Ireland: Rapid change fuels opportunity

Author: | Published: 1 Oct 2008
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The island of Ireland is in a unique legal position when one considers the electricity market. Northern Ireland, part of the UK, is not usually mentioned in the context of Republic of Ireland law, but as of November 2007 we have had a single electricity market (SEM) for the entire island (including the Republic of Ireland and Northern Ireland). Indeed, work has already begun on developing a single gas market for the island as well.

The SEM may provide a template for future supranational electricity markets, particularly for those that are either small or geographically isolated. Where reference is made to state-owned or specific legislation, it is to what applies in the Republic of Ireland.

Historically the state-owned Electricity Supply Board (ESB) and Bórd Gáis Éireann (BGE) had, for all practical purposes, vertically integrated monopolies in electricity and gas respectively. Over the last 10 years, market opening has been achieved, with Viridian, Tynagh, Endesa and a host of windfarm operators joining the ranks of electricity generators. More recently there has been a substantial amount of consolidation in the market involving M&A activity in both the thermal and the renewable sectors. Crossover has also commenced, with BGE seeking to enter the renewable energy market.

When the SEM started in November 2007, the National Grid in the Republic of Ireland was run by the state-owned operator EirGrid and the transmission network in Northern Ireland was with SONI. Previously, ESB National Grid was the transmission system operator in the Republic. The transition to separate operation through EirGrid was not without controversy. The intention of the Irish Government is that the grid will be owned by EirGrid by the end of 2008. SONI was a subsidiary of Northern Ireland Electricity, in turn owned by Viridian. In August 2008, EirGrid announced that it was acquiring SONI. When all of this is completed, independent ownership and operation of the grid will be carried out by EirGrid. In the meantime the regulators ensure independent operation with no cross-subsidisation or sharing of information.

Regulator

The Commission for Energy Regulation (the Regulator) regulates the electricity and gas markets in Ireland. The powers of the Regulator have been increased regularly since the original enabling legislation in 1999. To enable the SEM to work, the Regulator has entered into memoranda of understanding with its counterpart in Northern Ireland (NIAUR) regarding electricity markets.

The Regulator oversees and implements the system of authorisation for building generation units and licensing for supplying electricity. It has a broad remit that includes ensuring that:

  • the lights stay on;
  • the gas continues to flow;
  • the prices charged are fair and reasonable;
  • the environment is protected; and
  • electricity and gas are supplied safely.

Having previously run a Generation Capacity 2005 Competition with a view to encouraging additional thermal capacity, in 2007 the Regulator entered into an agreement with the ESB whereby, in return for the ESB being allowed to build a new 430 MW combined cycle gas turbine plant in County Cork, the ESB was obliged to reduce its generation portfolio by selling existing plant. On July 31 2008, Endesa agreed to purchase two power stations, two peaking plants and two sites from the ESB; this is a substantial step towards achieving the Regulator's objective of reducing ESB's market share in power generation to 40% by 2010.

In recent times, price setting for retail/consumer electricity and gas prices has been one of the tasks with which the general public would probably most associate the Regulator, whereas the successful implementation of the SEM is much more noteworthy. The Regulator has relatively new powers in relation to electrical contractors and gas safety.

The SEM

The SEM unified the wholesale electricity markets in the Republic of Ireland and Northern Ireland. Substantial changes were needed, not just to the legislative/regulatory environment but also to bilateral arrangements such as offtake contracts. A new bespoke trading and settlement code was developed. A comprehensive market power mitigation strategy was needed. Specific enabling legislation was passed in the Republic of Ireland and Northern Ireland in 2007. The initial plan was that all generators would sell into a pool with any long-term arrangements being in the background in the form of contracts for differences. One exception was made for small (10 MW or less) renewable generators. After an extensive consultation process, the regulators agreed that other renewable generators could also be freed from the burden of full participation in the pool by appointing an intermediary (usually the other party to the offtake contract).

The pool

The electricity market operates on the basis of a gross mandatory pool. A single system marginal price (SMP) is set for each trading period based on a market schedule that assumes no constraints due to transmission limitations. The system also provides for capacity payments as well as compensation for any transmission system constraint.

Part of the market power mitigation strategy has been the imposition of directed contracts on ESB Power Generation. At the end of 2007 ESB had 44% of market share. The thinking behind the directed contract concept is that, because the regulatory authorities specify a price for contracts for difference, ESB has less incentive to submit uncompetitive high bids or hold back capacity to influence the market price. A continual review of the effectiveness of the SEM is achieved through an SEM committee consisting of members from the Regulator, NIAUR and an independent member, with various market oversight committees dealing with day-to-day matters.

Demand for electricity has been rising, seemingly inexorably, on the island and there have been frequent concerns about whether there is sufficient capacity during times of peak demand. Ireland has substantial renewable resources (it's windy here) and some aspire to the island being a source of renewable energy for other places. In a move that accommodates both views, EirGrid will build a 500 MW interconnector between the east coast of Ireland and north Wales by 2012. The marine survey was completed in May 2008 and connection offers have been achieved at both ends of the route. Imera, an independent company, has similar plans. Building new interconnectors (both north/south to link with Northern Ireland and east/west to link with Wales) are an important part of the energy strategy for the island.

