Phasing out fossil fuel subsidies in the EU? Exploring the role of state aid rules

ABSTRACT

The paper aims to identify and analyse potential legal avenues for phasing out fossil fuel subsidies (FFS) in the European Union (EU) using State aid rules. Our analysis reveals that the EU State aid rules would allow the European Commission to effectively target and monitor a vast number of FFS. From a policy perspective, the requirements for notification, examination, transparency, reporting, and recovery of unlawfully granted aid are of particular importance. The legal framework also provides avenues for the EU Commission to start a ‘Fossil Fuel Inquiry’, while providing important tools for civil society to apply pressure on states for the removal of FFS. Based on our legal analysis and pertinent literature, we discuss which of these different FFS and corresponding estimates are likely (or not) to fall under the EU State aid rules. Despite inherent uncertainties, the EU State aid toolbox offers various possibilities to the EU to actively advance its climate change policy and comply with its international commitments to reduce FFS.

Key policy insights

• Member States in the EU still subsidize both the consumption and production of fossil fuels by a myriad of different measures, despite pledges to reduce FFS as part of the EU’s ambitious climate policy.

• A major part of these fossil fuels subsidies could be addressed by the already existing EU State aid rules, which provide an effective system that is not dependent on Member States political will and has a powerful enforcement mechanism.

• A first key step would be for the EU Commission to start a ‘Fossil Fuel Inquiry’, which would identify and quantify all support for fossil fuels within Member States.

• The EU State aid rules could also provide civil society with the possibility to actively lobby for State aid control, while offering the court systems in Member States as an additional avenue for enforcement.With this in mind, the EU State Aid rules could be used effectively to help the EU to phase out a major part of FFS.

KEYWORDS:

• Climate change policy
• European Union
• EU State aid rules
• Energy Policy
• Fossil Fuel Subsidies

1. Introduction

Governments have long used subsidies to make energy available at affordable prices to both households and industries. Traditionally, these subsidies have gone to fossil energy such as coal, oil, and natural gas (Johansson et al., 2012). To some extent, fossil subsidies alleviated energy poverty and fostered industrialization. However, subsidies have also created a dependence on fossil energy, exacerbated negative externalities (e.g. mortality and morbidity rates from poor air quality) and increased inefficiencies and misallocation of resources across the energy system (Cao 2003; Johansson et al., 2012).

From a socio-economic perspective, fossil fuel subsidies (FFS) are often understood as any governmental actions that alter fossil fuel price mechanisms (OECD, 1998; De Moor & Calami, 1997; IEA, 2015). The broad category of FFS includes direct cash transfers, credits, tax exemptions, risk transfers, price controls, research and development, market access/restrictions, equity infusions, loan guarantees, direct budget transfers, State aid, and even policy inaction (Koplow, 2009; Coady et al., 2015). Most FFS are not given as direct monetary support to producers but are provided via tax exemptions or interventions to the pricing mechanism that deflate the end-user price. However, the conceptual elements of what constitutes a fossil-fuel subsidy are vast and finding a common definition is a complex task (IEA et al., 2010). In this paper, we define FFS as any government action that reduces, directly or indirectly, the costs of fossil fuels for users and/or producers below the market price.

Estimating the volume of FFS can be done using a variety of methods¹, and depending on the method used, different estimates arise. For example, the IEA (2014; 2016) produced upper bounds estimates in the proximity of US$580 billion (e.g. for the years 2008 and 2012) and lower bounds in the range of US$300-350 billion (e.g. for the years 2007, 2009 and 2015). Even higher estimates of global FFS, in the range of US$4.2 trillion (2011) to US$5.3 trillion (2015), were made by the IMF by also taking into account negative externalities (Coady et al, 2015).

Regardless of the actual monetary amount, phasing out subsidies to fossil energy is deemed a cost-effective response to climate change that countries could implement in the near-to-medium term (Ellis, 2010; Burniaux et al., 2009, De Coninck et al. 2018; but see Jewell et al., 2018, and Erickson et al., 2020, who are critical of this claim). In December 2015, the Paris Agreement was adopted, committing its parties to ‘making financial flows consistent with a pathway towards low greenhouse gas emissions and climate resilient development’ (Paris Agreement, 2015: Article 2.1.c). However, progress towards phasing out FFS has been slow (Rentschler & Bazilian, 2017) and their value is still high. A major problem relates to the political feasibility of phasing out FFS (Skovgaard & van Asselt, 2018), which have been implemented with good intentions from the start, such as reducing poverty or supporting industrialization. Initiating and implementing policies for reducing FFS take time as these initiatives must confront, for example, capture of legislature, enforcement issues and lack of acceptability.

The EU has an ambition to reduce FFS, but has been criticized for its limited action. As an example, as part of their National Energy and Climate Plans, EU Member States are required to make national submissions on their levels of FFS and ways to reduce them. However, these measures have not been successful due to insufficient compliance by Member States (van der Burg et al., 2019).² Substantial FFS still exist and the European Parliament in 2017 estimated FFS to be in the range of €39 to over €200 billion per year (European Parliament – Policy Department A, 2017). The most recent number is provided by the Overseas Development Institute (ODI) and Climate Action Network (CAN), which estimate FFS in the range of €112 billion per year between 2014–2016 in the EU’s 11 largest economies (accounting for 83% of the EU’s greenhouse gas emissions) (Gençsü et al., 2017).

Within this context, a relatively unexplored route for phasing out FFS via existing legal frameworks is emerging. A recent paper addressed the possibility of using the World Trade Organization (WTO) system on subsidies to challenge some of the FFS (Verkuijl et al. 2017), concluding that FFS have never been challenged and substantial difficulties remain in litigating such subsidies. In the EU, the existing framework on State aid³ could offer similar tools to the WTO rules. The ODI/CAN report (Gençsü et al., 2017) also highlights the potential for State aid and the Commission Guidelines on State aid for environmental protection and energy to address FFS (State aid Guidelines Environment & Energy 2014–2020: para 3-9). However, the actual potential of the EU’s State aid to target FFS has not been studied in detail.

