Table of Contents

As filed with the Securities and Exchange Commission on June 28, 2007
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 20-F
 
     
o
  REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR(g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the Fiscal Year Ended: December 31, 2006
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
o
  SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    Date of event requiring this shell company report
For the transition period from          to          
 
Commission file number: 1-14970
 
ENEL-Società per Azioni
(Exact name of registrant as specified in its charter)
 
ENEL S.p.A.
(Translation of registrant’s name into English)
 
Italy
(Jurisdiction of incorporation or organization)
Viale Regina Margherita 137, Rome, Italy
(Address of principal executive offices)
 
 
 
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
         
Title of Each Class
 
Name of Each Exchange on Which Registered
 
American Depositary Shares     New York Stock Exchange  
Ordinary shares with a par value of €1 each     New York Stock Exchange(*)  
 
 
 
 
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
 
 
 
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
 
 
 
 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
 
6,176,196,279
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes      þ     No      o
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.
 
Yes      o     No      þ
 
Note — checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 from their obligations under those sections.
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes      þ     No      o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  þ     Accelerated filer  o     Non-accelerated filer  o
 
Indicate by check mark which financial statement item the registrant has elected to follow.
 
Item 17      o     Item 18      þ
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes      o     No      þ
 
 
(*) Not for trading, but only in connection with the registration of the American Depositary Shares.


 

 
TABLE OF CONTENTS
 
                 
  ii
  iv
 
  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS   1
  OFFER STATISTICS AND EXPECTED TIMETABLE   1
  KEY INFORMATION   1
  INFORMATION ON THE COMPANY   18
  UNRESOLVED STAFF COMMENTS   86
  OPERATING AND FINANCIAL REVIEW AND PROSPECTS   86
  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES   127
  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS   139
  FINANCIAL INFORMATION   141
  THE OFFER AND LISTING   148
  ADDITIONAL INFORMATION   150
  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK   179
  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES   186
 
  DEFAULTS, DIVIDENDS, AVERAGES AND DELINQUENCIES   186
  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND PROCEEDS   187
  CONTROLS AND PROCEDURES   187
  [RESERVED]   192
  AUDIT COMMITTEE FINANCIAL EXPERT   192
  CODE OF ETHICS   192
  PRINCIPAL ACCOUNTANT FEES AND SERVICES   192
  EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES   193
  PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS   193
 
  FINANCIAL STATEMENTS   193
  FINANCIAL STATEMENTS   194
  EXHIBITS   195
 Exhibit 1.1
 Exhibit 4.3
 Exhibit 4.4
 Exhibit 8.1
 Exhibit 12.1
 Exhibit 12.2
 Exhibit 12.3
 Exhibit 13.1


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PRESENTATION OF FINANCIAL AND OTHER INFORMATION
 
Unless we indicate otherwise, the financial information contained in this annual report is prepared in accordance with International Financial Reporting Standards (“IFRS”), as adopted by the European Union (“EU”), that we have applied for the first time in preparing our financial statements for periods beginning after December 31, 2004. There are no differences between IFRS as adopted by the EU (“IFRS-EU”), and the IFRS, as published by the International Accounting Standards Board (“IASB”), relevant for our consolidated financial statements. For a description of these principles, see note 2 to our consolidated financial statements included in this annual report. Until December 31, 2004, our financial statements were prepared in accordance with Italian GAAP and, to the extent such requirements or principles were silent on particular issues and not at variance, by those standards laid down by the International Accounting Standards Board (I.A.S.B.).
 
IFRS-EU differ in certain respects from generally accepted accounting principles in the United States (“U.S. GAAP”). We describe these differences in note 23 to our consolidated financial statements. Unless indicated otherwise, any reference in this annual report to our consolidated financial statements is to the consolidated financial statements (including the notes to the consolidated financial statements) included in Item 18.
 
We publish our consolidated financial statements in euros. In this annual report, unless we specify otherwise or the context otherwise requires:
 
  •  References to “dollars,” “$” and “U.S. dollars” are to United States dollars;
 
  •  References to “€” or “euro” are to the euro, the single currency established for participants in the third stage of the European Economic and Monetary Union, or EMU, commencing January 1, 1999; and
 
  •  References to “lire,” “lira” or “Lit.” are to Italian lire.
 
To facilitate a comparison, all lire-denominated financial data for periods prior to January 1, 2001, included in this annual report have been restated from lire to euro at the fixed rate as of December 31, 1998 established by the European Central Bank of Lit. 1,936.27 = €1.00.
 
For convenience only and except where we specify otherwise, we have translated certain euro figures into dollars at the rate of €1.00 = $1.3197, the noon buying rate in The City of New York for cable transfers in foreign currencies as announced by the Federal Reserve Bank of New York for customs purposes (the “noon buying rate”) on December 31, 2006, the date of the most recent balance sheet included in this annual report. By including convenience currency translations in this annual report, we are not representing that the euro amounts actually represent the dollar amounts shown or could be converted into dollars at the rates indicated. On May 31, 2007, the noon buying rate for the euro was €1.00 = $1.3453. For information about the rate of exchange between the dollar and the euro since 2002, you should read “Item 3. Key Information — Exchange Rates.”
 
Market share information and statistics
 
Unless otherwise specified or the context requires otherwise, references in this annual report to statistical, market and forecast data have been obtained or derived from industry sources and other publicly available information, such as industry reports published by the GRTN (as defined in the Glossary below), Terna and the Energy Authority (as defined in the Glossary below). Certain data may be revised from that presented in our annual reports on Form 20-F for prior years to reflect subsequent updates to, or changes in, such data. Unless otherwise indicated, statistical data and other information presented herein regarding market trends and our market position relative to competitors represent our best estimates as of the date hereof based on data derived from publicly available sources or other information obtained from independent third parties. Although we believe that such sources are reliable, we have not independently verified such information.
 
Adjustments
 
Certain figures included in this annual report have been subject to rounding adjustments. Accordingly, figures shown for the same category presented in different tables may vary slightly and figures shown as totals in certain tables may not be an arithmetic aggregation of the figures which precede them.


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GLOSSARY
 
In this annual report, “Enel” and the “Company” refer to ENEL S.p.A. and the terms “Enel Group,” “Group,” “we,” “us” and “our” refer to ENEL S.p.A. together with its consolidated subsidiaries. In this document, when we use the word “currently,” we mean as of the date of this annual report.
 
The following are definitions of certain terms and abbreviations that we use in this report. The explanations of electricity-related terms are not technical definitions, but are intended to assist you in understanding their meaning.
 
Antitrust Authority The Italian Antitrust Authority.
 
Average thermal efficiency A measure of the efficiency of a thermal generating plant in converting sources of energy such as fuel oil into electricity. Average thermal efficiency is expressed as the amount of electricity actually produced in kWh as a percentage of the kWh equivalent of the energy source consumed.
 
Bersani Decree Legislative Decree No. 79 of March 16, 1999, aimed at liberalizing the Italian electricity market.
 
CIP 6 Regulation 6/92 issued by Comitato Interministeriale Prezzi, an Italian governmental committee, which established incentives for new generation plants using renewable resources and for the sale of electricity produced from renewable resources.
 
CO2 Carbon dioxide.
 
Combined Cycle Gas Turbine (or “CCGT”)
A type of generating plant that produces electricity through both gas turbines and steam turbines. Conventional boilers or other generators recover and use the exhaust heat exiting from gas turbines.
 
Co-generation The simultaneous generation of steam and electricity, typically where the need arises for industrial purposes.
 
Communications Authority The Italian Authority for the Guarantee of Communications.
 
Decommissioning The phase of declassification, decontamination and dismantling of nuclear power installations and clean up of the plant site with the aim of achieving: (i) the complete demolition of the nuclear power plant; (ii) the removal of any limitation due to the presence of radioactive material; and (iii) the restoration of the site for other activities.
 
Eligible Customer Electricity customers in Italy who meet consumption thresholds that permit them to participate in the free market for electricity.
 
However, from July 1, 2007, all customers will be eligible to purchase electricity on the free market.
 
Emission trading rights Tradable emission permits that give the right to produce the equivalent of one ton of carbon dioxide. These permits can either be assigned through a national allowance plan or earned through investments in projects in developing countries (Certified Emission Reductions) or in transition economies countries (Emission Reduction Units).
 
Energy Authority The Italian Authority for Electric Energy and Gas.
 
Environment Ministry The Italian Ministry of the Environment.
 
Gencos The three generating companies we disposed of in order to comply with the Bersani Decree, Elettrogen S.p.A. (now Endesa Italia S.p.A.),


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Eurogen S.p.A. (now Edipower S.p.A.) and Interpower S.p.A. (now Tirreno Power S.p.A.).
 
Generating unit An electric generator together with the turbine or other device which drives it.
 
Gigawatt (GW) 1,000,000,000 watts (1,000 megawatts).
 
Gigawatt hour (GWh) One gigawatt of power supplied or demanded for one hour.
 
GHG “Greenhouse gases,” which are gases that contribute to the greenhouse effect, such as carbon dioxide, methane, nitrous oxide, chlorofluorocarbons and SF 6 (sulphur exafluoride).
 
Gross installed capacity The maximum power that can be produced continuously throughout a prolonged period of operation with all equipment assumed to be fully operational.
 
GRTN A company owned by the MEF that until October 2005 mainly managed Italy’s national electricity transmission grid. These activities were transferred to Terna in November 2005. Since that time, the GRTN has focused on managing and promoting renewable resources (an activity it carried out also prior to November 2005). GRTN also owns the Single Buyer and the Market Operator (both as defined below). On October 2, 2006, GRTN was renamed Gestore dei Servizi Elettrici (GSE).
 
Independent power producers Industrial companies that produce electricity for their own use and for sale to third parties.
 
Italian power exchange (Borsa dell’Energia Elettrica)
A virtual marketplace in which producers, importers, wholesalers, the GRTN and Terna, other Eligible Customers and the Single Buyer buy and sell electricity at prices determined through a competitive bidding process.
 
Kilovolt (kV) 1,000 volts.
 
Kilovolt ampere (kVA) 1,000 volts ampere.
 
Kilowatt (kW) 1,000 watts.
 
Kilowatt hour (kWh) One kilowatt of power supplied or demanded for one hour.
 
Market Operator The entity, wholly owned by the GRTN, that manages the Italian power exchange.
 
Marzano Law Law No. 239 of August 23, 2004, aimed at reorganizing existing energy market regulation and further liberalizing the energy market.
 
MEF The Italian Ministry of the Economy and Finance and its predecessor, the Ministry of the Treasury, Budget and Economic Planning.
 
Megawatt (MW) 1,000,000 watts (1,000 kilowatts).
 
Megawatt hour (MWh) One megawatt of power supplied or demanded for one hour.
 
Megavolt ampere (MVA) 1,000,000 volts ampere.
 
Ministry of Productive Activities The Italian Ministry of Productive Activities and its predecessor, the Ministry of Industry, Commerce and Handcrafts.


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Net Installed Capacity The maximum power that can be produced continuously throughout a prolonged period of operation with all equipment assumed to be fully operational, as measured at the point of entry to the transmission network (or minus the power absorbed by plant use and the power lost in the transformers required to raise the voltage to the network level).
 
Non-Eligible Customers Electricity customers in Italy who do not meet consumption thresholds entitling them to participate in the free market.
 
However, from July 1, 2007, all customers will be eligible to purchase electricity on the free market.
 
NH3 Ammonia.
 
NOx Nitrogen oxides.
 
Orimulsion Abbreviation of “Orinoco emulsion,” which is a fossil fuel from the Orinoco river basin in Venezuela consisting of very fine bitumen dispersed in water. Orimulsion emits the same amount of CO2 as fuel oil of equivalent energy value.
 
Resellers Other distribution companies to whom we transport electricity because their networks are attached to our network rather than directly to the national transmission grid.
 
Single Buyer (Acquirente Unico) A company wholly owned by the GRTN, responsible for ensuring the supply of electricity to regulated customers who do not yet have access to the liberalized electricity market.
 
SO2 Sulfur dioxide.
 
Substation Equipment which switches and/or changes or regulates the voltage of electricity in a transmission and/or distribution network.
 
Terawatt (TW) 1,000,000,000,000 watts (1,000 gigawatts).
 
Terawatthour (TWh) One terawatt of power supplied or demanded for one hour.
 
Thermal unit A generating unit which uses combustible fuel as the source of energy to drive an electric generator.
 
Volt The basic unit of electric force.
 
Voltampere The basic unit of apparent electrical power.
 
Watt The basic unit of active electrical power.


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PART I
 
ITEM 1.   IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
 
Not applicable.
 
ITEM 2.   OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3.   KEY INFORMATION
 
The Enel Group
 
Energy Generation, Distribution and Sales
 
We are the principal electricity operator in Italy, with the leading position in the generation, distribution and sale of electricity. At December 31, 2006, we had net installed capacity in Italy of approximately 40.5 GW, which we estimate to have represented approximately 45% of total Italian net installed capacity at that date. Our net electricity production in Italy in 2006 was 103.9 TWh, and, based on data provided by Terna, we estimate that our production represented approximately 34% of Italian net production during 2006. In 2006, in Italy, we distributed 263.4 TWh of electricity and sold 142.7 TWh of electricity to end users. Of the total sold, 120.4 TWh were sold to approximately 30 million customers on the regulated market, of which approximately 23.6 million were residential customers (86.7% of all residential customers in Italy, based on our estimations) and 22.3 TWh were sold on the free market. At December 31, 2006, we also had electricity generation plants outside Italy (in Spain, Bulgaria and North, Central and South America) with aggregate net installed capacity of approximately 10.3 GW, as well as sales and distribution operations in Spain with more than 0.6 million customers. In addition, in April 2005 we acquired distribution and sales operations in Romania with approximately 1.4 million customers and in April 2006 we acquired generation operations in Slovakia with a gross installed capacity of approximately 7,000 MW. Based on revenues, we were one of the largest industrial companies in Italy in 2006, with operating revenues of €38,513 million, or approximately $50,826 million. We earned net income of €3,036 million, or approximately $4,007 million, in 2006.
 
We are also active in the import, distribution and sale of natural gas. In 2006, we sold approximately 5.9 billion cubic meters of gas to third parties, of which approximately 4.5 billion cubic meters were sold to nearly 2.3 million end users.
 
Until June 2004, we owned 100% of Terna, the principal Italian electricity transmission company, which currently owns more than 90% of the transmission assets of Italy’s national electricity grid. In light of Italian laws and regulations providing for the reunification of the ownership and management of the Italian transmission grid and imposing certain ownership restrictions on the entity that will own and manage it, in June 2004, we sold 50% of Terna’s share capital in an initial public offering in Italy and a private placement with certain institutional investors that was not registered under the Securities Act (the “Terna IPO”). In April 2005, we sold an additional 13.86% of Terna’s share capital in another private placement that was not registered under the Securities Act. In September 2005, we sold an additional 29.99% of Terna’s share capital to Cassa Depositi e Prestiti and in January 2006 we distributed 1.02% of Terna’s share capital as “bonus” shares that we had promised to certain Italian retail investors as part of the Terna IPO, thus reducing our current stake in Terna to 5.12%. In November 2005, the management of the Italian transmission grid was transferred from the GRTN to Terna, which was renamed Terna — Rete Elettrica Nazionale.
 
Other Operations
 
One of the objectives of our management is to focus on our core energy operations. In line with this strategy of focusing on our core energy operations, in February 2006 we completed the sale of Wind, our telecommunication company, to Weather Investments. Nonetheless, we remain active in other sectors, including real estate services,


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engineering and construction, information technology, personnel training and administration, factoring and insurance services.
 
Internal organizations
 
At the end of 2005, our management decided to re-organize the Group’s internal structure by dividing our Sales, Infrastructure and Networks Division into two separate divisions and by allocating our international generation sales and distribution operations, which had previously been included in other divisions, to a new International Division. This reorganization is effective as of January 1, 2006 and, therefore, our divisions are currently the following: Domestic Generation and Energy Management Division, Domestic Sales Division, Domestic Infrastructure and Networks Division and the International Division. Each division is headed by a senior manager who reports directly to the Chief Executive Officer of Enel. Moreover, all non-core activities provided by companies of the Group to other Group companies have been grouped in our Services and Other Activities sector. Enel, as the parent company, defines the strategic objectives for the Enel Group and coordinates the activities of all Group companies. Each of Enel, our divisions and the Services and Other Activities sector constitutes a reportable segment for financial reporting purposes.
 
Ownership
 
The Ministry of Economy and Finance of the Republic of Italy, or the MEF, currently owns 21.11% of Enel’s shares, and Cassa Depositi e Prestiti S.p.A., a company 70% owned by the MEF and 30% owned by a consortium of Italian banking foundations, owns 10.15% of Enel’s shares.
 
Strategy
 
We have worked to face the challenges posed by market deregulation by capitalizing on our expertise in the electricity and gas sectors and by seeking new opportunities for growth in Italy and abroad. We have refocused our operations on our core energy businesses, and we aim to achieve cost leadership in the generation, distribution and sale of electricity and gas, and make customer care a high priority. In addition, we will continue our expansion in our existing markets and in new markets by enhancing efficiency through closer integration of existing assets and with new international acquisitions. In particular, with our acquisition of a 24.97% stake in the Spanish energy company Endesa S.A. (“Endesa”) and the agreements we have entered into with Acciona S.A. (“Acciona”) regarding a joint tender offer and (if such offer is successful) the joint management of Endesa, we have taken a significant step towards the creation of a major European energy group with substantial presence both in Spain and in the rest of the world. Please see “Item 4. Information on the Company — History and Development of the Company — Proposed Acquisition of Endesa” for more information.


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Selected Consolidated Financial Data
 
You should read the following selected consolidated financial data together with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and notes thereto included elsewhere in this annual report.
 
Our consolidated income statement data for each of the years in the three-year period ended December 31, 2006 and the consolidated balance sheet data at December 31, 2004 and 2005 set forth below in euro millions have been derived from our audited financial statements prepared in accordance with IFRS-EU, which differs in certain significant aspects from U.S. GAAP. The related U.S. GAAP data as of and for the five-year period ended December 31, 2006 have also been derived from our audited financial statements. For an explanation and quantification of such differences, see note 23 to our consolidated financial statements. The audited financial statements as of December 31, 2006 and 2005 and for the three-year period ended December 31, 2006 are included in this annual report.
 
                                 
    As of December 31,  
    2004     2005     2006     2006(2)  
    (Euro in millions,
    (Dollars in
 
    except per share
    millions, except
 
    amounts)(1)     per share amounts)  
 
CONSOLIDATED STATEMENT OF INCOME DATA
                               
Amounts in accordance with IFRS-EU:
                               
Operating revenues
    31,027       33,787       38,513       50,826  
Income from equity exchange transaction
                    263       347  
Operating expenses:
                               
Depreciation, amortization and impairment losses
    2,201       2,207       2,463       3,250  
Other
    22,940       26,314       29,880       39,433  
Total operating expenses
    25,141       28,521       32,343       42,683  
Net income/(charge) from commodity risk management
    (16 )     272       (614 )     (810 )
Operating income
    5,870       5,538       5,819       7,679  
Financial income
    365       230       513       677  
Financial expense
    (1,192 )     (944 )     (1,160 )     (1,530 )
Loss from investments accounted for using the equity method
    (25 )     (30 )     (4 )     (5 )
Income before taxes
    5,018       4,794       5,168       6,820  
Income taxes
    2,116       1,934       2,067       2,728  
Income from continuing operations
    2,902       2,860       3,101       4,092  
Income (loss) from discontinued operations (net of tax)
    (155 )     1,272              
Net income (before minority interest)
    2,747       4,132       3,101       4,092  
Basic earnings per share(2)
    0.45       0.67       0.50       0.66  
Number of shares outstanding (in millions)
    6,104       6,157       6,176          


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    As of December 31,  
    2004     2005     2006     2006(2)  
    (Euro in millions,
    (Dollars in
 
    except per share
    millions, except
 
    amounts)(1)     per share amounts)  
 
Amounts in accordance with U.S. GAAP(3)
                               
Operating revenues
    31,535       35,875       39,023       51,498  
Income from equity exchange transaction
                263       347  
Operating expenses
    24,436       29,235       32,551       42,957  
Net income/(charges) from commodity risk management
    (16 )     272       (614 )     (810 )
Operating income(4)
    7,083       6,912       6,121       8,078  
Income from continuing operations before income taxes and minority interest(4)
    6,344       6,119       5,762       7,604  
Income from continuing operations (before minority interest)
    4,056       4,128       3,777       4,984  
Basic earnings per share(2)
    0.17       0.76       0.60       0.79  
 
                 
    As of December 31,  
    2002     2003  
    (Euro in millions, except per share amounts)  
 
CONSOLIDATED STATEMENT OF INCOME DATA
               
Amounts in accordance with U.S. GAAP:
               
Operating revenues
  30,604     31,237  
Depreciation and amortization
    4,069       4,506  
Operating income
    2,617 (5)     4,966  
Income before taxes
    1,373       3,798  
Net income
    1,399       2,376  
Earnings per share(2)
    0.23       0.39  
 
                                 
    As of December 31,  
    2004     2005     2006     2006(1)  
    (Euro in millions)     (Dollars in
 
          millions)  
 
CONSOLIDATED BALANCE SHEET DATA
                               
Amounts in accordance with IFRS-EU:
                               
Property, plant and equipment, net
  36,702     30,188     34,846     $ 45,986  
Current assets
    13,532       12,746       13,000       17,156  
Total assets
    65,378       50,502       54,500       71,924  
Current liabilities(10)
    18,607       10,322       11,424       15,076  
Short-term debt(6)
    6,589       2,296       1,409       1,859  
Long-term debt(7)
    20,291       10,967       12,194       16,092  
Shareholders’ equity
    17,953       19,057       18,460       24,362  
Amounts in accordance with U.S. GAAP(3):
                               
Property, plant and equipment, net
    37,589       30,320       33,684       44,453  
Total assets
    67,152       50,596       56,104       74,040  
Short-term debt(6)
    6,589       2,296       1,409       1,859  
Long-term debt(7)
    20,291       10,967       12,056       15,910  
Shareholders’ equity
    15,697       17,638       17,220       22,725  

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    As of December 31,  
    2002     2003  
    (Euro in millions)  
 
CONSOLIDATED BALANCE SHEET DATA
               
Amounts in accordance with U.S. GAAP:
               
Fixed assets, net
  38,304     37,407  
Total assets
    66,423       68,505  
Short-term debt(6)
    8,371       8,643  
Long-term debt(7)
    17,172       18,005  
Shareholders’ equity
    18,526       18,651  
 
See notes on next page.
                                 
    As of December 31,  
    2004     2005     2006     2006(1)  
    (Euro in millions)(1)     (Dollars in
 
          millions)  
 
CONSOLIDATED CASH FLOW DATA
                               
Amounts in accordance with IFRS-EU:
                               
Net cash provided by operating activities
    4,835       5,693       6,756       8,917  
Net cash (used in) provided by investing activities
    (1,953 )     1,092       (2,374 )     (3,133 )
Net cash (used in) provided by financing activities
    (2,966 )     (6,654 )     (4,322 )     (5,704 )
 
                                         
    As of December 31,  
    2002     2003     2004     2005     2006  
 
Operating Data
                                       
Net installed capacity (GW) in Italy
    43.8 (8)     41.8       42.0       42.2       40.5  
Net electricity production in Italy (TWh)
    145.1 (9)     137.8       125.9       112.1       103.9  
Electricity sales to end users in Italy (TWh)(10)
    181.3       152.2       157.8       148.2       142.3  
Total electricity distributed in Italy (TWh)(11)
    258.0       265.0       261.2       259.3       263.4  
Natural gas sold to end users (billions of cubic meters)
    4.0       4.4       5.2       5.2       4.5  
Natural gas sales customers at year end (millions)
    1.7       1.8       2.0       2.1       2.3  
Employees
    71,204       64,770       61,898       51,778       58,548  
 
 
(1) We have translated euro amounts into dollar amounts at the noon buying rate for euro on December 31, 2006, of €1.00 = $1.3197.
 
(2) We calculate earnings per share by dividing our consolidated net income by the number of Enel’s ordinary shares outstanding during each period. At December 31, 2006, the MEF owned 21.14% and its subsidiary Cassa Depositi e Prestiti owned 10.16% of Enel’s ordinary shares. As of December 31, 2006 Enel’s share capital amounts to €6,176,196,279 divided into 6,176,196,279 shares with a par value of €1.
 
(3) For information concerning differences between IFRS-EU and U.S. GAAP that are relevant to our consolidated financial statements, you should read note 23 to our consolidated financial statements.
 
(4) You should read note 23 to our consolidated financial statements for a discussion of the impacts generated by the differences between IFRS-EU and U.S. GAAP in calculating operating income.
 
(5) Includes gain on sale of Eurogen, previously classified as other non-operating income (expense).
 
(6) Includes current portion of long-term debt.
 
(7) Excludes current portion of long-term debt.
 
(8) Including 2.6 GW of capacity of Interpower, which was divested in January 2003.
 
(9) Including 8.0 TWh generated by Eurogen before it was divested, and 5.7 TWh generated by Interpower.
 
(10) Excludes short term debt.


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(10) Excluding sales to resellers.
 
(11) Including electricity distributed to resellers.
 
Exchange Rates
 
The following table shows, for the periods indicated, information concerning the exchange rate between the U.S. dollar and the euro. These rates are provided solely for your convenience. We do not represent that the euro could be converted into U.S. dollars at these rates or at any other rate.
 
The column of averages in the table below shows the averages of the relevant exchange rates on the last business day of each month during the relevant period. The high and low columns show the highest and lowest exchange rates on any business day during the relevant period.
 
                                 
    End of Period     Average     High     Low  
    U.S. dollars per euro(1)  
 
Year:
                               
2002
    1.0485       0.9495       1.0485       0.8594  
2003
    1.2597       1.1411       1.2597       1.0361  
2004
    1.3538       1.2478       1.3625       1.1801  
2005
    1.1842       1.2400       1.3476       1.6667  
2006
    1.3197       1.2661       1.3327       1.1860  
Month ended:
                               
December 31, 2006
    1.3197       1.3204       1.3327       1.3073  
January 31, 2007
    1.2998       1.2993       1.3286       1.2904  
February 28, 2007
    1.3230       1.3080       1.3246       1.2933  
March 31, 2007
    1.3374       1.3245       1.3374       1.3094  
April 30, 2007
    1.3660       1.3512       1.3660       1.3363  
May 31, 2007
    1.3453       1.3517       1.3616       1.3419  
 
 
(1) Based on the Noon Buying Rate for the euro for the periods indicated.
 
The Noon Buying Rate on June 21, 2007 was $1.3399 per euro.
 
Enel’s ordinary shares are quoted in euros on Mercato Telematico Azionario (“Telematico”), the Italian automated screen-based trading market managed by Borsa Italiana S.p.A. (“Borsa Italiana”). Enel’s American Depositary Shares (“ADSs”) are quoted in U.S. dollars and traded on the New York Stock Exchange (“NYSE”).


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Risk Factors
 
You should carefully consider the risks described below and all of the other information in this document. If any of the risks described below actually occurs, our business, economic and financial results and the trading price of Enel’s ordinary shares or ADSs could be materially adversely affected.
 
Risks Relating to our Energy Business
 
Regulatory changes promoting market liberalization have significantly increased competition in our energy businesses.
 
The Italian energy market is currently undergoing a process of liberalization which has had a significant effect on our business by eliminating the monopoly position we previously had. In particular, the most significant effects of this process have been:
 
  •  a reduction in our generating capacity, through the mandatory disposal of three generating companies, which we refer to as the Gencos,
 
  •  the introduction of limits on the amount of energy we may produce and import,
 
  •  the introduction on April 1, 2004, of the Italian power exchange, where prices are determined by competitive bidding,
 
  •  the required disposal of certain of our municipal networks to local utilities, and
 
  •  mandated increases in the number of consumers who are eligible to buy electricity on the free market, with all non-residential customers having become eligible as of July 1, 2004, and all customers scheduled to become eligible as of July 1, 2007.
 
As a result of these regulatory changes, we now compete in the electricity generation business with a number of other operators, including independent power producers, municipal utilities and other Italian and international power companies. For a more detailed description of our competitors, see “Item 4 — Business — Competition in the Italian Electricity and Natural Gas Markets.”
 
We expect that competition will increase further due to:
 
  •  an increase in bilateral contracts between our competitors and final customers,
 
  •  the construction of new generation facilities by our competitors and the development of new interconnection lines that will increase the volume of electricity that may be imported in Italy,
 
  •  possible initiatives taken by the Energy Authority to further competition, such as the imposition of virtual power plant contracts that would oblige us to sell electricity to resellers (who otherwise compete with us) at lower-than-market prices set by Energy Authority, thus increasing the supply available for resale to final customers, and restrictions on the operation of pumped-storage plants (hydroelectric plants that use some of the energy they produce to pump water to elevated areas for use at a later time to generate electricity).
 
In the sale of electricity, based on data from Terna and from GRTN (for the years before 2005), we estimate that our market share in Italy has decreased from 92% in 1999 to approximately 45% in 2006 (with an estimated market share of 86% in the regulated market and 15% in the free market). Our market share could decline further in coming years as liberalization progresses, particularly after July 1, 2007, when all customers, including currently regulated customers, will become free to choose their supplier. In sales of electricity on the free market, we face competition both from other electricity producers as well as from wholesalers that resell the electricity they purchase.
 
Our ability to expand our business and increase operating profits may be limited unless we are able to offset the decrease in generation and sales volumes of our electricity business through improved efficiency, increased sales in other areas of our business or international expansion.


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Regulatory changes can have a material adverse effect on our businesses.
 
The sectors in which we operate, both in Italy and abroad, are heavily regulated. In light of our dominant market position in the Italian energy sector, and the recent regulatory trend towards liberalization, regulatory changes in the past have tended to have an adverse effect on our business and results of operations.
 
The Energy Authority has issued several proposals to promote competition in the wholesale electricity market and reduce the market power of the dominant producers. In particular, on August 4, 2005, the Energy Authority required us to entrust to Terna the management of certain power plants deemed essential to cover demand for electricity, and hence whose production is a significant determinant of the wholesale price of electricity. We successfully appealed the decision of the Energy Authority, which, in turn, appealed the judgment in our favor. A final decision is expected in the second half of 2007.
 
Although we are not the dominant player in the Italian natural gas market, and therefore can derive some benefits from regulations that have been adopted since 2000, which have sought to gradually introduce competition in the import, export and sale of natural gas, our gas operations nonetheless expose us to regulatory uncertainty that could have an adverse effect on our business. For instance, gas sales were supposed to have been completely liberalized by January 1, 2003, with all customers eligible to choose their supplier and sellers able to freely determine prices. However, while all customers are now able to freely choose their suppliers, the Energy Authority has retained the right to control prices for certain, mainly residential, customers. By limiting our ability to set prices, such regulations may have a material adverse effect on our business prospects, financial conditions and result of operations. We cannot predict whether or when the natural gas market in Italy will be fully liberalized, or how it will develop under these conditions.
 
In addition, in June 2007, the Italian government approved an emergency law decree to complete the implementation of EU directives on gas and electricity. For a description of the risks associated with this new law decree, see “— European and Italian regulations require the separation of distribution and sales operations in the electricity and gas sectors, which limits our ability to exercise control over our subsidiaries engaged in these activities.”
 
Future laws and regulations issued by the European Union or the Italian national and local authorities, in particular the decisions and policies of the Energy Authority, may require further significant changes in our business or otherwise affect our business in ways that we cannot predict. Any new regulations that cause us to restructure or otherwise change our business or significantly change the conditions under which we operate may have a material adverse effect on our business prospects, financial condition and results of operations. You should read “Item 4. Information on the Company — Business — Regulatory Matters” for a description of the regulatory environment in which we operate.
 
Our facilities and other critical operating systems could face service interruptions arising from malfunction or other events beyond our control, resulting in potential costs, losses and liabilities that could have a material adverse effect on our financial condition and results of operations.
 
Our generation plants and distribution networks are constantly exposed to risks related to their malfunction and other interruptions in service resulting from events outside of our control. These events may result in increased costs and other losses. Although we have acquired insurance coverage for events of this nature in line with general market practice, our coverage may prove insufficient to fully compensate us for any increased costs or losses that may occur as a result of service interruptions or malfunctions, with a consequent material adverse effect on our business prospects, financial condition and results of operations.
 
Malfunctions or interruptions of service at our facilities could also expose us to legal challenges and sanctions. For instance, we face legal proceedings and potential regulatory measures arising from the 2003 power outage that affected all of Italy, as described in “Item 8. Financial Information — Other Financial Information — Legal Proceedings — Blackout Litigation.” Any such legal proceedings or sanctions could, in turn, have a material adverse effect on our financial condition and results of operations.
 
Moreover, in January 2007, the Energy Authority issued proposals for public comment on the adoption of a system of automatic compensation payable by electricity distributors to affected customers in the event of a


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blackout or other prolonged service interruption. For a description of this proposal, see “Item 4. Information on the Company — Regulatory Matters — Electricity Regulation — Continuity and Quality of Service Regulation.” The adoption of this system would increase the economic risks we face in the event of any such interruption in service.
 
We may not be able to complete our power plant conversion and other capital investment programs that are critical to our strategy on schedule or realize the expected benefits of these programs.
 