Price movements

The recent substantial increases in the price of oil and gas have resulted in the pool price in the SEM increasing to the extent that we have gone from a position where the Renewable Energy Feed in Tariff (REFiT) price for large-scale wind exceeded the best new entrant price in 2005 to a situation last year where the best new entrant price was almost 50% more than the REFiT (large-scale wind) price.

Such substantial movements in relative pricing positions have inevitably resulted in generators seeking opportunities to operate as merchant plant. One windfarm has already cancelled its long-term offtake contract and refinanced its bank debt with private equity. That was an established operation with a track record of production and a modest loan to value ratio. High loan to value ratios, combined with the tightening of credit and bank caution about the volatility of fossil fuel prices, means that it is unlikely that a windfarm in the course of construction or in the early stages of production would be able to follow this example. However, there may be developments with private equity providing mezzanine funding, or it may even get to the stage where a bank will be prepared to refinance long-term debt through consenting to an established operator with a relatively low loan-to-value ratio participating in the pool in return for accelerated repayment of the bank debt.

The English pool experience in the nineties is a salutary one for Ireland. Efforts have been made to restructure projects so that the generator procures a supply licence to come within REFiT rules and thereby obtain the comfort of a floor for the price of electricity produced. However, this is not without risk or legal uncertainty. REFiT was put in place and (eventually) received state aid approval from Brussels on the basis that the various forms of renewable energy production needed state support through artificially high pricing or else the generating units would not be built. While this rationale still has validity in relation to the younger and less developed sectors such as offshore wind and ocean energy, at the moment it does not apply for onshore wind, biomass or hydro when one compares the REFiT pricing with what the pool will pay.

The pool pays more than REFiT in each of the latter three categories. Other state assistance (such as capital allowances) has been changed where the original need had passed or undue use was being made of it.

Planning law

The Planning and Development (Strategic Infrastructure) Act 2006 (2006 Act) was enacted to make it easier for important infrastructure developments to obtain planning permission quickly. Previously such applications (as with other planning applications) would have to go through at least two stages before obtaining planning permission. The first would be an application to the local planning authority and the second would be an appeal to An Bórd Pleanála (the Irish planning appeals board). Under the 2006 Act, any developer with a project that qualifies as either important energy infrastructure, transport infrastructure or environmental infrastructure can now go straight to An Bórd Pleanála, albeit with a substantial application fee.

Among the types of development that can generally avail of the 2006 Act are a windfarm with at least either 50 turbines or a total output of 100 MW, an oil pipeline of at least 20 kilometres and associated facilities, a thermal power station and an LNG facility. It is important to appreciate that the new process does not mean that the application is without public review. The applicant must obtain an environmental impact statement and a notice appears in a national newspaper. Ultimately, it is for An Bórd Pleanála, an independent public body, to decide whether the project qualifies under the 2006 Act for the fast track process, and an oral hearing may be required by An Bórd Pleanála.

The 2006 Act also made interesting changes to the law in relation to electricity transmission and strategic gas infrastructure. There had been uncertainty in Irish law about whether state authorities required planning permission to carry out developments. This was clarified in 2000 when an approval process akin to but not the same as planning permission was introduced. The 2006 Act has now specified that, where the development is for the purpose of electricity transmission (a high voltage line or an interconnector, for example) or where it is a strategic gas infrastructure development (whether down-stream or up-stream and including associated facilities), an application must be made to An Bórd Pleanála for approval. In other words, while planning permission is not required, an approval process must be followed.

In addition, the Department for the Environment has fed into the overall planning process by producing local planning authorities guidelines regarding wind energy development (in 2006, updating those previously issued in 1996).

Oil and gas

In 1996 a gas field known as Corrib was discovered off the west coast of Ireland. Bringing the gas onshore has proved to be a time consuming and sometimes fraught task. There have been repeated public protests in and around the location of the planned landfall for the offshore pipeline and where the onshore terminal is being built. While protestors were jailed for contempt of court at one stage, various forms of disruption continue.

Corrib was the first big stand-alone gas discovery offshore of Ireland since the seventies (when the Kinsale Head Gas Field was located off the south coast of Ireland). Other more recent exploratory work close to the Kinsale Heads Field has resulted in, for example, the Seven Heads Gas Field coming on stream approximately five years ago without any noticeable upset, using Kinsale Head infrastructure.

In general, oil and gas exploration has taken place offshore. Ireland has very substantial territorial seas with significant oil and gas potential. Prospecting requires a licence and the relevant Government Department stresses the quality of the exploration programme in deciding the matter – it is not an auction. The increase in fossil fuel prices has made Ireland a more attractive location for exploration, and there has been increased interest in obtaining the relevant authorisations.

Renewables

The Government of Ireland includes two Green Party ministers, so it is not surprising that there has been a focus on what can be done to encourage the production of electricity from renewable sources. However, there is a general acceptance of the need to use renewable sources for producing electricity. For example, the 2007 White Paper Towards a Sustainable Energy Future for Ireland was published before the Greens joined the ruling coalition and it set targets for the period up to 2020. The original 2010 target of 13.2% for electricity was increased to 15%. Within this, bio fuels, CHP and biomass were given specific targets. The 2020 overall renewable target was 33.33%, with a figure of 40% discussed for the intervening time.

