Getting FIT for the WTO: Canadian green energy support under scrutiny

6 April 2011

A climate protection policy already used widely all around the globe recently entered the stage of WTO dispute settlement. With Japan's challenge of a Canadian feed-in-tariff (FIT), the WTO might soon have to rule for the first time on a support policy for renewable power generation. With around 50 countries having enacted FITs, including 18 developing countries, this precedence ruling could have great repercussions for global green energy support policies.

Last September, Japan brought Canada to the WTO over the province of Ontario's FIT programme, which enables the province to subsidise renewable energy generation by guaranteeing electricity purchase prices, grid access, and long-term contracts to green energy producers making their cost intensive investments worthwhile. In other words, the FIT is a sophisticated purchasing guarantee for renewable energy.

It is not the FIT as such though, but a controversial "local content" provision of Ontario's FIT that landed Canada at the WTO. The "made-in-Ontario" provision mandates that a certain portion of all green energy project inputs be manufactured (goods) or provided (services) in the province, as it strives to create local jobs. Japan argues that conditioning FIT support on the basis of local input requirements discriminates against equipment for renewable energy generation facilities produced outside of Ontario and amounts to a prohibited subsidy under the WTO subsidy agreement.

Japan also argues that because the local content requirement affords less favourable treatment to Japanese companies exporting solar panels and other equipment to the province, it violates WTO national treatment obligations included in the General Agreement on Tariffs and Trade (GATT) and the Agreement on Trade-Related Investment Measures (TRIMS), under which foreign and domestic producers ought to be treated on an equal footing. The EU and US followed suit by requesting to join Japan in the dispute less than two weeks later.

Buy-Ontario

The local content requirement says renewable energy suppliers must meet a "minimum required domestic content level" in order to be eligible for the benefits of the FIT. Those levels range from 25 percent for wind projects over 10 kilowatts in 2009-2011 to 60 percent for solar projects over 10 kilowatts starting in 2011. For instance, if a company producing solar power wants to receive the price guarantees and grid access granted by the FIT, it needs to ensure that 60 percent of the equipment used to produce that energy, including solar panels, and respective services comes from Ontario.

Ontario on its part introduced the local content requirement with the aim of attracting foreign investment and creating jobs by spurring domestic demand for green energy products. In fact, many countries face domestic opposition when aiming to implement green energy support programmes as the policies are feared to raise the costs of electricity. Selling "green" as a stimulus measure is often seen as a means of reconciling the goal of creating jobs while increasing the share of renewable energy. It was this move that effectively eased much of the public opposition and allowed Ontario's government to implement the programme.

Ontario's FIT has succeeded in increasing the share of renewable energy and drawing manufacturers to Ontario. The largest deal under the province's green power plan is a US$6.7 billion green investment by South Korea's Samsung Group to build four wind and solar power clusters in Ontario. Some observers have speculated that Japan is targeting Ontario in the wake of the South Korean deal and the fact that Japan and its companies - such as Sharp, Mitsubishi, and Kyocera - were on the losing end of a US$20 billion nuclear power deal in the United Arab Emirates. The Ontario deal could be perceived by Japan as a sign of losing ground in the green energy arena, some experts have said.

According to its request for consultations, the US joined the dispute because of its substantial trade interests in renewable energy as a major innovator in the field and as a primary source of Canadian imports. It joins Japan in its condemnation of what it perceives as the trade distorting effects of the local content requirement.

In past disputes, local content requirements have been found to violate numerous WTO agreements, including GATT and the Subsidies and Countervailing Measures Agreement (SCMA). The preference of locally produced goods over foreign manufactured goods on the basis of nationality has been found to breach the non-discrimination principle under GATT, and can qualify as a ‘prohibited subsidy' under the SCMA, which rules out subsidies contingent on the use of domestic input.

The latter consideration introduces the highly important and controversial question of whether FITs constitute a "subsidy" under WTO law. Whether a case is resolved under GATT or the SCMA matters for several reasons. First, subsidies can be found illegal if a country is able to prove an adverse effect on any sector or part of its economy provided that the same sector in the other country benefited from the subsidy. This is wider than the scope of GATT. Secondly, the remedies as well as available exemptions and justifications differ, making the SCMA (potentially) a desirable legal ground.

Government procurement vs subsidy

For a policy to qualify as a subsidy under the WTO's subsidy accord, it has to be a "financial contribution by a government or any public body whereby a benefit is conferred." The SCMA lists four different alternatives of a financial contribution, including the purchase of goods or services by the government. Under WTO law, electricity is qualified as a good, thus the payment of feed-in-tariffs could amount to a purchase of goods by a government.

In that case, however, it might as well qualify as government procurement rather subsidisation, experts suggested. The global government procurement market, amounting to around US$4,733 billion annual spending in OECD countries alone, remains largely outside the realm of WTO law. Until today, only OECD countries signed onto the WTO's specialised agreement on Government Procurement (GPA), and in many cases their sub-federal and local institutions also remain uncovered. This is true for Ontario's Power Authority (OPA) administering Ontario's FIT programme.

