Market Operator in Electricity Distribution: Long-term Purchasing Agreements Must Balance Risks and Rewards

electricity wires
A market operator accepts to be bound in long-term contracts, which entail more risk because market conditions may change, only when he gets compensated with more certainty that costs will remain stable. Contractual clauses which vary from standard commercial practice are suspect. A measure can be selective even when it uses objective criteria to define eligible beneficiaries. Trade can be affected and competition distorted when a public authority reserves a certain infrastructural capacity only for certain operators. Undertakings can claim legitimate expectations only when assurances are given by an EU institution. The Commission is under no obligation to quantify precisely the amount of aid that has to be recovered.

Introduction
 
An observation I have made in a number of articles on this blog is that Member States grant unlawful aid [i.e. non-notified aid] at their peril. This is because about 40%-50% of unlawful aid is found by the Commission to be incompatible with the internal market and recovery of incompatible aid can be complex and protracted.The risks associated with unlawful aid are well illustrated in two judgments of the General Court rendered on 30 April 2014 in cases T‑179/09, Dunamenti Erőmű v European Commission and T‑468/08, Tisza Erőmű v European Commission.[1] Dunamenti Erőmű [DE] and Tisza Erőmű [TE] applied for annulment of Commission Decision 2009/609 which found that Power Purchase Agreements [PPAs] concluded between the Hungarian public operator of the electricity network and private electricity operators contained incompatible State aid that had to be recovered.

It should be noted that these judgments relied to a large extent on the reasoning in an earlier judgment in joint cases T‑80/06 and T‑182/09, Budapesti Erőmű v Commission.[2]

Background

In the 1990s, DE, TE and other electricity generators on the Hungarian market entered into long-term power purchase agreements with MVM, the manager of the electricity network. The PPAs had two elements. First, they reserved for MVM all or a substantial part of the generation capacities of the power plants covered by the agreement. Second, the PPAs required MVM to purchase a specific minimum quantity of electricity from each power plant at pre-determined prices that covered variable costs, fixed costs and the cost of capital. The PPAs were to be in force for a long period of time that extended over significant part of the lifetime of the generating units, thereby guaranteeing a return on the generators’ investment.

In its Decision 2009/609, the Commission examined the PPAs using the Market Economy Investor Principle [MEIP]. It found that the PPAs did not conform to the MEIP and, therefore, contained State aid. Then it considered whether the aid was existing or new. It classified it as new, because the aid did not benefit from the provisions of the Treaty of Accession of Hungary to the EU. Lastly, it assessed the compatibility of the aid and, because it was operating aid and did not comply with the rules on stranded electricity costs, it concluded that it was incompatible aid and instructed its recovery.

The judgments

It should be noted at the outset that the two cases are very similar. For the sake of economy of space, I quote the main findings from the judgment concerning DE. At the end I also consider a couple of pleas raised only by TE. Therefore, the quoted excerpts are from the judgment concerning first DE and then TE.

The first issue that the General Court had to examine was whether the aid was existing or new. This is an important issue because existing aid does not have to be recovered. The aid was granted before Hungary acceded to the EU. Normally, aid granted before a country becomes a member of the EU falls outside the scope of Articles 107(1) and 108(3).

However, Hungary, and all the other new Member States, had signed Association Agreements with the EU. These Agreements imposed the same discipline on national aid measures as that of Article 107(1). Moreover, under the terms of the Treaty of Accession, aid that was granted before entry into the EU could benefit from being classified as existing aid only if it were listed in an annex to the Treaty. This was not the case with respect to the PPAs.

DE argued that the PPAs were not regarded as State aid in order for them to be explicitly listed in the annex. The reply of the Commission, endorsed by the Court, was that doubt as to the potential inclusion of State aid in a public measure is not a valid defence. More importantly, the decisive element on whether the PPAs represented existing or new aid was that they remained in force and were substantially amended after Hungary’s entry into the EU. So, irrespective of whether they were covered by the Treaty of Accession or not, the PPAs contained new aid.

Then the Court turned its attention to the central issue of the case: the conformity or not of the PPAs with the MEIP. The Court first observed that “76 … the test of a private operator in a market economy is satisfied where the State in fact merely acts in the same way as any private operator would do acting in normal market conditions. In such circumstances, there is no advantage attributable to intervention by the State, because the beneficiary could theoretically have derived the same benefits from the mere functioning of the market”.

In order to determine whether MVM acted as a private operator who was trying to procure a certain volume of electricity on the best possible commercial terms, the Commission identified the main practices of commercial operators on European electricity markets and assessed whether the PPAs were in line with those practices or provided generators with guarantees that a buyer would not accept if it acted on purely commercial grounds.