An important element of our strategy to address the competitive challenges arising from the liberalization of the Italian electricity market is to be the cost leader in the generation of electricity and in the distribution and sale of electricity in Italy. To reduce our generation operating costs, we are implementing a program to convert several of our thermal generation plants to more efficient technology or use cheaper fuels, such as coal. Several events beyond our control could prevent us from completing our conversion program in accordance with the schedule we have set or in the manner currently contemplated. For instance, there is public opposition to our construction plans and the conversion of power plants in certain municipalities, and we cannot exclude the possibility that in the future such opposition could interfere with our plans. Our inability to implement our strategy as currently contemplated could have a material adverse effect on our competitive position and thus a material adverse effect on our business prospects, financial condition and results of operations. Moreover, even if we were to fully implement our cost reduction strategy as currently contemplated, we can offer no assurance that we would be able to offset the increased competition resulting from the liberalization process.
 
We have expanded and expect to continue to expand our operations, particularly outside of Italy, through significant acquisitions. These acquisitions raise the difficult challenges of integrating the acquired companies or assets into our existing operations and of successfully developing the acquired businesses. They can also result in financial and operating burdens and restrictions on our business. Our expansion outside of Italy, moreover, exposes us to risks associated with local market conditions.
 
The expansion of our operations has entailed and we expect will continue to entail significant acquisitions of companies or other assets, particularly outside of Italy. For instance, we filed with Spain’s securities regulator, the Comisión Nacional del Mercado de Valores or “CNMV,” a prospectus and related documentation in connection with a joint tender offer we intend to launch with the Spanish company Acciona for 100% of the shares of Spanish utility Endesa. For more information on this proposed acquisition, see “Item 4. Information on the Company — History and Development of the Company — Proposed Acquisition of Endesa.”
 
As a result of our expansion outside of Italy we currently have operations in Spain, Slovakia, Romania, Bulgaria, Latin America, North America, Russia, France, Greece and Turkey. This international expansion requires us to become familiar with new markets and competitors in order to manage and operate these businesses effectively, and exposes us to local economic, regulatory and political risks. Operating internationally may also subject us to risks related to currency exchange rate fluctuations, foreign investment restrictions or restrictions on remittances by local subsidiaries. Unfavorable developments in or affecting our operations outside of Italy could adversely affect our business prospects, financial condition and results of operations. For a description of our international operations see “Item 4. Information on the Company — Business — The Enel Group — International Operations.”
 
The process of integrating acquired operations, personnel and information systems, whether inside or outside of Italy, can be difficult and could absorb management time and resources and distract management from other opportunities or problems in our business and industry. In addition, some of the companies we have acquired may require significant capital investments. Our inability to successfully integrate these businesses into our existing operations or failure in developing their business could have a material adverse effect on our results of operations.
 
Furthermore, we may also have to incur indebtedness in order to finance these acquisitions. Such financings not only increase the financial burdens we must carry, but sometimes entail restrictions on our business. For instance, in connection with the proposed acquisition of Endesa, we have entered into a syndicate credit facility which imposes on us some financial covenants, including a limit on our consolidated net borrowing as of June 30 and December 31 of any given year equal to 6 times our consolidated EBITDA for the 12-month period ending on that date, and a limit on the financial indebtedness of our subsidiaries equal to 20% of the gross total assets of our


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Group. Covenants of this type limit our flexibility to incur future indebtedness or adopt other measures that could be necessary for the successful development of our business, and thus could have a material adverse effect on our financial condition and results of operations.
 
Our acquisition of a majority interest in Slovenské elektrárne (“SE”) exposes us to potential liabilities arising from the generation of nuclear power.
 
In April 2006, we purchased 66% of SE, which currently has four nuclear power generating units with an aggregate net installed capacity of 2,398 MW and two nuclear units under construction. Although we believe that all of SE’s existing nuclear plants use internationally accepted technologies and are managed in accordance with Western European standards, our acquisition of a majority participation in SE’s share capital exposes us to the risks of ownership and operation of nuclear generating facilities, including the disposal and storage of radioactive materials and spent fuel, as well as of the potential harmful effects on the environment and human health. In addition, while the Republic of Slovakia and SE have ratified the Vienna Convention, potential limits may arise on the amount and types of insurance commercially available to cover the risks associated with these operations. Potential risks may also arise in connection with the decommissioning of these nuclear plants, particularly as the regulatory regime for nuclear power and nuclear decommissioning in Slovakia is currently in the process of being defined. We have not owned any nuclear power plants since November 2000, and we have not produced electricity from nuclear power plants since 1988. For an additional information on our acquisition of SE see “Item 4. Information on the Company — Business — The Enel Group — International Operations — International Electricity Generation.”
 
Significant increases in fuel prices or disruptions in our fuel supplies could have a material adverse effect on our business.
 
Our thermal generation plants use fuel oil, natural gas and coal to generate electricity. Increases in energy prices therefore have a direct effect on our operating costs. Both the cost and availability of fuel are subject to many economic and political factors and events occurring throughout the world, particularly those that affect fuel-producing regions. Although we attempt to manage our risk through the use of financial instruments hedging our exposure to fluctuations in the price of fuel, we can neither control nor accurately predict these factors and events.
 
Given our ongoing conversion of significant generation capacity to combined-cycle technology, we expect natural gas to account for a significant portion of our fuel consumption in the future. In 2006, approximately 44% of the electricity we produced at our thermal plants was generated by plants using natural gas. We currently obtain a significant portion of the natural gas we use directly from Algeria and Nigeria through pipelines and by sea. Imports of natural gas from these countries may be subject to disruption due to a number of factors, including maintenance works on the pipelines, bad weather conditions at sea or political instability in these countries. Any major disruption of this imported supply, as well as the emergency measures that the Ministry of Productive Activities or other Italian authorities may take in the event of such disruption, could adversely affect our ability to generate electricity using natural gas.
 
If in the future there are significant or unexpected changes in the price of the fuels we use to generate electricity or if adequate supplies of fuel become unavailable, our financial condition and results of operations could be materially adversely affected.
 
We face legal proceedings and potential regulatory measures arising from the 2003 power outage that affected all of Italy. Further power outages involving our electricity operations could also adversely affect our financial condition and results of operations.
 
On September 28, 2003, Italy suffered a complete blackout of electrical service that affected the entire country with the exception of the island of Sardinia. After the blackout, approximately 21 hours were necessary before electricity again became available to all customers. The Energy Authority in September 2004 initiated formal proceedings to determine whether certain companies, including our subsidiaries Enel Produzione S.p.A. (“Enel Produzione”), Enel Distribuzione S.p.A. (“Enel Distribuzione”), and Deval S.p.A. (“Deval”), may have been partially responsible for the blackout. One of these proceedings, against Deval, was dismissed. Enel Produzione and


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Enel Distribuzione settled the other proceedings by means of a cash payment of €52,000 each, without admitting any responsibility with respect to the blackout. Although no further fines may be imposed on us, the Energy Authority may still impose measures to improve reliability of our energy supply, which may have an adverse impact on our results of operations.
 
Furthermore, certain of our customers brought legal actions against Enel Distribuzione and Enel in the Italian courts seeking a total of €100 million in damages as a result of this blackout. So far, the courts have issued more than 40,000 decisions, most of which have been unfavorable to us. Enel Distribuzione and Enel have appealed all unfavorable decisions before the competent courts, which in most cases have overturned such decisions on the grounds that the plaintiffs had not proven any damages. In some cases, the courts have also determined that the defendants had no responsibility for the blackout. Enel Distribuzione has further appealed the relatively few cases in which its initial appeal was unsuccessful before the Italian Supreme Court. Although the claims that have been brought forth by private plaintiffs as a result of the blackout tend to be for minor amounts, an increase in the number of decisions finding us liable for damages could result in an increase in the number of such claims filed and the magnitude of the aggregate damages sought. For more information on the civil and administrative proceedings related to the blackout, please read “Item 8. Financial Information — Other Financial Information — Legal Proceedings — Blackout litigation.”
 
While we do not believe we were responsible for the blackout, we cannot exclude the possibility that we will be held liable for it by Italian courts and/or the Energy Authority. Any finding of liability on our part could result in the imposition of fines and other administrative sanctions and in additional lawsuits by other parties against us, which could have a material adverse effect on our financial condition and results of operations.
 
Given the heavy regulatory environment in which we operate, and the dominant position we have in the electricity market in Italy and in some jurisdictions abroad, we are from time to time subject to numerous regulatory investigations and proceedings that could result in significant fines and other onerous sanctions.
 
Given the heavy regulatory environment in which we operate, and the position we have in the electricity market in Italy and in some jurisdictions abroad, we are from time to time subject to numerous antitrust and other regulatory investigations. Currently, these investigations and proceedings include the following:
 
  •  On December 28, 2006, the Spanish Antitrust Court (Tribunal de Defensa de la Competencia) imposed a fine of €2.5 million and temporary injunctive measures on our subsidiary Enel Viesgo Generación for abuse of dominant position. Enel Viesgo Generación appealed the decision. Currently, Enel Viesgo Generación is also subject to another proceeding for abuse of dominant position.
 
  •  On May 3, 2007, the Spanish Antitrust Authority initiated proceedings against all electricity distribution companies operating in Spain, including our subsidiary Enel Viesgo Distribution, for abuse of dominant position in the access to market information.
 
  •  In 2006, the Energy Authority started an inquiry against Enel Trade for violations of the minimum gas storage requirements during the 2004-2005 and 2005-2006 winter seasons. At the end of the inquiry, the Authority imposed an aggregate fine of €24 million, equal to €12 million for each winter season. Enel Trade paid a cash settlement of €52,000 with respect to 2004-2005 winter season, and decided to appeal the decision imposing this fine before the Administrative Court of Lombardy with respect to the 2005-2006 winter season. On June 25, 2007 the Administrative Court of Lombardy issued a decree canceling the €12 million fine for the 2005-2006 winter season.
 
  •  In November 2006, the Energy Authority started an inquiry against Enel Distribuzione for alleged violations in the period 2003-2005 of the obligation to carry out yearly meter readings for customers having contracted for power equal to 30 kW or less. The final decision is expected by July 2007. The Energy Authority could impose a fine on Enel Distribuzione ranging from approximately €25,800 to €154,937,070.
 
  •  In December 2006, the Energy Authority started an inquiry against Enel Distribuzione for alleged violations through March 2006 of the duty to disclose to clients a means by which they could pay their energy bills without having to pay additional processing charges. On March 21, 2007, the Energy Authority imposed a €11.7 million fine on Enel Distribuzione. Although Enel Distribuzione appealed this decision before the


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  Administrative Tribunal of Lombardy, and these proceedings remain pending, we cannot exclude an increase in the civil suits brought by our clients to recover damages originating from such alleged violations.
 
For more information on our regulatory and antitrust investigations and proceedings see “Item 8. Financial Information — Other Financial Information — Legal Proceedings.”
 
Although we have contested each of these proceedings, we cannot exclude the possibility that we will be held liable in any of them, or if found liable, that we would be successful in our appeals. We also can offer no assurance that there will not be in the future other investigations or proceedings by the Energy Authority, the Antitrust Authority or other regulatory bodies in Italy or abroad. Should we be held liable in the current or any future investigations or proceedings, and should such liability result in the imposition of significant fines or of material restrictions on our activity, there could be a material adverse effect on our financial condition and results of operations.
 
The European Commission has launched an investigation into the functioning of the European energy market that could lead to measures which could have a material adverse effect on our operations.
 
In June 2005, the European Commission launched an investigation into the functioning of the European energy market. In January 2007, the European Commission published the results of this investigation, highlighting several issues, including high levels of market concentration, vertical integration of supply and possible collusion between incumbent operators to share markets. The Commission is expected to tackle these problems through individual cases under the competition rules (anti-trust, merger control, and state aids) and will act to improve the regulatory framework for energy liberalization. Although we cannot at this stage predict what actions the European Commission may take as a result, we cannot foreclose the possibility that the report will lead to the adoption of measures that could adversely affect our operations.
 
We exceed our CO2 emission quotas in both Italy and Spain and have to purchase CO2 emission rights in the market to cover the excess. We can not predict what effect such ongoing excess of CO2 emission will have on our business.
 
Our operations in Italy and other Member States of the European Union are subject to CO2 emission quotas that were adopted by regulatory authorities pursuant to the Kyoto Protocol. Our operations in both Italy and Spain exceeded their respective quotas in 2005 and 2006 by an aggregate for both years of 20.74 million tons and are likely to exceed their respective quotas again in 2007. The European Commission has recently approved the quotas for the period from 2008 through 2012. We do not expect to meet the 2008-2012 quotas applicable to our operations in Italy and Spain. Failing to meet these quotas will require us to dedicate additional resources towards the purchase of CO2 emission rights. While the price of such rights has decreased significantly in recent periods due to an oversupply in the European market, we can offer no assurance that our ongoing excess of CO2 emissions in Italy and Spain above the relevant quotas could not eventually result in significant costs that could have a material adverse effect on our results of operations. For additional information on our CO2 emissions in Italy and abroad see “Item 4. Information on the Company — Business — The Enel Group — Domestic Generation and Energy Management — Generating Facilities — Thermal Production” and “Item 4. Information on the Company — Business — The Enel Group — International Operations — International CO2 Emission Trading”, respectively.
 
European and Italian regulations require the separation of distribution and sales operations in the electricity and gas sectors, which limits our ability to exercise control over our subsidiaries engaged in these activities.
 
European legislation adopted in 2003 requires the separation or “unbundling” of distribution and sales operations in the electricity and natural gas sectors. In 2007, the Energy Authority adopted rules to ensure an adequate level of separation of these activities in Italy at a functional level. These rules require that the distribution activities of integrated groups such as ours be managed independently of the group’s other businesses. Accordingly, our subsidiaries engaged in the distribution of natural gas or electricity must be able to exercise independent decision making. Moreover, there are limitations on the ability of directors of our other businesses serving as directors in our distribution subsidiaries. Although we have appealed the decisions of the Energy Authority in this


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regard, so long as they remain in force we will be able exercise only limited control over the day-to-day operations and investment decisions of these subsidiaries.
 
In addition, in June 2007 the Italian government approved an emergency law decree to complete the implementation of EU directives on gas and electricity, and, in particular, EU directives on the unbundling of gas and electricity distribution operations. The new law decree takes the rules on unbundling already in place one step further by requiring electricity distribution companies with at least 100,000 costumers to establish separate companies to carry out their selling activities by December 2007. However, household customers and small enterprises that do not elect to participate in the free market will continue to be supplied by their current distribution company, or its selling affiliate, under conditions set by the Energy Authority. The Single Buyer will continue to be responsible for purchasing electricity for resale to these household customers and small enterprises. The new law also empowers the Energy Authority to adopt additional rules on the functional separation of gas and electricity distribution activities of integrated groups such as ours and calls for the Minister of Economic Development to issue rules that guarantee that all customers, other than household customers and small enterprises who had not elected to participate in the free market, have access to a supplier of last resort. Unlike legislative decrees, law decrees are emergency measures and as such must be ratified by the Italian parliament within sixty days from their approval, otherwise they are no longer effective.
 
For additional information on these regulatory requirements see “Item 4. Information on the Company — Regulatory Matters — Electricity Regulation — Distribution of Electricity.”
 
Regulatory measures have terminated priority access to the trans-national transmission grids for electricity purchased under long-term supply contracts with suppliers in other EU members states, thus impairing our ability to import electricity into Italy.
 
We are currently parties to three long-term supply contracts with electricity generators outside of Italy — two in France and the other in Switzerland — from which we can obtain the equivalent of approximately 2,000 MW in generation capacity. Until December 31, 2005, the energy we purchased under all of these contracts enjoyed priority access to the electricity transmission grid connecting France and Switzerland to Italy, and thus we were able to import that electricity for sale in Italy. Measures adopted by French and Italian authorities, however, have terminated the priority access rights for our French contracts, which are due to expire at the end of 2007 and 2033, and thus impaired our ability to import the electricity we purchase under these contracts. The electricity we are unable to import into Italy must be sold abroad, usually at a lower price. For additional information on the measures adopted by the French and Italian authorities see “Item 4. Information on the Company — Regulatory Matters — Electricity Regulation — Imports.” Our long-term supply contract with the Swiss supplier is unaffected by the regulatory actions described above, since Switzerland is not a member of the European Union.
 
We operate our Italian electricity and gas distribution networks and hydroelectric plants under government concessions. Non-renewal of these concessions upon their expiration, and, in certain cases, the possible acceleration of their expiration date, could adversely affect our business, result of operations and financial condition.
 
We operate our Italian electricity and gas distribution networks and our hydroelectric plants under government concessions. The concession of our gas distribution networks are due to expire as follows:
 
  •  As a result of recent regulatory changes, gas distribution concessions awarded prior to May 2000 by means other than competitive tender expire by law at the earlier of their original expiration date or December 31, 2007, and may be extended up to December 31, 2009 if certain conditions are met; local authorities may at their option extend this date by one additional year.
 
  1.   The compatibility of the Italian law establishing these expiration dates with EU law is currently under scrutiny in a case unrelated to us before the Administrative Court of Lombardy. This tribunal has submitted the question to the European Court of Justice. A finding by European Court of Justice that the law is incompatible with EU law would bring into question the expiration date of our natural gas concessions falling under this category.


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  •  Certain gas distribution concessions for southern Italy, partially financed through public funds made available in the context of a public incentive plan for the use of natural gas, expire at the later of June 21, 2012 or twelve years from the entry into force of their approval by the Ministry of Economy and Finance.
 
  •  Gas distribution concessions awarded prior to May 2000 by competitive tenders expire at the earlier of their original expiration date or December 31, 2012.
 
The majority of our existing gas distribution concessions are currently due to expire on December 31, 2009, although as stated in the first bullet point above, the concessions awarded to us prior to May 2000 by means other than competitive tender remain subject to a certain degree of legal uncertainty. For additional information regarding our gas distribution concessions and related regulatory changes see “Item 4. Information on the Company — Regulatory Matters — Gas Regulation.”
 
The concessions for our hydroelectric plants are due to expire in 2029, except for those located in Trentino-Alto Adige, a region that enjoys special autonomous status under Italian law, which are due to expire in 2010. These hydroelectric plants accounted for approximately 36% of our net installed capacity in Italy as of December 31, 2006 (approximately 5% for those in the region of Trentino-Alto Adige).
 
We do not enjoy renewal preferences as the existing holder of any of our concessions. Accordingly, upon their expiration we will have to compete with other operators in order to renew them, and may not be able to do so at all or on favorable terms. This could have a material adverse effect on our business, result of operations and financial condition.
 
In addition, beginning in 2004, the European Commission has challenged certain Italian regulations concerning hydroelectric concessions, including their current expiration date in 2029 (and 2010 in Trentino-Alto Adige), on the ground that they violated EU law. Although the Italian government has made a number of regulatory changes in response to these proceedings, the expiration dates in 2029 (and 2010 in Trentino-Alto Adige) remain. We do not know whether the European Commission will decide to bring its proceeding to an end in light of the regulatory changes, but since the proceedings remain at least partially open, we can offer no assurance that the European Commission will not seek to accelerate the expiration date of hydroelectric concessions in Italy, including ours. For additional information on the proceedings brought by the European Commission and the regulatory changes adopted by the Italian government, see “Item 4. Information on the Company — Regulatory Matters — Electricity Regulation — Hydroelectric Power.”
 
Our businesses are subject to numerous environmental regulations, and we are parties to a significant number of legal proceedings relating to environmental matters, that could significantly affect our financial condition and results of operations.
 
Our businesses are subject to extensive environmental regulations under Italian law and the laws of other countries in which we operate, including laws adopted to implement European Union regulations and directives and international agreements on the environment. Environmental regulations affecting our business primarily relate to air emissions, water pollution, waste disposal and electromagnetic fields. The principal air emissions deriving from thermal electricity generation are sulfur dioxide (SO2), nitrogen oxides (NOx), carbon dioxide (CO2) and particulate matter such as dust and ash.
 
We incur significant costs to comply with environmental regulations requiring us to implement preventive or remedial measures. Environmental regulations may also influence our business decisions and strategy, such as by discouraging the use of certain fuels. In addition, expressions of public concern about environmental problems associated with electricity generating plants, power lines and other facilities may result in even more stringent regulation in the future, which could further increase costs. We are also parties to a significant number of legal proceedings relating to environmental matters. The aggregate amount of damages that we may be required to pay and the aggregate costs of remediation or preventive measures we may be required to implement in connection with these proceedings may be significant.
 
The adoption of any additional or more rigorous environmental regulations applicable to our businesses would be likely to increase our costs and could have a negative effect on our financial condition and results of operations. Please see “Item 4. Information on the Company — Regulatory Matters — Environmental Matters” and “Item 8.


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Financial Information — Other Financial Information — Legal Proceedings” for a more detailed discussion of environmental matters.
 
Other Risks Relating to Our Businesses
 
Our historical consolidated financial and operating results may not be indicative of future performance.
 
In 2005, we discontinued the operations of our former Telecommunications Division and Transmission Division, following the deconsolidation of Wind and Terna, respectively, as a result of our disposal of a controlling interest in each of these companies. During 2005 and 2006, we also made significant acquisitions, entered into agreements to make additional significant acquisitions, and made other significant strategic investments. Please see “Item 4. Information on the Company — History and Development of the Company” for additional information on these transactions.
 
We may continue to divest assets as a part of our ongoing efforts to refocus our activities on our core electricity and gas businesses, and to acquire new businesses and make other significant investments as part of our international expansion. As a result, our historical consolidated financial and operational performance during or as of the end of periods ending on or prior to the consummation of these transactions may not be indicative of our future operating and financial performance.
 
The Italian social security fund is seeking to impose significant liabilities on us.
 
As a former state-owned company we do not believe we are required to make certain contributions to the Italian social security system with respect to our employees. However, on May 6, 2005, the Italian social security fund or INPS, issued a circular extending these social security obligations to former state-owned companies and national public entities carrying out industrial activities. Moreover, INPS indicated in its circular that this obligation would be applied to privatized companies such as Enel with retroactive effect as of the date of the privatization. As we believe that this circular should not apply to us, we challenged it before the Tribunal of Rome.
 
In March 2006, the Italian Council of State, upon INPS’ request, expressed the opinion that INPS may not impose retroactive obligations. Although this opinion supports our position, it is not binding on the Tribunal of Rome and we can offer no assurance that this court will rule that the INPS circular does not apply to us, whether for the period after its issuance or retroactively. We estimate that the amounts we would be required to pay if the circular applied to us would total approximately €80 million per year going forward, of which €30 million are for social security contributions relating to involuntary unemployment, and a total of approximately €500 million in retroactive payments. However, on August 1, 2006, the Ministry of Labor concluded a formal inquiry determining that Enel and its subsidiaries are in fact exempted from social security contributions relating to involuntary unemployment.
 
Despite the favorable decisions of the Council of State and the Ministry of Labor, in 2006 and 2007 we received from INPS several invoices requesting payment for the social security contributions in dispute for previous years. Some of these invoices were subsequently withdrawn by INPS, others were suspended by Italian courts upon our requests. Despite these favorable outcomes, we can offer no assurance that we will ultimately prevail in our dispute with INPS regarding these social security contributions and our failure to do so could in turn have a material adverse effect on our results of operations and financial condition.
 
Legislation enacted in 2005 could increase our local property tax burden.
 
On May 31, 2005, the Italian parliament passed a law to aid local governments that included, among other things, provisions regarding the determination of the deemed value of electricity generation facilities for purposes of assessing local property taxes. Under this law, owners of electric utilities are required to include in the computation of the taxable value of their facilities not only land and buildings, but also the value of removable parts of the facilities, such as generation equipment. Should these provisions be applied to all our electricity generation facilities, and the pending and prospective litigation regarding the assessment of their deemed value be


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unsuccessful, we expect that our local property tax (the imposta comunale sugli immobili, or ICI) would increase by approximately €80 million per year.
 
In addition, local authorities may claim, on the basis of a recent decision by the Italian Supreme Court in a case relating to one of our facilities, that they can apply the provisions in question retroactively, starting from fiscal year 2003. We believe that the court’s decision does not in fact provide grounds for such a claim and thus, if such a claim were raised, we would challenge it before the competent court. However, should such a claim be successful, we estimate that our ICI liability would increase by up to €40 million for each fiscal year starting from 2003.
 
The constitutionality of the provisions in question is currently under review by the Italian Constitutional Court. However, their applicability has not been suspended pending the Court’s decision.
 
We are defendants in a number of legal proceedings.
 
We are defendants in a number of legal proceedings incidental to the generation and distribution of electricity and our other business activities. Our pending legal proceedings include various civil and administrative claims and disputes relating to the construction and operation of several power stations, transport and distribution lines, and other matters that arise in the normal course of our business. We have established a reserve for litigation and other contingent liabilities where we consider it probable that a claim will be resolved unfavorably and where we can reasonably estimate the potential loss involved. This reserve, which also includes provisions for other contingencies and uncertainties related to our operations, is included in other non-current liabilities in our consolidated balance sheet, and amounted to €3,729 million at December 31, 2006, of which €348 million related to legal proceedings. Please see “Item 8. Financial Information — Other Financial Information — Legal Proceedings.”
 
However, we are not able to predict the ultimate outcome of any of the claims against us, and any material damages or other costs imposed on us in the event of an unfavorable outcome may be in excess of our existing reserves. We cannot exclude that unfavorable decisions in proceedings against us could have a material adverse effect on our financial position or results of operations.
 
Risks Relating to our Ordinary Shares and ADSs
 
The MEF, our major shareholder, has significant influence over our actions.
 
The MEF is our major shareholder as it currently directly owns 21.1% of our outstanding share capital and controls Cassa Depositi e Prestiti S.p.A., which owns 10.1% of our outstanding share capital. However, as explained in more detail in “Item 7 — Major Shareholders and Related Parties Transactions — Major Shareholders”, we do not believe that the MEF exercises powers of direction and control over us and our operations. Nonetheless, the MEF, as our major shareholder, could exercise significant control over all matters to be voted on by our shareholders, including, without limitation, the election and removal of directors, approval of the annual financial statements and possible capital increases or amendments to our by-laws. As a result, other shareholders’ ability to influence decisions on matters submitted to a vote by our shareholders may be limited.
 
The special powers of the Italian government may permit it to influence our business, regardless of the level of its shareholding.
 
The Italian privatization law (as amended) and our by-laws confer upon the Italian government, acting through the MEF (which acts after consultations with and in agreement with the Ministry of Productive Activities), certain special powers with respect to our business and actions by our shareholders. These powers, which the MEF confirmed with a decree issued on September 17, 2004, may permit the government to influence our business, regardless of the level of its shareholding.
 
In particular, the MEF has the following special powers:
 
  •  The power to oppose the acquisition by persons or entities of an interest in the us equal to or in excess of 3% of our shares with voting rights at ordinary shareholders’ meetings,


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  •  The power to oppose certain types of shareholders’ agreements entered into by holders of at least one-twentieth of the voting capital stock at ordinary shareholders’ meetings,
 
  •  The power to veto any resolution to dissolve, merge or demerge us, transfer a significant part of our business or our registered headquarters outside of Italy, change our corporate purpose or eliminate or modify any of the MEF’s special powers, and
 
  •  The power to directly appoint one non-voting member of our board of directors, in addition to the voting members elected by our shareholders.
 
The MEF may exercise these powers only for due cause when it believes that a concrete detriment to vital national interests would otherwise result. The special powers retained by the MEF are described in further detail under “Item 7. Major Shareholders and Related Party Transactions — Major Shareholders” and “Item 10. Additional Information — By-Laws.” As a result of these powers, we may not enter into change of control transactions without the approval of the MEF, in agreement with the Ministry of Productive Activities. This may limit the ability of our shareholders to benefit from a premium in connection with a change of control transaction. The European Commission has challenged these special powers of the Italian government before the European Court of Justice, claiming that they are contrary to EU law. These proceedings are currently pending and we can offer no assurances as to their possible outcome.
 
The value of our ordinary shares or ADSs may be adversely affected by sales of substantial amounts of shares by the MEF or other shareholders or the perception that such sales could occur.
 
The MEF and/or Cassa Depositi e Prestiti may sell our ordinary shares at any time. Since 2004, the MEF has sold ordinary shares representing approximately 28.8% of our share capital by means of public offerings and private placements to institutional investors that were not registered under the Securities Act. These sales have brought the MEF’s direct and indirect ownership of our share capital to its current 30.2%. There are no minimum ownership or similar requirements under Italian law that would limit sales of additional shares by the MEF or Cassa Depositi e Prestiti. Sales of substantial amounts of ordinary shares by the MEF or other shareholders, or the perception that such sales could occur, could adversely affect the market price of our ordinary shares and American Depositary Shares, or ADSs, and could limit our ability to raise capital through equity offerings.
 
The value, expressed in dollars, of our ordinary shares and ADSs and of any dividends we pay in respect of our ordinary shares and ADSs will be affected by the euro/dollar exchange rate.
 
We pay cash dividends in euros. As a result, exchange rate movements may affect the amounts, expressed in U.S. dollars, that investors holding ADSs receive from JP Morgan Chase Bank, the depositary for our ADR program, in respect of such dividends. Moreover, the price of our ordinary shares is quoted in euros. Therefore, exchange rate movements may also affect the U.S. dollar price of the ADSs corresponding to our ordinary share price. Since January 2, 2004, the U.S. dollar has depreciated 6.41% against the euro, to $1.3399 per euro as of June 21, 2007.
 
It is possible that the price of ordinary shares and ADSs will experience significant volatility.
 
The market price of our ordinary shares and ADSs may be significantly affected by factors such as variations in our results of operations, market conditions specific to our industry and changes in regulations applicable to us. In addition, stock markets can experience significant fluctuations that may be unrelated to the performance or circumstances of the specific companies whose shares are affected. Market fluctuations, as well as economic conditions, may adversely affect the market price of our ordinary shares and ADSs.
 
If you hold ADSs rather than ordinary shares it may be difficult for you to exercise some of your rights as a shareholder.
 
It may be more difficult for you to exercise your rights as a shareholder if you hold ADSs than it would be if you directly held ordinary shares. For example, if we offer new shares and you have the right to subscribe for a portion of them, the depositary of our ADR program is allowed, in its own discretion, to sell for your benefit that


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right to subscribe for new shares instead of making it available to you. Furthermore, in some cases, you may not be able to vote by giving instructions to the Depositary on how to vote for you.
 
Forward-Looking Statements
 
This annual report includes forward-looking statements. When used in this annual report, the words “seek(s),” “intend(s),” “estimate(s),” “plan(s),” “project(s),” “aim(s),” “expect(s),” “will,” “may,” “believe(s),” “should,” “anticipate(s)” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements regard, among other things:
 
  •  Anticipated trends in our businesses, including trends in demand for electricity,
 
  •  Changes in the regulatory environment and expectations on how and when new regulations will be implemented,
 
  •  The remuneration of our generation activities based on competitive electricity prices rather than tariffs following the introduction of trading on the Italian power exchange,
 
  •  The impact of changes in electricity and gas tariffs,
 
  •  Our ability to implement our cost reduction program successfully,
 
  •  The possibility that significant volumes of lower-cost electricity will become available as a result of increased imports and the construction of new plants in Italy,
 
  •  Our intentions with respect to future dividend payments,
 
  •  Our intention to expand our core businesses, including by increasing our presence in renewable energy and developing our gas distribution and sales business,
 
  •  Our intention to expand our operations outside Italy, and
 
  •  Future capital expenditures and investments.
 
The forward-looking statements included in this annual report are subject to risks, uncertainties and assumptions about the Group. Our actual results of operations may differ materially from the forward-looking statements as a result of, among other things, the risk factors described under “— Risk Factors.” We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or events otherwise occurring after the date of this annual report. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this annual report might not occur.
 
ITEM 4.   INFORMATION ON THE COMPANY
 
History and Development of the Company
 
Enel was established in December 1962 as a state-owned entity (Ente Nazionale per l’Energia Elettrica) through the nationalization of approximately 1,250 private power companies in Italy. In 1992, Enel S.p.A. was incorporated under the laws of Italy as a società per azioni, or a company whose capital is represented by shares, owned by the Italian government through the MEF.
 
Under its current statuto, or by-laws, Enel’s corporate duration expires on December 31, 2100. Enel’s principal place of business is Italy, but it also has operations in Spain, Slovakia, Romania, Bulgaria, Latin America, North America, Russia, France, Greece and Turkey. Its registered office is located at Viale Regina Margherita 137, Rome, Italy. Enel’s main telephone number is +39 06 83051. Enel is represented in the United States by our subsidiary Enel North America Inc. (“Enel North America”), located at One Tech Drive, Suite 220, Andover, MA 01810.


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Important Events in the Development of the Company’s Business
 
Liberalization
 
Italy’s electricity market was highly regulated until the Bersani Decree came into force on April 1, 1999. The Bersani Decree began the liberalization of the Italian electricity market, allowing energy prices charged by generators to be freely determined by the market. The Bersani Decree and other liberalization reforms required significant changes in our business, including:
 
  •  the separation of our significant businesses into separate subsidiaries (beginning in October 1999),
 
  •  the transfer of management and control of the Italian national electricity transmission grid and electricity dispatching to the GRTN (now the Gestore dei Servizi Elettrici or GSE), a company wholly-owned by the MEF, and the subsequent sale of 94.88% of our former wholly-owned subsidiary Terna, which owns more than 90% the Italy’s transmission grid; as a result of this sale, Terna was deconsolidated on September 15, 2005, and
 
  •  the sale of three generation companies (accounting for approximately 15,000 MW of our generating capacity) and several municipal distribution companies.
 
