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Court wrangle for Drax over renewable energy subsidy

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Note: since this piece was posted DECC has won its appeal against Drax (7 August 2014) and the power generator has abandoned further legal action (with its share price duly dropping). See “The Court of Appeal judgment” below.

Shares in UK energy company Drax leapt more than 40p after it won a High Court victory against the Department of Energy  and Climate Change (DECC) over renewable energy subsidies (14 July 2014). It is the second court win against DECC mishandling of the green energy business sector announced within days. (See previous post)

DECC had failed to accept one of Drax’s biomass conversion projects as eligible for a subsidy scheme involving contracts for difference (CfDs), intended to provide certainty on prices for renewable generation.

Mrs Justice Andrews ruled that: “When properly understood, Drax’s application did satisfy the Key Criterion [for the CfD subsidy] and no decision maker, properly informed, who accepted that Drax was telling the truth …  could have concluded that it had failed to do so or that the information given by Drax was insufficient to satisfy him that it passed the test.” She added: “The matter will have to be remitted to DECC for reconsideration in the light of this judgment.”

The new CfD system is intended as an improvement on the Renewables Obligation scheme whereby each licensed electricity supplier was required to produce a certain number of renewables obligation certificates (“ROCs”) in respect of each megawatt hour of electricity that it supplied to customers during a specified period. These ROCs are tradable and are sold by generators to suppliers who may or may not be supplying renewable electricity. They are generally worth less than the likely price under the CfD system (see end of post below).

In 2011 the UK Government announced it would move over to a system using contracts for difference. Andrews J noted: “The CfD is a long-term private law contract with a Government-owned limited liability company, under which an ‘eligible generator’ using renewable energy sources will be paid the difference between the estimated market price for electricity (the reference price) and an estimate of the long-term price needed to bring forward investment in a given technology (the strike price). In other words, it is a form of hedge against electricity price volatility. The scheme is to be funded by a levy on electricity suppliers.” (See the Energy Act 2013

The advantage of the new system is that it creates greater certainty about the price obtainable for renewable energy production and, as a private law contract between the generator and the government company, it is not subject to the political risk of shifting government policy. The Renewables Obligation regime will continue in parallel until March 2017.

In April the Department of Energy announced eight large renewable projects would get support under the new CfD system, involving £12bn in investment. One of Drax’s applications, involving converting three of its six coal plants in Selby, North Yorkshire, to run on woodchips, was accepted but a second (“Unit 3”) was not on the list even though it had met the eligibility criteria a few months before in December 2013. Its plans to convert three units were stymied. Unit 2 was converted under the RO regime and remains locked into it for the time being; the application for Unit 1 was successful.

The case
The Government said Unit 3 did not meet one of the crucial criteria (the Key Criterion) for granting an investment contract worth £1.3bn under the scheme – even though it had apparently met the conditions in the previous December.

Under the “Key Criterion” Drax had to show that “without an Investment Contract there is a significant risk that the electricity generation to which the Investment Contract relates will not occur or will be significantly delayed” – in other words that the switch from coal to biomass at the unit would not occur or would be delayed. 

During earlier stages of decision-making Drax was held to be joint-first among applicants for the Investment Contracts. Andrews J noted:

It was only at the final stage that DECC concluded that Drax did not fulfil the Key Criterion and thus was ineligible for an IC. From Drax’s perspective it had given exactly the same reasons throughout the Process for demonstrating a significant risk that without an IC, the electricity generation to which the IC related would be significantly delayed. However, DECC maintained that there had either been a material change or (to put it at its lowest) the original application had been ambiguous, and DECC had reasonably understood it in a different sense from that which Drax intended.” 

The issue was the establishment of reliable contracts with suppliers to feed the unit with biomass – woodchip pellets. The Government told Drax its submissions “do not explain in a satisfactory manner how the alleged delays in fuel supply chain investment caused by the absence of an Investment Contract would prevent or delay generation”. Andrews accepted that Drax had explained “that an IC would create the necessary certainty to enable it to make the necessary investments to secure the continuous fuel supplies that it needed to run Unit 3 on biomass alone in the medium to long term”. Also the IC “would create the opportunity to raise funds against the UK assets of the business without putting Drax’s credit rating under pressure”.

