Potential legal implications of proposed EU and UK caps on low carbon generation pricing

Background

• The European Commission and the UK Government are both taking steps to impose caps on the wholesale electricity price that can be received by low-carbon generators, such as renewables and nuclear (but also including lignite in the case of the EU Council Regulation dealing with this). This is because of the perception that these generators are making excessive profits, due to exceptional market prices.
• The policy rationale cited as the driver for the intervention is the fact that wholesale electricity prices have historically been linked to gas. This is because pricing on a given day is set by reference to the most expensive plant generating. These are now gas-fired plants with operating costs far in excess of what was ever reasonably contemplated, resulting in high profits for all non-gas-fired generators. There is concern that generators should not benefit to an excessive degree because of increased prices arising, for the most part, from Russia's invasion of Ukraine.
• The position arises from unprecedented gas price volatility following Russia's "weaponization" of gas supplies to European customers leading to cessation of supply and high prices, culminating in very significant state subsidies being afforded to household and industry consumers, at epic cost to state budgets.
• The UK Government's proposals in relation to pricing are to take the form of a temporary "cost-plus-revenue" limit (essentially a revenue cap) for low-carbon generators (including nuclear) that are not already subject to a cap (through a strike price) under a Contract for Difference. The level of this limit or cap is not yet known as it is subject to consultation. However, press reports indicate this may be set at a level significantly less than the EUR180/MWh adopted under the emergency EU Council Regulation. Recent UK press reports have suggested a level of £50-60/MWh which is clearly a fundamentally different proposition.
• Current debate has focused upon the risks of creating instability by upturning established pricing models and thus deterring investment at a time when maximising the availability of alternatives to fossil fuels generally and Russian gas specifically has never been more important. It is also pointed out that inflation and the rising cost of raw materials (including speciality steel which Ukraine was a significant producer of) mean that the economics for new renewables projects are already a challenge.

Domestic legal issues

• The immediate legal issues that arise are what obligations the UK Government faces in terms of consultation and how far its proposals may be subject to challenge. In summary, domestic law may offer little opportunity for meaningful challenge, although international law as reflected in investment protection elements of investment treaties may offer greater scope.
• Because the UK Government's proposals are due to be effected through primary legislation (the Energy Prices Bill) albeit with much of the detail set out in secondary legislation, there will be limited scope to challenge through judicial review (which in any event would not give rise to damages). In theory there may be scope to seek redress on the basis that human rights (specifically that of peaceful enjoyment of property) are impacted, both under national legislation and potentially the European Convention on Human Rights but the bar is a high one.

The role of international law.

• As yet missing from the debate seems to be an appreciation of the role that international law has to play, particularly that of the Energy Charter Treaty (ECT) in constraining the actions of host state governments and supporting the "legitimate expectations" of investors as to how they would be treated formed when their investments were made. This may be significant since national legislation cannot limit rights and protections afforded under international law.
• The ECT (and other investment treaty protection) is potentially important because it can be directly enforced against states through international arbitration, which national courts can do little to interfere in and which can lead to significant sums in compensation being ordered by tribunals.
•  It is obviously important that governments are aware of their ECT commitments to investors in renewables and vice versa. The implications of such protections being invoked by investors in renewable projects may serve to cause government to pause and revise their proposals.
• The ECT incorporates two significant protections which may be of particular relevance in this context: the requirement to afford "fair and equitable treatment" (FET) and the prohibition on expropriation without compensation.
• The FET standard serves to impose obligations of non-discrimination and transparency of treatment, as well as the respecting of an investor's "legitimate expectations" as to their treatment based on what was said to them when the investment was made. A state has a "legitimate right to regulate" which includes bona fide taxation (the ECT expressly provides for such right, although it is debatable to what extent the adjustment of pricing mechanisms would constitute a tax (and the new UK government has been concerned to avoid levying "windfall" taxes)).
• An example of a failure to accord FET on current facts could include pricing changes which fail to take account of the fact that renewables generators may not in fact immediately benefit from increases in price linked to gas pricing because they have entered into hedging arrangements for the forward sale of electricity or long term fixed price power purchase agreements. Another could be a failure to adequately consult or the application of revised pricing in a manner that has the effect of discriminating against investors from particular states.
• The public international law prohibition on expropriation is of wide effect because it covers "measures tantamount to expropriation" (i.e. wider than physical seizure) and "creeping expropriation" (i.e. steps taken over time). Expropriation involves depriving an investor of the value of their investment, a far wider concept than just physical seizure.
• In order to attract treaty protection the investor must have the nationality of a different treaty contracting state from that of the host state. A nationality requirement may be satisfied at various stages of the chain of ownership. By way of illustration, a UK company investing in UK renewables would not itself have protection but, for example, an EU company would. However it may be the case that shareholders or possibly even lenders to the UK company could benefit from protection where they possess, for example, EU nationality (issues of corporate and individual nationality can be complicated in investment law and arbitral tribunals have in the past taken diverging positions in the area).
• The ECT has 54 signatories including EU member states (other than Italy) and the UK. Intra EU claims (i.e. claims between EU investors and EU member states) face difficulties as EU courts have found that they are contrary to EU law following recent ECJ decisions that investment treaty protections within the EU are inconsistent with EU law. The UK has no similar limitations and so may offer advantages for investors in the sector.
• It is too early to say what the ramifications of the UK's proposals or those of the European Commission may be on growth of the renewables sector, transition to net zero and development of alternatives to Europe's reliance on Russian gas but the "law of unintended consequences" suggests that a full – and fully informed - consideration of the implications of changing long established pricing models is an imperative.