Privatization
 
As a result of the liberalization reforms, the MEF was also required to reduce its ownership of Enel, beginning with an initial public offering in November 1999 of 32% of our share capital, as part of which our ADSs were listed on the New York Stock Exchange and our shares listed on the Telematico, the Italian screen-based trading market managed by Borsa Italiana. The initial public offering was followed by a number of offerings of our shares to international institutional investors and/or to retail investors in Italy by the MEF in 2003, 2004 and 2005. These offerings reduced the MEF’s direct ownership to its current 21.1%. The MEF indirectly has an additional stake in our share capital through Cassa Depositi e Prestiti, a company now owned 70% by the MEF, to which it sold 10.15% of our share capital in 2003.
 
Expansion of Electricity Operations Abroad
 
In 2002 and 2003, we began to expand our electricity operations abroad through the acquisition of Electra de Viesgo S.L. (“Viesgo”), a company with electricity generation and distribution operations in Spain, and Maritza East III Power Company AD (“Maritza East III”), a company with electricity generation operations in Bulgaria. These initial steps were followed by the acquisition of power producers specializing in renewable resources in the Americas, and the launch of our Enel Unión Fenosa Renovables S.A. joint venture in Spain. More recently, we completed a number of additional acquisitions as part of our expansion outside of Italy, including the following:
 
  •  in April 2006, we acquired a 66% interest in Slovenské elektrárne (“SE”) for total consideration of approximately €840 million. SE, the principal electric power generation company in Slovakia, has a total net installed capacity of approximately 6,442 MW,
 
  •  in June 2006, we won the auction for a 67.5% stake in the Romanian power distribution company Electrica Muntenia Sud (“EMS”), an electricity distributor with approximately 1.1 million customers in Bucharest, Romania, for total consideration of approximately €820 million. We expect to complete this acquisition in the second half of 2007,
 
  •  in June 2007, we won an auction to acquire for approximately $1.5 billion (approximately €1.1 billion) a 25.03% stake in JCS Fifth Generation Company of the Wholesale Electricity Market or OGK-5, one of the six thermal wholesale generation companies in Russia, which has four thermal power plants located in various regions of the country with an aggregate installed capacity of approximately 8,700 MW. Later that same month, we increased our stake in OGK-5 by 4.96%, bringing our total stake in that company to 29.99%.
 
For a complete list of our recent acquisitions outside of Italy see “ — Business — The Enel Group — International Operations.”


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Former Telecommunications Operations
 
In 1997, together with France Télécom and Deutsche Telekom, we founded the telecommunications company Wind, in which we originally had a 51% stake. We subsequently increased our ownership through various transactions to 100%. In May 2005, in line with a refocusing of our strategy on our core energy operations, we entered into an agreement for the sale of Wind to Weather Investments in a series of transactions, which were completed in February 2006. As consideration for the sale, we received cash of €3,009 million and a 26.1% interest in Weather Investments, a private consortium headed by Naguib Sawiris that controls the Egypt-based mobile phone operator Orascom. In December 2006, we sold our 26.1% interest in Weather Investments to Naguib Sawiris for approximately €1,962 million. Wind was deconsolidated on August 11, 2005.
 
Corporate Reorganization
 
At the end of 2005, our management decided to re-organize the Group’s internal structure by dividing our Sales, Infrastructure and Networks Division into two separate divisions and by centralizing all of our international generation, sales and distribution operations, which previously had formed part of separate divisions, in a new International Division. This reorganization was effective as of January 1, 2006. Our divisions under the new structure are as follows:
 
  •  Domestic Generation and Energy Management Division,
 
  •  Domestic Sales Division,
 
  •  Domestic Infrastructure and Networks Division, and
 
  •  International Division.
 
Each division is headed by a senior manager who reports directly to the chief executive officer of Enel. Moreover, all non-core services provided by Group companies to other companies of the Group have been classified under Services and Other Activities. Enel, as the parent company, defines the strategic objectives for the Enel Group and coordinates the activities of all Group companies. Each of Enel (which for reporting purposes we have classified as the “Parent Company”), our divisions and Services and Other Activities, constitutes a separate segment for business and financial reporting purposes.
 
For additional information on our divisions and their activities, see “— Business — The Enel Group” below. For a detailed discussion of our operational and financial results in the period 2004-2006, see “Item 5. Operating and Financial Review and Prospects.”
 
Expansion Into Gas Exploration
 
In April 2007, Enineftegaz, a consortium in which Enel has a 40% interest and Eni (the largest Italian oil and gas company) a 60% interest, successfully acquired a group of natural gas related assets formerly owned by Yukos, including OAO Arcticgaz, ZAO Urengoil, OAO Neftegaztechnologia and a 20% stake in OAO Gazprom Neft, for total consideration of approximately $5.83 billion (equal to approximately €4.3 billion), $852 million of which is payable by Enel (equal to approximately €631 million).


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Capital Investment Program
 
We have summarized in the table below our aggregate capital expenditures on tangible and intangible assets for our current and discontinued operations by division during each of 2004, 2005 and 2006. During these years, we have not incurred significant capital expenditures with respect to the activities of our Parent Company. Following the reorganization of the Group’s internal structure at the end of 2005, capital expenditures relating to international generation, sales and distribution operations in 2004 and 2005, which had previously been included in other divisions, have been allocated to our International Division. In the tables below, capital expenditures under “Transmission” relate to the activities of our former subsidiary Terna, which was deconsolidated on September 15, 2005, following our divestiture of 94.88% of our stake in this company, and under “Telecommunications” to the activities of our former subsidiary Wind, which was deconsolidated on August 11, 2005, following the sale of our entire stake in this company. For additional information on our divisions and their activities see “Business — Overview” and “Business — The Enel Group.”
 
                         
    2004     2005     2006  
    (In millions of euro)  
 
Current Operations:
                       
Parent Company
    10       11       13  
Domestic Generation and Energy Management Division
    678       798       897  
Domestic Sales Division
          53       56  
Domestic Infrastructure and Networks Division
    1,663       1,570       1,459  
International Division
    227       299       467  
Services and Other Activities
    112       98       71  
                         
Total for Current Operation
    2,690       2,829       2,963  
Discontinued Operations:
                       
Transmission
    277       142        
Telecommunications
    867       286        
                         
Total for Discontinued Operations
    1,144       428        
Total for Current and Discontinued Operations
    3,834       3,257       2,963  
                         
 
In 2006, we incurred total capital expenditures on tangible and intangible assets in our core electricity generation, sales and distribution businesses of €2,879 million (of which €2,718 million was spent on tangible assets).


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We have summarized in the table below our aggregate capital expenditures on tangible assets by division during each of 2004, 2005 and 2006.
 
                         
    2004     2005     2006  
    (In millions of euro)  
 
Current Operations:
                       
Parent Company
          2       3  
Domestic Generation and Energy Management Division
    667       778       880  
Domestic Sales Division
          2       13  
Domestic Infrastructure and Networks Division
    1,586       1,508       1,381  
International Division
    221       290       444  
Services and Other Activities
    87       68       38  
                         
Total for Current Operation
    2,561       2,647       2,759  
Discontinued Operations:
                       
Transmission
    277       139        
Telecommunications
    680       251        
                         
Total for Discontinued Operations
    957       390          
Total for Current and Discontinued Operations
    3,518       3,037       2,759  
                         
 
For the period 2007-2011, we expect to incur capital expenditures on tangible and intangible assets for the Enel Group of approximately €20.3 billion. Of this total, we expect to incur capital expenditures of approximately €4,535 million in 2007 and approximately €4,811 million in 2008. We expect to cover our capital expenditures in the 2007-2011 period with our cash flow from operations.
 
We have summarized in the table below our expected aggregate capital expenditures for 2007-2011 by geographical region.
 
         
Geographical Region:
  2007-2011  
    (In millions of euro)  
 
Italy
    14,523  
Spain
    1,913  
Slovakia
    1,724  
Romania
    766  
North America
    619  
France
    381  
Bulgaria
    247  
South America
    128  
Russia
    2  
         
Total
    20,303  
 
The following discussion analyzes in greater detail the capital expenditures in 2006 of each of our divisions, focusing on tangible assets, which are the most significant part of our capital investments in our core electricity and gas operations.
 
Domestic Generation and Energy Management
 
In 2006, the Domestic Generation and Energy Management Division had capital expenditures on tangible assets of €880 million, an increase of €102 million or 13.1% from €778 million in 2005. These expenditures included the ongoing process of conversion of our approximately 1,900 MW oil-fired plant at Torrevaldaliga North to “clean coal” technology, on which we spent approximately €303 million during the year. We also continued implementing our strategic plan to increase investment in renewable (wind, hydroelectric, geothermal) generation facilities, spending approximately €238 million in 2006. Of this amount, we spent €112 million on capital


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improvements that we expect will allow us to better comply with regulations requiring us to provide a specified amount of “green certificates” each year.
 
Overall, our Domestic Generation and Energy Management Division expects to invest approximately €6,300 million on tangible and intangible assets in the 2007-2011 period. It expects to make approximately €2,900 million of those expenditures on tangible assets on the ongoing implementation of our program to convert oil-fired thermal generation plants to CCGT or to burn coal. The bulk of these expenditures are destined for our coal conversion program. In particular:
 
  •  with respect to CCGT conversions, we have completed the conversion of approximately 4,600 MW of capacity and plan to continue the CCGT conversion program at the Termini Imerese power plant (for approximately 375 MW), and
 
  •  with respect to coal conversions, we plan to continue the conversions of our thermal generation plants at Torrevaldaliga North and begin similar conversions of certain other power generation units, expected to affect in the aggregate approximately 3,800 MW of net installed capacity. The conversion plans for approximately 1,900 MW of this amount are still subject to regulatory approval.
 
Our Domestic Generation and Energy Management Division also plans to invest approximately €1,650 million in the 2007-2011 period on developing generation from renewable resources.
 
Domestic Sales Division
 
Capital expenditures on tangible assets in our Domestic Sales Division increased sharply to €13 million in 2006, from €2 million in 2005, due primarily to the renewal of the hardware platform of our call center.
 
Domestic Infrastructure and Networks
 
Capital expenditures on tangible assets in our Domestic Infrastructure and Networks Division decreased 7.3% to €1,381 million in 2006, from €1,508 million in 2005.
 
Capital expenditures on our Italian electricity distribution networks decreased 9.0% to €1,159 million in 2006, from €1,200 million in 2005, reflecting more selective investing in quality improvements in light of the service continuity levels already achieved. The expenditures in 2006 included approximately €285 million relating to our “Telemanagement” digital meter project (see “Business — The Enel Group — Distribution of Electricity — Telemanagement System” for additional information on this system). In 2006, we installed an additional 2.9 million meters, bringing the total number of meters installed at December 31, 2006 to approximately 29.8 million, of which approximately 28.9 million were already remotely connected to our system. We expect the Telemanagement project, for which we expect installation of the new meters to be completed by the end of 2007, to entail total investments of approximately €2.4 billion, of which approximately €2.2 billion have already been spent.
 
Capital expenditures on our gas distribution network increased 25.0% to €88 million in 2006, from €71 million in 2005, due to our project to expand our methane distribution network.
 
In the 2007-2011 period, our Domestic Infrastructure and Networks Division plans to invest approximately €6,923 million in tangible assets, plus an additional €459 million in intangible assets, on our electricity and natural gas distribution networks. This amount includes the following planned expenditures:
 
  •  approximately €2,652 million to connect new customers to our electricity distribution network,
 
  •  approximately €1,230 million to improve the service quality of our electricity network, so that we may continue to exceed the targets established by the Energy Authority in those areas in which we are exceeding them, and improve our performance in those areas in which we are not, and
 
  •  approximately €452 million in developing our natural gas distribution networks, primarily by building new pipelines, either in response to customer requests or as part of our business development policies, as well as by improving the quality of our gas service levels and safety.


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Our Domestic Infrastructure and Networks Division also plans to invest approximately €200 million on internal resource planning software to improve the efficiency of both our distribution activities and our accounting system.
 
International Division
 
International generation operations.  Aggregate capital expenditures on international generation operations in 2006 were (before eliminations relating to transactions with companies of our Domestic Generation and Energy Management) approximately €439 million, as compared to €231 million in 2005. The capital expenditures in 2006 included:
 
  •  approximately €175 million for the conversion of certain of Enel Viesgo Generación’s plants to CCGT technology,
 
  •  approximately €79 million for the Maritza East III’s ongoing plant refurbishment project,
 
  •  approximately €71 million for recurrent maintenance at Slovenské elektrárne,
 
  •  approximately €54 million for the development of renewable generation facilities by Enel Unión Fenosa Renovables,
 
  •  approximately €45 million for development of wind-generation projects and recurrent maintenance in North America, and
 
  •  approximately €15 million for maintenance activities to sustain our current levels of generation capacity in Latin America.
 
International distribution and sales operations.  Aggregate capital expenditures on international sales and distribution operations in 2006 were approximately €134 million, as compared to €68 million in 2005. The capital expenditures in 2006 included:
 
  •  approximately €66 million invested by Electra de Viesgo Distribución SL on tangible assets, primarily to upgrade its distribution network in compliance with regulatory requirements and to roll out the digital meter project,
 
  •  approximately €66 million to improve our distribution network in Romania, and
 
  •  approximately €2 million to be invested by Viesgo Energia SL.
 
Planned Investments 2007-2011.  In the 2007-2011 period, we plan to spend approximately €5,781 million on our international operations, of which we plan to spend €4,651 million on our international generation operations and €1,124 million on our international distribution and sales operations.
 
The planned capital expenditures on our international generation operations include the following:
 
  •  approximately €1,724 million at SE, of which €1,110 million would be directed towards the construction of two units at the nuclear power plants at Mochovce,
 
  •  approximately €1,088 million at Enel Viesgo Generación, primarily to implement a program to convert certain of its coal plants to CCGT,
 
  •  an aggregate of approximately €748 million in North America and South America, of which €128 million would be directed towards the development of a new hydroelectric plant in Guatemala (which we expect to become operational in 2011) and on geothermal exploration activities in Chile, and €620 million would be directed towards the development of new wind farms in North America,
 
  •  approximately €421 million on further development of our generation capacity from renewable resources at Enel Unión Fenosa Renovables,
 
  •  approximately €381 million that Enel Erelis plans to invest on various wind farms projects in France, and


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  •  approximately €233 million at Maritza East III in Bulgaria, primarily to complete its ongoing plant refurbishment program.
 
The planned capital expenditures on our international distribution and sales operations include the following:
 
  •  In June 2006, we won the auction for a 67.5% stake in the Romanian power distribution company EMS. We expect to complete this acquisition in the second half of 2007. Upon successful completion of the acquisition, we expect to make capital expenditures of approximately €435 million at EMS.
 
  •  Electra de Viesgo Distribución SL is planning to invest approximately €354 million to improve service performance and network safety, and to implement its own digital meter project.
 
  •  We plan to invest approximately €332 million at Electrica Banat and Electrica Dobrogea to improve the quality and the efficiency of our distribution network in Romania, in line with the plan authorized by the Romanian Authority (ANRE) for the years 2005-2007.
 
Services and Other Activities
 
With respect to Service and Other Activities, we incurred total capital expenditures on tangible and intangible assets of approximately €71 million in 2006, as compared to €98 million in 2005, and expect to maintain our capital expenditures on tangible and non-tangible assets in 2007 at a level similar to that of 2006.
 
Transmission and Telecommunications
 
In 2005, we discontinued the operations of our former Telecommunications Division and Transmission Division, following the deconsolidation of Wind and Terna, respectively, as a result of our disposal of a controlling interest in each of these companies. Accordingly, all capital expenditures on tangible and intangible assets related to Wind and Terna (€286 million and €142 million in 2005, respectively, as compared to €867 million and €277 million in 2004), refer to the period prior to our deconsolidation of these companies. We intend to use the proceeds from these sales primarily to finance our international expansion outside of Italy through acquisitions. However, should we fail to identify assets that meet the criteria set forth in our investment strategy by the end of 2007, we may use part of the available financial resources to buy back Enel shares in the market.
 
Proposed Acquisition of Endesa
 
Consistent with our objective to become one of the largest electricity companies in Europe, on April 11, 2006, we filed with Spain’s securities regulator, the Comisión Nacional del Mercado de Valores or “CNMV”, a prospectus and related documentation in connection with a joint tender offer we intend to launch with the Spanish company Acciona for 100% of the shares of Spanish utility Endesa. Our proposed offer originally contemplated a price per each Endesa share of €41.3, but in accordance with the terms and conditions of the offer contained in the prospectus we filed with the CNMV, the proposed offer price per share has been reduced to €40.16 to reflect the effect of a dividend payment recently announced by Endesa. The price can be further reduced to reflect the gross effect of any additional Endesa dividends, distributions (including any premiums that Endesa has agreed to pay to its shareholders for attending shareholders’ meetings), splits or share dividends up to the date on which the results of the joint offer are published. The offer price would be payable in cash.
 
Endesa is a limited liability energy company organized under the laws of Spain, with shares traded on the Madrid, Barcelona, Bilbao and Valencia stock exchanges in Spain, on the Santiago Off-Shore Stock Exchange in Chile and on the New York Stock Exchange (where they trade in the form of American Depositary Shares).
 
Based on publicly available information that we have not verified independently, Acciona, our partner in this initiative, is a group active primarily in Spain whose main lines of business include the development and management of infrastructure and real estate projects, transportation services, urban and environmental services, generation of electricity from renewable sources and the development of renewable energy infrastructure.


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The prospectus we filed with the CNMV provides that the joint tender offer would be subject to the following conditions:
 
  •  that the shares of Endesa tendered, together with any shares of Endesa held directly or indirectly by us or Acciona, represent more than 50% of the share capital of Endesa, and
 
  •  that Endesa adopt certain amendments to its bylaws, such as removal of limits on shareholders’ voting rights.
 
In connection with the joint tender offer, we have entered into an agreement with Acciona (together with its wholly controlled subsidiary Finanzas Dos) for the joint control of Endesa, should the joint bid be successful. In this agreement we undertake with Acciona to create a joint-venture holding company to which we would together transfer 50.02% of Endesa’s share capital. The new holding company would be owned 50.01% by Acciona and 49.99% by us. Acciona and we would be entitled to appoint the same number of directors to the boards of both the new holding company and Endesa; the chairmen of both boards would be appointed by Acciona, and the chief executive officers of Endesa would be appointed by us.
 
Our agreement with Acciona also contemplates the integration of Acciona’s and Endesa’s renewable energy assets under a new company (Acciona Energia) in which Acciona would hold at least 51% of the share capital and Endesa the remaining part of the share capital. This new company would have operations in 24 countries and an expected generating capacity from renewable assets of more than 12,000 MW by 2009.
 
In order to finance the joint tender offer described above, our board of directors approved the following transactions:
 
  •  our entry into a €35 billion syndicated term loan facility divided into three tranches with different maturities, subsequently reduced to €30 billion, which contains various covenants and undertakings on our part, including a limit on our consolidated net borrowings as of June 30 and December 31 of any given year equal to 6 times our consolidated EBITDA for the 12-month period ending on that date, and a limit on the financial indebtedness of our subsidiaries equal to 20% of the gross total assets of our Group,
 
  •  renewal of our medium-term notes program with an increase of the principal amount we may issue under it from €10 billion to €25 billion,
 
  •  one or more bond issuances for an aggregate amount of €5 billion, in euros or other currencies, to be placed with institutional investors by December 31, 2007.
 
Endesa’s board of directors has not taken any formal position with regards to our proposed joint tender offer.
 
We expect to move forward with the proposed tender offer when and if it is authorized by the CNMV. However, various factors beyond our control can interfere in this process. We therefore can offer no assurances that the proposed joint tender offer will be successful or executed on the terms currently contemplated.
 
Through our wholly-owned subsidiary Enel Energy Europe S.r.l., we currently hold shares representing 24.97% of the Endesa’s share capital. On April 26, we received the Spanish regulatory authorizations necessary to complete these purchases.
 
Our Dispute with E.On in Connection with its Tender Offer for Endesa
 
On February 21, 2006, E.On AG of Germany announced its intent to make an offer for all the outstanding ordinary shares and ADSs of Endesa. The E.On tender offer was subject to a number of conditions, including receipt of valid tenders for at least 50.01% of Endesa’s share capital.
 
On March 26, 2007, E.On filed a complaint against Enel and Enel Energy Europe with the U.S. District Court for the Southern District of New York alleging violations of U.S. securities laws in connection with our purchase of Endesa shares during the first half of 2007.
 
On April 2, 2007, Acciona and we entered into an agreement with E.On settling all legal disputes with regard to Endesa, including the suit filed with the U.S. District Court for the Southern District of New York. Under this agreement, E.On undertakes not to purchase any of the Endesa shares tendered in response to its offer if shares


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representing less than 50% of Endesa’s share capital were tendered. Under the same agreement, Acciona and we agreed to transfer to E.On:
 
  •  Enel Viesgo Generación S.L., Electra de Viesgo Distribución S.L., Viesgo Energia S.L. and Enel Viesgo Servicios,
 
  •  all of the assets owned by Endesa in Italy, France, Poland and Turkey,
 
  •  certain thermal power plants owned by Endesa in Spain with an aggregate installed capacity of 1,475 MW (equal to approximately 2% of the total installed capacity of Spain),
 
  •  a combined-cycle gas-turbine power plant with 800 MW of installed capacity currently under development, and
 
  •  over 450 MW of nuclear installed capacity to be provided pursuant to a 10-year supply agreement .
 
Our agreement, but not the settlement of the litigation initiated by E.On, is conditioned upon our successful acquisition of at least 50% plus one share of Endesa’s share capital and voting rights exercisable in the shareholders’ meeting, and the power to appoint the majority of the board members of Endesa.
 
On April 10, 2007, E.On announced that its public tender offer had failed and, in accordance with our agreement, waived its right to purchase the 6% of Endesa’s share capital that had been tendered.
 
Business
 
Overview
 
We are the principal electricity operator in Italy, with the leading position in the generation, distribution and sale of electricity. Based on revenues, we were one of the largest industrial companies in Italy in 2006, with operating revenues of €38,513 million (approximately $50,826 million). We earned net income in 2006 of €3,036 million (approximately $4,006 million). We believe that, in terms of the volume of electricity sold in the year 2006, we were one of the largest electric utilities in Europe, and according to Bloomberg, we are also one of the largest publicly traded electric utilities in the world based on market capitalization.
 
The following table shows selected operating data for our electricity and natural gas operations in Italy for each of the past three years. Net production equals gross production of electricity less consumption by units generating electricity and mechanical and electrical losses in production.
 
                         
    2004     2005     2006  
 
Net installed capacity (GW) in Italy at year end
    42.0       42.2       40.5  
Net electricity production in Italy (TWh)
    125.9       112.1       103.9  
Electricity sales to end users in Italy (TWh)(1)
    157.8       148.2       142.7  
Electricity sales on the regulated market in Italy (TWh)
    137.0       129.7       120.4  
Electricity sales on the free market in Italy (TWh)
    20.8       18.5       22.3  
Total electricity distributed in Italy (TWh)(2)
    261.2       259.3       263.4  
Natural gas sales to end users in Italy (billions of cubic meters)
    5.2       5.1       4.5  
Natural gas sales customers in Italy at year end (millions)
    2.0       2.1       2.3  
 
 
(1) Excluding sales to resellers.
 
(2) Including electricity distributed to resellers.


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The following chart sets forth each of our business reporting segments and the main companies that comprise each segment, as well as the country in which each company is incorporated. All subsidiaries in the chart are directly or indirectly wholly-owned by Enel, except in those cases where the chart notes our interest of less than 100%.
 
(GRAPH)


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Corporate
 
Enel S.p.A., as the Parent Company, defines the strategic objectives for the Enel Group and coordinates the activities of all Group companies. In addition, Enel manages finance operations and insurance risk coverage for all Group companies and provides assistance and guidelines on organizational, human resources, industrial relations, accounting, administrative, tax, corporate and legal matters.
 
In addition, Enel S.p.A. is the party that enters into the Group’s long-term contracts for the procurement of electricity outside of Italy. Currently we are party to three such contracts, two with one supplier in France that expire, one in 2007, the other one in 2033, and one with a supplier in Switzerland that expires in 2011. These contracts are for 1,400 MW per year, 600 MW per year and 55 MW per year, respectively. The electricity we purchase under these contracts is generally for import into Italy, which since April 2004 we have been required to sell to the Single Buyer. Recent regulatory changes, however, have made it more difficult for us to import electricity into Italy by terminating priority access rights for the use of transnational transmission lines for the import of electricity under long-term contracts from other EU countries. The electricity that we purchase under these contracts that we are unable to import into Italy we sell outside of Italy, generally at a lower price.
 
In 2006, Enel S.p.A. had revenues, after intra-segment eliminations, of €1,178 million, compared to €1,118 million in 2005.
 
Domestic Generation and Energy Management
 
Our Domestic Generation and Energy Management Division is responsible for our operations relating to the production of electricity and the procurement and trading of fuel for electricity generation, and until the end of 2005, encompassed not only our power generation activities in Italy, but also those abroad. Effective January 1, 2006, our international power-generation operations were allocated to our new International Division.
 
We are the largest producer of electricity in Italy. At December 31, 2006, we had net installed capacity in Italy of approximately 40.5 GW, which, based on data provided by Terna, we estimate to have been approximately 45% of Italy’s total net installed capacity at that date. Our net electricity production in Italy in 2006 was 103.9 TWh, and, based on data provided by Terna, we estimate that our production represented approximately 34% of Italian net production during 2006. Our net production declined by 7.3%, or 8.2 TWh, in 2006 as compared to 2005, due primarily to three factors:
 
  •  government measures intended to limit the use of natural gas in response to the natural gas shortages experienced in the first quarter of 2006, thus reducing the production from our gas-turbine plants,
 
  •  greater flexibility of our coal-fired power plants to respond to market demand, and
 
  •  down-time in the latter part of 2006 at two of our units to enable environmental upgrading.
 
As of December 31, 2006, we had 597 generating plants in Italy, consisting of thermal, hydroelectric, geothermal and other renewable-resource facilities. In 2006, 71.0% of our net production was from thermal plants, 23.6% was from hydroelectric plants and the remaining 5.4% was from geothermal and other renewable-resource plants. We do not own or operate any nuclear plants in Italy.
 
In 2006, the Domestic Generation and Energy Management Division had revenues, after intra-segment eliminations, of €15,661 million. This compares to revenues, after intra-segment eliminations, of €12,995 million in 2005.
 
Domestic Infrastructure and Networks
 
We are the largest electricity distributor in Italy, distributing a total of 255 TWh of electricity in 2006. At December 31, 2006, our Italian distribution network consisted of a total of 1,096,300 kilometers of transmission lines, mostly medium and low voltage, and 415,934 primary and secondary transformer substations, with a total transformer capacity of 166,434 MVA.
 
At December 31, 2006, we offered natural gas distribution services in 1,243 municipalities and distributed natural gas to approximately two million end users. At December 31, 2006, our Italian distribution network


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extended for a total of 31,113 kilometers. In 2006, we distributed 0.412 billion cubic meters of natural gas on behalf of gas companies that are not part of the Enel Group and 3.252 billion cubic meters to end users on behalf of gas companies of the Enel Group.
 
In 2006, our Domestic Infrastructure and Networks Division had revenues, after intra-segment eliminations, of €5,707 million, reflecting revenues after intra-segment eliminations of €5,421 million from electricity distribution and €286 million from natural gas distribution in Italy. In 2005, the Domestic Infrastructure and Networks Division had revenues of €5,532 million, after intra-segment eliminations, reflecting revenues after intra-segment eliminations of €5,231 million from electricity distribution and €301 million from natural gas distribution in Italy.
 
Domestic Sales
 
We are also the largest seller of electricity in Italy. The market for electricity sales in Italy is divided into a regulated market and a free market. Customers in the regulated market must purchase electricity from their local distributor; customers in the free market may choose from whom to purchase their electricity. In 2006, we sold electricity to approximately 23.6 million residential customers, which we estimate represented approximately 86.7% of all residential customers in Italy. In 2006, we distributed and sold approximately 120.4 TWh of electricity on the regulated market, and sold approximately 22.3 TWh of electricity on the free market (including sales to final customers by Enel Trade S.p.A. (“Enel Trade”) of our Domestic Generation and Energy Management Division, which took place during the first quarter of 2006, prior to its transfer to the Domestic Sales Division).
 
We are also active in the sale of natural gas in Italy, which we import from other countries. In 2006, we sold approximately 5.9 billion cubic meters of natural gas to third parties, of which approximately 4.5 billion cubic meters were sold to nearly 2.3 million end users.
 
In 2006, the Domestic Sales Division had revenues, after intra-segment eliminations, of €21,108 million, reflecting revenues after intra-segment eliminations of €19,377 million from electricity sales and €1,731 million from natural gas sales in Italy. In 2005, the Domestic Sales Division had revenues, after intra-segment eliminations, of €19,487 million, reflecting revenues after intra-segment eliminations of €17,913 million from electricity sales and €1,574 million from natural gas sales in Italy.
 
International Division
 
Since January 1, 2006, our international generation, sales and distribution operations have been carried out by our International Division.
 
As of December 31, 2006, we had electricity generation facilities in Slovakia, Spain, Bulgaria, France, and North, South and Central America, with an aggregate net installed capacity of approximately 10.3 GW, and a total net production in 2006 of approximately 27,516 GWh. In 2007, we also acquired a group of wind farms in Greece with an aggregate installed capacity of 127 MW, 43 MW of which are still under construction. Since 2004, we have managed a 900 MW generation plant in Russia. In addition, we recently entered into a joint venture agreement for the construction of two power plants in Belgium with an aggregate installed capacity of 485 MW and won an auction to acquire a 25.03% interest in OGK-5, an 8,700 MW thermal generation company in Russia. In late June 2007, we increased our stake in OGK-5 by 4.96%, bringing our total stake in that company to 29.99%. We are also parties to a non-binding memorandum of understanding with French utility EDF regarding investments in the French electricity market, including a minority investment in EDF’s nuclear reactor project, and a joint venture agreement with Turkish construction company Enka to explore generation, distribution and sales projects in Turkey.
 
We have electricity sales and distribution operations in Spain and Romania and, on June 21, 2006, we indirectly acquired a 49.5% interest in RusEnergoSbyt, an electricity sales company in Russia. In 2006, our International Division distributed 12.6 TWh and sold 17.2 TWh of electricity.
 
In 2006, the International Division had revenues, after intra-segment eliminations, of €3,068 million, compared to €1,858 million in 2005.


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Services and Other Activities
 
Following the corporate reorganization that took place at year-end 2005, all intra-Group services, including real estate, information technology, personnel training and administration, factoring and insurance services, are classified under Services and Other Activities for segment reporting purposes. However, management does not consider these services to be a separate division, since their focus is on supporting the activities of Group companies. In 2006, Services and Other Activities had revenues of €1,161 million, compared to €1,741 million in 2005.
 
On January 1, 2006, the engineering, procurement and construction activities relating to the operations of our Domestic Generation and Energy Management Division, which, for reporting purposes, had been classified during 2005 under Services and Other Activities, were transferred to our Domestic Generation and Energy Management Division.
 
Strategy
 
In 2006, we completed the process of refocusing our strategy on our core energy businesses. We believe that we are strongly positioned in the energy business and aim to become a leading integrated operator in the European electricity and natural gas market through improved efficiency and new acquisitions.
 
Our principal strategic objectives are to:
 
  •  consolidate our leadership in the Italian electricity market despite the challenges posed by the market’s liberalization, which is expected to be completed by July 2007,
 
  •  reduce our per-customer costs through investments that will enhance the efficiency of the services we provide, without sacrificing their quality,
 
  •  expand our activities in Europe and increase our presence in the field of power generation from renewable sources in the rest of the world through investments and acquisitions, and
 
  •  consolidate our lead in the use of advanced and environmentally-friendly technologies in the generation and distribution of electricity.
 
In order to pursue the Group’s overall objectives, each of our divisions has its own set of specific strategies, as described below.
 
Domestic Generation and Energy Management Division
 
As a result of the progressive liberalization of the Italian electricity market and the required sale of a portion of our generation capacity, we estimate, based on data provided by Terna, that our share of the power generation market in Italy has declined from approximately 63% in 1999 to approximately 34% in 2006.
 
In order to maintain profitability and provide services on competitive terms, our Domestic Generation and Energy Management Division seeks to be the lowest-cost generator of electricity in Italy, particularly by appropriately diversifying its use of fuels. In this respect, we have reduced the percentage of our total production that we generate through plants fueled by oil and natural gas (excluding natural gas-fueled plants that use CCGT technology) from approximately 45% in 2002 to approximately 25% in 2006. At the same time, we have increased the percentage of electricity we generate through thermal plants fired by coal and orimulsion from approximately 22% in 2002 to approximately 27% in 2006 (we do not currently generate any electricity using orimulsion, but we did in 2002). We have also increased the percentage of electricity we generate through renewable resources from approximately 24% in 2002 to approximately 29% in 2006 and the electricity we generate from CCGT technology from approximately 9% in 2002 to approximately 19% in 2006. Our aim is to generate approximately 30% of our overall electricity output using renewable resources.
 
