Annual Report - EDP

notes to the consolidated and company financial statementsfor the EDP years - Energias ended Portugal, 31 december S.A. 2012 and 2011Notes to the Consolidated and Company Financial Statementsfor the years ended 31 December 2012 and 20111. ECONOMIC ACTIVITY OF EDP GROUPThe Group’s parent company, EDP – Energias de Portugal, S.A. (EDP, S.A.), was incorporated in 1976 as a result of the nationalisation and merger of the majorPortuguese companies in the electricity sector operating in mainland Portugal. EDP S.A.'s head office is located in Lisbon at Praça Marquês de Pombal, 12. During1994, as established by Decree-laws 7/91 and 131/94, the EDP Group (EDP Group or Group) was set up following the split of EDP, S.A., which led to a number of directlyor indirectly wholly owned subsidiaries of EDP, S.A.The Group’s businesses are currently focused on the generation, distribution and supply of electricity and distribution and supply of gas. Although complementary, theGroup also operates in related areas such as engineering, laboratory tests, vocational training, energy services and property management.The EDP Group operates essentially in the European (Portugal, Spain and France) and American (Brazil and the United States of America) energy sectors.Activity in the energy sector in PortugalElectricityThe National Electricity System (SEN) basis of organization and operation, as well as the general basis applicable to the production, transportation, distribution andsupply activities of electricity, and to the market organization, are established by the Decree-Law 29/2006 of 15 February, this DL was developed by the DL 172/2006 of23 August. The DL 29/2006 was updated by DL 104/2010 of 29 September, by DL 78/2011 of 20 June, by the DL 75/2012 of 26 March and by the DL 215-A/2012 andB/2012 of 8 October, incorporating essentially the principals of the European Parliament and Council’s Directive 2009/72/CE of 13 July, establishing common rules forthe electricity internal market.The National Electricity System (SEN) includes the activities of generation and supply of electricity under free competition conditions, subject to licensing, and theactivities of transmission and distribution provided through the award of public service concessions.Transmission, distribution and supply of last resort activities are subject to regulation from Entidade Reguladora dos Serviços Energéticos - ERSE (Energy SectorRegulator), which is responsible for the preparation, issuance and enforcement of regulations and for establishing the tariffs and prices related to network usage -access tariffs - and electricity supply for clients in the regulated market - electricity tariffs charged by the Supplier of Last Resort.For transmission, distribution and supply of last resort activities, the law establishes a remuneration right fixed by ERSE, under the tariff regulations, in order toeconomic and finance balance in terms of efficient management.Electricity transmission is ensured by the National Transportation Network (RNT) and is carried out under public service concessions, exclusively by REN - RedesEnergéticas Nacionais, SGPS, S.A., for a period of 50 years.GenerationThe generation of electricity covers generation under ordinary and special regimes. Under the ordinary regime, where EDP Group is represented by EDP Gestão daProdução, S.A., electricity is generated and sold under free market conditions, in organised markets or through bilateral agreements, being subject only to licensing.The special regime (PRE) allows producers to deliver electricity to the network, through bilateral agreements with the Supplier of Last Resort (CUR), being subject tospecific legislation, namely to promote the use of endogenous renewable resources, cogeneration or micro generation. The EDP Group is present in this segmentthrough its subsidiaries EDP Gestão da Produção, S.A. and EDP Renováveis Portugal, S.A., among others.Following the publication of Decree-Law 240/2004 of 27 December, which established the creation of a compensation mechanism to maintain the contractualbalance (CMEC), in January 2005 the EDP Group signed the early termination of contracts for the Power Purchase Agreements (PPAs) related to the binding electricityproduction plants of the EDP Group, effective as of 1 July 2007, date of the launch of the Iberian Electricity Market (MIBEL).On 16 February 2007 the Portuguese Government confirmed its decision to early terminate the PPAs and implement the CMEC mechanism and defined the rules tocalculate the compensations due to the power generators for such early termination, which essentially consisted in an adjustment of the reference market price ofelectricity used to calculate the CMEC initial compensation amount. On 15 June 2007, EDP and REN agreed on the early termination of the PPAs, effective as of 1 July2007. The new CMEC regulation sets the compensation due at 833,467 thousands of Euros, which in accordance with the legislation can be subject to securitisation.In June 2007, Decree-Law 226-A/2007 of 31 May, which approves the new legal regime for using hydric resources under the terms of the new Water Law (Lei daÁgua), came into force. This Decree-Law extends the period on which the companies, owning the hydroelectric plants relating to the various dams, can operate thepublic hydric resources. The extension of the operating period, and the consequent extension of the useful life of the related hydraulic fixed assets, implied a paymentby the holders of the hydroelectric plants of an amount of economic and financial compensation. On that basis, the Government (INAG), REN and EDP Gestão daProdução de Energia signed on 8 March 2008, several service concession arrangements for which EDP Gestão da Produção de Energia paid approximately 759millions of Euros for the extension of the period to operate the public hydric domain for an additional average period of 26 years.It is expected an adjustment to the interest rate applicable to the tariff repercussion of the yearly fixed amount of the costs for maintenance of the contractual balance(CMEC), for the period 2013 to 2027, by an average amount of 13 millions of Euros per year, corresponding to a present value of 120 millions of Euros. This adjustmentresults from the calculation mechanism of the CMEC fixed amount interest rate established under Decree-Law 240/2004, of 27 December.On 20 August 2012, the Law 251/2012 was published. This regulation replaces the previous mechanisms and establishes a new incentive scheme to energygenerators. Capacity payments should contribute decisively and rationally to maintain the production capacity of electricity (availability incentive) and to perform futureinvestment in new production capacity (investment incentive), and therefore, to ensure security supply levels that are not guarantee by the operation of the normalmarket mechanisms. Availability incentive is applicable to thermoelectric power plants until the end of the operating license, beginning in the calendar year followingthe date of termination of the PAF ("Programa de Apoio Financeiro"). This incentive corresponds to an annual compensation of 6,000 Euro/MW/year. Investmentincentive is applicable to new hydroelectric power plants and power enhancement projects, during the first 10 years after the formal recognition of their eligibility toreceive the incentive.EDP - Annual Report 2012171