included in the scope of application of Royal Decree 5/2004 of 27 August. The National Allocation Plan also establishes the methodology for calculating the individual allocation allowances and, specifically for the electricity industry, the methodology employed is established on the basis of the actual historical average emissions in the period from 2000 to 2002 and on the application of certain geographical and technological criteria. The emissions measured which exceed the emission allowances initially assigned will make it necessary to purchase emission allowances in the market (see notes , 15 and 26). Also, Royal Decree Law 5/2005 and Law 24/2005 on measures to foster productivity established the internalization by owners of nuclear power plants of the financing of the costs of the second part of the nuclear fuel cycle from 31 March 2005 onwards. These provisions replaced the financing system which charged the cost of dismantling nuclear power plants, managing spent fuel and radioactive waste to the electricity tariff, by a system in which the owners of the facilities become responsible for this financing from the aforementioned date onwards, through the payment of a levy. The financing of the aforementioned costs which are incurred before 1 April 2005 will continue to be treated as diversification and security of supply costs paid for by the electricity tariff. The operation of the Spanish electricity system was assumed by two private-sector companies responsible for the economic and technical management of the system, called the Market Operator and the System Operator, respectively. The Market Operator is responsible for the economic management of the system. This includes accepting bids, matching demand to supply, and performing the settlement transactions. The System Operator is responsible for technical management, i.e. -14-

17 activities relating to the administration of power flows, taking exchanges with other interconnected systems into account, and including the determination and assignment of transmission losses and the management of the supplementary services. Royal Decree-Law 5/2005 on urgent reforms to increase productivity enlarged the scope of the functions of the System Operator making it responsible also for the settlement of the payments of the supply guarantee, settlement for diverting supply and supplementary services, and limited the scope of the functions of the Market Operator to the daily and intradaily market. The transmission and distribution activities were deregulated by generalizing third-party access to the networks. Ownership of the networks does not guarantee exclusive access. The price for using the transmission and distribution networks is determined by the access fees approved by the government, which are single fees without prejudice to the different prices based on voltage, level and type of consumption. Also, in order to guarantee the independence and transparency of these activities, the legal unbundling of regulated and non-regulated activities was established for the electric utilities and, accordingly, the corporate purpose of companies which carry on any of the activities regulated in the Law (economic and technical management of the system, transmission and distribution) must be confined exclusively to said activities and, accordingly, these companies may not carry on non-regulated activities. However, incompatible activities may be carried on within the same group of companies, provided that they are performed by different companies. Royal Decree 1955/2000, of 1 December, regulating the transmission, distribution, retailing and supply activities and electricity facility authorization procedures, established the legal system applicable to the transmission, distribution, retailing and supply of power and the relationships between the various players carrying on these business activities. The remuneration of the transmission activity is regulated for each party in Royal Decree 2819/1998, of 23 December, which regulates the electricity transmission and distribution activities, on the basis of facility investment, operating and maintenance costs, and other costs required to carry on this activity. Pursuant to the Law, the remuneration of the distribution activity is regulated and is assigned to each player on the basis of the following criteria: facility investment, operating and maintenance costs, power distributed, a model characterizing the various distribution areas, incentives for supply quality and loss reductions, and other costs required to carry on this activity. The annual revision of the remuneration of distribution is performed pursuant to the provisions of the aforementioned Royal Decree 2819/1998, of 23 December. The electricity retailing activity s position is consolidated with the Electricity Industry Law electricity retailing is based on the principles of freedom of contract and supplier choice. A transitional period was established for its progressive implementation in order to make freedom of choice a reality for all consumers. Royal Decree-Law 6/2000 established a new deregulation schedule, whereby all electricity consumers have been eligible consumers since January 1, 2003 Transitional Provision Six of Electricity Industry Law 54/1997 recognized the existence of costs relating to the transition to competition for the companies that owned the production facilities, which at 31 December 1997 were included in the scope of application of Royal Decree 1538/1987 of 11 December, and recognising the right of said companies to receive compensation for these costs over an initial transition period of ten years. Royal Decree-Law 2/2001, published on 2 February 2001 amended the aforementioned transitional provision, with the following implications: the consolidation of the amount of the electricity industry s fixed costs of transition to competition (CTCs) provided for in Law 50/1998, of 30 December, the extension to 2010 of the period over which the CTCs will be collected, the elimination of the allocation of a percentage of rate billings to cover the fixed CTCs and an adjustment of the rates at which the fixed CTCs will be collected based on the amount by which the selling price of the output of each utility exceeds the EUR cents 3.61/kWh already recovered by each utility. Also, the Ministerial Order dated 21 November 2000, introduced the procedure for establishing the producers contribution in relation to the shortfall in revenues from regulated activities and the order in which said shortfall will be passed on to the producers. The remuneration for the consumption of local coal was afforded the same priority as the remuneration of the distribution and transmission activities. Subsequently, Ministry of Economy Order ECO/1588/2002 of 12 June, established