In order to implement its strategy, our Domestic Generation and Energy Management Division intends to:
 
  •  continue its program to convert certain of our thermal generation plants to CCGT plants capable of generating approximately 5,000 MW. To date, the Domestic Generation and Energy Management Division


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  has completed the conversion of approximately 4,600 MW and plans to continue the CCGT conversion program at the Termini Imerese power plant,
 
  •  upgrade additional plants to run on lower-cost fuels, such as coal, while still respecting environmental norms,
 
  •  consolidate its position in the field of renewable energy, including through an investment program expected to total approximately €1.65 billion from 2007 through 2011. This program includes plans for the maintenance, refurbishment and construction of wind, hydroelectric and geothermal generation plants in Italy that we expect will result in 400 MW of additional net installed capacity,
 
  •  reduce CO2 emissions through our integrated investment strategy, which contemplates the conversion of old oil-fired plants into CCGT and high-efficiency coal plants, and the enhancement of our renewable generation capacity, as well as procurement of CO2 credits by participating in emission reduction projects under the terms of the Kyoto Protocol (Clean Development Mechanism and Joint Implementation projects),
 
  •  continually seek to achieve operating excellence by increasing the efficiency and availability of its plants and respecting the environment and the health and safety of its employees,
 
  •  continue its efforts to reduce its operating and maintenance expenses until it attains international best-practice levels; and
 
  •  optimize its fuel procurement activities, through a diversification of suppliers and supply channels.
 
Domestic Infrastructure and Networks Division
 
Electricity distribution.  We estimate that we currently distribute through our network more than 80% of the electricity distributed in Italy (which does not include electricity flowing through the transmission grid). The overall goal of electricity-distribution operations is to meet the challenges resulting form the market liberalization and the changes in tariff regimes by reducing the costs we incur in distributing electricity, in particular our cash cost per customer, as well as by continuing to focus on the quality of service we provide. In particular, we intend to:
 
  •  continue our program to reduce operating costs by seeking to streamline our administrative processes and to increase our use of technology to support our activities,
 
  •  optimize our investment expenditures by seeking to tighten the financial criteria by which we evaluate our investments,
 
  •  continue to improve our performance with respect to the targets set by the Energy Authority for quality and continuity of service in those geographic areas where these targets have not yet been achieved, and to maintain the quality and continuity of service where they have been achieved or exceeded, and
 
  •  complete the rollout of our “Telemanagement” digital metering program in Italy by the end of 2007, in order to:
 
  •  reduce costs associated with physical measurement of consumption and on-site maintenance of meters by our personnel, as these tasks would be accomplished remotely,
 
  •  measure the electricity consumption of our customers more accurately,
 
  •  improve our response times in providing technical assistance to our customers and provide higher quality service, and
 
  •  offer our customers tailored tariff plans that promote the use of electricity in off-peak periods and provide customers with opportunities to save money.
 
In March 2004, we entered into an agreement with IBM to commercialize our digital metering know-how for use by other utilities in Italy and abroad, in an effort to benefit further from the digital metering program. As of December 31, 2006, we had installed approximately 29.8 million digital meters, of which approximately 28.9 million were connected to our remote network.


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Gas distribution.  In our natural gas distribution business, our primary objective is to operate as efficiently as possible and consolidate our market position, through both bidding on new gas distribution concessions and, where appropriate, acquiring additional gas distribution companies, particularly where there are opportunities for significant synergies with our existing operations. By controlling costs and increasing our customer base, we expect to reduce further our distribution cash cost per customer.
 
Domestic Sales Division
 
As a result of the liberalization process, based on data from Terna and from the GRTN (for the years before 2005), we have seen our market share in direct sales of electricity to end users in Italy decline from approximately 92% in 1999 to approximately 45% in 2006.
 
Our strategy to counter the effects of this trend is to continue to improve the quality of our service and our cost-containment policies, increase our focus on small business clients and leverage our brand to target customers who elect to participate in the free market.
 
In our natural gas sales business, we intend to increase our market share and margins by selectively expanding our customer base and by increasing the volume of natural gas we sell. We seek to increase our customer base and to retain customers who elect to participate in the free market through initiatives targeting residential and medium-size customers, including “dual fuel” offers in which we provide electricity and gas service through one sales network, with one customer service department and one bill, and offers tailored to customers. We also aim to lower the costs we incur in serving our customers.
 
International Operations
 
Consistent with our objective to become one of the largest electricity companies in Europe, our goal is to continue to expand and strengthen our operations outside of Italy by solidifying our presence in our existing markets (such as Spain, Slovakia, Romania, Bulgaria, France, Russia and the Americas), and by exploring new opportunities in other markets (such as in Central and Eastern Europe).
 
In particular, our strategy in markets where we already have a presence is the following:
 
Iberian Peninsula.  The Spanish electricity market is particularly important for us, since the demand for electricity in Spain is expected to grow at a higher rate than in other European markets, and we are already present in Spain through our Spanish subsidiaries Enel Viesgo Generación (electricity generation), Electra de Viesgo Distribución (electricity distribution) and our affiliate EUFR (electricity generation from renewable resources). We intend to develop our ability to generate electricity from renewable resources and convert certain coal and gas/oil-fired units into CCGT and more environmentally-friendly technologies. Moreover, by 2009, we intend to install a Telemanagement digital meter system in Spain similar to the system we are completing in Italy. Please see “— The Enel Group — Distribution of Electricity — Telemanagement Systems” for a description of our Telemanagement digital meter system in Italy.
 
Central and Western Europe:
 
  •  Slovakia.  We are interested in the Slovakian electricity market due to its strong interconnection with other Central European markets. We already have a strong presence in the Slovakian electricity market through SE, and we will monitor further opportunities that may arise. We also plan to upgrade SE’s existing nuclear plants and to invest in renewable resources. We intend to build two additional nuclear units for SE by 2013.
 
  •  France.  We took our first step into the French market in 2005, when we signed a non-binding memorandum of understanding with EDF regarding investments in the French electricity market and, in particular, the European pressurized nuclear reactor project. In July 2006, we also acquired Erelis S.a.s., a company promoting wind energy projects with a project portfolio amounting to 500 MW (now Enel Erelis).
 
South Eastern Europe.  The electricity market in South Eastern Europe is particularly attractive because of its expected growth, its strategic location with respect to Italy and its ongoing privatization and liberalization process.


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  •  Romania.  We are already present in Romania through Enel Electrica Banat (formerly Electrica Banat) and Enel Electrica Dobrogea (formerly Electrica Dobrogea), two distribution companies in which we acquired a 51% stake in 2005, and in which we are introducing management know-how and standards that we believe are in line with Western European best practices. Moreover, upon completion of our acquisition of Muntenia Sud in the second half of 2007, through which we expect to serve approximately 2.5 million customers, we would become a leading operator in electricity distribution and supply in Romania.
 
  •  Bulgaria.  In Bulgaria, we have increased our stake in Maritza East III to 73% and have signed a memorandum of understanding with our partner Nek for a preliminary study on the feasibility of an upgrade of the Maritza plant to increase its aggregate net installed capacity by 640 MW.
 
  •  Other regions.  We are exploring potential opportunities in generation and power distribution.
 
Russia.  In partnership with Eni S.p.A, we recently acquired from Yukos a business unit for exploration and production of gas and petroleum in Russia. We also recently won an auction to acquire a 25.03% stake in JCS Fifth Generation Company of the Wholesale Electricity Market or OGK-5, a wholesale generation company in Russia with four thermal power plants with an aggregate installed capacity of approximately 8,700 MW. We subsequently increased our stake in OGK-5 by 4.96%, bringing our total stake in that company to 29.99%. Further opportunities may arise from the privatization process of thermal generation assets.
 
The Americas.  We are present in North America through Enel North America, and in Central and South America through Enel Latin America. We intend to grow our operations in these regions, particularly in the renewable-resource market through the acquisition and development of hydroelectric, wind and geothermal generation plants.
 
Italian Electricity Demand
 
Demand for electricity in Italy has grown at an average annual rate of approximately 2.1% during the past five years. The following table shows the annual rate of growth in Italy’s GDP in real terms and the annual rate of growth in electricity demand for the years indicated.
 
                                                 
                                  Average Annual
 
                                  Growth Rate
 
    2002     2003     2004     2005     2006(1)     2001-2006  
 
Growth in real GDP(1)
    0.4 %     0.3 %     1.2 %     0.0 %     1.9 %     0.76 %
Growth in electricity demand(2)
    1.9 %     3.2 %     1.5 %     1.3 %     2.2 %     2.08 %
 
 
Sources:
 
(1) National Institute of Statistics (Istituto Nazionale di Statistica).
 
(2) Terna (data for the years before 2006 were provided by the GRTN). Data for 2006 are provisional.
 
Growth in demand for electricity is determined by a variety of factors, including the rate of economic growth, the level of business activity and weather conditions. According to data published in June 2007 by the Italian National Institute of Statistics, Italian GDP increased by 0.3% in the first quarter of 2007 as compared to the fourth quarter of 2006, and by 2.3% as compared to the first quarter of 2006.


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Per capita electricity consumption is lower in Italy than in a number of other leading industrialized countries. On the basis of data from the GRTN (now the Gestore dei Servizi Elettrici or GSE), we calculate that in 2005, the most recent year for which such data is available, electricity consumption in Italy was approximately 5,286 kWh per capita, compared to 5,236 kWh in 2004. As differences in the industrial/commercial and service sectors among countries not related to individual electricity use can distort comparisons of overall per capita consumption, we prefer to use per capita residential electricity use as our basic comparative measure. The following table compares per capita residential electricity consumption in Italy with that of other countries in the European Union for 2005, the most recent year for which complete data is available.
 
                         
                Per Capita
 
          Residential
    Residential
 
    Inhabitants     Consumption     Consumption  
    (In millions)     (TWh)     (KWh per person)  
 
France
    60.8       150.2       2,472  
United Kingdom
    60.0       120.0       2,000  
Germany
    82.6       140.8       1,705  
Spain
    43.4       60.6       1,397  
Italy
    57.6       68.0       1,180  
European Union(25)
    459.5       783.3       1,705  
 
 
Source: Enel, based on data established by Enerdata: World Energy database, April 2007.
 
We believe that a reason per capita residential electricity consumption is lower in Italy than in the other countries of the European Union indicated in the table above is that in the past the tariff structure established by government regulation in Italy discouraged high-volume residential use. Please see “— Regulatory Matters — Electricity Regulation — The Tariff Structure” for a discussion of the current tariff structure.
 
The Italian Power Exchange
 
On April 1, 2004, a new pool market for the trading of electricity, the Italian power exchange, became operational as part of the continuing liberalization of the Italian electricity market. Under the new system, generation companies may sell their electricity on the Italian power exchange or through bilateral contracts with other market participants. In addition, as part of the new system, the Single Buyer, a company wholly-owned by the GRTN (now the Gestore dei Servizi Elettrici or GSE), is responsible for ensuring the supply of electricity to customers who purchase their electricity on the regulated market. As a result, our generation companies are now required to sell electricity destined for regulated customers to the Single Buyer, and our distribution companies are now required to purchase electricity to be distributed and sold on the regulated market from the Single Buyer. Please see ‘‘— Regulatory Matters — Electricity Regulation — The Italian Power Exchange” and “— Regulatory Matters — Electricity Regulation — The Single Buyer” for additional information.
 
The Enel Group
 
Domestic Generation and Energy Management
 
This division is responsible for:
 
  •  electricity generation, primarily through our wholly-owned subsidiary Enel Produzione, the division’s lead company and our generating company in Italy (in 2005 Enel Green Power was merged into Enel Produzione),
 
  •  the purchase of fuel for all of our generation operations, which is carried out by Enel Trade,
 
  •  the sale of electricity to wholesalers, which is carried out by Enel Trade,
 
  •  the sale of natural gas to gas distribution companies, which is carried out by Enel Trade,
 
  •  fuel trading, which is carried out by Enel Trade,


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  •  commodity risk management for all Group companies in Italy and abroad, which is carried out by Enel Trade,
 
  •  emission trading, which is carried out by Enel Trade,
 
  •  engineering, procurement and construction activities for all Group companies, a task that this division assumed from Service and Other Activities on January 1, 2006, and
 
  •  research and development, mainly through Enel Produzione.
 
Until April 2006, the Domestic Generation and Energy Management Division was also responsible for sales of electricity to customers with annual consumption higher than 100 GWh, an activity which is now carried out by our Domestic Sales Division, and, until December 2005, for our international generation operations, which now fall under the purview of our International Division.
 
Our research and development expenditures in 2006 were approximately €22 million, a slight increase with respect to the €20 million we spent in 2005. As part of R&D activities, we develop new products and processes internally and also acquire technology in the market, which we then customize for our own purposes. The objectives of our research and development are to:
 
  •  improve the efficiency and capacity of our core energy operations, particularly by improving the efficiency of our generation plants and distribution networks,
 
  •  reduce the environmental impact of our operations, particularly of electricity generation, by developing alternative fuels and innovative technologies, including hydrogen and high temperature solar technologies, and
 
  •  expand and make more innovative the services we offer.
 
Generating Facilities
 
As of December 31, 2006, Enel Produzione operated a total of 597 generating plants. Our Italian generating facilities include:
 
  •  thermal plants (which burn fossil fuels),
 
  •  hydroelectric plants, and
 
  •  geothermal plants, wind farms and other facilities that generate electricity from renewable resources.
 
As of December 31, 2006, these plants had a total net installed capacity of 40.5 GW, representing approximately 45% of Italy’s total net installed capacity. Our net electricity production in 2006 decreased by 7.3% to 103.9 TWh from 112.1 TWh in 2005. We estimate that our net electricity production in 2006 represented approximately 34% of total electricity production in Italy during that year, compared to 39% in 2005.
 
The following table shows data on electricity production and demand in Italy during 2004, 2005 and 2006.
 
                         
    2004     2005     2006(4)  
    (In GWh)     (In GWh)     (In GWh)  
 
Thermal
    246,125       253,072       263,252  
Hydroelectric
    49,908       42,929       43,022  
Geothermal and other renewable
    7,288       7,671       8,742  
                         
Total gross electricity production in Italy
    303,321       303,672       315,016  
Power used by auxiliary installations(1)
    (13,299 )     (13,064 )     (13,290 )
                         
Total net electricity production in Italy
    290,022       290,608       301,726  
                         
Net electricity imports(2)
    45,635       49,155       44,718  
Total pumped storage consumption(3)
    (10,300 )     (9,319 )     (8,648 )
                         
Total electricity demand in Italy
    325,357       330,444       337,796  
                         


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(1) Refers to the electricity consumed by auxiliary installations of generating plants.
 
(2) Imports consist of electricity purchased from foreign producers on the spot market or under annual or long-term contracts.
 
(3) Refers to the use of electricity by pumped-storage hydroelectric plants to pump water to elevated areas for use at a later time to generate electricity.
 
(4) Data for 2006 are provisional.
 
Source:  Terna (data for the years before 2005 were provided by the GRTN).
 
The following table shows data on our domestic generating facilities.
 
                                         
    At December 31, 2006     For Year Ended, December 31, 2006  
    Net
    Weighted
          Percentage
    Forced
 
    Installed
    Average Age
    Net
    of Our Net
    Outage
 
    Capacity     of Plant(1)     Production     Production     Factor(2)  
    (GW)     (Years)     (GWh)     (Percent)  
 
Thermal
    25.1       19       73,842       71.1       2.3  
Hydroelectric
    14.4       44       24,475       23.6       2.9  
Geothermal and other renewable
    1.0       8       5,593       5.4       1.5  
                                         
Total
    40.5               103,910       100.0          
                                         
 
 
(1) The weighted average age of the plants does not take into account refurbishments or upgrades after initial construction, but does reflect the effects of the refurbishing of geothermal plants, the conversion of thermal plants into CCGT plants and the conversion of one coal unit to clean coal technology that we completed in 2005.
 
(2) The forced outage factor represents the amount of electricity that was not produced during the period because of unplanned outages, expressed as a percentage of the maximum theoretical amount of electricity that could have been produced during the period.
 
The following table provides a breakdown of our net electricity production in Italy for the periods indicated.
 
                                                 
    2004     2005     2006  
    Net
          Net
          Net
       
    Electricity
    Percentage
    Electricity
    Percentage
    Electricity
    Percentage
 
    Produced     of Total     Produced     of Total     Produced     of Total  
    (TWh)           (TWh)           (TWh)        
 
Thermal:
                                               
Natural gas
    40.6       32.3       37.8       33.7       32.4       31.2  
Coal and orimulsion(1)
    30.7       24.4       30.0       26.8       27.9       26.8  
Oil
    20.5       16.3       14.0       12.5       13.5       13.0  
                                                 
Total thermal
    91.8       73.0       81.8       73.0       73.8       71.0  
Hydroelectric
    28.7       22.8       24.9       22.2       24.5       23.6  
Geothermal
    5.1       4.1       5.0       4.5       5.2       5.0  
Wind and solar
    0.24       0.2       0.37       0.3       0.4       0.4  
                                                 
Total
    125.9       100.0       112.1       100.0       103.9       100.0  
                                                 
 
 
(1) We do not currently generate any electricity using orimulsion.
 
In the near term, we have no plans to construct new plants or add significant amounts of generating capacity in Italy, other than from renewable resources. Instead, we have focused our investment plans on our existing generating plants. Please see “— History and Development of the Company — Capital Investment Program — Domestic Generation and Energy Management” for a more detailed discussion of these plans.


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Thermal Production
 
At December 31, 2006, we owned 43 thermal plants in Italy, with an aggregate net installed capacity of approximately 25.1 GW, or 62.1% of our net installed capacity in Italy at that date. In 2006, our net production from thermal plants in Italy was approximately 73,842 GWh, as compared to 81,823 GWh in 2005, representing 71.0% of our net production in Italy for that year.
 
All our thermal plants consist of two or more generating units and most have a standardized design, with the generating units being of one of three types: steam-condensing units, gas turbine units and internal combustion units. Steam-condensing units consist of closed-cycle plants in which water is transformed into steam and used to drive a turbine to generate electricity. Steam is turned back into water through a cooling process using sea or river water or air tower cooling. Gas-turbine units burn natural gas and diesel fuel to drive a turbine that generates electricity. Internal combustion units use diesel engines to generate electricity. In addition to these conventional thermal plants, we own plants with CCGT gas turbines. At December 31, 2006, we derived approximately 71% of the net installed capacity of our thermal plants from steam-condensing units, approximately 26% from CCGT units, approximately 3% from gas-turbine units in repowered steam plants and less than 1% from gas-turbine units in open cycle. Internal combustion units represented a minimal part of our thermal gross installed capacity.
 
Each of our thermal generating units is designed to operate using one or more kinds of fuel:
 
  •  Single fuel units use either natural gas, petroleum products or coal,
 
  •  Dual fuel units use petroleum products and either natural gas or coal, and
 
  •  Triple fuel units use petroleum products, coal and natural gas.
 
As of December 31, 2006, the average thermal efficiency, or the ratio of useful energy produced to the energy consumed to produce it, of our thermal plants (including our CCGT plants) was 38.7%, in line with the ratio in 2005.
 
In 1997, we initiated a program to convert our conventional thermal plants into CCGT plants in order to increase their efficiency and reduce their emissions. Since then we have converted plants with an aggregate generating capacity of approximately 4,600 MW, and we expect to convert an additional 375 MW of capacity by the end of 2007. The conversion is typically performed by installing one or more gas turbines and replacing conventional boilers with heat recovery steam boilers that use the recovered heat to boil water, which is then used to drive existing steam turbines. We estimate the average costs of conversion to be approximately €350,000 per MW of net installed capacity, which amounts to approximately €1,700 million as of December 31, 2006. Our CCGT plants have an average thermal efficiency of approximately 53%.
 
In addition to our CCGT conversion program, we have also initiated a program to upgrade certain of our plants into clean-burning coal technology. To date we have completed this upgrade at our Sulcis power plant and are planning to upgrade additional plants with an aggregate net installed capacity of approximately 3,800 MW by:
 
  •  converting three units at our fuel-oil plant at Torrevaldaliga Nord (accounting for approximately 1,900 MW), a process that is in progress and that we expect to complete between 2008 and 2009, and
 
  •  subject to receipt of required permits, converting an additional three units to clean coal technology (accounting for approximately an additional 1,900 MW).
 
Since 1990, we have also made significant investments to improve the environmental standards of our thermal plants and to comply with the emission thresholds established by applicable environmental laws and regulations. These measures have included installing desulphurization and denitrogenation units and upgrading burners and units for the treatment of waste water and ash resulting from the electricity generation process. Installation of desulphurization and denitrogenation units increases our flexibility to use different types of fuel, including lower-cost fuels such as high sulfur fuel oil, while maintaining compliance with emission restrictions. Our capital expenditures in connection with environmental improvements to our plants amounted to approximately €75 million in 2006, compared to approximately €35 million in 2005.
 
The Kyoto Protocol established a market mechanism for the trading of CO2 emission rights. Pursuant to EU directives implementing this mechanism, the Italian Environment Ministry issued a decree in February 2006


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allocating emission rights among Italian producers for the 2005-2007 period. Enel Produzione was assigned emissions quotas of 48.2 million, 41.2 million and 42.4 million metric tons of CO2 for the years 2005, 2006, 2007, respectively. Our emissions for 2005 and 2006 were, respectively, 8.0 million tons and 9.9 million tons higher than the emission quotas we were assigned for the same years. To cover this excess we were required to purchase emission trading rights in the market for an aggregate amount of €253 million in 2005 and 2006.
 
As reported in a release by the European Commission published in May 2006, in 2005, emissions of CO2 by the European industries subject to the emission trading system were generally below the assigned emission quotas. This phenomenon was primarily due to an over-allocation of emission quotas rather than to an actual reduction of CO2 emissions. Since May 2006, the oversupply of CO2 emission rights in the system prompted a collapse in the price of CO2 credits.
 
Hydroelectric Production
 
As of December 31, 2006, we had 500 hydroelectric plants in Italy with an aggregate net installed capacity of approximately 14.4 GW, or 35.5% of our net installed capacity in Italy at that date. In 2006, our hydroelectric net production in Italy was approximately 24,475 GWh, or 23.6% of our net production in Italy for the year, as compared to 24,883 GWh, or 22.2% of our net production in Italy, during 2005.
 
Our hydroelectric plants fall into one of three categories:
 
  •  Pondage or reservoir plants, in which the altitude difference through which water must fall to drive the generating turbines results from the creation of a reservoir. Pondage plants are those for which it takes up to 400 hours to fill the reservoir from empty based on normal water flow, while reservoir plants are those in which it takes longer than 400 hours.
 
  •  At December 31, 2006, we had pondage plants in Italy with an aggregate net installed capacity equal to approximately 19.8% of our net installed hydroelectric generation capacity in Italy at that date, which generated approximately 24.3% of our net hydroelectric production in Italy during 2006.
 
  •  At December 31, 2006, we had reservoir plants in Italy with an aggregate net installed capacity equal to approximately 16.7% of our net installed hydroelectric generation capacity in Italy at that date, which generated approximately 24.8% of our net hydroelectric production in Italy during 2006.
 
  •  Pumped storage plants, in which water is pumped up to storage units to create the required altitude difference through which water must fall to drive the generating turbines.
 
  •  At December 31, 2006, we had pumped storage plants in Italy with an aggregate net installed capacity equal to approximately 52.0% of our net installed hydroelectric generation capacity in Italy at that date, which generated approximately 25.5% of our net hydroelectric production in Italy during 2006.
 
  •  Run-of-river plants, in which the natural flow of a river is used to drive the generating turbines.
 
  •  At December 31, 2006, we had run-of-river plants in Italy with an aggregate net installed capacity equal to approximately 11.5% of our net installed hydroelectric generating capacity in Italy at that date, which generated approximately 25.4% of our net hydroelectric production in Italy during 2006.
 
In 2006, we invested €130 million on our hydroelectric plants, including amounts spent on work carried out to comply with safety and environmental regulations, as well as on refurbishment and revamping, compared to €178 million in 2005.
 
Our hydroelectric plants generate electricity from water streams in the public domain under licenses from the Italian government. Under the Bersani Decree, the Provincial Authorities of Trento and Bolzano, which enjoy special autonomous status under Italian law, were entitled to impose earlier license termination dates for hydroelectric plants in these areas. The authorities of both Trento and Bolzano set a termination date of 2010 for their respective licenses, while licenses granted by the Italian government are due to expire in 2029. If our licenses in Trento and Bolzano are not renewed upon their expiration, we will have to transfer the affected hydroelectric plants (with an aggregate net installed capacity of approximately 2 GW, or approximately 5% of our current total net installed capacity) to the respective provincial authorities. Please see “Item 3. Key Information —


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Risk Factors — Risks Related to Our Energy Businesses — We operate our Italian electricity and gas distribution networks and hydroelectric plants under government concessions. Non-renewal of these concessions upon their expiration, and, in certain cases, the possible acceleration of their expiration date, could adversely affect our business, result of operations and financial condition.”
 
Production from Geothermal and Other Renewable Resources
 
At December 31, 2006, we had in Italy:
 
  •  31 geothermal power plants, which generate energy from naturally occurring subterranean heat sources, with an aggregate net installed capacity of approximately 671 MW, and which generated approximately 5,195 GWh in 2006,
 
  •  19 wind farms, which use the natural flow of the wind to drive the generating turbines, with an aggregate net installed capacity of approximately 305 MW, and which generated approximately 398 GWh in 2006, and
 
  •  4 solar photovoltaic power plants, which use solar energy to generate steam that is then used to drive the turbines, with an aggregate net installed capacity of approximately 3 MW, and which generated approximately 0.5 GWh in 2006.
 
Part of our revenues from renewable energy come from sale agreements entered into under the CIP 6 regime, which provides temporary incentives for the production of energy from renewable sources (including energy produced by small hydroelectric plants). Please see “— Regulatory Matters — Electricity Regulation — Promotion of Renewable Resources” for a description of the CIP 6 regime. The portion of our revenues deriving from CIP 6 regime continues to decline as these incentives expire.
 
To comply with current regulations requiring producers to supply a specified amount of electricity generated from qualifying renewable resources, we can either produce electricity from qualified renewable resources ourselves, which would entitle us to receive “green certificates,” or we can purchase “green certificates” through Enel Trade from other qualified producers or GSE. Based on our production for 2005, we were required to provide approximately 2.2 TWh of electricity from qualified renewable resources in 2006. During that year, we generated 1.8 TWh of energy from qualified renewable resources and purchased “green certificates” for the remaining 0.4 TWh, at a cost of approximately €56 million. We estimate that, in 2007, we will increase our generation from qualified renewable resources significantly, thus reducing the amount of green certificates we will have to purchase from other qualified producers or from GSE in order to comply with the regulatory requirements.
 
Part of our capital investment program is aimed at reaching a level of qualifying production from renewable resources of approximately 2.7 TWh by year-end 2008, which we believe would permit us to meet regulatory requirements. This program is expected to result in an additional increase in our renewable capacity (hydroelectric, wind and geothermal) of about 400 MW by 2011.
 
Fuel
 
In 2006, approximately 44% of net electricity generated by our thermal plants in Italy was produced through the use of natural gas, 38% through the use of coal and 18% through the use of fuel oil. We do not currently generate any electricity using orimulsion. We do not use significant amounts of fuel in operating our hydroelectric, geothermal or other renewable resource plants. Italy has small reserves of fossil fuels. As a consequence, we depend on imported fuel oil, natural gas and coal for a large proportion of our energy needs.
 
Our fuel costs are influenced by prices in the world market for oil, fuel oil, natural gas and coal. In 2006, the average per barrel market price for Brent crude oil increased approximately 20%, from $54.4 in 2005 to $65.1 in 2006. The sharp fluctuations in the price of oil result from a variety of factors, including geopolitical conditions, stockpiles and weather conditions, which are beyond our control. We seek to mitigate the effects of such fluctuations on our business by diversifying our sources of fuel and by partially hedging against rising fuel prices. Please see “Item 3. Key Information — Risk Factors — Risks Relating to our Energy Business — Significant increases in fuel prices or disruptions in our fuel supplies could have a material adverse effect on our business” for a


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description of the risks connected to significant increases in fuel prices. See also “Item 11. Quantitative and Qualitative Disclosure about Market Risk” for a discussion of our hedging activities.
 
In addition, we seek to increase our use of less expensive fuels, such as coal, as well as fuels that have less impact on the environment when consumed, such as natural gas. However, electricity generation using coal generally results in higher emissions levels compared to natural gas. Our ability to increase our use of coal is thus dependent on our ability to acquire and implement technologies that will permit us to comply with restrictions on emissions established by national and European Union authorities. Please see ‘‘— Regulatory Matters — Environmental Matters” for a discussion of these restrictions.
 
We manage our fuel supply by entering into term contracts for base quantities and supplementing these contracts with purchases of fuel on spot markets both in Italy and abroad. Our long-term fuel contracts, primarily for the purchase of natural gas, will require us to pay an average of approximately €2,667 million per year over the next five years, based on current prices. Please also see “Item 5. Operating and Financial Review and Prospects — Contractual Obligations and Commitments.”
 
In 2006, our aggregate fuel costs for thermal production, including fuel transport, at our plants in Italy and abroad were €4,086 million, compared to €3,910 million in 2005. This 4.5% increase was primarily due to higher prices in the international fuel markets, the effect of which was only partially offset by the lower volume of electricity production during 2006.
 
Our wholly-owned subsidiary Enel Trade is responsible for the purchase and sale of fuel for all of our domestic generating operations, as well as a portion of the fuel requirements of our Spanish subsidiary Viesgo, and has land and sea fuel shipping operations. As part of its management of, and efforts to optimize, its supply of fuel to the rest of the Group, Enel Trade also engages in fuel trading activities. In 2006, Enel Trade purchased an aggregate volume of 23.3 million tons of oil and oil equivalents, including petroleum products, coal and natural gas, of which 1.2 million tons were sold to third parties, compared to purchases of 24.3 million tons of oil and oil equivalents in 2005, of which 1.6 million tons were sold to third parties. For additional information on our trading activities, please see “Item 11. Quantitative and Qualitative Disclosure about Market Risk.”
 
Fuel Oil
 
As a result of the conversions of some of our fuel-fired plants to coal and natural gas, our reliance on fuel oil for power generation is decreasing. Nonetheless, due to government measures intended to limit the use of natural gas in response to the natural gas shortages experienced in the first quarter of 2006, the amount of fuel oil we consumed in 2006 was in line with 2005.
 
In 2006, we purchased approximately 68% of our fuel oil on the spot market and approximately 32% under contracts ranging in term from one to twelve months. All purchases made on the basis of term contracts were indexed to market prices.
 
The following table shows the amount of fuel oil supplied to our generation companies by domestic and foreign suppliers.
 
                         
    Year Ended
 
    December 31,  
    2004     2005     2006  
    (In millions of tons)  
 
Domestic suppliers(1)
    1.0       0.9       0.7  
Foreign suppliers(2)
    3.8       2.7       3.0  
                         
Total fuel oil purchased
    4.8       3.6       3.7  
                         
 
 
(1) Domestic suppliers are suppliers whose headquarters are in Italy, including the Italian energy group Eni S.p.A.
 
(2) Foreign suppliers are suppliers and refiners outside of Italy and traders of primarily non-Italian sources of oil.


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The following table shows the amounts of fuel oil with low, mid and high sulfur content that we purchased in each of the periods indicated.
 
                         
    Year Ended
 
    December 31,  
    2004     2005     2006  
    (In millions of tons)  
 
Low sulfur oil
    3.0       2.3       2.2  
Mid sulfur oil
    1.6       1.0       1.3  
High sulfur oil
    0.2       0.3       0.2  
                         
Total
    4.8       3.6       3.7  
                         
 
Natural Gas
 
We purchase most of our natural gas under long-term, take-or-pay contracts. The price of natural gas under these contracts is generally tied to market prices for fuel oil. In 2006, we purchased 13.8 billion cubic meters of natural gas, of which 7.5 billion cubic meters were used for our thermal generation operations, 4.6 billion cubic meters were used by our gas distribution and sales operations and 1.4 billion cubic meters were sold to third parties.
 
During 2006, we procured our natural gas from the following sources:
 
  •  approximately 41% from Sonatrach, the Algerian gas producer,
 
  •  approximately 26% from Eni, the main Italian gas supplier and transporter,
 
  •  approximately 27% of the natural gas we purchased in 2006 pursuant to our gas contract with NLNG, as described below:
 
  •  In 1992, we entered into a 20-year take-or-pay contract with NLNG, a Nigerian joint venture, for the supply of 3.5 billion cubic meters of liquefied natural gas per year, commencing in October 1999. However, due to environmental concerns, a once-planned Italian regasification facility has never been constructed. As a result, we are unable to import liquefied natural gas, and instead, in 1997, entered into a swap agreement with Gaz de France and related transportation arrangements with Eni whereby Gaz de France takes the liquefied natural gas supplied by NLNG under the contract and provides us with an equivalent volume of non-liquefied natural gas. Under current regulations, we expect to continue to receive reimbursements for part of our stranded costs incurred in connection with the NLNG contract until 2009. Please see “— Regulatory Matters — Electricity Regulation — Stranded Costs” for additional information on reimbursements of our stranded costs.
 
  •  approximately 4% from Edison S.p.A., an Italian gas and electricity company, and
 
  •  approximately 2% on the Italian and international spot markets.
 
On June 21, 2005, we sold to BG Group plc (formerly British Gas plc) (“BG”) our 50% interest in Brindisi LNG, which we had formed as a partnership with BG to build and manage a liquefied natural gas regasification terminal in Brindisi in southern Italy. Under the terms of the deal, we were entitled to receive €44 million, which was intended to reimburse us for the costs we incurred for the project. Of the total consideration, we received €17 million at closing in 2005 and the balance of approximately €27 million in 2006.
 
