The Pricing of Access to an Important Project of Common European Interest

The Pricing of Access to an Important Project of Common European Interest - m 7 2

Infrastructure that is commercially exploited [e.g. charging of tolls] is an economic activity. Infrastructure that is freely available to users is not economic activity. Access fees or tolls may be regulated. State aid must be necessary and proportional even if access fees are regulated.

 

Introduction

This article examines Commission decision SA.39078 concerning the Fehmarn belt fixed link in Denmark.[1] This is an unusual case because the State aid was approved on the basis of Article 107(3)(b) which exempts aid to important projects of common European interest [IPCEI]. The only other measure that has been approved recently on the same legal basis is the aid for the construction of the Oresund link between Denmark and Sweden [see SA.38371 which was examined in an article published on this site on 23 December 2014][2].

In the present case, the purpose of the aid was to finance the construction of road and rail connections between Denmark and Germany, which form part of broader transport networks between Scandinavia and central Europe. Similarly to the Oresund link, part of the Fehmarn project included the construction of hinterland rail and road connections. The Fehmarn project itself consisted of the construction of a motorway and a rail track through a tunnel and bridges.

The project is managed by Femern A/S which was appointed specifically for this purpose and has no other commercial activity. Initial capital of DKK 500 million has been injected in Femern A/S by the Danish government. Femern A/S, backed by a government guarantee, will borrow on the international financial markets. It will repay the loans by raising revenue from tariffs that it will charge to users of the fixed link. The state guarantee will be provided at an annual premium of 0.15% of the outstanding loan.

A different entity will be responsible for the hinterland connections and it too will have no other commercial activity. This entity will also receive capital and a guarantee from the State aid.

The Pricing of Access to an Important Project of Common European Interest - Banner EStALI%20Autumn

Existence of State aid

The purpose of the assessment was to determine whether the capital injection and guarantee were State aid. As in the Oresund decision, the Commission made a distinction between the part of the project that was an economic activity and the part that was not economic.

The hinterland rail and road connections are open to all users and are not commercially exploited through the charging of tolls. They were found not to be economic in nature [paragraph 52]. The entity responsible for their financing and construction is not allowed to be involved in any other activity. Rail infrastructure is a closed sector in Denmark and there is no possibility of competition in the provision of network construction or management services. Therefore, the entity responsible for the hinterland connections cannot exploit public resources in carrying out an economic activity. Accordingly, it was found not to be an undertaking [paragraphs 54-57].

The Danish authorities also argued that Femern A/S was not an undertaking because: i) it pursued public policy objectives; ii) the fixed link required the prior consent of Denmark and Germany, therefore it could not be carried out by the market; iii) the fixed link was part of the broader public planning of transport networks; iv) the activities of Femern A/S were ring-fenced; v) the user fees (tolls) were fixed by the state. This was not the case in the Oresund link where the operator was free to set fee rates. [Paragraphs 52-66]

The Commission rejected all of these arguments. The decisive element was that Femern A/S provided services to users for a fee [paragraph 68]. The facts that the fixed link was constructed for a public policy purpose, that it was part of the overall planning of transport networks, that it required prior consent by two countries and that Femern A/S could not engage in other activities or enter other markets were not relevant for the purpose of determining the economic nature of the construction and operation of the fixed link.

The Commission paid particular attention to the fact that the fee was fixed by the state – a feature that was absent from the operations of the Oresund link. “This is a specific feature of the project which normally does not apply to undertakings operating on the market” [paragraph 76].

The Commission observed that “(77) […] a public entity (which also fulfils supervisory duties of a public nature) performs an economic activity when it provides services against a fee at a rate which it is free to set, and where the entity itself determines the conditions on which the services are provided. Conversely, […] the fact that a service provided by a public entity and connected to the exercise by it of public powers is provided in return for remuneration laid down by law and not determined, directly or indirectly, by that entity, is not alone sufficient for the activity carried out to be classified as an economic activity.”

