Partner Kaja Kallas on energy support

The Minister of Economic Affairs and Communication stated recently that support for renewable energy should be reduced. It is commendable that politicians are thinking about ways to reduce the price of electricity. But before going to all the trouble of amending laws, decisions should be carefully analysed, discusses the firm’s partner Kaja Kallas.

Why is renewable energy support necessary?

To answer that question, we need to go back in time and look at why support was written into the law in the first place. When Estonia joined the European Union the state assumed several obligations in the energy sector. One of them was liberalisation of the energy market. This meant – in addition to creating interconnections with other Member States – that if the consumer could no longer buy electricity at a fixed price, the market would have a number of producers that would start to compete for the consumer. Since there is only one product (electricity), competition would be mainly on the basis of price. Put differently, whoever produces the cheapest electricity can also sell its electricity to the consumer.

Although electricity produced from oil shale is expensive in the long term (considering the need to invest in outdated equipment, pollution fees and emission of greenhouse gases), short-term production of electricity from oil shale is cheap. It is so cheap that in order to compete with existing power stations, some other incentive must be found to attract investors for the energy sector.

The second obligation agreed in the European Union was to promote use of renewable energy sources and efficient co-generation. Putting two and two together, the state found that in order to create new production capacity to compete with state-owned Eesti Energia (Estonian Energy), an incentive should be offered to investors in the form of subsidies. The state also decided that for ecological reasons it was necessary to subsidise electricity produced from renewable energy sources and in efficient co-generation technology. Therefore, the objective of support was to attract investors and to create competition between energy producers with a view to reducing electricity tariffs in the long run. Another alternative would have been to use budget funds to invest in electricity production, but this is too much even for larger European countries.

As investments started to pour into the energy sector after the state promised the support and the subsidy fulfilled the objective set by the state for creating new production capacity, the same state would now appear to be saying, “Sorry, we did not know that you will be earning a profit from producing electricity”. It is necessary to recall at this stage the elementary truth: businessmen decide to start a business when it promises to make a profit for them. Promising a state subsidy can be seen as a form of contract between the state and the investor, where the investor will help increase Estonia’s energy independence and develop electricity production there based on renewable energy sources, with the state for a certain period guaranteeing that investors can sell the electricity and cover their costs. Now that the investor has met its obligation to the state, it would not be honest for the state to announce that it had changed its mind. Pacta sunt servanda – contracts must be fulfilled.

Support is limited both in terms of time and volume. Under the Electricity Market Act, electricity produced from renewable sources is eligible for a support only for the first 12 years from the start of production (it should be noted here that oil shale is eligible for a subsidy for 20 years). An additional restriction exists for producers of electricity from wind: subsidies will be paid until 600 kWh of electricity has been produced from wind. After subsidies end, power plants will still be producing but no longer at a cost to the state. At the same time these stations will still be competing with each other and state-owned Eesti Energia. This competition should eventually bring down the price of electricity to the consumer.

Surely a logical step before developing these restrictions would have been for the Ministry of Economic Affairs and Communication to make in-depth calculations on how much new production capacity Estonia needs in order to fulfil its renewable energy objectives plus increase Estonia’s energy independence and supply security. Strangely, however, these targets are already said to have been fulfilled and no need exists for incentives for new production capacity. And where is the study or justification for this? A recent malfunction of the boilers in the Baltic Power Station in Narva could send an entirely different signal: lack of preparation, either when the subsidies were written into the law or when talking about abolishing subsidies. For instance, at present the total wind power output of Estonian wind farms is 150 MW while, according to the Development Plan of the Estonian Electricity Sector recently approved by the Estonian Government (Parlament), it should be 900 MW in eight years’ time.

Why punish those who started early? Renewable energy producers who make a profit, as reported by the media, started production in a situation where market practice and experience were absent. Thus, these producers also took a bigger risk. In business, taking a bigger risk usually means getting a higher profit in the future. If the state were now to retract on its promise and remove the subsidy from producers who already started production, this will essentially be equal to punishing those producers for making a profit. This kind of behaviour by the state resembles a different kind of state order: the totalitarian kind, where Estonia was until 20 years ago.

Use of subsidies

As mentioned above, support was intended for creating new production capacity, increasing Estonia’s energy independence and creating competition on the electricity market. For this reason, subsidies were limited to 100 MW of production capacity until last summer. Since it was unlikely that new production capacities in excess of 100 MW were to be developed, such a restriction ruled out the possibility that existing power plants in Narva would be allowed to simply burn wood in their oil shale boilers and be eligible for the subsidy. Under the pretext of amending the State Budget Act in the summer of 2009, this restriction was removed from the law and enabled Narva power stations (owned by state company Eesti Energia) to start burning wood instead of oil shale yet receive a state subsidy. This step multiplied the subsidy paid for wood and peat, for instance.

