State of grace?

Without state aid approval, EMR is dead in the water. Paul Brennan looks at the hurdles it will face and its prospect of clearing them

The adoption of the single counterparty model removes any doubt as to the need for European Commission state aid approval for feed-in tariff contracts for difference (CfDs) and investment instruments for low-carbon generation. Illegal state aid must be repaid by the recipient, so without approval, developers and funders will not commit to full-scale project development and Electricty Market Reform (EMR) will not get off the ground.

Responsibility for making an application for state aid approval rests with the government. The Commission has two months, running from the point at which it has received a “complete” application, to conduct an initial assessment.

In straightforward cases, for instance where the proposed aid falls within limits set out in the Commission’s guidelines on state aid for environmental protection, the Commission may decide not to raise objections. In more complex cases it will proceed with a more intensive investigation, with opportunities for member states and affected parties to comment. Such an investigation could take 18 months to complete.

In determining whether or not to authorise the aid and what conditions, if any, should be attached to its approval, the Commission will balance the positive contribution of the aid to the achievement of an objective of common interest (in this case, reduction of carbon emissions) against its negative impact in terms of the distortion of competition and trade between member states. The aid must be necessary and proportionate to achieve the objective.

The operational framework for CfDs, released by the Department of Energy and Climate Change (Decc) alongside the Energy Bill, envisages a protracted genesis for the new regime. In the first instance, investment contracts with negotiated strike prices will be agreed between the secretary of state and early movers, such as nuclear developers. These contracts will in all probability include a condition precedent relating to state aid approval – with full-scale development unlikely to proceed until that condition precedent is satisfied. Subsequently, CfDs proper will be introduced.

In the initial stages, CfD strike prices, differing according to technology type, will be set by government. The CfDs will be awarded on a first come, first served basis, with six-monthly allocation rounds adopted in the event that demand for CfDs cannot be comfortably accommodated within the available budget. In the longer term, the intention is to move to price-setting through a competitive tendering process, initially for specific technologies, such as wind, and ultimately on a technology-neutral basis.

With each stage of the process involving a different method for establishing the contract price, and with different development and operating costs for each low-carbon technology, the EMR delivery programme will entail a series of state aid notifications to the Commission. Although the process is not referred to in Decc’s EMR delivery timeline, back in March last year Tim Abraham, then Decc’s head of EU policy, indicated that Decc would make a formal submission to the EU for approval of awards to new nuclear plant in the next few months. With rumours suggesting Decc has recently all but agreed a strike price of between £95 and £99.50 per MWh for EDF’s Hinkley Point C project, the first application for state aid approval for new nuclear power may not be too far away. In contrast, the first administratively set strike prices for CfDs for renewable energy will not be established until the end of this year.

It is not just a question of price. Equally important is the duration of the aid and the precise terms on which approval is granted – the longer the duration of the aid, the more protracted its impact on competition. Decc’s operational framework indicates that CfDs for renewables will run for 15 years, although it is not clear whether this period will run from contract award or first operation. The duration of investment contracts and CfDs for nuclear projects is unclear. Whether Decc will be able to persuade the Commission to overcome its reluctance to grant approval for such extended periods remains to be seen.

In the case of the Renewables Obligation, the government committed to renotify the scheme to the Commission after ten years, with the next renotification due in 2018. The risk of the government failing to obtain renewed approval does not appear to have had a dampening effect on developers’ willingness to invest under the Renewables Obligation, but it is unlikely that developers under EMR will face this risk with the same level of equanimity: whereas the state aid element in the Renewables Obligation was limited, being confined to the redistribution of the buyout fund, state aid is much more fundamental to CfDs.

Worryingly for owners of Renewables Obligation-funded plant, the use of powers in the Energy Bill to provide for the purchase of Renewables Obligation Certificates (Rocs) at a fixed price by Ofgem or the single counterparty substantially increases the state aid component of the Renewables Obligation, even if the changes will have little impact on the value of Rocs. Much has changed since the Renewables Obligation was initially approved, not least the introduction of the carbon price floor, and there will be even greater changes as the market responds to the Industrial Emissions Directive and the implementation of EMR. The renewal of state aid approval for the Renewables Obligation may not be quite so straightforward as has been assumed.

One of the negative impacts of CfDs for low-carbon generation is the potential deterrent to investment in more flexible forms of generation required to maintain security of supply, a fear that has led to the proposed introduction of a new capacity market. In contrast to CfDs, there will be no state-owned counterparty to capacity agreements and it is not yet clear whether or not payments under capacity agreements will constitute state aid.

Either way, the Commission is likely to have its say. A recent Commission consultation paper on capacity mechanisms alludes to the legal responsibilities of member states under the Electricity Security of Supply and Internal Market Directives and puts forward the view that the same criteria can and should be used to ensure that market interventions comply with the requirements of both energy policy and competition policy. The objective of the consultation is to determine whether further measures should be introduced in this area, such as a Commission recommendation on the design of capacity mechanisms or further ­legislation.

It is ironic that it EMR – widely perceived as ushering in a more centralising, interventionist approach to the GB electricity market – is being introduced by the Conservatives. How much more ironic would it be if the process accelerates increasing regulatory intervention from Brussels.

By Paul Brennan, energy specialist at law firm Morgan Cole LLP

This article first appeared in Utility Week’s print edition of 8th March 2013.

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