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The Court endorsed this approach. Accordingly, it found that “(87) […] the PPAs entail less risk for electricity generators than spot contracts, which are mainly day-­ahead contracts in which electricity is traded one day before physical delivery takes place and therefore entail a significant degree of uncertainty concerning the remuneration of fixed and capital costs, and the level of utilisation of generation capacities. Trade in power on spot market exchanges is based on marginal pricing, which guarantees only that short-run marginal costs, and not all fixed and capital costs, are covered. Owing to the impossibility of storing electricity economically, after generation, there is no assurance about the level of utilisation of generating capacities.”

“(88) That is also true in part for ‘forward’ contracts, whose prices are fixed in advance. […] a standard forward contract places on the generator the obligation to provide a certain amount of energy at a price agreed in advance, over a period of one year starting within at most six years of the conclusion of the contract. Those contracts do not therefore provide assurance to generators that all their fixed and capital costs are covered, because production costs may increase if fuel costs increase. The fluctuation in fuel cost for forward contracts is therefore borne by the generators and not, as in the present case, by MVM. In addition, even though, for forward contracts, the uncertainty concerning the level of utilisation of generation capacities is lower than in the case of spot contracts, due to the longer time horizon of forward contracts, those contracts cover only a limited period of time, however, compared to the lifetime of their power generation units. It is clear from that comparison that the combination of ‘long-term capacity reservation, a minimum guaranteed off-take and price-setting mechanisms covering variable, fixed and capital costs’ as laid down by the PPAs do not correspond to usual contracts on European wholesale markets.”

“(89) By comparison with spot and forward contracts, PPAs entail a lower level of risk for generators, by providing them with certainty both concerning the remuneration of fixed and capital costs and the level of use of generation capacities.”

“(93) The Commission then correctly underlined the foreseeable consequences of the PPAs for the public authorities, namely that, while MVM would be able to find enough electricity to fulfil the needs of the public utility sector over a long period of time, the public authorities, however, had no assurance concerning the level of price that would have to be paid for the electricity over that same period, because the PPAs do not provide hedging against risks of price fluctuations, which are due in particular to fluctuation in fuel costs. Furthermore, as the Commission stated, the combination of long-term capacity reservation and the associated minimum guaranteed off-take deprive the public authorities of the possibility of benefiting from more attractive prices offered by other generators”.

In a nutshell, the PPAs were not in conformity with the MEIP because they contained clauses not normally found in comparable commercial contracts. These clauses in effect enabled generators to shift all risk to MVM as the PPAs guaranteed prices that covered all of their costs, including any fluctuations in fuel prices. By contrast, MVM accepted all risk without deriving any corresponding benefits. It bore the risk of changes in fuel prices and was deprived of the possibility of accessing alternative sources of supply at perhaps lower prices. No private operator would enter into long-term contracts without hedging against possible adverse changes in prices or costs.

Another complaint lodged by DE was infringement of the principles of the protection of legitimate expectations and of legal certainty. The General Court observed that “(100) […] three conditions must be satisfied in order for a claim to entitlement to the protection of legitimate expectations to be well founded. First, precise, unconditional and consistent assurances originating from authorised and reliable sources must have been given by the authorities to the person concerned. Second, those assurances must be such as to give rise to a legitimate expectation on the part of the person to whom they are addressed. Third, the assurances given must comply with the applicable rules”. “(101) As regards the principle of legal certainty, it requires that EU legal rules be clear and precise in order that interested parties can ascertain their position in situations and legal relationships governed by EU law”.

The Court found that none of the above principles applied to DE and “(104) In any event, a recipient of unlawfully granted aid, implemented without prior notification to the Commission, as in the present case, cannot have a legitimate expectation that the grant of the aid is lawful”.

Lastly, the Court had to deal with the method that the Commission used to indicate how much aid had to be recovered. It should be recalled that the Commission is under no obligation to quantify precisely the amount of recoverable aid. This is the obligation of the granting Member State. Given that the PPAs contained State aid because they shifted all risk to MVM, the Commission in its Decision indicated that the recoverable aid was the revenue of the generators under the PPAs and the revenue they would have received under agreements with standard purchasing clauses.

DE complained that the method adopted by the Commission was not precise enough. The Court rejected this claim and considered the method appropriate in the specific circumstances of this case.

The Court clarified that “(188) The existence of an economic advantage must, in this instance, in accordance with the principle of a private operator in a market economy, be assessed on the basis of the conduct of the public undertaking conferring the advantage under consideration, not on the basis of the conduct of the beneficiary of that advantage. Therefore, […] that advantage is reflected in the difference between the amounts which MVM would, under normal market conditions, have paid for the purchase of the electricity needed and the amounts which it actually paid for the electricity purchased, whether it was needed or not”.

A related issue was whether profit or revenue should have been taken into account to determine the extent of the advantage conferred on DE. The Court agreed with the Commission that the correct measure was revenue, not profit. This is because profit was affected by factors that fell outside the terms of the PPAs [e.g. worker salaries], while revenue depended solely on items fixed by the PPAs such as quantity purchased and price.

