Tempus Energy and the Capacity Market – where are we now?

In November the General Court of the European Union (the Court) annulled the state aid approval for the Capacity Market in Great Britain (CM) following its judgment in the Tempus Energy case¹. The CM has now entered a standstill period whilst state aid approval is sought (see our previous article here).

A month later and there is still uncertainty surrounding the implications of the decision and the possible outcome of the European Commission’s investigation into the CM. Although, in principle, it has two months to appeal the General Court’s decision before the Court of Justice of the European Union (on points of law only), the Commission has not indicated that it will do so.

The Department for Business, Energy and Industrial Strategy (BEIS) launched a consultation on 19 December into technical changes to the CM to accommodate a top-up auction and recognising some provisions of existing capacity market agreements (CMAs). In this briefing, we consider some of the questions which existing and future capacity providers will be considering.

The Commission must now reconsider the matter. In practice, given the Court’s judgment, it is likely to move quickly to launch a formal investigation into the original notification for the CM under Article 108(2) Treaty of the European Union (TFEU). This will need to meet all process requirements referred to in the Court’s judgment. The investigation will cover CMAs already entered into, including those for 2018/19 and 2019/20. According to the BEIS consultation, the Commission expects to issue an “opening decision” to begin their formal investigation in early 2019. This will summarise factual and legal bases for the investigation and the Commission's doubts as to the measure’s compatibility with EU state aid rules. It will be published in the EU’s Official Journal and will invite submissions from the UK, other Member States, the recipient companies and also from third parties, competitors or trade associations, all of whom will normally have 30 days in which to submit comments.  The UK will also be invited to comment on observations submitted by third parties.

There are no formal time limits for the in-depth investigation, and while the Commission claims to aim to have it completed within six months, the process has in many cases lasted for well over a year. Regulation 2015/1589 (the Procedural Regulation) requires the Commission to “so far as possible endeavour to adopt” a decision within 18 months of opening the formal investigation.

The Commission's final decision following the formal investigation may be to clear the aid, to prohibit it, or to clear it subject to conditions. This decision will be published in the Official Journal. 

Given that BEIS states that it is already working closely with the Commission to aid its investigation and seek timely state aid approval, we anticipate that the process might be faster than usual – in principle it could be within a matter of months. However, given the content of the judgment, the Commission will also be keen to ensure that it is not exposed to further challenge on the process that it runs and accordingly an ultra-fast process seems unlikely. Capacity providers should also note that there will be a two month period from the date of publication of the approval of the aid for a further challenge to be instituted.

The Government has indicated that, even in the event of a no deal scenario, it intends to transpose the EU state aid rules into UK domestic legislation. In a no deal scenario, any notifications which have not yet been approved as at March 29, 2019 by the Commission will be submitted to the UK Competition and Markets Authority instead. The Competition and Markets Authority are currently preparing procedures and guidance for their state aid process.

While Brexit should not therefore have a material impact on the substantive approach to the aid, the process, will be completely new and untested – which could have implications for the time-frames for a decision.

The Commission is under an obligation to eliminate all doubts regarding the compatibility of the aid with the internal market. According to the judgment, this means that the Commission is required to research and examine, thoroughly and impartially, all of the relevant information for the purposes of its analysis. There are three possible outcomes following the Commission’s investigation. Firstly, the Commission might find the measure wholly incompatible with state aid rules. However, given its previous approval of the CM, in our view this is unlikely. Secondly, the Commission might reapprove the scheme on its current terms. Given that the Court was critical of the Commission’s assessment of demand-side response (DSR), and in particular of its failure to take into account certain information regarding DSR which was available to it at the time, a third possible outcome is that the CM may be changed in order to secure approval. In doing so, the Commission will be required to take into account knowledge which is currently available to it.

In its consultation², BEIS has advised that existing CMAs are still capable of being enforced during the standstill period, although no payments may be made. However, during the standstill period, the requirement to provide credit support has been waived and capacity providers are permitted to request the return of their credit cover.

National Grid (as EMR delivery body) and the Electricity Settlements Company are continuing to operate the CM, but without making payments, to ensure that capacity providers are eligible for deferred payments after the standstill period, subject to state aid clearance and continued compliance with the obligations under those CMAs. It is envisaged that 2019/2020 CMAs would also be eligible for deferred payments should state aid approval slip beyond 1 October 2019.

