The Compatibility of State Aid with the Internal Market: Lessons from “Hinkley Point C” – Part II

The objective of common interest that should be supported by state aid does not have to be an objective agreed by all Member States.

 

Existence of market failure and need for aid

Austria and Luxembourg claimed that the intervention by the UK was not necessary and that there was no evidence that the liberalised market for the generation and supply of electrical power was failing.

The Court first reiterated that “(150) Article 107(3)(c) TFEU does not expressly include a condition relating to the existence of a market failure. That provision merely requires that the aid should relate to a public interest objective, and that it be appropriate, necessary and not disproportionate […] Accordingly, in the context of the application of that provision, the question that is relevant is whether the public interest objective pursued by the Member State would be attained without that Member State’s intervention”.

“(151) While the existence of a market failure may be a relevant factor for declaring State aid compatible with the internal market, the absence of market failure does not necessarily mean that the conditions laid down in Article 107(3)(c) TFEU are not satisfied […] For example, State intervention may be considered to be necessary for the purposes of that provision where market forces are not capable by themselves of ensuring that the public interest objective of the Member State is achieved in sufficient time, even if, as such, that market cannot be considered to be failing.”

At this point the Court cites cases T-162/13, Magic Mountain Kletterhallen v Commission, paragraph 77; and T-92/11 RENV, Andersen v Commission, paragraph 69. These two cases plus the present judgment tell us clearly that a Member State can justify its aid merely on the grounds that it achieves outcomes not possible or likely under the autonomous decisions of market operators. Since the second principle of the Commission’s common assessment principles stresses the existence of market failure (or the pursuit of an equity objective), it would be good at the forthcoming revision of State aid rules that the Commission clarifies that what Member States must show is how the aid effects market conditions and that market failure is one way of proving that the aid is needed. In essence, Member States must show a divergence between desirable market outcomes and actual market outcomes.

The Court observed that “(155) the Commission noted […] that investment in nuclear energy was subject to significant risk given the combination of high upfront capital costs with long construction times and a long period of operation to recover the investment costs. According to the Commission, there were no market-based financial instruments or other types of contracts that could hedge against such substantial risk, which was a phenomenon specific to certain technologies, including nuclear energy. The instruments available on the market did not provide time horizons in excess of 10 or 15 years, either in the form of long-term contracts or as risk-hedging instruments. In that context, the Commission also referred, inter alia, to the extremely long and complex life cycles of nuclear power stations, unlike most other energy infrastructures and indeed unlike most infrastructure investments in general. In particular, it noted, first of all, that it would normally take 8 to 10 years to construct a nuclear power plant, and that the costs to be incurred before any revenues were generated and the risks were to be borne only by the investor. Next, the 60-year operational life is characterised by the generation of revenues, but these are based on an uncertain evolution of wholesale prices. Moreover, the ensuing decommissioning period could last 40 years, with funds to be set aside for the shutdown of the installation. In addition, high-level nuclear waste storage and treatment is typically carried out on-site before transfer to a repository, where waste is expected to be stored for thousands of years. Last, there is a ‘hold-up’ risk that may compound uncertainty for private investors, because successive governments could take different views on the desirability of nuclear technology, given its controversial nature.” “(156) It must be held that the Commission’s considerations […] disclose with sufficient clarity the reasons why, in its view, without United Kingdom intervention, given, in particular, the lack of market-based financial instruments and other types of contracts that could hedge against such substantial risk, the investment in new nuclear energy generating capacity would not be delivered in sufficient time.”

It then added that “(170) in order to establish that the Commission made a manifest error in assessing the facts such as to justify the annulment of the contested decision, the evidence adduced by the applicant must be sufficient to make the factual assessments used in the decision implausible”. “(171) The Republic of Austria did not explain why the substantial risks to which investment in nuclear energy is subject — owing, notably, to the combination of high upfront capital costs, long construction times and a long period of operation to recover the investment costs, as well as the extremely long and complex life cycles, uncertain evolution of wholesale prices and decommissioning costs and the ‘hold-up’ risk — would not also preclude financing by international syndication or individual financing.”

 

The gross grant equivalent amount of the aid

In another plea, Austria submitted that the Commission did not sufficiently determine the aid elements contained in the three UK measures. It argued that, having failed to determine them sufficiently, the Commission was not in a position to comment on whether they could be authorised pursuant to Article 107(3)(c) TFEU.

In this connection, the Court recalled that “(248) in order to be able to declare an aid measure to be compatible with the internal market under Article 107(3)(c) TFEU, the Commission must establish that it is aimed at a public interest objective set by the Member State and that, in the light of that objective, it is appropriate and necessary and that it does not adversely affect trading conditions or competition conditions disproportionately in the light of the advantages arising therefrom (see paragraph 48 above).”

Then the Court made an important observation. “(249) Article 107(3)(c) TFEU does not, however, expressly require the Commission to quantify the precise amount of the grant equivalent arising from an aid measure. Accordingly, if the Commission is in a position to conclude that an aid measure is appropriate, necessary and not disproportionate without that amount being made explicit, it cannot be criticised for failing to quantify it.”