“(80) […] the services provided by Femern A/S compete with services provided by private operators, in particular ferry operators, and the financial analysis assume that tolls are set by reference to the ferry prices (see footnote 35) [this footnote comes later in the decision and it is quoted in its entirety later on in this article]. This seems to indicate that Femern A/S commercially exploits the Fixed Link by providing services on a market, and could hence be engaged in an economic activity.”

Despite this analysis, the Commission concluded that it was not necessary to decide whether the planning, construction and operation of the fixed link constituted an economic activity because even if the public financing of Femern A/S were to be State aid, it would in any event be compatible with the internal market.

This is unfortunate because Member States are left uncertain whether such arrangements fall within the scope of Article 107(1) or not. The Commission should not have had any doubts that the construction and operation of the fixed link were economic activities. The definition of economic activity is well-known: It is the offering of a good or service on a market. There is a market for a product when, in principle, a price can be obtained that can cover its costs.[3]


Do you know we also publish a journal on State aid?

EStAL banner
The European State Aid Law Quarterly is available online and in print, and our subscribers benefit from a reduced price for our events.


 

In a project of this size and duration it is difficult to determine what the market price is. In principle it is a price that can cover the cost of construction and operation over the life of the project, including financing costs. Since the bulk of the costs are incurred up front, the fact that the price may be very low does not mean much because operational costs are also very low in comparison to the initial investment costs. The reference to ferry prices is not very relevant either [probably, the Danish government was worried about an abusive price increase]. A fixed link always has strong advantages over ferry links which are affected by the weather and even in the best conditions cannot operate continually.

The decisive element was that the state guarantee enabled Femern A/S to borrow from the market and it eliminated the time risk for private investors. Hence, Femern A/S could operate just like a normal company and could cover its costs, by repaying its debt, within a predetermined time period. This is how the market functions. The fact that the user fees were fixed by the state was irrelevant because as long as they covered operational costs, the state guarantee enabled Femern AS to stretch out the repayment of the commercial loans to a 55-year period. Extended over a long-enough period, even large loans stop being a burden [incidentally, this is how the EU proposes to deal with Greece’s debt repayment problem]. Annual revenue may be lower than otherwise, but the guarantee also reduces costs. And revenues and costs are two sides of the same coin. A simple example can clarify this important point.

Assume a project requires investment of 100 and has a life of just one year. Further assume that the project operator can borrow a 100 at 5% with a state guarantee or 15% without a state guarantee [which, to simplify calculations, is assumed to be granted for free]. This means that the amount of aid is 10. The project is expected to have 100 users. With total financing costs of 105 [= 100 + 5] and operating costs of, say, 50, its total costs are 155. It follows that the break-even price paid by users is 155/100 = 1.55. However, the government wants to regulate the price and fix it at, say, 1.25. Revenue will only be 125. The project cannot be undertaken without additional State aid of at least 30 to cover the difference between the positive cash flows [= 125] and the negative cash flows [= 155]. However, the total amount of State aid is 40 [= 10 + 30 = 165 – 125].

The fact that the government regulates the price is of no real relevance because the government, by granting State aid, reduces the costs that are effectively borne by the operator by an amount that is equal to the revenue shortfall. The government either increases the revenue and reduces the amount of State aid or lowers the revenue and increases State aid. The arrangement it chooses makes no difference to the economic nature of the project.

Compatibility of the aid

The Commission assessed the compatibility of the State aid according to the 2014 guidelines on Important Projects of Common European Interest [IPCEI]. This is the second project to be assessed according to those guidelines which incorporate, like all the other guidelines, the common assessment principles.

There was of course no doubt that the project was important and that it pursued an objective of common interest. What is more enlightening is how the Commission examined the necessity and proportionality of the aid.

