State Aid to Electricity Intensive Users

The risk of relocation outside the EU is not accepted as a justification for the granting of State aid.

 

Introduction

The European Commission has had to assess many measures of State aid to producers of electricity from renewable energy sources [RES producers or “green” electricity producers] and to intensive users of electricity [EIUs]. The former have benefitted from investment grants and operating subsidies to offset the higher cost of generating electricity from windmills, solar collectors, waves or biomass. The latter have received relief from taxes or levies intended to raise the cost electricity from fossil fuels. These taxes aim to discourage the use of fossil fuels which contribute to CO2 emissions.

In almost all cases the subsidies to green electricity producers are linked to the subsidies to energy intensive users. The revenue for the subsidies to green electricity is raised by the taxes or levies on users of electricity. The higher the tax, the larger the revenue for green electricity and, of course, the larger the impact on consumers of electricity. The operating costs of industries which use a large amount of electricity as a source of energy, such as metals and chemicals, increase commensurately. This creates a competitiveness problem for them because many of their competitors outside the EU are not subject to similar taxes. For this reason, the 2014 Environment and Energy Aid Guidelines [EEAG] allow for aid in the form of partial exemption from energy taxes.

This article reviews a recent Commission decision that found that aid to producers of non-ferrous metals in Germany was incompatible with the internal market. Although the decision [2016/695] was published in the official journal only on 5 May 2016, it was taken on 17 July 2013 and was based on the Environmental Aid Guidelines that were in force until 30 June 2014.[1] Those Guidelines did not have provisions on aid to EIUs. It should be clarified at the outset that the aid that was proposed to be granted by Germany was not linked to any tax reduction. Nonetheless, aid to EIUs would have been found today to be compatible with the internal market for the simple reason that the EEAG do allow such aid under certain conditions. The focus of this article is not on the form of the aid [reduced environmental taxes] but how the necessity of aid to EIUs can be justified.

The changes in the environmental guidelines reflect the fact that State aid guidelines in general evolve according to the experience of the Commission in approving and interpreting aid measures and aid rules, the experience of Member States in implementing aid measures, technological innovations, the changing conditions of competition and the market and whether State aid is found to be effective in reaching its policy objectives. Newer guidelines allow or prohibit aid that used to be considered as incompatible or compatible, respectively. This kind of policy evolution is not surprising.

What makes Commission decision 2016/695 particularly interesting is the reasoning it employs to declare aid to EIUs as incompatible with the internal market. This article compares that reasoning with the conditions for compatibility in the current EEAG. Legally, what matters is what the current rules allow. However, it can still be questioned whether the current rules adequately safeguard the common interest and ensure that only aid with incentive effect is granted, as required by the common compatibility principles.

Aid to non-ferrous metal producers

In December 2009, Germany notified the State aid measure in question and argued that the aid was necessary because the economic crisis and higher electricity prices caused by the EU emissions trading system [ETS] harmed the competitiveness of metal producers such as aluminium, copper and zinc and would lead them to relocate their production outside the EU. Shifting production outside the EU would lead to direct loss of jobs and industrial output, indirect negative impact on downstream producers [i.e. users of aluminium and copper] and would also damage the environment because other countries did not have emission restrictions – the so-called “carbon leakage”. Germany proposed to grant aid to undertakings in the non-ferrous metal sector, which consumed more than 10 GWh of electricity per year and electricity costs accounted for more than 15% of their gross value added [GVA].

The Commission had little difficulty showing that the German measure constituted state aid. In fact, this aspect of the measure was not contested by Germany. Then the Commission found the measure to provide operating aid. Operating aid is normally not allowed, but it can be permitted in certain situations. The Commission concluded that that operating aid did not fall within the scope of any of the then GBER or potentially relevant guidelines [regional development, rescue & restructuring]. With respect to the then Environmental Aid Guidelines [EAG], the Commission noted that there was only provision for relief from ETS, but no reference to prevention of carbon leakage. Also the specific guidelines on ETS applied as of 1 January 2013 which was after the foreseen date of implementation of the measure that had been notified by Germany.

Since none of the regulations or the guidelines were applicable, the Commission had to assess the aid directly on the basis of the Treaty. There were two options: Article 107(3)(b) and Article 107(3)(c).

Aid on basis of Article 107(3)(b)?

Germany contented that its measure was compatible with Article 107(3)(b) which allows aid for the purposes of remedying serious disturbances in the economies of Member States. Indeed, more than 450 aid measures have been approved by the Commission on this legal basis since the outbreak of the economic crisis in September 2008.

