On 6 October 2022, the Council of the European Union adopted a Regulation on an emergency intervention to address high energy prices (the “Regulation”). The Regulation was published in the Official Journal of the European Union on 7 October. The Regulation has three main elements:
- A requirement to reduce electricity consumption by 5% in peak hours;
- A measure to return the excess revenues or profits of energy companies to the individual Member States; and
- The allocation of proceeds to customers to alleviate retail electricity prices and an extension to Small and Medium-sized Enterprises (SMEs) of the categories of beneficiaries of a possible Member State intervention in the retail price.
The Regulation’s market intervention is exceptional (albeit in response to an extraordinary geopolitical market disruption). It will have widespread positive and negative impacts for energy market sellers and buyers. These circumstances may provoke a range of disputes, transaction (re)structurings or additional compliance obligations that will require expert advice and understanding of the details of the Regulation.
Reduction in electricity consumption
EU Member States will endeavour to reach an overall 10% reduction in electricity consumption by all consumers. The benchmark against which that reduction will be measured is the average of gross electricity consumption in the corresponding months of the reference period, i.e. from 1 November to 31 March in the five preceding years, starting from 2017. In addition, in order to reduce retail prices and improve supply security, Member States are obliged to deliver a 5% reduction of electricity consumption during peak hours, (defined as the hours of the day where day-ahead wholesale electricity prices are expected to be the highest; gross electricity consumption is expected to be the highest; or gross consumption of electricity generated from sources other than renewable sources is expected to be the highest). These measures will apply from 1 December 2022 until 31 March 2023.
Within certain parameters, Member States have the discretion to devise the appropriate delivery measures, including extending national measures already in place. Those parameters include safeguards to prevent contravening the EU’s green goals. Member States may only make financial compensation for electricity that was not consumed as expected. The amount of financial compensation paid to market operators in addition to their revenues must be established through a competitive process.
Cap on surplus revenues for non-gas/hard coal electricity producers
In a pay-as-you-clear electricity market where the price is set by the marginal price of the last unit of energy added to the grid to meet demand, gas- and coal-fired plants often determine the electricity price. With soaring gas prices caused by Russia’s weaponisation of energy, electricity prices are exceptionally high and have resulted in “surplus” revenues at “inframarginal” power plants – mainly renewable producers of electricity from sources other than gas and hard coal. To address this market oddity, the Regulation provides for a compulsory cap on realised revenues of inframarginal plants, unless they are already capped. By limiting the cap to “realised market revenues” only, forward hedging or contractual obligations entered into when prices were low would be left outside the mechanism. These revenue caps will apply from 1 December 2022 until 30 June 2023. Realised market revenues in excess of the cap must be repaid to Member States.
Setting the level of such a cap so as not to divert investment away from renewable energies is a complex exercise. In setting the cap at €180 MW/h, the Commission assessed that there would still be sufficient margin for renewable electricity producers, since the capped price is higher than both the average wholesale electricity price over the last decade and the current levelised cost of energy (LCOE) for the relevant generation technologies.
Unlike the Iberian Peninsula gas price cap mechanism, the proposed measure does not have an impact on spot electricity prices and does not require taxpayers to fund subsidies to reduce fossil fuel power plants’ costs, which in turn reduce retail electricity prices. The surplus revenues from the cap must be used by Member States to support final electricity customers.
Surplus congestion income revenues
In an addition to the initial Commission proposal, the final Regulation also allows EU Member States to use surplus congestion income revenues to finance measures for the benefit of final electricity customers, subject to the approval of the relevant regulatory body. Surplus congestion income revenues result from the allocation of cross-zonal capacity, which accrues to Transmission System Operators (TSO). In a normal market situation, the TSO in question would be free to decide on the use of such income beyond a priority allocation foreseen in the EU’s Electricity Directive. The regulation removes that discretion from the TSO and gives it to Member States to allocate as set out below.
Distribution of surplus revenues (including of congestion income) to final customers
The Regulation lists a number of ways surplus revenues might be used:
- financial compensation for consumption reduction;
- direct grants;
- compensation to suppliers who deliver electricity below costs;
- lowering electricity purchase costs; or
- promoting investment into decarbonisation technologies, renewables and energy efficiency measures.
The Regulation also contains a provision to redistribute the surplus revenues between net importing and exporting countries, to ensure that all Member States have the resources needed to support their final customers.
Retail price regulation of electricity
The Regulation allows SMEs to benefit temporarily from State intervention in setting the retail electricity price. This provision foresees the possibility that the end price could even be set below cost, provided that such an intervention does not distort demand reduction and that suppliers are both compensated and not discriminated against.
Since State intervention in electricity pricing is generally considered to create market distortions, it is normally only permitted in specific and limited circumstances – as set out in the Electricity Directive – through the entrustment of a Public Service Obligation (PSO). The Commission has determined that the current situation meets those conditions and therefore the Regulation authorises deviation from the EU’s Electricity Directive and the extension of retail price reduction to SMEs.
Solidarity contribution on excess profits of fossil fuel firms
The Regulation also provides for a mandatory temporary (2022-2023) solidarity contribution on the excess profits generated by fossil fuel companies. It intends to capture at least 33% of the profits that are 20% above the average taxable profits of the four fiscal years starting in 2018. Member States must implement this obligation by 31 December 2022.
The Council has mandated that the proceeds of this contribution be used to provide financial support to final energy customers – with a particular focus on vulnerable households and energy intensive industries (the latter must use the support to invest in renewables, energy efficiency or other decarbonisation technologies).
Support to companies
These emergency measures provide Member State support to final electricity customers (or to suppliers where they sell their electricity below cost). Although funded by the energy sector, it is possible that such support may amount to State aid when granted to companies. Therefore, these measures must be designed and, where necessary, be notified for prior approval in accordance with, for instance, the Temporary Crisis Framework (TCF) (as we discussed earlier here).
The Regulation does not address the issue of electricity suppliers who may face increased costs due to having hedged their positions because of the increased collateral required on exchanges, even though this liquidity problem may severely impact suppliers and their ability to trade. However, on 6 October, the Commission launched a Member States consultation to prolong and amend the TCF. The amendments under consideration focus on a number of areas, including:
- Revising the aid amount and simplifying the criteria to support companies affected by high energy prices as provided for under the current version of the TCF;
- Facilitating access for energy companies to liquidity support from Member States to cover financial collateral;
- Clarifying how Member States may recapitalise their energy companies; and
- Introducing assessment criteria under State aid law for measures supporting electricity demand reduction.
Covington will continue to monitor and update you on the latest developments in EU law in the context of current crisis.