The necessity of aid is normally established by comparison to a counterfactual scenario without aid. Since for a project of this size there is hardly a credible counterfactual, Denmark submitted information concerning what would happen without State aid. Aid is shown to be necessary where a project cannot be realised without aid. A public enquiry had concluded that the private sector was interested in participating in the design, financing, construction and operation of the fixed link on condition that the government provided a subsidy and guarantees [another indicator of the economic nature of the project]. It was apparent that private investors required a high internal rate of return to compensate for the substantial risks connected with the project. Lenders also demanded high interest rates and a high debt coverage ratio in order to overcome those risks. These requirements led to such high costs of capital that the project was not feasible without public support.

The Pricing of Access to an Important Project of Common European Interest - Banner SA ESIF Hub

According to point 30 of the guidelines on IPCEI, the amount of aid may not exceed the minimum necessary for the project to be sufficiently profitable, which means, for example, that the internal rate of return (IRR) corresponds to what private investors expect to earn or the firm’s cost of capital.

Calculations submitted by Denmark showed that the project’s IRR was 4.2% over a repayment period of 55 years[4] (i.e. 4.2% was the discount rate that made the net present value of the investment equal to zero after 55 years) while the WACC was estimated to be 11.0%. Since the WACC exceed the project’s IRR, the NPV with a discount rate of 11% would have been negative by a very large amount [not indicated in the decision]. On the basis of this evidence, the Commission concluded that the aid was necessary.

Proportionality of aid

According to point 31 of the IPCEI guidelines the maximum amount of aid should not exceed the identified funding gap of the project. The funding gap, calculated as the discounted difference between the positive and negative cash flows over the lifetime of the investment, including the net operating costs for the 55-year period and the expected TEN subsidies, amounted to EUR 3.1 billion. The NPV of the eligible investment costs was EUR 5.6 billion. The Commission determined the project’s funding gap ratio to be 55% [= 3.1/5.6].

The Commission explained that the amount of aid in the guarantee, state loans and the capital injection was EUR 2.8 billion. This corresponded to aid intensity of 51% [= 2.8/5.6] i.e. below the project’s funding gap ratio. The Commission considered this as proof that the aid did not exceed what was necessary. This is true. But it immediately raises the question that if the aid did not match the full extent of the funding gap, how was it possible for the project to generate sufficient revenue to cover its costs and pay back the private investors? In fact, this is not the first case where the Commission appears to be satisfied that the aid is proportional because it falls below the funding gap rate. This implies that either the commercial viability of the project is at risk or that the financial calculations are unduly pessimistic.

Prevention of undue distortions of competition

After finding that the aid was appropriate and would generate large benefits, the Commission also made the following interesting observations with respect to potential negative effects.

“(113) […] Also as the guarantee/loans only cover debt related to the planning, construction and operation of the Fixed Link until the debt is fully repaid – there is no risk that the guarantee/loans can be used to subsidise other non-eligible costs and activities. Therefore, the Commission considers that chosen aid instrument is appropriate.”

“(116) The opening of the Fixed Link will however have a negative impact on the ferry operators […]. Decreased ferry operations may also have a negative impact on the ports used by those ferries in terms of traffic volumes and revenues. These effects are inherent in the project, which seeks to offer a quicker and more convenient alternative to the ferry services.”

“(117) The Fehmarn Belt fixed link will be open to all users on equal and non-discriminatory basis. […] The pricing structure will be non-discriminatory and transparent […] It is expected that the user tolls on the road link will correspond to the price charged by the ferry operator.”

“(118) Moreover, the cost benefit analysis of the Fehmarn Belt Fixed Link project clearly shows that the expected socio economic outcome of the Fehmarn Belt fixed link in the long run is positive, regardless of the fact whether the ferry service continues or is terminated. […] Despite significant investment costs in the Fixed Link and related hinterland connections, the project will return a net benefit and produce an economic return of 4.7 per cent for Europe.[5] The net benefit reflects mainly time savings and greater flexibility in departure times for the various travellers using the Fixed Link.”

The Commission concluded that the aid was compatible with the internal market.

