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State aid for Hinkley Point C (3): What hope for “no aid” arguments?

This post is the third in a series on the European Commission’s initial assessment of the package of measures by which the UK Government proposes to provide financial support for the proposed new nuclear generating station at Hinkley Point (HPC) by NNB Generation Company Limited (NNBG).  In this post we focus on the Commission’s analysis of the UK Government’s arguments that its support for HPC does not constitute state aid within the meaning of Article 107(1) of the Treaty on the Functioning of the European Union and that HPC would be performing a service of general economic interest (SGEI), effectively meaning that it fell outside the state aid rules (for a summary of the overall framework of the Commission’s appraisal, click here).

As noted in the previous post, any “no aid” decision, or categorisation of the HPC as an SGEI, effectively turns on the application of the so-called Altmark criteria.  The quality of the Commission’s arguments in this strategically important area is variable. 

The Commission begins by making the point that it sees a service of general economic interest (SGEI), such as the Government claims would be provided by NNBG, as a service which an undertaking would not supply if it were considering its own commercial interest, and which serves a general economic interest.  In the context of HPC, the Commission’s starting point is that NNBG’s service would be to supply (baseload) electricity; yet that, the Commission says, is “normally considered a commercial activity and a market in which competition takes place”.  It suggests that nuclear generation is no exception to this principle, noting the “nuclear plants which are operated commercially” in the UK by NNBG’s parent EDF, and the “UK’s own assessment” that “private investors [would]…invest in nuclear energy in the UK by 2030 at the latest.  Finally, if the service which would not be provided without aid is the construction of HPC by an earlier date than the private sector would otherwise build new nuclear capacity, the Commission suggests that the UK has not made a convincing case for such early construction being in the general economic interest on security of supply or decarbonisation grounds.  

Almost every assertion that the Commission makes in the two pages or so which it takes to reach these provisional conclusions on “the existence of a SGEI” is questionable in terms of its accuracy or its relevance.  Electricity generation is indeed a commercial activity.  That does not mean that the construction of a new nuclear reactor is a service that will be provided without state aid.  Nor does the existence of the UK’s legacy nuclear fleet help the Commission’s case, constructed as it was by the CEGB in the days of nationalisation.  The Commission’s dismissal of security of supply and decarbonisation as interests served by the putative service of constructing and operating HPC is similarly one-sided.  For example, it effectively denies that there is any benefit in securing decarbonisation sooner if you think the market will decarbonise a few years later, and it ignores the effects on both security of supply and decarbonisation in both the longer and the shorter term which assurance about the viability of HPC (in the form of state aid clearance) could have.

The first Altmark criterion (which is also key to any attempt to justify a measure under Article 106(2)) is that the beneficiary be entrusted with a public service obligation (PSO).   The Commission argues that provisions of the CfD which limit the return which NNBG can make on its investment in HPC or penalise it for late delivery of the project are not capable of being PSOs.  The best claim that the CfD has to being regarded as placing NNBG under an obligation is that if it does not build HPC (or delivers it late), it will receive no money (or less money) under the CfD.  The Commission appears to be suggesting that in order to be a PSO, an obligation (e.g. to commission HPC by a certain date) has to be “enforceable” by some means other than the payment or non-payment of aid.  If the Commission is right about this, it may have implications for the design of the CfD contract terms more generally.  However, the Commission only engages very briefly with the case of Fred Olsen, which appears to offer some support to the UK Government’s view.  In that case, which concerned ferry services, the Court of First Instance remarked that the fact that an operator “unilaterally abandoned or altered the conditions for the operation of some maritime routes indicates at most” that it “failed to honour some of the obligations imposed on it by the provisional arrangements”, and seems to have found that not even the fact that an operator was subsidised at its own request prevented it from satisfying the first criterion.   

Looking beyond the particular circumstances of HPC, what the Commission seems to be saying here could have implications for the financing of other CfD-subsidised schemes.  If the Altmark criteria do truly require the state to have the means of enforcing compliance with requirements, such as the construction of HPC, that go beyond the stimulus provided by the absence of CfD revenues if no electricity is generated, it may not be possible to construct bankable CfDs which satisfy those criteria.  Elsewhere, in the analysis of Article 106(2) arguments, the Commission suggests that the absence of a true PSO is what excuses the UK from having to comply with the public procurement rules in respect of letting a CfD in respect of HPC, and that, conversely, if the requirements imposed on NNBG could be shown to constitute a PSO, the UK Government would have failed in its alleged obligation to follow the public procurement rules.