The DECC report on Drax’s application said, however, that Drax had indicated that it would proceed with the investments for Unit 3 after receiving an IC but before state aid approval was given, so it may therefore be possible for Drax to make these investments on the strength of the Renewables Obligation support which they are currently obtaining for co-firing, and could obtain for operating as a conversion in future. They do not explain why this is not the case.” If Drax was willing to take a risk and go ahead with investment before it knew what state aid it would get, why couldn’t it do so under its present Renewables Obligation regime? DECC took the view that “There was no obligation to give Drax another opportunity to produce that further evidence.”

This Andrews regarded as unreasonable. The application had said that the contractual certainty from a private law [IC] will provide the necessary increased confidence above and beyond that provided by grandfathered ROCs, that our biomass and logistics chain is looking for” and that “private law CfD Investment Contracts will therefore allow us to contract with confidence”. Andrews points out: “The passage in the Binding [final] Application that I have quoted in this paragraph can only be understood by a properly informed assessor as contrasting the position with that under an RO.” This, in effect, was the explanation DECC said was not produced.

Additionally she said: “On a fair reading there was no difference between what Drax had said at Phase 1 and Phase 2 [of the application process] about the importance of a private law contract in securing the necessary increased confidence that its biomass supply and logistics chain was looking for (which DECC plainly and correctly understood at the time) and what it was saying about it at the binding application stage. The Binding Application began by saying ‘as we stated in our Phase 1 and Phase 2 application…’ and then summarised Drax’s case consistently with what Drax had stated previously.”

Andrews said of the failure to accept Unit 3: “Although a Court will not lightly interfere with a decision of this nature, particularly when such a large sum of money is involved … I am driven to the conclusion that the Claimant has succeeded in discharging the onerous burden of proving that the decision was unreasonable in the Wednesbury sense [see comment below] and that none of the reasons given by DECC in the decision letter can possibly sustain it.”  

Comment
That Andrews J has found DECC acted “Wednesbury unreasonably” on grounds of irrationality suggests DECC has blundered rather badly over Drax’s application. Wednesbury unreasonableness sets a very high bar for claimants to reach in challenging administrative decisions in public law cases. That is why Andrews was so circumspect saying “a Court will not lightly interfere with a decision of this nature”.

The Wednesbury definition of unreasonableness (from Associated Provincial Picture Houses v Wednesbury Corporation [1947] EWCA Civ 1) is that the decision is “so outrageous in its defiance of logic or accepted moral standards that no sensible person who had applied his mind to the question to be decided could have arrived at it”. This allows a lot of leeway for state decision-makers to make not wholly reasonable decisions. A judicial review such as this will never substitute a “right” decision for a “wrong” one – but it will strike down decisions that defy logic, as here.

Twitter: alrich0660

The Drax High Court case is here (Bailii.org)
See also: Government blunder on feed-in tariffs

The Court of Appeal judgment
Andrews J’s judgment has now been reversed by the Court of appeal. In that case Lord Justice Richards noted (in contrast to Andrews):

“This brings me back to the different perspective from which DECC was scrutinising the case put forward by Drax at the Binding Application stage. It now appeared that conversion of Unit 3 to full biomass was considered to be commercially feasible under the RO regime. The fact that Drax was saying that if an IC was awarded it was willing to proceed with the conversion of Unit 3 without waiting for State Aid approval, i.e. when there was no certainty that IC support could actually be implemented, also suggested that Drax was prepared to convert and operate the unit under the RO regime. It was reasonable in those circumstances for DECC to scrutinise the application rigorously for an explanation of why it was said that a delay in generation would nevertheless arise without an IC; and it was reasonable for DECC to take the view that a satisfactory explanation had not been provided.” (Para 84)

