Reviewing and approving capital investment plans: The Lithuanian experience

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1 Reviewing and approving capital investment plans: The Lithuanian experience Ignas Kazakevičius National Commission for Energy Control and Prices (NCC), Lithuania www. erranet.org

2 Content of the presentation NCC activities Pricing principles Approving of investments Main principles TYNDP Investment projects Yearly investment plans Connection to the grid investments Projects of Common interest (PCIs) 2

3 ABOUT NCC Independent national regulatory authority; Established on 10 th of February, 1997; Composed of 5 Commissioners, 101 staff members in total currently; 3

4 Areas of activity Natural gas Electricity Renewables District heating Water supply and waste water management Transport 4

5 Natural gas sector Source: ETSO-G 5

6 Imported gas quantities (TWh) , , , , , , ,7 Total: , , ,3 Source: AB Amber Grid 6

7 Competences in regulation Licensing, financial capacity evaluation of licensees and permit holders Approval of methodologies for regulated prices Setting of price caps for transmission, distribution, LNG terminal, exchange, LPG activities Control over unbundling of vertically integrated undertakings Prevention of cross-subsidies Approval of investments for regulated activities Supervision of competition level in the supply activities 7

8 Concept of regulated cost The costs of regulated services (products) must be economically justified and necessary for the company to provide regulated activities. Economically justified (necessary) costs are understood as costs, without which company would be unable to carry out a regulated activity. That is, to ensure implementation of legislative obligations related to the energy supply reliability, security and infrastructure development Same principle is applied to the investments 8

9 Pricing principles for regulated activities NCC sets price caps for 5 years regulatory period Price caps are annually adjusted for inflation, investment, changes in energy volumes The regulated prices include only investments approved by the NCC Allowed revenues should ensure the effective implementation of regulated activities by the company The allowable ROI is set. If the company earns higher profit, the correction applies NCC sets quality indicators for service quality and reliability for regulatory period (for TSO and DSO) 9

10 Price cap calculation ROI RAB x WACC Price cap= Annual allowed revenues Annual consumption capacity Depreciation (amortization) Operating costs (OPEX) NCC sets depreciation periods (linear method) Efficiency requirements and incentive scheme applies 10

11 RAB and Depreciation From evaluating RAB and depreciation cost following assets are eliminated: EU support or other received subsidies; Grants, received fees from new customer connection; Assets which are conserved, still under construction (except for PCIs); Inefficient investments and other. Examples of depreciation periods: Pipelines 55 Power lines 55 Corrosion protection 18 Transformers 35 Taps/knots/ compressors 20 Vehicles 6 Gas meters 9 12 Electricity meters 9 11

12 Weighted average cost of capital (1) WACC = R d W D + R e 1 1 m W E R d cap of cost of debt (interest rate), % W D share of debt capital (optimal capital structure) 0,6 W E share of equity capital (optimal capital structure) 0,4 R e return on equity, % m tax rate, % 12

13 Weighted average cost of capital (2) WACC is set for 5 years period: Entity Regulation period WACC (%) AB Amber Grid (TSO) AB Energijos skirstymo operatorius (DSO) ,09 AB Klaipėdos nafta (LNGT) ,86 AB Achema (DSO) ,15 13

14 Financial capacity evaluation (1) In order to be able to carry out and investments companies must have a sufficient financial capacity: 1) Equity and share capital ratio 0,5 2) No overdue debts 3) According to NCC methodology, NCC annually sets company s general financial strength indicator which have to be higher then the lower limit of financial strength indicator of corresponding activity (TSO, DSO, supply) and sector (electricity, gas) Lower limit of financial strength indicator = average financial strength indicator of the activity * 0,6 Indicators are converted to the scores ranging from 1 to 5. 14

15 Financial capacity evaluation (2) Financial indicators Calculated values Calculated scores values Indicator The calculation formula Income protection indicators Net profit margin (R1) (net profit / sales income) x 100 Financial leverage indicators Indebtedness ratio (R2) (total liabilities / asset) x 100 Liquidity ratio (R3) (current assets / current liabilities) Commercial activity indicators Customer debt ratio ((365 d.) (R4)) (trade receivables / sales income) x 365 Trade payables turnover ratio ((365 d.) (R5)) (trade payable / sales cost price) x 365 Company general financial strength indicator (BR) Company general indicator Arithmetic average of R1-R5 15

