Elements of risk management and uncertainty

Introduction

This chapter illustrates the main uncertainties that characterise Snam’s routine operations, in spite of most of them being regulated and therefore exposed to regulatory and compliance risk, all types of risk relating to the business operations that are the subject of careful analysis. In addition, in a constantly evolving context, a brief section is devoted to dealing with emerging risks.

Financial risks are described in Note 18, “Guarantees, commitments and risks-financial risk management”, of the Notes to the consolidated financial statements.

Regulatory risk for Snam is closely linked to the regulation of activities in the gas segment. The relevant directives and legal provisions issued by the European Union and the Italian government and the resolutions of the Authority and, more generally, changes to the regulatory framework may have a significant impact on the Company’s operating activities, financial position and results. Considering the specific nature of its business and the context in which Snam operates, changes to the regulatory context with regard to criteria for determining reference tariffs are particularly significant.

Legal and non-compliance risk concerns the failure to comply, in full or in part, with the European, national, regional and local rules and regulations with which Snam must comply in relation to the activities it carries out. The violation of such rules and regulations may result in criminal, civil and/or administrative sanctions, as well as damage to Snam’s balance sheet, financial position and/or reputation. As regards specific cases, the infringement of regulations on the protection of workers’ health and safety and of the environment, and the infringement of anti-corruption rules, inter alia, may also result in (possibly significant) sanctions on the Company based on the administrative responsibility of entities (Legislative Decree 231 of 8 June 2001). With regard to the Risk of Fraud and Corruption, Snam believes it is of vital importance to ensure a climate of fairness and transparency in corporate operations and repudiates corruption in all its forms in the widest context of its commitment to abiding by ethical principles. Snam’s top management is strongly committed to pursuing an anti-corruption policy, trying to identify possible areas of vulnerability and eliminating them, strengthening its controls and constantly working to increase employees’ awareness of how to identify and prevent corruption in various business situations.

Snam has been working since 2014 in partnership with Transparency International Italia and joined the Business Integrity Forum (BIF) and, in 2016, became the first Italian company to join the Global Corporate Supporter Partnership.

Reputational checks and accepting and signing the ethics and integrity agreement are pillars of the control system designed to prevent the risks associated with illegal behaviour and criminal infiltration of our suppliers and subcontractors, with the goal of guaranteeing transparent relations and professional morality requirements throughout the production chain and for the entire duration of the association; in this context Snam confirmed its Suppliers’ Workshop in 2017 as well, dedicating a special area to the subject of ethics and transparency as excellence and innovation in business operations.

For Snam, economic risk is closely connected to the impacts that changes in the macroeconomic situation could have on the capacity of the Group to access the debt and capital markets, or to refinance the existing debt to meet its liquidity requirements, creating an increase in the cost of the Snam Group’s debt with consequent negative effects on its operations, results, balance sheet and cash flow.

Because of the specific nature of the business in which Snam operates, there are also risks associated with political, social and economic instability in natural gas supplier countries, mainly related to the gas transportation segment. A large proportion of the natural gas transported through the Italian national transportation network is imported from or passes through Countries that are currently politically, socially or economically unstable, and/or which may also suffer instability in the future. The importing of natural gas from these countries, or the transit through them, is subject to the inherent risks in these countries, such as: high inflation; volatile exchange rates; inadequate legislation on insolvency and creditor protection; social tensions; limits on investment and the import and export of goods; increases in taxes and excises; forced renegotiation of contracts; nationalisation or renationalisation of assets; political unrest; changes in trade policies; monetary restrictions; and losses or damage caused by disorder and unrest.

If a Shipper using the transportation service via Snam’s networks cannot procure natural gas from the aforementioned countries because of said adverse conditions, or in any way suffers from said adverse conditions, or is consequently unable to fulfil contractual obligations towards Snam, this could have negative effects on the Snam Group’s operations, results, balance sheet and cash flow.