The Commission disagreed. Aid under Article 107(3)(b) addresses “large-scale” problems facing the “whole” of the economy or sectors which are “vital” for the economy as a whole because they have a “systemic role”, not any particular regions or sectors [paragraphs 50 & 54 of the Commission decision]. “(54) […] A serious economic disruption is not remedied by an aid that ‘resolve[s] the problems of a single recipient […], as opposed to the acute problems facing all operators in the industry’. […] Article 107(3)(b) requires disturbance of a certain magnitude. So far, it has not been demonstrated that a significant part of the German economy suffered from a serious disturbance. Moreover, it is unclear how a serious disturbance of a Member State economy should be alleviated by granting State aid to only 11 beneficiaries.”

The Commission went on to observe that “(55) the argument that a declining non-ferrous metal production in Germany would severely impact downstream industries is to some extent contradicted by a point made by interested parties: one non-ferrous metal producer highlighted the trade intensity of non-ferrous metal production in Germany and Europe by stressing that so far, European producers still had the advantage of customer proximity over their overseas competitors. While the latter had to invest in warehousing to supply the European market, the former could produce on demand, being close to the production sites of their customers. However, the producer who raised this point feared that this advantage could soon be wiped out by rising electricity costs, at relatively low additional costs for customers: Indeed, if electricity costs in Europe were to rise even more, it could become more interesting for customers — rather than to rely on Union-based producers — to purchase non-ferrous metals from overseas producers (who would ship their products to Europe and stock them in warehouses). According to this view, the downstream industries would in principle be able to source from the world market without being threatened in their existence. Rather, the very possibility that upstream producers could relocate shows that downstream industries could perfectly rely on suppliers from outside Germany.”

In other words, the Commission points out that the competitiveness of German producers was not solely based on production costs. Other factors such as location, flexibility and relations with customers were also important. In addition, their problems were in fact an advantage for downstream industries because competition from abroad for the upstream producers improved supply conditions for the downstream industries. These two issues are very important and will be revisited later on when the provisions of the EEAG are assessed.

 

Aid on basis of Article 107(3)(c)

The only other possible legal basis for exempting the aid was Article 107(3)(c) for the development of certain economic activities to an extent which is not contrary to the common interest. According to the case law, aid must pursue an objective of common interest, must be necessary and must not cause undue distortion of competition [e.g. T-162/02, Kronoply v Commission; T-187/99, Agrana Zucker und Straerke v Commission; T-126/99, Graphischer Machinenbau v Commission; C-390/06, Nuova Agricast]. Following its own decisional practice, the Commission applied the balancing test to determine the compatibility of the aid.

The Commission noted that Germany argued that the aid was necessary, first, to prevent relocation and carbon leakage and, second, to prevent loss of jobs and output.

i) Carbon leakage

In relation to the aim of preventing carbon leakage, the Commission agreed that it was an objective of common interest. Then the Commission considered whether the producers of non-ferrous metals were likely to relocate. But, first, it rejected the view that the EU’s ETS rules took into account their need for relief. The Commission pointed out that the various relief possibilities and mechanisms were for the costs of reducing CO2 emissions of their own production, not for compensation for indirect CO2 costs (that is, the CO2 of electricity producers and the resulting higher cost of electricity) [paragraph 72].

Then, it explained that “(73) the Commission takes the view, consistent with the ETS Guidelines, that an aid measure cannot be necessary and appropriate to prevent carbon leakage due to indirect CO2 emission costs unless at least three conditions are fulfilled: First, it is necessary to show that the potential beneficiaries of the aid bear, within their electricity costs, a substantial share of indirect CO2 costs passed on through electricity prices. Secondly, these indirect CO2 costs must make up a substantial share of the beneficiaries’ production costs. Thirdly, the beneficiaries must not be in the position to pass on these costs to their customers. Even if these conditions are met, it would be necessary to establish that production shifts or relocation would occur outside the EU/EEA, i.e. that production would move to countries with less stringent emission reduction requirements. Indeed, shifts of production within the EU-ETS would not constitute carbon leakage.”

With respect to the first condition, the Commission concurred with Germany that electricity producers were able to pass on to users most but “not entirely” or not 100% of their CO2 costs [paragraphs 75 & 80]. It is not known what was the actual percentage of the passed on costs. Not 100% can mean 99% or 89% or 79%, for example. The Commission sets a pretty high standard here. The Commission also observed that the proportion of the passed on costs depended “greatly” on the type and the timing of contract for the purchase of electricity [paragraph 80].

