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UK: Landmark ruling leads to the suspension of the UK Capacity Market

  • United Kingdom
  • Competition, EU and Trade
  • Energy and infrastructure - Clean energy

27-11-2018

On 15 November 2018, the General Court (the EU’s lower-tier court) found in favour of Tempus Energy in its challenge against the 2014 European Commission decision to grant State aid approval to the UK Capacity Market (the “CM”). The decision means that all Capacity Market arrangements have now been suspended, pending a new and more detailed investigation by the European Commission into the State aid compliance of the arrangements.

Background

The UK Capacity Market seeks to manage the risk of lack of capacity in periods of heavy demand, essentially by means of centrally-managed auctions to procure the (extra) capacity needed to ensure generation adequacy. The auctions are open to energy generators, demand side response (DSR) operators and storage operators. Successful bidders receive payments in return for a commitment to deliver electricity when called upon to do so by National Grid. Under EU law, such payments are deemed to constitute State subsidies which require authorisation by the European Commission before they may be granted.

Once the European Commission has received a State aid notification from a Member State, it has up to two months within which to conduct a preliminary investigation. At the end of that period it can approve or reject the proposed State aid measure or, where it has doubts as to the compatibility of that measure with EU law, it must open an in-depth formal investigation (which can take up to 18 months, sometimes longer) to be completed, before making a final decision.

In July 2014, the Commission issued its decision approving the CM arrangements, after only one month of carrying out a preliminary investigation (as opposed to the maximum two which is permissible).

Tempus Energy, a DSR operator, challenged the Commission’s decision essentially on the basis that various aspects of the Capacity Market arrangements raised, among other things, issues of proportionality and discrimination against DSR providers which merited detailed consideration and should have led to a decision to open a formal, in-depth State aid investigation.

Review of the ruling

This ruling sets aside the Commission’s original decision. In effect this means that it is currently not legal for any payments to be made under the CM scheme. Indeed, the UK Government has made it clear that CM auctions and payments under the existing CM contracts have been suspended, pending a new decision by the European Commission.

At the same time, the Department for Business, Energy and Industrial Strategy (“BEIS”) has released a statement confirming that the UK Government remains committed to pursuing CM auctions for delivering secure electricity supplies at low costs and that it is working with National Grid (as the CM delivery body) to contact and provide more detailed advice for CM contract holders and CM applicants on the impact of this judgment.

What happens next?

It seems unlikely that the Tempus case will be appealed (not least because of the timescale that such an appeal would involve). Accordingly, the UK Government is focusing its attention on working closely with the Commission to ensure that it has all the necessary information that would lead to a new clearance decision as swiftly as possible. As part of this process, BEIS will also be looking into whether any changes to the CM arrangements might be required.

For its part, National Grid has confirmed that it is continuing with activities that do not involve State aid, which includes completing the pre-qualification process for the 2019 auctions (on the assumption that these will ultimately be required).

At this point, it is unclear how long the Commission will take to conclude its formal investigation into this case but given the Court’s view that essentially a more in-depth investigation was necessary, it would be reasonable to assume that this will take more than a few months to complete.

Impact on the next round of CM auctions

The UK Government has instructed National Grid to postpone indefinitely the upcoming T-4 and T-1 Auctions for Delivery for 2022/23 and 2019/20 respectively in accordance with the Electricity Capacity Regulations 2014. The postponed T-4 Auction is intended to be run as a T-3 Auction in next year’s round, however this is subject to the Commission completing its formal investigation and providing State aid approval for the main CM scheme.

The UK Government intends to seek separate State aid approval from the Commission for a ‘replacement’ T-1 Auction.

National Grid has confirmed that applicant credit cover being held for all the postponed auctions will be returned and that CM contract holders may also request the return of credit cover for previous CM contracts arising from past auctions.

Impact on CM agreement holders

Whilst the CM remains in standstill, no capacity payments can be made. However, the capacity agreements are still valid, and guidance is anticipated from National Grid regarding how it will treat non-performance or penalties under the CM agreements.

The UK Government hopes that CM contract payments will resume as soon as possible but these remain subject to State aid approval for the CM being provided by the Commission and the Commission agreeing that the UK can make payments under existing CM contracts. The UK Government has indicated that no steps will be taken to recover CM payments already made at this stage and it is hoped that this can be avoided. Ultimately, the issue might not be clarified until the completion of the Commission’s new investigation. 

Comment
 
The Court’s decision seems to have come as a surprise to many in the industry. Pending further guidance from the UK Government / National Grid, capacity providers would be well advised to treat their capacity agreements as valid and in full effect. This will of course have some adverse impacts for operators, in particular new build operators. It is however expected that National Grid will provide detailed guidance in due course, which will give further clarity, and that it will take a pragmatic approach to enforcement and deadlines.

Separately, it is worth keeping in mind that when the Commission announces that it has initiated an in-depth formal investigation, it will give one month to interested parties to submit their views on the capacity market and whether, for example, it is structured in a way which might distort competition. This will be the right moment for any parties concerned with the current suspension of capacity market arrangements or indeed, concerned with the way in which the capacity market is in fact structured, to make their views known, so that the Commission takes them into account before taking a (new) decision.

Aside from the immediate impacts on capacity providers, the decision will no doubt also have an impact on investor confidence in a sector which has seen wide ranging policy changes in recent years (including for instance reviews to de-rating factors for CM, and reviews of embedded benefits and reductions in triad benefits).

Thrown into the mix is the uncertainty which on-going Brexit developments might create. In this regard, it is worth noting that the EU27 have made it clear that any future trade agreement with the UK must involve detailed rules which essentially provide for a regularly level playing field, including as regards State aid. This approach is adequately reflected in the Withdrawal Agreement. Separately, the UK Government has made it clear that even in circumstances where there is a “no deal” Brexit, the Government intends to implement a national State aid regime which mirrors EU State aid rules, with the Competition and Markets Authority, taking on also the role of State aid regulator. Accordingly, the industry is well advised to continue to give regard to State aid considerations and concerns in its planning.

How we can help you

Our team of State aid experts have been involved in advising clients on State aid issues across Europe, including in the context of State aid investigations and litigation in the EU and UK courts and can assist you in working through the implications of this judgment and ramifications for your business as well as potential courses of action in seeking to mitigate its effects. Equally, our energy experts have the expertise to provide you with detailed advice on the impact of the decision on capacity market auctions and existing contracts. 

For more information contact

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