Recent changes to EU legislation appear to make state support to energy companies acceptable where it can be proved necessary to assist the implementation of any number of Community Directives in the energy and environment sectors. But how do such subsidies differ from (illegal) state aid?

It has largely gone unnoticed that the outgoing and much-criticized Italian Presidency of the European Union tried unsuccessfully to amend the Draft EU Constitution in two spheres of influence where it contended that the European Commission would become too powerful at the expense of Member States: energy and state aid. Indeed, the application of the EC Treaty provisions outlawing state subsidies has become increasingly complex and controversial in the energy sector.

A few recent examples are illustrative. First, there is the long-running saga as to the legality of subsidies and other related incentives to assist the writing-off of "stranded assets," with a number of cases now pending before the European Courts. Second, there has been heated discussion as to whether the allocation of emission trading rights and green certificates could also raise issues of state subsidies, if certain companies benefit more than others in this process. And third, there has been controversy over subsidies for renewable sources of energy.

The legality of the bail-out of British Nuclear Fuels also came under fire in 2003. And of course, last but by no means least, has been the much publicized Commission decision requiring Electricité de France to repay Eur1.2-bil in illegal state aid, the estimated value of the tax concessions and unlimited state guarantees from which EdF has benefited over a considerable period of time.

As this is the largest amount of aid to be ordered for recovery in the history of EC state aid control, it is not surprising that this decision has attracted wide coverage (EUE 72-73/8). It also seems to indicate that the Commission is at last willing and able to take major decisions in a sector which many believe has escaped effective state aid scrutiny for too long.

Against this background it comes as an initial surprise to discover that the Commission is not actually conducting an all-out, anti-state subsidy crusade in the EC energy sector. In fact EC policy is, if anything, increasingly to encourage national governments to give financial support to the sector, where necessary. The 2001 Directive on the promotion of renewable energy is somewhat agnostic on the subject, merely stating that where governments subsidize the promotion of renewable energy forms this should comply with the Treaty state aid articles.

The draft Directive on CHP, as recently amended by the European Parliament, also raises issues of the legality of various forms of state support to meet binding national targets leading to a twofold increase in CHP (EUE 72-73/24). Nor can it be excluded that Member States could resort to subsidization measures to ensure the realization of targets for investment in reserve generation capacity, a requirement which could become binding if the Commission's latest draft directive on electricity security of supply is eventually adopted.

Who pays for the PSOs?

In this context it is worthwhile revisiting certain provisions of the two new "internal market directives" - Directive 2003/54 (electricity) and Directive 2003/55 (gas) - adopted in July last year. These Directives seek, inter alia, to define the types of public service obligations (PSOs) which member states can impose on gas and electricity companies, with a view to securing a myriad of objectives, including security of supply, regularity, quality and price of supplies, and environmental protection, including energy efficiency and climate protection.

That Member States can grant "financial compensation" to secure the fulfilment of these obligations is explicitly provided for in Article 3(4) of the Electricity Directive and adequate 'economic incentives' are also expressly permitted by Article 3(7) Electricity and Article 3(4) Gas. The introductory paragraphs of both Directives also make favorable reference to national measures to achieve the objectives of social and economic cohesion which may include "adequate economic incentives" as well as, more obscurely, "liability mechanisms to guarantee the necessary investment." These "liability mechanisms" appear to resemble some form of state guarantee (also a form of state aid) but no further guidance on the interpretation of this rather unusual term is provided.

Nonetheless, it is also made clear in both Directives that if these same measures to finance PSOs amount to state aid, they must first be notified to the Commission in accordance with the standard EC state aid regime procedures. The Commission has exclusive power to examine planned aid, and to declare it to be compatible with the objectives of the common market.

The full version of this story was published in Platts EU Energy.