Analysis by Andreas Gunst: Removal of the United Kingdom Climate Change Levy Exemption

14 July 2015

The United Kingdom´s Climate Change Levy (CCL) was introduced in 2001 under the Finance Act 2000 with the aim of taxing the energy usage of non-domestic consumers  with the exception of the transportation sector. An exemption system was introduced to allow consumers of renewable source energy to avoid paying the CCL, by means of the levy exemption certificate (LEC) system.

Operators of United Kingdom resident installations and foreign installations could obtain accreditation for the scheme and receive LECs. These would ultimately be sold together with the underlying renewable source electricity to suppliers in the United Kingdom who would claim exemption on behalf of their consumers.  LECs would be sold with other evidentiary instruments such as guarantees of origin and generator declaration for the purpose of fuel mix disclosure (FMD), feed-in tariff levelisation benefits, related determination of green excluded electricity under the contracts for difference (CfD) scheme and as evidence on 'green tariff' products. The appertaining commercial benefit was usually priced into the LEC price.  

In the United Kingdom´s 2015 Budget, announced on 8 July 2015, Chancellor George Osborne claimed that as the United Kingdom has established a long-term framework for investment in renewable energy, the CCL exemption scheme, and therefore the LEC scheme, shall be removed. It is from the announcement not fully clear whether the exemption will be removed for both national and foreign installations, or just the latter. The explanation for the change appeared to be mainly concerned with foreign installations. 

This note will briefly outline consequences of the removal of the CCL exemption regime on relevant agreements, notably:

§  agreements for the delivery of LECs and guarantees of origin/generator declarations;

§  agreements for the delivery of renewable source electricity into the British  electricity market; and

§  agreement for the purchase of interconnection capacity and transmission services on interconnectors into the British  electricity market.    

Deadline and transitional period

It is suggested that the relevant legislation will be introduced in the Summer Finance Bill 2015 to amend paragraph 19 of Schedule 6 to the Finance Act 2000, so that any renewable source energy generated on or after 1 August 2015 will no longer be eligible for the CCL exemption. This amendment will enter into force at midnight on 31 July 2015.

A transitional period will however apply for suppliers who have purchased renewable source energy and LECs relating to renewable source energy generated prior to 1 August 2015. They will be allowed to continue making CCL-exempt supplies under the existing or new renewable source agreements. These suppliers may continue allocating LECs to renewable source agreements during the transitional period, until the earlier of: (i) the transitional period ends, or (ii) the supplier´s credit balance is used up.

Regulator (Ofgem) has provided further guidance on the changes which suggest that despite the removal of the CCL exemption, LECs will still be issued and can be used (together with related guarantees of origin) for FMD and feed-in tariff levelisation, as well as use them to demonstrate the supply of renewable source electricity under 'green tariffs' to customers as well as green excluded electricity under the CfD scheme. Ofgem has, however, also suggested that it is in the process of reviewing these procedures during the transition period.

Effects on the LEC agreements and related contractual arrangements

LEC Agreements and Renewable PPAs

United Kingdom installations have usually sold their LECs under a power purchase agreement (PPA) together with the electricity, ROCs, REGOs and embedded generation benefits. However, there have also been (secondary) sales of LECs under the dedicated LEC agreement. Foreign installations only sell LECs under a dedicated LEC agreement, and often via aggregators. 

There is no LEC agreement standard in the market as such, although a number of agreements reflect similar concepts and terms. The agreements can be either single transaction or master agreements. They are also subject to different governing law, including for instance England &Wales, Norway or Germany. This does not allow providing a general view on the legislative changes. However, the following points may highlight common issues:

-          Representation & Warranties: There is often an express representation on usability of the LEC for CCL exemption. However, it is customarily given at time the agreement is entered into, or, in the case of a master agreement, an individual transaction is entered into. This would limit new transactions for post July 2015 renewable source electricity and LECs. The proposed changes would however not lead to a breach by the seller.

-          Illegality: Some agreements provide for situations where the trading of LECs becomes illegal or unlawful. As Ofgem's guidance suggests that LECs will still be issued and can be traded and used for other remaining benefits, this is unlikely to be triggered.

-          Invalidity/Change in Law: Most agreements regulate an event where a LEC becomes invalid or cannot be used anymore.  A number of agreements cover the cases where the buyer is unable to realise "the full economic value" or the "redemption value". Whilst there will still be commercial value in the remaining benefits, it is likely that this clause is triggered.

