Court of Appeal provides guidance on modifications to energy code

The case of R. (on the application of SSE Generation Ltd (SSE)) v Gas and Electricity Markets Authority (GEMA)¹ raises important issues in relation to the operation of the system for the setting of charges for the transmission of electricity.

Key takeaways

This case raises issues of commercial significance to network operators, as well as important issues of public law which will be of interest to regulators.

• The Court of Appeal held that "congestion management" costs must be included in the calculation of transmission charges, meaning that they will be subject to a cap within permitted ranges (which will be of commercial benefit to operators).
• GEMA, as regulator, had a discretion to introduce an interim "stop gap" solution which was not wholly compliant with the law, as part of its long-term plan to ensure compliance.
• The Court also reiterated the important principle of public law that a public decision maker cannot prevent itself from complying with its statutory duties by entering into, or approving, an inconsistent private law contract.

Background

The Connection and Use of System Code (the Code) is the contractual framework for connecting to and using the National Electricity Transmission System. It sets the charges to be paid by generators to use that system.

This case concerns a decision by GEMA (GEMA Decision) to modify the Code to implement GEMA's view of the correct interpretation of EU Regulation 838/2010 (the Regulation). The Regulation establishes a mechanism for the compensation of transmission system operators for the costs of hosting cross-border flows of electricity and provides for a common regulatory approach to transmission charging.

The Regulation provides at Annex B that annual average transmission charges should be within specified ranges. Paragraph 2 of Annex B provides that, for the purpose of calculating those ranges, transmission charges should exclude (amongst other things):

• charges paid by producers for physical assets required for connection to the system or the upgrade of the connection; and
• charges paid by producers related to ancillary services.

Prior to the GEMA Decision, the Code's charging methodology did not comply with the Regulation. However, the modifications in the GEMA Decision also did not comply with Annex B to the Regulation, although they provided for an interim regime that was closer to compliance.

Interim solution issue

GEMA's modification to the Code meant that charges would be within the specified ranges, as required by Annex B, but did not exclude physical assets from the calculations. GEMA had therefore modified the Code so that it only partially complied with the Regulation. This was intended by GEMA as an interim "stop gap" solution to prevent transmission charges outside the specified ranges, pending full resolution of the issue.

Congestion issue

A further issue was GEMA's definition of "congestion" (where there is a physical blockage or bottleneck impeding the flow of electricity) and "congestion management", and how this affected the calculation of the ranges under Annex B.

There are many costs associated with managing congestion on a network. If those costs were to be considered an "ancillary service" under Annex B paragraph 2, they would be excluded from the calculation of transmission charges and fall outside the charge limits in that Annex. The interpretation of "congestion" therefore could have a significant commercial impact on operators.

GEMA's position was that "congestion" only referred to costs attributed to the management of congestion on interconnectors governing international trade between EU Member States. This meant that costs attributable to congestion management elsewhere in the transmission system, for example within Great Britain, were not to be included when calculating the permitted range under Annex B. Accordingly, they would not be subject to the limits imposed by Annex B.

High Court judgment

SSE, an electricity generator, brought a statutory appeal of the GEMA Decision to the Competition and Markets Authority (CMA), which upheld GEMA's decision. SSE subsequently sought judicial review of the CMA's decision to uphold the GEMA Decision, as well as of the GEMA Decision itself.

In relation to the interim solution issue, the High Court held it was unlawful for the CMA to approve the GEMA Decision endorsing the imposition of charges which did not comply with the Regulation, even if introduced as an interim measure.

However, in relation to the "congestion" issue, the High Court upheld the conclusion of the CMA and GEMA that the only congestion management costs falling outside of the exclusion for ancillary services under Annex B of the Regulation were those relating to congestion management on interconnectors between EU Member States.

Court of Appeal judgment

The Court of Appeal heard two appeals:

(1) an appeal by GEMA in relation to its power to adopt interim measures which include non-compliant components (the interim solution issue); and

(2) an appeal by SSE concerning the treatment of congestion management costs (the congestion issue).