With regard to the second condition, the Commission stated that Germany did not provide any information on the proportion of CO2 costs in the total production costs of the aid beneficiaries [paragraph 76]. The word total is underlined here because as will be seen later on, the EEAG criteria refer to costs in proportion of GVA.

In relation to the third condition, the Commission accepted that the available evidence indicated that the non-ferrous metal producers could not influence prices and therefore could not pass on any price increases to their customers [paragraph 85].

However, the Commission concluded that the information submitted by Germany was not conclusive [paragraph 86].

Then the Commission turned its attention to the question whether the aid had any incentive effect. It doubted whether the aid would induce the beneficiaries to retain production in German because the main aim of the aid was to enable the beneficiaries to cope with the economic crisis rather than deal with their long-term business issues [paragraphs 87-90].

The Commission also found that the proportionality of the aid was not proven. Germany based its calculations on certain benchmark prices and costs which did not necessarily correspond to the “actual” CO2 costs incurred [paragraph 96]. Germany also made some adjustments to take into account the different situation of the various without justifying them with objective data. For these reasons, the Commission concluded that it was not ensured that the compensation was limited to the minimum necessary [paragraph 98].

In relation to the likely impact of the aid on competition, the Commission noted that operating aid is the most distortive type of aid [paragraph 103]. The aid was linked to the consumption of electricity but not to actual CO2 costs and it could even reduce their incentive to produce in a more energy-efficient way. The Commission also remarked that the aid was “not linked to any efficiency benchmark” although its precise meaning was not elaborated further and therefore it is difficult to understand what the Commission could have meant [paragraph 107].

The Commission argued that “(109) […] support granted only to German producers in order to improve their competitiveness towards non-Union competitors at the same time risks also making them better off in comparison with their Union competitors.” Of course, this is the case with all aid granted by any Member State. It distorts competition between the EU and the rest of the world as well as within the EU. It is not clear why this issue is given such prominence here.

The Commission went on to add that “(110) […] distortions of competition in the internal market are not only measured by the relocation of plants from one to the other Member State. Distortions of competition already arise when production capacity can be maintained in one Member State because of State aid, as this has repercussions on the profitability of production capacity in other Member States.” Again, this is true for all State aid. If it were not true, the measure would not have been found to constitute State aid in the first place. Why it is stressed here is not clear.

“(111) In addition, the Commission sees the risk that a scheme like the one at hand would trigger a subsidy race between Member States, a situation in which competition on the internal market would be significantly distorted according to the availability of budgetary resources in the various Member States.” “(113) […] Distortions cannot only arise within economic sectors, but also between sectors: If a Member State decides to grant support to some sectors, but not to others, the unsupported sectors may have to bear a heavier burden in view of the Member State’s emission targets.” Once more, these risks exist for all State aid, even the aid that is found to be compatible with the internal market. It should be pointed out that in paragraphs 109-111 of its decision, the Commission is not arguing that the distortion is large or disproportional. It only observes that it exists. But, this is inherent in all compatible aid.

On the basis of the above considerations, the Commission concluded that there would be substantial distortions while the positive effects of the aid were unclear. It, therefore, prohibited the measure for being incompatible with the internal market. However, it still proceeded to assess the other line of argumentation of Germany, according to which the aid was necessary to safeguard jobs.

ii) Job protection

The Commission reiterated that in its opening decision it voiced doubts as to whether the prevention of relocation for the purpose of protecting jobs could be seen as an objective of common interest. The Commission, correctly, “(119) […] also had doubts whether operating aid to prevent the relocation of companies was the least distortive instrument to save jobs, as measures to improve the situation on the job market usually focus on sustainable measures such as improving the education and training of employees, or facilitating access to capital for new investments.”

More importantly, the Commission recalled that “(121) there is no precedent in its decisional practice or in the case-law of the Courts of the Union where the alleged risk of relocation outside the Union as such had been accepted as a justification for the granting of State aid.”

“(124) Moreover, any State aid needs to be limited to the minimum amount necessary to achieve the objective of common interest. This means that in the case at hand, the notified scheme should ensure that aid is limited to the amount necessary to prevent job losses.”

“(125) The notified scheme was found to be disproportionate in the prevention of carbon leakage since it did not include sufficient safeguards against overcompensation. This finding also applies here, given that the prevention of carbon leakage and the prevention of job losses have, as a common denominator, the preservation of production capacity. If there is overcompensation in view of the first objective (because the aid is disproportionate in preserving production capacity), there will also be overcompensation in view of the second objective.”

