In 2010, the world’s economies began to turn around, but the pace of the recovery was uneven in different areas.
Europe seems to be struggling more than other geographic regions in returning to a growth path and, within it, there are countries, Germany, for example, that appear to have overcome the crisis, while others, including Italy, are finding it difficult to reestablish a sustained growth trend and some countries, such as Greece and Ireland, are faced with a period of deep financial crisis. In addition, recent events in North Africa are casting additional doubts on the durability of the global recovery.
In the energy field, after the slump in consumption that occurred in 2009, the upturn in demand is not strong enough to foreshadow a quick return to pre-crisis levels.
In the Italian electric power industry, the negative impact of low demand levels was compounded by the market entry of new production capacity built based on investment decisions made when the reference scenario was substantially different from the one we have today. The combined effect of lower demand and increased supply put significant pressure on generating margins, which contracted further, falling below the already depressed levels of 2009.
The scenario in the natural gas market is even more complex. In Europe, over the past five years, import capacity (new gas pipelines and new LNG terminals) increased by more than 25%. An increase of comparable magnitude occurred in Italy as well. However, due to the economic crisis, European demand for natural gas was down sharply, showing only partial signs of a turnaround in the past year. In addition, rising production of non-conventional gas in the United States has made that country self-sufficient with regard to internal consumption, with the result of flooding the market with huge quantities of liquefied natural gas that, lacking buyers in North America, were shifted mainly to Europe. The combined impact of these three developments (increased import capacity, lower demand and shift of LNG supply from the United States to Europe) put extreme pressure on spot natural gas prices, which diverged dramatically from the prices charged under conventional long-term contracts, which continue to be indexed to oil prices and are enforced by virtue of take-or-pay clauses. The reduction in the spot market price of natural gas had a strong cascading effect on price trends in the end-customer market, eventually causing margins on gas procured under long-term contract to turn negative. This situation, which affected all companies in the energy industry, including Edison, made it necessary to renegotiate the terms of gas contracts with suppliers and, in some cases, file for arbitration.
Edison responded to this situation of drastic changes in the energy scenarios and fierce competition with a series of activities designed to counteract short-term economic effects and reestablish the conditions for a return to adequate levels of profitability over the medium term. In the electric power area, the effect of a decrease in the profitability of generating activities was offset by sharply increasing sales volumes, optimizing of the use of the portfolio of production facilities and expanding trading activities. Overall, the activities of the electric power operations in the deregulated market increased their operating margin, achieving what should be viewed as a highly significant success, given the context within which the Company operated.
On the other hand, the contribution provided by power plants that operate under CIP6 regulations decreased due to the expiration of some contracts. At the same time, Edison decided in 2010 to terminate ahead of schedule the CIP6 contracts for the Jesi, Milazzo, Portoviro and Porcari power plants, generating a nonrecurring benefit of more than 170 million euros that fully offset the abovementioned decrease.
In the hydrocarbon area, the benefit of steadily growing results reported the exploration and production activities, both in Italy and internationally, was offset by the effect of vanishing profit margins on the importation and sales of natural gas. Edison views this negative situation as temporary, in that it is caused by the macroeconomic developments described above and does not reflect the expect positive outcome of the current renegotiations of long-term gas contracts. As you may know, these contracts, in exchange for the take-or-pay obligations undertaken by the importer, provide the importer with the right to an adequate margin. The purpose of the negotiations currently under way is to reestablish ad6equate margins and, when completed, should lead to the return of normal levels of profitability and make up for the margins lost in 2010.
The reduction in Edison’s overall operating margins is entirely due to the situation described above, as the Group’s other businesses maintained or improved their profitability.
The awareness of the severity of the crisis and the uncertain outlook of our markets for the near future,caused the Board of Directors to apply conservative valuations to the measurement of some assets. In total, the Company recognized writedowns and provisions amounting to more than 400 million euros concerning the assets that are most exposed to market uncertainties. As a result of the decrease in profitability and the provisions and writedowns mentioned above, the Company’s net result for the year amounts to 21 million euros compared with a net profit of 240 million euros in 2009. This result does not allow the distribution of an annual dividend either to the common shares or the savings shares.
The priority for 2011 will be to continue the negotiations aimed at reestablishing adequate margins under long-term gas contracts. We will pursue this objective with determination, comforted by our belief in our rights, but without rushing to secure short-term fixes that could prove to be detrimental over the medium term. The use of arbitration proceedings, which could extend for periods beyond 2011, could have a negative impact on the result for the current year. However, we believe that it is our duty to protect the Company’s long-term profitability potential, even at the cost of some temporary sacrifices.
Obviously, in this environment, all efforts will focus on strict management control and the constant pursuit of greater efficiency. In this respect, we find comfort in the outstanding results produced by the Operating Excellence programs launched in previous years, which will revamped and expanded. In addition, Edison will continue to seek growth in all of those areas that were less affected by the current economic crisis: investments in gas storage facilities, renewable sources, energy conservation and efficiency will provide to an increasing extent a replacement for the support formerly provided by traditional market activities and for the missing contribution of contracts for regulated activities.
During crisis periods, such as the one we are currently experiencing, industry players think in terms of repositioning and future outlook. Italy, differently from other European countries, has an anomalous situation with a large number of producers, some of whom are quite small. If the Italian market will provide consolidation opportunities, Edison will be ready to consider them, if they serve the purpose of strengthening its position as the second largest operator both in the electric power market and the natural gas market. Your Company can count on top-notch people, competencies and technical facilities and is certain that it will emerge stronger from this difficult period.