On 3 April 2020, Spain’s Official State Journal (Boletín Oficial del Estado) published Circular 4/2020, of 31 March, of the National Markets and Competition Commission, which establishes the methodology for remunerating natural gas distribution (the “Circular”).

In the Circular, the Spanish National Markets and Competition Commission (Comisión Nacional de los Mercados y la Competencia, or “CNMC”) establishes the remunerative framework applicable to the distribution of natural gas for the second regulatory period (beginning on 1 January 2021 and ending on 31 December 2026), replacing the framework applicable up to that date, as established in Annex X of Law 18/2014, of 15 October, on the approval of urgent measures for growth, competitiveness and efficiency (“Ley 18/2014”).

It should be highlighted that the Circular initially proposed by the CNMC – submitted to public consultation on 5 July 2019 – substantially modified the methodology for remunerating natural gas distribution established in Law 18/2014.

Indeed, the remuneration structure in Law 18/2014 is an activity-based remuneration model, which has been used to remunerate natural gas distribution since 2002. However, the first version of the Circular established a mixed model, in which: (i) facilities brought into service up to 2020 would be subject to an asset-based remunerative model, based on the net value of the assets (excluding, therefore, those that had depreciated), implying the receipt of a depreciation-based component – including the application of a Rate of Financial Return (Tasa de Retribución Financiera, or "RoFR") – and an operation and maintenance component; (ii) assets brought into service from 2021 onwards would be subject to an activity-based market development remunerative model, applying the parametric formula defined in Law 18/2014, albeit with a number of modifications.

In that context, in Circular 2/2019, of 12 November, of the National Markets and Competition Commission, which established the methodology for calculating the rate of financial return for the transmission and distribution of electricity, and the regasification, transport and distribution of natural gas, the CNMC approved a RoFR of 5.83% for natural gas distribution for the 2021-2026 regulatory period.

The first version of the Circular elicited huge sector response because, although the CNMC anticipated that the methodology would mean an average reduction of 17.8% in the remuneration of natural gas distribution, the truth is that the impact was very uneven (and could be far higher) for different companies depending on the age (and, therefore, degree of depreciation) of their assets.

As a result, on 3 December 2019, the CNMC restarted the process and sent a new Circular for public consultation in which it dropped its plans to change the remunerative methodology used, retaining the remunerative structure used since 2002 (pursuant to Annex X of Law 18/2014), albeit subject to certain modifications and adjustments. The Circular that has now been approved essentially keeps those terms.

  • The main features of the remunerative framework contained in the Circular are described below.
  • When will the methodology established in the Circular apply?
  • How will the new methodology be applied?: annual resolutions and new gas year
  • What are the key features of the remunerative methodology established in the Circular?
  • Does the RoFR for natural gas distribution established by Circular 2/2019 apply in the new remunerative model?
  • How is the remuneration for distribution existing in year 2000 adjusted?
  • Will the adjustment be applied progressively?
  • What modifications have been made to the parametric formula for remunerating new business?
  • What impact does the new methodology have on the remuneration for distribution?

When will the methodology established in the Circular apply?

The Circular establishes a methodology for remunerating natural gas distribution that will apply during the period 2021-2026.

However, the methodology could apply beyond that period1. The Eighth Additional Provision of the Circular establishes2 that the CNMC “will conduct an assessment of the remunerative model established in this circular before the end of the regulatory period”, and that the assessment “will be set out in a report that will be published, preceded by a period of public consultation”, also pointing out that the report may “refer to the criteria that may be followed when adjusting the remunerative model established in the circular, on the basis of the evaluation of its effects, with the aim of affording the regulatory framework contained in the circular with stability and predictability for subsequent regulator periods”.

The Circular also includes a new provision that – subject to terms that the CNMC shall establish by issuing a new circular – a distributors must send regulatory information on costs and any other information required to determine if “they are receiving an adequate return for natural gas distribution”.