Although numerous provisions in State aid regulations and guidelines and good practice require that the gross grant equivalent (GGE) of aid is calculated before it is granted – so that its proportionality can be ensured – it is not always necessary to establish ex ante the GGE as long as there is in place a mechanism that can prevent the granting of unnecessary amounts of aid. For example, this is typically the case where aid is calculated on the basis of a “funding gap” methodology, as in infrastructure projects, or the amount aid is determined on the basis of a competitive procedure, as in aid for the generation of electricity from renewable resources.

Then the Court examined one by one the three aid measures benefiting NNBG and showed that it was not possible to calculate beforehand the precise amount of aid because the aid was contingent on certain adverse events occurring such as electricity prices falling below NNBG’s costs, or a political decision reversing state support for nuclear power or an early shutdown of Hinkley Point nuclear power station. (Paragraphs 269-284) Given that the aid was contingent on certain events occurring, it also followed that if those events would not occur, no aid would be paid.

However, regardless of whether the aid was contingent, the UK government assumed certain liabilities. The question that arose was how the Commission could conclude that the aid and therefore the liabilities were the minimum necessary. The Court returned to this issue when it examined the proportionality of the aid.

However, before it assessed the proportionality of the aid, it turned its attention to the calculation of the aid in the state guarantee. It found, in a long and detailed analysis, that the Commission acted correctly in asking the UK to raise the premium that NNBG paid for the guarantee. (Paragraphs 285-348)


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Appropriateness of the aid

Austria argued that the aid measures were not appropriate, necessary or proportionate.

In response, the Court first reiterated that “(370) in order to be compatible with the internal market for the purposes of Article 107(3)(c) TFEU, an aid measure must be appropriate and necessary in order to attain the public interest objective pursued. Moreover, the adverse effect on trading conditions and distortion of competition caused by the measure must not be disproportionate in relation to the positive effects resulting from it”. (Here the Court cites cases T‑371/94, British Airways v Commission, paragraphs 282 and 283, and T‑135/12, France v Commission, paragraph 60.)

And added that “(371) not only was the United Kingdom entitled to choose nuclear technology as an energy source forming part of its energy mix, but, […], it was also entitled to decide on the construction of new nuclear energy generating capacity as a public interest objective for the purposes of Article 107(3)(c) TFEU.”

On the basis of this reasoning, the Court concluded that “(381) the arguments put forward by the Republic of Austria merely call in question the appropriateness of the measures at issue with regard to the pursuit of other objectives, such as improving security of supply, diversification of suppliers and decarbonisation. They do not, however, seek to call in question the appropriateness of those measures as regards the common interest objective decided upon by the United Kingdom, that is, the creation of new nuclear energy generating capacity, which the Commission took into account. It follows that those arguments put forward by the Republic of Austria are not capable of calling in question the merits of the Commission’s considerations in relation to the appropriateness of those measures. They must therefore be rejected as being ineffective in this context.”

“(382) Nevertheless, it must be held that some of the arguments put forward by the Republic of Austria are aimed, in essence, at the Commission’s weighing up in the contested decision of the positive and negative effects of the measures at issue. Those arguments will be taken into account in the examination of the third part of the sixth plea, concerning that balancing exercise.”

What the Court says is that State aid is not a panacea, capable of solving all potential policy problems. It is sufficient that it can support the achievement of the public policy objective which forms its target. Indeed, the Court noted in paragraph 370 that appropriateness is determined in relation to the “objective pursued”, as “decided upon” by the Member State that grants the aid (Paragraph 381), and repeated later on that “(406) the appropriateness and necessity of the measures at issue must be assessed in the light of the public interest objective of creating new nuclear energy generating capacity”.

Although it is true that the implementation of any public policy instrument can create trade-offs between conflicting policy objectives [e.g. efficiency v equity; simplified procedures v legal certainty; preventing terrorism v protecting civil rights], it is not clear at which stage such trade-offs are considered either in the case law on Article 107(3)(c) or in the Commission’s common assessment principles. The principle of appropriateness, as indeed acknowledged by the Court, examines whether the chosen aid measure is the most suitable – i.e. most effective – for achieving a certain policy objective. It does not ask whether the pursuit of one policy objective may impede the achievement of another. I suppose what the Court says here that any policy trade-offs that cause distortion of competition should be taken into account in the balancing of positive and negative effects of aid.

 

Necessity of the aid

In this context, Austria and Luxembourg argued that the aid measures went beyond what was necessary to achieve the objectives of improving security of supply, diversifying suppliers and decarbonisation, and therefore caused excessive distortion of competition. In addition, they claimed that more moderately sized power stations would have been sufficient.

With respect to the arguments that the measures were not necessary in order to attain the objectives of security of supply, diversification of suppliers and decarbonisation, the Court repeated that “(390) the Commission took into account the public interest objective relating to the creation of new nuclear energy generating capacity […] Consequently, the arguments of the Republic of Austria and of the Grand Duchy of Luxembourg to the effect that the measures at issue were not necessary in order to attain the objectives of improving security of supply, diversification of suppliers and decarbonisation are not capable of calling in question the merits of the Commission’s considerations. They must, therefore, be rejected.”

