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

 

 

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:

 

 

 

 

 

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

 

 

 

TABLE OF CONTENTS

 

 

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:

 

 

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.

 

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.

 

 

 

Not applicable.

 

Not applicable.

 

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,

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.

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.

 

 

 

 

See notes on next page.

 

 

 

 

 

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.

 

 

 

 

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”).

 

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:

 

 

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:

 

 

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.

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

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

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

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:

 

 

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

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:

 

 

 

 

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.

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

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 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

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.

 

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:

 

 

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.

 

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.

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:

 

 

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:

 

 

For a complete list of our recent acquisitions outside of Italy see “ — Business — The Enel Group — International Operations.”

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:

 

 

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).

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.”

 

 

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).

We have summarized in the table below our aggregate capital expenditures on tangible assets by division during each of 2004, 2005 and 2006.

 

 

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.

 

 

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

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:

 

 

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:

 

 

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:

 

 

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:

 

 

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:

 

 

 

The planned capital expenditures on our international distribution and sales operations include the following:

 

 

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.

The prospectus we filed with the CNMV provides that the joint tender offer would be subject to the following conditions:

 

 

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:

 

 

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

representing less than 50% of Endesa’s share capital were tendered. Under the same agreement, Acciona and we agreed to transfer to E.On:

 

 

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.

 

 

 

 

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%.

 

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:

 

 

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

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.

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:

 

 

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:

 

 

 

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:

 

 

 

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.

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:

 

 

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.

 

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.

 

 

 

Sources:

 

 

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.

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.

 

 

 

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:

 

 

 

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:

 

 

Generating Facilities

 

As of December 31, 2006, Enel Produzione operated a total of 597 generating plants. Our Italian generating facilities include:

 

 

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.

 

 

 

Source:  Terna (data for the years before 2005 were provided by the GRTN).

 

The following table shows data on our domestic generating facilities.

 

 

 

 

The following table provides a breakdown of our net electricity production in Italy for the periods indicated.

 

 

 

 

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.

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:

 

 

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:

 

 

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

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:

 

 

 

 

 

 

 

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 —

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:

 

 

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

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.