The Commission broadly accepts that the second Altmark criterion is satisfied – i.e. that the parameters on the basis of which the compensation is calculated are established in advance in an objective and transparent manner.  However, when it comes to the third criterion, that the compensation cannot exceed what is necessary to cover the costs incurred in the discharge of the PSO, its assessment is much less favourable.  Moreover, some of the arguments which emerge here also read across into the Article 106(2) and Article 107(3) analysis.

The Commission is concerned, firstly, that the Government does not appear to have a firm view of what the costs of discharging the PSO are (making the level of compensation by definition hard to assess); secondly, that the level of profit that NNBG can expect to earn over the lifetime of the CfD was negotiated with NNBG rather than being “established by reference to the rate of return on capital that would be required by a typical undertaking considering whether or not to provide the alleged SGEI”; and thirdly, that because the 35 year lifetime of the CfD is shorter than the 60 year lifetime of HPC, NNBG could earn super-normal profits in years 36 to 60. 

It is hard to comment on the first two of these points as far as HPC is concerned without access to the UK’s submissions to the Commission, although in response to the second one might ask: what is a “typical undertaking” considering whether or not to build HPC, let alone (as the Commission goes on to elaborate) “the average cost structure of efficient and comparable undertakings in the sector under consideration” – none of which have been built under exactly the same regulatory regimes as HPC would be built and operate under?  Moreover, for much of the period during which the Government was negotiating with NNBG, it was simply the only undertaking willing to contemplate any form of investment in new nuclear build in the UK.  On the other hand, prospective recipients of aid under enduring CfD regime for renewables in mind regime may take some comfort in this context from the fact that their strike prices will not be the result of bilateral negotiations. 

But the Commission’s point about the duration of the comparative lifetimes of the CfD and the generating station is something on which we can comment in the HPC context.  The strike price, we are told, has been set at a level which is designed to ensure that NNBG covers the costs of construction and operation and makes a return of 9.87% on the project as a whole over its lifetime (in post-tax, nominal terms).  Yet, as the Commission points out, once the CfD expires, the profitability of the plant is uncertain because the level of revenue accruing to the operator from the sale of electricity is no longer controlled by the strike price mechanism.  This makes it harder for the Commission to rule out the possibility of overcompensation during the post-CfD period of the plant’s operation.  The Commission suggests two ways of dealing with this problem: making the CfD coterminous with the life of the plant, or providing some means for the state to recover any overcompensation within the CfD itself (effectively a gain-share provision for the period when the strike price mechanism no longer applies).  One problem with the first of these, if taken in isolation, is that it is not possible to predict the lifetime of a plant with certainty when the strike price is initially calculated.  

In principle, it would seem that this arguments is not unique to the case of HPC and could be applied to the wider CfD regime.  The differences are that the periods of time involved – both CfD durations and plant lifetimes – are shorter for non-nuclear projects, so that the calculations are less dependent on very long range predictions of electricity prices; and that there is more comparative data on which to assess technology costs.  Whether the Commission will consider these differences to be sufficient for it to take a more favourable view of this aspect of the wider CfD regime than it has so far in the case of the HPC package remains to be seen.  In this context it is curious that the Commission states that “nuclear production, which requires very high levels of capital for the investment in the construction and hence before revenues can be generated, while also being characterised by a relatively low level of operating costs once the plant has been built, has few, if any, equivalents in commercial activities”: the CfD regime as a whole is surely predicated on the assumption that all the technologies it covers (renewable, nuclear, CCS) have in this sense a similar cost profile.

The fourth Altmark criterion is that where the undertaking which is to discharge a PSO is not chosen through a public procurement process, the level of compensation must be determined on the basis of an analysis of the costs which a typical, well run, undertaking would have incurred.  Here again, the problem is in finding the appropriate comparator.  Unsurprisingly, the Government has commissioned a review of NNBG’s cost estimates to determine whether they are “reasonable”.  The Commission says that this is not what the Altmark criterion requires.

