Key Takeaways
- S&P Global Ratings believes the regulatory frameworks for electricity and gas networks in the Czech Republic provide operators with a strong regulatory advantage.
- The frameworks allow full coverage of costs and investment with a two-year time lag, and the regulatory asset base (RAB) figure is still far below the net book value of operators' RAB.
- For the current regulatory period 2016-2020, the Energy Regulatory Office (ERO) has set a fixed power and gas rate of return reflecting the weighted average cost of capital (WACC) of 7.95% and 7.94% respectively.
Table 1
| Czech Republic Electricity And Gas Market | ||||
|---|---|---|---|---|
| Regulator | Energy Regulatory Office (ERO) | |||
| Key players | CEPS (owned by CEZ) - Power TSO | |||
| Net4Gas (NR) - Gas TSO | ||||
| CEZ (A-/Negative) - Power DSO | ||||
| Czech Gas Networks (BBB+/Stable) - Gas DSO | ||||
| E.ON (BBB/Stable) - Gas and power DSO | ||||
| Pražská Plynárenská (NR) - Gas and power DSO | ||||
| Tariff-setting methodology | Hybrid revenue cap as a mix of revenue cap and rate of return method | |||
| WACC 2016-2020 (electricity/gas): 7.95%/7.94% | ||||
| Regulatory period | Five years | |||
| Electricity and gas: 2016-2020 and 2021-2025 | ||||
| Regulatory assessment | Strong | |||
| DSO--Distribution system operator. TSO--Transmission system operator. WACC--Weighted average cost of capital. Source: S&P Global Ratings, ERO. | ||||
Operator Profiles
Gas
The Czech gas market is dominated by transmission system operator (TSO) Net4Gas (not rated) and distribution system operator (DSO) Czech Gas Networks Investments S.a r.l. (Gasnet BBB+/Stable/--). The other DSOs are E.ON (BBB/Stable/A-2), based in Moravia, and Pražská Plynárenská (PP; not rated) in the region of Prague.
Chart 1
Net4Gas has a natural monopoly in Czech Republic as the sole gas TSO. As of Dec. 31, 2019, Net4Gas operated more than 3,800 kilometers (km) of pipelines and transmitted about 45 billion cubic meters (m3) of natural gas annually, of which around 8 billion m3 is for domestic consumption.
Gasnet is the country's largest gas DSO with a market share of about 80%. Gasnet owns and operates about 65,000 km of distribution networks, effectively distributing about 6.6 billion m3 to about 2.3 million customers.
PP, the second largest gas DSO, is 78% owned by EnBW and 22% by the city of Prague. PP operates solely in Prague. It owns and operates 4,455 km of gas pipelines and distributes about 0.9 billion m3 to about 425 000 customers.
E.ON is the country's third largest gas DSO. It operates solely in Southern Bohemia through its 5,000 km network, and distributes about 0.3 billion m3 to about 105,000 customers.
Electricity
The Czech power market is composed of one TSO, CEPS (not rated), which is fully owned by the government and operates under a natural monopoly. The DSOs are CEZ, E.ON, and PRE.
Chart 2
CEZ has a 65% market share in the distribution sector and distributes about 36 terawatt hours (TWh) of electricity through its 165,000 km network in the north of the country.
E.ON operates power distribution networks in the southern part of Czech Republic. The group distributes about 14 TWh of power to about 1.2 million customers through its 66,000 km network.
PRE owns and operates about 12,500 km of power distribution networks in the Prague region. The group distributes about 6.3 TWh of electricity to about 802,000 customers.
Assessment Factors
Regulatory stability: Predictable and unchanged since 2002
The regulatory framework in Czech Republic has applied some form of revenue cap, setting the allowed revenue, since its inception in 2002. There were no changes to the framework for the third or fourth regulatory periods, except for an extension of the third period to six years rather than the usual five years. This framework provides stability, transparency, and predictability to operators' cash flows.