——————————————————————–

[1] The full text of the decision can be accessed at:

http://ec.europa.eu/competition/state_aid/cases/256101/256101_1677572_164_2.pdf.

[2] Here is the link to the article on the Oresund project:

http://stateaidhub.eu/blogs/stateaiduncovered/post/1057.

[3] The price should cover costs in principle because occasionally prices do not cover costs and firms go bust. This does not mean that all of a sudden an activity seizes to be economic just because demand weakens or costs rise or, simply, a firm is inefficient.

[4] Footnote 35: “The calculation of repayment period of 55 years results from the following assumptions i) the project planning and construction costs of EUR 7.4 billion (2014 prices) based on the priced offers received from bidders of the four principal civil works contracts on 22 December 2014 plus reserve account of EUR 0.5 billion and average annual costs of operation, maintenance and reinvestment for the Fixed Link of EUR 72.5 million (2014 prices); ii) a continued hourly scheduled ferry service; iii) risk-free market interest of 3.0 per cent (in real terms) and projected inflation 2.0 per cent; iv) TEN subsidies for the Fixed Link amounting to 50% of the planning costs and 18% of the construction costs; v) traffic development following the opening of the Fixed Link based on the ‘FTC forecast’ drawn up by INTRAPLAN Consult GmbH and BVU Beratergruppe Verkehr and Umwelt GmbH in November 2014; vi) assumed road tolls based on average ferry list prices; e.g EUR 65 for passenger cars and EUR 276 for lorries and a rail infrastructure payment of EUR 52.9 million per year”.

[5] Footnote 39: “Taking into account all benefits and costs for Denmark alone, the Fixed Link and the associated hinterland connections in Denmark will generate a net social benefit of DKK 28 billion over 50 years. This equates to an economic return of 5.3 per cent.”

Tags

Über

Phedon Nicolaides

Dr. Nicolaides was educated in the United States, the Netherlands and the United Kingdom. He has a PhD in Economics and a PhD in Law. He is professor at the University of Maastricht and the University of Nicosia. He has published extensively on European integration, competition policy and State aid. He is also on the editorial boards of several journals. Dr. Nicolaides has organised seminars and workshops in many different Member States, and has acted as consultant to several public authorities.

Hinterlasse eine Antwort

Zusammenhängende Posts

14. Mai 2024
State Aid Uncovered von Phedon Nicolaides
Restructuring State Aid - State Aid Uncovered photos 12

Restructuring State Aid

Introduction State aid to failing undertakings is the most distortionary form of public subsidies. They prevent the market exit of inefficient companies. For this reason, State aid for rescue or restructuring of undertakings in difficulty must always be notified to the Commission which examines each case very carefully and allows this kind of aid only when, among other things, the […]
26. Mrz 2024
State Aid Uncovered von Phedon Nicolaides
Applying the Funding Gap Method to an Important Project of Common European Interest – Part II - State Aid Uncovered photos 7

Applying the Funding Gap Method to an Important Project of Common European Interest – Part II

Introduction On 28 February 2024, the General Court delivered an important judgment in case T-390/20, Scandlines v Commission.(1) The judgment is important because it interpreted the Commission guidelines on Important Projects of Common European Interest [IPCEI], the funding gap methodology for determining the necessary amount of aid and the 2008 Commission Notice on state guarantees. Scandlines sought annulment of Commission […]
19. Mrz 2024
von Phedon Nicolaides
Applying the Funding Gap Method to an Important Project of Common European Interest – Part I - State Aid Uncovered photos 1

Applying the Funding Gap Method to an Important Project of Common European Interest – Part I

Introduction On 28 February 2024, the General Court delivered an important judgment in case T-390/20, Scandlines v Commission.(1) The judgment is important because it interpreted the Commission guidelines on Important Projects of Common European Interest [IPCEI], the funding gap methodology for determining the necessary amount of aid and the 2008 Commission Notice on state guarantees. Scandlines sought annulment of Commission […]
20. Feb 2024
State Aid Uncovered von Phedon Nicolaides
Another Case of Indirect State Aid - State Aid Uncovered photos 4

