The German electricity sector has changed profoundly since deregulation in 1998, with around 200 new suppliers drawn in to a market with consumption of 500 TWh/yr and an annual turnover of euro 53 billion (US$65 billion). Perhaps most significantly renewable energy has, flanked by legislative measures and the planned phase-out of nuclear power, become a sizeable energy source and an important industry sector in Germany.RE Insider – March 15, 2004 The legal background Key provisions affecting energy-related business in Germany can, apart from general cartel law, mainly be found in three Acts: the Energy Industry Act 1998 (EnWG), the Renewable Energy Sources Act 2000 (EEG) and the Act on Combined Heat and Power Production 2002 (KWKG). The EnWG sets out the licensing requirements for supplying energy. Exceptions are made for electricity exclusively supplied to distributors and, in certain cases, for energy generated from more than 50% renewable sources or in combined heat and power facilities. Apart from measures to ensure compliance with the EnWG, German law does not provide for any specific public supervision of investments in energy infrastructure. General planning law and environmental protection are considered to give sufficient protection. The EnWG aimed to provide an open market system based on negotiated third-party grid access on a nondiscriminatory basis. After an enthusiastic start, however, difficulties arose which the Federal Cartel Office was unable to fully address, including the wheeling of energy and related charges (amongst the highest in Europe), together with the new EU Electricity Directive adopted in June 2003. These have forced the German government to refocus towards regulated grid access. As a result a new regulatory authority will be installed by July 2004. Furthermore, the EU requirement for legal unbundling, i.e. the separation of grid operations and other activities into different legal entities, will result in additional legal changes and will have a further impact on the German market. Whereas the EnWG’s basic objective was to open the German energy market and to ensure a low price level for energy, the EEG focuses on the promotion of energy generated from certain renewable sources. This is intended to reduce emissions, increase diversity of energy sources available and encourage development of related technologies and investment in Germany. However, in contrast to the coal industry, which received public subsidies in aggregate of around euro 4.4 billion (US$5.3 billion) in 2002, decreasing to euro 3.5 billion (US$4.2 billion) in 2004, the promotion of renewable energy is not paid for by the state. Instead, the EEG obliges grid operators to connect to renewable energy power plants of a certain maximum capacity and to purchase electricity produced from solar energy, hydropower, wind power, geothermal power and biomass at high but decreasing statutory rates. The EEG provides a guaranteed operating time of up to 20 years, helping to stimulate investment. Grid operators, however, may be obliged to upgrade their networks at their own expense to enable access. Accordingly, the question of when necessary grid investments constitute a simple granting of access, payable by the energy generating company, or an upgrade, payable by the grid operator, is heavily disputed by all parties. The surcharge payable by grid operators under the EEG is partly compensated by a nationwide balancing system and may, in general, be added to the consumers’ electricity bill. Accordingly, in June 2003 the German Federal Supreme Court (BGH) did not find any violation of the constitutional rights of grid operators. However, the latest amendments to the EEG allow companies of certain energy-intensive production sectors to apply for a limitation on their purchase of renewable energy, provided it is proven that their ability to compete would be seriously affected should they pay the full price. Amendments to the EEG are expected in the near future, the details of which are heavily disputed within the German government. Among other changes, the amendments are expected to include additional sources of renewable energy, shift subsidies for wind power from coastal to offshore facilities and restrict the promotion of electricity produced from hydropower to modernized high-capacity plants. About 10% of Germany’s fossil-fuel based electricity is generated by cogeneration. Supplementing the EnWG and the EEG, the KWKG ensures profitable operation of CHP plant, encourages modernization of less efficient cogen plant and stimulates the creation of smaller facilities for de-centralized power supply. It provides a decreasing bonus system until 2010, with total bonuses of approximately euro 4.5 billion (US$5.5 billion), (the maximum ordinary bonus is about euro 1.53-1.74 cents/kWh, but smaller facilities may receive bonuses of euro 2.56 cents/kWh or euro 5.11 cents/kWh for the use of fuel cells). As for the fixed prices under the EEG, this surcharge is payable by the grid operators but can, in principle, be passed on to the consumer. Important recent decisions – access and obligations The legislation described above may seem to provide a comprehensive legal framework for Germany’s energy sector. However, the complex nature of these laws and the subsequent issues that are arising, as well as the remaining market power of several larger players, have led to some interesting recent court decisions. In the past, grid operators have tried to escape from, or at least delay, the economic consequences of their access and purchase obligations under the EEG by proposing unbalanced contractual terms, resulting in drawn-out pre-contractual negotiations. They argued for the possible invalidity of their obligations and interpreted the