Italy's Enron Moment? Crackdown Leaves Power Market in Turmoil

(Bloomberg) -- Italy’s power industry is in the throes of the biggest shakeup since it opened to competition almost two decades ago after rising prices and a regulatory crackdown unmasked risky practices and spurred losses.

Two of the country’s energy providers are liquidating, forcing thousands of customers, from Italian units of Coca-Cola Co. and Vodafone Group Plc to shipmaker Fincantieri SpA, to find new suppliers, often at higher rates. The disruption is unlikely to stop there.

“In the next few months we will see three things: bankruptcies, mergers and CEOs losing their jobs,” said Gianfranco Sorasio, chief executive officer of power supplier eVISO Srl. “The Italian energy market is shaking.”

The tumult is increasing costs for some manufacturers and municipalities just as Italy’s economy is emerging from a decade-long slump, with the effects rippling from the industrial regions in the north to Rome’s state-backed enterprises. Fincantieri, a builder of merchant and military ships based in Trieste, had to scramble to sign new power contracts at higher prices after Innowatio SpA stopped service at short notice in October, said a person familiar with the situation who asked not to be identified. 

Industry Challenge

The nation’s largest banks, UniCredit SpA and Intesa Sanpaolo SpA, could face combined losses of almost 20 million euros ($24 million) from the failure of Innowatio, said people with knowledge of the situation who didn’t provide a breakdown. It’s unclear whether the banks have set aside funds to provision for the potential losses, which are small relative to their $900 billion balance sheets. The lenders declined to comment.

Both Bergamo-based Innowatio, which provided power via subsidiary YouTrade, and Gala SpA, a publicly traded energy supplier based in Rome, said in November they plan to liquidate. Gala shares have been suspended from trading since June 30. Officials for the companies declined to comment.

“These disruptions pose a challenge for industry in Italy, especially manufacturers,” said Meredith Annex, an analyst at Bloomberg New Energy Finance in London.

At the root of the turmoil was a market dynamic that encouraged energy suppliers in parts of Italy to withhold power to create shortages, only to profit when the state-backed grid operator, Terna SpA, paid inflated prices to avert blackouts. Playing this so-called balancing market -- where Terna matches supply with demand each day -- allowed firms to profit in a manner that wasn’t clearly forbidden in Italy, as it is in most major power markets.

Read here for more on the potential risks for banks from Innowatio

An investigation by Italy’s competition authority, for example, found that between late March and mid-June of last year, state-controlled Enel SpA and Sorgenia SpA were withholding power in Puglia, on the southeast coast, during normal business hours. They created shortfalls so large and urgent that on days when the going rate for power was 69 euros per megawatt-hour, Sorgenia received 999 euros a megawatt from Terna, according to a statement from the competition regulator. 

The authority estimated the grid operator overpaid for electricity by some 320 million euros during the first six months of the year in Puglia alone. Officials from Enel, Italy’s largest utility, and the competition regulator declined to comment. A Sorgenia official said the probe found no wrongdoing by the company.

Separately, Italy’s energy authority said in March it was investigating 100 companies over “irregular behavior” in the balancing market during 2016, and had closed its case against the first nine. They engaged in behavior that “conflicted entirely with the diligence and expertise required of a professional and expert operator," the regulator said in a statement, without identifying the companies. It ordered them to repay Terna. The probe is continuing.

Italy's Enron Moment? Crackdown Leaves Power Market in Turmoil

An official at Rome-based Terna said it notified the authorities of opportunistic behavior from some energy producers and traders in the March-June period of last year and early in 2017, and that since May the situation had improved.

The practice calls to mind past efforts to sway power markets, according to Annex at BNEF. In 2013, JPMorgan Chase & Co. agreed to pay $410 million to settle U.S. Federal Energy Regulatory Commission allegations that the bank manipulated power markets, enriching itself at the expense of consumers in California and the Midwest from 2010 to 2012. The bank accepted the facts in the settlement agreement without admitting or denying wrongdoing. That’s after Enron Corp. trading led to price increases and blackouts in California affecting millions of customers in 2000 and 2001.

In Italy, some providers found it advantageous to attract as many customers as possible, even at rock-bottom prices, to increase their potential for profits, said Roberto Poti, a senior adviser at Edison SpA, the Italian unit of Electricite de France SA. The business model relied on prices staying low, in part because these firms frequently sold electricity to industrial companies on extended, fixed-rate contracts. Many also juiced profits by neglecting to hedge against higher prices, one of the most expensive parts of running a utility, Poti said.

Winners and Losers

The strategy began unraveling last year when the government cracked down on the behavior and passed rules requiring power suppliers to keep more cash on hand. At the same time, energy prices climbed, forcing some providers to pay more for power than they were receiving from their customers. 

"The volatility of energy prices was such as to jeopardize the solidity of those traders which were not sufficiently capitalized,” said Catia Tomasetti, a partner at law firm BonelliErede in Rome.

More trouble may lie ahead. BNEF estimated that at least 100 power retailers could be hurt by the crackdown, with high prices unlikely to ease during the winter. The industry leaders, Enel, Edison and Hera SpA, which is controlled by a group of municipalities, stand to benefit from the shakeout by grabbing a bigger slice of the market. That’s also true of smaller providers that operated more prudently.

"The market is now separating gold from pyrite,” said Lorenzo Parola, a partner at Paul Hastings LLP in Milan. “Players that don’t have robust human capital, adequate equity resources and sound risk management policies are left behind.”

©2017 Bloomberg L.P.