A provider of services of general economic interest may receive both investment aid and compensation for the extra costs of public service obligations.
Governments normally support large infrastructural projects through guarantees. This is because such projects have a long life, the initial investment costs are very high and the recoupment of investment takes place over a long period through fees charged to users. Many things can happen in a period that can span several decades. Although banks and other creditors are happy to lend millions in the knowledge that there will be a steady stream of income from user fees, they also need the assurance of a state guarantee.
Energy terminals are no exception. If they have to be subsidised, normally they get a state guarantee and, if that is not enough, they receive an up-front amount to cover part of the investment costs. It is rare that they get other types of aid.
However, when Lithuania proposed to build a terminal to import liquefied natural gas [LNG] to reduce its absolute dependency on Russian gas supplied by Gazprom, it provided to the operator of the terminal both a guarantee to cover loans from the EIB and other creditors and operating aid. The operating aid was funded by a levy on the users of the terminal and final gas consumers.
The Commission, in decision SA.36740, found that both the guarantee and the revenue from the levy constituted State aid. It approved both for being compatible with the internal market on the grounds that the guarantee was necessary to bridge a funding gap while the operating aid was necessary to cover the extra costs of public service obligations imposed on the terminal operator. Lithuania designated the operation of the terminal as a service of general economic interest [SGEI]. Although the decision is from November 2013, it was made public only on 4 May 2016.
The terminal was built at the port of Klaipeda and the designated builder/operator was AB Klaipedos Nafta. The operator is a majority state-owned company [72%] that was appointed without any competitive selection.
The aid granted to AB Klaipedos Nafta was partly based on Article 107(3)(c) and partly on Article 106(2) [SGEI]. This is very unusual. Therefore, this article is in two parts. Part I examines the investment aid that was granted on the basis of Article 107(3)(c) and next week Part II analyses the operating aid that compensated for the extra costs of public services obligations and was granted on the basis of Article 106(2).
The state guarantee
Lithuania granted a guarantee to cover 100% of the loans that the operator obtained from EIB and other sources. The guarantee premium was 0.1% of the total value of the loans and was backed by a 100% collateral that was secured against the property of the terminal. The duration of the guarantee matched the duration of the loans which was 20 years.
The problem here was that a 100% guarantee was not in conformity with the conditions for the valuation of guarantees laid down in the 2008 Commission notice. The Commission skipped over this issue without any explicit mention. Rather in paragraph 102 it explained the four methods it used in its decisional practice to determine the market price of a guarantee. These methods are as follows:
- Comparator method: The premium charged on the state guarantee is compared to the price charged by commercial creditor for a guarantee of the same amount and same risk to the same undertaking.
- Benchmarking method: The premium charged on the state guarantee is compared to prices of similar guarantees or instruments such as credit default swaps on the market.
- Costing method: The premium is worked out on the basis of the probability of default, the required return on capital and the administration costs involved.
- Rate differential method: This is the typical method used for guarantees that cover 100% of the loan. Since it is unlikely that a commercial creditor would offer a 100% guarantee, it is difficult or impossible to establish a market rate. Hence, in such cases the Commission calculates the amount of aid involved in a state guarantee as the difference between the interest that it would pay on the loan without the guarantee and the interest it actually pays with the guarantee minus any premium it pays for the guarantee.
The Commission chose the fourth approach and accepted that the difference in the financing costs of the loan could be calculated according to the following formula proposed by Lithuania:
Borrowing rate = Pre-tax required return on capital of lender + opportunity cost of funds + risk cost + administrative cost.
The risk cost was calculated according to the credit rating of Lithuania [BBB] and the quality of the collateral pledged by the terminal operator. The quality of the collateral was deemed to be high because the loss given default was only 14%.
The amount that was derived was business secret as many other amounts and rates.
The Commission first had to determine whether the revenue from the levy constituted state resources. Although it was paid by terminal users and gas consumers, it was imposed and defined by legislation, collected and used according to the terms defined in that legislation and supervised by the national energy regulator. The Commission concluded in paragraphs 91-96, that the state exercised control over it, regardless of the fact that it was not managed by a public authority.