Therefore, although it cannot be ruled out that the remuneration structure established in the Circular might be changed for the next regulatory period (2027-2032), any change ultimately made would have to have been anticipated in some way in the aforementioned evaluation report.

How will the new methodology be applied?: annual resolutions and new gas year

The Circular establishes that the CNMC will, after prior consultation, each year approve a Resolution in which it announces the remuneration for gas distribution in application of the new methodology. However, it must be borne in mind that, although annual remuneration had up to now been approved and matched the calendar year, the Circular establishes that the regulatory periods are now divided into “gas years”, which, in accordance with Commission Regulation (EU) 2017/460 of 16 March 2017 establishing a network code on harmonised transmission tariff structures for gas, are defined as periods running from 1 October of year “y-1” and 30 September of year “y”.

As such, the first gas year 2021 will start on 1 January 2021 and will end on 30 September 2021. Successive gas years will then run from 1 October of one year until 30 September of the following year.

What are the key features of the remunerative methodology established in the Circular?

 

The Circular establishes a similar remuneration structure to, and is essentially a continuation of, the one contained in Annex X of Law 18/2014.

  • On the one hand, it establishes a base remuneration (retribución base, or “RDE”), constituting market remuneration for distribution at 31 December 2020. That base remuneration RDE is calculated on the basis of the distribution remuneration for 2020 calculated according to the methodology established in Law 18/204, minus what is known as a distribution remunerative adjustment (ajuste retributivo de la actividad de distribución, or “AAD”). The AAD component includes an adjustment (and this is one of the new elements included in the Circular) to the remuneration for the distribution activity already performed in 2000. However, the adjustment is applied gradually by recognising a transitional distribution remuneration (retribución transitoria de distribución, or “RTD”), decreasing over time, between 2021-2025.
  • On the other hand, it establishes a market development component (retribución por desarrollo de Mercado, or “RDM”), which remunerates gas distribution on the basis of market development after 1 January 2021 according to a parametric formula similar (albeit with a number of minor modifications) to the one established in Law 18/2014.
  • Finally, a new incentive – or penalty, depending on the case – is established to cover gas leakages (Incentivo por la liquidación de las mermas de gas, or “IM”), which is calculated (as up to now) according to the provisions of article 14 of Order IET/2446/2013, of 27 December, which establishes the tariffs and charges associated with third party access to gas facilities and the remuneration of regulated activities.

The Circular also includes two new features:

  • It includes an adjustment applicable to companies that supply connected products or services to third parties for which they use installations and resources remunerated on the basis of the remunerative structure. Defining the methodology for determining that adjustment for each connected product or service is deferred for a later CNMC Resolution, but it does set out the criteria that can be assessed for that purpose. In the meantime, and without prejudice to a subsequent reduction once that methodology has been established, that adjustment is set at 50% of the annual income obtained from the performance of those activities.
  • It establishes, with effect from year 20243a financial prudence penalty, which can reach a maximum of 1% of the company’s overall remuneration and is linked to the recommended ratios and values for assessing companies’ indebtedness and economic and financial capacity established by the CNMC’s Communication 1/2019, of 23 October, of the National Markets and Competition Commission, which defines the ratios for evaluating the level of indebtedness and economic and financial capacity of companies that perform regulated activities, and the recommended ranges of those parameters, the contents of which were explained in a previous e-bulletin: The CNMC approves Communication 1/2019 on the leverage ratios of undertakings that perform regulated activities in the energy sector (14 November 2019).

Does the RoFR for natural gas distribution established by Circular 2/2019 apply in the new remunerative model?

No. As mentioned above, the RoFR made sense in the first draft of the Circular. In the Circular that was ultimately approved, by opting to continue with an activity-based remunerative model, the RoFR approved by Circular 2/2019 no longer applies.

How is the remuneration for distribution existing in year 2000 adjusted?

