European Commission Launches State Aid Sector Inquiry into Member States’ Energy Capacity Mechanisms

July 20, 2015

1.       INTRODUCTION

1.1    In April this year, the European Commission (the "Commission") launched an unexpected State aid sector inquiry (the "Sector Inquiry") into capacity mechanisms. Capacity mechanisms are essentially back-up energy supply facilities, established in order to ensure energy security and consistency of supply. Given that capacity mechanisms are usually supported by State aid, the Sector Inquiry aims at reviewing the various support mechanisms in place in Member States. In this regard, the Commission recently approved a significant amount of State aid for capacity mechanisms in the UK, i.e. the Hinkley Point C nuclear power plant ("Hinkley").[1] The political sensitivities surrounding Hinkley and the UK’s intense lobbying for an approval have certainly played a large role in the decision to introduce the Sector Inquiry.

1.2    The EU has predicted that by 2050, electricity demand will have increased by 1,2% every year, leading to an increased need for investments in energy generation in order to guarantee security of supply. However, as a result of the European Union’s "green" State aid policies, which strongly favour renewable energy sources ("RES") over conventional energy sources, an important share of these investments are directed at RES. However, the intermittent nature of RES means that it will be incapable of being the EU’s future main source of stable electricity supply nor alone meet increased future demand this. Nevertheless, with the strong support for RES and the onset of the financial crisis, investments in conventional energy have been declining.

1.3    The problems arising from the lack of investment in conventional energy are further exacerbated by the fact that the few support schemes which do exist for conventional energy often favour inflexible and inefficient forms of conventional energy technologies (such as the State aid scheme supporting coal-based energy supply in Spain) over more flexible and efficient technologies.[2] In addition, incentives to invest in conventional energy sources have been further reduced by Member States introducing price caps on both the wholesale and retail markets and the general lack of regulatory certainty in the EU electricity market.   

1.4    One solution to the problem of fulfilling future power needs is to introduce interconnectors which facilitate cross-border trade in the EU and allow Member States to export excess capacity.[3] However, an often domestically more popular solution is the construction of domestic back-up capacity mechanisms based on conventional energy sources. This solution is often preferred by Member States as it increases domestic economic activity, but given that such capacity mechanisms are designed to allow Member States to be self-sufficient at the national level, they remove incentives for the establishment of inter-connectors facilitating cross-border trade. This in turn leads to the fragmentation of the internal energy market.  

1.5    The Commission therefore faces a dilemma between on the one hand, allowing Member States the freedom to choose how they meet the future increase in demand, and on the other hand, ensuring the development of the Energy Union.

2.       WHAT CAN BE ACHIEVED BY THE SECTOR INQUIRY?

2.1    The Sector Inquiry seeks to verify whether State aid is granted to support capacity mechanisms. However, this involves certain risks.

2.2    Many Member States have established capacity mechanisms for which some form of public assistance is granted which qualifies as State aid. Some Member States have, however, established complex mechanisms that do not necessarily involve State aid under which the power is bought at fixed or market prices but where the provider carries the risk of maintaining the plant. This makes it very difficult to establish to what extent the public intervention involves State aid. Nevertheless, in light of the Commission’s very critical view of the German RES support schemes, which have also triggered 18 cases pending before the General Court, it is likely that the Commission will take a critical approach in its analysis of the public mechanisms and find that in many cases State aid has indeed been granted.

2.3    Assuming that a number of national measures in support of capacity mechanisms involve the grant of State aid, the real question is whether the Commission will approve such aid. If the Sector Inquiry will lead to many cases where the Commission finds that State aid for capacity mechanisms is compatible aid, this risks indirectly legitimising and giving the appearance of favouring systems which contradict the EU’s own internal market and environmental policies, including decarbonisation and energy efficiency. For example, in view of the fact that the US shale gas boom has resulted in coal being exported to the EU, thereby making coal the cheapest form of energy, it is not unlikely that there are several support mechanisms which favour the use of coal. If the Sector Inquiry leads to the approval of coal-based capacity mechanisms, it thus will contribute to the granting of more State aid for one of the most polluting and inefficient forms of conventional energy generation.

2.4    Further, providing aid to capacity mechanisms runs, in many ways, directly against incentives for further completion of the Energy Union, given that with capacity mechanisms in place supported by State aid, there are reduced incentives to construct interconnectors which are fundamental for cross-border energy trade. 

2.5    On the other hand, if the Commission does not approve the majority of cases involving State aid for capacity mechanisms, it risks jeopardising short term security of supply (at least until other solutions have been found, which is unlikely to happen in the near future). At the same time, by approving some (but not all) State aid cases which may be based on the same energy source, the Sector Inquiry may end up leaving the impression that certain undesirable technologies are favoured over others.

2.6    In light of this, the EU should rather address the issue of the lack of investment incentives for conventional energy sources, including its policy on RES support which causes market distortions and cause artificial "market prices".[4] The Sector Inquiry seems to focus on the consequences of market-distorting aid granted to RES, rather than addressing the more fundamental issue of why RES itself still needs to be supported by aid. This also raises further difficult questions on how the EU’s "green" policy can be aligned with its competition rules and Internal Market Policy.

2.7    It would appear that the provision of State aid to both RES and capacity mechanisms is throwing more money at the wrong place in the electricity supply chain, helping to support a system which is internally incoherent and not sustainable in the long term. A better and more focused use of public resources would be to reduce support for RES and create a sound investment environment for conventional energy production, which would automatically contribute to the creation of a more level playing field.[5] In light of this, the outcome of the Sector Inquiry will hopefully provide results which will make the EU take a more proactive approach towards reforming RES capacity mechanisms and the policy behind the support mechanisms for them.

   [1]   Commission Decision of 08.10.2014 on the aid measure SA.34947, Brussels, 08.10.2014, C(2014) 7142 final.

   [2]   The Commission has noted that "in the electricity sector today, some Member States continue to provide financial support for generators which use inflexible and relatively inefficient technology. This displaces more flexible or efficient forms of generation as is seen for example by the impact of the support for coal in Spain on the revenues of newer gas powered stations or in Bulgaria". Commission Staff Working Document: Generation Adequacy in the internal electricity market – guidance on public interventions, 5.11.2013, SWD(2013) 438 final, page 15.

   [3]   The EU has fixed a minimum interconnection target for electricity at 10% of installed electricity production capacity of the Member State in question by 2020.

   [4]   The Commission has acknowledged that "most support schemes applicable today were designed when renewables technologies were in their infancy and with negligible market shares. As the internal electricity market in particular evolves, as renewable technologies mature and as their penetration rates increase, support schemes should be adapted to those changed circumstances, in order to foster the next generation of renewables with improved performance and to contain the costs of these schemes to energy consumers", Communication from the Commission: Delivering the internal electricity market and making the most of public interventions, Brussels, 5.11.2013, C(2013) 7243 final ("2013 Communication"), page 5.

   [5]   As the Commission recently acknowledged, "Fostering competition between technologies can help to ensure that support is limited to a minimum and leaves it to the market to select the most efficient technologies lowering the distortive effect of the support systems", 2013 Communication, page 10.

        The Commission has acknowledged that "A fully functioning internal market, providing efficient investment signals, is the best means to reduce the need for capacity mechanisms", Communication from the Commission on A Framework Strategy for a Resilient Energy Union with a Forward-Looking Climate Change Policy, Brussels, 25.2.2015, COM(2015) 80 final, page 10.

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