However, these clauses can also provide that in case of such triggering event, a party is unable to perform its obligations. This may, however, be questionable since the delivery of LECs is still possible (for some other benefits). Since there is no permanent representation on the usability of LECs for CCL exemption, it may be argued that even through LECs and associated benefits have been used for a variety of circumstances, the main purpose of the trade was to achieve exemption from the CCL and therefore the ability of the LEC to attract CCL exemption was an implied term. 

-          Force Majeure: Whilst the Change in Law provision usually expressly prevail over the Force Majeure provisions, in some contracts that do not provide for Change in Law, this clause may be applicable. The question whether or not it applies is similar to that discussed in Change in Law above, i.e. if an implied term as to exemption from CCL exists, it will be impossible for a party to perform its obligations thus be treated as an event of Force Majeure.

Some of the aforementioned points are similarly relevant for LEC sales under PPAs, to the extent the CCL exemption is also removed for national generation. It is worth noting that the scope of relevant changes in law events are different and remedies are different, with a greater emphasis on adjustment of the PPAs pricing terms. This reflects the role of LECs as essentially 'by products' under PPAs, compared to LEC agreements, where they are the principle product. 

It is also worth noting that the remedies envisaged by the LEC agreements in the above mentioned cases are different. They can encompass automatic termination, right to terminate, unwinding of entire transactions with obligations to return LECs and pay for them, obligations to negotiate contract adjustments, and suspension. 

Even more diverse is the landscape of agreements between aggregators and installation operators for LEC accreditation and purchase of renewable source electricity. Here the provisions are usually not as detailed as in the context of LEC agreements, and not all agreements foresee a cross-termination or back-to-back treatment between the LEC agreement and the agreement with the installation operator.  Whether or not a termination right is implied will turn notably on the law applicable to those agreements. 

Other Power Purchase and Transmission Capacity Arrangements

The LEC agreements, notably relating to renewable source electricity produced outside the United Kingdom, will be related to agreements that have been concluded to demonstrate that the electricity produced by the installation that received LECs has been transmitted into the United Kingdom.

The impact of the potential change in law on these agreements is more complex. Some LEC agreements have been concluded together with individual transactions under an electricity sales master agreement, e.g. the EFET General Agreement for electricity sales. In the majority of cases there is no express cross-termination provision. There is also no change in law provision or, if added to the agreement as additional terms (as has been done by some participants), its wording appears to be generally too broad to capture the proposed change in law on the CCL exemption. Force majeure would equally not be applicable as electricity delivery/acceptance can still be performed. In some cases, the LEC agreements however intended to create a nexus and, in one form or another, expressed that termination of one agreement should also lead to termination of the other. In such a case it is possible that the agreement for the related sale of renewable source electricity is brought to an end as well.

In most cases, however, the trading of renewable source electricity is done on a short term bilateral basis, and, in the transmission systems covered by market-coupling, through buy and sell bids on the relevant exchanges. In practice, the exposure to agreed sales of renewable source electricity without an underlying LEC sales transactions may be limited.  

In addition, depending on the choice of a delivery point in the LEC agreement, there may be additional exposure under agreements for purchase of transmission capacity and related transmission on the interconnectors, notably the IFA.  The IFA access rules do not provide for a separate change in law provisions. They recognise in Rule A4 that changes in law which have an effect on the Rules will lead to amendments to the provisions. The force majeure provision under Rule F5 is unlikely to be triggered by the proposed change in law on the CCL exemption.  In the case of agreements on secondary transmission  capacity and related services, however, market participants have often included a provision that relate to the existence of the CCL regime and it would appear possible that these can be terminated. 

What to do next

Whilst the full scope of the revocation of the CCL exemption is not fully clear, most parties will struggle to form a definite opinion on how to approach the contracts and the related exposure. Given the short timeframe, it is however prudent to start some review and preparation activities now, including:

§  forming a view on whether you wish to continue trading for the enduring benefits (FMD, FiT levelisation);

§  approaching counterparties and reserving your rights accordingly;

§  a review on the LEC agreements, notably the clauses outlined above and any related implied terms under the governing law of the LEC agreements;

§  a review of Renewable PPAs; and

§  a review of the nexus with other agreements on transmission capacity, transmission services and purchase of renewables source electricity or aggregation services.

 

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Andreas Gunst-

Solicitor England and Wales

Partner, DLA Piper, London & Vienna

Email: andreas.gunst@dlapiper.com