EC tightens up state aid rules

The UK could have to amend its Electricity Market Reform package following the tightening of criteria in the European Commission’s state aid guidelines, say Gordon Downie and Joanne McDowall.

The need for member states to ensure they act in compliance with EU state aid rules while striving to meet the 2020 targets has arguably never been higher. With a number of big-hitting member states being the subject of high-profile investigations by the European Commission (including the UK, France and Germany), the time is right for industry and investors to have some certainty. Will the new guidelines on state aid for environmental protection and energy adopted by the Commission on 9 April 2014 help to achieve this certainty? Will the UK’s Electricity Market Reform (EMR) package comply with the new rules?

The guidelines were published in draft and put out to consultation in November 2013. Following the consultation and after some amendments, the guidelines have been finalised. They will take effect on 1 July 2014 and remain in force until 31 December 2020. They seek to ensure that national support schemes for securing environmental protection and energy objectives do not unduly distort competition in the internal market.

Despite having increased the notification thresholds in the final version of the guidelines, it seems clear from the detailed compatibility criteria that the Commission is tightening the application of the state aid rules in these sectors. Member states will almost certainly be required to work harder to convince the Commission that their state aid measures are lawful. If they fail to do this, they will not be permitted to implement their measures.

In essence, there is a seven-stage test to be passed before state aid will be permitted. Further, any state aid schemes that exceed those specified aid intensity thresholds will require individual clearance from the Commission.

Significantly, the EMR package falls into this category and currently awaits clearance from the Commission. Indeed, the Department of Energy and Climate Change (Decc’s) April update paper acknowledged that changes may be required to the draft contract for difference (CfD) prior to implementation to satisfy state aid rules.

Under the guidelines, support will be permitted across a broad range of areas, including energy infrastructure, carbon capture and storage, district heating and cooling and resource efficiency and waste management. Perhaps of most interest in the UK, in the context of EMR, however, are the provisions permitting support for the following:

•    energy from renewable sources and how these fit with the CfD proposals;

•    generation adequacy measures and how these fit with the capacity mechanism proposals;

•    energy-intensive users (for example, in the form of exemptions from renewable surcharges).

At the highest level, some comfort may be taken by industry and investors from the fact that the Commission has explicitly permitted each of these types of support within the new guidelines.

This is in contrast with the position for state aid for nuclear generation. Support for nuclear is not covered within the scope of the guidelines. Therefore, member states must submit individual notifications to the Commission to seek approval. The UK’s nuclear state aid notification has resulted in the Commission opening a detailed investigation. What we know from that decision to investigate is that clearance for UK support schemes is by no means a formality.

The degree of scrutiny applied to the UK’s proposed state aid scheme for Hinkley Point C and the extent of criticism levelled at the UK’s analysis of and justification for the proposed support is clear evidence of this. Many in the UK energy sector will be hoping that the UK has been able to present a more compelling case to the Commission for the rest of its EMR package.

On a positive note, it is clear that the structure of the EMR proposals exceeds the Commission’s requirements in some respects. For example, its decision to award CfDs and capacity contracts following competitive bidding procedures (as opposed to on a first-come, first-served basis) means the UK will be conducting competitions before it is legally required (in 2017). Competitive bidding procedures are seen by the Commission as a key step in ensuring the extent of any state aid will not exceed what is necessary and as such, any distortion of competition minimised.

The fact that generators will not be permitted to benefit from both a CfD and a capacity contract will also be vital in ensuring that generators are not overcompensated. The negative effects that such overcompensation would have, in terms of distorting competition, would outweigh any positive effects, for example, in terms of increasing security of supply, and as such would not be permitted.

While there would not appear to be any obvious stumbling blocks with the EMR package, the devil will be in the detail (of the UK’s application) as to whether clearance will be forthcoming. As noted, the Commission was critical of the UK’s analysis in respect of the Hinkley application (for example, in its failure to consider alternatives). It is the detailed analysis for the EMR proposals that will determine whether the seven-stage compatibility test will be satisfied.

Unfortunately for the UK government, even if it obtains clearance from the Commission for EMR, it is understood to face a separate investigation in relation to the £75 million loan guarantee it has awarded to Drax for the conversion of its coal-fired plant to biomass. Ironically, even more recently, Drax has threatened to sue the government over its decision not to award it an early CfD for one (of two) of its units at the biomass plant.

The state aid rules have never been so high on the agenda, nor such a contentious issue, in the UK and EU energy sector. At what is a critical time in reshaping the energy industries across Europe to meet 2020 targets and address security of supply concerns, it is vital that all concerned obtain transparency and certainty as to what state aid will be permitted. It remains to be seen whether the guidelines will provide this, but they are expected to be an important step in the right direction.