Snam in 2018 - Summary Data and Information 46 Annual report 2018 Applicable regulatory framework and principal developments TARIFF REGULATION IN ITALY By means of Resolutions 514/2013/R/gas, 438/2013/R/gas and 531/2014/R/gas, the Energy Grid and Environment Regulatory Authority (ARERA) defined the tariff criteria for the fourth regulatory period, in force from 1 January 2014, for transportation and regasification activities and from 1 January 2015 for storage activities. Furthermore, with resolutions 575/2017/R/gas, 653/2017/R/gas and 68/2018/R/gas, the Authority defined tariff criteria for the transition period, respectively for the transmission and regasification businesses (period 01 January 2018-31 December 2019) and for storage (period 01 January 2019-31 December 2019). Fourth regulatory period Transportation 4 years + 2 years (transitional) January 2014 December 2019 Regasification 4 years + 2 years (transitional) January 2014 December 2019 Storage 4 years + 2 years (transitional) January 2015 December 2019 With reference to the transmission business, in 2018 the Authority published two consultation documents relative to criteria for determining the revenues recognised for the fifth regulatory period, starting 2020 (DCO no. 347/2018/R/ gas and DCO no. 512/2018/R/gas), confirming the stability and continuity of the regulatory principles with respect to current regulations. More specifically, the Authority proposed confirming a 4-year regulatory period (2020-2023), the revalued historic cost methodology and the inclusion of works in progress (LIC) for the determination of the RAB, the recognition of a flat amount of Net Working Capital, the excess charge of ±4% of revenues correlated with the volumes transported, the useful lives of assets of the current regulatory period and the update of operating costs on the basis of the price cap mechanism. Moreover, the application is proposed of an increase in the WACC of +1% for 10 years for investments that will come into operation in 2020-2021 and with a ratio of benefits/costs of more than 1.5, deferring application of the cost coverage mechanism based on total spending (“Totex”) to the following regulatory period. Directors’ report - Snam in 2018 – Summary data and information 47 The following graphic shows the primary tariff components for each of the regulated activities carried out by Snam, based on the regulatory framework in force as at 31 December 2018. Further information regarding major new rate developments occurred, with respect to each business sector, is provided in the chapter “Business segment operating performance – Tariff regulations” of this Report. Transportation Regasification Storage Period end of regulation Transitional period: Transitional period: Current period: (TARIFFS) ■■■■1 January 2018 – ■■■■1 January 2018 – ■■■■31 December 2018 31 December 2019 31 December 2019 Transitional period: ■■■■1 January 2018 – 31 December 2019 Calculation of capital Revalued historical cost Revalued historical cost ■■■■Revalued historical cost net invested ■■■■Deduction of restoration costs recognised for recognised the purpose of regulation (RAB) Remuneration of ■■■5.4% years 2016 ■■■■6.6% years 2016 ■■■6.5% years 2016 invested capital ■■■5.7% year 2019 ■■■6.8% year 2019 ■■■6.7 year 2019 net recognised for regulatory purposes (pre-tax WACC) (*) Incentives on new Transitional period: Transitional period: Current and transitional period: investments (investments in FY 2018-2019): (investments in FY 2018-2019): ■■■■Withholding for 8 years of ■■■■+1% for 12 years + (investments ■■■■+1.5% for 12 years (investments in 20% of the greater revenue in new capacity of transmission new capacity of regasification) with respect to recognised and with an analysis of benefits ■■ Remuneration investments revenue deriving from the positive) t-1 (starting from investments procedures insolvency ■■■■Remuneration investments t-1 2017) to offset time-lag regulatory ■■■■Remuneration investments (starting from 2017 investments) t-1 to offset the time-lag to offset the time-lag regulatory regulatory (from 2014) Efficiency factor Transitional period: Transitional period: Current period: (X Factor) ■■■■1.3% - on operating costs ■■■■0% ■■■■1.4% - on operating costs Transitional period: ■■■■To be defined with 2019 tariffs (*) The rate of return on net invested capital (WACC) in force from 1 January 2016 was set by the Authority by means of Resolution 583/2015/R/com of 2 December 2015, “Rate of return on invested capital for infrastructural services in the electricity and gas sectors: calculation and updating criteria”. The duration of the WACC regulatory period for infrastructural regulations in the gas sector is set at six years (2016-2021), and a mechanism is provided to update the rate halfway through the period according to the economic situation. By Resolution 639/2018/R/COM of 06 December 2018, the Authority updated the rate of remuneration of the invested capital for the infrastructural services of the electricity and gas segments for the years 2019-2021. 