The final sections of the Commission’s analysis of the UK’s “no aid” arguments deal with the credit guarantee and the proposal to compensate NNBG in the event of a “political shutdown” of HPC.  On the credit guarantee, the Commission essentially reserves judgment owing to the lack of detail available.  However,  it does lay down a marker when it observes that the guarantee “seems to differ from ordinary debt guarantees in that it would be drawn before equity, apart from equity already spent…It would therefore appear that [it] might diminish the risks borne by equity holders”.  The Commission appears prepared at this stage to accept the UK’s argument that political shutdown proposals do not constitute state aid, subject to the provision of more information “on whether this compensation…would also be available to other market operators placed in a similar situation”.  This is intriguing.  It is presumably possible that the UK Government would be prepared to offer a similar deal on political shutdown to another nuclear operator, but such a deal is clearly not on the table for operators of renewable technologies, for example, and whilst a political shutdown of UK wind farms may be a more remote possibility than something like the German reaction to Fukushima, will that point be sufficient to satisfy the Commission that the enduring regime for renewables should not in this respect be “levelled up”, to confer on its beneficiaries the additional protection offered to NNBG?

It is clear that the Commission is highly reluctant to reach a finding that there is “no aid” in the HPC package, or to find that there is an SGEI within the meaning of Article 106(2).  It does not want to treat nuclear power as a special case.  Yet unless it is prepared to recognise that nuclear power is not just another source of baseload electricity, how could the Commission find that there is no aid (or that there is a SGEI) in a CfD negotiated directly between a Government and the beneficiary undertaking which includes a generous strike price, a 35 year term and investor protection in the event of political shutdown – and still realise its ambition of cutting back on subsidies for renewables? 

To go by the evidence of the Commission’s initial assessment, the Government would – rightly or wrongly – have to do a lot more work both in terms of scheme design (including changing some features of the currently proposed CfD arrangements) and in terms of arguing its corner with the Commission if it is to persuade the Commission that there is “no aid” to NNBG.  It is possible that the Court of Justice might be more sympathetic to the Government on some of these points, but EU litigation would not help the timeliness of the delivery of EMR objectives.

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State aid for Hinkley Point C (3): What hope for “no aid” arguments?

State aid for Hinkley Point C (2): Outline of the Commission’s analysis

This is the second in a series of posts on the European Commission’s initial assessment of the package of measures by which the UK Government proposes to provide financial support for the proposed new nuclear generating station at Hinkley Point (HPC): click here for the first in the series.  The text of Commission’s letter is now also available in the Official Journal of the European Union: interested parties have one month from the date of its publication (7 March 2014) to comment.   

In this post we summarise the Commission’s analysis of the HPC support package.  This consists chiefly of a proposed Contract for Difference (CfD) and a credit guarantee conferred by participation in HM Treasury’s UK Guarantees Scheme: both are conveniently summarised in the opening paragraphs of the Official Journal notice.

Introduction: the state aid rules

It is worth beginning by reminding ourselves of the key EU Treaty provisions on state aid.  Article 107 of the Treaty on the Functioning of the European Union (TFEU) states:

1. Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.

Article 107(2) then lists certain types of aid which fall within Article 107(1) but which “shall” be considered compatible with the internal market.  These relate to aid having a social character or relating to natural disasters, economic crises or German unification and can therefore be disregarded for present purposes.  Article 107(3) contains a further list of types of aid which “may” be considered compatible with the internal market.  Article 108(2) and (3) TFEU state:

2. If, after giving notice to the parties concerned to submit their comments, the Commission finds that aid granted by a State or through State resources is not compatible with the internal market having regard to Article 107, or that such aid is being misused, it shall decide that the State concerned shall abolish or alter such aid within a period of time to be determined by the Commission.

If the State concerned does not comply with this decision within the prescribed time, the Commission or any other interested State may, in derogation from the provisions of Articles 258 and 259, refer the matter to the Court of Justice of the European Union direct…

3. The Commission shall be informed, in sufficient time to enable it to submit its comments, of any plans to grant or alter aid. If it considers that any such plan is not compatible with the internal market having regard to Article 107, it shall without delay initiate the procedure provided for in paragraph 2. The Member State concerned shall not put its proposed measures into effect until this procedure has resulted in a final decision.

