On 15 November 2018, the EU’s General Court annulled the European Commission’s decision to approve Great Britain’s Capacity Market.*
In short, this means that:
- The Capacity Market and all associated subsidies are suspended, pending a decision on whether they comply with EU law; and
- An investigation will be opened, which experts and interested parties should feed into.
A summary of the judgment is below – homing in on aspects that should be of interest to several expert audiences – including energy market experts and State aid lawyers.
The Capacity Market case in a nutshell
This case was brought in December 2014 by Tempus Energy, a UK-based ‘demand side response’ (DSR) operator. The action was based on Tempus’s view that the GB Capacity Market was designed to favour fossil fuels (gas, coal and diesel generators), at the expense of cleaner technologies. They argued that this grants unnecessary extra profits to polluting energy companies, and unnecessarily increases consumer bills.
The core of their case – which the Court agreed with – is that the Commission approved the Capacity Market without properly assessing the claims made by Tempus and other market players and experts that it was badly designed.
The General Court found that the Commission had breached legal requirements by approving the huge (up to £23.4 billion from 2018-2024) State aid scheme after only one month of assessment in July 2014 – rather than launching the in-depth investigation required for complex schemes which may not comply with State aid law. For this reason, it has annulled the Commission’s decision, and ordered the Commission to pay Tempus’s costs.
This means that the Commission will now have to reassess the Capacity Market’s compliance with State aid law. The UK Government might want to make some changes to the scheme before the Commission starts its analysis. The Capacity Market will be suspended until the Commission issues a fresh approval decision.
Background – what is the Capacity Market?
The stated aim of the Capacity Market is to ensure that in periods of peak electricity demand, enough electricity can be supplied to meet Great Britain’s needs. It pursues this aim by providing subsidies to operators who successfully bid for ‘capacity agreements’ in auctions. These auctions are organised either four years ahead (T-4 auctions) or one year ahead (T-1 auctions) of the year in which the operator must supply the capacity.
The capacity agreements are of varying length – a central point for the Court’s decision. Existing electricity generators can secure agreements of up to 3 years, if they are refurbishing; new-build generators can get agreements of up to 15 years; and all other capacity providers can receive agreements of only up to one year. Those ‘other’ providers include both existing generators that will not be refurbished, but also innovative clean energy technologies such as ‘demand side response’ (DSR).
In its original State aid approval, the UK Government estimated that the Capacity Market would cost between £8.1 billion to £23.4 billion from 2018-2024 alone. These costs will ultimately be borne by British electricity consumers.
And what is DSR?
DSR operates by allowing consumers to reduce their electricity consumption (demand) in response to high electricity prices, saving consumers money as they shift their consumption to a time when power costs less. It can also do this at times of peak demand: in return for capacity payments, consumers shift their consumption to periods of lower overall demand, easing pressure on the grid. This is the much cleaner alternative to getting electricity generators to increase supply at these times of peak demand.
Tempus claims that the Capacity Market discriminates against DSR by allowing it only to bid for one-year contracts, whereas generators – mainly fossil fuel operators – can bid for contracts lasting for three or even 15 years. This is despite the fact that setting up new DSR operations also requires upfront investment, and justifies support over a number of years – the exact rationale the Government puts forward for allowing generators to bid for these longer contracts. Tempus also claims that other conditions that bidders have to meet discriminate against DSR operators.
The General Court’s judgment – more details
For the State aid lawyers – when does the Commission have to open a formal investigation?
The Court went into a lot of detail on the question of when a formal investigation must be opened.
State aid assessments by the Commission are divided into three stages:
- The ‘pre-notification’ stage – informal discussions between the Member State and the
Commission. This comes to an end when the Commission has enough information to
consider the notification to be complete.
- The ‘preliminary investigation’ (Phase 1) – the Commission’s initial assessment as to whether
the aid scheme is compatible with the internal market. If it has doubts, it must proceed to
Phase 2; otherwise it can issue a ‘positive decision’ approving the aid. Phase 1 lasts up to
- The ‘formal investigation’ (Phase 2) – the Commission’s in-depth assessment of compatibility
with the internal market. This involves gathering the opinions of third parties (competitors,
technical experts, etc), and lasts a lot longer – up to 18 months. At the end of this, it can
either approve the aid or reject it as incompatible (or a combination of the two).