This is the right conclusion. State aid granted for one policy objective does not have to achieve other conceivable objectives.

“(391) In the second place, the Court must reject the Republic of Austria’s argument that smaller, potentially modular, power stations would be sufficient, as they could be switched on more quickly and an outage at such a power station would be more manageable than an outage at Hinkley Point. In so far as that argument concerns non-nuclear power stations, it is sufficient to recall that such power stations are not appropriate for the purpose of achieving the objective of promoting nuclear energy pursued by the measures at issue.”

 

The positive and negative effects of the aid

Austria and Luxembourg disputed that the potential for competition distortion caused by the aid measures was limited and was offset by the positive effects of those measures.

 

Positive effects

In connection to the positive effects of the measures identified by the Commission, the Court observed that “(405) in the light of the scheduled closure of existing nuclear power stations and coal-fired power stations, the construction of Hinkley Point C is intended to limit the decline in the contribution of nuclear energy to total electricity needs. According to the Commission’s findings, it is not possible to address the future gap in energy generating capacity caused, on the one hand, by the increase in demand and, on the other, by the closure of existing nuclear power stations and coal-fired power stations solely by relying on renewable energies. In that context, the Commission took account of the fact that nuclear energy represents a baseload method of electricity supply, that is to say, a form of continuous energy generation that is not intermittent, unlike numerous technologies for generating energy from renewable sources. The Commission also stated that the equivalent of the power that should be supplied by Hinkley Point C corresponds to 14 gigawatts of onshore wind or 11 gigawatts of offshore wind energy capacity, and considered that it would be unrealistic to expect that capacity to be provided in the same time frame.”

 

Negative effects

With respect to the negative effects of the aid, the Court noted that the measures “(465) had the potential to distort competition as regards the generation and supply of electrical power and to affect trade between Member States. […] those measures could [also] potentially distort investment decisions and displace other possible investments. […] However, […], the Commission concluded that competition distortions resulting from the commissioning of Hinkley Point C would be kept to the minimum necessary and be offset by the positive effects of those measures.”

“(466) The Commission examined distortions of investment that will be caused by the measures at issue and their impact on trade flows. […], it concluded that those measures would have an insignificant impact on trade flows, on prices and on investment. That conclusion is based on three considerations”.

“(467) First, the Commission noted that a widespread use of contracts for difference could substantially interfere with, or altogether remove, the role of prices as investment signals, and to effectively lead to price regulation of electricity generation at government-chosen levels. Contracts for difference required generators to sell on the market, thereby preserving some of the incentives which apply to unsupported market operators. The Commission noted, however, that such incentives were mainly preserved at the operational level, and not at the level of investment decisions, which were likely to be determined by the revenue stability and certainty provided by the contract for difference. In any event, market distortions deriving from the Contract for Difference at the operational level were very limited for nuclear energy generators, which had low marginal operating costs and were therefore likely to sell on the market regardless of price levels and occupied the initial positions in the supply merit curve.”

“(468) Second, the Commission found that the construction of Hinkley Point C was estimated to have a minimal impact on wholesale prices in the United Kingdom. In that context, it explained that the modelling work carried out suggested that prices in Great Britain would decrease by less than 0.5% as a result of the operation of that nuclear power plant, which in turn would translate into a cumulative and overall decrease in interconnector revenues of less than 1.7% up to 2030. This result stems from the fact that, even though the marginal cost of the electricity produced by that plant was lower than the price of existing plants, its overall capacity would be a small fraction of overall capacity in Great Britain, and from the fact that a decrease in wholesale prices and in interconnector revenues could be expected to take place also if that plant were not to be built.”

“(469) Third, as regards trade distortions, […], the Commission found that Hinkley Point C had a negligible impact on prices other than those of Great Britain, which was quantified as 0.1% at most. That would translate into a decrease in cross-border flows of less than 1%.”

The Court concluded that “(471) the arguments put forward by the Republic of Austria to the effect that the Commission failed to take account of the negative effects of the measures at issue on the internal market must be rejected.”

However, there is something puzzling about the findings of the Commission and their endorsement by the Court. If, on the one hand, Hinkley Point C was so important for sufficient energy supply in the UK, why, on the other hand, did the aid not have a more substantial impact on energy output and trade of electricity?

At any rate, the Court also examined in detail and rejected a number of related arguments put forth by Austria and Luxembourg alleging discrimination against alternative sources of energy and incorrect analysis of market needs and trends. It went on to conclude that the Commission did not make a manifest error of assessment in relation to the weighing up of the positive and negative effects of the aid. In reality, what the Commission did, with the Court in agreement, was to establish that the likely negative effects were small. No quantification and weighing of effects is carried out in the assessment of the compatibility of the aid. This of course leads to the so far unanswered question as to what happens when the negative effects are large even though they are the minimum necessary.

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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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