Andrews J had said of the standard or intensity of the reasonableness test to be applied: “In my judgment this is not a case in which the Court has to adopt a “light touch” in scrutinizing the reasonableness of the decision, according a wide degree of deference to the decision maker. The decision did not relate to matters of policy or political judgment, nor did it require the exercise of particular technical expertise. It was simply an evaluation of whether, on the information provided, a project satisfied the stipulated pass/fail criteria.” (HC para 58)

Richards LJ disagreed: “The present case does not involve the kind of policy-laden, esoteric or security-based decision where particular caution, or a particularly light touch, is required. On the other hand, it seems to me that the judge was unduly dismissive in describing it as “simply an evaluation of whether, on the information provided, a project satisfied the stipulated pass/fail criteria” (paragraph 58 of her judgment). It is true that satisfaction of the Key Criterion was a pass/fail matter rather than one that called for scoring and ranking of applications. But in order to pass, an applicant had to demonstrate to the satisfaction of DECC that the Key Criterion was met. In deciding whether it was so satisfied, DECC had to make an assessment as to the risk that the generation to which the IC related would not occur or would be significantly delayed in the absence of an IC. It was an assessment to be made on the basis not just of the information provided by the applicant but also of DECC’s own experience in relation to the relevant renewable energy support regimes and technologies. The sophistication and technicality of the process of assessment no doubt depended on the specific features of the individual case, but the general context is one calling in my view for the exercise of a considerable degree of caution by the court in determining a challenge on grounds of Wednesbury unreasonableness.” (Para 71)

The implication was that Andrews came close to substituting a different view for DECC’s own view rather than assessing whether DECC’s view came within the parameters of reasonableness. So:

“The result of Andrews J’s declaration in this case has been to require the Secretary of State to make a statement to Parliament to the effect that the Key Criterion is met in relation to Unit 3 even though, on the basis of the assessment made by DECC, he does not consider it to be met. There is nothing wrong in principle with such an outcome if, as the judge held, the only conclusion reasonably open is that the Key Criterion is met. It is, however, a curious position and one that serves to underline the need for caution on the part of the court.” (Para 72)

The Court of Appeal judgment is here (Bailii.org).

 

Explanation of ROCs v CfDs: Andrews J
“In 2002 the Government introduced a scheme called the Renewables Obligation (“RO”) which required electricity suppliers to source an increasing proportion of their electricity from renewable sources. The RO became the main financial mechanism for encouraging the deployment of large-scale renewable energy generation. Each licensed electricity supplier was required to produce a certain number of renewables obligation certificates (“ROCs”) in respect of each megawatt hour of electricity that it supplied to customers in the UK during a specified period. ROCs are issued by Ofgem to electricity generators on the basis of their output of eligible renewable energy. There is a market in ROCs, which are sold by the generators to electricity suppliers with or without the associated renewable electricity. The ROCs therefore provide financial support by way of a top up to the income that the electricity generator receives from sales of electricity into the wholesale market.

The advantages of a CfD over the RO are, first, that it creates greater certainty in respect of the price that can be obtained by the generator for renewable energy, and therefore provides a predictable level of income in comparison to the RO. Secondly, as a long-term private law contract, it is not subject to the same political and regulatory risks. Thus the CfD regime substantially reduces the commercial risks associated with conversion, and encourages investment in low-carbon generation. The Government intends that the stabilisation of revenue under CfDs will increase the rate of investment and lower the cost of capital, thereby reducing costs to consumers.”

According to Utility Week: “Biomass power generated will earn an estimated £10/MWh less under the RO than the CfD. With a CfD, biomass conversion is guaranteed £105/MWh. Under the RO, it gets 0.9 RO Certificates, currently worth £41.50/MWh, plus the wholesale power price.”

 

 
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About alrich

Journalist and blogger on legal and financial/economics issues

4 responses »

  1. Phillip Cozens

    It looks as if late in the day DECC finally came to the view that it is an expensive folly to burn wood in such a plant and on such a vast scale in the quest for green energy, however, DECC has only itself to blame for this – unfortuntely we will all pay the price.