Government encouragement to the sector has been through a mixture of tax breaks (corporate tax relief through s486b, business expansion scheme relief and capital allowance schemes) and guaranteed prices through the alternative energy requirement (AER) programmes. REFiT is the latest government initiative, dating from 2006. This was a departure from the previous arrangements, as the focus of REFiT is on paying the suppliers rather than increasing the price to be paid to generators. Among the successful projects, wind predominates. Generation capacity of in excess of 600 MW is to benefit from this programme. Originally it was intended that 400 MW would benefit but such was the response and given the growing concern about environmental impact, additional support was agreed. Delays were encountered in getting state aid approval from Brussels, but the implementing statutory instrument has now been published (July 2008).

The previous AER programmes were focused on the ESB taking the electricity produced by the projects. REFiT enabled other suppliers to benefit as well, mirroring the opening up of a competitive market in wholesale electricity supply.

Grid access

Ireland has been a victim of its success in relation to renewable projects. The grid was not designed to take a multiplicity of relatively small units providing electricity in a form that was not dispatchable. EirGrid warned the Regulator that fundamental problems would arise if windfarms continued to be added on a case-by-case basis. The Regulator entered into an extensive consultation process and then decided to have a gate access system whereby batches of windfarms would be approved from time to time. The Regulator had to achieve a balance between the requirements of each individual project in terms of getting to market and the overall national interest of getting as much renewable sourced electricity in production as quickly as possible in a way that would not impair the operation of the national grid.

In tandem with this, a very substantial investment programme has been announced by Eirgrid to embark on a capital investment programme to improve the infrastructure of the National Grid.

Planning expiry

An unfortunate consequence of the inevitable delay that the gate access system has given rise to has been that the life of planning permissions has been expiring or coming close to expiration before the windfarm has been built. One of the key issues at financial close for project financing of renewable projects has been whether there was a sufficient buffer between expected construction completion and the date on which the planning permission would expire.

One can obtain a time extension from the local planning authority where substantial works have been completed in a reasonable time and if the whole development will be completed within a reasonable time. There is no common approach by the various planning authorities as to what substantial works means. For example, a prospective operator may have invested much money and time in carrying out wind tests, analysing wind map data, negotiating leases and wayleaves from local landowners, arranging for appropriate qualified advisers to analyse the project, retaining suitable contractors and securing the necessary grid access and wind turbine supplies without having anything physically done on site other than the erection of an anenometre. The current law gives the planning authority a wide discretion in applying the tests. The notion of works relates to physical items and arguably a broader concept, such as preparation, is now needed to take account of the reality that on many wind projects, while construction may have been delayed and while grid problems are being sorted out, there is nevertheless substantial time, money and preparation being powered into the other aspects of the project in parallel.

Public-private partnerships

The acronym PPP has been attributed to many projects that would not fit into the usual definition. A buoyant economy, a manifestation of the so-called Celtic Tiger, enabled the Republic to directly fund many projects, but that healthy budgetary position is changing rapidly. We have the benefit of legislation such as the State Authorities (Public-Private Partnership Arrangements) Act 2002, which gives certainty of the power of public authorities to engage in public-private partnerships.

The National Development Finance Agency (NDFA) has the power to enter into PPPs with a view to transferring them to the relevant state authority and/or to act as agent for state authorities for PPP procurement. The NDFA also provides advice to state authorities, including government departments, to assist them in evaluating financial risks and costs of public investment projects, considers financing options and may raise finance for public investment projects.

Broader legal environment

Ireland has a common law system with a written constitution that protects private property rights. As a member of the EU, much of the liberalisation of markets such as electricity and gas has been instigated to comply with EU requirements.

Our corporate law is similar to, but not the same as, that in England. We continue to have the ultra vires rule and whitewash for financial assistance. The floating charge concept is well recognised. Taking fixed security over book debts is possible, but case law is not as clear as it might be as to how one draws the dividing line between fixed and floating security.

A special division of the High Court deals with commercial disputes. This commercial court has rapidly developed a strong reputation for its prompt and practical approach to disposing of its business. Choice of law and choice of forum in agreements is allowed in the usual manner pursuant to the Rome Convention on the Law Applicable to Contractual Obligations and the Brussels Regulation on Jurisdiction of the Courts and Recognition of Judgments in Civil and Commercial Matters. The New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards has been ratified in Ireland.

As well as receivership, which would usually be triggered by the security holder, an examiner can be appointed to freeze matters for a relatively brief period to allow for a rescue of all or part of the business. Due to concerns about the latter process being open to use mainly to frustrate the security holder, a higher threshold of an independent accountant's report that the entity appears to have a reasonable chance of success now applies.

The energy market in Ireland has been experiencing a period of rapid change, which is likely to continue as an all-island gas market is developed. There are many opportunities for project finance, and the recent downturn in the health of state finances must give rise to more through public-private partnerships or similar structures.

By Kevin Hoy of Mason Hayes + Curran