The GB Capacity Market was approved after a lengthy pre-notification, but only one month of Phase 1, in July 2014. This seems a remarkably short period for assessing such a complex, novel and expensive scheme – the first time the Commission had ever assessed a capacity mechanism of this type.
The Court agreed. It held that the Commission cannot rush through a Phase 1 approval simply to satisfy ‘third party interests’ (e.g. the UK wanting to get this approved quickly). If the Commission has doubts as to compatibility of the aid, it is required to open Phase 2.
Importantly, the Court held that the question of whether there should be ‘doubts’ is an objective question. It is not just a matter of the Commission’s opinion. If the Phase 1 investigation is “insufficient or incomplete”, this strongly indicates that there are doubts.
The Commission and the UK had argued that the lengthy pre-notification, together with the public consultations run by the UK Government on the scheme at a national level, helped justify the short Phase 1 approval. The Court gave this short shrift, emphasising that the ‘pre-notification’ period has no formal role in the assessment process, which must be done at Phase 1 / Phase 2, and that the Commission has an obligation to gather all the information from interested parties that is relevant to assessing compatibility of the aid with EU law. It cannot simply rely on consultations carried out by Member States at the national level.
A final, very important point for third parties who might want to challenge a proposed State aid: during Phase 1, three types of electricity operator submitted comments to the Commission detailing their thoughts on whether the aid was compatible with the internal market. This, the Court emphasised, indicated that there were in fact doubts as to compatibility. The operators did this despite the fact that there was no formal procedure for them to submit these comments. The lesson: don’t be afraid to contact the Commission – the more information it has, the better informed it will be, and the stronger your position in the State aid process.
For the energy market experts, part 1 – the important role of DSR in addressing capacity concerns
The Court reached some strong conclusions regarding the role of DSR in addressing capacity concerns, noting that both generation and DSR have advantages in addressing capacity concerns. They both “provide an effective solution to the capacity adequacy problem…each solution has its advantages and disadvantages”.
It went on to conclude that “the Commission could not be satisfied merely by the openness of the measure and conclude, consequently, that it was technology neutral, without examining in greater detail the reality and effectiveness of the appreciation of [DSR] in the capacity market.” DG COMP had not assessed the potential of DSR for the purposes of the Capacity Market. It simply accepted the UK’s arguments on this point, even where there was contradictory evidence available.
The Court refers to the EU law principle that “comparable situations must not be treated differently, and different situations must not be treated in the same way unless such treatment is objectively justified”.
The Capacity Market treats DSR and generators very differently – in particular, DSR can only receive capacity agreements for one year, whereas generators can get agreements for three years (existing generators) or 15 years (new generators). This is despite the fact that it claims to be technology neutral. This could only be justified if the Commission did detailed analysis of whether it was appropriate to treat generators and DSR differently in this manner.
The Court concludes that the Commission did no such analysis – it merely accepted the UK’s statement that DSR operators do not have the same capital needs as operators of new generation plants. Indeed, the UK Demand Response Association (UKDRA) had informed the Commission that the opposite was the case, and asked the UK Government to do some modelling that would demonstrate this (this did not happen).
The obligation was on the Commission to go and research this point – perhaps by asking organisations like Tempus and UKDRA to provide evidence. The Commission cannot criticise third parties for failing to provide this information spontaneously, which it did in this case. In fact, UKDRA had actually offered to provide further information on this – the Commission never took up this offer.
The Commission should therefore have adequately assessed what role DSR could play, having regard to principles in State aid guidelines. Since it did not do that, it should have had doubts as to the scheme’s compatibility with the internal market and opened the Phase 2 investigation.
For the energy market experts, part 2 – conditions for DSR participating in the Capacity Market
Tempus made various arguments to the effect that the conditions imposed on operators (including DSR) to participate in the Capacity Market were highly problematic, and justified opening a Phase 2 investigation.