16 Financial capacity evaluation (3) Indicator Conversion matrix Net profit margin (R1) R R1<15 5 R1<10 0 R1<5 R1<0 scores values (K1) Indebtedness ratio (R2) R R2<70 50 R2<60 40 R2<50 40>R2 0 Scores values (K2) Liquidity ratio (R3) R3 1,5 1,2 R3<1,5 1,1 R3<1,2 1,0 R3<1,1 1,0>R3 0 Scores values (K3) Customer debt ratio R R4<90 45 R4<60 30 R4<45 R4<30 (365 d.) (R4) Scores values (K4) Trade payables turnover ratio (365 d.) (R5) R <R <R <R <R5 Scores values (K5)

17 National legislation (1) Law on Energy Art. 15 (3) Energy undertakings carrying out an regulated activity have to present their planned investments for the NCC for an approval. Investments which are not approved by the NCC are not justified and cannot be in included into the state regulated energy prices Note: Investments can be approved at any stage of project implementation (before, during or after the construction or implementation). Also, project promoters provide investments reports 17

18 National legislation (2) Other requiremens for investments are depicted in: Law on Natural Gas Art. 31 transpose Gas Directive Art. 22 provisions regarding TSO Ten Year Network development plan (TYNDP) Law on Natural Gas Art sets requirement for large DSOs to present TYNDP as well Procedure for the evaluation and approval of investment projects of energy undertakings in NCC TEN-E regulation regarding the approval of Projects of Common interest (PCIs) 18

19 10 year national development plan (TYNDP) Strategic document which covers main investment projects for the following 10 years Transperancy for the current and future market participants NRA approval of the plan does not mean the approval of the concrete projects. Thus, projects have to be approved individually Where the TSO does not execute an investment, NCC shall: Require the TSO to execute the investments; Oblige the TSO to accept a capital increase to finance the necessary investments and allow independent investors to participate in the capital. NRA approve whether national TYNDP is consistent with the nonbinding ENTSOs TYNDP 19

20 10 year national development plan (TYNDP) Source: AB Amber Grid 20

21 Investment projects Investment project is considered as an investment which value exceeds the certain value: Electricity: 3,5 mln. Eur for TSO, 1,5 mln. Eur for DSO 1 mln. Eur for entities which have a large influence on the market District heating: 1,5 mln. Eur 0,3 1,5* mln., 9 % of yearly depreciation Gas: 5 % of company s yearly investments (but not lower then 0,15 mln. Eur) 2 mln. Eur 21

22 Net benefit calculation n t=1 B n (1 + k) n > 0 B n financial, social-economical cash flows (costs and benefits) during the payback period k discount rate n payback period, half of the depreciation period but 20 years 22

23 How the investment project budget is planned Good practice of the comparable previous/similiar projects Market research Material suppliers public tender results Public procurement 23

24 Criteria for the assessment of investments (1) No. Investment type / purpose 1. Investments depicted in the national energy strategy (approved by Parliament) or national development plan (approved by Government) which purpose is SoS, renewal/reconstruction, connection to the RES and DH) 2. Electricity and gas investments to smart-meters, PCIs FNPV Not assessed Calculated FNPV and included into net benefit Financial justification FIRR Not assessed Calculated FIRR and included into net benefit Fin. capabili ty Net benefits Positive Positive for electricity and gas (except for renewal/reconstruc tion and connection to RES) Not assessed for DH Positive Positive Economical justification Impact to the price cap Provided for informational purposes Provided for informational purposes Other aspects (social, SoS) Described social and SoS benefits Described social benefits 24