Coal
 
In 2006, we purchased 11.8 million tons of coal, compared to 12.8 million tons in 2005, all of which was used by our generating companies and imported, principally from South Africa, South America, the Far East and Eastern Europe.


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Energy Purchase, Sales and Trading
 
The Domestic Generation and Energy Management Division, through Enel Trade, purchases electricity to diversify our sources of electricity, reduce our costs and sell to third parties. In addition, since April 1, 2004, our Domestic Generation and Energy Management Division, through Enel Produzione, purchases electricity to comply with a new rule that took effect with the start of trading on the Italian power exchange requiring electricity generators to purchase from third parties the electricity used to power pumping at pumped-storage hydroelectric plants. We previously used our own electricity production for these purposes.
 
Until April 1, 2006, our Domestic Generation and Energy Management, through Enel Trade, sold electricity on the free market to customers with annual consumption above 100 GWh. Since April 1, 2006, those sales have been carried out by Enel Energia of our Domestic Sales Division. Enel Trade also sells electricity to our Domestic Sales Division and to wholesalers in Italy.
 
Our Domestic Generation and Energy Management Division, through Enel Trade, also engages in trading of electricity on the main European power exchanges and over-the-counter markets and in trading of fuel (including sales of natural gas to distribution companies).
 
Electricity
 
In 2006, Enel Trade sold 82.8 TWh of electricity, approximately 70% higher than the 48.7 TWh it sold in 2005, with the increase resulting primarily from an increase in electricity trading on foreign markets and in intra-group sales.
 
The table below provides a breakdown by volume of the electricity sold by Enel Trade:
 
                         
    2004     2005     2006  
    (TWh)  
 
Electricity sold to intra-group companies
    8.1       8.9       20.2  
Electricity sold to third parties in Italy(1)
    18.9       16.0       18.1  
Electricity sold to third parties abroad(2)
    7.6       23.8       44.6  
                         
Total electricity sold
    34.6       48.7       82.8  
                         
 
 
(1) Refers to sales in Italy to wholesalers and to customers with consumption higher than 100 GWh (until April 1, 2006) and sales on the Italian Power Exchange.
 
(2) Refers to sales on other European power exchanges, in particular, Powernext in France and EEX in Germany, and sales in the over-the-counter markets.
 
The table below provides a breakdown of Enel Trade’s energy procurement portfolio:
 
                         
    2004     2005     2006  
    (TWh)  
 
Electricity purchased from intra-group companies
    21.1       18.1       29.7  
Electricity purchased from third parties in Italy
    5.2       4.7       6.8  
Electricity purchased from third parties abroad
    8.7       26.1       46.4  
                         
Total electricity purchased
    35.0       48.9       82.9  
                         
 
Natural gas
 
In addition to acquiring natural gas for the other Group companies, Enel Trade sells natural gas to third parties and distributors. In 2006, we sold approximately 1.4 billion cubic meters of gas compared to 1.6 billion cubic meters of gas in 2005.


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Domestic Infrastructure and Networks
 
Our Domestic Infrastructure and Networks Division operates in Italy in both the electricity and natural gas markets and is responsible for the management of our electricity and natural gas distribution networks. This division operates mainly through:
 
  •  Enel Distribuzione, which distributes electricity in Italy,
 
  •  Deval, a subsidiary in which we own a 51% interest, which distributes and sells electricity in the Italian region of Valle d’Aosta,
 
  •  Enel Rete Gas, which distributes natural gas in Italy, and
 
  •  Enel Sole, which offers public lighting services in Italy.
 
Distribution of Electricity
 
We own and operate the principal electricity distribution network in Italy. We use the term “distribution” to refer to the transport of electricity from the transmission grid to end users. Enel Distribuzione, our wholly-owned subsidiary, holds almost all of our distribution assets and operations, excepts for the assets and operations held by Deval in Valle d’Aosta. Its main responsibilities consist of operating and maintaining the distribution network, distributing electricity to the free market and distributing and selling electricity on the regulated market.
 
The following table sets forth the aggregate volumes of electricity distributed by Enel Distribuzione and Deval for the periods indicated:
 
                         
    Year Ended December 31,  
    2004     2005     2006  
    (In GWh)  
 
Distributed to free market:(1)
                       
Through high voltage lines
    45,083       46,212       46,016  
Through medium voltage lines
    63,372       67,060       73,518  
Through low voltage lines
    5,236       8,098       15,520  
                         
Total distributed to free market
    113,691       121,370       134,654  
Distributed to the regulated market:(1)
                       
Through high voltage lines
    4,827       5,319       4,819  
Through medium voltage lines
    23,966       20,247       15,646  
Through low voltage lines
    108,168       104,111       99,920  
                         
Total distributed to the regulated market
    136,961       129,677       120,384  
                         
Total electricity distributed
    250,652       215,047       255,038  
                         
 
 
(1) Excluding sales to resellers, which do not account for a material portion of our sales.
 
The total volume of electricity we distributed in 2006 increased by 1.6% compared to the volume distributed in 2005. The volume of electricity we distributed to the free market increased by 10.9% in 2006 compared to 2005, reflecting an increase in the number of Eligible Customers and their migration to the free market. The volume of electricity we distributed to the regulated market decreased by 7.2% in 2006 compared to 2005, in part because of our sale of local distribution networks in Modena. Please see “— Regulatory Matters — Electricity Regulation — Eligible and Non-Eligible Customers” for additional information on consumers eligible to participate in the free market.
 
In 2006, we distributed a total of 50,835 GWh of electricity to customers connected to high-voltage lines, generally large industrial customers, a decrease of approximately 1.4% from the 51,531 GWh we distributed through high-voltage lines in 2005. For medium-voltage lines, which generally serve medium-sized businesses, electricity distributed to the regulated market decreased by 22.7%, primarily reflecting the significant increase in the number of customers eligible to participate on the free market in 2006, many of whom migrated to that market.


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As a result of this migration, our distribution of electricity to the free market over medium-voltage lines increased by 9.6%. Overall, the amount of electricity we distributed through medium-voltage lines increased by 2.1% to 89,164 GWh, from 87,307 GWh in 2005, reflecting the overall increase in electricity demand. The amount of electricity we distributed to the free market over low-voltage distribution lines, which generally serve small business and residential customers, increased by 91.7% in 2006, reflecting in part the gradual migration of non-residential customers to the free market following the reclassification of all such customers as Eligible Customers on July 1, 2004. For the same reason, the volume of electricity distributed and sold to low-voltage customers on the regulated market decreased by 4.0%. Overall, the amount of electricity we distributed through low-voltage lines increased by 2.8% to 115,440 GWh, from 112,209 GWh in 2005, reflecting the overall increase in electricity demand.
 
We have focused on reducing operating costs in our electricity distribution operations in recent years. In particular, we have reduced the aggregate number of employees involved in these operations by approximately 15.7% over the past three years. We expect this reduction to continue in coming years, but at a lower rate.
 
The following table shows the aggregate number of employees of Enel Distribuzione and Deval at the dates indicated:
 
                         
    At December 31,  
    2004     2005     2006  
 
Employees
    32,595       29,299       27,474  
 
We have also invested in our Telemanagement digital meter system since 1999 in connection with our focus on reducing costs. Please see “— Telemanagement System” below for additional information.
 
As a result of our corporate reorganization, since January 2006, our electricity sales operations have been carried out by our Domestic Sales Division. For a description of these activities see “— Domestic Sales Division — Sales of Electricity on the Free Market.”
 
Electricity Distribution Network
 
The table below sets forth certain information about our primary and secondary distribution networks at December 31, 2006.
 
                                                 
    Underground
    Insulated
    Bare
          Number of
    Transformer
 
Type
  Lines     Aerial Lines     Aerial Lines     Total Lines     Substations     Capacity  
    (km)     (km)     (km)     (km)           (MVA)  
 
Primary:
                                               
High voltage lines (40-150 kV)
    491             18,313       18,804       n.a.       n.a.  
Primary substations
    n.a.       n.a.       n.a.       n.a.       2,407       95,959  
Secondary:
                                               
Medium voltage lines (1-30 kV)
    127,552       8,300       200,666       336,517       n.a.       n.a.  
Low voltage lines
    232,075       388,474       120,431       740,979       n.a.       n.a.  
Secondary substations
    n.a.       n.a.       n.a.       n.a.       413,887       70,475  
 
In September 2003, pursuant to a ministerial decree, Enel Distribuzione transferred to Terna the ownership of approximately 900 kilometer of high-voltage transmission lines. Enel Distribuzione transferred an additional 100 kilometers of high-voltage transmission lines to Terna in 2004 and 140 kilometers more in 2006.
 
Our replacement and construction of distribution lines and substations are subject to Italian environmental and aesthetic regulatory limitations, including legislation on electromagnetic fields that may make it more difficult to build new distribution lines and substations in the future and may require removing existing distribution lines and substations. Please see “— Regulatory Matters — Environmental Matters — Electromagnetic Fields” for a more detailed description of the environmental laws and regulations affecting our distribution operations and the risks they pose for our business.


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Consolidation of Electricity Distribution Networks
 
The Bersani Decree included provisions for the consolidation of distribution networks in municipalities served by more than one electric utility, giving certain municipal networks the right to request that we sell our distribution network in their municipalities. As a consequence, we have been forced to sell a significant number of our local distribution networks in the past few years. In June 2006, we sold 18 local distribution networks in the province of Modena with approximately 80,000 clients and an annual sales volume of approximately 160 million kWh to Hera S.p.A., an Italian energy company, for aggregate consideration of approximately €107.5 million. From January 1, 2001 through December 31, 2006, we sold a number of local distribution networks, including those in the Rome, Milan and Turin metropolitan areas, serving an aggregate of approximately two million customers, for aggregate consideration of approximately €1,974 million. At the same time, we acquired the distribution networks of 62 other small municipalities, serving an aggregate of approximately 22,700 clients, for aggregate consideration of €18.6 million. Negotiations are currently pending regarding our sale of the distribution networks of 27 small municipalities and our acquisition of the distribution networks of certain other small municipalities. We are also currently negotiating with the Province of Bolzano over the sale of our local distribution network in that province, which serves approximately 85,000 customers and has 5,000 kilometers of transmission lines.
 
The distribution networks that we sold were more profitable than our average distribution network, mainly because distribution in metropolitan areas has lower costs because of high customer concentration. In 2004, the Energy Authority put in place a mechanism to compensate affected distributors for some of the comparative disadvantages of serving non-urban areas. Please see “— Regulatory Matters — Electricity Regulation — The Tariff Structure” for additional information.
 
Public and Art Lighting
 
Enel Sole operates our public lighting services in Italy. Enel Sole targets the general market for public lighting, as well as the market for customized lighting systems for monuments, public squares, churches and other landmarks and public spaces. Enel Sole offers both indoor and outdoor lighting systems, and provides maintenance services for the systems and the related electricity plants.
 
In 2006, Enel Sole built lighting systems for third parties with an aggregate value of approximately €37 million. In addition, Enel Sole signed new contracts for approximately 83,000 public lighting points throughout Italy in 2006. As of December 31, 2006, Enel Sole managed approximately 1.9 million public lighting sites in more than 4,000 client municipalities.
 
Telemanagement System
 
Since 1999, we have been rolling out our “Telemanagement” digital metering system in Italy, which enables us to manage and read electricity meters remotely. Through this system we expect to:
 
  •  reduce costs associated with physical measurement of consumption and on-site maintenance of meters by our personnel, as these tasks will be accomplished remotely,
 
  •  measure more accurately the electricity consumption of our customers,
 
  •  improve our response times in providing technical assistance to our customers, and
 
  •  offer our customers diversified tariff plans that promote the use of electricity in off-peak periods.
 
As of March 31, 2007, we had installed 30.0 million digital meters, of which approximately 29.3 million were connected to the remote network. To complete the rollout, we must still install an additional 1.7 million meters and remotely connect 2.4 million meters to the system. Please see “— History and Development of the Company — Capital Investment Program — Domestic Infrastructures and Networks” for additional information on the rollout of this system and the related capital expenditures we have incurred.


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Natural Gas Distribution
 
Our Domestic Infrastructure and Networks Division is responsible for the management of our distribution networks through Enel Rete Gas and other minor companies, which own local distribution networks in specific parts of Italy and hold the related concessions for their use.
 
The following tables set forth information on our gas distribution activities:
 
                 
    December 31,
    December 31,
 
    2005     2006  
 
Number of municipalities served
    1,205       1,243  
Length of distribution network (in kilometers)
    29,869       31,113  
Total Number of end users connected to network
    1,983,741       2,023,193  
As percentage of total natural gas customers in Italy(1)
    8 %     12 %
 
 
(1) Source: Anigas, the Italian association of gas distribution companies.
 
                 
    2005     2006  
 
Gas distributed on behalf of companies of the Enel Group (millions of cubic meters)
    3.614       3.252  
Gas distributed on behalf of companies that are not par of the Enel Group (millions of cubic meters)
    0.333       0.412  
                 
Total natural gas distributed (millions of cubic meters)
    3.947       3.664  
                 
 
While full liberalization of the Italian gas market continues to evolve, we believe that the most effective way for us to build our natural gas business is through acquisitions of other distributors or client bases. We believe that expanding our natural gas distribution activities offers us opportunities for potential synergies, including, for example, the ability to schedule and perform gas and electric network maintenance and upgrades in the same area at the same time, and the ability to use call centers for both gas and electricity customers. It also offers, in our view, certain competitive advantages, including potential cost savings from economies of scale. Since March 2005, we have offered Eligible Customers in several Italian cities, including Rome and Milan, “dual fuel” contracts, which provide electricity and gas service through one sales network, with one customer service department and one bill.
 
Over the past several years we have acquired the following gas distribution and gas sales companies with operations in various Italian regions:
 
  •  in 2000, the Colombo Gas Group, which served approximately 76.000 customers,
 
  •  in 2001, So.ge.gas and Agas, which together served a total amount of approximately 247.000 customers,
 
  •  in 2002, Camuzzi Gazometri (subsequently renamed Enel Rete Gas), which served approximately 1.2 million customers. In acquiring Camuzzi Gazometri, we acquired both significant gas distribution assets and Camuzzi Gazometri’s waste management operations for total consideration of approximately €1 billion. In February 2004, we sold Camuzzi’s waste management operations, the Aimeri Group, to Green Holding for approximately €14 million,
 
  •  in January 2004, the gas distribution company Sicilmetano and the gas sales company Sicilmetano Energy, which together served approximately 37,000 customers in Sicily, for approximately €40 million,
 
  •  in September 2004, the gas distribution company Ottogas Rete and the gas sales company Ottogas Vendita, which together serve approximately 36,000 customers in the provinces of Naples and Salerno, for approximately €31.5 million,
 
  •  in December 2004, the gas distribution company Italgestioni and the gas sales company Italgestioni Gas, which together serve approximately 34,000 customers in 83 municipalities in the provinces of Calabria and Naples, for approximately €32 million,


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  •  in October 2005, the gas distribution company Metanodotti Padani and the gas sales company Easygas, which together serve approximately 19,000 customers in the northern Italian provinces of Rovigo, Padova, Trento, Mantova, Ferrara and Modena, for approximately €23 million,
 
  •  in January 2006, the gas distribution company Simeo, which serves approximately 24,000 customers in Sicily, for approximately €37 million, and
 
  •  in July 2006, the gas distribution company Metansicula and the gas sales company Metansicula Vendita, which together serve approximately 12,000 customers in Sicily, for approximately €13 million.
 
Through these acquisitions, by 2003, we had become the second-largest operator in the Italian gas sales and distribution market, second only to Eni’s subsidiary, Italgas, the incumbent provider, according to a study of the Italian gas industry by Anigas (the Italian association of gas distribution companies) published in 2005.
 
The various gas distribution companies we acquired have been merged into Enel Rete Gas, in which we hold a 99.8% interest, while most of the gas sales companies were merged into our wholly-owned subsidiary Enel Energia (formerly Enel Gas).
 
As a result of our corporate reorganization, since January 2006, our gas sales operations have been carried out by our Domestic Sales Division. For a description of these activities see “— Domestic Sales Division — Natural Gas Sales”.
 
Domestic Sales Division
 
Our Domestic Sales Division sells electricity and natural gas and provides electricity-related services, mainly through:
 
  •  Enel Distribuzione, which sells electricity on Italy’s regulated market,
 
  •  Enel Energia, which sells electricity on the Italian free market and sells natural gas to end users,
 
  •  Metansicula Vendita, which sells natural gas to end users in Sicily, and
 
  •  Enel.si, which offers electricity systems-related services and “beyond-the-meter” products and services, such as consulting and sales of electricity equipment.
 
The following table sets forth the amount of electricity we sold in the free market, in the regulated market for the years indicated:
 
                         
    Year Ended December 31,  
    2004     2005     2006  
    (In GWh)  
 
Electricity sold in free market(1)
    20,840       18,484       22,267  
Electricity sold in the regulated market(1)
    136,961       129,677       120,385  
                         
Total electricity sold
    157,801       148,161       142,652  
                         
 
 
(1) Excluding sales to resellers, which do not account for a material portion of our sales.
 
In 2006, electricity sold on the regulated market decreased by 7.2%, to 120.4 TWh from 129.7 TWh in 2005, and electricity sold on the free market increased by 20.5%, to 22.3 TWh from 18.5 TWh in 2005. The decrease in electricity sold on the regulated market and the increase in electricity sold on the free market are mainly due to the liberalization of the Italian electricity market, which has gradually allowed customers to purchase their electricity on the free market.


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Sales of Electricity on the Regulated Market
 
The regulated market for electricity sales in Italy consists of:
 
  •  in the period before July 1, 2007, all customers who do not meet the consumption threshold for participation in the free market, which we refer to as Non-Eligible Customers, and Eligible Customers that choose not to participate in the free market, and
 
  •  after July 1, 2007, all customers who choose not to participate in the free market.
 
The consumption threshold for qualification as an Eligible Customer, which is set by regulation, has decreased over time, reducing the number of customers who must buy electricity on the regulated market. Please see “— Regulatory Matters — Electricity Regulation — Eligible and Non-Eligible Customers” for further information. The Marzano Law provides for the complete liberalization of sales in the electricity market beginning July 1, 2007, when all customers will be eligible to purchase electricity on the free market. The law provides that the Single Buyer will nonetheless continue to supply electricity to consumers who choose not to leave the regulated market.
 
Sales of Electricity on the Free Market
 
Since July 1, 2004, all Italian non-residential customers (approximately 7 million consumers) have qualified as Eligible Customers, and may choose to purchase electricity on the free market.
 
According to our internal estimates, total Italian electricity consumption on the free market increased by approximately 6% in 2006 to 144 TWh, representing approximately 49% of total Italian electricity consumption for the year. We believe our share of the free market in 2006 was approximately 15% (as compared to 14% in 2005). We currently expect that in 2007, total Italian electricity consumption on the free market will be approximately 161 TWh, or approximately 53% of total Italian electricity consumption for the year.
 
Until April 1, 2006, sales of electricity on the free market to customers with annual consumption above 100 GWh were carried out by our Domestic Generation and Energy Management Division. Since April 1, 2006, those sales have been carried out by Enel Energia. Please see “— Regulatory Matters — Electricity Regulation” for additional information on the regulatory framework of Italy’s electricity market.
 
The progressive liberalization of the Italian electricity market requires that Enel Energia provide its customers with increasingly flexible and competitive services that go beyond providing a reliable supply of electricity. As part of our marketing efforts, we have implemented a series of customer initiatives including specially tailored contract terms for different types of customers and value-added services such as energy monitoring and management.
 
Customer Service
 
Providing high-quality customer service is an important part of our commercial strategy. In recent years, our Domestic Sales Division has reorganized its sales network to change the manner in which customer relations are managed. We have expanded our customer services to provide customers with access to us through a number of different channels, and we have introduced specialized departments to manage relations with corporate and individual customers. Among other things, we have a customer call center, targeted primarily at individual consumers, and provide a self-service area through our Internet portal. The call center is supported by both a national documentation center located in southern Italy, which receives, processes and electronically files all contractual documentation, and by a national printing center, which prints and distributes all correspondence with customers.
 
Continuity and Quality of Network Service
 
The Energy Authority has issued guidelines setting targets for electricity service continuity (based on minutes of service interruptions per year) and quality (such as waiting time for appointments). The Energy Authority has also instituted a system that grants bonuses to companies that exceed targets for continuity of service or lack of service interruptions, and imposes penalties on companies that fail to meet them. Please see “— Regulatory Matters — Electricity Regulation — Continuity and Quality of Service Regulation.”


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Distributors that outperform the targets are paid their bonuses through a component of the tariff structure. We have on average exceeded our continuity of service targets, and received resulting bonus payments, for each year since 2000. In 2006, we received a €118 million bonus for having outperformed the continuity of service targets in 2005. We estimate that, in 2006, our average duration of service interruptions per customer decreased to 51 minutes, or by approximately 19%, from 63 minutes in 2005. We expect to receive, in the second half of 2007, approximately €164 million in bonus payments with respect to continuity of service for 2006.
 
In May 2005, the Energy Authority issued for public comment a proposal for a system of automatic compensation payable by electricity distributors to affected customers in the event of a blackout or other prolonged service interruption. The Energy Authority is expected to issue a final decision on this proposal in the second half of 2007. In April 2006, the Energy Authority issued for public comment a proposal for new standards for improving the continuity and quality of electricity service for the 2008-2011 period, including limitations on the duration of interruptions, quality contracts, and incentives to invest on distribution networks.
 
Please see “— Regulatory Matters — Electricity Regulation — Continuity and Quality of Service Regulation.”
 
Electricity Systems-related Services
 
Enel.si offers our clients electricity systems-related services through a franchising network made up of selected companies that operate in the electrical maintenance and installation business. Enel.si franchises draw on the technical capabilities of the Enel Group to assist clients in optimizing their use of electricity, as well as to offer them consulting and personnel training services.
 
At the end of 2006, Enel.si had a total of 260 franchise stores focusing on the retail market (residential and small office/home office customers), offering services and products aimed at providing safety (such as safer electrical installations and security systems), energy efficiency (such as air conditioning, heating, and home automation systems) and environmentally friendly energy systems (such as solar, thermal and small photovoltaic plants).
 
Enel.si also provides business customers full assistance with their energy facilities, including construction and maintenance services for small co-generation power plants and medium-large photovoltaic plants.
 
Natural Gas Sales
 
In 2006, we sold approximately 4.5 billion cubic meters of natural gas to more than 2.3 million end users (representing approximately 14% of natural gas customers in Italy), as compared to the approximately 5.1 billion cubic meters of natural gas sold to nearly 2.1 million end users in 2005. The following table shows the total amount of natural gas we sold to end users in the years indicated, and the number of customers to whom these sales were made, broken down by type of customer:
 
                         
    2004     2005     2006  
 
Natural gas sold to retail customers (in millions of cubic meters)
    2,783       3,021       2,973  
Natural gas sold to business customers (in millions of cubic meters)
    2,403       2,068       1,572  
                         
Total natural gas sold (in millions of cubic meters)
    5,186       5,089       4,545  
                         
Number of retail customers
    1,963,577       2,140,865       2,329,184  
Number of business customers
    2,038       2,129       1,867  
                         
Total number of customers
    1,965,615       2,142,994       2,331,051  
                         
 
These figures do not include the 1.7 billion cubic meters, 1.6 billion cubic meters and 1.4 billion cubic meters of natural gas sold to third parties in 2004, 2005 and 2006, respectively, by Enel Trade, which is part of our Domestic Generation and Energy Management Division.


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The Italian natural gas market is undergoing a process of liberalization. Under current legislation, the natural gas market was supposed to have been completely liberalized as of January 1, 2003, with all consumers able to choose their supplier freely and all sellers able to freely set prices to all customers. However, while all consumers are now able to choose their supplier freely, the Energy Authority retained the right to control prices for certain customers, mainly household consumers that qualified as Gas Non-Eligible Customers as of January 1, 2003. Please see “— Regulatory Matters — Gas Regulation” for a more detailed discussion of gas regulation in Italy.
 
International Operations
 
Following the re-organization of the Group’s internal structure at the end of 2005, our international generation, distribution and sales operations, which had previously formed part of other divisions, are carried out by our International Division. Please see “— History and Development of the Company” for more details on the re-organization of the Group’s internal structure.
 
International Electricity Generation
 
We set forth below a list of the principal generation companies through which we operate internationally, as well as a description of the background and recent developments in relation to each such company:
 
  •  Slovenské elektrárne (“SE”), the principal power generation company in Slovakia:
 
  •  On April 28, 2006, we purchased a 66% interest in SE, which has an estimated market share of more than 80% in the Slovakian power generation market, for approximately €840 million and entered into a shareholders’ agreement with the state-owned entity National Property Fund, the remaining shareholder of SE.
 
  •  SE has total net installed capacity of 6,442 MW, of which 38% is nuclear-powered, 36% is hydroelectric-powered and 26% is powered by conventional thermal sources. The net production of SE in 2006 amounted to 15,618 GWh.
 
  •  This acquisition marks our re-entry into the field of nuclear power generation; we have not owned any nuclear power plants since November 2000, and we have not produced electricity from nuclear power plants since 1988.
 
  •  SE owned, prior to our acquisition, six nuclear power units with net installed capacity of 400 MW each, which we believe were equipped with internationally accepted technology. Prior to the closing, certain conditions were fulfilled, including:
 
  •  the approval by the Slovakian government of the strategic investment plan we prepared for SE for the 2006-2013 period,
 
  •  the transfer to state-owned companies of the assets and liabilities (including spent nuclear fuel and the radioactive waste) of a nuclear power plant built in 1970 and operational since 1978 that is in the process of being decommissioned,
 
  •  the disposal of a hydroelectric plant, and
 
  •  the approval by the Slovakian government of legislation on a new fund for the decommissioning of nuclear installations in Slovakia and new rules governing the Slovakian electricity market.
 
The four nuclear power units that SE now retains have been recognized by the International Atomic Energy Association as being in line with Western European security standards. SE will continue to sell the energy produced by one of the spun-off nuclear units (the other one was closed at the end of 2006) and reimburse the state-owned company for the costs it incurred in the operation of this nuclear unit.
 
  •  Enel Viesgo Generación, an electricity generation company in Spain:
 
  •  In January 2002, we acquired from Endesa S.A. the Spanish company Electra de Viesgo S.L. (“Viesgo”), which owned Viesgo Generación (currently Enel Viesgo Generación) as well as certain distribution


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  companies, for total consideration of €2,070 million, including €1,920 million in cash and the assumption of €150 million in debt.
 
  •  Enel Viesgo Generación operates 6 thermal plants and 12 hydroelectric plants in Spain, which together have a total net installed capacity of approximately 2,199 MW, and, in 2006, had a net production of 5,363 GWh.
 
  •  Enel Unión Fenosa Renovables S.A. (“EUFR”), a company active in the field of renewable energy in Spain, in which we currently own a 50% interest:
 
  •  In December 2003, we acquired from Unión Fenosa Generación S.A. 80% of the share capital of Unión Fenosa Energías Especiales (now EUFR), for €178 million. We granted Unión Fenosa Generación S.A. an option to repurchase 30% of EUFR’s capital stock before the end of 2007. In May 2006, Unión Fenosa Generación S.A. exercised this option and repurchased 30% of EUFR for approximately €82 million. As a result, Unión Fenosa Generación SA and we each now hold 50% of EUFR.
 
  •  EUFR’s assets include plants and projects for the generation of electricity from renewable resources, primarily wind and hydroelectric facilities. EUFR has 457 MW of net installed capacity currently in operation, and more than 229 MW in development that we expect to be in operation by the end of 2007. EUFR’s net production in 2006 was 1,508 GWh.
 
  •  Maritza East III, a generating company in Bulgaria:
 
  •  In March 2003, we acquired from Entergy Power Bulgaria Ltd. (“Entergy”), through our subsidiary Enel Generation Holding BV, 60% of the share capital of Maritza East III Power Holding BV, which in turn holds 73% of Bulgarian generation company Maritza East III Power Company A.D., now Enel Maritza East 3 A.D. (“Maritza East III”), for €73.5 million. In June 2006, we purchased from Entergy the remaining 40% stake in Maritza East III Power Holding BV and 100% of Maritza O&M Holding Netherlands BV, a Dutch company holding 73% of Maritza East 3 Operating Company A.D., now Enel Operations Bulgaria A.D. (a company responsible for the maintenance of Maritza East III), for total consideration of €47.5 million.
 
  •  Maritza East III, which has 560 MW of net installed capacity and had a net production of 3,111 GWh in 2006, is working on the refurbishment, environmental upgrade and management of its lignite-fired generation plant located on the border with Greece. The total financial outlay of Maritza East III for the project, which is expected to result in an increase in Maritza East III’s net installed capacity to 794 MW, is estimated to be approximately €570 million, to be funded through project financing, cash flow from operations and equity.
 
  •  In October 2006, we signed a memorandum of understanding with the Bulgarian state-owned company Nek for a preliminary study of the feasibility of an upgrade of Maritza East III to increase its aggregate net installed capacity by 640 MW.
 
  •  Enel North America Inc., which is active in power generation from renewable sources in North America:
 
  •  At December 31, 2006, Enel North America Inc. operated 65 power plants in the United States and two in Canada with an aggregate net installed capacity of 402 MW and a net production of approximately 1,372 GWh in 2006.
 
  •  In April 2005, Enel North America Inc. acquired full control of the 25 MW Sheldon Springs hydroelectric project located on the Missisquoi River in Sheldon, Vermont (in which it had previously owned a 1% stake).
 
  •  On February 9, 2006, Enel North America Inc. acquired an additional 36% interest in St. Felicien Cogeneration Limited Partnership (“St. Felicien”), a 21.4 MW biomass project in Quebec (Canada), thereby increasing its stake in this company to 96%.


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  •  In September 2006, Enel North America Inc. entered into an agreement with TradeWind Energy LLC, a U.S. wind power development company, for the development of wind projects in the Midwest and possibly other regions of the United States.
 
  •  In October 2006, Enel North America Inc. entered into an agreement with Windkraft Nord USA, acquiring the rights for the development of the 63 MW Snyder Wind Project to be developed in Scurry County, Texas.
 
  •  In June 2007, Enel North America Inc. acquired full control of AMP Resources, LLC from AMP Capital Partners and another minor shareholder. The acquisition consists of a currently-operating geothermal project and four other projects in the advanced stages of development for a capacity of approximately 150 MW that Enel North America Inc. will complete in the next four years.
 
  •  Enel Latin America, which is active in power generation from renewable sources in Central and South America:
 
  •  At December 31, 2006, Enel Latin America operated two hydroelectric plants and a wind plant in Costa Rica, two hydroelectric plants in Chile, three hydroelectric plants in Guatemala, 20 mini-hydroelectric plants in Brasil and 1 hydroelectric plant in Panama, which together had aggregate net installed capacity of 471 MW and net production of 1,297 GWh in 2006.
 
  •  In June 2006, we entered into an agreement with the Rede group for the acquisition in two tranches of 11 companies that own concessions to operate hydroelectric plants in Brazil with a total installed capacity of 98 MW. In October 2006, Enel Brasil Partecipações, a Brazilian subsidiary of Enel Latin America, acquired 10 of these companies, which operate 20 mini-hydro plants, for total consideration of approximately 464 million Brazilian real (approximately €168 million). The acquisition of the remaining company, which operates two mini-hydro plants, is expected in the second half of 2007.
 
  •  In August 2006, we acquired, through our Dutch subsidiary Enel Investment Holding, 100% of Hydro Quebec International Latin America Ltd. (now Enel Panama Ltd.) from Hydro Quebec International Inc. and Fonds de Solidarité des Travailleurs du Québec for $150 million (equal to approximately €118 million). As a result of this transaction, Enel acquired 24.55% of EGE Fortuna S.A., a Panama hydro-generation company with total installed capacity of 300 MW. We subsequently increased our stake in EGE Fortuna S.A. (now Enel Fortuna S.A.) to 49%, when we acquired from Globeleq in February 2007, again through our Dutch subsidiary Enel Investment Holding, 100% of Globeleq Holdings Fortuna S.A., a company incorporated in Panama, for consideration of $161.3 million (approximately €124.5 million).
 
  •  Erelis S.a.s. (now Enel Erelis), a French company operating in the development of wind plants, which we acquired in July 2006 for €14 million.
 
In addition to the operations described above, Enel ESN Energo, a wholly-owned Russian subsidiary of Enel ESN Management BV, entered into a three-year agreement (renewable for an additional year) in June 2004 with OAO North-West CHPP to manage North West Thermal Power Plant (“NWTPP”). NWTPP is a CCGT generation plant near St. Petersburg, Russia, controlled by RAO UES, the company that operates Russia’s unified power system. With the completion of its second unit in November 2006, NWTPP increased its installed capacity to 900 MW. Enel ESN Management BV is a joint venture currently held 75% by us and 25% by ZAO ESN, a privately held Russian company.
 
On May 30, 2005, we also entered into a non-binding memorandum of understanding with EDF for an industrial partnership permitting us to invest in the French electricity market, including in EDF’s latest European Pressurized Water Reactor, or “EPR,” a nuclear reactor that is expected to be fully operational by 2012. Under the terms of this memorandum of understanding:
 
  •  we will have a 12.5% stake in EDF’s EPR project,
 
  •  we will bear our proportional share of the costs associated with the project, including investment, operating and fuel costs, as well as our share of budgeted reactor decommissioning costs and the corresponding share of the back-end fuel and waste disposal costs,


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  •  EDF will be the operator of the power plant and will bear any related nuclear civil liability, and
 
  •  we will receive a share of the generation capacity and output proportional to our initial stake in the project, which may be increased, so long as EDF retains a majority interest.
 