But burning wood in Narva power stations does not create new production capacity for Estonia, nor does it increase Estonia’s energy independence. So, for this reason it did not serve the initial objective of the support. When this mistake was noted in the winter of 2010, the Electricity Market Act was amended again so that subsidy to biomass (including wood) would be paid only if electricity is produced in an efficient co-production system (by using to the maximum extent the heat energy generated during electricity production). The fact that Narva power stations do not produce electricity in co-generation mode should have ruled out these stations as ineligible for the subsidy and end burning wood in these boilers. But this summer, the Estonian Government approved guidelines for co-generation of electricity from biomass that took the co-generation coefficient to a level that also covered the Narva power stations. All of this was done in spite of the fact that in normal terms electricity produced in Narva power stations cannot be considered efficiently produced.

Another huge question mark about use of support is the procedure for paying support. Although consumers are forced to pay renewable energy subsidy on a monthly basis according to volumes submitted by Elering (the Estonian transmission system operator), many renewable energy producers actually receive no support (although the electricity produced by them is included in calculating the fee payable by consumers). The reason is: non-compliance of their production equipment with regulations. Put differently, the Electricity Market Act creates a possibility not to pay support if production equipment does not comply with network requirements. In other words, a fee is being collected from consumers but it is not paid to renewable energy producers.

Returning to the largest recipient of this support, network regulations provide an exception for the Narva power stations (state-owned power plant). That is, their production equipment must comply with requirements only on January 1st, 2016. Here it should be noted that this equipment should have complied with requirements on January 1st, 2010, but since nothing had been done, the deadline was simply postponed and the network regulation was changed. To say nothing about non-compliance of a large power station is a risk to the independence of the whole energy system where support is also paid for electricity produced by this non-compliant equipment whereas much other smaller production equipment does not get support on the pretext of being a risk to energy security.

Analysis by the Competition Authority

In his statements about reducing renewable energy subsidies, the Minister of Economic Affairs and Communication refers to analysis by the Estonia’s Competition Authority which found that the subsidy rates were too high. It is known that data were collected only from those green energy producers that make a profit. Therefore, the findings of the study are unreliable because the study does not cover the whole market. It also begs the question whether the study was commissioned with the objective of collecting evidence to support a position already prepared by the Ministry of Economic Affairs and Communication. If this is true, using the already limited resources of the Competition Board seems wasteful if the findings had already been decided on.

Removal of support would deteriorate the investment climate. In addition to the fact that the state could be sued by electricity producers on the basis that the principle of their legitimate business expectations has been infringed, changing support schemes could have wider repercussions. The euro alone is not sufficient to revive the Estonian economy. However, the state must be sufficiently stable from the investors’ perspective so that they want to bring their money here. Constantly amending laws clearly worsens the investment climate.

If the Estonian state fails to keep its promises and retracts the support it has promised to businesses that have invested in electricity production capacity, it will create the impression that Estonia is an unstable state where the state is making decisions that are both hasty and not properly thought through. Even if we decide that we no longer need to invest in electricity production, retracting such a promise would inevitably affect investment in other sectors since no-one can be clear what the state would decide next. Perhaps the state will establish a profit limit in all economic sectors? Or decide that retail stores can be operated only by wholesale traders? Or perhaps abolish the possibility to import production inputs?

In summary, even if the state finds that support schemes must be revised, revision should not be retroactive. In other words, support paid to existing stations should remain in force for the whole 12-year period (or, in the case of wind, until fulfilling the volume quota) that the law promised them at the start of production. One should also ask whether the Estonian state needs new production capacity. If the answer to this question is in the negative, then one should assess whether private producers are ready to invest in the energy sector even without subsidies. Otherwise, in-depth studies are required to establish the right rate and term of validity of subsidies. Undoubtedly, it is necessary to analyse whether the subsidy paid to the Narva power stations, the largest beneficiary of the subsidy, is justified both in terms of time and volume. Before we label some energy source as expensive, we should be able to answer the question: which form of electricity is cheaper, especially in a timeframe of 10, 20, or 30 years.

Kaja Kallas has extensive expertise in counselling clients on energy matters. She has participated in most of the leading and innovative renewable energy projects in Estonia and has acted as legal counsel to various energy projects in disputes. Kaja has also been engaged in drafting legislation for regulating different aspects of energy generation.