This paper aims to fill this gap by providing a first exploratory legal analysis of the potential for using the EU State aid rules to address FFS. From a policy perspective, the study has several implications. First, the EU’s State aid control mechanism is already agreed upon, has an established enforcement system, and thus does not depend on the political will and agreement amongst Member States. Potentially, this existing legal tool can thus be used actively to reduce FFS via adjustments by the EU’s executive power to monitor and effectively target FFS. Second, the EU State aid rules provide civil society with opportunities to lobby for State aid control and potentially to challenge FFS in court.

Our paper is based on a mixed methodology of legal dogmatics that address the interpretation and application of law. ‘The law’ is the subject of legal science while the application of law to the facts is the realm of legal practice (McLeod, 1999). Legal science uses the doctrinal method to systematise and interpret the law to achieve a coherent set of rules and principles at an abstract level with the aim of establishing what is ‘the law’ (Peczenik, 2000). In this paper, we first use the doctrinal method to establish the law, or de lege lata with regard to EU State aid rules. The second step, the application of this framework to the relevant facts in a concrete case is where the paper diverges from classical legal methodology. In the latter, ‘the law’ is applied to the facts of an individual case. Instead of the facts of a concrete individual case, our paper focusses on the ‘measures’ identified in the ODI/CAN’s report (Gençsü et al, 2017). ‘Measures’ refer to activities that might or might not constitute FFS or State aid (e.g. direct payments, preferential loans, etc.). The measures identified in the ODI/CAN report are based on the WTO definition of subsidy, designed to promote free trade. This is close but not equal to the EU definition of State aid (Rubini, 2009). Thus, the use of the ODI/CAN report’s categories of measures that constitute FFS introduces a level of uncertainty in our analysis, and this is duly acknowledged.

First, uncertainty exists with regard to the classification of the FFS reported by ODI/CAN as State aid under the EU rules. While the report is based on country reports, which provide information on what measures in what country are included for the calculation, we stress that this information does not suffice for a definite answer as to whether the measures constitute State aid. As in all legal assessments, the analysis is dependent on the legal and factual framework in the specific case. Such an individual assessment is often very resource intensive (Einarsson & Kekelekis, 2015) because the actual design of the measure and the companies/industry involved matter a great deal for the legal assessment. Thus, a measure that has been qualified as likely to be subject to the EU State aid rules might, in a specific case, not fall under the regime. The opposite is also true: measures deemed as unlikely to be subject to the EU State aid regime may still be subjected to it. To counter this level of abstraction and uncertainty, the paper uses a dualistic distinction. It distinguishes categories of measures that are unlikely from those that are likely to fall under the EU State aid regime by combining legal analysis with the categories and sub-categories of measures identified in ODI/CAN report by assessing whether these measures meet the legal criteria of State aid (details in the next section). Given the inherent uncertainties and the partly speculative nature of the legal analysis, we aim to be as conservative as possible by, for example, grouping unclear forms of FFS as unlikely subject to the State aid rules.

The paper is structured as follows. We begin with a review of the conceptual elements in the EU State aid regime in Section 2 and then we assess which of the identified measures are likely or unlikely to fall under the EU State aid rules in Section 3. We discuss and propose various amendments to policy for implementing a potential phase out of FFS in Section 4. Based on legal analysis, this also includes a short attempt to roughly estimate the amount of FFS that could be potentially subject to State aid rules. Despite the uncertainties and levels of abstraction driven by the legal analysis, we approximate these figures to show what a significant amount of taxpayer money is in question. Conclusions are drawn in Section 5.

2. The EU State aid rules

EU law has its own definition of ‘State aid’; this definition is not the same as, but overlaps with, the concept of a subsidy. The relevant provisions regulating State aid in the EU are contained in Article 107ff of the Treaty on the Functioning of the European Union (TFEU). The main provision that also sets out the criteria for defining State aid measures is contained in Article 107(1) TFEU. It states that: ‘[s]ave as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market’ (emphasis added). This definition is typically broken down into its five cumulative constituent parts: ‘advantage’, ‘provided to an undertaking’, ‘selectivity’, ‘State resources’, and ‘effect on trade and competition’ (Commission Notice, 2016), which are explored in more detail below (2.3.1-2.1.4).

The EU definition of State aid has a different purpose than the definitions and methods presented in the introduction, and thus its effects and implications are different. The EU State aid regime is aimed at protecting trade and competition within the internal market and not at identifying FFS. Yet, the EU definition is relatively close to the WTO definition of subsidy which is designed to promote free trade (Rubini, 2009). In most cases, measures that are considered subsides under the WTO definition are also considered State aid in the EU. The difference between WTO and EU State Aid stems mainly from the enforcement side. The EU system relies on an independent, third-party enforcement body: the EU Commission. Moreover, private actors might bring direct court action in State aid cases under certain conditions, but this is not possible under the WTO system. In the WTO, a State needs to enforce the rules against another State. Thus, they risk a possible trade war, creating a ‘hawks will not pick out hawks’ eyes’ problem that does not exist in the EU framework. Table 1 provides an overview of the two systems.

Table 1. The EU state aid system vs the WTO subsidies system.