Secondary legislation has established an administrative framework for dealing with state aid cases (for further detail, click here).  Measures that are put into effect without having been notified and approved under Article 108(3) are “unlawful aid”.  If the Commission finds unlawful aid is incompatible with the internal market, it may require Member States to recover it from the beneficiaries.

To gain the Commission’s approval for the HPC package, the UK Government must therefore persuade the Commission either that its support for HPC does not constitute state aid within the meaning of Article 107(1), or that such support is compatible with the internal market.  The Government has identified three possible ways to avoid a finding of incompatibility, as set out below.

The “no aid” arguments

Any claim that a measure does not constitute state aid depends on showing that one of the elements of aid set out in Article 107(1) – state origin of the aid, conferral of a “selective advantage”, impacts on intra-EU trade and competition – is not present.  We take each of these in turn below as they have been applied to the HPC support package.

  • Apparently, the UK authorities “do not contest” that the CfD is financed from resources under the control of the state.  The Commission points out that the CfD will be administered by a Counterparty body essentially controlled, and potentially underwritten, by the Secretary of State.
  • As regards distortion of competition and an effect on intra-EU trade, the Commission observes: “As in this case the notified measures will enable the development of a large level of capacity which might otherwise have been the object of private investment by other market operators using alternative technologies from either the UK or other Member States, the notified measures can affect trade between Member States and distort competition.”.
  • That leaves as the key battleground the question of whether the support package confers a “selective advantage” on HPC.  Would HPC be getting a deal that will give it an advantage in the market and that is not open to its competitors?  In order to show that this element of the definition of aid is made out, the Commission has to engage with the criteria laid down by the Court of Justice in the case of Altmark.  In that case, the Court found that in certain circumstances compensation provided to undertakings entrusted with a public service function would not constitute state aid.  The Commission considers the Altmark criteria (discussed in the Commission’s 2012 Communication on compensation for the provision of services of general economic interest (SGEI)) in some detail.  Overall, the Commission finds it hard to see that HPC would be entrusted with the kind of public service obligation (PSO) that the Altmark criteria envisage.  It also inclines to the view that the compensation which HPC stands to receive under the CfD would be more than the Altmark criteria permit. 

The “aid is compatible” arguments

The Government argues that if the HPC package is considered to be state aid, its contribution to the common EU objectives of decarbonisation, security of supply and diversity of electricity generation, and addressing related market failures, outweighs its negative impact on the internal market.  The Commission is not persuaded by these arguments in favour of a finding of compatibility under Article 107(3).  For example, it is sceptical of claims about decarbonisation on the basis that support for HPC could crowd out investment in other low carbon technologies; and it queries claims about security of supply on the grounds that the most immediate concerns about the adequacy of the UK’s electricity generation capacity relate to the current decade, not the 2020s when HPC would be commissioned.

But the Commission’s scepticism about the objectives of the HPC support package is only the beginning of its concerns from an Article 107(3) point of view.  Even if it were prepared to accept that the HPC package is aligned with one of the “common EU objectives”, the Commission queries whether state aid – in the combined form of the proposed CfD and credit guarantee – is needed to enable HPC to achieve these objectives.  Overall, the Commission suspects that the level of protection from ordinary market risks which the support package provides is excessive: more or less every aspect of the package, from the duration of the CfD to the way in which it has been negotiated, is viewed in sceptical terms, so that the Commission concludes by saying that it doubts “whether it effectively addresses a market failure”; questions “whether [it] can be deemed…to be proportionate”; and is “concerned about its distortive effects on competition”.

A “service of general economic interest”?

In between the “no aid” and “compatible aid” limbs of its case, the Government argues that the HPC package with the internal market, fulfils the conditions of the Framework which the Commission has put in place for determining whether larger SGEI schemes fall within Article 106(2) TFEU.   Article 106(2) states:

2. Undertakings entrusted with the operation of services of general economic interest or having the character of a revenue-producing monopoly shall be subject to the rules contained in the Treaties, in particular to the rules on competition, in so far as the application of such rules does not obstruct the performance, in law or in fact, of the particular tasks assigned to them. The development of trade must not be affected to such an extent as would be contrary to the interests of the Union.

