Is Ed’s energy freeze lawful?

by Carl Gardner on September 25, 2013

Lee Haywood | Creative Commons

The centrepiece of Ed Miliband’s speech to Labour’s conference yesterday was this:

If we win the election 2015 the next Labour government will freeze gas and electricity prices until the start of 2017. Your bills will not rise. It will benefit millions of families and millions of businesses.

Since then there’s been some question whether this plan complies with EU law – with Gillian Sproul of Mayer Brown expressing some doubt, Open Europe concluding it’s lawful, and Ed Miliband himself assuring listeners to the Today programme this morning that his legal advice is “absolutely” that he can do it (from 2 minutes 18 seconds in).

I think it should be possible to design this policy in such a way as to be legally defensible. But there is legal risk here, and the details will need care.

Instinctively people think the policy must raises issues of EU competition law – but it’s not quite that in fact. EU competition law strictly so called – that is, the law on anti-competitive agreements under article 101 of the Treaty on the Functioning of the European Union (TFEU) and the law on abuse of a dominant position under article 102 TFEU – only apply to the behaviour of firms themselves. EU competition law isn’t about what governments do.

EU law is relevant to Ed Miliband’s freeze, though, in two ways: first, it has to comply with EU internal market rules relating to the energy market; and second, any public subsidy it involves to industry must comply with EU state aid rules.

In principle, imposing fixed or maximum prices can be a restriction on the freedom to provide services under article 56 TFEU (see the Tasca case from 1976, which makes the principle clear in relation to free movement of goods), particularly if they force importers to operate at a loss.

Usually the next question is whether such a restriction can be justified under article 52 on grounds of public policy, or under the principles laid down in ECJ case law – see Alpine Investments. But here, we’re dealing with markets regulated in detail by the EU under Directives – specifically the Electricity Directive, 2009/72 and the Gas Directive, 2009/73, adopted as part of the EU’s “third energy package”. So it’s to the detailed provisions of those Directives that we must turn in order to answer the question whether price regulation in energy markets is permitted. It seems to be.

It’s true that the entire purpose of the Directives is to liberalise the gas and electricity markets, allow genuine competition and so achieve the best deal for consumers in the long run. But they preserve important powers of state intervention. Article 3.2 of the Electricity Directive says

Having full regard to the relevant provisions of the Treaty, in particular Article 86 thereof, Member States may impose on undertakings operating in the electricity sector, in the general eco­nomic interest, public service obligations which may relate to security, including security of supply, regularity, quality and price of supplies and environmental protection, including energy effi­ciency, energy from renewable sources and climate protection. Such obligations shall be clearly defined, transparent, non- discriminatory, verifiable and shall guarantee equality of access for electricity undertakings of the Community to national consum­ers.

Article 3.2 of the Gas Directive is in identical terms (except of course that it refers to the gas sector, and natural gas undertakings). Note that it says

Member States may impose on undertakings … public service obligations which may relate to … price of supplies …

In the Federutility case in 2010, Italy successfully used the predecessor of article 3.2 to ward off a challenge by its gas industry to what was effectively the imposition of maximum “reference” prices. The European Court accepted that “the very purpose and the general scheme” of an earlier Gas Directive – article 3.2 of which was almost identical to the current provision – was

progressively to achieve a total liberalisation of the market for national gas in the context of which, in particular, all suppliers may freely deliver their products to all consumers.

But, the Court went on to say (paras. 20-21)

[the Directive] is also designed to ensure that, in the context of that liberalisation, ‘high standards’ of public service are maintained and the final consumer is protected.

In order to meet those latter objectives, Article 3(1) of [the Directive] states that it applies ‘without prejudice’ to Article 3(2), which expressly permits Member States to impose ‘public service obligations’ on undertakings operating in the gas sector, which may in particular concern the ‘price of supply’.

The ECJ did, though, make clear (para. 35), that as well as acting in a clearly defined, transparent and non-discriminatory way, the state can only intervene proportionately, where it’s necessary to do so:

First, such an intervention must be limited in duration to what is strictly necessary in order to achieve its objective, in order, in particular, not to render permanent a measure which, by its very nature, constitutes an obstacle to the realisation of an operational internal market in gas.

Whether it was sufficiently limited in time would depend

whether and to what extent the relevant national law requires the administration to make a periodic re-examination, at close intervals, of the need for it to intervene in the gas sector and the manner of its doing so, having regard to the development of that sector.

And while prices can in principle be regulated for business consumers as well as households (paras. 42 and 43)

it would be necessary to take account, in assessing the proportionality of the national measure in question, of the fact that the situation of undertakings is different from that of domestic consumers, the objectives pursued and the interests present being not necessarily the same and also of objective differences between the undertakings themselves, according to their size.

In those circumstances … the requirement of proportionality referred to above would not, in principle, be complied with if the definition of ‘reference prices’ for the supply of natural gas, such as those at issue in the main proceedings, were to benefit individuals and undertakings in an identical manner, in their capacity as final consumers of gas.