Chart 3
Tariff setting: Detailed and transparent
The framework for both power and gas contains a hybrid revenue cap, based on allowed costs and RAB-based allowed profits. The method includes incentives that allow DSOs to retain a higher amount of profits, if they are efficient and can optimize their costs.
Allowed costs is the average of the accounting costs for two years (2012 and 2013 for the current period) netted for extraordinary costs, that is, costs not related to the standard activity performed by the entity, and not every year. These costs are then adjusted using the escalation factor to the time value of 2015. The arithmetic average of the values represents the allowed costs. This cost base is adjusted annually by applying both the escalation factor and the efficiency factor. The escalation factor is composed of two items:
- The annual business service price index (70%).
- The annual consumer price index with a 1% bonus (30%).
Chart 4
The efficiency factor is 1.01% per year for the entire regulatory period for all companies in all sectors. It represents the year-on-year decrease of costs and is part of the escalation factor. Allowed depreciation represents the planned depreciation values in each year, corrected with two years' delay based on actual depreciation and the time value of money. The correction factor is the difference between planned and realized depreciation of assets in year t-2.
Allowed profit = RAB x WACC + correction factors.
- The WACC is the same for DSOs and TSOs within the same industry and is based on the cost of debt, expressed as the sum of the risk-free rate of return and a sector-based credit spread (the interest premium that reflects the rate of risk inherent in the investment).
- The RAB is updated annually to reflect net investments.
- The correction factor represents the difference in returns due to planned versus realized RAB, and between planned and realized investments in t-2.
The market factor reflects unexpected costs that were not planned into allowed costs (such as, new duties from legislation). The quality factor refers to prescribed levels of parameters SAIDI (System Average Interruption Duration Index) and SAIFI (System Average Interruption Frequency Index): maximum bonus or penalty +/- 4% of allowed profit.
Chart 5
Financial stability: Strong, based on full cost recovery and operators' access to long-term capital
We consider that the Czech regulatory framework makes the sector attractive for long-term funding providers, as demonstrated by long-term bank loans and bonds in Czech companies' debt portfolios. Moreover, if an operator's actual costs are higher than allowed costs, the company may ask the regulator, ERO, to include the higher costs in the market factor, although the ERO's acceptance is not certain. Operators' investments and depreciation are based on planned values notified to ERO. If final investments and depreciation differ from this plan, the differences are removed through a correction factor in year +2.
In addition, the operators' RAB is updated annually, although it is far below actual net book values. The correction factor for the RAB includes unplanned capital expenditure (capex) but does not account for power DSOs' assets that are under construction, due to regulatory limits and conditions.
Regulator's independence: Strong, owing to independent finances and annual board replacements
Established on Jan. 1, 2001, as a public body, the ERO is responsible for controlling prices and regulatory frameworks for gas, electricity, heating, and renewables. We assess the ERO as independent from the government due to its independent funding system and separate budget allocation. We don't know of any court cases between the ERO and network operators. The ERO is run by a five-member council, whose chairman is appointed by the government for five years. The council members work under uncertain mandates. Each year, one member is either replaced or reappointed. In 2019, the Czech government replaced three members due to a breach of their duties.
Related Criteria
- Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013
Related Research
- E.ON SE, July 15, 2020
- Czech Gas Networks And Proposed Debt Rated 'BBB+'; Outlook Stable, July 6, 2020
- CEZ a.s. Outlook Revised To Negative On Tight Financial Headroom Amid Market Turmoil; Ratings Affirmed, March 31, 2020
This report does not constitute a rating action.
| Primary Credit Analyst: | Renata Gottliebova, Dublin +353 1 568 0608; renata.gottliebova@spglobal.com |
| Secondary Contacts: | Pierre Georges, Paris (33) 1-4420-6735; pierre.georges@spglobal.com |
| Emeline Vinot, Paris (33) 1-4075-2569; emeline.vinot@spglobal.com |
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