	Purpose of the system	Definition of State aid vs definition subsidies	The system’s enforcement mechanism
EU definition of State aid	Ensuring a level playing field for companies in the EU.	(1) a selective advantage (2) provided by or through State resources (3) is provided to an undertaking (4) that distorts competition (5) and that has an effect on cross-border trade in the EU.	1. State aid measures need to be notified to the Commission and then can be approved by the Commission. 2. The Commission can order the recovery of illegal State aid. 3. National courts can issue an order that prevents the paying out of State aid that has not be notified to the Commission.
WTO definition	Controlling that Member States do not disadvantage their trade partners	(1) a financial contribution (2) by a government or any public body within the territory of a Member (3) which confers a benefit.	Member States can sue other Member States before the WTO dispute settlement body and impose counter-measures (custom duties) with the same value

In the following, we explore the definition of State aid in more detail, estimate the level of FFS that could be covered by the EU State aid system, and explain the reasons why this tool is potentially effective for pursuing the phase out of FFS.

2.1. What is state aid under EU law?

The first part of the definition of State aid contained in Article 107 (1) TFEU rests on the definition of ‘advantage’. The EU courts have explained that ‘advantage’ refers to an ‘an economic advantage which [the undertaking] would not have obtained under normal market conditions’ (Case C-39/94, para 60; Joined Cases T-204/97 & T-270/97, para 66). Moreover, the economic advantage can either be in the form of positive benefits or in easing a financial burden.⁴ This assessment is an effect-based analysis.⁵ A measure is not State aid if the company paid a fair market value for the benefit granted by the State; thus, no economic advantage exists.⁶ In other words, transactions where the State buys fossil fuels at fair market value are out of the scope of EU State aid law.

Overall, this definition is broad and means that all kinds of measures can be considered to fall within the meaning of economic advantage. Examples range from direct payments, the preferential sale of land, to more favourable tax regimes. However, while the definition of economic advantage is broad, not every economic advantage is State aid. The definition of State aid under Article 107 (1) TFEU requires that all four other constituent parts are cumulatively fulfilled:

2.1.1. Advantage granted to an undertaking

The second of the constituent elements is that it must be granted to an ‘undertaking’. The European Court of Justice (ECJ) defines undertakings as entities ‘engaged in an economic activity, regardless of the legal status of the entity and the way in which it is financed’ (Case C-41/90, para 21). Thus, a functional approach is used where ‘substance prevails over form’ (Louri, 2002). This functional definition of undertaking broadens the scope to EU State aid law because EU State aid law applies not only to public companies but might apply to entities that are part of the general administration of the state.⁷ At the same time, it can also have a limiting function. Thus, EU State aid law cannot apply where an entity is not engaged in an economic activity, although the entity can be considered a regular company under company or tax laws (Case C-343/95).

In the context of fossil fuels, this definition would mean that even measures that benefit entities, which are formally considered part of the state, are within the scope of EU State aid. Hence, it applies to state-owned enterprises and all entities that are active in the energy market regardless of whether they are considered to be part of the State under, for example, tax or company laws. Similarly, State aid rules can be applicable where, for example, State hospitals obtain access to fossil fuels below market price.

2.1.2. Selectivity of the advantage

The third element of the definition of State aid, ‘selectivity’, is the main limiting factor of EU State aid law. The economic advantage granted to the undertaking must be selective in nature. The ECJ in this context examines whether the advantage is available to some undertakings but not to others in a comparable situation (Case C-143/99: para 48; Case C-409/00, para 47). When performing this assessment, the size of their groups is immaterial (Case C-143/99: para 48; Case C-409/00: para 47). For example, a measure can be selective in a geographical sense. This is the case where the advantage is available only in certain regions but not in others, except where the benefit granted in one region is the result of an independent decision by a regional body, such as a region (Commission Decision 2005/261/EC, para 31). So, where a certain region would benefit from subsidized fossil fuels, such as for example a lower tax for gas, the EU’s State aid regime can be applicable.⁸ Aside from being regionally selective, measures can also be selective in a material sense. The ECJ held that this is the case where a measure ‘favour[s] certain undertakings … in comparison with other undertakings which are in a legal and factual situation which is comparable in the light of the objective pursued by the measure in question’ (Case C-409/00: para 41). For example, this criterion is fulfilled in situations where only undertakings of a certain size or those which are active in certain sectors obtain preferential access to fossil fuels. Similarly, a system would be subject to State aid control where a legal framework favours fossil fuels compared to other forms of energy in a specific market, for example in the form of a beneficial tax system. Another example could be a tax rate that is lower for diesel and petrol than for renewable fuels.

2.1.3. Granted by the State or through State resources

The fourth element of the definition of State aid is that measures must be granted directly or indirectly through the resources of a Member State (Case C-379/98, para 58). This can be highlighted with an example. As already explained, any reduction of charges or forgone revenue provides an advantage. Thus, the Netherlands’s initial nitrogen oxide (NOx) permit system involved State resources (Case C-279/08 P). The system set up a 55-kiloton target for large industrial facilities based on the national emission ceiling for NOx in 2010. When it became clear that this target would not be reached, the Netherlands set up a trading system with a uniform NOx emission standard covering all industrial facilities with installed total thermal capacity above 20 MW. Companies subject to the system either had to comply with the set standard or buy permits from others. The system foresaw penalties for non-compliance but granted a certain number of permits for free to companies. Those permits could subsequently be traded. The ECJ found that the Netherlands would forgo revenue because the relevant permits were not sold or auctioned off. The fact that it is sufficient that the resources are only indirectly attributable to the State further broadens the reach of State aid law. This can be seen in the cases where, for instance, the money comes from a private company, which the State has sufficient influence over (Case C-482/99; Case T-442/03). Thus, as long as the State has sufficient influence over an entity, the State cannot evade the State aid regime by paying State aid for fossil fuels via a private company or an independent institution.

