OVERVIEW - Temporary windfall profit reduction mechanism on remuneration from electricity production activity in Spain

Author: Oran Viriyincy. License: Creative Commons, Attribution-ShareAlike 2.0 Generic.

September 27 (Renewables Now) - Renewables Now is republishing an overview by Watson Farley & Williams of the latest measures taken in Spain in response to the surge in wholesale power prices. The full article, published on September 23, can be read here.

TEMPORARY WINDFALL PROFIT REDUCTION MECHANISM ON REMUNERATION FROM ELECTRICITY PRODUCTION ACTIVITY IN SPAIN

On 15 September 2021, Royal Decree-Law 17/2021 of September 14, 2021, providing for urgent measures to mitigate the impact of soaring natural gas prices in the retail gas and electricity markets (“RD-L 17/2021”) was published in the Spanish Official Gazette (BOE) and came into force the following day.

RD-L 17/2021 includes several tax and regulatory measures that aim to minimise the impact of rising wholesale power prices for Spanish electricity consumers. The measure, which is most relevant for renewable energy asset owners is a mechanism for the temporary reduction (until 31 March 2022) in the remuneration of electricity production activity to reduce windfall profits (i.e. extra profits earned from non-emitting plants on the back of high gas and carbon prices) that, in the Government’s view, are received by these generators (the “Mechanism”). Other regulatory and tax measures included in RD-L 17/2021 are detailed in the Annex to this Memorandum.

The Mechanism has been justified by the Government in the Preamble of RD-L 17/2021 on the following grounds:

-- the evolution of the quotation of greenhouse emission rights in the European market, which shows values above EUR 60 per ton, and increases of 120% with respect to the value of a year ago;
-- the unprecedented rise in the price of natural gas across national and international hubs (in the Iberian gas market, managed by MIBGAS, the spot gas price at the virtual balancing point -VBP- has recently exceeded EUR 60/MWh, compared to the minimum prices of the year recorded in February, which were around EUR 15/MWh. This represents an annual increase of almost 300%); and
-- the need, in the Government’s view, to incorporate regulatory instruments that, in view of the exceptional circumstances of the raw materials markets, temporarily limit the excess remuneration obtained by non-greenhouse gas emitting installations to the detriment of all consumers.

The Mechanism will require plants that fall within its scope – during the period of application of this temporary measure – to pay back to the Spanish electricity system an amount based on the energy generated by the plant, the cost of natural gas in MIBGAS and the number of hours in a month where combined cycle gas turbines (CCGTs) set the price.

The key points of this Mechanism are summarised below.

The following facilities are expressly excluded from its scope of application: (i) facilities that have a specific regulated remuneration scheme (i.e. subsidised renewable assets); (ii) facilities in the electricity systems of non-peninsular territories; and (iii) facilities with net power equal to or less than 10 MW. The amount subject to pay back is based on a mid-merit CCGT SRMC if gas prices are higher than EUR 20/MWh.

The formula to calculate the price / amount to pay back is:

-- Price to pay = Energy generated x (Gas price – 20) x α / FMIG;
-- FMIG = mid-merit CCGT (55%) / weighted average of hours in month where CCGTs set the price;
-- Average Factor of Internalising Natural Gas (FMIG in Spanish);
-- The α factor aims to make the measure proportional, and it is set at 0.9; and
-- In the hours where the marginal price is set by a technology other than CCGT, it will be assumed the offer has internalised the CCGT cost if there are CCGTs with bids within 10% of this value. This will be considered in calculating the FMIG, and it disincentivises non-emitting plants from bidding based on CCGT running costs.

Settlement/payment of the relevant amounts will be made monthly and the system operator must notify the generator before the 15th of each month the amount to be paid. Once this notification has been made and received by the owners of the affected facilities, they shall have one month to pay the said amounts to the system operator.

The payments referred to in the previous paragraph shall be considered payments on account of the settlement that the system operator shall make for each facility once the definitive data on production measurements at busbars for the period are known.

The amounts derived from the settlements will be considered as liquid / available income of the system, and will be used to finance the costs funded by the electricity system charges of article 16.1 of the LSE and to cover, if applicable, temporary mismatches between income and costs of the system.