Article 106(2) is in some ways the ultimate derogation provision.  It says, in effect, that certain undertakings will be exempt from the requirements of EU competition and state aid law if the application of that law would “obstruct the performance” of a service of general economic interest entrusted to a particular undertaking.  The meaning of Article 106(2) has therefore been the subject of many arguments between the Commission and Member States.

The Commission has, for example, argued that Article 106(2) “authorizes measures contrary to the Treaty only to the extent to which they are necessary to enable the undertaking concerned to perform its task of general economic interest under acceptable economic conditions and, therefore, only if they are necessary for the financial equilibrium of the undertaking itself”.  But the Court of Justice, whilst acknowledging that Article 106(2), like all derogations, must be interpreted strictly, has found that it “seeks to reconcile the Member States’ interest in using certain undertakings, in particular in the public sector, as an instrument of economic or fiscal policy with the Community’s interest in ensuring compliance with the rules on competition and the preservation of the unity of the common market”.  Moreover, Member States “cannot be precluded, when defining the services of general economic interest which they entrust to certain undertakings, from taking account of objectives pertaining to their national policy or from endeavouring to attain them by means of obligations and constraints which they impose on such undertakings”.  As a result, “for the Treaty rules not to be applicable to an undertaking entrusted with a service of general economic interest under Article 90(2) of the Treaty, it is sufficient that the application of those rules obstruct the performance, in law or in fact, of the special obligations incumbent upon that undertaking. It is not necessary that the survival of the undertaking itself be threatened”.  (See Case C-157/94, Commission v Netherlands.)

                                                   

                                                A service of general economic interest

The Commission’s analysis in response to the UK’s SGEI arguments overlaps to a large extent with what it says in relation to the Altmark criteria and/or the Government’s Article 107(3) arguments.  It concludes that the Commission doubts whether the HPC package qualifies as an SGEI within the meaning of Article 106(2) and the Framework, and that even if it did so qualify the Commission doubts that it would comply with the Framework.

Overall characteristics of the Commission’s analysis

In future posts we will examine some of the Commission’s arguments in more detail.  For now, it is worth noting some more general features of the Commission’s appraisal.

  • There is a degree of unevenness about the Commission’s analysis.  It makes some extremely good points and some decidedly weak ones. 
  • There are a number of points when the Commission appears to help the UK by indicating possible ways of correcting what it sees as deficiencies in the HPC package in state aid terms.  Whether these potential “escape routes” are in practice open to the UK Government is another matter.
  • The Commission – intentionally or otherwise – draws attention to a number of places where the HPC package is different from the rest of the CfD regime (or at least the enduring regime for renewables).  Sometimes this is to the latter’s advantage, but not always.  In an ideal world, the whole of the CfD regime would have been worked out in full before being notified together, but it so happens that the first part of the regime that the Commission examines in detail is not entirely typical or representative of the regime as a whole.
  • Inevitably, much of the analysis is somewhat tentative, because details of almost all parts of the package still remain to be fully worked out.

Behind everything lurks the question: how much (or how little) freedom do the EU state aid rules allow Member States to have as regards ensuring that a certain proportion of their electricity generating capacity belongs to a specified technology type? 

 

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State aid for Hinkley Point C (2): Outline of the Commission’s analysis

State aid for Hinkley Point C (1): the context of the Commission’s letter of 18 December 2013

On 18 December 2013, the European Commission announced that it was opening an in-depth state aid investigation into the Government’s package of financial support for the proposed Hinkley Point C (HPC) new nuclear generating station.  On 31 January 2014 the Commission published a version of the letter setting out its reasons for launching a detailed investigation and the points on which it requires to be persuaded of before giving state aid clearance to the package.

What does the letter tell us?  It is a fairly closely-argued 67 pages, so it will take more than one post to cover it.  Today, we begin by setting the scene. 

The potential of HPC – an image from gov.uk

The critical tone of parts of the Commission’s analysis has been noted in a number of reports, but this is perhaps not the most surprising feature of the letter if one considers its context.