2.1.4. Effect on competition and trade

The final element of the definition of State aid to be considered under Article 107 (1) TFEU is that the measure ‘must affect trade and competition’. This effect is established mainly by means of the Commission’s notice on the de minimis thresholds for Article 107 (1) TFEU. This de minimis threshold, most recently set in Regulation 1407/2013, means that the effect is presumed once certain monetary thresholds are met. In this sense, only larger amounts of aid to undertakings are covered by the State aid regime. In general, this means that the regime applies wherever a single undertaking received benefits which are worth more than €200,000 within three years. Yet, in some areas, like the road freight transport sector, the lower-level threshold applies. Thus, the State aid rule may apply where the benefit to the individual company is even smaller. For the road freight transport sector, the level is €100,000 within three years. An effect on competition is presumed once a selective advantage for an undertaking or a sector and a relevant market are established (da Cruz Vilaca, 2009: 444-445). This means that a high overall number of subsidies does not necessarily imply that the EU State aid rules apply. If a huge number of companies would each receive a small benefit, the EU State aid rules might not apply.

3. Using the EU State aid as a tool to phase out fossil fuels?

3.1. FFS as State aid under the EU’s regime

Having set out the five defining constitutive parts/criteria of assessment of EU State aid, we now analyse which of the categories of FFS can be subject to the State aid rules. Four general points need to be highlighted to begin with.

First, the definition of EU State aid is close to the definition of subsidies used by the WTO. Hence, the ODI/CAN’s report that already uses the WTO method provides a good starting point to estimate the potential of the EU State aid rules. Due to the closeness of the WTO and EU definitions, it can be assumed that a great number of the identified FFS can also be subject to EU State aid control. This closeness means that the FFS identified in the ODI/CAN report as consisting of the three groups: a) ‘fiscal support’ —that is to say, direct spending by government, tax breaks, as well as income or price support – b) ‘public finance’ – that is to say, support through the provision of grants, loans, equity and guarantees – and c) ‘investment by SOEs’, could all be subject to the State aid regime. While a detailed analysis and individual assessment of each measure within those groups would need to be carried out (e.g. whether the measure is selective and favours certain activities like fossil fuels), a determination with certainty it is beyond the scope of our study.

Second, it is important to distinguish between benefits that are granted to companies (or ‘undertakings’ in the EU context) versus benefits granted to consumers, as the latter are often not State aid. Thus, direct cash transfers, tax exemptions or tax credits, support for research and development, preferential loans and guarantees, or investment support given to companies, would typically be subject to the State aid regime, in particular where these benefits are not available on similar terms to other non-fossil fuel companies. This reflects the focus of the EU State aid regime to protect trade and competition. The situation is different where the benefit is made available to consumers. Typically, social measures that benefit consumers (in the sense of natural persons) – such as tax reductions or direct payments – cannot be classified as State aid. State aid law only applies to measures that (at least indirectly) benefit businesses in contrast to measures that benefit consumers. Due to the selectivity criterion, State aid law only applies where such measures indirectly benefit fossil fuel businesses specifically (e.g. where the support is only available for energy sources from fossil fuels). Moreover, in terms of investments by Member States through development banks or through other SOEs, we need to take into account the market investor principle. In a nutshell, this principle means that whenever a state grants benefits under conditions that the company would not have been able to obtain from the market, State aid can be assumed (Cyndecka 2017).

Third, State aid measures must be granted by EU Member States. Where the EU, rather than a Member State, provides the benefit to the companies, the EU State aid rules do not apply. The fourth general point relates to the so called de minimis threshold. For a benefit to be considered State aid covered by the EU rules, the benefits must surpass the relevant de minimis threshold of €200,000 (or €100,000 for an individual road freight company) per three years.

3.2. Identifying the FFS measures potentially subject to the EU State aid regime

The ODI/CAN report uses a detailed inventory approach that analyses all publicly available numbers from EU Member State policies and programmes that support fossil energy production and consumption. ODEI/CAN presents the FFS in different forms. For example, it subdivides subsidies for production or for consumption by sector/activity and provides examples (see Gençsü et al., 2017: 20). These examples are given in Tables 2 and 3.

Table 2. Subsidies to production.

Coal mining:	Oil and gas:	Electricity
Budget support (R&D) for exploration technologies and processes, and for field development Budget support and SOE investment on mine development activities Price support (i.e. direct payments to producers, linked to the market price of fossil fuels) Government-provided insurance and indemnification for risks and damages such as pollution Early retirement payments for coal miners through government budgets Government assumption of liabilities or spending on mine decommissioning	Concessional loans to exploration companies, including for exploration equipment, from national and multilateral development banks Tax deductions for the field development phase Fiscal support (including budget support and tax breaks) and SOE investment on field development activities Government-regulated price of feedstock (oil, gas and coal) for refining and processing Tax and royalty exemptions linked to amount of fuel produced Government, multilateral development banks or EU budget spending on oil and gas pipelines, interconnectivity and storage infrastructure Government loans to fossil-fuel extracting companies to cover liabilities of field decommissioning Early retirement payments for oil and gas through government budgets	Grants and tax breaks for the construction of plants for heat and electricity generation and refineries Relief on property taxes and charges for land, water use and pollution for processing facilities and power plants Government-regulated price of feedstock (oil, gas and coal) for electricity and heat generation Investment by SOEs in plant operation and modernization, domestically and internationally Capacity payments to fossil fuel-fired power plants Fiscal support (including budget support and tax breaks) or SOE investment in grid infrastructure for fossil fuel-powered electricity

Subsidies as explored in Gençsü et al., 2017.

Table 3 Subsidies for consumption.