Although article 4 of RD 17/2021 states that the remuneration of the affected facilities will be reduced “by an amount proportional to the greater income obtained by these facilities as a result of the incorporation of the value of the price of natural gas into electricity prices on the wholesale market”, article 5 provides that the Mechanism will be applied to relevant non-emitting plants regardless of the contracting method used (i.e. regardless of whether generators sell electricity on the wholesale market or through power purchase agreements (PPAs)).

Therefore, on the face of RD 17/2021, energy sold outside the daily market (through bilateral agreements, including at a fixed price) would also be subject to the Mechanism and therefore reduced as it would be assumed under RD 17/2021 that all of the energy sold (regardless of the contracting method used) is internalising the opportunity cost of selling it on the daily market, where the cost of natural gas is already internalised.

Accordingly, there appears to be a contradiction between the statement and the wider aim of the Mechanism included in section 4 of RD 17/2021 and the provisions that regulate the practical application of the Mechanism.

As a result, the Mechanism introduced by RD-L 17/2021 has generated discussion and interest in the renewables sector due to the direct effect that it could have on the remuneration of energy generation facilities using renewable sources that have signed bilateral contracts at a fixed price for all or part of their production.

In this respect, several news articles have been published in recent days suggesting that, according to several sources in the sector, the Government may publish a clarifying note to exclude from the scope of application of the Mechanism all those generation facilities which, strictly speaking, have not benefited from an extraordinary increase as a result of the rise in the price of electricity due to the increase in the price of gas (e.g. those subject to fixed price PPAs).

Within this context, on Monday, September 20, 2021, the Government published a note (the “Note”) clarifying the Mechanism. In particular, the Note clarifies that Articles 4 and 5 of RD-L 17/2021 must be interpreted in accordance with the purpose of the regulation, which establishes that the reduction only applies “in an amount proportional to the greater income obtained by these installations as a result of the incorporation into electricity prices on the wholesale market of the value of the price of natural gas by the marginal emitting technologies”. In other words, if there are no windfall profits as described in article 4 above (and this could be demonstrated – see further below), these projects / installations will be excluded from the application of the Mechanism.

In this regard, the Note states that the owners of facilities that meet all the following requirements will not be subject to the Mechanism:

(i) that the electricity produced is covered by a forward contracting instrument(s) (bilateral agreement(s))¹, whose date of signature was prior to the date of entry into force of RD-L 17/2021;

(ii) that these contracting instrument(s) are at a fixed price. In other words, that they do not have a recognised delivery price indexed to the spot market price of electricity production²; and

(iii) that these contracting instrument(s) are not intra-group contracts (i.e. contracts signed between the generator and any company in its business group for the sale of the energy produced by the generator, ultimately to a marketer in the same group).

In order to demonstrate compliance with the above requirements, the following information must be provided:

(i) responsible declaration by the owner of the facility of the monthly energy covered per facility with forward contracting instrument(s), including the volume, price and delivery or settlement period of the energy negotiated and committed in fixed price contracts, with physical delivery or with financial settlement previously declared, where applicable, in the clearing houses (cámaras de compensación) in which these facilities have been registered;

(ii) information accrediting the contracting of said energy with a third party, or through a market or intermediary agency; and

(iii) information accrediting the communication of said operations to the corresponding body (under the REMIT or EMIR regulations), justifying, where appropriate, the absence of said accreditation.

This documentation shall be provided to the System Operator, who shall issue it to the National Markets and Competition Commission (“CNMC”, in its Spanish acronym), as the body responsible for settlements.

[1] According to the Note, the scope of the exemption of this Mechanism will correspond to that part of the energy that is effectively covered by these contracting instruments/agreements.
[2] According to the Note, in the case of partial indexation to the spot market price in such contracts, only the energy linked to the non-indexed part of the contract shall be exempt.

Authors:

David Diez, Partner
Rodrigo Berasategui, Partner
Katherine Best, Partner
Luis González, Counsel
Senior Associate Ignacio Soria also contributed to this article.

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WFW are an international law firm specialising in the energy, real estate and transport sectors.

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