As mentioned above, the RDE base remuneration is based on the value for remunerating gas distribution in 2020, established in accordance with Law 18/2014.

That value is reduced according to the distribution remunerative adjustment AAD. This component aims to offset the excess remuneration of assets that have already depreciated. An overview of the adjustment is provided below.

The remuneration of natural gas distribution for 2020 is calculated on the basis of the remuneration value in 2014, which was established by Law 18/2014. That remuneration was calculated on the basis of the remuneration established in 2013, applying a linear adjustment of €110,687,809. The result was distributed across three remunerative items: number of customers (60%); sales at pressures equal to or lower than 4 bar (25%) and sales at pressures higher than 4 bar (15%). A unit value was thus calculated for each one of those items (dividing the corresponding overall amount among the number of customers and the number of sales of each category in 2013); those unit values were much higher than those that were taken into account to calculate the remuneration for new market development in the parametric formula.

The Circular calculates the AAD component by multiplying the number of customers and sales equal to or lower than 4 bar and those higher than 4 bar in year 2000 by the difference between the unit values calculated in 2014 to calculate the remuneration for distribution (the Circular sets them out precisely: to two decimal places, it would be €112.18/supply point and €5.07 and €1.66/MWh, respectively) and the lowest unit values that Law 18/2014 established for new remunerated supplies in the form of new market development.

In essence, what means is that the Circular reduced remuneration payable for natural gas distribution by reducing the remuneration assigned to that activity existent in 2000, treating it as if it constituted new supplies in year 2014. For example, each supply point existing at year 2000 would be due remuneration at €50, rather than the €112.182374639316 received up to now.

Will the adjustment be applied progressively?

Yes, the RDE adjustment will be applied progressively. The transitory RTD component will apply during the transitional period 2021-2025; as a result, the impact of the changes will be progressive. The RTD is calculated as a percentage of the AAD component: 85% in gas year 20214, 70% in 2022, 50% in 2023, 35% in 2024 and 15% in 2025. What this means in practice is that the remuneration for distribution in 2000 will be adjusted gradually: 15% in 2021, 30% in 2022, 50% in 2023, 65% in 2024, 85% in 2025. Only in 2026 would the adjustment apply in full.  

What modifications have been made to the parametric formula for remunerating new business?

These modifications are relatively minor. In essence:

  • In Law 18/2014, all supplies at a maximum design pressure equal to or lower than 4 bar with an annual consumption exceeding 50 MWh were remunerated at one same unit value. In the Circular, consumptions exceeding 8 GWh are remunerated (at a lower unit value) as if they were supplies at a pressure higher than 4 bar.
  • A new component has been created – given a different treatment and which has its own unit value – for natural gas supplied and billed during the first five years at new supply points with a maximum design pressure of between 4 and 60 bar and put into service after 31 December 2020.
  • In general, it has been established that remuneration for market development accrued in gas year “y” in a recently gasified municipality5 cannot exceed the income received from distribution tariffs billed in that municipality during that gas year “y”.
  • A new provision that gives a different treatment to natural gas billed at supply points on the distribution network corresponding to service stations and used to sell natural gas for vehicles.

What impact does the new methodology have on the remuneration for distribution?

The Notes to the Circular point out that the average remuneration for distribution in the regulatory period 2021-2016 will be reduced from €1.42 billion pursuant to the methodology under Law 18/2014 to €1.283 billion from using the new methodology, meaning an average reduction of 9.6%. In the case of the final year of the regulatory period (2026), the Notes offer a new overall remuneration for distribution of €1.181 billion, rather than the €1.42 billion that would have applied using the methodology in Law 18/2014.

However, it should not be forgotten that the reduction is primarily due to the adjustments made to the remuneration for distribution existent in year 2000; therefore, irrespective of what the average reduction might be, its impact on the different operators will be greater or smaller dependent on the greater or smaller weight of that “legacy” business in the operators current business.