Transport (excluding infrastructure)	Business and industry	Households	Agriculture
Energy tax relief for public transportation Tax breaks for diesel or other fuel sources Company car tax breaks Tax breaks for airlines Energy tax exemption for fuels used in aviation Energy tax exemption for shipping Energy tax exemption for fuels used in internal waterway transportation	Energy tax relief for energy-intensive processes Tax relief for specific processes Energy tax relief for LPG and natural gas used in engines	Energy tax breaks for household heating and electricity Budget support for new gas boilers Direct aid to poor families (e.g. coal)	Energy tax breaks for agriculture Rebates on diesel fuel tax in agriculture, horticulture, farming and inland fisheries.

Subsidies as explored in Gençsü et al., 2017.

One can notice, however, that a number of examples contained in tables 2 and 3 are overlapping. For example, tax reductions and budget support appear multiple times. Thus, the reports present the different measures in three overarching groups. These are ‘fiscal support’, ‘public finance’, and ‘investment by SOEs’ (see Gençsü et al., 2017: 22-23). We have studied whether these categories of measures of FFS identified in the ODI/CAN report could fall under EU State aid rules by analysing if they fulfil (or not) the five criteria of the EU State aid regime. We used the three categories as a starting point but then explored the FFS measures that are grouped under these in more detail. Our assessment distinguishes between the subsidies that are ‘unlikely’ and those that are ‘likely’ subject to the EU’s State aid regime.

3.2.1. Measures unlikely to be subject to the EU State aid rules.

First, EU measures such as the European Central Bank’s (ECB) bond buying programme, support via the EU’s development bank, or direct payments by the EU are not subject to the EU State aid rules. Yet, there are also subsidies granted by Member States that are not considered to fall under the EU State aid rules, as they do not fulfil the four criteria. In the following, we explain why certain subsidies identified in the ODI/CAN report are unlikely to be subjected to the EU’s State aid control regime. However, this finding is always subject to proviso that the application depends on the actual set up of the system. For instance, early retirement payments for coal miners through government budgets estimated by the report are unlikely to be covered by the EU State aid regime. This is because these benefits are typically granted to individuals and not to companies or undertakings in the EU State aid lingo. Moreover, even if they are granted in a way that benefits companies, these payments will typically be available to the whole sector that should be phased out and are therefore unlikely to be selectively available to certain companies. However, while deemed unlikely here, there is still a possibility that early retirements could be considered as providing an advantage to the whole coal sector.

Another category of measures that are unlikely subject to the EU State aid rules are payments for decommissioning or rehabilitation. These measures would typically not benefit specific companies and thus would not be subject to State aid control. Yet, where these payments are available only to certain companies and relieving these companies from existing national or EU law requirements, such payments would fall within the scope of the EU State aid rules.

Similarly, the ODI/CAN’s assessment of investment by SOEs in plant operation and modernization domestically and internationally would unlikely be covered by the EU State aid rules. The latter only come into play where these investments could not have been obtained under market conditions. Finally, a group of measures in the ODI/CAN report called ‘‘Other Unspecified Forms of Transition Support’ is deemed unclear on whether the group would be subjected to the EU State aid rules. This group of measures might well be subject to the EU rules on State aid, but a more detailed individual assessment would be needed. Thus, it seems sensible to classify them more conservatively as unlikely.

Table 4 provides an overview of measures unlikely to be considered as State aid, according to the five conditions for EU State aid.

Table 4. Measures unlikely to be State aid.

	The five conditions of State aid
		Advantage	Selectivity	Provided to an undertaking’	Granted by the State	Effect on trade and competition
Measures identified in the ODI/CAN Report	Early retirement payments for coal miners	Yes	No, as most likely available to not only to specific but all companies. But there is a (small) possibility these are considered selective: if only available in this sector but not in comparable sectors.	No, most likely granted to individuals (natural persons rather than companies)	Yes	Yes (except where de minis)
	Payments for the decommissioning or rehabilitation	Yes	No, as typically available to all companies is comparable situations. But yes, if a company is relieved from existing national or EU law requirements	Yes	Yes	Yes (except where de minis)
	Investment by SOEs in plant operation and modernization	Yes	No	Yes	Yes	Yes (except where de minis)
	Other Unspecified Forms of Transition Support	Individual assessment of specific measures needed	Individual assessment of specific measures needed	Individual assessment of specific measures needed	Individual assessment of specific measures needed	Yes (except where de minis)
Colour coding:
Yes	Yes, but some uncertainty	No but some uncertainty	No

3.2.2. Measures likely to be subject to the EU State aid rules

In the following, we highlight why the other measures could be addressed via the EU State aid rules. In general, three subcategories of subsidy measures are likely to be subjected to EU State aid rules.

First, any form of budget, price or financial support⁹ by means of direct payments to companies – whether state-owned or private – could most likely fall within the EU State aid regime because it is the most direct form of aid paid to companies. In the context of tax measures, EU State aid law assesses whether the benefits are available only to a specific group of companies/industries or whether these are available more broadly. As the ODI/CAN report lists those tax measures as specifically addressing fossil fuels, it is likely that these measures are sufficiently selective to be considered State aid. The report, in particular, lists tax reductions such as deductions in the development phase of fossil fuel projects, tax breaks for the construction of refineries or plants for heat and electricity generation, or tax relief from property taxes or energy intensive processes. These would likely be subject to the EU State aid regime. However, this category also includes government regulated prices for feedstock, tax breaks for diesel or other fuels, and tax breaks for industries. While tax breaks for industries from property taxes or tax breaks for development of fossil fuel projects (e.g. refineries) would likely be subject to the State aid regime, the details regarding these measures are unclear as the specific design determines whether a measure is considered State aid. The relevant question is whether these measures benefit the fossil fuel industry specifically and are therefore selective. For example, there is specific uncertainty with regard to tax breaks for diesel because these might be the result of EU rules rather than Member States’ activity (diesel is occasionally treated differently than petrol under some EU tax rules). In this case, these tax breaks would not be State aid but would be considered EU support that is not covered under the EU State aid rules. The same can apply to other fuels and it would equally depend on whether the reductions are based on EU rules. An EU link immunizing tax measures for other fuels is less likely as the EU rules mainly provide for special treatment of diesel. That being said, there are cases where tax breaks for petrol but also for diesel have been considered State aid under EU law.¹⁰

Second, government-provided insurance, loans, or concessions to fossil fuel companies that are provided below market rate are also likely subject to the State aid regime. Because the EU State aid rules use a market rate test to determine whether something is classified as State aid, these would most likely be covered by the EU State aid regime.

