Ofgem’s recently announced goals and developments and changes to the post-Brexit state aid regime will have important implications for market players.
By John D Colahan, Stephanie Adams, and Anuj Ghai
2020 is set to be a an important year for competition law-related enforcement in the UK energy sector not least as it waits for the final contours including any material changes post Brexit. We explore in this post two areas that we consider to be of particular importance:
- The implementation of Ofgem’s goals flagged in its 2019 Energy Market Report
- The implications for the energy sector of post-Brexit state aid enforcement in the UK
State of the Energy Market Report 2019
In October 2019, Ofgem published its State of the Energy Market Report for 2019 (the Report). The Report sets out Ofgem’s analysis of the current state of energy markets, including the retail and wholesale energy markets and energy networks. In its Strategic Narrative, Ofgem sets out the three key outcomes it wants to achieve:
- Enable competition and innovation which drive down prices and result in new products and services
- Decarbonize to deliver a net zero economy at the lowest cost to consumers
- Protect consumers, especially the vulnerable, stamping out sharp practice, and ensuring fair treatment
Ofgem considers that there are signs of declining quality of service in retail markets: while overall customer complaint numbers remain stable, the number of Energy Ombudsman cases relating to small suppliers has increased significantly. Additionally, whilst switching rates continue to increase, reliability and speed-related issues continue to affect the process. Ofgem notes that concentration in retail markets has fallen as medium suppliers grow and exert more competitive pressure on large suppliers — this has resulted in large supplier profit margins falling to a nine-year low of 3% on average in 2018. Ofgem considers that the Competition and Markets Authority (CMA) price transparency remedy has improved the level of price information available to microbusinesses but notes that levels of engagement for microbusinesses remains low with more than a third of the smallest microbusinesses on expensive default contracts.
Ofgem considers that the wholesale electricity and gas markets are working reasonably well. The Report notes that electricity wholesale prices fell in 2019, as the number of generators increased, reducing the opportunity for any generator to exert market power or make excessive profits. Ofgem considers that electricity markets are “moderately concentrated”; the wholesale gas market, by contrast, is “less concentrated” with a large number and diversity of producers contributing to competition in the market.
As regards the wholesale supply of electricity, Ofgem notes that there are currently 189 firms with a licence to generate electricity in Great Britain, up from 170 in 2018 and that this suggests that “any barriers to entry and exit that may exist are low and not a concern”. It notes that the wholesale electricity market is only “moderately concentrated”. Total installed capacity also increased from 103.5 GW in 2017 to 107.9 GW in 2018.
With respect to the wholesale supply of gas, Ofgem notes that there is a low level of concentration in the wholesale gas market. The six largest gas suppliers accounted for only 55% of the market in 2018/2019. The HHI figure remained low at 754 in 2018, which is below the threshold of 1,000 above which the CMA considers a market to be concentrated. Ofgem states that “this reduces the possibility of individual gas suppliers exerting unilateral market power”.
Ofgem considers that despite the successes of the RIIO-1 price controls, the overall cost to consumers of energy networks have turned out to be higher than required. Ofgem notes that the majority of network companies are “achieving earnings toward the higher end of our expectations for each sector”. Ofgem have also set out plans to introduce forms of competition into the ownership and operation of new onshore transmission links, as well as to open up network investment to competition across the gas and electricity sectors.
Going forward, we expect Ofgem to pay continued close attention to levels of concentration in wholesale energy markets; consolidation in this area will be closely scrutinised by the CMA and Ofgem to ensure that firms are not able to exert market power and generate excessive profits. We expect that developments in energy markets will continue to receive close political scrutiny with retail energy outcomes likely to be of particular political interest.
Post-Brexit state aid enforcement in the UK energy sector
How state aid will be controlled in the UK post-Brexit is currently far from clear but will have ramifications for the UK energy sector. With the Brexit transition period provided for by the UK-EU withdrawal agreement having commenced and due to run until 31 December 2020 (the Transition Period), 2020 will surely be an important year that should see a firmer picture emerging.
The UK-EU withdrawal agreement provides for the continuation of the European Commission’s (the Commission) jurisdiction over UK state aid granted by the UK up until the end of the Transition Period. This is with the exception of measures that affect trade in goods between Northern Ireland and the EU, which, pursuant to the Protocol on Ireland / Northern Ireland, will continue to be subject to EU state aid rules and EU jurisdiction in perpetuity. Significant uncertainty remains for how UK state aid will be controlled in the period after December 2020.