It’s these Federutility conditions that pose a challenge for Ed Miliband’s policy in terms of internal market law. Article 3.2 and Federutility don’t leave much scope for the Commission or industry to challenge price regulation, but in its 2012 Communication on energy the Commission said (para. 3.2.1, page 11) that it

will continue to promote market-based price formation in retail markets, including through infringement cases against those Member States maintaining price regulation that is not meeting the conditions laid down by EU law

and you can be sure that the energy industry will jealously protect its rights. Miliband’s policy is vulnerable then, in respect of how its duration is justified, and in the extent to which it applies to business.

Of course we know already that the policy will be time-limited: that helps. But how can Miliband know now that, in about 20 months time, intervention will be needed for exactly another 20 months? If he is in government in May 2015, he’ll need to ensure he can justify the need to intervene then, and that he builds in some form of review, perhaps, to make sure intervention is defensible for at least the 20 months he plans.

And while Miliband said the police would apply to “millions of businesses”, he probably means small businesses, rather than all of them. The Commission is clearly taking paragraph 43 of the Federutility judgment seriously because it’s taking Poland to the European Court for introducing price regulation for all business customers regardless of size.

Finally, state aid. Ed Miliband said on the radio this morning that if energy companies claimed the freeze was unsustainable (perhaps because of some market shock, Justin Webb suggested to him in his Today interview, from 3 minutes 54 seconds) then they could “make their case” to him. In order to ensure continued energy supplies the government could subsidise energy firms to compensate for losses due to the freeze, and this compensation (since it would be provided to offset the cost of fulfilling a “public service obligation”) could escape the prohibition on state aid to industry under article 107 TFEU – but only if it fulfils the “Altmark criteria” laid down ten years ago in the Altmark Trans case. These include, in summary (see paragraph 95 of the judgment), that

  • firms to be compensated have clearly defined public service obligations (which is already required by article 3.2 of the Electricity and Gas Directives of course),
  • the basis of calculating compensation has been established in advance, objectively and transparently, and
  • compensation does not exceed the costs incurred by firms in fulfilling their obligations, taking into account a reasonable profit.

This 2012 Commission Communication on state aid and “public service compensation” explains in detail the Commission’s approach to the Altmark criteria today. It’s worth noting that Irish aid to the energy sector has been cleared in the past.

If I were a government lawyer advising on this, I’d also be concerned, if ministers decided in effect to underwrite the price freeze through subsidy, in case the effect of the price freeze on business customers ended up indirectly favouring some industry sectors – perhaps those sectors where energy is a big component of costs – or giving big British exporters a cost advantage their over EU competitors. That would be another way in which the policy could infringe state aid rules, as France and Spain have found according to this Energy Community Secretariat report (see page 6). So for this reason too (as well as compliance with Federutility) Ed Miliband would be wise to limit the freeze to households and small business customers only.

Ed Miliband will need to ensure, then, that he still has a good case for price intervention in 2015 – and it’ll be interesting to see what happens to energy prices between now and then if he continues to lead in the polls. But assuming he does, and that he limits the freeze to household and small business customers, then I think it could be successfully defended in terms of EU law – even if Miliband is forced to step in to underwrite the freeze using government funds.

The policy would have a cost in terms of wider European policy, though. As the Commission’s 2012 Communication I mentioned above made clear (page 10) the UK is, as things stand, one of the minority of EU countries like Germany, the Netherlands and Sweden in which energy prices are free of state intervention. Ed Miliband’s policy would change that. The UK has traditionally promoted its own vision of Europe based on open and free markets, rejecting the short-term, protectionist and interventionist regulatory approach we like to associate with France. Ed Miliband’s energy policy would do at least some damage to Britain’s credibility on that score; and I wonder whether we’re seeing the second of Britain’s big political parties begin to edge away from the positive, economically liberalising European policy they pursued under both Thatcher and Blair.

{ 3 comments… read them below or add one }

1 Pynch September 26, 2013 at 10:33

Great analysis. The State Aid issue is key in assessing this proposal against wider industrial policy aims.

The big deal at the moment in the EU is price differential with the US which has a glut of cheap gas which it can’t export.

If you regulate prices lower for domestic users – but not for large businesses – then businesses will still not get cheap bills like in the US, and may well end up paying at least part of the domestic sector’s costs too.

2 Nick Drew September 30, 2013 at 11:03

You might also like to consider whether it would be non-discriminatory within the energy sector. If, as you say (correctly, IMHO) that the measure would be targeted at residential + smaller business customers, it would fall predominantly on the ‘Big 6’, who have 99%+ of the residential sector and most of the small business customers. Unless Big-6 shareholders are forced to take the whole hit, they may be ‘forced’ to shift costs onto their large industrial customers. But in that sector they face competition from several firms who only sell in that sector – and who would thereby obtain a cost advantage.

By the way, don’t fall into the common trap of describing this policy as a ‘freeze’. As Miliband made clear in follow-up interviews, it’s a cap, not a price-fixing. The significance of this is great: a fixed price is a common offering anyway in the market, (and can readily be hedged). But a cap is much more problematic for suppliers: they cannot pass through wholesale costs above the capped level, but must (or at least, are expected to) pass through any cost reductions.

3 Jennifer October 7, 2013 at 22:02

Great analysis, will be interesting to see if anything like this is put into practice

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