for 2000 and subsequent years the order in which the shortfall in revenues from regulated activities would be passed on to the producers. This Order included the provisions of the Ministerial Order on this same issue published on 21 November 2000, and only included the amendments required to take into account the inclusion of Viesgo Generación, S.L. as a new participant in the settlement procedure. This Ministerial Order established that the amounts deducted from each utility for the purpose of covering the shortfall in revenues from regulated activities in a given year would be taken into account when calculating the balance of the costs of transition to competition as of December 31 of that year. With respect to the tariff regime in the electricity industry, Royal Decree 2017/1997 of 26 December, on the organisation and regulation of the settlement procedure relating to transmission, distribution and retailing costs under the tariff system, to ongoing system costs and to the diversification and security of supply costs, establishes the settlement procedure for payment obligations and collection rights required to remunerate the regulated costs and activities, guaranteeing the distribution of the collections made by the distributors and retailers among the various parties that perform the system activities, in accordance with the remuneration to which they are entitled. Royal Decree 1432/2002 of 27 December, which -15-

18 established the methodology for calculating the average or reference electricity rate, establishes, inter alia, the various cost components which have to be taken into account in the calculation of the average annual electricity tariff, as well as an objective and transparent calculation methodology for setting the average or reference electricity tariff for each year. In 2005 certain legal provisions were approved in compliance with the Plan to Strengthen the Economy approved by the government in February, which, with the objective of increasing productivity, made various amendments in the regulatory framework of the electricity industry, without changing the industry s basic principles or organizational and regulatory model. Specifically these include Royal Decree-Law 5/2005, of 11 March, on urgent measures to foster productivity and to improve public procurement, Law 24/2005, of 18 November, on reforms to increase productivity, indicated above, and Royal Decree 1454/2005, of December 2, amending certain provisions relating to the electricity industry. On 23 December, Royal Decree 1556/2005 establishing the electricity tariff for 2006 was approved. This Royal Decree approved an average or reference tariff increase for 2006 of 4.48% on the 2005 tariff, setting its value for 2006 at EUR cents /kWh. It should be noted that this Royal Decree expressly states that the government, on 1 July 2006, will approve or modify the average or reference tariff, and will review the costs derived from the activities required to supply electricity, the ongoing system costs and the diversification and security of supply costs, including the reimbursement, out of the proceeds from sales under the tariff system in subsequent years to each of the electric utilities of the amounts contributed to finance the 2005 shortfall, including the related accrued interest (see Note 17) The gas industry The deregulation of the gas industry in Spain began with the publication in 1998 of Oil and Gas Industry Law 34/1998 of 7 October. The regulatory framework for the gas industry was subsequently expanded through Royal Decree-Law 6/2000 of 23 June on urgent measures to intensify competition in the goods and services markets and Royal Decree 949/2001 of 3 August regulating third-party access to gas installations and establishing an integrated economic system for the natural gas industry. Ministry of Economy Order ECO/2692/2002 of 28 October, which was published in 2002, regulated the procedures for the settlement of the remuneration of regulated activities in the natural gas industry and of the specific quotas and established the information that the utilities must present. In December 2002 Royal Decree 1434/2002 of 27 December was published. This Royal Decree regulates natural gas transmission, distribution, and supply activities and the authorization procedures for natural gas facilities. Royal Decree 1716/2004, of 23 July, regulated the obligation to maintain minimum natural gas safety stocks, to diversify sources of natural gas and the Strategic Oil Product Reserves Corporation. On 31 January 2005, the Ministerial Orders that define each year the economic regime for the natural gas industry and regulate the remuneration of regulated activities, tolls and royalties and natural gas selling prices (ITC/102/2005 Order revised the remuneration for regulated activities in the gas industry, ITC/103/2005 Order established the fees and charges for third-party access to gas installations and ITC/104/2005 Order established the rates for piped natural gas and manufactured gases, meter rentals and connection charges for consumers connected to systems at 4 bar or less. The Council of Ministers, in its meeting on 25 February 2005, approved the Plan to Strengthen the Economy and increase productivity, which includes a program of economic reforms affecting an extensive number of industries the purpose of these reforms is to achieve lasting and balanced growth of the Spanish economy, based on increased productivity. In relation to the gas industry, within the framework of this plan the following legislation was published: Royal Decree-Law 5/2005, of 11 March on urgent measures to foster productivity and to improve public procurement, Royal Decree 942/2005, of 29 July, amending certain provisions relating to oil and gas and Law 24/2005 on reforms to increase productivity. On 11 October ITC/3126/2005 Order was published, this Order approved the Technical Management Rules for the Gas System ( NGTS ). The purpose of the NGTS is to establish the procedures and mechanisms for the technical management of the system, coordinating the activity of all the players or agents involved in it, in order to guarantee the correct technical functioning of the gas system and the continuity, quality and security of supply of natural gas and piped gases. On 30 December 2005, the new Ministerial Orders were published establishing the economic regime for the natural gas industry in 2006, (ITC/4099/2005 Order on remuneration of regulated activities, ITC/4100/2005 Order on fees and charges and ITC/4101/2005 Order on tariffs) these Orders came into force on 1 January The most significant new features of these new Ministerial Orders are those relating to the abolition of the tariffs for units 1, 2.5, 2.6 and 4, which involved the creation of transitional tariffs that will cease to exist in 2006, and the creation of the new fees for interruptible transmission and distribution, international transit fees and the fees applicable to contracts of less than one year. Lastly, as regards gas regulation in the European Union, 1 July 2004, was the deadline for the transposition into national legislation of the Directive concerning common rules for the internal market in gas. This Directive, which further deregulates the gas industry in Europe has not yet been transposed into Spanish law and, accordingly, the European institutions initiated the appropriate infringement proceedings in