It is amply clear now that if a public authority imposes a tax and designates a private entity to manage the proceeds according to its instructions, the proceeds will be considered to constitute State aid for the recipient of the money. Interestingly, the Commission referred to the landmark cases of Pearle [C-345/02] and Doux Elevage [C-677/11] and explained that the levy was not applied as a result of a free decision of the designated body, nor did it finance activities chosen by that body to advance its interests, as in Pearle and Doux Elevage. Rather the levy aimed to support public policy objectives.
The revenue from the levy was intended to support the financing costs of the investment as well as the fixed costs of the operation of the terminal. The amount of the levy was calculated in such a way so as to enable the operator to cover its costs and earn a reasonable return on its capital which was defined by the Lithuanian energy regulator as the regulated asset base of the terminal. The regulated asset base decreases each year in proportion to the depreciation of the assets concerned.
The formula for the levy is as follows:
Levy = (fixed costs + return on capital + administration expenses)/gas quantity
The fixed costs are given by such items as maintenance, repairs, staff costs, etc.
The return on capital is calculated on the basis of the weighted average cost of capital [WACC] before tax. It was estimated to be 7.09%.
WACC = (Rd x D) + (Re x E x 1/(1-t)), where
Rd = interest on debt
D = part of capital assumed to be financed by debt [70%]
Re = required rate of return on equity
E = part of capital assumed to be financed by equity [30%]
t = the Lithuanian corporate tax rate which stands at 15%.
The required rate of return on equity, Re, was calculated according to a variant of the formula of the capital asset pricing model:
Re = Rf + MRP x (β + (1 + (1-t) x D/E)), where
Rf = risk-free return given by a 10-year government bond
MRP = the market risk premium + a specific country premium for Lithuania
β = the beat coefficient for the specific risk of gas companies.
On the basis of the above calculations, the Commission derived the amount of the money that would be provided to the terminal operator.
Once the Commission established that the guarantee and the levy constituted State aid, it proceeded to assess their compatibility with the internal market.
The investment aid was assessed according to the criteria in the balancing test which are largely reflected in the current common compatibility principles. The Commission concluded that:
- The aid was in the common interest because the project contributed to energy security by reducing the dependency of Lithuania on Gazprom. Security of energy supply has been recognised by the Court of Justice as being an “overriding reason in the public interest” [see C-105/12, Essent].
- The aid was an appropriate instrument because the reduction in dependency on Gazprom could not be regulated.
- The aid was necessary because, despite the very high of gas in Lithuania, the market was not making the necessary investments to expand supply [this could have been caused by the Gazprom’s links to a number of gas providers in Lithuania]. Funding gap analysis showed that the terminal would not be viable without the aid. Interestingly, Lithuania also submitted information to demonstrate that investment in other projects would not reduce its dependency. For example, construction of pipelines to Latvia would not be effective because Latvia was equally dependent on Gazprom, while a pipeline to Poland would not be operational before 2020.
- The aid had an incentive effect because the net present value without aid was negative and the internal rate of return was below the WACC. In addition, the Commission verified that the terminal operator was not legally obliged to construct and operate the terminal under EU regulations on energy.
- The aid was proportional because it did not result in any excess profits for the operator as the IRR with aid was still lower than the WACC.
- The aid was not expected to cause any undue distortion of competition as it would increase competition on the gas market. Also the terminal operator would pay the same fee as other users of the port facilities and the terminal itself would be open to all users on a non-discriminatory basis.
On the basis of the above assessment, the Commission concluded that the aid linked to investment was compatible with the internal market on the basis of Article 107(3)(c).
However, it could not authorise operating aid [revenue from the levy on users and consumers] on the basis of Article 107(3)(c). Therefore, it considered the applicability of Article 106(2) on SGEI and in particular, whether, the funding arrangements complied with the conditions in the 2012 SGEI Framework.
 The full text of the decision can be accessed at: