Global Warming Policy Forum, 6 November 2016
John Constable, GWPF Energy Editor
The Court of Appeal recently upheld the government’s right to cancel the Climate Change Levy (CCL) exemption for renewable generators. In effect this is a retrospective removal of subsidy entitlement, and should remind investors that even a seemingly secure economic rent will collapse when push comes to shove. This has significant implications for the Carbon Price Floor (CPF) and also the value of certificates issued under the Renewables Obligation (RO). The Renewable Heat Incentive (RHI) may also be affected. For the time being the Feed-in Tariff (FiT) and Contracts for Difference (CfD) are probably safe, but anyone in the electricity sector relying on subsidies and handouts has been given fair warning: The government giveth, and the government taketh away.
The main flaws with current energy policies as they relate to climate revolve around their inflexibility. Broadly speaking, the policies simply assume that the premises driving their motivation cannot change, except to require still more urgent action to reduce emissions. This was clearly an error. A full gearbox, including a reverse gear, is a necessary feature of any legislation whatsoever, principally because errare humanum est. This is still so even when the policy is grounded in area designed to minimise such errors, scientific research. Indeed, both the history and the philosophy of science tell us that scientific propositions are without exception provisional and subject to change. There simply are no absolute truths in any scientific field, even at a very fundamental level, a point that Schrödinger famously noted in What is Life? (1944) when he reminded his audience that “the laws of physics and chemistry are statistical throughout”.
Scientists should never forget, though in the heat of policy debate they sometimes do, that their propositions are reasoned abstractions from observations, and those observations are necessarily finite. There is always more to learn, even in areas that seem rock solid. We may not expect the clock to suddenly go backwards and wind its own spring, but, as Schrödinger puts it, this infinitesimal probability “always remains the background”. In many cases, particularly those relevant to policy, the probability of change is far from infinitesimal.
This sceptical point has from time to time been apparent to political leaders. It is over three hundred years since Oliver Cromwell, with a mighty puritan oath, “in the bowels of Christ”, asked the Synod of the Church of Scotland to “think it possible that ye may be mistaken”. But legislatures become overconfident, and the necessity for provisions for flexibility in law-making is neglected. The Climate Change Act of 2008, for example, is designed as a one-shot rocket, quite without steering and with precious little provision for deceleration.
Paradoxically, this lack of flexibility makes the legislation fragile, and investors relying on such law should be extremely cautious. What cannot go on, will not go on, and if a change of pace is not possible, abrupt termination becomes inevitable. Precisely because the legislation contains no obvious means of control and reversal, government, being under the pressure of force majeure itself, may simply apply overwhelming legal pressure to adjust the vehicle’s direction, and even turn it around. A recent ruling in the Court of Appeal reminds us that government is entitled to act robustly in the public interest.
In the July 2015 budget, the then Chancellor George Osborne removed the exemption from the Climate Change Levy (CCL) applying since 2001 to renewable generators. At the time of removal this exemption was worth approximately £5/MWh to all existing generators, so in that sense was retrospective. While the CCL subsidy was small in comparison to those available under the Renewables Obligation (for example £45/MWh for onshore wind and £90/MWh for offshore wind), it was a very welcome extra layer of jam, £381m thick in 2014/15, and its removal much resented. Infinis Energy Holdings Ltd, owner of one of the larger renewable generation portfolios in the UK, and Drax Power Ltd, one of the largest single producers of renewable energy, both attempted to challenge the decision in the courts, arguing, in essence, that they had reasonable expectations that the exemption would continue, and that the government had acted unfairly and unreasonably. The High Court rejected their challenge. Drax then, sensibly, withdrew; but Infinis took the case to the Court of Appeal, which, in the persons of Sir Terence Etherton MR, Lord Justice Lloyd Jones and Lord Justice Sales, delivered its judgment this week, and firmly rejected the arguments that Infinis had presented. It seems unlikely that this judgment will be reversed.
The Court of Appeal summarised the case thus:
The central issues in dispute between the parties are as to what standards of foreseeability and legal certainty EU law requires in the context of changes to the tax regime and what requirements have to be satisfied to generate a legally protected legitimate expectation. (Para 42)
The Court concluded, from a broad review of jurisprudence and other cases, that the standard applicable was rigorous not loose. The relevant state authorities must have given “precise assurances” and “actively promoted” these expectations. “Vague indications” are not enough. The Court observed:
In our judgment, the Appellant in the present case cannot bring itself within the principle of protection of legitimate expectations according to this test. The Respondents had made no promise and given no assurance that the RSE Exemption would be maintained indefinitely, nor that it would be subject to the giving of a period of notice before being changed. In the context of establishing and changing the rules of a national tax regime, a prudent and circumspect economic operator would appreciate that the tax authorities and the national legislature might change the tax code without giving notice. They are entitled to do so, as it is their function in a democratic society to manage the public finances by weighing up all the competing demands on the public purse against all the possible, conflicting ways of raising tax revenue and adjusting the elements on both sides of the equation as they see fit, in accordance with the policy they think should be pursued. Further, the Appellant was not entitled to expect that the existing situation involving having the RSE Exemption in place would continue, because, absent any precise assurance given to the contrary, the tax authorities and Parliament had a general discretion to alter the tax regime as they saw fit. (Para 55)
In the absence of precise assurances, by which Parliament might bind itself, there is a “general discretion” to make such changes as are required in the public interest.
The significance of this point for other renewable subsidies, for example the Renewables Obligation, is substantial. Of course, it is perfectly true that the RO is not a tax exemption, and may not at first glance appear to be a tax. The revenue is not collected by the Treasury from consumers and disbursed to the renewable generators, instead it passes from consumers to generators via electricity suppliers. However, and unsurprisingly since the imposition on consumers is both unavoidable and unrequited, the Treasury does, for accounting purposes, regard it as public expenditure, and has consequently asserted its authority over this spending through the Levy Control Framework (LCF).
In principle, then, the RO is indeed a tax, though of a special kind, and as a result no one should assume that this judgment is irrelevant to the continued value of Renewable Obligation certificates. Indeed, the RO system was designed explicitly so that the value of the certificates would fall as the targets were met, a fact that may become relevant in the years to come.
In other areas the judgment has a straightforward relevance. The Renewable Heat Incentive (RHI) is funded via the Treasury, and anyone relying on this income may wish to hedge immediately. The Carbon Price Floor is straightforwardly a tax, and rumours are already in circulation that government is considering making major changes, perhaps even cancellation.
The status of the Feed-in Tariff, and that of the new Contracts for Difference, seems more secure. These are both contractual entitlements, “precise assurances” regarding particular prices, though doubtless everyone will now be reading these contracts extremely carefully to see whether there is any room left in which Parliament’s “general discretion” might be exercised.
In this context the numerous and at first sight vacuous government statements on the need to respect the burden placed on the consumer may now seem rather more important. However, and in spite of the discretion that this important judgment outlines, governments have been and will continue to be quite properly reluctant to achieve flexibility in legislation by abrupt or forceful means. The state would prefer to be regarded as trustworthy. That said, no one will respect a government for persisting in obviously foolish or economically dangerous policies, as the climate policies very probably are, and when in a tight corner the government will do what it must, even if specific undertakings have been given.
Investors should recognise this as a normal business risk. Machiavelli had neither a Harvard MBA nor a degree in PPE from Oxford, but his advice is nonetheless sound: “A ruler will never be short of reasons to explain away a broken promise”.