The third area where State aid rules are likely to apply are capacity mechanisms that ensure the availability of sufficient dispatchable power generation.¹¹ These would not be selective as long as the design of these mechanisms is technology neutral. In practice, many capacity mechanisms give benefits to either gas or coal power plants and are technology neutral only on paper.¹² The Commission issued 19 decisions on capacity mechanisms between 2014 and 2019, establishing for example that the UK’s capacity mechanism is subject to the State aid rules as it is selective (Commission Decision SA.35989).¹³

However, as always in law, there is a caveat, in that this paper does not pursue a detailed, fact-specific assessment involving a close examination of all legal conditions surrounding these measures and the position of the companies. There is still a possibility that, depending on the specific arrangement in the different Member States, these subsidies would not be considered to be State aid. For example, if these subsidies are available to all (and not only fossil fuel) companies or if the level each company receives is below the de minimis threshold. These findings are summarized in Table 5.

Table 5. Measures likely to be State aid.

	The five conditions of State aid
Measures identified in the ODI/CAN Report		Advantage	Selectivity	Provided to an undertaking’	Granted by the State	Effect on trade and competition
	Budget, price or financial support by means of direct payments to companies	Yes	Yes, if they specifically benefit the fossil fuel industry but occasionally they might be available to all fuels ands not selective.	Yes	Yes, but unclear as exceptionally it maybe granted by an EU rather than a Member State measure.	Yes (except where de minis)
	Government provided insurance, loans or concessions for fossil fuel companies below market rate	Yes	Yes	Yes	Yes	Yes (except where de minis)
	Capacity mechanisms	Yes	Yes, if they specifically benefit the fossil fuel industry but occasionally they might be technologically neutral and then not be selective.	Yes	Yes	Yes (except where de minis)
Colour coding:
Yes	Yes, but some uncertainty	No

4. Discussion: making use of the EU State aid toolbox

The EU rules on State aid are one of the most powerful tools that the EU Commission has in addressing economic activities in EU Member States. Numerous policy consequences result from being within the scope of this legal framework. In the following section, we briefly highlight the main powers of the Commission and the State aid procedures, as well as the conditions under which State aid can be allowed. We argue that the EU State aid tools are underutilized by the EU to actively advance its climate change policy and comply with the EU’s international commitments to reduce FFS for three reasons. Finally, we attempt to estimate roughly the amount of FFS that could be potentially subject to the State aid regime.

4.1. Effects and effectiveness of the EU State aid regime in the context of FFS

First, the EU can monitor and stop State aid. This power stems from the notification requirement. Any FFS of a Member State that qualifies as State aid under Article 107 (1) TFEU (and is not subject to a block exemption and in particular the General Block Exemption Regulation)¹⁴ needs to be notified¹⁵ to the Commission.¹⁶ In other words, the measure needs to be reported to the Commission and the Member States must refrain¹⁷ from the implementation of the aid until the Commission has decided on its legality. To ensure the effectiveness of this notification requirement, so that Member States do not simply circumvent it, the Commission can order the State not to implement the aid measures or, where this has already happened in contravention of the obligation imposed, order the recovery of the aid¹⁸ according to Article 13.¹⁹

Second, the EU rules create transparency which allows for public scrutiny and increased public pressure. This transparency can be achieved in three different ways. In 2016, a general transparency requirement came into force (DG Competition 2016). Thus, the name of the beneficiary, the amount, the location, the sector, and the objective of the aid are now publicly available in the State Aid Transparency Public Search (an open online database that details the beneficiaries and the amount of aid). Based on this information, the EU publishes the yearly State Aid Scoreboard²⁰ which summarizes the expenditure for State aid by the different EU Member States and the relevant areas for which State aid has been granted. This report serves to benchmark the Member States and is based on their mandatory yearly submissions reporting existing aid.²¹

Additionally, the Commission under Article 25 of Regulation 2015/1589 has the power to start State aid sector inquiries. Such inquiries examine the whole sector to provide the Commission with a better understanding of its functioning and to uncover aid measures that do not comply with the legal framework. These transparency tools can be used and further increase their effectiveness vis-a-vis FFS accountability. In particular, the EU can categorize, record, track, and score State aid measures for FFS separately. Currently, the EU does not recognize FFS or, more precisely, State aid for FFS as a separate category of State aid. Thus, the EU’s State Aid Score Board does not contain a category that shows how much State aid is provided for FFS. Instead, many of the FFS will likely be summarized under ‘Energy and Environmental Aid’, which in 2016 was the largest category of aid totalling €45.3 billion. However, FFS are likely also recorded as other forms of aid such as ‘aid for research and development’. The categorization of FFS under ‘Energy and Environmental Aid’ is problematic because it lumps environmental aid designed to address climate change together with aid for energy; whether this is energy aid for renewables or aid for the fossil fuel industry. Establishing a separate category for fossil fuel aid allows the EU not only to name and shame but also to change the conditions under which such aid can be granted. It would offer the chance to successively reduce the available aid by means of the Commission’s power to allow or disallow State aid (see also below). A sector inquiry by the Commission could help to better measure and understand the FFS. Moreover, other measures might not have been recorded yet as State aid and could be ‘uncovered’ in the context of a sector enquiry. The inquiry would also provide an important, publicly open platform for an empirically grounded assessment of such measures under the EU State aid rules.

