Aiding and betting?

Decc is gambling that EMR - particularly measures to support new nuclear - will clear state aid rules. Paul Brennan and Hilda O'Connor are not so sure.

Even with a Liberal Democrat at the helm of the ­Department of Energy and Climate Change (Decc), it did not take long for the coalition’s commitment to no public subsidies for new nuclear power plant to morph into something more practical. No public subsidies for nuclear, explained Chris Huhne, the then secretary of state, “means there will be no levy, direct payment or market support for electricity supplied or capacity provided by a private sector new nuclear operator, unless similar support is also made available more widely to other types of generation”. Measures to offset environmental externalities, the Select Committee on Energy and Climate Change was later assured, cannot properly be regarded as subsidies. Instead they are “corrections to market failures”.
The first of these “corrections” is the carbon price floor (CPF), implemented through the imposition of the Climate Change Levy on fossil fuels for generation, with the stated intention of increasing the levy to achieve a net price for carbon, at 2009 prices and including the projected cost of European Union Emissions Trading System allowances, of £30 per tonne of carbon dioxide in 2020 and £70 per tonne in 2030. As a result of the increased costs to price-setting gas-fired plant, it was claimed new low-carbon generation – renewable and nuclear – would benefit from increased wholesale prices.
The second measure, feed-in tariff (FIT) contracts for differences (CfDs), also seeks to equate the value of renewable and nuclear generation. The basic principle of a FIT CfD is that the generator receives the difference between the market price and the contract price when the market price is the lower of the two and pays the difference when it is the higher. To reflect the different operating characteristics of nuclear and renewables, different reference prices will be used – day-ahead for intermittent renewables and year-ahead baseload for nuclear.
Decc is initially opting for an “administrative” approach to price setting, with government setting prices that it considers will bring forward the required amount of investment. If new low-carbon development is not to be dominated by the cheapest, lowest-risk technology, then different prices will have to be offered for different technology types. The outcome would be not dissimilar to the current banded Renewables Obligation, expanded to encompass nuclear, but with the crucial difference that, as a result of the CfD, the generator will not benefit from increases in wholesale prices.
The CPF and FIT CfD, along with the emissions performance standard, are aimed at decarbonising electricity generation. The second Electricity Market Reform (EMR) objective, security of supply, is to be addressed by a capacity market, although the new mechanism will be introduced only if adequate capacity is not developed under the other market arrangements. Under the new mechanism, generators will receive payments for guaranteeing capacity availability and incur penalties if they fail to do so. It would appear that, unlike FIT CfDs which will be long term, capacity contracts will be annual, though longer-term contracts might be awarded to new plant. Contracts will be awarded through an auction process, typically held around four years in advance of the delivery date. On the face of it, the capacity market, with its relatively short lead times and limited contract duration, will do little to encourage new nuclear generation, or for that matter windfarms, which are unable to guarantee availability at times of peak demand.
EMR appears to be predicated on the assumption that nuclear and renewable generation are equivalents, with the differences being accommodated by minor variations in detailed design. Yet from a legal perspective this assumption is wrong. The Renewable Energy Directive establishes binding targets for renewable energy usage, and whereas the European Commission’s guidelines on state aid for environmental protection contain specific guidance on aid for renewables, aid for nuclear power would be considered under the more nebulous principle: is its positive impact outweighed by its potentially negative side effects?
It is likely that the FIT CfD mechanism, as currently envisaged, will require state aid clearance from the Commission, both for administrative price-setting and any subsequently developed auction. The process will be challenging, particularly if, due to the common approach being adopted for nuclear and renewables, the government cannot readily demonstrate compliance with the Commission’s guidelines.
The CPF presents a potentially more intractable problem. The Treasury is adamant that the CPF does not amount to state aid and is simply a taxation measure within exclusive UK jurisdiction. However, it is well established that an environmental tax can constitute state aid if the benefits of the tax are not intrinsic to its objectives. The CPF was expressly introduced to support new low-carbon investment, but raising wholesale prices also benefits existing renewable and fossil fuel plant. Moreover, once FIT CfDs are introduced, any new low-carbon generators will, as a result of the CfD, be deprived of the benefit of any further increases in the CPF. Already anti-nuclear pressure group Energy Fair has lodged a complaint with the Commission citing the CPF and (prematurely, given they have not yet been introduced) FIT CfDs and the capacity market as illegal state aids.
The regulatory regime for the capacity market is as yet insufficiently detailed to determine whether the proposed mechanism will require state aid clearance or be treated as permissible compensation for the discharge of public service obligations. Decc is as yet unclear as to whether FIT CfD generators will be eligible to participate in the capacity market, if it is activated, and if so on what basis – possibly with an eye on including baseload nuclear plant within the mechanism. Consequently, it is also impossible to determine the impact of the capacity market on the prospects of obtaining state aid clearance for FIT CfDs.
The resulting uncertainty affects not only prospective low-carbon developers, but also developers of new gas-fired plant, the prime candidate for filling the gap when generation is curtailed due to wind conditions or unscheduled outages of massive new nuclear stations. With its relatively short-term contracts, the capacity market, which itself could lead to significant reductions in wholesale prices, will be of little comfort to developers looking to secure revenues in their seventh year of operation and beyond, when the market is scheduled to be increasingly dominated by baseload nuclear and intermittent wind.
The initial EMR consultation document indicated that the government would judge EMR design options against four broad principles: cost-effectiveness (preserving competitive pressures to ensure efficient decision-making, and maintaining overall affordability); durability (the ability to cope with a number of potential outcomes); practicality (policies that work in practice as well as theory, with a manageable transition period); and coherence (measures that work in a complementary way, not against each other). As a priority, the new secretary of state needs to consider whether, as currently envisaged, EMR matches those goals.

Paul Brennan is head of energy and environment at law firm Morgan Cole LLP. Hilda O’Connor is a barrister specialising in state aid

This article first appeared in Utility Week’s print edition of 16 March 2012.
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