Urgent measures to mitigate the impact of the increase in natural gas prices in the retail gas and electricity markets

On 14 September 2021, the Government approved a series of urgent temporary measures through Royal Decree-Law 17/2021, published in BOE of 15 September, in order to mitigate the impact of rising natural gas prices on the retail gas and electricity markets. They consist of a reduction in the remuneration received by certain electricity production installations, the reinforcement of protection for the most vulnerable electricity consumers, the implementation of fiscal mechanisms aimed at reducing the cost of the final electricity bill, the promotion of forward contracting of electricity through auctions and the limitation of the increase in the cost of the raw material included in the last resort tariff for natural gas.

By virtue of this regulation, the Government also introduces another series of significant updates in the field of water as well as in that of aid for the self-employed and companies derived from the Covid Line.

On Monday 20 September, the Ministry for Ecological Transition and the Demographic Challenge (the "Ministry"), given the importance of the approved regulation and the doubts raised regarding its application (particularly in relation to the mechanism for reducing the remuneration for the electricity production activity introduced by this provision) made public the response sent by this Ministry to the consultation made by the System Operator ("REE").

More specifically, the Royal Decree-Law, which came into force on 16 September 2021, introduces the regulatory, fiscal and economic measures detailed below:

The following measures have been introduced in the electricity sector:

• Temporary reduction in the remuneration received by certain electricity production facilities

Given its special relevance for the sector, and in particular for the profitability of certain renewable generation projects, and in view of the clarifications made by the Ministry regarding its content and application in practice, it is appropriate to begin by first analysing in greater detail the scope, purpose and effects of this measure, which is basically contained in articles 4 to 9 of the approved provision.

i. What does this measure essentially consist of?

The introduction of a mechanism to reduce the remuneration received on the wholesale market for electricity production, calculated on the basis of the higher income obtained by the facilities affected by the influence on the price obtained on the wholesale market of the high prices at which natural gas is quoted.

ii. Which installations are affected?

Those facilities that do not emit greenhouse gases (mainly nuclear, hydraulic and renewable) located in the Spanish peninsular territory, that do not have a recognised Specific Remuneration Regime nor have been awarded in any of the auctions carried out under article 14.7. bis of Law 24/2013, of 26 December, on the Electricity Sector, and whose net production power is greater than 10 MW.

iii. What is its purpose?

The objective pursued by the Government with this measure, according to the Explanatory Memorandum, is none other than to contain the impact on the electricity market of the unprecedented upward trend in the price of natural gas on international markets.

This is intended to correct the excess remuneration that, in the Government's opinion, electricity producers are receiving in the market due to this situation and the marginalist operation of the production market itself, and thus mitigate the escalation of electricity prices and their reflection in the electricity bill.

iv. What criteria will be taken into consideration to calculate the amount to be reduced in each case?

The Ministry has clarified that the reduction will only be applied in an amount proportional to the greater income obtained by the 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.

This means that facilities whose owners can prove that the energy produced is covered by a forward contracting instrument (PPAs) entered into prior to the entry into force of the regulation, which is subscribed at a fixed price (a price not indexed to the market price), and which has not been formalised between the generator and any company in the group for the sale of the energy produced to a marketer in the same group, will not be subject to this reduction mechanism in the first place.

However, in line with the criteria established by the Ministry, not being subject to the reduction will only correspond to the part of the energy that, not having been matched on the regulated market, is subject to PPAs with physical delivery, as well as that energy covered with instruments with financial settlement during the period of validity of the mechanism by the net selling position of the owner of the installation (in the latter case, the Ministry also provides a series of more specific criteria to be observed to determine the part of the energy that will be exempt from the reduction).

A relevant issue in this regard is also clarified by the Ministry in its document of Monday 20 September, which states that the documentary accreditation of the concurrence of these circumstances exempting the measure will be an obligation of the owner of the facility itself, which must collect and provide these documents to REE for subsequent verification and verification in conjunction with the CNMC.

v. How will this measure be implemented?

REE will calculate on a monthly basis the reduction of the corresponding remuneration for these facilities, which will also have to be settled and paid on a monthly basis.

The formula for calculating the amount to be reduced in each case is set out in article 7 of the approved regulation and, in summary, takes into consideration the total amount of electricity produced by type of installation in the last month (measured at power station busbars) as well as a variable indicating the degree of internalisation of the price of natural gas in the price of the daily electricity production market in the same month.

It should be noted that the measure incorporates a floor in the price of gas from which the measure is applied, of 20 €/MWh (taking as a reference the average price of the Iberian gas market), so that if the price of fuel is lower than this threshold, the reduction will be zero.

In this way, before the 15th of each month, the said operator will notify the companies affected of the amounts resulting from the reduction corresponding to the previous month, with the latter having a period of one month from the notification received to make the corresponding payment.

Said payments shall be considered as income to be settled by the system and shall be used to finance the costs of the electricity system charges and to cover, where appropriate, temporary mismatches between income and costs of the system itself.

vi. What will its implementation mean for the owners of the affected facilities?

The amount of the reduction on the market price is estimated by the renewable energy associations to be approximately 55% of the final price obtained by generators on the wholesale market.