The third reason why the EU State aid tools are helpful in addressing FFS is the power of the Commission to determine what State aid is legal and under which conditions such aid can be granted. Any measure that satisfies the conditions of Article 107 (1) TFEU and is not compatible with the internal market by virtue of Article 107 (2) TFEU, needs to be declared compatible by the European Commission. While this is closely related to the first procedural point relating to notification, this power also involves a substantive element. The Commission has the power to declare whether such State aid measures are compatible. Such a declaration of compatibility is possible by means of specific exemption regulations ²² or by a decision of the Commission based on Article 107 (3) TFEU. The general yard stick in this regard is Article 107 (3) TFEU. In the context of this Article and in the adoption of block exemption regulations by the Commission, the Commission has a considerable degree of discretion. This discretion must be exercised with European interests in mind and can equally take account of the EU’s international commitments.²³ This has two specific policy consequences. On the one hand, the Commission has the power to stop and order the recovery of any FFS that does not fulfil the conditions of Article 107 (3) or the Block Exemption. In general, the Commission’s approach in the Regulation and its decisional practice aims at preventing aid for the operation of activities (operating aid) but is more lenient towards aid for the setting up of such activities (investment aid). This is based on the so-called incentive (see also Article 6 of the Regulation). It should ensure that the activity by companies is the result of the aid and would not be undertaken otherwise, in this way any free riding by companies is minimized. As a result of this requirement, it can be expected that any aid measure like continued support to produce fossil fuels would not meet the test due to the missing incentive effect and would thus be prohibited. On the other hand, the Commission could use its discretion to further toughen up the requirements for those subsidies that are still legal under the current framework in order to gradually phase out FFS. Establishing a separate category of fossil fuel aid would be helpful in this regard. Such a category would allow the Commission to actively engage and change the conditions under which such aid can be granted.

4.2. Rough estimates of FFS potentially subject to EU State aid rules

With due limitations, the above legal analysis provides a basis to make a very rough estimate of the amount of FFS that can be potentially subject to State aid rules. However, several caveats need to be considered beforehand before using the ODI/CAN numbers. First, it is unclear how the ODI/CAN report estimated the level of subsidy, and while the report acknowledges this difficulty in its method section, such calculations (and margin of errors) are still not visible in the main text and country data sheets. Second, the report does not provide detailed figures for all measures that we have identified as likely subject to State aid.²⁴

Notwithstanding these uncertainties, it is still possible to identify the value of all measures that are unlikely to qualify as State aid. By doing so, in turn, we can approximate the value of measures that are likely to qualify as State aid. To that end, we simply subtract the value of the measures that legal analysis deemed or suggested as unlikely to be subject to the EU State aid rules from the total value of subsidies, see Table 6.

Table 6. Rough estimates of FFS potentially subject to State aid control

Overall level of FFS as estimated by ODI/CAN	€112 billion*
Measures unlikely subject to State aid control based on legal analysis
EU measures (eg. ECB bond buying, support EU Development Bank’s support, EU direct payments)	€4 billion*
Early retirement payments for coal miners	€0.3 billion*
SOEs investment (plant operation and modernization, domestically and internationally)	€12 billion*
‘Other Unspecified Forms of Transition Support’	€2 billion*
Estimated total value of FFS unlikely subject to State aid control based on legal analysis	€18.3 billion
Estimated total value of FFS likely subject to State aid control	€93.7 billion

* Values of FFS according to ODI/CAN (see Gençsü et al., 2017).

Overall, these rough estimates suggest that approximately €90 billion of FFS are potentially subject to State aid control. This level could be taken as a lower bound due to a number of reasons. First, as the ODI/CAN report highlights, the estimates provided for each country are likely underestimates since many subsidy measures are unknown or because the level of support is not reported and thus cannot be calculated. Second, the ODI/CAN report is only based on the FFS of the 11 biggest EU economies rather than all the 27 EU Member States. Third, the ODI/CAN report excluded some fossil fuel support measures from its calculations that would likely be subject to the EU State aid regime. In particular, any subsidy given in the context of transport infrastructure or grid distribution systems are excluded, but these may very well be subject to the EU’s State aid rules. Similarly, the EU State aid rules would also cover other benefits excluded from the ODI/CAN report such as benefits provided in the context of plant construction, operation, and distribution of petrochemicals and any support provided at the sub-national as well as pay-outs in investor-State disputes. Whereas these estimates are certainly open for discussion, they provide a rough order of magnitude about the policy implications of using EU State aid rules to phase FFS.

5. Conclusion

This paper analysed the potential legal avenues for phasing out fossil fuel subsidies (FFS) in the European Union using EU State aid rules. We identified several policy areas that could make EU State aid control an effective policy tool to do so, including the requirements for notification, examination, transparency and reporting, and recovery of unlawfully granted aid. The analysis suggests that the EU Commission could make full use of the State aid rules to control and reduce FFS by establishing a separate category of aid, namely aid for fossil fuels. The analysis also suggests that the EU could use this legal framework to show its commitment to international climate policy and start a sector inquiry into fossil fuels. Such action would be in line with the EU Parliament’s recent call for ‘net-zero’ emission by 2050 and make such State aid measures more transparent. Based on the identified FFS in the ODI/CAN report, and with due limitations and uncertainties, our legal analysis suggests that a majority (approximately 80% of €112 billion) of the identified FFS measures could be potentially subject to the EU State aid regime. Whereas these figures are certainly open for discussion, they provide another element to visualize the potential policy implications of using EU State aid rules to tackle FFS. In all, the EU State aid toolbox as policy mechanism appears to be underutilized; however, it offers various possibilities for the EU to actively advance its climate change policy and comply with its international commitments to reduce FFS.

