State intervention in the European electricity market

21st November 2013

On 5 November the European Commission published a Communication, ‘Delivering the internal electricity market and making the most of public intervention’. Public, or state, intervention can be at regional, national or local level and can take different forms, such as: state aid to certain sectors or companies in the form of grants or exemptions from taxes and charges; imposing public service obligations; or regulation through general measures.

This Communication is the latest in a line of documents emanating from Europe around energy. It has been issued now because the EU has set a deadline of 2014 for the completion of the internal EU energy market, where cross-border markets for gas and electricity must be up and running in all parts of the EU, but there is concern that this deadline will not be met.

It is specifically focused on the electricity market although the principles can be applied in other energy sectors such as gas and heating. The Commission has focused on reviewing public intervention in the electricity market in particular because such intervention has a significant influence on the cost and prices of electricity. There is a need for public intervention to secure a level playing field, overcome market failures, foster technology and innovation, and, more generally, support the market in delivering appropriate investment signals. If not done properly, public intervention risks being counterproductive and distorting the functioning of the internal market, leading to higher energy prices for both households and businesses.

The Communication sets out principles for state intervention in:

• National support schemes for renewable energy (mostly solar and wind)
• Setting up back-up capacities for renewable energy (mostly fossil fuels), for when renewable energy is not being generated/times of peak demand.

Renewable energy support schemes
The Communication recommends the following best practice principles:

• Financial support should be limited to what is necessary and should help to make renewables competitive
• Support schemes should be flexible and respond to falling production costs. As technologies mature and investment costs fall, they should be exposed to market prices and eventually support must be fully removed. In practice this means that feed in tariffs (a fixed price per kWh) should be replaced by feed in premia (i.e. the market price plus a premium) or other support, such as quota obligations (energy suppliers having to ensure that a certain quota of the electricity they supply comes from renewable sources), that gives incentives to producers to respond to market developments
• Avoid unannounced or retroactive scheme changes. Investors’ legitimate expectations concerning the returns on existing investments must be respected. The UK has learnt this the hard way with its early and frequent changes to the solar PV tariffs, subsequently resolving this problem by implementing a system of tariff degression linked to deployment levels.
• Member states should better co-ordinate their renewable energy strategies to keep costs low for consumers.

Back-up capacities for renewable energy
The increase in renewable energy makes it more of a challenge to keep producing electricity when the wind is not blowing and the sun is not shining. The Communication therefore also gives guidance on how member states can design back-up capacities (such as coal and gas power plants) in a cost-effective way that takes full advantage of the European market:

• Before deciding on capacity mechanisms, governments should first analyse the causes of inadequate generation
  Secondly, they should remove any distortions that may prevent the market from delivering the right incentives for investment in generation capacity, such as regulated prices or high subsidies for renewable energy
• Governments should ensure that renewable energy producers react to market signals and promote flexibility on the demand side, such as different tariffs to incentivise consumers to use electricity at off-peak times (“smart grids” and “smart metering”)
• Back-up capacity mechanisms should be designed with a European perspective, not just the national market.

What does this mean for UK’s electricity market reform proposals?
The Commission has developed this Communication in tandem with revising the guidelines on state aid for environmental protection as part of its state aid modernisation programme. It will follow the main principles set out in this Communication when it is assessing whether public intervention in renewables support schemes or to promote generation adequacy constitutes a state aid or not. It appears that the new guidelines on state aid for environmental protection will be based on the idea that public interventions should, wherever possible, be more market-based, more open to cross-border solutions and allow for more competition between supported technologies. Watch this space!

Further information
For more information on state aid, please contact Richard Auton.