    Reply
  2. Alrich, I’m currently looking at this in more detail, but I’m not sure your generalisation that the new contracts for difference fully insulate against political risk is an entirely accurate one. Although the right to expect performance of the agreed terms by the CfD counterparty, including payment of the stipulated Strike Price, should be enforceable in accordance with the same principles as any other contract, it is still within the competence of Parliament to impose changes on an agreed contract – whether prospectively, or with retroactive effect. The CfD terms do provide for certain protections in respect of changes in law, primarily aimed at those that increase costs or generation and are aimed in a discriminating fashion at CfD or low carbon generators, but it’s not at all clear that these will protect against an imposed change to the Strike Price. A change like that would be profound, and volatility in the subsidy level certainly isn’t anticipated by the legislation in the same way that it is for ROCs (which then has to be constrained by the grandfathering policy of the UK government). it may also trigger claims under the HRA or any applicable investment treaty, but I don’t think it’s possible to say with certainty that political risk is no longer a factor.

    Reply
    • This is an interesting point. The CfD regime is an attempt to create a purely contractual relationship between the energy producers and the Government, one that will be overseen by courts independently of the Government. To that extent it keeps “politics” out of it. But, of course, Parliament is sovereign so conceivably politics could intervene if a Government felt a need to change this particular policy on renewables.

      Whether it would do that is a moot point – the implication of governments’ utilising parliamentary sovereignty to interfere with private law contracts are serious and potentially repressive – particularly if they were retrospective changes. It is likely that judges would indicate as much if such interference occurred – not least because contracts are property and property is protected by the European Convention on Human Rights (Article 1 Protocol 1).

      This is the subject of my previous posting: https://alrich.wordpress.com/2014/07/10/contractual-rights-are-property-rights-government-blunder-on-feed-in-tariffs/

      The judges cannot strike down primary legislation – but things would become pretty hot for the Government, not least because international trade bodies, as you suggest, would be somewhat concerned at a Government riding roughshod over the law of contract.

      Reply
      • I don’t disagree with you in terms of the storm such legislation would provoke, but I’m always keen to distinguish government from Parliament. Yes, for sure, it would be government policy implemented through a majority they would in all likelihood control, but you’d still need the majority in favour which makes it as democratic a decision as it’s possible to have in this country.

        Also, although you could argue it’s repressive, I’m not sure the judges would stand up to it either under common law or Art 1 Pro 1. For a start, my read of the solar case was that they didn’t regard the right to future income streams as a property right, but rather the value represented by the contract. It’s a fine point, but the CfD is arguably not as assignable as other contracts simply by virtue of the limited eligibiltiy criteria. The only “value” is the right to secure lending using the payment rights. I may have misunderstood the solar judgment though.

        Secondly, it wouldn’t be retrospective in the way that judges occasionally voice disquiet about. I would assume that nothing would be done to recover subsidy payments already paid (although that is precisely what Spain did), so the impact would be on future rights to revenue. Even if you put some faith in the courts constraining retroactive legislation either through interpretation or common law limitations on sovereignty, I’m not sure this would be enough to activate that resistance.

        I’ve done a rough check and Parliament seems to make legislation changing contract terms only apply to contractual liability or terms entered into from the date of the legislation; one that stands out in contrast is the legislation around frustration in the 40s. Parliament doesn’t seem to be afraid to amend existing contract rights when there is a regulatory element, though, in the context of the petroleum extraction industry. There have been multiple occasions where the terms and conditions for the extraction licences have been amended for existing licences, which were (as I understand it) structured as contracts in order to convince developers and investors that it was better than a simple licence.
        The CfD contract terms and conditions are incorporated by reference from promulgations of secondary legislation, much like the extraction licences, and I don’t think it’s a given that the change in law machinery would kick in.

        I do agree though that legislating to change the terms of contracts would lead to concerns about the robustness of English private law in general, although I’m a bit more cynical about whether there could be traction in distinguishing these as essentially functions of a regulatory regime rather than part of the same family as more typical market based arrangements. Ultimately, sovereign decisions can impact contracts and sovereigns will deploy that power if the political desire to do so is sufficiently potent. You only have to go back to the concerns people had around euro exit and currency redenomination, or similar discussions around Scottish independence to see that.

        Lovely topic though.

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