European Union: EU General Court Endorses Aggressive Use Of State Aid Rules In Energy Markets

Introduction

On 13 February 2012, the General Court (GC) confirmed that power purchase agreements (PPAs) concluded in Hungary between 1995 and 2001 (before its accession to the EU in 2004) by State-owned entities and power generators constituted illegal State aid. Therefore, Hungary must recover any illegal advantage granted through the PPAs. The GC rejected an appeal filed by a Hungarian energy generator against the Commission negative decision of 2008. This note provides a brief analysis of the judgment.

Background

The appeal was launched by Erőmű ZRT (the applicant), a Hungarian subsidiary of Electricité de France International SA, which manages four power plants that supply district heating for the Budapest region.

Pursuant to a series of long-term PPAs, the Hungarian State-owned public undertaking MVM purchased a fixed quantity of electricity from the applicant at a price calculated according to a formula ensuring recovery of variable and fixed costs as well as a return on investment. At the time the PPAs were executed (mid 1990's), Hungary's objective was to encourage investments in generation capacity to ensure security of supply. Some of these PPAs remained applicable after its accession to the EU in 2004.

In 2005, the Commission opened proceedings in order to investigate the compatibility of the PPAs with EU State aid rules. In its view, the PPAs shielded power generators from any commercial risk and placed them in a better position with regard to other power generators and potential new market entrants.

In 2008, the Commission finally adopted a negative decision¹ holding that the PPAs conferred illegal State aid on the power generators and had to be terminated. The Commission also ordered the recovery of the aid from beneficiaries amounting to the difference between the actual price paid by MVM and the "market price." As reference for the "market price," the Commission used the price of electricity sold on "spot" markets in the period between the date of Hungary's accession to the EU and the end of the PPAs.

The General Court Ruling

The GC dismissed Erőmű's appeal seeking the annulment of the decision.

Erőmű had argued that since the PPAs had been concluded before the date of accession they were an "existing aid" and therefore the Commission could not declare them illegal or order their recovery.

The GC rejected this plea, stating that the categories of "existing aid" for Hungary, as of the date of accession, were defined in a list annexed to the formal act of accession to the EU; this list did not include the PPAs.

Further, the GC endorsed the Commission's position that a measure which was not regarded as State aid when it was put into effect could become "new" State aid following the liberalization of the relevant market (a consequence of the accession to the EU), a possibility expressly foreseen by the State aid Procedural Regulation.²

Secondly, the applicant argued that PPAs did not confer any economic advantage on power generators. In fact, the Hungarian State-owned entity acted as a "private operator in a market economy" when entering the PPAs with the generators, something which excluded the application of State aid rules.

The GC dismissed this plea, noting that the combination of a long-term capacity reservation, a minimum guaranteed off-take and a price-setting mechanism covering variable, fixed and capital costs in the PPAs does not correspond to the standard contracts on European wholesale markets. Despite the periodical price reviews, the PPA freed the applicant from risks normally borne by power generators and provided it with a better guarantee than standard commercial contracts. A "prudent investor" would not have accepted such terms.

Thirdly, the applicant argued that the PPAs had been entered into to discharge a public service obligation (ensuring "security of supply"), and were therefore exempt from State aid rules.³ The GC also rejected this plea because no public service obligation had been "clearly defined" in the PPAs and entrusted to the applicant as required by EU law.

Finally, the Court upheld the Commission's methodology for the calculation of the amount of aid that Hungary had to recover from the applicant. The Commission found that this amount was equivalent to the difference between the price paid to the applicant by MVM and the "market price." In the Court's view, the Commission correctly calculated the "market price" by reference to the "spot" market for wholesale electricity sales. The Court thus dismissed the applicant's claim that the Commission's simulation should have accounted for a number of hypothetical elements, such as the fact that without the PPAs the power generators would not have invested in power plants in Hungary, which would have affected the "market price."

Interestingly, the Court clearly ruled out the relevance of political arguments (e.g., to attract investment), stating that "political reasons underpinning a measure are immaterial for the purposes of determining whether or not there is aid" (paragraph 83).

Comment

The GC ruling has general implications regarding PPAs signed by State-owned utilities prior to the country's accession to the EU. The GC endorsed the Commission's analysis of the "advantage" granted by the PPAs in full, as well as the methodology for calculating the recoverable amount. It can be expected that the same framework of analysis might be applied to similar arrangements which come to the attention of the Commission. In that regard, apart from Hungary, the Commission had already addressed similar concerns with regard to the Polish energy market in a 2007 Decision.⁴

The GC's judgement should be assessed in light of more general goals set by the EU in its Third Energy Package⁵ which aims at removing barriers to competition (including risks of foreclosure) attributed to vertical integration. In the absence of an explicit treatment in the Package, long-term contracts in the upstream and downstream markets have been addressed by the Commission on a case-by-case basis and in a less drastic manner, e.g., by means of informal settlements or commitments. Such a nuanced approach was also applied in State aid control prior to the Polish and Hungarian decisions.⁶ The Court's judgement marks the approval of a more "pro-active" stance adopted by the Commission concerning PPAs in two regards.