Interim solution issue

The Court of Appeal noted that this case involved a situation where a regulator (GEMA) was confronted with circumstances in which a system (in this case, a charging regime) was not compliant with the law, and so was required to devise a solution to bring the system into compliance. This could not be brought about easily or immediately. GEMA's expert judgment was that a transition to a state of compliance would be best achieved in two stages, meaning the first stage would still fall short of compliance with the law (despite being a significant improvement upon the status quo).

The issue to be determined by the Court of Appeal was whether, in adopting such a non-compliant stop gap/interim solution, the regulator was acting lawfully.

The Court of Appeal held that GEMA enjoys a relatively broad margin of discretion and judgment in identifying a solution to bring the charging regime into compliance with the Regulation. On the facts of this case, the Court found the GEMA Decision to be lawful, even though it involved the temporary adoption of a methodology which might have created a transient risk of non-observance.

The Court also emphasised that the Code (a private law contract) cannot take precedence over the statutory duty of GEMA to ensure timely compliance with the law. Accordingly, if there is a conflict between the Code and the statutory duties of GEMA, the latter prevail. Nothing in a private law contract can override or permit a departure from an overarching obligation to secure compliance with the law (as set out in Annex B). The Court did not consider that GEMA had taken such approach, and that the logic of its decision was that its duty was to ensure ultimate compliance (despite the "stop gap" being the only practical option in the interim).

The Court of Appeal therefore allowed GEMA's appeal on the interim solution issue.

Congestion issue

The issue to be determined by the Court of Appeal in relation to “congestion management” was whether the costs of managing certain aspects of network congestion must be included in the calculation of transmission charges.

The Court of Appeal noted that "very substantial sums of money rested upon the correct meaning of this expression", highlighting the potentially significant commercial impact on generators. Were all costs attributable to congestion management to be taken into account when calculating transmission charges, they would be subject to the cap (or permitted ranges) on transmission charges levied on generators by network operators.

A since repealed 2009 Regulation defined "congestion" as referring to congestion at interconnectors between different states which impeded international trade. However, this definition was changed in the 2019 Recast Regulation, which removed reference to interconnectors and international trade between states, and repealed the 2009 definition. This position has since been complicated by:

• the transposition of the relevant 2019 EU measures into EU retained law, which adopted the 2009 repealed definition of "congestion"; and
• the contrasting position set out in the version of the law applicable under the Northern Ireland Protocol, which adopted the most recent 2019 EU definition.

The question before the Court of Appeal was whether "congestion" was to be interpreted as referring to the costs of congestion management only on interconnectors governing international trade, or, on the entirety of a transmission system wherever it arises.

The Court of Appeal allowed SSE's appeal, finding that when the GEMA Decision was taken, the governing definition of "congestion" was the 2019 Recast Regulation. This provided that congestion was not limited to problems arising across international interconnectors, and that ancillary services excluded congestion management. Charges for congestion management therefore fell outside of the ancillary services in Annex B, and so were required to be included in the calculation of transmission charges.

Comment

The Court of Appeal's finding on the interpretation of "congestion management" is significant for commercial operators. As a result of the Court finding that congestion management costs must be included in the calculation of transmission charges, they are now subject to a cap, which will be of commercial benefit to generators.

The case also raises important issues of public law, which will be of interest to regulators. The Court of Appeal took a practical and pragmatic approach to the interim solution issue, acknowledging that it may be permissible for a regulator to adopt an interim solution which is not wholly compliant with the law when seeking to rectify a non-compliant regime. Further, the Court highlighted that in the case of a conflict between the Code (a private law framework) and a regulator's statutory duties, the latter will prevail. It is a fundamental principle of public law that, a decision maker cannot prevent itself from complying with its statutory duties by entering into, or approving, an inconsistent contract.