48 Annual report 2018 Regulation in European countries of interest to Snam: main features 2016 2017 2018 2019 2020 2021 2022 2023 TAG System GCA 3° Regulatory period regulated Transmission Terēga System ATRT6 Transmission regulated System Storage ATS1 regulated IUK System of Introduction of the regulated system Transmission exemption TAP System of Long-term contract Transmission exemption DESFA System Transmission/ Regulatory period 1 Regulatory period 2 regulated LNG TAG GCA Terēga IUK DESFA Transmission Transmission Transmission Transmission/LNG ■■ RAB differentiated ■■ RAB value adjusted ■■ Under exemption until ■■ RAB based on historic between the portion annually using the October 2018; cost, work in progress financed with equity inflation rate (Consumer ■■ Transfer from an remunerated by WACC; (revalued historical cost) Price Index), considering exemption system to ■■ Nominal pre-tax rate of and portion financed new investments a regulated system at remuneration of 9.22% with debt (book value). and amortisation/ expiry of the for 2017 and 2018; Moreover, different depreciation (Current long-term contracts ■■ The parameters for the treatment is envisaged economic cost method); (October 2018). new regulatory period between old assets ■■ Rate of remuneration of are currently being (pre-2012) and new WACC equal to 5.25% reviewed; investments; actual pre-tax. TAP ■■ RAB of approximately ■■ Different rates of Transmission 0.8 billion euro remuneration are Terēga (Transmission + LNG); envisaged for the share Storage ■■ Third Part Access ■■ Socialisation of the of RAB financed with exemption on initial cost of LNG in the equity (Cost of Equity (*) ■■ Storage in regulated capacity (10bcm/y); transmission tariffs 8.92% actual pre-tax) and starting January 2018; ■■ Exemption from the (75%); for the share financed ■■ Rate of remuneration of tariff regulation on the ■■ Recovery of the with debt (Cost of Debt WACC equal to 5.75% initial and expansion cumulative OLD 2.7% nominal pre-tax). actual pre-tax; RAB capacity. recoverable differences approximately 1.2 billion 2006-2016 of euro. approximately 326 million euro, spread out over 16 years, from 2017 to 2032. Directors’ report - Snam in 2018 – Summary data and information 49 Snam in 2018 - Summary Data and Information Results In order to allow for a better assessment of the performance of economic-financial operations, this Report includes the reclassified financial statements and some alternative performance indicators (non-GAAP measures), mainly represented by the results in the adjusted configuration1. More specifically, the operating profit and the adjusted net profit are obtained by excluding the special items (respectively gross and net of the related taxes) from the operating profit and the reported net profit, as per the scheme of the Income Statement. Income entries classified as special items for FY 2018 refer to: (i) the financial expenses deriving from the buy-back of bonds on the market as part of the Liability Management transaction (35 million euro, net of the related tax effect); (ii) the expenses for incentives to take voluntary redundancy in application of the early pension tool regulated by Art. 4, paragraphs 1-7 of Italian Law no. 92/2012, the “Fornero Law”, together with the introduction of the “quota 100”, envisaged by the 2019 Budget Law (15 million euro, net of the related tax effect). ADJUSTED RESULTS2 EBIT adjusted (million euro) Due to soundness and efficiency of operational management and rigorous financial discipline, Snam achieved very positive results, beyond expectations, +2.0% +3.1% in 2018. Adjusted EBIT3 totalled 1,405 million euro, up 42 million euro (3.1%) compared with the same value from the 2017 financial year. The greater 1,405 1,336 1,363 revenues (+87 million euro; +3.6%), mainly due to the contribution made by the natural gas transmission sector and the change in the consolidation scope, deriving from company mergers regarding the new businesses of CNG and biomethane, were partially offset by the increase in amortisation, depreciation and impairment (-31 million euro; 4.7%) recorded in all business segments and the increase in operating costs (-14 million euro; 3.3%). This increase is mainly due not only to the change in the consolidation scope, but also to the expenses stemming from the greater use of unaccounted-for-gas (UFG) with respect to the quantities conferred in kind by transmission users, the effects of which were partly absorbed by the efficiency