Moreover, GATTs national treatment principle recognised an exemption for "governmental agencies purchasing for government purpose and not with a view to commercial resale". The question is then whether the distribution of purchased electricity is a commercial resale. This, by nature, requires a commercial interest, usually profit. Following that thought a FIT could be government procurement as long the resale of electricity does not create profit. Prices, usually the best indicator to calculate profit, however, remain highly distorted in the electricity sectors. Likewise, the impact of FIT programmes is unlikely to show before the measure is used on a large scale over a reasonably long period of time.

In either case, the government procurement exemption does not apply to the SCMA. To the contrary, the SCMA recognises that a purchase of goods and services by a government can qualify as a financial contribution if the price paid is above market standard. The question whether a FIT can amount to a subsidy then becomes even more important. If FITs were found to be government procurement but not a subsidy they could easily fall off the WTO's table. Classifying a FIT as a subsidy, however, would trump the government procurement exemption.

Lost in implementation: Who acts and who pays?

There are three main scenarios as to how governments can implement a FIT. First, a public body could use public funds to execute the FIT programme through, for instance, state-owned enterprises (SOEs). Second, a government could direct a private body to execute the programme but provide the necessary funds itself. And third, a government could direct a private body to execute and pay for the programme by generating resources through a relocation of costs or other means. While the first two scenarios represent clear instances of government contribution, the third appears "private" in nature.

To prevent the circumvention of subsidy rules by directing private bodies, the SCMA says that if the government directs or entrusts a private body to implement and fund a programme that involves "a practice normally followed by the government," it will be considered a subsidy nonetheless.

This distinction is of critical importance as each country implements its FIT in a different way. In many nations the electricity sector remains state owned or state regulated with state-owned enterprises, public price setting bodies and other regulatory institutions playing a great role. In other countries, however, a government might decide to obligate electricity network operators to purchase green energy at a minimum price while reallocating the costs among electricity undertaking, network operators and consumers. Ontario's story is very telling in this regard.

Ontario's energy system continues to be state regulated, with the Ontario Power Authority (OPA) "ensuring an adequate, long-term supply of electricity in Ontario" as directed by the Ministry of Energy. It has also been entrusted with designing and implementing the feed-in tariff programme, which includes price setting and administering contracts. As the OPA functions under the direction of the Ministry and the Ontario Energy Board (OEB), it finds itself in a control-and-command relationship, an important indicator that the OPA is a public body. However, according to the Ministry of Energy the OPA is not a public body, which has created considerable confusion among energy experts and Ontario's greater public.

As for the SCMA, the Appellate Body ruled only a few days ago (US-AD/CVD DS 379) that a "'public body' connotes an entity vested with certain governmental responsibilities, or exercising certain governmental authority." It is a quite "straightforward [case] when a statute or other legal instrument expressly vests authority in the entity concerned." "What matters is whether an entity is vested with authority [...] rather than how that is achieved." This new ruling could suggest that the transfer of responsibility and authority make an entity a "public body" even if its legal status suggests otherwise, as in the case of the OPA. The analysis, however, is far from easy.

In addition to the OPA, local distribution companies and transmission asset (the electricity towers etc.) owners and system operators play an important role in the implementation of the FIT programme. There are two different contract partners - the OPA signing onto the general terms and conditions (the ‘FIT contract') and the distribution and transmission companies having to agree on the specific conditions for connection and implementation to manage the actual ‘feed-in' process. Hydro One is Ontario's largest transmission company and it holds approximately 96 percent of all transmission assets within the province while its distribution network covers about 75 percent of the region's area. It distinguishes itself from the other 83 local distribution companies available in Ontario as it remains a Crown Corporation whose assets are owned one-hundred percent by the government of Ontario - making it a state-owned enterprise (SOEs). Until recently, trade lawyers understood these to be "public bodies" by nature. Since the last ruling, however, this notion is turned upside down as the Appellate Body found certain SOEs to be "private bodies" as they did not "exercise governmental authority."

In addition to these numerous public and private entities, Ontario's Global Adjustment Mechanism (GAM), a funding mechanism established for adjusting the price of electricity supply within the region, plays a critical role. "The cost of electricity is recovered through a combination of global adjustment and the hourly Ontario energy price (HOEP, the ‘market price'), which are inversely related. For example, if HOEP increases, the global adjustment decreases and vice versa," the OPA explains. Costs are thus offset through consumer payments and the global adjustment. Depending on whether the revenue generated through the sale of electricity offsets the costs spent for the FIT programme (and other programmes) consumers receive adjustment payments from the mechanism or are required to pay additional contributions. For the FIT programme, the hourly market price hardly ever rises even to the level of the lowest FIT rates.