Acknowledgement

We would like to thank particularly the two reviewers for their comments on earlier versions of this paper and Joseph Malcontento and Rica Papa for research/editing assistance.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 For an overview of the different methodologies for measuring FFS see UNDP et al (2019).

2 Lately, the ‘Energy Charter Treaty’ (ECT) has opened a new front of policy debate to tackle FFS in the EU. For example, see this ‘Open letter from climate leaders and scientists’ addressing the ECT at http://www.endfossilprotection.org/.

3 The definition of State aid is provided in Article 107 (1) Treaty on the Functioning of the European Union and has typically five basic elements: (i) a selective advantage (ii) provided by or through State resources (iii) is provided to an undertaking (iv) that distorts competition (v) and that has an effect on cross-border trade in the EU.

Throughout the paper we use the terms State aid regime, State aid law, State aid control mechanism interchangeability. It refers the rules of the EU State aid control contained in Article 107 Treaty on the Function of the European Union and its enforcement system by the EU Commission which is based on case law by the European Court of Justice, EU secondary law (in particular Regulations) and Commission guidelines.

4 See e.g.: Case C-237/04, para 42; Case C-387/92, para 13; Case C-501/00, para 90.

5 See e.g. Case 173/73, para 13; ; Joined Cases C-106/09P and C-107/09P, para 48; Case T-613/97, para 160.

6 See Case 30/59, page 19, and also e.g. Heidenhain, M. (2010) and Nicolaides (2010).

7 For example, where the State administration rather than a State own company sells good such as tabaco, see for instance: Case 118/85; Commission Decision 90/456/EEC.

8 On the consequences of this application see section 4 below, which covers the consequences and power of EU State aid law.

9 The ODI/CAN report also mentions tax measures as a form of fiscal support.

10 See European Commission’s (2017) press release titled ‘Taxation: Commission refers Italy to the Court of Justice over excise duty reductions for petrol and diesel’.

11 Dispatchable power generation is typically thermal power plants like coal and gas power. Renewables like wind and solar PV are not dispatchable. The need for capacity mechanisms has arisen with the increasing share of intermittent solar and wind power in the power systems

12 Such a case has occurred in Poland. The European Commission warned Poland not to provide State aid to coal by means of a capacity mechanism, see Darby (2016).

13 For an overview see Stoczkiewicz (2015).

14 Commission Regulation (EU) No 651/2014 of 17 June 2014 declaring certain categories of aid compatible with the internal market in application of Articles 107 and 108 of the Treaty [2014] OJ L 187/1. This Regulation provides exemptions for a number of aid forms. In general, the Regulation aims at preventing aid for the operation of activities (operating aid) but is more lenient to aid for the setting up of such activities (investment aid) with the aim of achieving a so-called incentive effect. This effect is stipulated in Article 6 of the Regulation and should ensure that the activity of the undertaking is the result of the aid and would not otherwise have been undertaken, in this way any free-riding effects should be minimised. Thus, one would expect that any aid measure like the continued support to produce fossil fuels would not meet the test due to the missing incentive effect.

15 There are some exceptions to this requirement of notification. The first relates to old or existing aid, such aid does not need to be notified (Either because they have already been reported or because they predate the existence of the EU.) but the Commission according to Article 108 (1) TFEU keeps them under ‘constant review … [for] the progressive development or […] the functioning of the internal market.’ The second exception relates to measures that are covered by the Block Exemption. The others relate to de minimis aid, that is to say smaller amounts of aid (Amounts not exceeding €200,000 per undertaking over any period of 3 fiscal years or €100,000 in the road transport sector) and aid which is granted under a scheme which had previously been authorised by the Commission.

16 The details of the procedure are set out in Council Regulation (EU) 2015/1589 of 13 July 2015 laying down detailed rules for the application of Article 108 of the Treaty on the Functioning of the European Union [2015] OJ L 248/9.

17 See also Article 3 of Council Regulation (EU) 2015/1589.

18 That is to say the repayment of the moneys from the undertaking to the State, as happened in the famous Apple Irish tax case.

19 Of the Council Regulation (EU) 2015/1589.

20 The State aid scoreboard can be found at https://ec.europa.eu/competition/state_aid/scoreboard/index_en.html.

21 This obligation is imposed by Article 5 of Commission Regulation (EC) No 794/2004 of 21 April 2004 implementing Council Regulation (EC)No 659/1999 laying down detailed rules for the application of Article 93 of the EC Treaty [2004] OJ L 140/1.

22 Furthermore, the prohibition of Article 107 (1) TFEU may not apply, in cases where the aid distorts competition, but this restriction is necessary for the provision of a service of general interest, because of Article 106 (2) TFEU. Typical examples are utilities like telecoms.

23 See e.g., Article 2 and 3 of the Treaty of European Union (TEU) which require the EU to strive for ‘wellbeing of its people’, ‘sustainable development’, ‘environmental protection’ and should contribute to sustainable development on the international scene while ensuring ‘strict observance and the development of international law’.

24 Occasionally, the figures for certain measures are not provided and only the overall figure for the category (fiscal support/public finance/ investment by SOE) is available. For example, it is reported that 3.3 billion are spent on fiscal support for the coal industry, but it remains unclear how much of that amount is spent on budget expenditure (e.g., direct spending on R&D for fossil fuel exploration), tax exemptions (e.g., tax breaks for diesel use in transport), and price and income support (e.g., provision of electricity at a lower price for specific groups or sectors, such as households or industry).