law in such a way that it led to generating companies’ claims for access and payment requiring the prior signing of an energy supply contract between the generating company and the grid operator. In June 2003, the BGH clarified that this was not the case. It is now commonly understood that energy producers can directly claim access to grids and payment for electricity provided. This claim does not require an energy supply contract between the parties as the key obligations (e.g. the purchase price) are laid down by the law. The court also rejected the energy supply companies’ arguments concerning an invalidity of their EEG obligations under German constitutional law and European law on subsidies and free trade. The former because of grid operators’ dominant market position and the nationwide balancing system limiting economic effects, and the latter because of an ECJ ruling on 13 March 2001 which affirmed the legislation’s conformity with EU law. As a result, energy-generating companies falling within the scope of the EEG do not need to restrict their legal actions to the agreement of an energy supply contract but can sue directly for payment. They may also be entitled to claim damages if the grid operator refuses to pay for energy before an agreement has been reached. In reaction to the decision grid operators have expressed concerns that the lack of contractual arrangements may affect the reliability of electricity supplies in general. The reason for this is that without an agreement relating to the management of production levels, the grid operators cannot effectively react to bottlenecks which may lead to under- or over-capacities. Charging of surcharges under ongoing contracts Another question arising under German energy law is: “When can energy suppliers pass on the additional expenses incurred under the EEG and KWKG to their existing clients?”. The BGH is expected to make a ruling, by the end of this year, on whether price adjustment clauses used in the past allow costs to be passed on. In the past, long-term energy supply contracts frequently included price adjustment clauses which obliged consumers to bear the costs of “energy-related taxes or public charges of any kind”. Based on this provision, energy suppliers passed on the additional expenses arising from the EEG and the KWKG until this was ruled to be illegal by two higher regional courts. Because neither the fixed prices under the EEG nor the surcharges under the KWKG are payable to the state, the courts held that they could not be considered as “taxes or public charges of any kind”. In addition, it was held that the law itself does not allow energy suppliers to modify existing contracts and pass the costs on, and that the situation does not warrant modification of contracts by the courts, as the parties were generally aware of comparable price risks when entering into such agreements. Should the BGH affirm these judgments, which is likely, energy suppliers are only entitled to pass on the costs if this has specifically been provided for in the underlying contract. Ordinary price adjustment clauses, as mentioned above, will need to be amended and existing contracts terminated and/or re-negotiated where possible. (Re-)Measuring of electricity delivered It is in the interests of grid operators to (re-)measure the electricity received from third parties. Accordingly it has, until recently, been common practice for them to charge energy-generating companies the costs of (re-)measuring, normally by deducting measuring costs from the price payable under the EEG. However on 12 September 2003, the Higher Regional Court of Hamm clarified that grid operators are not entitled to deduct such charges unless this has been specifically agreed between the parties. The court held that the responsibility for measuring supplied electricity rests with the energy generating company, which must therefore bear the relevant costs as far as measurement is necessary for the sale and the calculation of the purchase price. However, generating companies are not obliged to accept measuring charges from grid operators, but can take the relevant measurements themselves or instruct third parties to do so. Furthermore, if an generator already operates a suitable measurement device, the costs of any re-measurement by the grid operator, or for the grid operator’s inspection of the measuring device, are not deductible. Because this recharging of the (re)measuring costs was common practice throughout Germany, and by virtue of the number of similar cases anticipated, the OLG has granted leave for an appeal to the BGH, underlining the fundamental importance of this issue. Forecast – clarification via the courts to continue In the near future the German energy sector is likely to face legislative changes which will make it even more necessary to keep an eye on future court rulings. Legislation and court decisions should, however, also create further business opportunities for new or flexible players in the German market, which is estimated to require about 40,000MW of new capacity by 2020. Article originally published in Power in Europe, Issue 413 / 10 November 2003 About the author… Markus Strelow heads private equity in Germany and has been with Ashurst Frankfurt since its foundation. Ashurst Frankfurt is the German division of Ashurst, an international law firm advising corporations and financial institutions, with core businesses in M&A, corporate and structured finance. He is qualified as a German Rechtsanwalt. Markus specializes in leveraged buy-outs and venture capital and has extensive experience in giving general corporate and finance advice to German and international clients including, in particular, mergers and acquisitions and joint ventures in the global market.