Potential capacity providers with a new build units with CMA for future delivery years are under certain obligations and must meet certain milestones to ensure timely delivery. BEIS is consulting on delaying certain milestones which involve significant financial commitments, recognising that these will be difficult to justify during the standstill period (the majority of proposals relate to CMAs with the 2020/2021 delivery year).

BEIS are also consulting on proposals that any termination fees or penalties accruing during the standstill period will be set-off against deferred payments and settled only once the Secretary of State determines that the standstill period has ended (the ‘domestic law trigger’).

Following discussions with the Commission, and because of the potential spike in consumer bills, the Government is minded to restart collection of the CM supplier charge so that it is in a position to make any deferred payments due, once state aid approval is granted. BEIS is now consulting on measures to ensure continuity in supplier charging arrangements so that funds will be in place to make any payments once the CM is reapproved. Options being considered include continuing to collect the supplier charge, and modification of the Balancing and Settlement Code to require suppliers to pay an amount equivalent to the supplier charge into a trust or into escrow.

It should be noted that if the CM is altered in order to secure state aid approval, there could be an impact on CMAs awarded at past auctions (otherwise the grant of the aid would not be in conformance with the terms of the approval). Much will depend on the conditions associated with the approval.

There is a risk of past payments being required to be refunded, although BEIS is not taking steps to recover capacity payments at this stage. An advice note³ issued by National Grid on November 19, 2018 states that BEIS will discuss with the Commission the extent to which aid already paid may need to be recovered as part of the Commission’s formal investigation.

If the aid is deemed to be incompatible with the internal market (following the Commission’s investigation) the Commission will take a recovery decision requiring the UK to take all necessary measures to recover aid from the beneficiaries, including interest at a rate to be fixed by the Commission (though, given the circumstances, this interest is probably unlikely to be significant). Member States are required to take all necessary steps available to them within their respective legal systems to recover the aid.

However, the Commission will not require recovery of the aid if this would be contrary to a general principle of EU law: the principle of legitimate expectations. For legitimate expectations to apply in EU law, the Member State must have notified the Commission of the aid and the aid must have been granted in accordance with Article 108 of the TFEU. Case law suggests that a recipient of illegally granted aid might seek to rely on exceptional circumstances on the basis of which it had legitimately assumed the aid to be lawful and so justify declining to refund that aid, although this is a complex area which would need to be tested in practice ...

The Secretary of State has exercised his powers under the Electricity Capacity Regulations 2014 to postpone the T-1 capacity auction which was scheduled to be held in January 2019. Instead BEIS has confirmed the intention to hold a T-1 top-up auction during summer 2019, for delivery in winter 2019/20.

BEIS is now consulting on necessary regulatory changes to allow for the possibility of a T-1 top-up auction in summer 2019 with responses due by January 10, 2019⁴. Notably, in order to avoid the grant of state aid during the standstill period, the T-1 auction would not automatically give rise to any CMAs, with these being granted only following the outcome of the Commission’s formal investigation, upon activation by the Secretary of State of an ‘agreement trigger’. As a result, secondary trading would only be possible after the agreement trigger. There will be no changes to the eligibility criteria and so BEIS propose that those who pre-qualified for the postponed T-1 auction would remain pre-qualified for the top-up auction, but would be allowed to withdraw their application or update their information. The Secretary of State would then adjust the target capacity in light of these updated pre-qualification results.

BEIS has also recognised that holding the T-1 top-up auction in the summer will significantly reduce the period of time for meeting any delivery key milestones, particularly as the CMAs will only come into effect after the state aid approval is granted and the activation of the agreement trigger. As a result, it is proposed that capacity providers be required to demonstrate key milestones are met by September 30, 2019 (the ‘delivery year readiness deadline’), although penalties and/or termination of a CMA would only occur if such milestones remained unmet on the later of the date four weeks after the agreement trigger or the delivery year readiness deadline (the ‘grace period deadline’). Credit cover requirements are also waived for prequalified units in this auction.

If you would like to discuss any of the issues raised in this article, please don’t hesitate to get in touch with the Norton Rose Fulbright team.