The control of state aid granted by the UK up until the end of the Transition Period
The Commission’s continued jurisdiction under the transition arrangements will include state aid granted by the UK pre-31 December 2020 but not yet investigated by the Commission (the Commission will be able to initiate new state aid procedures for up to four years after the transition period ends), as well as cases opened pre-2021 involving alleged illegal state aid currently being investigated by the Commission or challenged in the EU Courts.
The latter category includes the appeal being brought by Austria to the European Court of Justice (ECJ) against the General Court’s judgment upholding the Commission’s 2014 approval of UK state aid granted to the future operator of Hinkley Point C, a subsidiary of EDF. The case was heard by the ECJ on 28 January 2020 — just three days before the UK formally left the EU. A win for Austria could result in the Commission’s 2014 approval of the aid package being annulled and ultimately a new decision finding the aid to not comply with EU rules. While the likelihood of Austria prevailing is thought to be slim, the practical implications of such an outcome for the Hinkley Point C project could be huge. The UK Government subsidies considered necessary for this key energy infrastructure project to take place would have to be withdrawn or modified.
The control of state aid granted by the UK after the Transition Period
The continued application of EU state aid rules in relation to aid granted up until the end of the Transition Period is a continuation of the status quo, and so something that the energy sector and the UK Government should be well used to. However, during 2020 the UK Government must finally resolve how state aid granted by the UK after 31 December 2020 will be controlled.
An ongoing sticking point in EU-UK negotiations is the extent to which the UK will commit to alignment with EU state aid rules after the Transition Period. The Commission’s February 2020 negotiating directives reinforce the EU’s position that a comprehensive EU-UK trade deal will depend on “dynamic alignment” by the UK with EU state aid rules, meaning that the UK would commit to remaining in-step with EU state aid rules as they evolve in the future. However, current rhetoric from the UK Government points to a clear aversion to any such commitment. In his February 2020 speech in Greenwich, Boris Johnson stated that “the UK will maintain the highest standards in these areas —better, in many respects, than those of the EU — without the compulsion of a treaty.”
In this context, it is highly probable that the UK will have some kind of domestic state aid regime in place following the end of the Transition Period. When Theresa May was Prime Minister, the plan for state aid control in the event of a no-deal Brexit was to transpose EU state aid rules into UK domestic law (subject to certain technical amendments to allow the rules to work in a domestic context). While the current government may be stating its opposition to alignment with EU rules, a regime that is at least similar to EU state aid rules seems likely if an EU-UK trade agreement is in place in time for 1 January 2021. If a “no-deal” exit is to occur on 1 January 2021, it seems improbable that a new domestic UK state aid regime that differs significantly to the previous government’s no-deal plan of transposing EU rules into UK law would be in place in time.
It may well be, however, that these nuanced differences between possible UK state aid outcomes end up being of critical importance to the UK energy sector. One area where this is apparent is in relation to the question of whether or not EU guidelines covering the application of EU state aid rules to the energy sector will continue to apply in the UK. Two sets of EU state aid guidelines of specific relevance to the energy sector are:
- The Guidelines on State aid for environmental protection and energy 2014-2020 (or Environmental Protection and Energy Aid Guidelines, EEAG Guidelines)
- The “Guidelines on certain State aid measures in the context of the greenhouse gas emission allowance trading scheme post-2012” (ETS State Aid Guidelines).
The EEAG Guidelines set out the conditions under which aid for energy and environment may be considered compatible with the internal market. This includes providing the basis against which the provisions of national surcharge systems are measured. The ETS State Aid Guidelines set the conditions under which EU Member States can compensate electro-intensive undertakings active in a sector exposed to international trade, for part of the higher electricity costs resulting from the EU Greenhouse Gas Emission Trading Scheme in the period 2013-2020. The Commission has announced its intention to prolong the application of the EEAG Guidelines until 2022. However, the ETS State Aid Guidelines are due to expire on 31 December 2020, after which they will be updated.
If the UK commits to dynamic alignment with EU state aid rules post-31 December 2020, these two important sets of guidelines — including future updates thereto — would continue to be relevant to the UK. If, however, UK Government rhetoric is taken to its full logical conclusion and an entirely new domestic state aid regime is established in the UK, then how aid granted for activities currently impacted by these guidelines will be treated remains an entirely unanswered question. To the extent that the post-31 December 2020 UK state aid outcome ends up being some kind of middle ground compromise, we may see something similar to these guidelines continuing to apply to aid granted by the UK, but the precise form and scope remain unknown.
In this context, and as state aid has become an unlikely bargaining chip in the UK-EU trade negotiations, energy sector participants would be wise to pay close attention.
 See paragraphs 94 to 97 of the Directives for the negotiation of a new partnership with the United kingdom of Great Britain and Northern Ireland (https://www.consilium.europa.eu/media/42736/st05870-ad01re03-en20.pdf)
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