On 23 July 2014 the European Commission issued two State aid decisions in relation to the UK’s comprehensive Electricity Market Reform (EMR).  These are on the Capacity Market generation scheme and the introduction of Contracts for Difference (CfDs) to promote generation from renewable resources.  The Commission examined the measures under the new Guidelines on state aid for environmental protection and energy, adopted by the Commission in April 2014 and applied to all decisions taken on or after 1 July 2014.  At the same time, the Commission approved Investment Contract support based on the CfD scheme to five large offshore wind farm projects.

Capacity Market

Under the Capacity Market scheme, the GB system Operator will organise annual centrally-managed auctions to procure the level of capacity required to ensure generation adequacy.  Auctions will be open to existing and new generators, demand side response operators and storage operators.  The UK has also committed to opening participation to new interconnectors from 2015.

The scheme will run for 10 years.  New generators will be eligible for a 15-year capacity agreement and other capacity providers will be eligible for 1-year capacity agreements (except in the case of existing generators requiring significant refurbishment).  Payments will be made as a function of the amount of capacity set out in each provider’s capacity agreement.  The measure will be financed through a levy on electricity suppliers. 

This was the first assessment of a capacity market under the special provisions in the new Guidelines.  Key components of the Commission’s compatibility decision were the UK government’s demonstration that the capacity market was introduced only following a thorough investigation of its necessity and the potential for alternative measures to contribute to the security of supply objective; that the measure itself will be open to a range of technologies, including demand side response and interconnection; and the use of auctions to ensure that aid granted is limited to the minimum necessary.

Contracts for Difference

The CfD scheme provides long-term revenue stabilisation to low-carbon plant. Aid granted under the scheme will be paid out as a variable premium on top of a reference electricity (wholesale) price, and up to a pre-defined strike price.  When the average wholesale price of electricity is below the strike price, generators will receive a top-up payment.  In case of high wholesale electricity prices, revenues for the generator will be capped at the strike price to ensure that there is no overcompensation. 

The payments under the CfDs will be financed through a tax imposed on energy suppliers.  To ensure that the tax does not discriminate against overseas generators, imported renewable electricity will not be subject to the tax.  In later years, overseas generators will be able to compete for CfDs on the same terms as national generators.  

The CfD scheme will run for 10 years starting in April 2015.  Selected individual projects will be able to receive support for up to 15 years.
The CfD scheme describes three categories of technology.  Plants using “established” technologies (such as onshore wind, solar photovoltaic, energy from waste with combined heat and power, small hydropower, landfill gas and sewage gas) will compete against each other for support in a common auction.  Plants using “less established”, new and innovative technologies (such as offshore wind, wave, tidal stream, anaerobic digestion or geothermal energy) will initially benefit from allocated budgets in order to promote their further development, but will also be subject to competitive auctions with some degree of cross-technology competition.  Biomass conversion plants will be supported through dedicated tenders up to 2017, after which the UK will evaluate whether biomass can be included in the common tenders for established technologies. 

The European Commission has concluded that the scheme is in line with the objective to promote renewable energy while avoiding overcompensation and without unduly distorting the internal energy market, given in particular the competitive and non-discriminatory procedures to allocate the aid. 

Five large offshore wind projects also received State aid clearance based on the Guidelines.  The investment contract support for these projects is based on the CfD mechanism.  Separate consideration and decisions were required because of the size of the projects.  The Commission’s approval focused on the same themes of promotion of renewable energy and environmental protection, absence of distortion of competition in the Single Market and the transparent, non-discriminatory and competitive process by which the projects were selected for support, designed to limit the aid to what is really necessary for the investments to be carried out. 

Conclusions 

The Commission’s approval of these measures is a positive step forward for the UK’s implementation of EMR.  The non-confidential detail of the decisions, including the separate decisions on the individual projects, will be available on the Commission’s website in due course.  They will doubtless be reviewed with great interest by investors seeking support for new developments and EU governments looking to design capacity markets in keeping with the Guidelines.

If you would like to discuss the impact of these decisions for your business, please do not hesitate to get in touch with one of the partners named below, or your usual CMS contact.