Tempus argued that the cost recovery methodology (based on consumer demand between 16:00-19:00 each day, rather than the highest demand peaks across the year) increased the amount of aid granted and required the UK to procure more capacity than is actually required.
The Court dismissed the Commission’s response that cost recovery concerns the financing side of the Capacity Market, and that this was not relevant to the compatibility assessment. This was not correct, since cost recovery methodology affects the total level of aid and amount of capacity purchased.
This is very clearly correct – State aid schemes always require money to be put in, and the amount of money put in has a huge impact on the overall size of the scheme and its impacts on the market. Yet the Commission did no detailed assessment of these issues.
Tempus also raised various technical arguments concerning the design of the auctions and conditions for participation of capacity (including DSR) in those auctions. In particular, the Court considered its arguments on the one year ahead (T-1) and four years ahead (T-4) auctions.
The Court found that the Commission may have been correct that the design of the T-1 auction may genuinely encourage development of DSR. However, the limited amount of capacity reserved for T-1 (as opposed to the T-4) auctions, and the lack of any legal guarantee supporting the UK’s political statement that it would procure at least 50% of capacity reserved for the T-1 auction through that auction, meant that the Commission should have had serious doubts regarding the size of the ‘incentive effect’ of the Capacity Market. Establishing the incentive effect is a key part of finding the measure compatible with EU law.
Regarding the T-4 auction, Tempus argued that:
- the requirement to provide capacity for ‘open-ended’ (i.e. uncertain duration) rather than ‘time
bound’ capacity events discriminated against DSR;
- that the requirement to provide a significant ‘bid bond’ (in effect, security for failure to supply
capacity on demand) was a barrier to entry for DSR; and
- that the requirement to provide at least 2 MW of capacity to be eligible to participate
discriminated against DSR.
On (1) and (2), the Court found that the Commission had failed to verify DSR’s financing needs, and so should have had doubts as to compatibility with EU law.
On (3), the Court found that the Commission should have had doubts as to whether the requirement to provide at least 2 MW capacity was compatible – this was 20 times the 100 kW minimum requirements for participation in, for example, the US’s ‘PJM’ capacity market.
For the energy market experts, part 3 – the only argument Tempus lost
Tempus argued that DSR should be compensated for reducing the amount of electricity lost in transmission and distribution when providing capacity (since, unlike generation, DSR does not involve transmitting electricity).
The Court’s view was that the Commission was correct that State aid law requires capacity mechanisms to be assessed solely in terms of how much capacity is provided – and not on e.g. the amount of electricity delivered. So, the Commission should not have had serious doubts on this basis.
Next steps – reassessing the GB Capacity Market
When the judgment came out, the UK Government announced that current operation of the Capacity Market would be suspended until the Commission issues a new State aid approval – no more auctions would take place, no more capacity agreements entered into, and no more aid paid out under existing capacity agreements.
The Commission will need to reassess the Capacity Market. The UK Government will likely make some changes and re-notify the scheme, meaning that we go back to the pre-notification phase and the start of Phase 1.
The Court was very clear that the Commission should open a Phase 2 investigation. This means that the Commission might conclude Phase 1 quickly, and in less than two months, so that it can open Phase 2. The Phase 2 procedure can take up to 18 months; it can also take a lot less time. There will be considerable pressure and efforts from the UK Government to conclude this investigation as quickly as possible – it seems quite likely it could be concluded by the middle of 2019, and seems very unlikely to last until 2020.
What can I do?
Market players and technical experts will be able to participate in this Phase 2 procedure. This is an excellent opportunity to demonstrate how capacity mechanisms generally have not achieved their goals, and the GB Capacity Market in particular, and why – if they are to exist at all – they should be redesigned to promote clean energy solutions rather than fossil fuels.
Sam Bright can be reached via email
*The GB Capacity Market does not apply to Northern Ireland, which is instead part of the all-Ireland Single Electricity Market.
This article was amended on 21 November 2018.