The parties had agreed to execute a definitive agreement by September 30, 2005, subject to the receipt of a favorable non-binding opinion of the European Commission, which it has not yet released. Although the parties have not executed a definitive agreement, pursuant to the memorandum of understanding, we have been receiving a portion of the electricity generated by EDF from nuclear sources since January 1, 2006, which is expected to increase over time to a maximum of 1,200 MW, pending completion of the EPR project.
 
As part of our strategy to expand our international operations, we have recently also entered into the following transactions:
 
  •  In December 2006, we entered into a joint venture agreement with the Turkish construction company Enka to explore electricity generation, distribution and sales projects in Turkey, including the participation in the bidding process for the acquisition of three state-owned electricity distribution companies.
 
  •  In March 2007, we entered into a joint venture agreement with the Belgian steel company Duferco for the construction of two power plants in Belgium with net installed capacity of 420 MW and 65 MW, respectively.
 
  •  In 2007, we acquired from the Copelouzos and the International Constructional group wind farms in Greece with aggregate installed capacity of 127 MW, of which 43 MW are still under construction.
 
  •  In June 2007, we won an auction to acquire for approximately $1.5 billion (approximately €1.1 billion) a 25.03% stake in JCS Fifth Generation Company of the Wholesale Electricity Market or OGK-5, one of six thermal wholesale generation companies in Russia, which has four thermal power plants located in various regions of the country, with an aggregate installed capacity of approximately 8,700 MW. Later that same month, we increased our stake in OGK-5 by 4.96%, bringing our total stake in that company to 29.99%.
 
In addition, we have taken steps to launch, with the Spanish company Acciona, a joint tender offer for 100% of the shares of Spanish utility Endesa. For additional information on this proposed joint tender offer, see “— History and Development of the Company — Proposed Acquisition of Endesa.”
 
The following table shows the net installed capacity of our foreign generating companies at December 31, 2006, broken down by type of plant. Net installed capacity excludes capacity held by unconsolidated associated companies:
 
                                                         
          Enel
    Enel
                      Total at
 
    Slovenske
    North
    Latin
          Maritza
          December 31,
 
    Elektrame     America     America     Viesgo     East III     EUFR     2006  
                      (MW)                    
 
Thermal
    1,653                   1,527       560             3,740  
Hydroelectric
    2,329       313       447       672             11       3,772  
Wind
          67       24                   192       283  
Biomass and Biogas
          22                               22  
Cogeneration
                                  24       24  
Nuclear
    2,460                                     2,460  
                                                         
Total
    6,442       402       471       2,199       560       228       10,301  
 
Our international operations generated a total of 27,516 GWh of electricity in 2006, as compared to 13,625 GWh in 2005, including 15,618 GWh produced by SE (which we consolidated as of April 28, 2006), 5,363 GWh produced by Enel Viesgo Generación (7,423 GWh in 2005), 3,111 GWh produced by Maritza East III (3,005 GWh in 2005), 2,670 GWh produced by our North and Latin American companies (2,167GWh in 2005) and 754 GWh generated by EUFR (1,030 GWh in 2005).


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International Electricity Distribution and Sales Operations
 
We list below information on the principal companies through which we carry out our international electricity distribution and sales activities:
 
  •  In Spain, we carry out our international electricity distribution and sales activities through our wholly-owned subsidiaries Electra de Viesgo Distribución SL and Enel Viesgo Energia SL:
 
  •  In accordance with EU law, electricity sales in Spain are also divided between a free and a regulated market. Please see “— Regulatory Matters — Electricity Regulation” for a discussion of relevant EU law.
 
  •  In 2006, our sales of electricity in Spain amounted to 4,617 GWh (compared to 4,861 GWh in 2005), of which 3,968 GWh were sold by Electra de Viesgo Distribución SL to the regulated market (compared to 3,576 GWh in 2005) and 649 GWh by Enel Viesgo Energia SL to the free market (compared to 1,285 GWh in 2005). The decrease in sales at Enel Viesgo Energia SL was mainly due to an interruption in sales of electricity in the high voltage segment from January to September.
 
  •  Electra de Viesgo Distribución SL owns 29,989 kilometers of distribution network, and it distributed 5,311 GWh of electricity in 2006 (compared with 5,196 GWh in 2005) to 638,000 customers in the Spanish regulated market (625,000 customers in 2005).
 
  •  In Romania, we carry out our international electricity distribution and sales activities through Enel Electrica Banat S.A, which operates in western Romania, and Enel Electrica Dobrogea S.A., which operates in eastern Romania:
 
  •  On April 28, 2005, Enel Distribuzione acquired a 51% interest in each of Electrica Banat S.A (now Enel Electrica Banat S.A.) and Electrica Dobrogea S.A. (now Enel Electrica Dobrogea S.A.), purchasing approximately 25% of each of these companies’ share capital from Electrica S.A., a Romanian state-owned company, and simultaneously subscribing to a capital increase of approximately 26% in each of these companies for aggregate consideration of €131 million (including price adjustments).
 
  •  Enel Electrica Banat S.A. and Enel Electrica Dobrogea S.A. own an aggregate of 80,100 kilometers of distribution network and, in 2006, distributed 7,259 GWh of electricity in the Romanian regulated market to 1,438,200 customers.
 
  •  In 2006, Enel Electrica Banat S.A. and Enel Electrica Dobrogea S.A sold an aggregate of 5,194 GWh of electricity, mostly in the regulated market.
 
In June 2006, we also won the auction for a 67.5% stake in the Romanian company Electrica Muntenia Sud (“EMS”), an electricity distribution company with approximately 1.1 million customers and a 45,350 kilometer distribution grid in the region of Bucharest, Romania, for total consideration of €820 million. We expect to complete this acquisition in the second half of 2007. Upon successful completion of this transaction, we expect to serve approximately 2.5 million customers in Romania.
 
In addition, in June 2006, we acquired from the ESN Group a 49.5% interest in Res Holding, a Dutch company holding 100% of the Russian electricity sales company RusEnergoSbyt, for total consideration of $105 million (corresponding to approximately €88 million). Between July and December 2006, RusEnergoSbyt sold approximately 7,644 GWh of electricity.
 
The following table shows our international electricity sales on the regulated and free markets in Spain, Romania and Russia, as well as the electricity dispatched on our foreign distribution networks in Spain and


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Romania, in each of the years indicated. Data from our Russian operations is provided only from the date of our entry into this market in July 2006.
 
                         
    2004     2005     2006  
    (TWh)  
 
Electricity sales on the regulated market(1)
    3.709       6.766       8.411  
Electricity sales on the free market(1)
    0.749       1.327       9.044  
                         
Total electricity sales(1)
    4.458       8.093       17.455  
                         
Electricity transported on our distribution networks(2)
    4.952       9.651       15.570  
 
 
(1) Excluding sales to resellers, which do not account for a material portion of our sales.
 
(2) Excluding electricity distributed to resellers, which do not account for a material portion of our distribution.
 
International CO2 Emissions Trading
 
Spain.  Our subsidiary Enel Viesgo Generación has been assigned emission quotas by the Spanish Environment Ministry of 3.9 million, 3.4 million and 2.65 million metric tons of CO2 for the years 2005, 2006 and 2007, respectively. The emissions of Enel Viesgo Generación were 6.0 million tons in 2005 and 4.1 million tons in 2006, therefore an aggregate of 2.9 million tons over the emission quotas assigned for these years. To cover this excess, Enel Viesgo Generación was required to purchase emission trading rights in the market for an aggregate amount of €45.9 million in 2005 and €10.3 million in 2006. We expect CO2 emissions by Enel Viesgo Generación for 2007 to be 2.1 million metric tons higher than the quotas Enel Viesgo Generación has been assigned for 2007. Enel Viesgo Generación has purchased emission trading rights on the market for an aggregate amount of €6.8 million to cover the expected difference.
 
Slovakia.  Our subsidiary SE has been assigned emission quotas by the Slovak Environment Ministry amounting to 5.3 million tons per year for the period 2005-2007. SE’s CO2 emissions in 2005 and 2006 were 1.1 million tons below the assigned emission quotas. The excess emission quotas for 2005 and 2006 were sold on the market. We expect SE’s CO2 emissions in 2007 to be below the assigned emission quotas again.
 
Services and Other Activities
 
In line with our strategy of focusing on our core energy operations, we divested certain of our non-core operations, including real estate and water activities, and are re-focusing our remaining non-core operations on providing services to the companies of our Group rather than third parties.
 
We set forth below a description of the services and other activities of the Group in 2006.
 
Services
 
Enel Servizi is responsible for shared services related to personnel and payroll management, accounting, general services and information technology for Group companies, as well as for the management of pension funds and social security funds and for related administration services. Pursuant to existing agreements, Enel Servizi continues to offer certain services to third parties that are similar to those that it provides to Group companies. In 2006, Enel Servizi recorded revenues of approximately €939 million, of which approximately €60 million related to services provided to third parties.
 
Real Estate and Other Services
 
At December 31, 2006, Dalmazia Trieste owned most of our real estate assets, with a net book value of approximately €495 million. Our goal is to exploit the opportunities available with respect to properties used by the Group and to divest all of our residential properties by 2010.


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Factoring
 
Our subsidiary Enel.factor is responsible for managing receivables owned by third parties against companies of the Group. In January 2005, we acquired 20% of Enel.factor’s share capital from Meliorbanca, an Italian bank, for approximately €7 million, becoming its sole shareholder. Since March 2007, Enel.factor is also responsible for granting personal loans to our employees.
 
Professional Training Services
 
Our subsidiary Sfera is responsible for providing professional training services to our employees. In 2006, Sfera provided a total of 81,826 “full-time equivalent” classroom days of instruction through its integrated remote training system.
 
Water
 
In 2004 and 2005, we divested most of our water activities. We continue to own Enel.NewHydro, a company we formed in June 2004, which holds a 51% interest in Wisco, a joint venture company we set up with Trenitalia S.p.A. that is active in industrial waste water purification.
 
Competition in the Italian Electricity and Natural Gas Markets
 
In Italy, we face competition in the generation and sales of electricity, but not in electricity distribution, in which we have natural local monopolies.
 
Competition in Italian Electricity Generation
 
In 2006, we accounted for approximately 34% of Italian electricity production. Italian electricity demand has historically exceeded the amount of electricity produced in the country each year, with the difference being made up through electricity imports. We purchased approximately 38% of the electricity imported into Italy, and also purchased electricity produced by independent power producers and electricity produced from renewable resources under the CIP 6 regime, which the GRTN (now the Gestore dei Servizi Elettrici or GSE) buys from producers and resells at auction on the free market. For a description of the CIP 6 regime see “— Regulatory Matters — Electricity Regulation — Promotion of Renewable Resources.”
 
As a result of limitations on the production and import of electricity imposed by the Bersani Decree, we were required to sell generation plants with a total installed net capacity of at least 15.0 GW by January 1, 2003. In order to comply with the requirement, we created and sold the Gencos (Edipower, Endesa Italia and Tirreno Power) after transferring an aggregate of approximately 16.0 GW of gross installed capacity to them. As of December 31, 2006, we estimate that we had approximately 45% of total Italian net installed capacity, as compared to approximately 75% at the start of 2001.
 
The disposal of the Gencos has exposed us to increasing competition from other generating companies. Our competitors also include domestic independent power producers, municipal utility companies and foreign operators that have acquired Italian generation assets or export electricity to the Italian market. Between 2003 and 2006, other producers were authorized to build approximately 21 GW of new generating capacity in Italy, of which approximately 9 GW is already operational, and another 7 GW is expected to be operational by 2011. We expect that competition will increase further due to:
 
  •  the introduction on April 1, 2004, of trading on the Italian power exchange,
 
  •  an increase in bilateral contracts between our competitors and final customers,
 
  •  regulations limiting each operator’s access to international electricity sources to a maximum percentage of available interconnection capacity, and
 
  •  the development of new interconnection lines that will increase the volume of electricity that may be imported into Italy.


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In addition, on May 7, 2005, the Energy Authority issued for public comment proposals for possible measures to promote competition in the wholesale electricity market and limit the impact of market power held by dominant producers. Please see “— Regulatory Matters — Electricity Regulation — The Italian Power Exchange” for additional information on these proposals.
 
Our main competitors in Italy are Edison, the three former Gencos and Eni, though EniPower. According to their respective annual reports, as of December 31, 2006, Edipower had a reported installed capacity of 8.4 GW, Edison had a reported capacity of 7.7 GW, Endesa Italia had a reported capacity of 6.6 GW, EniPower had a reported capacity of 4.5 GW and Tirreno Power had a reported capacity of 3.2 GW.
 
The following table sets forth the main energy producers in Italy and the amount of energy they produced, the total amount of energy imported into Italy and the total demand for energy in Italy during 2006:
 
                         
    2006
    Percentage of Total
    Percentage of
 
    Production(1)     Italian Output     Demand  
    (GWh)              
 
Enel
    103,910       34 %     31 %
Former Gencos
    61,458       20 %     18 %
Edison(2)
    39,498       13 %     12 %
EniPower
    24,820       8 %     7 %
Main municipal electricity companies(2)
    15,000       5 %     4 %
Other independent power producers
    57,040       19 %     17 %
                         
Total production in Italy
    301,726       100 %      
                         
Pumped storage consumption(3)
    (8,648 )            
Net imports
    44,718             13 %
                         
Total demand in Italy
    337,796             100 %
                         
 
 
(1) Electricity production, net of power used by generating and auxiliary installations.
 
(2) Excluding stakes in former Gencos.
 
(3) Refers to the use of electricity by pumped-storage hydroelectric plants to pump water to elevated areas for use at a later time to generate electricity.
 
Source: Enel elaboration based on provisional data for Italy from Terna, and publicly available information of other producers.
 
The following table shows the main energy producers in Italy and our estimates of their net installed capacity, as well as the total net installed capacity in Italy, for each of the years indicated:
 
                 
    As of December 31,  
    2005     2006  
    (GW)  
 
Enel
    42.2       40.5  
Former Gencos
    17.9       18.2  
Eni
    4.3       4.5  
Edison(1)
    6.9       7.7  
Main municipal electricity companies(1)
    4.0       4.5  
Other independent power producers
    10.2       12.1  
                 
Total net installed capacity in Italy
    85.5       89.8  
                 
 
 
(1) Excluding stakes in former Gencos.
 
Source: Enel estimates


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The main municipal electricity companies are AEM S.p.A. of Milan, ACEA S.p.A. of Rome, Iride and ASM Brescia S.p.A. They are each publicly traded, but remain majority-owned by the relevant municipality. In addition to their electricity businesses, these companies offer gas and/or water services.
 
Competition in Italian Electricity Sales
 
For sales on the free market, we compete with independent and other power producers, importers, wholesalers and brokers. We expect competition in the free market to increase further following the Energy Authority’s decision to permit all non-residential customers to qualify as Eligible Customers as of July 1, 2004 and to allow residential customers access to the market as of July 1, 2007.
 
Competition in Italian Gas Sales
 
In our natural gas business, we compete mainly with Eni, the incumbent operator that historically held a monopoly for natural gas distribution and sales activities in Italy and continues to hold a significant majority of the overall market for such activities. In 2006, our share of the market for natural gas sales to end users, based on number of customers served, was 14%.
 
The Italian natural gas market is currently going through a process of liberalization. Please see “— Regulatory Matters — Gas Regulation” for a discussion of the regulation of the natural gas market.
 
Seasonality of Electricity and Gas Consumption
 
Electricity and gas consumption in Italy is somewhat seasonal. Since use of artificial light is highest in winter, electricity and gas consumption peak during winter months. Nevertheless, increased use of air conditioning during the summer months has rendered less significant the difference in electricity demand during winter versus summer months, and increased use of natural gas for industrial production has rendered less significant the difference in gas demand during winter versus summer months. Electricity and gas consumption is particularly low in August, the traditional vacation period in Italy.
 
Discontinued Operations
 
In 2005, we discontinued the operations of our former Telecommunications Division and Transmission Division, following the deconsolidation of Wind and Terna, respectively, as a result of our disposal of a controlling interest in these companies.
 
Telecommunications
 
Our Telecommunications Division consisted of Wind and its subsidiaries. Wind is a telecommunications company providing mobile and fixed-line telephony, Internet and data transmission services in Italy.
 
In line with our strategy of focusing on our core energy operations, in May 2005, we entered into an agreement for the sale of Wind to Weather Investments in a series of transactions. Weather Investments is a private consortium headed by Naguib Sawiris, who controls Orascom, an Egypt-based mobile phone operator that provides telecommunications services in the Middle East, Africa and Asia and is listed on the London Stock Exchange and the Cairo and Alexandria Stock Exchange. On August 11, 2005, we completed the first part of the transaction, which consisted of our sale of a 62.75% stake in Wind to one of Weather Investments’ subsidiaries for €2,986 million plus the acquisition by us of a 5.2% stake in Weather Investments through our subscription to a €305 million capital increase. On February 8, 2006, we completed the transaction by selling to one of Weather Investments’ subsidiaries an additional 6.28% stake in Wind for €328 million, and, thereafter, transferring to Weather Investments the remaining 30.97% stake in Wind in exchange for shares representing 20.9% of Weather Investments’ share capital. As a result of these transactions, we no longer have any direct interest in Wind, and we received aggregate cash consideration of €3,009 million and a 26.1% interest in Weather Investments. In December 2006, we sold our 26.1% interest in Weather Investments to Naguib Sawiris for approximately €1,962 million.
 
We view this holding in Weather Investments solely as a financial investment. In addition, we entered into a shareholders’ agreement with Weather Investments II S.a.r.l., Weather Investments’ controlling shareholder, which


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provides for an initial public offering of Weather Investments when market conditions are favorable, and for both our and Weather Investments II S.a.r.l.’s undertakings, subject to certain exceptions, not to sell any share of Weather Investments before the initial public offering. Moreover, the shareholders’ agreement grants de facto consent rights to identified directors (including directors designated by us) over certain transactions taken by Weather Investments or its subsidiaries (for example, transactions effected to incur additional indebtedness or to sell certain material assets).
 
Transmission
 
We use the term “transmission” to refer to the transport of electricity on high and very high voltage interconnected networks from the plants where it is generated (or, in the case of imported energy, from the points of acquisition) to distribution systems.
 
Our Transmission Division consisted of Terna and its subsidiaries. Terna owns a large majority of the Italian national transmission grid. In light of Italian laws and regulations that impose certain restrictions on the ownership and management of the Italian transmission grid, we have disposed of most of our interest in Terna and retain only 5.12% of its share capital. In particular, in June 2004, we sold 50% of Terna’s share capital in an initial public offering in Italy and in a private placement with certain institutional investors that was not registered under the Securities Act (the “Terna IPO”). In April 2005, we sold an additional 13.86% of Terna’s share capital in the context of a private placement, and in September 2005, we sold an additional 29.99% to Cassa Depositi e Prestiti. Finally, in January 2006, we distributed 1.02% of Terna’s share capital as “bonus” shares that we had promised to certain Italian retail investors as part of the Terna IPO.
 
Regulatory Matters
 
Overview of Regulation in the Energy Sector in Italy
 
The Ministry of Economic Development and the Energy Authority share responsibility for overall supervision and regulation of the Italian energy sector, comprising both electricity and gas.
 
The Ministry of Economic Development is responsible for establishing the strategic guidelines for the energy sector and for ensuring the safety and economic soundness of the electricity and gas sectors.
 
The Energy Authority is responsible for:
 
  •  setting and adjusting tariffs on the basis of general criteria established by law,
 
  •  advising the Ministry of Economic Development on the structuring and administration of licensing and authorization regimes for the energy sector,
 
  •  ensuring the quality of services provided to customers,
 
  •  overseeing the separation of utility companies into distinct units for accounting and management purposes,
 
  •  promoting competition, and
 
  •  otherwise protecting the interests of consumers, including the authority to mediate disputes between utilities and consumers, and to impose sanctions for violations of regulations.
 
The EU also takes an active role in energy regulation by means of its legislative powers, as well as investigations and other action by the European Commission.
 
Electricity Regulation
 
The regulatory framework for the Italian electricity sector has changed significantly in recent years pursuant to the implementation through the Bersani Decree of the December 1996 EU Electricity Directive.
 
The Bersani Decree, which entered into force on April 1, 1999, began the liberalization of the electricity sector through the separation of generation, transmission and distribution activities and the gradual introduction of free


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competition in power generation and sales to consumers meeting certain consumption thresholds, while maintaining a regulated monopoly structure for power transmission, distribution and sales to the other customers. In particular, the Bersani Decree, among other things,
 
  •  liberalized, as of April 1, 1999, the generation, import and export of electricity,
 
  •  provided that consumers, or Eligible Customers, meeting certain consumption thresholds, which have been progressively reduced, may negotiate supply agreements directly with any domestic or foreign producer, wholesaler or distributor of electricity, while other, “Non-Eligible Customers” must continue to purchase electricity from the distributor serving the area in which they are located and pay regulated prices determined by the Energy Authority,
 
  •  provided that after January 1, 2003, no electricity company may produce or import more than 50% of the total of imported and domestically produced electricity in Italy, which limit resulted in our sale of the Gencos,
 
  •  provided for the establishment of the Single Buyer, a central purchaser of electricity from producers on behalf of all Non-Eligible Customers,
 
  •  provided for the creation of the Italian power exchange, a virtual marketplace in which producers, importers, wholesalers, the GRTN, other Eligible Customers and the Single Buyer buy and sell electricity at prices determined through a competitive bidding process,
 
  •  provided for the creation of a Market Operator to manage the Italian power exchange,
 
  •  provided for the separation of management and operation of the national electricity transmission grid, which was to be licensed to an independent transmission system operator, the GRTN, from ownership of the grid assets, which were retained by existing owners, primarily Terna, and
 
  •  established a new licensing regime for electricity distribution and provided incentives for the consolidation of electricity distribution networks within each municipality.
 
The Bersani Decree was amended following the enactment of a law in October 2003 that provided, among other things, for the reunification of management and operation of the national transmission grid with its ownership under a single private entity. Pursuant to an implementing decree enacted in May 2004, on November 1, 2005 responsibility to manage the national transmission grid and the related assets was transferred from the GRTN to Terna, although the GRTN retained its other responsibilities. Starting from October 2, 2006, GRTN has been renamed Gestore dei Servizi Elettrici (GSE).
 
Following the transfer of assets to Terna, no electricity operator, including us, is entitled to voting rights in excess of 5% with respect to the appointment of Terna’s directors. In addition, the implementing decree required us to reduce our holding in Terna to no more than 20% by July 1, 2007. Accordingly, we have reduced our holding to 5.12%.
 
In 2003, the EU adopted a new directive and a related regulation to further liberalize the electricity market. The new Electricity Directive, which replaced the 1996 Electricity Directive, enables all consumers to freely choose their supplier by 2007, irrespective of consumption levels, with all non-household consumers enjoying this right of choice from 2004. Further, the new Electricity Directive introduces new definitions of public service obligations and security of supply, establishes a regulator in all EU member states with well-defined functions, and, finally, requires legal unbundling of network activities, including distribution, from generation and supply starting from July 1, 2007 at the latest. The related EU regulation establishes common rules for the cross-border trade in electricity in the EU, laying down principles on charges to be paid as a result of transit flows and access to networks as well as on congestion management. EU member states were required to implement the new directive by July 1, 2004, except for certain provisions relating to unbundling of network activities, for which implementation could be delayed until July 1, 2007. Italy partly implemented this directive through the Marzano Law and a Law Decree approved in June 2007, which are discussed below.
 
On September 28, 2004, the Marzano Law (so named after the then-Minister of Economic Development, Antonio Marzano), a law aimed at reorganizing existing energy market regulation and further liberalizing the


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natural gas and electricity markets, took effect. Among other things, the Marzano Law aims to clarify the respective roles of the Italian central government, regional and local authorities, and the Energy Authority. The Marzano Law also seeks to facilitate investments in the energy sector. To further liberalize the market, and consistent with the new Electricity Directive, the Marzano Law provides that all customers will be eligible to purchase electricity on the free market from July 1, 2007, although the law provides that the Single Buyer will nonetheless continue to supply electricity to consumers who choose not to leave the regulated market.
 
The Marzano Law also authorized the Italian government to limit the ability of companies based in other EU member states to invest in the Italian energy sector if their home country did not adequately guarantee a reciprocal ability for Italian companies to invest in its energy market. The Italian government had already approved such a measure in 2001, which limited the ability of EDF to exercise its voting rights with respect to the stake it held in Italenergia Bis S.p.A., the controlling shareholder of Edison. In June 2005, the European Court of Justice ruled that this limitation was contrary to EU law. However, the Italian government lifted the limitation before the European Court of Justice issued its judgment. Accordingly, in July, 2005 EDF and AEM took control of Edison.
 
Certain provisions of the Marzano Law concerning the allocation of powers between the Italian national and regional government have been challenged before the Italian Constitutional Court. In 2005, the Constitutional Court rejected an action brought by the Italian Region of Tuscany for interference by the national government with the regional government’s authority. The national government has also challenged a law passed by the Tuscany government for interference with the national government’s authority in the field of competition and regulation. In June 2006, the Constitutional Court issued a judgment upholding the government’s position and therefore confirming that the national government has prevailing authority over the regions, whose provisions on gas and electricity were declared incompatible with the Italian Constitution.
 
Further changes to the regulatory framework may occur as a result of European Commission follow-up actions after its completion of an inquiry into the energy sector. In June 2005, the European Commission launched an inquiry into the effects of the regulatory measures that have been adopted which showed that progress in achieving a truly integrated energy market had been slow. The final report was issued on January 10, 2007 and confirmed the preliminary findings released in February 2006. According to the report, market concentration, vertical foreclosure, lack of market integration, lack of transparency and price formation, limited competition at the retail level, distortions in the balancing markets (i.e. markets for the supply of electricity that ensures real time balance between demand and supply) and obstacles to realize the full potential of LNG as a way to improve security of supply are the main barriers to a fully functioning internal energy market. In order to remedy these shortcomings, the European Commission has proposed further regulatory measures, including a proposal to separate ownership of transmission infrastructure from other activities in the electricity and gas sectors and strengthening of the power of regulators. Legislative measures to realize these proposals are being discussed at the European level. Finally, as it had already indicated when it released the preliminary findings of the report in February 2006, the Commission intends to make more use of its existing powers to enforce competition law. In particular, on May 16, 2006, it launched unannounced inspections at Hungarian utilities, specifically targeting possible foreclosure effects stemming from long-term supply contracts. Please see also see “Item 3. Key Information — Risk Factors — Risks Relating to our Energy Business — The European Commission has launched an investigation into the functioning of the European energy market that could lead to measures which could have a material adverse effect on our operations.”
 
The Commission is also empowered to bring infringement actions against Member States for failure to adequately implement EU legislation. In April 2006, the Commission had started such proceedings against certain Member States, including Italy, for failure to adequately enact EU legislation concerning energy. These proceedings are still pending.
 
In addition, in June 2007, the Italian government approved urgent measures to complete implementation of EU directives on gas and electricity. In particular, the law decree provides that starting from July 1, 2007, electricity distribution companies, with at least 100.000 customers, have to set up a separate selling company, by December 2007. The Law Decree empowers the Energy Authority to issue rules on functional separation of gas storage, distribution and transmission system operators from the vertically integrated undertaking. Furthermore, the Law Decree provides that all household customers and small enterprises (as defined in the Law Decree who elect not to participate in the free market will continue to be supplied by the distribution company or its sales company under


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conditions set by the Energy Authority. The Single Buyer will continue to be responsible for purchasing electricity for resale to household customers and small enterprises. A decree of the Minister of Economic Development will issue rules to guarantee that all customers other than household customers and small enterprises have access to a supplier of last resort. The Law Decree is an emergency measure issued by the government for reasons of celerity. The Parliament has the power to ratify the Law Decree and to make changes. If the Parliament does not ratify the Law Decree within sixty days from its approval, the provisions set forth therein will be no longer valid.
 
Eligible and Non-Eligible Customers
 
One of the most important features of the regulatory framework was the distinction between Eligible Customers and Non-Eligible Customers. Eligible Customers may enter into bilateral contracts for the supply of energy at freely negotiated prices directly with any domestic or foreign producer or retailer or, since January 1, 2005, buy electricity directly on the power exchange. Retailers, including our subsidiaries Enel Energia and Enel Trade, may buy electricity for resale to Eligible Customers from any producer or on the power exchange. All customers that do not qualify as Eligible Customers are considered Non-Eligible Customers.
 
In accordance with the new 2003 Electricity Directive implementing measures, the Energy Authority on June 30, 2004, recognized all non-residential customers, or approximately 7 million consumers, as Eligible Customers as of July 1, 2004, permitting them to take part in the free market from that date if they so choose. From July 1, 2007, all customers, including residential customers, will be eligible to purchase electricity on the free market. Pursuant to a Law Decree approved in June 2007, all household customers and small enterprises (as defined in the Law Decree) who elect not to participate on the free market will continue to be supplied by the distribution company or by its sales company under conditions set by the Energy Authority. The Law Decree also provides that the Single Buyer will continue to be responsible for purchasing electricity for resale to household customers and small enterprises that choose not to leave the regulated market. A decree of the Minister of Economic Development will issue rules to guarantee that all customers other than household customers and small enterprises have access to a supplier of last resort.
 
Taking into account that, as of July 1, 2007, all customers will become Eligible Customers and be able to purchase electricity freely on the market, the Energy Authority has started to take actions to help customers choose their suppliers and to guarantee that they continue to enjoy a high level of service. In July 2006, the Energy Authority approved guidelines concerning the transparency of billing documents for electricity customers.
 
Under these guidelines, the electricity bill must contain two sections for the presentation of data. The first section must present data on the main components of the final amount of the electricity bill; the second section must present information to allow customers to have more details on the way the final amount has been calculated, as well as additional information concerning the type of consumption. In addition, at least once a year customers are entitled to receive information on the mix of sources used to generate electricity in Italy. Non Eligible Customers will be able to receive this information starting from July 1, 2007.
 
In 2007, the Energy Authority issued further measures to ensure a smooth transition to the free market for residential customers. The Energy Authority is seeking to enable customers to make informed choices about their suppliers. In particular, the Energy Authority requires that customers are able to compare the prices offered by suppliers with the price they would pay on the basis of tariffs or reference prices published by the Energy Authority. For customers other than residential customers, the Energy Authority requires a higher degree of transparency and suppliers are requested to also provide information on the components of the service provided and the relative break down of costs to arrive at the final offer.
 
The Single Buyer
 
The Single Buyer, a corporation formed in 1999 and wholly owned by the GSE, is responsible for ensuring the efficient, adequate and non-discriminatory supply of electricity to Non-Eligible Customers until they are allowed to freely choose their supplier. The Single Buyer became operational on January 1, 2004. Electricity distribution companies, including us, may take stakes of up to 10% in the Single Buyer, although the GSE must remain the majority shareholder.


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Based on its own periodic estimates of future electricity demand and Ministry of Economic Development guidelines, the Single Buyer purchases all electricity for the regulated market from us and other domestic and foreign producers. All distribution companies, including ours, are required to purchase electricity to be distributed on the regulated market from the Single Buyer.
 
The Single Buyer may purchase electricity on the power exchange, through bilateral contracts (including “contracts for differences,” as described below) with domestic and foreign producers, or from the GSE, which resells the electricity it is required to purchase under the CIP 6 regime.
 
The Single Buyer held an auction in March 2004 for contracts for the physical delivery of a total of 4,800 MW of electricity to be supplied to customers on the regulated market for the period from April 1, 2004 through December 31, 2004. Producers bid for these contracts on the basis of percentage discounts from a base price. Under these contracts, winning bidders were awarded their discounted bid price, plus a fixed component aimed at covering the cost of fuel. In these auctions, we were awarded physical delivery contracts for approximately 3,620 MW of electricity purchased by the Single Buyer (or approximately 75% of the total amount awarded).
 
Since 2004, the Single Buyer has held a series of annual auctions for “contracts for differences,” which are financial derivative contracts used to hedge the price risk of operations on the power exchange. These contracts establish a reference price, or “strike” price for a specified quantity of electricity, which the Single Buyer then purchases on the power exchange at the market price. In 2004, these contracts were “two-way” contracts for differences: when the market price paid by Single Buyer was higher than the strike price, the counterparty would pay the Single Buyer an amount equal to the difference, while when the market price was lower than the strike price, the Single Buyer would pay the counterparty the difference. In 2005, Single Buyer offered only “one-way” contracts, under which the counterparty still paid the Single Buyer any excess of the market price for its electricity purchases over the strike price, while the Single Buyer instead paid the counterparty a contractually set premium. The Single Buyer auctioned approximately 19,500 MW in one-way contracts for differences. We won approximately 12,500 MW of the final amount awarded. These contracts give us the right to extend their duration at our option, a right which we exercised in May 2005. As a consequence, we will supply to the Single Buyer 6,660 MW until December 31, 2006 and 5,550 MW until December 31, 2007. In November and December 2006 the Single Buyer held additional auctions for “two-way” contracts for differences for 2007, totaling 1,216 MW. Enel was awarded “two-way” contracts for 700 MW (on top of the 5,550 MW “one-way” contracts we elected to supply pursuant to our option under the 2005 contract).
 