25 Criteria for the assessment of investments (2) No. Investment type / purpose 3. Investments for system development to the new areas, connection to the grid (except for DH) FNPV FNPV 0* Financial justification FIRR FIRR WACC* Company s financial capability assessment Net benefits Economical justification Impact to the price cap Positive Positive Can t increase the price cap (except for connection to the electricity grid) Other aspects (social, SoS) 4. Investments for existing infrastructure energy effciency / modernisation FNPV 0* FIRR WACC* 5. Investments of regulated independant heat producers which do not ensure heat generation reserve. Positive Positive Can t increase the price cap Can t increase the price cap for DH consumers. 25 Described social and SoS benefits

Proposed amendmends Payback period = depreciation period but 25 years Residual value of the investment project is evaluated in FNPV only in that case when the

26 Proposed amendmends Payback period = depreciation period but 25 years Residual value of the investment project is evaluated in FNPV only in that case when the project have FNPV>0 by itself, without residual value Stricter technical justification provisions with administrative help from the State Energy inspectorate 26

27 Installing the control and start-up chambers and operational control of the gas transmission system pipeline reconstruction Technical justification Replacement of worn out / depreciated taps, installation of a control and start-up chambers and SCADA system 2 examined alternatives Benefits SoS, lowered OPEX level, etc. EU funded Consistent with TSO s TYNDP Source: AB Amber Grid 27

28 Investment approval criteria 1 st criteria Technical justification Impact to the price cap +X Eur/MWh (indicative) FGDV and FIRR not assessed Net benefits >0 28

29 Vilnius-Panevėžys-Riga pipeline reconstruction (1) 1 st criteria Non-depreciated project Technical justification 2 examined alternatives Benefits SoS, lowered OPEX level, etc. EU funded. Consistent with TSO s TYNDP 29

30 Vilnius-Panevėžys-Riga pipeline reconstruction (2) Source: AB Amber Grid 30

31 Vilnius-Panevėžys-Riga pipeline reconstruction (3) Source: AB Amber Grid 31

32 Investment approval criteria 1 st criteria Technical justification Impact to the price cap +X Eur/MWh (indicative) FGDV and FIRR not assessed Net benefits >0 Residual value is excluded from allowed revenues 32

33 Examples of DSO investment projects Same approval principles are in place Corrosion protection systems Prevention of new investments Reduced OPEX Looping of natural gas distribution system in some of the major towns Improved SoS, supply quality indicators (SAIDI, SAIFI) 33

34 Yearly investment plans Composed of a list of investments which value is lower then a investment project Simplified assessment compared to the investment projects Technical/economical justification Report of the previous yearly investment plan have to be provided. All changes of the investments values compared to the approved plan have to justified NCC can oblige a company to exclude particular investments form yearly plan and present it as an investment project 34

35 Connection to the grid Connection to the grid must be calculated by NCC methodology Fixed fee for household users are set Companies apply individual fee for non-household users calculated according to the NCC methodology (considered as approved investments) In a gas sector consumers cover only non-economical investment part which currently coresponds to about 30 % of investment. Connection can t increase the price cap thus the fee is adjusted Payback period 15 years, for household users 20 years 35

36 Klaipeda LNG terminal Benefits: SoS (N-1 criteria) Diversification of gas supply Market based gas price and competition 36

37 Security of supply 37

38 Price convergence Eur/MWh Data of NCC *Not evaluated natural gas purchase costs of Achema and KTE as purchased gas used for their own purposes 38

Projects of Common Interest Gas Interconnection Poland Lithuania (GIPL): Diversification Integration to the EU market SoS Competition Further utilization of

39 Projects of Common Interest Gas Interconnection Poland Lithuania (GIPL): Diversification Integration to the EU market SoS Competition Further utilization of LNG terminal Planned by the end of 2021 Enhancement of LV-LT interconnection capacity SoS; Further intergration and utilization of the Inčukalns UGS in Latvia 39

40 THANK YOU FOR YOUR ATTENTION! Ignas Kazakevičius W ignas.kazakevicius@regula.lt Web:

Reviewing and Approving Investments and Network Development Plans. Casestudy: Lithuania

Reviewing and Approving Investments and Network Development Plans. Casestudy: Lithuania Ignas Kazakevičius Chief Specialist of Gas and Electricity Department 05/22/2018, Vilnius Importedgasquantities(TWh)