First, the Commission strictly applied the State aid rules to contracts concluded prior to Hungary's accession, an approach which was not taken with the older Member States. In the 2007 Sector Enquiry Report, i.e., 3 years after Hungary's accession, the Commission first expressed foreclosure concerns associated to longer-term contracts.⁷ Thus, the Commission's decision retroactively prohibits a measure that was not expressly considered problematic in 2004. Not only does the Court accept the Commission's application, but suggests that a general duty to harmonise its competition rules with EU law rested with Hungary even before its accession.

Second, the Commission was quite bold in its substantive assessment as well. In deciding the existence of an aid, the Commission normally operates a counterfactual analysis that accounts for the legal and market situation at the time when the contested measure entered into force. Yet, in the absence of a liberalised market in Hungary such an analysis appeared inopportune. The Commission therefore opted for a counterfactual analysis that presumed the existence of a liberalised market as of the first day of accession. Such departure from its previous practice serves the idea of promoting an immediate transition to post-accession liberalised markets. Accordingly, energy suppliers ought to have born further commercial risks thereby renouncing more commercially attractive PPAs. It is nevertheless unclear whether, absent of such attractive PPAs, investors would have invested in the first place given the uncertain political and economic environment of post-communist Hungary. In that regard, arbitration proceedings were brought by AES, a UK registered investor, against Hungary before the ICSID (the foreign investments arbitration court) for breach of the Energy Charter Treaty (to which also the EU is a contracting party), claiming that Hungarian legislation illegally forced the amendment of the PPAs. The Commission intervened in support of Hungary as amicus curiae and recently the ICSID ruled that the claims were unfounded.

In the current constellation of the state of the law, it is to be seen whether the Commission will take lead from the ruling to turn to other Member States where similar agreements are in place. More importantly, as new countries join the EU — like Croatia and in the future Serbia — their respective energy companies should be aware of the risks they incur from day one of accession. The States should — if they want to negotiate a solution — make sure that PPAs are included in the list of existing aid. Thus the ruling calls for very close scrutiny of any PPA with State-owned entities including clauses similar to those sanctioned by the Commission.

Footnotes

1 Commission Decision 2009/609/EC of 4 June 2008 on the State aid C 41/05 awarded by Hungary through Power Purchase Agreements (OJ L 225, p. 53).

2 Article 1(b)(v) of Council Regulation (EC) No 659/1999 of 22 March 1999 laying down detailed rules for the application of Article 93 of the EC Treaty (OJ L 83, 27.3.1999, p. 1).

3 Under Articles 107 and 106(2) TFEU (ex Articles 87 EC and 86(2) EC) as interpreted in Case C-280/00 Altmark Trans and Regierungspräsidium Magdeburg [2003] ECR I-7747.

4 Commission Decision 2009/287/EC of 25 September 2007 on State aid awarded by Poland as part of Power Purchase Agreements and the State aid which Poland is planning to award concerning compensation for the voluntary termination of Power Purchase Agreements (OJ L 83, p. 1).

5 Consisting of Regulation (EC) No 713/2009 of 13 July 2009 establishing an Agency for the Cooperation of Energy Regulators; Regulation (EC) No 714/2009 of 13 July 2009 on conditions for access to the network for cross-border exchanges in electricity and repealing Regulation (EC) No 1228/2003; Regulation (EC) No 715/2009 of 13 July 2009 on conditions for access to the natural gas transmission networks and repealing Regulation (EC) No 1775/2005; Directive 2009/72/EC 13 July 2009 concerning common rules for the internal market in electricity and repealing Directive 2003/54/EC; Directive 2009/73/EC of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC.

6 See three cases where no formal investigation had been opened under Article 108(2) TFEU concerning contracts concluded in Portugal, Northern Ireland and France, namely Commission decision of 8 October 2005 on state aid case N 161/04 — Portugal — Stranded costs in Portugal (OJ C 250, p. 9); Commission decision N.661/99 — United Kingdom — Competitive Transition Charge [2002] (OJ 113, p. 3) and Case NN/120/88 concerning EDF, Press release IP/89/752 of 11 October 1989.

7 DG Competition report on energy sector inquiry, SEC(2006)1724, 10 January 2007.

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