‘Brussels could declare UK’s energy U-turn illegal’

David Buchan, of the Oxford Institute for Energy Studies, examines UK energy policy and foresees a possible clash with Europe

The government’s planned electricity market reform, aimed at filling a looming shortfall in the country’s power generation, marks a U-turn in UK policy from reliance on market forces to state intervention.

But so sharp a change of direction poses policy problems for the European Union, or more specifically the European Commission, that could in turn pose legal obstacles to the UK carrying through all elements of its reform.

For London will need the Commission’s approval to use “state aid” in its reforms, leading one Brussels lawyer, who believes such assent will not be given, to dub the UK electricity reform  “a still-born child”.

Over the past 20 years or so, the UK and the EU have pursued parallel policies for the electricity and gas sectors. The Commission was inspired, or at least encouraged, in energy market liberalisation by the UK and Scandinavian examples.

Liberalisation meant ending monopolies, opening markets to new entrants, forcing energy groups to make transmission system operators independents so that these groups could not use grid ownership as a weapon of discrimination against rival suppliers.

UK plans for a capacity market pose a problem for Commission attempts to create and maintain a pan-EU market

While privatisation at home left UK companies basically too small to take much advantage of these opportunities to enter continental markets, UK self-interest in EU liberalisation has grown out of a desire to get the best price for the continental gas that the UK is now increasingly having to import.

However, UK policy is diverging. It is abandoning the liberalised model in order to entice investors with guaranteed prices into installing renewable energy and into rebuilding nuclear plants. The UK is also offering “capacity” payments to maintain some fossil-fuel generation as back-up for intermittent renewables in an energy market made less rewarding for traditional generators by the influx of those very renewables.

UK plans for a capacity market pose a problem for Commission attempts to create and maintain a pan-EU market. But the UK is not the only problem-poser for Brussels. Many EU countries either have or plan national capacity payment systems, which will further fragment the EU conventional power market, on top of national renewable subsidy schemes that discourage cross-border trading of green electricity.

So the Commission is in the process of drafting guidelines that it hopes member states will follow in terms of also relying on neighbouring countries, not on just themselves, for security of supply and so minimising possible “renationalisation” of the European market.

But the Commission itself has the legal authority to veto or amend capacity payments that generally count as state aid because, funded as a compulsory levy on electricity users, they are organised, albeit not actually paid, by the state.

The other elements of the UK reform are all aimed at increasing its low-carbon (renewable and nuclear) energy supply, and thereby reducing its carbon emissions. The Commission applauds these goals, but not the means to achieve them.

It is recognised in Brussels that the UK has got itself into a mess as a country with a poor delivery track record that agreed at the EU level to take the most stretching of all the EU-27’s national renewable targets and has dithered for years about replacing old nuclear reactors. So there is some understanding that, to get itself out of this mess, the UK feels the need for drastic action.

And there is some understanding, though not enough, that a major reason for this drastic UK national action is the failure of Europe’s Emission Trading System (ETS) to produce a carbon price high enough to help renewables and nuclear power compete against fossil fuels, and to curb the use of high-carbon fuels.

This is why two of the elements of the UK’s EMR – the carbon floor tax and the emissions performance standard – will probably get approval in Brussels. The UK carbon tax, which came into force last month, is designed to raise the cost of carbon for UK electricity producers to what the ETS’ designers in Brussels once hoped would be the European price level, but for multiple reasons, chiefly recession and bad system design, has not materialised.

The Commission is struggling, so far in vain, to reform the ETS to raise the traded carbon price. So, even though the UK tax will have a slightly distorting effect on the ETS, the Commission can hardly object to the UK doing at a national level what it would love to do at an EU level. Likewise, Brussels may have to turn to an emissions performance standard for Europe if it continues to fail to excite interest in carbon capture.

The main obstacle will be over the UK’s proposals to offer low-carbon generators guaranteed prices in the form of “strike prices” in so-called contracts for difference; generators get paid the difference between the market price and the strike price, when the latter is above the former, but when the price levels are reversed, generators have to repay the difference. This is state aid because it is funded out of a state-organised levy on consumers.

It is true that Brussels has approved many feed-in tariff (FiT) arrangements for renewables around Europe, including the UK, but there is a built-in reduction over time of the level of subsidy in almost all these FiTs. This phase-out feature does not exist in the UK contracts for difference. Moreover, FiTs for renewables can be justified as necessary support for new technologies.

This argument cannot really hold when applied to nuclear. EDF may be planning to build its relatively new European pressurised reactor (EPR) technology in the UK, but a reactor is still a reactor.

Nuclear power is deeply divisive in Europe, less so in the Commission, but very much so among member states and in the European Parliament. The Commission will have to walk on eggshells in dealing with the UK nuclear state-aid issue, all the more so because it knows any state aid permission for the UK will set a precedent for similar concessions elsewhere, especially in Central and East Europe.

On the other hand, should Brussels block innovative solutions at the national level, like Britain’s EMR, to a problem it has helped create with the failing ETS at a European level?

David Buchan is a senior research fellow at the Oxford Institute for Energy Studies and former energy editor at the Financial Times; previously he spent time in the FT’s Brussels bureau and is the author of several books on the EU.