This measure could seriously jeopardize the profitability of certain renewable generation projects that have price hedging instruments or forward power purchase agreements (PPAs) -the main associations in the sector, such as the Association of Renewable Energy Companies (APPA) and the Spanish Wind Energy Association (AEE), have expressed their views in this regard-, whose price mechanism is indexed to the market price. The same applies to those PPAs entered into by the generator with a marketer in its group, or those PPAs, whatever the price indexation formula, entered into after the date of entry into force of the Royal Decree-Law, which de facto affects the PPA market in the affected time period.

This is so if we take into account that by applying this measure, the owners of the facilities affected by it would be forced to sell their energy at a loss due to the impact of these reductions, insofar as it is not a settlement made by the market operator on the marginal price obtained from the sale of production, but a charge made by REE "ex post", which could exceed with some regularity, considering the current price of MWh on the electricity market, the fixed amount agreed by the generator with the PPA provider. This could result not only in significant litigation associated with the affected power purchase and sale contracts already signed and the potential default of the contracts signed with financial institutions, but also, ultimately, in the stoppage of the activity of these facilities to avoid incurring a negative result, which, in short, would reduce the supply of energy on the market, with a direct negative impact on the pool price, thus paradoxically achieving the opposite effect to that initially intended with the implementation of this measure.

vii. How long will this measure be in effect?

The measure will be in effect from the effective date of the rule, September 16, 2021, until March 31, 2022.

• Extension of the temporary suspension of the Tax on the value of the production of electrical energy

Article 2 provides for an extension for an additional quarter of the temporary suspension of the Tax on the value of electricity production established in Royal Decree-Law 12/2021 of 24 June adopting urgent measures in the field of energy taxation and energy generation, and on the management of the regulation tax and the water use tariff, thereby suspending this tax for the whole of the second half of the financial year 2021.

The measure is motivated, according to the Explanatory Memorandum to the regulation under analysis here, by the need to extend the measure agreed under Royal Decree-Law 12/2021 in view of the fact that the situation regarding wholesale prices taken into consideration at that time has continued to worsen.

• Reduction in the tax rate of the Special Tax on Electricity

The Sixth Additional Provision establishes, on an exceptional and transitory basis until the end of the year, the reduction of the tax rate of the Special Tax on Electricity, from 5.11269632 percent to 0.5 percent.

However, this reduction shall operate up to the minimum taxation limit harmonised at Community level in Council Directive 2003/96/EC of 27 October 2003 restructuring the Community framework for the taxation of energy products and electricity, set at 0.5 euros per megawatt-hour if the electricity is used for business purposes, and 1 per cent if it is used for other purposes.

• Measures to promote forward contracting

Article 3 provides for an auction system to finance the costs of the electricity system, with the aim of improving liquidity and competition in the forward markets.

In this regard, the approval by means of a resolution of the Secretary of State for Energy, following a report by the National Markets and Competition Commission (CNMC) of an auction calendar and the regulation by the same means of its essential aspects, such as the applicable method and settlement, among others, is foreseen.

• Increase in the amount of greenhouse gas emission allowances to be used to finance the costs of the electricity system

The First Final Provision increases the amount of greenhouse gas emission allowances to be used to finance the costs of the electricity system relating to the promotion of renewable energies from 1,100 million euros to 2,000 million euros.

• Extraordinary update of electricity system charges

The Third Additional Provision provides for a reduction in electricity system charges for the period between the date of entry into force of the regulation and 31 December 2021.

• Minimum vital supply

Finally, Article 1 regulates a minimum vital supply consisting of the extension for an additional six months of the four-month period that vulnerable consumers receiving the bono social eléctrico have to pay their electricity bill without interruption of supply.

The following measure has been introduced in the gas sector:

• Limitation for two quarters of the increase in the cost of raw materials included in the last resort tariff for natural gas

The Seventh Additional Provision introduces, as an exceptional social protection measure, a limitation for two quarters on the increase in the cost of the raw material included in the last resort natural gas tariff, in order to contain the impact on this tariff of the increase in the price of natural gas on the international market.

Finally, the following measures have been introduced in the area of water resources and direct aid to the self-employed and companies linked to the COVID Line:

• Rational use of water resources

Article 10 and the 3rd Transitional Provision provide for the specification of the criteria for the rational use of water resources established in article 55.2 of the Royal Legislative Decree 1/2001, of 20 July, approving the revised text of the Water Law.

These measures will affect those reservoirs greater than 50 cubic hectometres of total capacity, whose main uses are not irrigation, supply or other agricultural and livestock uses and are specified in the establishment of a minimum and maximum regime of average monthly flows to be released for situations of hydrological normality and prolonged drought, in addition to a regime of minimum volumes of reservoirs for each month.

• Modification of Royal Decree-Law 5/2021, of 12 March, on extraordinary measures to support business solvency in response to the COVID-19 pandemic

Lastly, the Third Final Provision provides for the extension of the temporary scope of validity of the extraordinary aid measures for the self-employed and companies framed in Royal Decree-Law 5/2021 (COVID direct aid line), so that the corresponding Administrations that have additional resources are empowered to make additional calls for such aid for the remainder of the year.

Should you wish to know more about the new regulations contained in the Royal Decree Law and their possible repercussions, please do not hesitate to contact one of our experts listed below or your usual contact at Osborne Clarke.