While highly fragmented with diffuse responsibilities resting with different bodies, the Ontario FIT is largely governmental in nature. This is in stark contrast to the German FIT system - the only FIT system that ever found itself in court, namely the European Court of Justice (ECJ). Germany has issued a purchase obligation for electricity network operators to purchase electricity from renewable energy sources at a minimum price. The costs for the programme are divided between electricity supply undertakings purchasing renewable energy and upstream private electricity network operators. Interestingly, the ECJ found that the German FIT could not be considered ‘state aid' (subsidy) under European law as a consequence of the absence of any direct or indirect transfer of state resources.

The Appellate Body has rejected a similar view under WTO subsidy law, finding that no public coffers need to be charged in order for a measure to qualify as a subsidy. This is an important conclusion for green energy subsidy programmes, since FIT programmes can be implemented without any cost to the government, as the German example shows.

FITs aren't "normal"

While more "liberal" on the source of finances, WTO law excludes a large amount of potential subsidies by requiring directed actions to "practices normally followed by the government". Accordingly, FITs implemented and financed by private entities only qualify as a subsidy if they are ‘normal' for governments. But what is "normal"?

Previous WTO panels and experts have narrowly interpreted this wording to cover only the particular government functions of taxation and expenditure of revenue. In cases where the government is engaged in regulation instead, the measure may not be considered a subsidy under WTO rules. The aim behind this is to strike a balance between the objectives of a) avoiding circumvention of the subsidy rules by directing private entities; and b) ensuring that governments retain the possibility of engaging in "command-and-control regulation" (regulation performed by private actors as directed by the government).

If no such distinction was made between regulation and governmental function, any direction by a government that could potentially distort trade would qualify as a subsidy.

Privately exercised FITs arguably do not represent a delegation of a "function" but a delegation of a "regulation." It is a purchasing obligation that is imposed on the private bodies and not the design or oversight of such a programme. Against this background, it would be extremely difficult to argue that the purchase of electricity as mandated by law would qualify as a "practice normally vested within the government that does not fundamentally differ from practices normally followed by the government." Otherwise, any obligation to put public policies into practice could qualify under the SCMA.

Yet again, the recent Appellate Body ruling has introduced a new level to that discussion: that of the "legal order of a country" as the benchmark for "normal," which could potentially change the assessment.

In any case, for FIT systems implemented by public bodies, this distinction is irrelevant. If the government acts, whether it is a "normal function" or a "regulation" - and all other requirements are met - a publicly run FIT could qualify as a subsidy.

Outlook

Should a WTO panel find that the Buy-Ontario clause violates WTO law, it would not be news to the ears of trade law experts despite its case specific impact. A ruling on the subsidy question, however, could clarify a number of outstanding issues and in that regard introduce greater legal certainty for countries that have implemented FITs or are planning to do so.

Likewise, a ruling could potentially clarify the basis upon which a FIT can be challenged. In the current case Japan argues that the FIT, thanks to its infamous buy-local clause, discriminates foreign manufacturers. Such a subsidy (contingent on either export performance or the use of local products) is prohibited under the SCMA. For all other subsidies (non-prohibited or ‘actionable'), however, the complaining party would need to show an adverse effect on its economy. While this can be more burdensome than certain requirements under GATT, it also means that an adverse effect could be shown in any affected sector if the like-sector benefited from the subsidy. It has been suggested that, in theory, this could also include a competing energy sector, such as coal-fired plants. However, in the light of the high standard of proof required under the SCMA and considering the distorted nature of the global energy market, it could be difficult for competing energy suppliers to show an adverse effect attributable to the implementation of a single FIT. For the moment, this seems to be a theoretical mind game, at most.

The most important outcome of the ruling could well be its impact on expert discussion. With the request of consultations the issue has entered the stage of the WTO inducing country delegates and external experts to discuss whether they find that the existing rules are supportive of sustainable development and the fight against global warming. As the above discussion has shown, the WTO agreements allow for various arguments and interpretations which reflects the WTO's nature as a negotiating body. It will be up to WTO members to decide whether they find these options supportive or whether a renegotiation would be beneficial. Those governments currently implementing or re-designing their FITs will be following the case closely, but it may be of relevance to a much broader group of countries wishing to further support the generation of electricity through renewable energies.

Geneva proceedings

The DSB has not yet been asked to establish a panel on the dispute as the countries continue their consultations searching for a negotiated solution to the case. Should the parties fail to agree and the case continues to the panel stage, it could take up to two years for the case to be resolved at panel and potentially appellate stage. The compulsory period for consultations of sixty days already expired last year - a panel request could thus be introduced at any moment.

One issue that has further complicated Canada's position in the dispute is its highly federal nature and Ontario's role as the implementing province. While Ontario is in full control of the FITs administration, including the decision to uphold the local content requirement, it is the federal government that negotiates in Geneva and that will have to ensure compliance with a WTO ruling.

Marie Wilke is Programme Officer for International Trade Law at ICTSD. This article is an abridged version of a longer study that will be available soon on ICTSD's website.

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