  • The package of support for HPC inevitably treats new nuclear as to some extent a “special case”.  State aid policy is administered on the principle that free markets are best and that claims that a particular industry is somehow “special” are to be treated with scepticism – even if that industry is one in which there is already massive state intervention in various forms. 
  • The European Commission’s decision-making on state aid cases has sometimes been criticised for being too politically expedient.  Here we have a case where the UK Government has invested huge political capital and the aid is going to a subsidiary of a company 84% owned by the French state.  Even if the Commission is ultimately minded to approve the HPC support package it cannot afford to be seen to have given it anything less than an economically rigorous evaluation.
  • In 2007, the Commission ruled on alleged state aid for the Olkiluoto 3 nuclear plant, to be built in Finland with French technology.  The issue was whether a guarantee given by the French state gave Areva an unfair competitive advantage over other potential suppliers.  The guarantee was found to have been given on market terms, so that there was no aid under the state aid rules.  However, the proceedings still lasted three years and the Commission went through an in-depth investigation before reaching a final decision. 
  • In 2006, the Commission approved the arrangements for setting up the Nuclear Decommissioning Authority (NDA).  Although the Commission acknowledged that the purposes behind the creation of the NDA were fully in line with the objectives of the Euratom Treaty, it was also very concerned about potential distortions of competition arising from it.  For example, notably tight controls were set on the pricing of electricity sold by the UK’s Magnox nuclear plants, to be run by the NDA, for the few remaining years of their life.
  • Most recently, the Commission decided that aid granted by Slovakia in relation to nuclear decommissioning was compatible with the state aid rules.  In doing so, the Commission emphasised that the aid related to plants that had already been shut down; that it did not subsidize current electricity production; and that it was “strictly limited to what is necessary to cover the costs of decommissioning historic nuclear facilities, for which no adequate provisions were created in the times of a centrally-planned economy”.  Moreover, the Slovak scheme was unlike “the numerous schemes of compensation for stranded costs, public service obligations and support schemes for renewable electricity, where the Commission has found that the financing of the support scheme through a levy has a protective effect of national electricity production”.
  • The HPC support package is the kind of arrangement that is intrinsically harder for the Commission to get itself comfortable with than the Okiluoto or NDA measures.  It explicitly and intentionally provides, under the Contract for Difference (CfD) mechanism, a guaranteed level of price for electricity and therefore a degree of revenue security which the market would not provide.  It can therefore be characterised as “operating aid” (as opposed to “investment aid”), which the state aid regime regards as particularly problematic – since it shields operating businesses from normal market risks.
  • Although there is an entire EU Treaty devoted to the promotion of nuclear power, it is politically controversial within the EU, and there are those who will take any opportunity to put the case, whether in administrative or judicial proceedings, against the adoption or approval of any measure that brings a “nuclear renaissance” in the EU closer.
  • There are undoubtedly some features of the support package for HPC which, at least at first sight and taken in isolation, appear very generous.
  • The Commission is in the process of “modernising” the state aid framework and has just published draft Guidelines on environmental and energy aid.  The Guidelines do not cover nuclear projects, but take a notably tough line on e.g. support for renewables, even though the deployment of renewables is mandated by EU law in a way that nuclear power is not.  Anything other than a searching approach to scrutiny of the HPC package would be out of keeping with the general thrust of current Commission policy in this area.
  • Whatever the ultimate outcome of the Commission’s evaluation of the HPC support package, the final decision can only be robust against potential challenge if it has clearly stated the potential objections to what the UK Government is proposing.

The UK public may have been encouraged to think that the hard part of HPC was over once development consent, a nuclear site licence, marine licence and other environmental permits were granted, and agreement on the strike price had been reached.  But obtaining state aid clearance in this case was always going to be a challenge.  And for all sorts of reasons, it is not surprising if at this stage the Commission has stated the “case for the prosecution” in clear and strongly worded terms.  In future posts, we will examine some of the Commission’s arguments a little more closely, consider the possible outcomes of the Commission’s investigation into the HPC support package, and look at what the Commission’s letter indicates about the prospects for state aid clearance of the rest of the Electricity Market Reform (EMR) package.

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State aid for Hinkley Point C (1): the context of the Commission’s letter of 18 December 2013