19 International electricity business The Unión Fenosa Group has a presence as an investor in: the electricity generation and distribution industry in Colombia and Panama, the electricity distribution industry in Guatemala, Moldova and Nicaragua and in the generation industry in Mexico, Kenya and the Dominican Republic. The regulatory frameworks of the countries in which the Unión Fenosa Group has investments in electricity distribution, reflect a deregulated electricity industry, i.e., unbundling of activities, introduction of competition in generation and retailing, regulated rates for transmission and distribution, limits on vertical and horizontal concentration and the existence of regulators independent from the government. In this model, there is no competition in distribution, electricity is supplied, at the tariffs approved by the regulator to the regulated market customers, i.e. customers that, because of their level of consumption, cannot choose their supplier. These regulated tariffs are the sum of the price at which the energy is purchased from the producers, the transmission fee and the distribution cost, i.e. the so-called Aggregate Distribution Value. Deregulated market customers or eligible customers who have opted to buy power from a different supplier pay the distribution fee or tariff, which is also approved by the regulator, for the use of distribution systems. The tariffs are adjusted automatically (every year, every six months, every three months or every month), in order to reflect the variations in energy purchase prices and transmission fees. With the same frequency, the tariffs are adjusted (also automatically), in order to reflect the changes in economic indicators (price indexes in the country in question and in the United States, exchange rates, customs duties, etc.) that influence the distribution costs or the aggregate distribution value. The aggregate distribution value and the procedures to automatically adjust the tariffs are in force for long periods of time, usually four or five years. The aggregate distribution value is established in such a way as to enable an efficient company to recover its operating costs and obtain a return on its investments. The concept of efficiency implies that the facilities are tailored to demand and that the operating and investment costs are within the standard international values for the type of network being operated and market being served. Efficiency is also applied to set the level of energy losses in the distribution systems, taking into account the standard international values for the type of network being operated and market being served and the level of energy losses at the beginning of the period.. In June 2002 the Aggregate Distribution Value was set for the distributors in Panama, thereby establishing the rates until June In 2005 the studies commenced to set the new value to be applied from July 2006 onwards. In June 2002 the distribution costs were approved which will be used to calculate the tariffs for Moldova until In June 2003 the Aggregate Distribution Value for the Colombian distributors was approved and in November 2005 there was a response to the request for a revision made by the Unión Fenosa Group distributors and the new value will be applied from January 2006 and will remain in force until December In February 2004 the Aggregate Distribution Value for the distributors in Guatemala was approved; the rates calculated on the basis of this new value came into force in February 2004 and will be applied in the following five years. In 2005, the studies to determine the Aggregate Distribution Value for Nicaragua were completed; however, approval of the Aggregate Distribution Value and of the procedures for the calculation of the new tariffs has been deferred until In November 2005 the Energy Stability Law was approved in Nicaragua, with measures to reduce the impact of high oil prices on the price of purchasing energy from the distributors and, therefore, on tariffs. This Law established: a) the obligation of the hydroelectric producer, which is state owned, to contract at preferential prices with the distributors; b) the settlement rules for the spot market were changed in such a way that the producers selling price to the distributors, in this market, would not exceed 10% of their variable costs, and c) tariff subsidies offsetting part of the tariff shortfalls, because of an energy purchase price in excess of the price recognised in the tariff for the distributors purchases from the state owned producers. Other provisions of the Energy Stability Law include the subsidy to residential consumers and the establishment of a recovery schedule for recognized losses from the distribution activity over the next five years. In the liberalized electricity industry, in which the Unión Fenosa Group s distributors operate, the producers sell their output in the wholesale market comprising contract and spot markets. The distributors, except in Colombia, are obliged to have contracts for part of or all the demand from its regulated customers. The prices, terms and conditions of the contracts are freely negotiated by the parties, and a public call for tenders is usually required for distributors to be able to enter into contracts for supplies to regulated market customers. In the spot market, which is managed by an independent operator, mismatches between the power produced and demand and the power supply commitments are negotiated. The hourly output of the power plants is also established in the spot market on the basis of the bids tendered by the plants or of their variable costs. The price for each hour is equal to the bid price of to the variable costs of the last generating facility required to meet demand. The Unión Fenosa Group operates as an independent producer in Mexico and Kenya. In these countries, the electricity industries have not been fully deregulated and most of the transactions are arranged through long-term power purchase and sale contracts in which the payments for available capacity fully cover the plants fixed costs and the price of the power produced is adjusted on the basis of fuel price variations. -17-