Operating risks consist mainly of the malfunctioning and unforeseen interruption of the service determined by accidental events, including accidents, breakdowns or malfunctions of equipment or control systems, reduced output of plants, and extraordinary events such as explosions, fires, earthquakes, landslides or other similar events outside of Snam’s control. Such events could result in a reduction in revenue and could also cause significant damage to people, with potential compensation obligations. Although Snam has taken out specific insurance policies to cover some of these risks, the related insurance cover could be insufficient to meet all the losses incurred, compensation obligations or cost increases.

There is also the concrete possibility that Snam could incur delays in the progress of infrastructure construction programmes as a result of several unknowns linked to operating, economic, regulatory, authorisation and competition factors, regardless of its intentions. Snam is therefore unable to guarantee that the projects to upgrade and extend its network will be started, be completed or lead to the expected benefits in terms of tariffs. Additionally, the development projects may require greater investments or longer timeframes than those originally planned, affecting Snam’s financial position and results.

Investment projects may be stopped or delayed due to difficulties in obtaining environmental and/or administrative authorisations or to opposition from political forces or other organisations, or may be influenced by changes in the price of equipment, materials and workforce, by changes in the political or regulatory framework during construction, or by the inability to obtain financing at an acceptable interest rate. Such delays could have negative effects on the Snam Group’s operations, results, balance sheet and cash flow. In addition, changes in the prices of goods, equipment, materials and workforce could have an impact on Snam’s financial results.

With regard to market and competition risks, note the risk related to retaining gas storage concessions, related to the gas storage business in which the subsidiary Stogit operates based on concessions issued by the Ministry of Economic Development. Eight of the ten concessions (Brugherio, Ripalta, Sergnano and Settala in Lombardy; Alfonsine, Cortemaggiore, Minerbio and Sabbioncello in Emilia Romagna) expired on 31 December 2016 and can be renewed no more than twice for a duration of ten years each time. With regard to these concessions, Stogit submitted – within the statutory terms -– the extension request at the Ministry of Economic Development and the proceedings are currently pending before the Ministry. Pending said proceedings the Company’s activities, as provided for by the reference regulations, will continue until the completion of the authorisation procedures in progress envisaged by the original authorisation, which will be extended automatically on expiry until said completion. One concession (Fiume Treste) will expire in June 2022 and has already been renewed for the first ten-year extension period in 2011 and another concession (Bordolano) will expire in November 2031 and can be extended for a further ten years²⁵. If Snam is unable to retain ownership of one or more of its concessions or if, at the time of the renewal, the concessions are awarded under terms less favourable than the current ones, there may be negative effects on the Company’s operations, results, balance sheet and cash flow.

With reference to the risk connected with changes in the price of natural gas, however, pursuant to the regulatory framework currently in force, changes in the price of natural gas to cover Fuel Gas and network leakages do not represent a significant risk factor for Snam, since all gas for its core activities is provided by Shippers in kind. However, in relation to transportation activities, the Authority has defined, starting with the third regulatory period (2010-2013), procedures for payment in kind, by users of the service to the leading transportation company, of quantities of gas to cover unaccounted-for gas (UFG), due as a percentage of the quantities respectively injected into and withdrawn from the transportation network. Specifically, the Authority, by means of Resolution 514/2013/R/gas, defined the permitted level of the UFG given the average value registered over the last two years, and decided to keep this amount fixed for the entire regulatory period in order to incentivise the main transmission system operator to deliver further efficiency improvements. For the relevant regulatory period, amounts of UFG higher than the permitted level would not be compensated. In view of the aforementioned mechanism for the payment in kind of UFG, there is still uncertainty about the quantities of UFG withdrawn over and above the quantities paid in kind by the users of the service. The change in the regulatory framework currently in force on the payment in kind of natural gas could have negative effects on the Snam Group’s operations, results, balance sheet and cash flow.