The additional pleas raised by TE

Given that the two companies were represented by different lawyers, it was natural that they entered different pleas. TE made three extra pleas: absence of selectivity, no imputability to the state and no affectation of trade and distortion of competition.

With respect to selectivity, the Court first recalled that “(159) […] the specific nature of a State measure, namely its selective application, constitutes one of the characteristics of State aid within the meaning of Article 107(1) TFEU. In that regard, it is necessary to determine whether or not the measure in question entails advantages accruing exclusively to certain undertakings or certain sectors of activity”.

“(160) More specifically, it is settled case-law that Article 107(1) TFEU requires it to be determined whether, under a particular statutory scheme, a State measure is such as to favour ‘certain undertakings or the production of certain goods’ in comparison with others which, in the light of the objective pursued by the scheme in question, are in a comparable legal and factual situation”.

In this connection, TE argued that the PPAs were not selective because long-term agreements existed in the entire electricity sector: between MVM and the generators, between MVM and the distribution companies as well as for imports. By contrast, the Commission had found that there were power plants operating without PPAs. The Court agreed with the Commission that the fact that the aid was not aimed at one or more specific beneficiaries defined in advance, but that the beneficiaries had been identified pursuant to a number of objective criteria did not mean that the PPAs did not confer a selective advantage. In other words, as is well established in the case law, a measure is selective even when it covers a whole sector.

With respect to imputability, the Court first observed that “(168) […] even if the State is in a position to control a public undertaking [such as MVM] and to exercise a dominant influence over its operations, actual exercise of that control in a particular case cannot be automatically presumed. A public undertaking may act with more or less independence, according to the degree of autonomy left to it by the State. Therefore, the mere fact that a public undertaking is under State control is not sufficient for measures taken by that undertaking to be imputed to the State. It is also necessary to examine whether the public authorities must be regarded as having been involved, in one way or another, in the adoption of those measures”.

“(169) In that regard, it cannot be required that it be demonstrated, on the basis of a precise inquiry, that in the particular case the public authorities specifically incited the public undertaking to take the aid measures in question. For those reasons, it must be accepted that the imputability to the State of an aid measure taken by a public undertaking may be inferred from a set of indicators arising from the circumstances of the case and the context in which that measure was taken”.

“(170) […] certain indicators might, in some circumstances, be relevant in concluding that an aid measure taken by a public undertaking is attributable to the State, such as, in particular, its integration into the structures of the public administration, the nature of its activities and the exercise of those activities on the market in normal conditions of competition with private operators, the legal status of the undertaking (in the sense of its being subject to public law or ordinary company law), the intensity of the supervision exercised by the public authorities over the management of the undertaking, or any other indicator showing, in the particular case, an involvement by the public authorities in the adoption of a measure or the unlikelihood of their not being involved, having regard also to the compass of the measure, its content or the conditions which it contains”.

On the basis of the above reasoning, the Court agreed with the Commission that the PPAs were attributed to a decision of the state.

Lastly, with regard to affectation of trade and distortion of competition, the Court explained that once the Commission correctly identified how the aid was capable of affecting trade, “(182) […] it was not required to carry out an economic analysis of the actual situation on the relevant market, of the market share of the undertakings in receipt of the aid, of the position of competing undertakings and of the trade flows in respect of the goods or services in question between the Member States”.

“(186) […] once the electricity market was opened up to competition […] measures favouring undertakings in the energy sector in one Member State were capable of impeding the ability of undertakings from other Member States to export electricity to the first Member State, or of favouring the export of electricity from that State to other Member States.”

Moreover, “(188) […] the capacities [reserved by the PPAs] were a barrier to new generators entering the wholesale market and that the PPAs led to foreclosure of the competitive market by, inter alia, limiting the scope for eligible customers to switch to the free market”.

We see, therefore, that competition can be distorted in the meaning of Article 107(1) not only when monetary advantages strengthen the competitive position of beneficiaries vis-à-vis their competitors, but also when non-monetary clauses or provisions included in an aid measure or other means of favourable treatment of the beneficiaries make it more difficult for competitors to enter the relevant market to access customers in that market.

 


[1] The judgments can be accessed at:

http://curia.europa.eu/juris/document/document.jsf?text=&docid=151504&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=515072

and

http://curia.europa.eu/juris/document/document.jsf?text=&docid=151503&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=381174

[2] It can be accessed at:

http://curia.europa.eu/juris/document/document.jsf?

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About

Phedon Nicolaides

Dr. Nicolaides was educated in the United States, the Netherlands and the United Kingdom. He has a PhD in Economics and a PhD in Law. He presently holds positions at the College of Europe and the University of Maastricht. He has published extensively on European integration, competition policy and State aid. He is also on the editorial boards of several journals. Dr. Nicolaides has organised seminars and workshops in many different Member States, and has acted as consultant to several public authorities.

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