“(126) In any event, the reasons why the overall balance of the scheme is negative with respect to the prevention of carbon leakage also apply here: operating aid to cover running costs an undertaking would normally have to bear is highly distortive and cannot, in principle, be justified, regardless of what particular objective of common interest is being pursued (that is to say, the prevention of job losses instead of the prevention of carbon leakage). The fact that the aid would have been granted ad hoc and outside the scope of any harmonised framework reinforces this analysis. The scheme, if approved, could have led to job losses in other Member States, thereby triggering a subsidy race in the Union.”


The new EEAG

This section reviews the main conditions for exemption of aid for EIUs when taxes or levies that generate revenue for compensation of RES producers raise the cost of electricity for EIUs.

i) Aid in the form of reductions in or exemptions from environmental taxes

The EEAG first explain that “(167) while reductions in or exemptions from environmental taxes may adversely impact that objective, such an approach may nonetheless be needed where the beneficiaries would otherwise be placed at such a competitive disadvantage that it would not be feasible to introduce the environmental tax in the first place.”

When reductions or exemptions are granted from non-harmonised taxes, the EEAG lay down in point 177, that the Commission considers the aid to be necessary when:

  • Beneficiaries are chosen on objective and transparent criteria, and the aid is granted in the same way for all competitors in the same sector.
  • The environmental tax without the reduction leads to a substantial increase in production costs as a proportion of GVA.
  • The substantial increase in production costs could not be passed on to customers without leading to significant sales reductions.

According to point 178, the Commission considers the aid to be proportionate when:

  • Beneficiaries pay at least 20% of the national environmental tax.
  • Or, the tax reduction is conditional on the conclusion of agreements between Member State and beneficiaries, which achieve environmental protection objectives with the same effect as a 20% national tax.

ii) Aid in the form of reductions in the funding of support for energy from renewable sources

Point 182 of the EEAG explains that these reductions are allowed in order to avoid that undertakings affected by the financing costs of renewable energy support are put at a significant competitive disadvantage.

Member States need to demonstrate that the additional costs reflected in higher electricity prices faced by the beneficiaries only result from the support to energy from renewable sources. The additional costs cannot exceed the funding of support to energy from renewable sources [point 184].

The aid should be limited to sectors that are exposed to a risk to their competitive position due to the costs resulting from the funding of support to energy from renewable sources as a function of their electro-intensity and their exposure to international trade. Aid can only be granted if the undertaking belongs to the sectors listed in Annex 3 [point 185].

Member States can include undertakings in their national schemes granting reductions from costs resulting from renewable support if these undertakings have an electro-intensity of at least 20% and belong to a sector with a trade intensity of at least 4% at Union level, even if it does not belong to a sector listed in Annex 3 [point 186].

The Commission considers the aid to be proportionate if the aid beneficiaries pay at least 15% of the additional costs without reduction [point 188].

However, when needed, Member States may limit the amount of additional costs to 4% of the GVA. For undertakings with electro-intensity of at least 20%, Member States can limit the overall amount to be paid to 0.5% of GVA [point 189].

Conclusions: Comparison between Commission decision 2016/695 and the EEAG

The objections raised by the Commission in its decision on the EEG 2012 are well founded. It observed correctly that:

  1. Higher electricity costs can be offset by other locational advantages [e.g. proximity to main clients].
  2. Higher electricity costs do not necessarily or automatically lead to relocation outside the EU, for the simple reason that relocation is costly. [The EEAG refer to disadvantage vis-à-vis non-EU producers. An EU producer will either lose market share or have to relocate abroad].
  3. State aid aiming to offset higher electricity costs does not by itself induce investment in more efficient production technology that counters competitive disadvantages from higher electricity costs.
  4. State aid that is linked to electricity costs may not actually be proportional to the competitive disadvantage of producers located in the EU.

It is striking that none of the first three issues appears to be taken into account in the assessment of the compatibility of aid to EIUs in the EEAG.

In relation to the third issue, the Commission implicitly assumes that producers will by themselves decide to invest in more efficient technology in order to reduce the costs of their energy consumption. But then, there should be a gradual reduction of the aid because it will become disproportional as the energy intensity of beneficiaries decreases.

The proportionality of the aid is presumed on the grounds that the eligible producers are exposed to trade and consume a lot of energy. These two factors are thought to place them at a competitive disadvantage in relation to producers outside the EU. But still the aid is linked to costs rather than the disadvantage that it supposed to address. And, there is no requirement for reduction of the aid intensity as the disadvantage declines.

——————————————————

[1] The decision is published in OJ L120, 5 May 2016. It can be accessed at:

http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016D0695&from=EN.

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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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