With reference to the risk connected with demand for gas, based on the tariff system currently applied by the Authority to natural gas transportation activities, Snam’s revenue, via Snam Rete Gas, is partly correlated to volumes transported. The AEEGSI, however, introduced a mechanism to guarantee the portion of revenues correlated to volumes transported, This mechanism provides for the reconciliation of revenues more than 4% higher or 4% lower than the reference revenues correlated to volumes transported. Under this mechanism, approximately 99.5% of total revenues from transportation activities are guaranteed. Based on the tariff system currently applied by the Authority to natural gas storage activities, Snam’s revenue, via Stogit, correlates to infrastructure usage. However, the Authority has introduced a mechanism to guarantee reference revenue that allows companies to cover a significant portion of revenues recorded. For 2015 and 2016, the minimum guaranteed level of revenue recorded was approximately 97%. For 2017 and 2018 the Authority is reviewing an integration of such mechanism which, for subsequent years, will result in reliance on the guaranteed minimum level of revenue, as well as the storage company’s efficiency in terms of managing capacity allocation procedures and service provision procedures, following a procedure launched by the Authority.

The change to the regulatory framework in force could have negative effects on the Snam Group’s operations, results, balance sheet and cash flow.

With regard to the main risks and uncertainties for the remaining six months of the year, there are further market and competition risks for Snam associated with the new CNG businesses and small scale LNG ones, which are involved in the development of new innovative services specifically to support the use of gas in the transportation area.

Emerging risks

The purpose of the process to identify emerging risks is to be able to look into the impacts and put in place the necessary strategies and mitigation measures with a view to both prevention and control. Some of the emerging risks identified by Snam are in the area of cybersecurity and risks relating to climate change, specifically with regard to emissions trading.

Cybersecurity

Snam carries out its activities through a complex technological architecture relying on an integrated model of processes and solutions capable of promoting the efficient management of the gas system for the entire country. The development of the business and recourse to innovative solutions capable of continuous improvement, however, requires increasing attention to be focused on aspects of cybersecurity.

For this reason Snam has developed its own cybersecurity strategy based on a framework defined in accordance with standard principles on the subject and focusing constant attention on Italian and European regulatory developments, especially as far as the world of critical infrastructures and essential services is concerned. First and foremost, this strategy involves adapting one’s own processes to the provisions of standards ISO/IEC 27001 (Information Security Management Systems) and ISO 22301 (Business Continuity Management Systems) and the formal certification of conformity to the listed standards.

Alongside this and in accordance with technological developments, preventative and reactive solutions aimed at protecting the Company from the cyber threats and malware are assessed and, where deemed appropriate, implemented. Special mention should be made of the creation, currently underway, of a Cyber Security Defence Center, which will also make info sharing with national and European institutions and peers more effective and efficient. Snam has, for some time, desired this in order to improve the capacity and speed of responses to various possible negative events which could have a large-scale impact.

A great deal of attention is also paid to increasing awareness and specialist training of personnel, in order to facilitate the identification of weak signals and raising consciousness about risks of a cyber nature which could occur during the course of normal work activities.

Climate change and emissions trading

The risks connected with the emissions market fall within the scope of the European Union Directives on the sale of permits relating to carbon dioxide emissions and the rules on controlling emissions of certain atmospheric pollutants. At the start of the third regulatory period (2013-2020), the greenhouse gas emission authorisation system, previously governed by Legislative Decree 216/2006, was updated and modified by Legislative Decree 30 of 13 March 2013, effective from 5 April 2013. According to the new provisions, the main aim of the decree was to update laws on greenhouse gas emission authorisations and to continually reduce free emission allowances. The allowances will be assigned to each plant on a gradually decreasing basis, and will no longer be constant (as in the second regulatory period), and will also depend on the actual functionality of the plants.

Compliance with greenhouse gas regulations in the future may require Snam to adjust its facilities, and to control or limit its emissions or undertake other actions that could increase the costs of complying with the regulations in force, and therefore have negative effects on the Snam Group’s operations, results, balance sheet and cash flow.