Another Case of Indirect State Aid

Introduction On 19 May 2021, the General Court, in case T-643/20, Ryanair v Commission, annulled Commission decision SA.57116 by which it authorised State aid in favour of KLM in the context of the measures implemented by the Dutch government to address the covid-19 pandemic. In July 2021, the Commission re-adopted its original decision without the errors that had been identified […]
23. Mai 2023
State Aid Uncovered von Phedon Nicolaides
The Temporary Framework Allows Member States to Grant Aid only to SMEs  - Untitled design

The Temporary Framework Allows Member States to Grant Aid only to SMEs 

Introduction  Although discrimination is in general prohibited in the EU, the fact remains that in the field of State aid Member States may grant State aid only to certain companies and may also decide how much aid to grant.  That the granting of State aid relies solely on the discretion of Member States has recently been re-confirmed by the General […]
04. Apr 2023
State Aid Uncovered von Phedon Nicolaides
Compensation for Damage Caused by COVID-19 Combined with Rescue Aid - dddddddddd

Compensation for Damage Caused by COVID-19 Combined with Rescue Aid

Introduction Member States are allowed to grant state to compensate undertakings for damage they suffer as a result of a natural disaster or exceptional occurrence. But, it is not always easy or possible to disentangle the damage caused by such an unforeseen event from losses caused by mismanagement or changes of market conditions. The art and science of calculating the […]
28. Jun 2022
State Aid Uncovered von Phedon Nicolaides
Individual Aid to Counter the Effects of Serious Economic Disturbance Is Legally Possible, but Is it Appropriate? - State Aid Uncovered SM posts 13

Individual Aid to Counter the Effects of Serious Economic Disturbance Is Legally Possible, but Is it Appropriate?

Individual aid need not be capable itself to remedy serious economic disturbance in the economy of a Member State. It is sufficient that it contributes to that effect. Introduction On 22 June 2022, in case T‑657/20, Ryanair v European Commission, the General Court confirmed once more that Member States have a right to grant State aid to the undertakings of […]
02. Mrz 2021
State Aid Uncovered von Phedon Nicolaides
State Aid May be Limited to Undertakings with Close Links with the National Economy (Part II) - StateAidHub blogpost8 9 Ryanair

State Aid May be Limited to Undertakings with Close Links with the National Economy (Part II)

State aid may be used to compensate airlines licensed by domestic authorities for losses incurred as a result of national travel restrictions. [In case you have missed part I, you can access it here.] Introduction The European Commission acted swiftly to adopt a fairly accommodating and wide-ranging “Temporary Framework” to regulate State aid for the purposes of counter-acting the impact […]
23. Feb 2021
State Aid Uncovered von Phedon Nicolaides
State Aid May be Limited to Undertakings with Close Links with the National Economy (Part I) - StateAidHub blogpost8 9 Ryanair

State Aid May be Limited to Undertakings with Close Links with the National Economy (Part I)

State aid may be used to compensate airlines licensed by domestic authorities for losses incurred as a result of national travel restrictions. Introduction The European Commission acted swiftly to adopt a fairly accommodating and wide-ranging “Temporary Framework” to regulate State aid for the purposes of counter-acting the impact of covid-19. The Temporary Framework was welcomed by both Member States and […]
27. Okt 2020
State Aid Uncovered von Phedon Nicolaides
The Common European Interest and the Environmental Impact of State Aid: The Case of Nuclear Power - nuclear power plant 4535761 1920

The Common European Interest and the Environmental Impact of State Aid: The Case of Nuclear Power

I am grateful to Peter Staviczky for comments on an earlier version. The possible negative impact of State aid on the environmental is taken into account when the aid measure violates directly the relevant EU law. The Commission protects the interests of other Member States by ensuring that the negative effects of State aid are kept to the minimum possible. […]