The UK is not alone in its preoccupation with the impact of climate change objectives on security of supply. For precisely that reason, the European Commission is consulting on extending its guidelines on environmental aid to cover aid to the energy sector more generally.
It is also consulting on proposed revisions to the General Block Exemption Regulation, which exempts smaller aid measures from the usual notification and approval requirements. Because aspects of Electricity Market Reform (EMR) – not least feed-in tariff contracts for difference (FIT CfDs) – will require state aid approval from the Commission, the consultations provide useful pointers as to the hurdles that need to be overcome if the Department of Energy and Climate Change (Decc) is to be successful in implementing its flagship energy policy on time.
The Commission’s guidelines on state aid provide a framework within which member states can design larger aid programmes confident that authorisation will be a relatively straightforward process. In many respects, Decc’s proposals for renewables fit well with the Commission’s emerging thinking. This is that initially there will be a range of administratively set strike prices for different technology types, progressively moving towards competitively set prices, and, assuming electricity prices rise over time, digressive support through the CfD mechanism.
The UK’s memorandum of understanding with Ireland on co-operation in the energy sector and the indication that CfDs may be used to support generation outside of the UK bode well in light of the Commission’s expectation that member states should promote common mechanisms to support cross-border support.
Less easy to square with the Commission’s thinking is the impact of CfDs on market prices. Inevitably, aid will distort the market in favour of renewables – that is its purpose. However, perhaps more could be done to structure CfDs so that they preserve market signals. As they are currently designed, there will be a tendency for the pricing of power purchase agreements to be based on the market reference price rather than being fully integrated into the market.
The Commission is considering the possibility of the guidelines being extended to cover support for nuclear energy, both for reasons of decarbonisation and security of supply, but this will be more of a stretch. Indeed, the Commission questions whether it will be possible to cover nuclear support in the guidelines and has called for an in-depth discussion as to whether market failures justify such intervention.
Exclusion from the guidelines does not preclude the grant of aid to nuclear projects, but the approval process will be more complex and the outcome uncertain. Given the cost uncertainties inherent in nuclear new-build and the range of associated costs borne by parties other than the developer and its customers, determining the appropriate level of support is likely to prove no less problematic for the Commission than it has been for Decc and EDF. The duration of the CfD, expected to be substantially longer than the 15 years proposed for renewables, may also prove a sticking point.
It is still not clear whether the capacity market will constitute state aid. Much depends on the detailed design of the market and developments in European Court of Justice case law. Whether or not state aid is involved, the Commission anticipates that it will have a role in ensuring the capacity market is consistent with the UK’s obligations under European law, either under the terms of European treaties or directives. A recent consultation on generation adequacy and capacity mechanisms advocated a common approach to ensuring that market interventions comply with European requirements on energy, competition and state aid.
Although some of the Commission’s proposed criteria for assessing capacity mechanisms appear to be met by Decc’s capacity market (for example, the non-discriminatory contract award process and relatively short-term contracts for existing plant), European endorsement cannot be taken for granted.
Decc will need to establish that the existing market will not deliver the necessary investment, and that there are no other measures, such as better interconnection, demand-side management or energy savings, that could alleviate the problem. As the UK’s transmission systems become increasingly interconnected with the rest of Europe, it is hard to see how a capacity market could be successful in achieving security of supply for the UK while meeting European expectations that it should not act as a barrier to cross-border trade or competition in the internal market.
The Commission is proposing to issue recommendations on capacity mechanisms, and possibly in the longer term legislation. As a first step, it will be analysing investment incentives and generation adequacy under the existing framework and developing criteria for assessing and ensuring consistency of national initiatives with the internal market. It is possible that this would enable the UK to launch capacity tenders in 2014 if both Decc and the Commission conclude that the circumstances warrant it, but there is precious little time for redesigning the market should it prove necessary to do so to reduce the risk of infraction proceedings.
The Commission plans to publish a consultation draft of the energy and environment guidelines this summer, as well as guidance on support schemes for renewables. This will give Decc the opportunity to refine CfDs for renewables (including proposals to exempt energy-intensive users from the costs of low-carbon support schemes) to maximise the chances of them complying with the guidelines when they are ultimately published – scheduled for early 2014. If they do, European approval may be achievable within two months of formal notification.
Of course, it is not easy to design an aid scheme so that it satisfies guidelines that have yet to be written. In addition, if EMR does not fall squarely within the guidelines, a more lengthy procedure will be initiated involving consultation with other member states and interested third parties.
The formal notification process cannot start until the details of the arrangements have been finalised, and strike prices for CfDs are not due to be set until the end of the year. The prices for investment contracts for early movers may be set earlier, but the Commission will be reluctant to take a decision on these prior to notification of the full EMR package. Given Commission scepticism as to whether guidelines should cover aid for nuclear developments, Decc can be expected to press ahead with notification as soon as it manages to reach agreement with EDF on Hinkley. But with decisions on state aid not covered by the guidelines taking up to 18 months to emerge, and sometimes longer, the prospects of a quick decision on state aid approval for new nuclear look bleak.
Paul Brennan, head of energy and environment teams, Morgan Cole
This article first appeared in Utility Week’s print edition of 7th June 2013.
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