The total payments by the Single Buyer to electricity producers for its purchases of electricity, either through bilateral contracts or on the power exchange, plus its own operating costs, must equal the total revenues it earns from sales to the regulated market under the regulated tariff structure. As a consequence, the Energy Authority may adjust tariffs from time to time to reflect the prices actually paid by the Single Buyer, as well as other factors.
 
The Single Buyer is currently responsible for the supply of electricity to Non Eligible Customers (i.e. domestic customers until July 1, 2007 only) and Eligible Customers who have not opted for the free market. Legislation currently in force provides that after July 1, 2007 the Single Buyer shall continue to purchase electricity for resale to household customers and small enterprises that choose not to leave the regulated market. As a result of the implementation of EU rules on unbundling of the distribution and supply of electricity, legislative changes are expected. The changes will affect the role of the Single Buyer and the role of distributors, to which the Single Buyer currently sells electricity for the supply to household customers and small enterprises who have chosen not to leave the regulated market. Please see “— Electricity Regulation.”
 
The Italian Power Exchange
 
The Italian power exchange, a virtual marketplace for the spot trading of electricity by producers and consumers under the management of the Market Operator, started operations on April 1, 2004.
 
In the initial phase of the power exchange, from April 1, 2004, through December 31, 2004, the GSE, based on its own estimates of aggregate electricity demand, placed bids on the power exchange on behalf of all consumers who had not fully satisfied their demand through bilateral contracts. Since January 1, 2005, Eligible Customers have been able to participate directly in bidding for electricity on the power exchange.


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The power exchange is organized into three different markets in order to ensure a steady supply of electricity — the “day-ahead” market, the “adjustment market” and the “ancillary service” market.
 
In the day-ahead market, sellers and buyers submit bids and offers for electricity to be supplied on the day following the transaction under the supervision of the Market Operator. The Market Operator is responsible for matching electricity demand and supply, and, consequently, for the definition of power injection (supply) and withdrawal (demand) schedules and for communicating these schedules to the transmission system operator, currently Terna, which is responsible for physical delivery of energy. Variations in the schedules agreed upon in the “day-ahead” market are negotiated through an “adjustment market.” In the “day-ahead” market and in the “adjustment market,” a market-clearing price (the “system marginal price”) at which all transactions must take place is set by the Market Operator on the basis of an aggregation of all bids and offers, starting, respectively, from the highest bid and the lowest offer. In addition, the Market Operator must also take into account physical network limitations that place constraints on the transport power from particular generation facilities to consumers and may result in market congestion.
 
If there is no market congestion, the Market Operator is able to set one system marginal price throughout Italy. However, if market congestion occurs, the Market Operator may divide the market into various zones, in which different system marginal prices may be set. In such event, the Market Operator will still determine one national price for purchasers on the power exchange, called the “unified national price,” based on a weighted average of the different system marginal prices set in the various zones. Suppliers, however, will receive the system marginal price that is applicable in their zone. In order to ensure that all producers in a congested zone bear the costs associated with the congestion, Terna will impose on suppliers who have produced electricity under bilateral contracts within a zone a congestion fee equal to the price differential between the applicable system marginal price in that producer’s zone and the unified national price.
 
In the ancillary service market, producers submit bids and offers to Terna to increase (or decrease) the volume of energy to be supplied (or withdrawn) in order to permit the real-time balancing of supply and demand required for the physical delivery of electricity. Terna also procures reserve production capacity through the ancillary service market by accepting bids from producers willing to guarantee availability of reserve power. Transactions on the ancillary service market also serve to help manage network congestion that results when physical delivery schedules agreed upon in the day-ahead and adjustment markets are incompatible with network constraints. In the ancillary service market, prices are determined on the basis of individual negotiations between producers and Terna, or on a “pay-as-bid” basis.
 
The Energy Authority and the Antitrust Authority constantly monitor the power exchange to ensure that it delivers the expected results: improved competition between electricity producers and enhancement of the efficiency of the Italian electricity system.
 
In February 2005, the Energy Authority and Antitrust Authority issued a joint report on the state of the liberalization process of the Italian electricity sector in which, among other things, we were found to be in a position to set wholesale electricity prices throughout Italy, except in Sardinia (where Endesa holds a similar power). On May 5, 2005, the Energy Authority proposed certain possible measures to further promote competition in the wholesale electricity market over the next few years. The proposals include measures to reduce the structural power of operators in the market and disincentives to electricity producers to seek to exercise market power, in particular with respect to prices. Among the structural measures proposed are the required sale by us of additional power plants (on top of the 15,000 MW of productive capacity we have already sold through the disposal of the Gencos), or the required lease by us to third parties of generating capacity, as well as the partial entrusting to the Terna of the management of certain power plants deemed essential to cover demand for electricity, and hence whose production is a significant determinant of the wholesale price of electricity. The proposed disincentives to the exercise of market power include certain price cap mechanisms and the imposition of a requirement that producers enter into two-way contracts for differences or “Virtual Power Plant” contracts (“VPP”), in either case at predetermined quantities and at regulated prices. VPPs are contracts similar to contracts for differences that give the buyer the right, when the market price is higher than the contract price, to request from the seller an amount equal to the difference between the market and contract prices. Following these proposals, in the last quarter of 2005, the Energy Authority required us to enter into VPP contracts for 2006. Furthermore, the Energy Authority decided that the


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functioning of plants that provide energy for pumping water into hydroelectric power production facilities should be regulated. These measures were reversed by an Italian administrative court on February 6, 2006.
 
In April 2005, the Energy Authority officially concluded that two cases of price spikes on the power exchange, one in June 2004 and one in January 2005, may not have been the result of underlying market conditions, and instead may have been caused by violations of antitrust law by us. As a result, the Antitrust Authority opened an investigation into these alleged violations and the surrounding events. The investigation was closed in December 2006 without any finding of violation on our part following our agreeing to certain to certain undertakings. According to Italian law, companies subject to antitrust investigations can offer undertakings to assuage competition concerns. If it accepts the undertakings, the Antitrust Authority is bound to close the investigation without issuing any finding of violation against the investigated party. Our commitments included supplying electricity pursuant to a VPP procedure based on contracts for differences. More specifically, we offered 1,000 MW of such energy for 2007 and 700 MW for 2008 to the market. We have assigned all available VPP contracts for 2007 in December 2006 to various operators. The execution of our commitments for 2008 is subject to the verification by the Antitrust Authority of structural conditions in the market. If structural conditions are such that Enel is not found in a position to exert an influence on price formation, the commitments for 2008 will not be necessary. We are required to provide information on the fulfilment of our commitments by October 2007. Contracts for 2008, if applicable, will have to be negotiated in the month of December 2007, subject to a verification of market conditions by December 1, 2007.
 
For more information on these matters, please see “Item 3. Key Information — Risk Factors” and “Item 8. Financial Information — Other Financial Information — Legal Proceedings.”
 
Imports
 
The volume of electricity that can be imported into Italy is limited by the capacity of transmission lines that connect the Italian grid with those of other countries and by concerns relating to the security of the system. Currently, a maximum import capacity of approximately 7,690 MW is available to import energy safely. A law passed in 2003 provides incentives to the development of new transmission infrastructures.
 
In 2005, we controlled approximately 2,000 MW of the total import capacity pursuant to two long-term supply contracts. Since April 1, 2004, the date on which the power exchange started operations, we sell the electricity imported pursuant to these contracts to the Single Buyer under terms set by Ministerial Decree. Until December, 31 2005 the energy we purchased under these long-term supply contracts enjoyed priority access to interconnection capacity for transmission of electricity into Italy from neighboring countries, for up to 2,000 MW. However, in 2006, the French regulatory authority decided not to assign to us any transmission or any reserved capacity for our import of the electricity we purchased under a long-term contract with EDF. As a consequence, only part of the electricity bought under this contract was imported into Italy, with the remaining part being sold in France. We appealed the decision of the French regulatory authority, but on March 30, 2007, the French Supreme Administrative Court rejected our appeal. According to that Court, the regulatory authority acted in accordance with EU law, as clarified by a 2005 judgment of the European Court of Justice on this matter. The decision of the French Supreme Administrative Court is final.
 
In April 2006, the European Commission started proceedings against certain Member States, including Italy, challenging, among other things, priority access for long-term supply contracts. These proceedings are still pending. However, priority access for our long-term contract on the French border has been cancelled for 2007 by both the Italian government and the French regulator. As a consequence we are currently selling electricity under this contract outside of Italy. This contract will expire at the end of 2007. We still enjoy priority access to interconnection capacity for our long-term contract on the Swiss border since Switzerland is not part of the European Union and therefore priority access to interconnection capacity with this country is not affected by the European Commission’s proceedings. This contract expires on December 31, 2011.
 
The Bersani Decree authorized the Ministry of Economic Development to set terms and conditions to allocate the interconnection capacity available after deducting the capacity used by existing long-term contracts, taking into account a fair allocation of the generally less expensive imported electricity between the free and regulated markets if import demand exceeds total interconnection capacity.


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The allocation mechanism for 2004 set out by the Ministry of Economic Development in accordance with EU law and applied by the Energy Authority and the GRTN considered the total interconnection capacity available at the borders with France and Switzerland (the north-west pool) and Austria and Slovenia (the north-east pool) separately. Interconnection capacity was allocated on a pro-rata basis; in addition, in no case may a single importer hold more than 10% of the interconnection capacity available in any given pool. The Ministry of Economic Development put a new allocation mechanism into effect for 2005. Under the new mechanism, capacity is allocated pursuant to an implicit auction mechanism, with the price to be paid for access to this capacity determined based on the price in the power exchange’s “day-ahead market” (please see “— The Italian Power Exchange,” above). Because of the link to prices on the power exchange, this mechanism may result in higher price volatility for, and an increase in the cost of, imported electricity. As a result, the Energy Authority has also established a mechanism to provide purchasers of imported electricity with an exemption from congestion charges. In 2005, this exemption was awarded by the GRTN on a pro-rata basis in the event applications exceed the total available quantity. In 2006, the exemption was allocated through an auction. The allocation mechanism for 2007 has been changed pursuant to an agreement between Terna and other operators responsible for network operations in neighboring countries. The allocation mechanism for 2007 is based on explicit auctions, i.e. those who take part in the auction bid a price for interconnection capacity. The bidders obtain the right to import electricity on a yearly, monthly and daily basis. The revenues arising from the auctions are shared evenly between the operators responsible for network operations involved. Terna is obliged to use the proceeds of the auctions in favor of final customers. This requires paying a fixed share of the proceeds to the Single Buyer as compensation for the costs it currently incurs in purchasing electricity for final customers.
 
Incentives to Provide Generation Capacity
 
In order to address a current deficit in Italian generation capacity relative to rising electricity demand, the regulatory framework provides incentives to power generators both to build new capacity as well as to maintain their existing plants in good working order and available to cover sudden variations in electricity demand.
 
In 2004, the Energy Authority established a provisional system of payments to remunerate producers that make generation capacity available to the electricity system at times of peak demand, known as “capacity payments.” Capacity payments to a given producer comprise both an amount due for capacity available on “critical” days, which was previously set by the GRTN and is now set by Terna, and a further amount payable when pool market prices fall below specified thresholds, as an extra incentive. This provisional mechanism remains in place. The Energy Authority is currently developing the definitive mechanism, which by law must be market-based and also provide incentives for new generation capacity.
 
New Generation Plants
 
In order to promote investment in new generation facilities, the October 2003 law amending the Bersani Decree included provisions to streamline the authorization procedures relating to the construction of new power generation plants and the renovation and expansion of existing plants.
 
The Marzano Law requires all entities receiving authorization to construct new plants or to increase generating capacity of existing power plants after September 28, 2004, to pay the authorities of the region in which the plant is located compensation (based on generating capacity) for the lost alternative use of the plant site and the impact thereof on surrounding communities, unless the parties agree otherwise.
 
Transmission
 
As noted, we use the term “transmission” to refer to the transport of electricity on high and very high voltage interconnected networks from the plants where it is generated or, in the case of imported energy, from the points of acquisition, to distribution systems. The Italian national electricity transmission grid includes all of Terna’s very high voltage (380/220 kV) and high voltage (150/132 kV) lines.
 
In accordance with a law passed in 2003 that required the reunification of ownership and management of the grid, we no longer control Terna following our disposal of a controlling stake in this company. Please see “— Business — The Enel Group — Discontinued Operations” for additional information.


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Distribution of Electricity
 
As noted, we use the term “distribution” to refer to the transport of electricity from the transmission grid to end users of electricity.
 
Distribution companies in Italy are required to be licensed by the state and to provide service to all customers who request it, subject to payment of applicable tariffs and to compliance with technical and safety requirements. In addition, distributors serving more than 300,000 customers must distribute electricity to the regulated market through separate companies whose sale activity is the distribution and sale of electricity on the regulated market.
 
Our concessions for the distribution of electricity are scheduled to expire on December 31, 2030.
 
The Bersani Decree sought to promote the consolidation of the Italian electricity distribution industry by providing for the issuance of only one distribution license within each municipality and establishing procedures to consolidate distribution activities under a single operator in municipalities where both we and a local distribution company were engaged in electricity distribution by giving municipal networks the right to request that we sell our distribution network in their municipalities to them.
 
Substantially all of the qualifying distribution companies in municipalities with co-existing networks made requests to purchase our networks in those cities. For more details on the consolidation process, please see “— Business — The Enel Group — Distribution of Electricity — Consolidation of Electricity Distribution Networks.”
 
On average, the distribution networks that we have been required to sell were more profitable than our other distribution networks, mainly because distribution in metropolitan areas has lower costs. In 2004, the Energy Authority put in place an equalization system to compensate distributors for the higher costs associated with serving non-urban areas. However, the compensation system does not apply to Enel Distribuzione. Please see “— The Tariff Structure” below.
 
Pursuant to European legislation passed in 2003, we are required to manage distribution and sales as two separate businesses. In 2007, the Energy Authority issued a decision setting out certain requirements that we and all other integrated groups operating distribution and sales need to meet in order to ensure an adequate level of separation or “unbundling”. In particular, unbundling requires that the network activities of distribution companies are managed independently of the other businesses. This implies that our subsidiaries that are involved in distribution must be able to adopt decision concerning network planning and expansion independently. As a consequence, there are limitations on our ability to control their day-to-day operations and investment decisions, though their overall level of investment is nonetheless subject to our control. In addition, there are limitations on the ability of directors to hold seats in one of our distribution subsidiaries if they are also directors of companies involved in other businesses. Similarly, employees of the distribution companies cannot have a financial interest in our other businesses, including stock options. In order to ensure non-discriminatory treatment to all companies wishing to supply electricity to customers in the area of a given distribution company, the distribution company must hold a database with information about customers. The database must be separate from other databases and be accessible on an equal basis to our subsidiaries and other providers. All transactions between the distribution companies and other companies belonging to the Enel Group must be at market prices. There can be no obligation for our distribution companies to purchase goods or services from other companies belonging to the Enel Group. The Energy Authority also envisages that, starting from 2010, metering activities will need to be managed as a separate business from distribution. These rules do not prevent energy groups from having a single company active in distribution of both electricity and gas.
 
Further rules on unbundling, including an obligation to manage distribution networks with at least 100,000 customers through a dedicated company, have been provided by a Law Decree approved in June 2007. Under the Law Decree, the Energy Authority is empowered to issue rules on functional separation of gas storage, distribution and transmission system operators from the rest of the vertically integrated energy group.
 
The Tariff Structure
 
Prices paid by all Italian customers for electricity include a transmission component, a distribution component, a generation component covering the price of the electricity itself and system charges.


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Under the current electricity tariff regime, all customers pay regulated prices, set either directly by the Energy Authority or in accordance with Energy Authority guidelines and subject to its approval, for the transmission and distribution components and system charges. The transmission and distribution components, together referred to as “transport charges,” are subject to a price cap mechanism aimed at progressively reducing these charges on the basis of annual efficiency targets. For customers purchasing electricity on the regulated market, the Energy Authority also regulates the generation component, which is set on a quarterly basis, while customers purchasing electricity on the free market pay prices agreed through bilateral contracts or on the power exchange.
 
The Energy Authority sets base tariff levels every four years. In setting the base tariff levels, the Energy Authority takes into account:
 
  •  Operating costs of generation (for electricity prices on the regulated market), transmission and distribution activities, including procurement costs, and amortization and depreciation. In order for operators to be able to recover particular costs, the costs must be both actually incurred by them and recognized by the Energy Authority,
 
  •  An appropriate return on invested capital, including both equity and debt financing, and
 
  •  The costs associated with system charges.
 
In 2004, the Energy Authority set new base tariffs for the 2004-2007 period, which have been in force since February 1, 2004. The Energy Authority estimated that the new tariff regime in place for 2004-2007 would result in a reduction of the overall tariff paid by regulated market customers of approximately 13% in real terms (assuming no change in fuel costs and system charges) during the period. The actual results were in line with the Energy Authority’s estimates.
 
Consultation procedures to set tariffs for the 2008-2011 period are in progress. These tariffs will concern transmission, distribution, and metering services. The Energy Authority has announced that the new tariffs will seek to promote efficiency and provide incentives for the development of infrastructure and be based on a simplified mechanism. Final rules will be adopted in the second half of 2007.
 
The actual impact of tariff levels on our revenues depends on a number of factors, including the volume of electricity we sell in the regulated market, fuel prices and the mix of customers we serve.
 
The tariff structure currently in place also includes certain mechanisms to take into account structural factors affecting distributors’ costs.
 
The Energy Authority in 2004 established a price equalizing mechanism intended to minimize the effects of a timing discrepancy in the setting of prices distributors pay to the Single Buyer for electricity to be distributed on the regulated market and the prices that distributors may charge to end users on the regulated market. The prices distributors pay to the Single Buyer for electricity to be distributed on the regulated market are set monthly by the Energy Authority based on the average unit costs incurred by the Single Buyer in connection with its purchases of electricity. However, the generation component included in the overall tariff that distributors may charge to end users on the regulated market is fixed by the Energy Authority on a quarterly basis, as explained in more detail below. In order to minimize the effects of this discrepancy, the Energy Authority has established a price equalizing mechanism applicable for the first time in 2004. The equalizing mechanism is funded through a system charge in an amount set by the Energy Authority, applicable starting in 2005.
 
In 2004, the Energy Authority also put in place a system to compensate distributors that serve areas where costs are significantly higher than the national average due to uncontrollable factors such as population density and geography. The costs to be taken into account in setting this compensation are to be based on infrastructural elements such as length of cables and installation type (aerial or underground). The compensation system does not apply to Enel Distribuzione, but it applies to our subsidiary Deval, which requested approximately €2.4 million as compensation. In September 2006, the Energy Authority granted Deval €1.6 million as compensation.


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The Energy Authority currently defines the following six tariff categories of electricity consumers:
 
  •  low-voltage domestic consumers (residential customers),
 
  •  low-voltage public lighting,
 
  •  other low-voltage end users,
 
  •  medium-voltage public lighting,
 
  •  other medium-voltage end users, and
 
  •  high-voltage end users.
 
Consultations are ongoing to modify the current tariffs structure. The Energy Authority is seeking to maintain tariffs for domestic low voltage customers even after July 1, 2007 (i.e. when all customers will be able to freely choose their supplier). The Energy Authority is also seeking to introduce a discount system for disadvantaged customers. A new consultation document is expected by the end of June 2007.
 
Generation Component of Electricity Tariffs
 
The generation component refers to the price paid by customers for electricity sold on the regulated market. Prior to the start of the power exchange on April 1, 2004, the Energy Authority determined generation costs based on fixed and variable components of production costs. The fixed-cost component, which was intended to reflect non-fuel operating costs, was based on an estimate of the average recognized fixed costs associated with generation plants in Italy and was set on annual basis.
 
The variable-cost component of the tariffs was principally intended to reflect fuel costs associated with thermal power generation. This system resulted in an increase in the relative profitability of:
 
  •  Hydroelectric or geothermal generation, since these plants do not incur fuel costs, and
 
  •  The resale of electricity imported under long-term contracts in effect as of the date of the entry into force of the first Electricity Directive on February 19, 1997, which was frequently cheaper than electricity generated in Italy.
 
The Energy Authority decided to reduce this potential windfall profit for hydroelectric or geothermal producers by establishing a new surcharge to be paid by these producers to the GSE with respect to electricity sold by them. This surcharge applied until December 2001. Pursuant to rules on stranded costs enacted in 2002 (which are described in more detail below), the surcharge on hydroelectric and geothermal generation was abolished as of January 1, 2002.
 
In February 2004, the Energy Authority modified the price electricity producers were permitted to charge to distributors for the electricity to be supplied to regulated customers in order to reduce the component of electricity tariffs related to generation during March 2004. We and other electricity operators challenged this reduction before the Administrative Tribunal of Lombardy, which annulled the Energy Authority decision. The Supreme Administrative Court, however, overruled this decision on January 16, 2006. Accordingly, we were required to reimburse consumers approximately €200 million, which is the difference between the price paid by regulated customers for the electricity supplied in March 2004 and the amount resulting from implementation of the reduction mandated by the Energy Authority.
 
Since April 1, 2004, the Energy Authority sets the generation cost component of the electricity tariff paid by customers on the regulated market every three months on the basis of the average costs incurred by the Single Buyer for the procurement of electricity, both on the power exchange and directly from producers.
 
We sell electricity on the free market through bilateral contracts at prices that are negotiated with each customer and that may vary based on several elements, such as quantity purchased, type of electricity sold and duration of the contract; electricity sold on the power exchange is sold at the price determined through the relevant market mechanism. Please see “— The Italian Power Exchange” above for additional details on these mechanisms.


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Transmission and Distribution Components
 
As noted above, the regulated tariff for transmission and distribution services, or transport charges, for all customers takes into account both the operating costs of transmission and distribution activities, including procurement costs, and amortization and depreciation, as well as an appropriate return on invested capital. In order for operators to be able to recover particular costs, the costs must be both actually incurred by them and recognized by the Energy Authority. The transmission component of the transport charges is currently set by the Energy Authority. As explained in more detail below, distributors may propose various price options for both residential and non-residential customers, within guidelines set by, and subject to the approval of, the Energy Authority.
 
The costs of transmission and distribution companies used in determining transport charges are subject to a price-cap mechanism. During the 2000-2003 period, the Energy Authority set the annual rate of reduction with respect to total costs (capital costs, depreciation and operating costs) in real terms at 4% for each of the transmission and distribution components. For the period 2004-2007, the Energy Authority has set the annual percentage decrease only for operating costs and depreciation, but excluding capital costs, for transmission and distribution services at 2.5% and 3.5%, respectively.
 
For distributors, the determination of operating costs is required to reflect the average costs incurred by the main distributors for the transport of electricity through the local distribution networks and for the sales-related services they provide to final customers, plus a specified return on invested capital. The return on capital recognized by the Energy Authority for the 2004-2007 period was set at 6.8% for distribution networks and at 6.7% for transmission networks, or a higher percentage for capital invested in transmission network development.
 
Depreciation and invested capital are calculated by the Energy Authority under criteria consistent with international regulatory practices. In setting tariff levels for the 2004-2007 period, the Energy Authority revised the way depreciation costs are calculated for transmission and distribution companies; whereas in the 2000-2003 period, the depreciation costs recognized were based on the value of a company’s network assets and the related depreciation expenses as recorded in companies’ statutory accounts, these costs are now calculated based on the historical cost of infrastructure, as revalued annually. The useful lives of assets considered by the Energy Authority to determine depreciation expenses to be recognized through the transport charges have also been increased to bring them into line with the expected useful life of plant and equipment.
 
Prior to 2004, both the transmission and distribution component of the transport charges paid by non-residential customers to distributors were set on the basis of proposals made by each distributor and approved by the Energy Authority. During that period, the transport charges for residential customers were set directly by the Energy Authority as part of the tariff paid by them to distributors. Starting in 2004, the Energy Authority has directly set the transmission component of the transport charge for all customers, while distributors retain the ability to propose to non-residential customers one or more options for the distribution component of the transport charge, based on the distributors’ costs as described above and within limits set by the Energy Authority.
 
These limits are of two types. One limit sets an aggregate maximum amount of tariff revenues that each distributor will be allowed to receive from all customers belonging to the same category in a single year. A second limit sets the maximum amount of tariff revenues that any distributor will be allowed to receive from a single customer in a given category. If the aggregate limit is exceeded, the distributor must compensate customers for the amount of the excess. The Energy Authority monitors compliance with the individual limit at the time the distributor submits its price options for approval. In addition, distributors must comply with a trade policy code aimed at ensuring transparency.
 
Residential customers do not have any options for the distribution component per se, since the tariff they pay includes the generation component and transport charges without distinguishing between the two. However, distributors may now also offer regulated market customers different tariff options, subject to approval by the Energy Authority. Please see “— Business — The Enel Group — Distribution of Electricity — Telemanagement System” for information regarding our tariff options.


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System Charges and Other Charges
 
The tariff structure also addresses the need to cover various costs resulting from public policy-related requirements imposed on the Italian electricity industry by providing for the following charges, payable by all electricity consumers:
 
  •  Charges concerning the electricity system, established by the Ministry of Economic Development, that consist of:
 
  •  a nuclear surcharge, covering part of the costs incurred by So.g.i.n., the company to which we transferred our discontinued Italian nuclear operations, in connection with the dismantling of nuclear plants and decommissioning of nuclear fuels; this surcharge is designed to cover substantially all of such costs when added to the funds that we transferred to So.g.i.n.,
 
  •  a surcharge that benefits producers from renewable resources,
 
  •  special surcharges covering the cost of supplying electricity at mandated discounts to certain customers (primarily the Italian state-owned railway company and Acciai Speciali Terni S.p.A., both of which transferred electricity assets to us as part of the nationalization of the Italian electricity industry in 1962),
 
  •  research and development surcharges, covering related costs, and
 
  •  certain stranded costs that have not yet been recovered. Please see “— Stranded Costs” below for a discussion of these costs.
 
  •  Other general interest charges established by the Energy Authority to adjust or refine the operation of the tariff mechanism, which include adjustments to cover potential differences between distributors’ costs as recognized under the current tariff structure and actual tariff revenues.
 
  •  Incentives for the enhancement of the quality of service.
 
  •  Charges recovered through upward adjustments to the price caps, as established by the Energy Authority, which cover:
 
  •  costs deriving from unforeseeable events, changes in the regulatory framework or new obligations for universal service,
 
  •  costs deriving from demand-side management initiatives intended to promote a more efficient use of resources by electricity customers, including information campaigns, and
 
  •  additional recognized costs incurred in connection with the offer of value-added services on top of basic options.
 
Revenues deriving from system charges are remitted to and managed by the Cassa Conguaglio per il Settore Elettrico, or the Equalization Fund, a public entity charged with redistributing these revenues to the electricity companies entitled to receive them.
 
Stranded Costs
 
Stranded costs are current costs deriving from contractual commitments or investment decisions that electricity companies:
 
  •  undertook for reasons of public policy,
 
  •  undertook at a time when the electricity markets were not yet open to competition, and
 
  •  could have been recovered in a monopoly regime but cannot be recovered under a regime of competitive electricity pricing.
 
To facilitate the transition to open electricity markets, the European Commission has stated that electricity companies should be refunded their stranded costs provided that:
 
  •  they minimize the impact of those costs (and, hence, the amount of the refund) on their future operations, and


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  •  they submit an industrial plan demonstrating the long-term profitability of the activity related to the stranded costs.
 
A law enacted in April 2003 limited the amount of stranded costs we are entitled to recover for periods through 2003 to (i) certain costs relating to our generation plants incurred to comply with requirements that were imposed in the past concerning their design and operation (for example, because of governmental policies, we built most of our plants to ensure a high degree of flexibility in the types of fuel that they can use), and (ii) costs arising from our inability to fulfill our Nigerian LNG contract because of the Italian government’s failure to allow construction of a required regasification terminal. The April 2003 law provides that for periods after January 1, 2004, we will be limited to recovering only those stranded costs associated with the Nigerian LNG contract.
 
In August 2004, the MEF and the Ministry of Economic Development issued a joint decree that determined the overall amount of stranded costs we are entitled to recover. On December 1, 2004, following the European Commission’s approval of the decree pursuant to the state aid rules of the European Union, we became entitled to recover approximately €513 million on account of stranded costs related to our generation plants for the period 2000-2003. The amount of stranded costs related to the Nigerian LNG contract we are entitled to recover was determined to be approximately €555 million in respect of the 2000-2003 period and approximately €910 million in respect of the 2004-2009 period.
 
The timing and manner in which these amounts are to be paid to us were set out in a decree issued jointly by the Ministry of Economic Development and the MEF on June 22, 2005. The decree provides that stranded costs related to the Nigerian LNG contract for the period ending in 2004 and stranded costs related to our generation plants will be reimbursed by December 2009 through quarterly payments. Stranded costs related to the Nigerian LNG contract for the period from 2004 through 2009 will be limited to the value of gas effectively used for electricity generation, calculated on a yearly basis. The total amount of payments in consideration of stranded costs we received was €361 million as of December 31, 2005, €1,230 million as of December 31, 2006, and €1,296 million as of March 31, 2007. As of March 31, 2007, we accrued a residual credit of €285 million, and €410 million will become due in the period from 2007-2009.
 
Continuity and Quality of Service Regulation
 
Since July 1, 2000, the Energy Authority has issued guidelines setting targets for electricity service continuity and quality. Continuity of service is measured by the frequency and total duration in minutes of service interruptions and is assessed with reference to annual targets set by the Energy Authority. Quality of service is measured in terms of waiting time for the performance of the most frequent commercial activities (such as connection cost estimates, connections, disconnections and reconnections).
 
The Energy Authority has instituted an incentive system whereby it grants bonuses to companies that exceed its targets for continuity of service and imposes penalties on companies that fail to meet them. We have consistently exceeded our continuity of service targets since 2000. Distributors that outperform the targets are paid their bonuses through a component of the tariff structure. We received bonuses of €63 and €118 million for having outperformed the continuity of service targets in 2004 and 2005. We expect that the Energy Authority will assign bonuses with respect to 2006 in the second half of 2007.
 
With respect to quality of service, if a distribution company fails to meet standards set by the Energy Authority in providing a particular service to a customer, the company is required to reimburse that customer an amount that is fixed by the Energy Authority. We have achieved most of the quality of service targets set by the Energy Authority, and have not been required to make material reimbursements.
 
We believe that the level of revenues expected under the current tariff structure will allow us and other distributors to cover the costs we need to incur to meet the continuity and quality of service targets set by the Energy Authority. See also “— Business — The Enel Group — Domestic Sales Division — Continuity and Quality of Network Service.”
 
In May 2005, the Energy Authority issued a consultation document, subject to public comment through June 30, 2005, proposing to institute a system of automatic compensation payable by electricity distributors to affected customers in the event of a blackout of other prolonged service interruption. Under these proposals,


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compensation would be payable by a distributor that fails to restore service within eight hours from the start of the interruption, if the interruption has not been caused by damage to the distributor’s facilities, or within 24 hours from the start of the interruption, if the interruption has been caused by damage to the distributor’s facilities. The Energy Authority’s proposals also provide for incentive mechanisms for distributors to restore service as soon as possible in the event of a widespread and prolonged service interruption. The Energy Authority has issued further consultation documents in June 2006 and January 2007. The Energy Authority is proposing to distinguish between “exceptional” and “normal” circumstances. Customers will be entitled to claim a fixed sum as compensation in both cases. Compensation for interruptions that take place in “exceptional” circumstances will be paid by a fund managed by the Equalization Fund. The fund is financed by final customers, distributors and Terna. It is yet unclear how the Energy Authority intends to deal with sharing of responsibilities between Terna and distributors in complex cases where interruptions involve also the transmission network. The Energy Authority is expected to issue a final decision in the second half of 2007.
 
In April 2007, the Energy Authority started the first consultation to define new standards for the continuity and quality of electricity service for the 2008-2011 period. The Energy Authority’s proposal under consultation includes rules on the maximum number of interruptions allowed, new quality measurement systems, promotion of specific measures to improve distribution networks’ reliability and safe operations. To implement the measures to improve distribution networks, the Energy Authority is proposing to apply a higher measure of remuneration of cost of capital than the one foreseen for the remuneration of capital invested in distribution networks.
 
Promotion of Renewable Resources
 
In 1992, the Comitato Interministeriale Prezzi, an Italian governmental committee, issued Regulation 6/92 (“CIP 6”), which established incentives for new generation plants using renewable resources and for the sale of electricity produced from renewable resources. Initially under the CIP 6 regime, we had been required to purchase substantially all of the qualifying domestic production of electricity from renewable resources at fixed prices. In November 2000, the Ministry of Economic Development issued a decree that transferred all energy produced from renewable resources under the CIP 6 regime to the GSE as of January 1, 2001. Under current regulations, the GSE is required to purchase all CIP 6 electricity, which it resells to Eligible Customers and, starting from 2004, also to the Single Buyer. The Single Buyer has a right to a predefined quota of CIP 6 electricity. Until 2003, Eligible Customers obtained CIP 6 electricity pursuant to an auction mechanism; starting from 2004, they are awarded CIP 6 electricity on a pro-rata basis. The GSE sells “green certificates” representing electricity from renewable resources purchased from CIP 6 producers. The total annual CIP 6 electricity production in 2005 was equal to approximately 50 TWh, in line with the amount produced in 2004. In 2006, the actual production was equal to 49 TWh and GSE estimates that total annual CIP 6 electricity production will slightly decrease in 2007.
 
The Bersani Decree provided that, starting in 2001, all companies introducing more than 100 GWh of electricity generated from conventional sources into the national transmission grid in any year must, in the following year, introduce into the national transmission grid an amount of electricity produced from newly qualified renewable resources equal to at least 2% of the amount of such excess over 100 GWh, net of co-generation, self-consumption and exports. Electricity from renewable resources may be produced directly or purchased from other producers who have obtained tradable “green certificates” representing a fixed amount of electricity certified as generated from renewable resources. In addition, the Bersani Decree granted priority dispatching to energy produced from qualified renewable resources.
 
An EU directive issued in September 2001 set targets for energy production from renewable resources, requiring that by 2010 a share equal to 22% of total electricity consumed in the EU be generated from renewable resources and providing recommended national targets to achieve this goal. Italy adopted legislation to implement this directive in December 2003, setting a 22.5% target for total production of electricity from renewable resources by 2010, lower than the 25% target for Italy recommended in the EU directive. December 2003 legislation amending the Bersani Decree provided for a progressive increase in the 2% share of electricity produced from newly qualified renewable resources electricity generators are required to introduce into the national transmission grid. For 2004, the percentage was increased to 2.35%. A further 0.35 percentage points increase applied in each of 2005 and 2006. Further increases shall be implemented for the three-year periods starting in 2007 and in 2010, given that EU Member States have agreed in March 2007 to achieve at least a 20% reduction of greenhouse gas emissions


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by 2020 compared to 1990 and increase to 20% the portion of primary energy consumption to be generated from renewable energy sources. This will affect national regulation on the promotion of renewable sources including the provisions of targets for Italy.
 
Hydroelectric Power
 
Under the Bersani Decree, all of our licenses for the generation of electricity from large bodies of water, which had originally been granted to us for an indeterminate period of time, were instead to expire in April 2029. In addition, the Bersani Decree automatically extended to December 31, 2010 the term of all hydroelectric licenses for the generation of electricity from large bodies of water that were granted to other electricity producers and were scheduled to expire before such date. All hydroelectric licenses expiring after December 31, 2010 were to retain their original expiration date. The decree also provided that in any bidding contest, an existing license holder would enjoy preferential treatment over competitors in the case of equal bids.
 
In January 2004, the European Commission determined that certain of the Italian regulations regarding hydroelectric concessions were contrary to EU law. In particular, the European Commission objected to the renewal preferences granted to existing holders of concessions (and in the region of Trentino-Alto Adige, to the operator controlled by the local authorities) upon the expiry of those concessions, as well as to the fact that the regulations provided for the expiration of all concessions in 2029 (and for the region of Trentino-Alto Adige, in 2010), even though these concessions had previously been of perpetual duration. In December 2005, Italy amended the relevant regulations, abrogating the renewal preferences and postponing the expiration of all concessions for additional 10 years. As a consequence, on June 28, 2006, the European Commission partially closed the proceedings. The proceedings concerning regulations in force in Trentino-Alto Adige remain open. However, they were suspended pending an action brought by five regional governments and the local authorities of the region of Trentino-Alto Adige before the Italian Constitutional Court, whereby they sought to obtain the reinstitution of the original expiry dates for operations they control. The Constitutional Court may not issue a judgment on this matter, though, because in January 2007 a law cancelled the 10-year postponement granted in 2005. We expect a decision by the European Commission on this matter by the end of 2007.
 
Taxes
 
Since January 1, 2001, consumers of electricity services have been subject to three indirect taxes, the first two of which are not applicable to residential customers whose consumption is below certain specified thresholds, qualifying them for a social protection scheme:
 
  •  A state tax for residential uses (of €0.0047/kWh) and for other uses (of €0.0031/kWh excluding users with consumption over 1.2 GWh per month),
 
  •  Additional local taxes that vary from €0.0093/kWh up to a maximum of €0.0204/kWh, and
 
  •  Value-added tax of 20% for all users with the exception of residential and industrial customers (who are taxed at a rate of 10%).
 
Gas Regulation
 
Italian regulations enacted in May 2000 pursuant to EU Directive 98/30, which mandated the general liberalization of natural gas markets in the member states, seek to introduce competition into the Italian natural gas market through the liberalization of the import, export, transport, dispatching, distribution and sale of gas. In 2007 or 2008, the Italian government may enact new regulations which, pursuant to EU Directive 2003/55, aim at fostering competition in the European natural gas market mainly by enhancing the separation, with respect to corporate governance and accounting, between businesses relating to the operation of a network (i.e. transport, distribution) from activities concerning the supply/production of gas.
 
Gas Eligible and Non-Eligible Customers
 
Until December 31, 2002, only certain large consumers known as Gas Eligible Customers were able to freely choose their supplier of natural gas. During the same period, customers, mainly residential, who did not qualify as


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Gas Eligible Customers, which we refer to as Gas Non-Eligible Customers, were obliged to purchase gas from distributors operating in their local area at a tariff set by the Energy Authority. Since January 1, 2003, all customers have had direct access to the natural gas system and the right to freely choose their natural gas supplier. However, natural gas suppliers are still subject to regulation with respect to the tariffs they may charge to domestic customers who were considered Gas Non-Eligible Customers at that date. In 2005, the churn rate of Italian customers amounted to 1.1%, a large part of which chose Enel as their supplier. Please see “— Distribution Tariffs and Sale Tariffs for Gas Non-Eligible Customers” below.
 
Transport and Storage
 
Companies engaged in the transport and dispatching of gas must allow access to their gas transport networks to third parties, provided that they have enough capacity and that granting such access is economically and technically feasible (TPA — Third Party Access). The Energy Authority establishes transport fees based on proposals from the individual operators. Pursuant to a law enacted in 2006, the Italian government is expected to adopt a Decree pursuant to which, after two years from its entry into force, no single person or company will be allowed to own more than 20% of the shares of State-controlled companies operating national gas transport networks.
 
Operators of natural gas storage facilities must obtain a concession from the Ministry of Economic Development and are required to provide storage services to third parties upon request, provided that they have enough capacity and that giving such storage services is economically and technically feasible. In addition, importers are required to maintain storage reserves equal to 10% of the gas they import from countries outside the EU.
 
Pursuant to a bill currently being examined by the Italian Parliament (the “Bersani bill”), in order to increase gas supply and foster competition in the Italian market, the Italian government may enact new regulations to promote investment in new gas import facilities and the MEF may grant financial incentives to local authorities authorizing the construction of these facilities within their territory.
 
The Marzano Law provides incentives for investment in new natural gas transport and storage facilities, as well as LNG regasification terminals, by exempting the investing companies from granting TPA to the new facilities. The exemption is granted on a case by case basis for no less than 80% of the capacity of such facilities and for a minimum of 20 years.
 
Distribution and Sale of Gas
 
The term distribution refers to the transport of gas through local networks for delivery to customer premises. Since January 1, 2002, gas distribution activities may be carried out only by companies that are not otherwise engaged in the natural gas industry, and gas sales to end users may be made only by companies that are not otherwise engaged in the natural gas industry except as importers, producers or wholesalers. In January 2007, a resolution by the Energy Authority required all groups or companies engaged in gas transport, distribution, storage, metering, and regasification of LNG to ensure the independence of each of these activities from any other businesses in the gas and electricity industries, with very limited exceptions, through separate accounts and fully independent governing bodies. Please see “— Overview of Regulation in the Energy Sector in Italy.”
 
Restrictions on Sale and Imports of Gas
 
The sale of gas to end users is made under an authorization granted by the Ministry of Economic Development , which both Enel Energia and Enel Trade have obtained. Enel Trade is also authorized to import gas to be sold to power plants and wholesalers. Each year from January 1, 2003 to December 31, 2010, no single operator has been allowed to hold a market share higher than 50% of domestic sales to final customers. In 2005, based on data provided by the Energy Authority, Enel had a market share in sales of natural gas of approximately 16%. In addition, no single operator is allowed to introduce imported or national gas into the domestic transmission grid in a quantity exceeding a specified percentage of the total, set at 75% in 2002 and decreasing by two percentage points each year thereafter, to 61% in 2010. The applicable percentage is calculated net of quantities of gas consumed by the relevant operator or by its controlled or affiliated companies.


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Rules Governing Distribution of Gas
 
Under Italian regulations, distributors operate under concessions awarded by local authorities pursuant to tender procedures for periods not longer than 12 years. Through service agreements, local authorities may regulate the terms and conditions for the provision of the service and the quality objectives to be achieved. The tenders are awarded based on financial terms, quality and safety standards, investment plans and technological and management skills offered. Distributors are required to connect to the distribution network any customer who so requests.
 
Prior to enactment of the Marzano Law, gas distribution concessions awarded prior to May 2000 by means other than competitive tender expired by law at the earlier of their original expiration date or December 31, 2005, with the expiration date extendible for up to five years under certain conditions. The Marzano Law, as interpreted by the Ministry of Economic Development in November 2004, provided instead that gas distribution concessions are to expire at the earlier of their original expiration date or December 31, 2007, with the expiration date extendible for up to five years under certain conditions. However, certain local authorities have passed measures that would terminate gas distribution concessions in their jurisdictions on December 31, 2005. The Italian administrative courts before which these measures have been challenged disagreed with the Ministry of Ministry of Economic Development ’s interpretation of the Marzano Law. To remedy the resulting uncertainty, on February 23, 2006, the Italian parliament approved a law confirming that gas distribution concessions expire by law at the earlier of their original expiration date or December 31, 2007, but extended the expiration date to December 31, 2009 under certain conditions. Local authorities may further extend the expiration date by one year. Furthermore, certain gas distribution concessions for southern Italy expire at the later of June 21, 2012 or twelve years from the entry into force of their approval by the Ministry of Economy and Finance. Finally, gas distribution concessions awarded prior to May 2000 by competitive tender expire at the earlier of their original expiration date or December 31, 2012. The majority of our existing gas distribution concessions are currently due to expire on December 31, 2009. In August 2006, the Administrative Court of Lombardy requested the European Court of Justice to assess the compatibility with the EC Treaty of the automatic extension of the expiration dates granted pursuant to the February 2006 law.
 
Pursuant to the Bersani bill, the Italian government may enact regulations to define new award criteria in competitive tenders for distribution concessions, as well as to provide incentives for gas distributors to broaden the territorial scope of their activities.
 
Distribution Tariffs and Sales Tariffs for Gas Non-Eligible Customers
 
In December 2000, pursuant to Italian regulations, the Energy Authority identified tariff criteria that we and other gas distributors and suppliers must apply in setting tariffs for the distribution and supply of gas to Gas Non- Eligible Customers. The tariff criteria for both distribution and supply include a fixed and a variable component reflecting the balance between fixed and variable costs incurred by distributors and suppliers, respectively, and operate to impose a cap on the rates gas distributors and suppliers may charge. The portion of the variable component in the sale tariff relating to the cost of natural gas is revised on a quarterly basis.
 
For distributors, the tariff criteria generally take into account average capital costs, as determined by the Energy Authority based on a sample of selected operators. However, since June 2002, the Energy Authority has permitted distributors to set their rates based on actually incurred capital costs if such costs can be adequately proven.
 
Following the annulment of the previous tariffs by the administrative courts, the Energy Authority has issued a regulation establishing new distribution tariffs for the period October 2004-September 2008. According to the new tariff mechanism, distributors have to apply progressively decreasing tariffs. However, distributors who made investments or merged with other distributors are allowed to apply a lower tariff reduction. We expect these new tariffs to have a positive impact on Enel’s 2007 and 2008 results.
 
From 2004, distributors are also bound by regulations concerning quality of service. So far, the Energy Authority has introduced both penalties for distributors that do not comply with applicable quality of service targets and incentives to achieve higher safety standards.


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For suppliers, prices charged to Gas Non-Eligible Customers were supposed to be freely set from January 1, 2003. However, in December 2002, the Energy Authority imposed a transitory regime under which suppliers were obliged to continue to supply former Gas Non-Eligible Customers using the tariff criteria established by the Energy Authority and in effect at December 31, 2002, if the Gas Non-Eligible Customers so requested.
 
In December 2004, the Energy Authority revised the 2002 sale tariff criteria for former Gas Non-Eligible Customers in order to reduce the effect of fuel price increases on gas prices. In June 2005, the Administrative Court of Lombardy annulled the Energy Authority’s decision in a series of rulings. Some of these rulings were appealed by the Energy Authority and subsequently quashed by the Supreme Administrative Court, while others were not timely appealed and, therefore, became definitive. Consequently, in March 2007, the Energy Authority issued new sale tariff criteria for the period January 2005-June 2008. Under the new criteria, gas sales companies are entitled to apply sale tariffs for these years that are more favorable than the 2004 criteria. With the same resolution, the Energy Authority established the criteria pursuant to which gas sales companies may apply the new tariffs to final customers with respect to previous years.
 
Environmental Matters
 
Our electricity and other operations are subject to extensive environmental regulation, including laws adopted by the Italian parliament or government to implement regulations and directives adopted by the European Union and international agreements on the environment.
 
The principal objective of our environmental policy is to comply with all relevant legislation and to seek to reduce adverse effects that our activities may have on the environment. Since 1996, we have taken the initiative of publishing an annual environmental report. In 2002, we also started publishing a sustainability report, which contains an environmental section. We believe that environmental performance will represent an increasingly important competitive factor in a liberalized market.
 
Environmental regulations affecting our business primarily relate to air emissions, water pollution, waste disposal, noise and the clean up of contaminated sites. The principal air emissions of fossil-fueled electricity generation that pollute the atmosphere are sulfur dioxide (SO2), nitrogen oxides (NOx), and particulate matter. A primary focus of the environmental regulations applicable to our business is an effort to reduce these emissions. We have also given particular attention to seeking to minimize the impact of electromagnetic fields and carbon dioxide (CO2) and other greenhouse gas (“GHG”) emissions.
 
Electromagnetic Fields
 
The Italian government adopted regulations in 1992 and 1995 relating to exposure to electromagnetic fields applicable to low frequency infrastructure, such as that used for the transmission, distribution and consumption of electricity. These regulations set two types of limits: maximum levels of exposure to electromagnetic fields from new and existing transmission and distribution lines and distribution substations, and minimum distances between transmission or high-voltage distribution lines or substations and residential buildings, office buildings and similarly habited areas for lines built after the adoption of the 1992 regulation.
 
In February 2001, the Italian parliament passed a framework law on electromagnetic field exposure amending these earlier regulations. The 2001 law is intended to protect the general public and workers against alleged potential long-term health effects of exposure to electromagnetic fields generated by both low frequency and high-frequency infrastructures. The law has made it more difficult to install new transmission and distribution lines and substations.
 
Furthermore, the 2001 law provides for the adoption and implementation of programs to restructure electricity transmission and distribution lines, substations and high frequency infrastructures, in accordance with maximum exposure levels. In 2003, two governmental decrees were enacted providing for measures to implement the 2001 law and setting maximum exposure levels, precaution levels and quality targets. However, these measures have not yet taken effect, as they require action from the Italian Authority for Environmental Protection that has not yet been taken.


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We believe that the costs of complying with these measures, including costs for the related restructuring described above, will not have a material impact on our results of operations. Moreover, because of the 2005 and 2006 disposal of all but 5.12% of our stake in Terna, which owns over 90% of Italy’s power transmission lines, we are no longer materially affected by regulations relating to electricity transmission. Currently, we only own power lines for the distribution of electricity.
 
CO2 Emissions
 
Both the European Union and Italy are signatories to the Kyoto Protocol, which was signed under the United Nations Framework Convention on Climate Change. In accordance with a burden-sharing agreement among EU member states, Italy has set a target to reduce emissions of CO2 and the other GHGs listed in the Kyoto Protocol over the 2008-2012 period by 6.5% from their 1990 levels. As of 2004, we produced approximately 11% of total GHG emissions in Italy.
 
In implementing the Kyoto protocol, on November 19, 1998, the Italian inter-ministerial committee for economic planning issued the guidelines for Italian policies and measures for the reduction of GHG emissions in order to implement the Kyoto Protocol. These guidelines, which were updated in 2002, set targets for CO2 and other GHG emissions to be achieved through measures concerning various sectors of the Italian economy, including a reduction of carbon produced in thermal electricity generation, an increased use of electricity generation from renewable resources and demand-side management to increase the efficiency of energy use. Furthermore, the guidelines promote certain projects aimed at the development of so called clean energy.
 
In July 2000, we signed a voluntary undertaking with the Environment Ministry and the Ministry of Economic Development to reduce the annual level of CO2 emissions produced by our plants during the period between 2002 and 2006 from our level of emissions in 1990. The undertaking anticipates a number of measures to reduce GHGs emissions, including employing high-efficiency technologies, such as CCGT conversions, promoting the use of renewable resources and developing innovative generation technologies. In 2006, our CO2 emissions per power generation unit was equal to 496 g/kWh, i.e. below the target limit set pursuant to this undertaking for that year (equal to 510 g/kWh).
 
In January 1999, the Italian government introduced a carbon tax in accordance with European Union directives. The carbon tax is designed to reduce Italy’s CO2 emissions so as to comply with the Kyoto Protocol. Under the current Italian legislation, the amount of the tax, which is based on fossil fuel consumption, although initially scheduled to increase on an annual basis from 1999 through 2005, has been frozen at the level for 1999. The relevant EU directives provide for a periodic review of this tax, including its possible abolition. We and other European electricity companies believe that, with the introduction of the emission trading rules in January 2005, the carbon tax should have been abolished in order to avoid market distortion and double taxation since both this tax and the emission trading rules have the objective of reducing CO2 emissions to comply with the Kyoto Protocol.
 
In the period between 2003 and 2005, our carbon tax liability decreased from approximately €40 million in 2003 and 2004 to €37 million in 2005. In 2006, our carbon tax liability was equal to €34 million, thus marking a further decrease.
 
Emission Trading
 
With a view to ensuring compliance with the Kyoto Protocol, in 2003 the EU adopted an Emission Trading Directive establishing a scheme for GHG emission allowance trading. . In October 2004, the EU also passed another directive (the so-called “linking directive”), which amended the Emission Trading Directive to allow the use of other flexible mechanisms for limiting GHG emissions.
 
The Emission Trading Directive requires that each member state submit to the European Commission a proposal on how it plans to comply with the directive’s emission limits. This proposal is to consist of an allocation plan by which each member state sets CO2 emissions thresholds for the 2005-2007 period for various industries, including the energy sector, and must provide for fines to be imposed on entities whose emissions exceed these thresholds. The allowable levels for the next period, i.e. 2008-2012, had to be proposed by 2006.


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With respect to Italy, in July 2004, the Environment Ministry and the Ministry of Economic Development submitted to the European Commission a national allocation plan for Italy concerning the 2005-2007 period. Under the national allocation plan, the thresholds for thermal power plants would vary depending on the type of fuel burned, so as not to disadvantage plants that burn fuels such as coal, which, although generating higher levels of emissions, contribute to the stability and reliability of supply. In December 2004, the Italian government put in place the procedures necessary to authorize plants to emit GHGs and to gather the necessary information to grant emission rights. We received the relevant authorizations for our power plants in December 2004. In an amendment to the national allocation plan published on February 2005, the Enel Group was assigned emission quotas of 54 million, 45 million and 45 million metric tons of CO2 for the years 2005, 2006 and 2007, respectively.
 
On May 25, 2005, the European Commission approved Italy’s national allocation plan, including, however, modifications that reduced the allowable emissions assigned to Italy by 9% (from 255 million metric tons to 232 million per year), which therefore required a revision to the February 2005 emission quota allocations. On February 23, 2006, the Environment Ministry issued a decree establishing the emission quotas for the Enel Group from 2005 through 2007, reducing the quotas we had been granted in February 2005 to 48.2 million, 40.5 million, 39.9 million tons of CO2 for the years 2005, 2006 and 2007 respectively. In December 2006, the Environment Ministry and the Ministry of Economic Development submitted to the European Commission a national allocation plan for Italy concerning the 2008-2012 period. In a decision issued in May 2007, the European Commission approved the plan, although it requested modifications that reduced allowable emissions by 6.3% (i.e., 195.8 million metric tons per year). A decision on emission quota allocations by Italian authorities is expected in the second half of 2007.
 
In Italy, Enel’s actual emissions in 2005 and 2006 were higher than the emission quotas to which its plants were entitled by approximately 8 million tons and 11 million tons, respectively. We expect that emissions in 2007 will also exceed allowed emissions by a similar amount. In compliance with the applicable provisions, we have purchase emission rights through the market in order to cover these differences. The quotas allocations do not include allowances reserved for new plants.
 
With respect to our operations in Spain, the national allocation plan approved by the European Commission in 2007 for the 2008-2012 period implied a reduction in allowable emissions (152.3 million metric tons per year, down from 152.7 million metric tons as per the original plan submitted by Spanish authorities). Action by the Spanish authorities to modify the national allocation plan to bring it in line with the European Commission’s decision is expected in the second half of 2007. Enel Viesgo Generacion’s emissions in 2006 were higher than the allowed limit by 0.7 million metric tons. In 2007, we expect an additional shortfall of over 1 million metric tons.
 
Slovakia’s national allocation plan for the period 2008-2012 was approved by the European Commission in December 2006 with a 25% reduction in the proposed allowable emissions. This decision was appealed by Slovakia and a judgment is expected in the second half of 2007. Slovenské elektrárne’s emissions in 2006 were lower than our allowed limit by 0.6 million metric tons. In 2007, we do not expect to exceed our allowances. Our allowable emissions for the period 2008-2012 will depend on the outcome of the appeal against the European Commission’s decision. Under the original plan, we were granted 9.2 million metric tons per year.
 
Bulgaria has yet to submit its national allocation plan to the European Commission. In 2007, we were granted 5.18 million metric tons. We do not expect material adverse consequences from the allocation plan for 2008-2012.
 
The measures that we have implemented in order to comply with the Emission Trading Directive limits and national implementing legislation include:
 
  •  Switching fuel,
 
  •  Converting existing oil-fired thermal power plants into gas-fired CCGT turbines or high-efficiency coal-fired plants,
 
  •  Increasing renewable energy capacity, and
 
  •  Sourcing CO2 credits through the development of Clean Development Mechanism (CDM) and Joint Implemetation (JI) projects in the energy sector (in particular geothermal), investing in carbon funds and purchasing emission reductions through bilateral contracting.


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SO2, NOx and Other Emissions
 
The principal EU directive on air emissions affecting the electricity industry is the large combustion plants directive (“LCPD”). The LCPD requires each EU member state to establish and implement a program of progressive reduction of total SO2 emissions and total NOx emissions from generation plants licensed before July 1, 1987, and to establish emission limits for SO2, NOx and particulate matter from individual generation plants licensed after July 1, 1987. In 2001, new, more stringent emission limits were set in an amendment to the LCPD.
 
Limitations on plant emissions set by Italian legislation are stricter than those envisaged in the LCPD as well as in the 2001 amendment (which Italy implemented in 2006), also requiring 5-year gradual reduction targets of aggregate emissions from plants licensed prior to July 1, 1988 through the end of 2003. We achieved the required reductions in each of the years in which they were applicable, including 2003.
 
In addition, Italy is bound by an EU directive issued in 2001 mandating that member states achieve specified reduction targets on SO2, NOx, volatile organic compounds and NH3 emissions by 2010. To this end, member states were required to establish and implement a program of emissions reduction in order to achieve the targets set in the directive. Italy is also a member of the Helsinki Protocol and the Oslo Protocol, which require signatory countries to reduce SO2 emissions, and the Sofia Protocol, which requires signatories to reduce NOx emissions. The requirements under these protocols have been reflected in Italian law.
 
In addition, in 1990, Italy established a regulation limiting emissions of polluting substances from thermal plants licensed before July 1, 1988 that is more strict than the LCPD and covers a much broader range of pollutants. This regulation required that individual existing thermal plants in Italy reduce emissions to levels similar to those established under the LCPD for individual plants licensed after July 1, 1988. This regulation also provided a time schedule for the implementation of environmental compliance measures at existing plants.
 
In response to this regulation, in 1990 we implemented a significant program of environmental measures that affect our entire thermal generation operation. We submitted this program to the relevant ministries of the Italian government, including those for industry, environment and health. The program was approved and provided for modifications of both physical plant and operating practices. Enel has achieved the targets the Italian regulation provided for the implementation of these environmental compliance measures for generating facilities.
 
We are currently in compliance with the limits set by existing legislation. We had received a derogation from the required limits with regard to our plant at Porto Tolle pending our receipt of required authorizations to effect a conversion of the plant to make it fully compliant. While this derogation expired on December 31, 2004, we expect to complete the conversion of this plant by 2012, and meanwhile are meeting the required limits at the plant through operational means.
 
The following tables show the level of SO2 and NOx emissions from our power plants included within our present limits in the period from 2001 to 2006, and the percent reductions in the level of these emissions compared to 2000.
 
Reductions of SO2 emissions against 2000 levels
 
                 
          Percentage
 
Year
  Metric Tons     Change  
    (In thousands)  
 
2001
    213       (11 )
2002
    187       (21 )
2003
    101       (58 )
2004
    94       (61 )
2005
    73       (69 )
2006
    69       (71 )


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Reductions of NOx emissions against 2000 levels
 
                 
          Percentage
 
Year
  Metric Tons     Change  
    (In thousands)  
 
2001
    71       (8 )
2002
    71       (9 )
2003
    62       (20 )
2004
    56       (28 )
2005
    49       (37 )
2006
    43       (44 )
 
In 1997, the Italian parliament imposed a tax on total SO2 and NOx emissions from thermal plants that have a nominal capacity greater than 50 MW. These plants are the same plants as those regulated under the LCPD. In 2004, 2005, and 2006 our costs in connection with this tax were approximately €8 million, €7 million, and € 6 million, respectively.
 
PCBs and Asbestos
 
In May 1999, the Italian government adopted a legislative decree concerning the recovery and disposal of electric transformers and other equipment containing polychlorinated biphenyls, or PCBs. The decree, as later amended, provides that:
 
  •  electric transformers and other equipment which contains PCBs above 500 parts per million must be decommissioned or decontaminated by 2009, and
 
  •  transformers which contain PCBs below the limit set out above can be used until the end of its operational life.
 
In December 2003, our Domestic Infrastructure and Network Division adopted a disposal plan to comply with this legislation. The phasing out of the equipment containing more than 500 ppm is expected by 2007 and the phasing out of the transformers containing less than 500 ppm by 2010. These targets are more stringent than those of the relevant legislation, which provides that equipment containing more than 500 ppm should be phased out by 2009 and that transformers containing less than 500 ppm could be used until the end of their operating life.
 
We also deliver waste products containing asbestos to specialized companies authorized to treat and dispose of asbestos. Such waste products derive from the clean up of our plants we conduct in accordance with our general maintenance and environmental clean-up programs.
 
Water Pollution Prevention
 
We are subject to environmental laws and regulations limiting heat and other physical and chemical characteristics of cooling water and industrial water discharges from our thermal plants and hydroelectric plants. In May 1999, the Italian parliament adopted a new law for the prevention of the pollution of fresh and salt water, which was amended in August 2000. In the same year, the EU adopted a directive to prevent water pollution. We believe that the waste water treatment facilities already in operation at our generation plants are in line with the new requirements on waste water under EU law.
 
In April 2006, Italy implemented the EU directive on water pollution through a legislative decree, which in addition took initial steps to reorganize Italy’s environmental regulations, in this field. We do not believe that this reorganization, which will be completed through additional decrees, will materially change the obligations to which we are subject with respect to water pollution.
 
Solid Waste Management
 
In February 1997, the Italian government issued a legislative decree implementing the EU directives on solid waste management. In accordance with this decree, we increased the level of recycling of our waste. In the last five years, our waste recovery rate has always exceeded 88%, and has been approximately 91% as a weighted average.


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Site Clearance
 
Italian legislation provides for ground and underground inspections to evaluate the possible contamination of sites, particularly in areas declared to be of national interest, using specific chemical, physical and historical analyses. If sites we own are found to be contaminated, the current regulation requires that we undertake a program of site clearance and remediation. In that case, under new legislation, the Italian government may provide financial support for remediation with respect to contaminated sites located in areas of national interest. Clearances need be preceded by site characterization plans.
 
Initiatives concerning areas designated as being of “national interest” pursuant to applicable legislation include a number of our thermal power plants and are currently ongoing.
 
Emergency measures were taken for groundwater safety and conservation near the power plants of Porto Marghera (Venice) and Fusina in an effort to settle a dispute with the government and judiciary authorities. These measures include construction of barriers to safeguard the canals of the lagoon from pollution.
 
Our costs of compliance with these measures were €16 million in 2005 and €33 million in 2006. For 2007, we currently expect to spend approximately 23 million.
 
Landscape Safeguards
 
We have taken the following actions to reduce the environmental impact of our power distribution lines:
 
  •  re-using routes of previous power lines wherever possible,
 
  •  using towers for high voltage lines whose design is aimed at reducing the environmental and aesthetic impact in non-urban areas of particular landscape value,
 
  •  acting to reduce the impact of lines in environmentally sensitive or protected areas,
 
  •  increasing use of underground cables in urban areas where possible,
 
  •  for medium-voltage lines, placing underground cables in urban areas and aerial cables with low environmental impact in other areas with specific environmental value, and
 
  •  using aerial insulated cables or underground cables in low voltage networks (at present, we have built approximately two-thirds of our network in this way).
 
We limit our use of underground high-voltage cables to urban areas because they are significantly more expensive than aerial cables and the process of installing and operating them may involve significant logistic and environmental problems. In 2003, our medium voltage aerial insulated cables and underground cables totaled 127,987 kilometer, which represented 38.3% of our medium voltage lines, compared to 35.9% in 2000, and our low voltage aerial insulated cables and underground cables totaled 600,675 kilometer, which represented 82.5% of our low voltage lines, compared to 80.6% in 2000. In 2005, due to further work on our network, the percentage of aerial insulated cables and underground cables rose to 40% and 83% for medium and low voltage lines, respectively. Further improvements occurred in 2006.
 
Environmental Registrations, Certifications and Authorizations
 
We have joined EMAS, a European Union initiative to implement a voluntary environmental management and registration system, which seeks to improve the level of environmental efficiency and disclosure of European industrial companies. Rules concerning EMAS are contained in an EU Regulation issued in 1993. Originally applicable only to individual sites, in 2001 the EU passed a new regulation which extended the scope of the EMAS system to groups of sites and non generation assets, such as distribution networks.
 
In October 2004, Enel Distribuzione’s distribution network obtained ISO 14001 environmental certification. In 2006, this certification has been confirmed. As of December 2006, generating plants that accounted for approximately 80% of our net installed generating capacity had obtained ISO 14001 certification. One hundred and forty one plants that accounted for approximately 45% of our net installed capacity have also obtained EMAS registration.


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EMAS registration has significant advantages in terms of the operation of our assets. In August 1999, the Italian government enacted a legislative decree implementing the 1996 EU directive on the prevention and reduction of pollution. This legislative decree requires all industrial plants to operate under a new integrated environmental license by 2007 and to make use of the best techniques available for the prevention and reduction of pollution. The new licenses set pollution limits and are reviewed every five years or at any time plants undergo significant renovation. This law, however, allows licenses for EMAS-registered and ISO 14001-certified plants to be reviewed every eight years and six (instead of five) in light of the stringent requirements that must be met to obtain EMAS an ISO 14001 qualifications. We have filed all applications necessary to obtain the prescribed environmental licenses by 2007.
 
Cost of Compliance
 
The costs of ensuring compliance with applicable environmental regulation generally consist of costs associated with equipping newly constructed facilities with required technology or modifying existing facilities to comply with applicable regulation and current expenditures to operate equipment needed to meet the environmental legislation.
 
In 2006, our environmental capital expenditures in Italy were equal to approximately €119 million, representing 4% of our total capital expenditures. In 2004 and 2005, environmental capital expenditures in Italy were equal to approximately €112 and €100 million, representing 2.9% and 3.1% of our total capital expenditures, respectively. In 2006, current expenses were equal to approximately €560 million, of which we spent approximately €474 million on the purchase of ’clean’ fuels (low- and very low-sulphur oil and natural gas) in lieu of standard fuels, when required.
 
These amounts do not include taxes on fuels, polluting emissions and geothermal generation and possible loss of revenues due to compliance with environmental standards that limit the operation of our plants.
 
Discontinued Nuclear Operations
 
Since November 2000, we have not owned any nuclear power plants. We have not produced electricity from nuclear power plants in Italy since 1988. For information on the nuclear power plants we now control in Slovakia and our nuclear related initiatives in France, please see “— Nuclear Liability” below.
 
Following a national referendum in 1987 in which the Italian electorate expressed its opposition to the use of nuclear power, the Italian government ordered the interruption of power production from nuclear fuels and we ceased operations at our four nuclear plants in Italy, which had an aggregate net installed capacity of 1,500 MW.
 
In addition to our nuclear power plants, we owned a 33% stake in NERSA, an electricity generation company that operated a nuclear power plant located in France. French and German utilities owned the balance of NERSA. In July 1998, we sold our stake in NERSA. We, however, retained ownership and responsibility for the decommissioning of our share of the nuclear fuel in the plant.
 
Pursuant to the Bersani Decree, we transferred our discontinued nuclear operations to So.g.i.n., then one of our wholly owned subsidiaries. The principal activity of So.g.i.n. will be the decommissioning of the nuclear plants and of our share of the nuclear fuel in the NERSA plant in France, including disposal of nuclear fuel and nuclear waste.