This article was featured in our 2023 Energy Arbitration Report, which is part of a series of industry-focused arbitration reports edited by Jus Connect and Jus Mundi.
This issue explores the energy industry, encompassing information on electricity & renewables, based on data available on Jus Mundi and Jus Connect as of September 2023. Discover updated insights into energy arbitration and exclusive statistics & rankings, as well as in-depth global and regional perspectives on energy projects, disputes, & arbitration from leading lawyers, arbitrators, experts, arbitral institutions, and in-house counsel.
THE AUTHORS:
Değer Boden Managing Partner at Boden Law
Ceren Saraçgil Associate at Boden Law
In the energy industry, a recurring trend emerges where increases in energy prices often lead to government actions aimed at gathering unexpected excess profits and then redistributing these gains to support vulnerable households, energy-intensive companies, and high-cost energy companies. Many countries that are significant energy producers, such as Australia, Nigeria, and Brazil, have tax systems that incorporate mechanisms ensuring that the government benefits when prices experience
an upswing. Governments in Europe and in many other countries have taken some measures to quickly try to curb the rising energy prices. Windfall tax and revenue caps are finance measures used in high energy prices.
Windfall taxes are imposed on excessive profits earned by energy com- panies during a period of significant energy price increases on an energy crisis. The tax is introduced by governments as a way to capture some of the unexpected and unusually high profits made by energy companies when energy prices surge due to supply disruptions, market manipula- tion, or other factors. The idea behind a windfall tax is to prevent energy companies from profiting excessively from a situation where consumers are facing soaring energy costs.
Several European nations such as Spain, Greece, Italy, Belgium, and Austria have already enacted such measures until the end of 2022, and Germany on early 2023. They have put in place “windfall profit taxes” targeting companies that have unexpectedly reaped substantial profits, especially as a result of rising energy prices. In parallel, the UK has intro- duced a levy on energy profits for oil and gas enterprises.
Several European States including Spain also provided price caps for electricity producers, utilizing what are referred to as “inframarginal technologies”. These technologies encompass renewables, nuclear, and lignite. These operators have experienced unexpectedly high financial gains lately, despite their operational costs remaining stable. This is primarily due to the influence of coal and gas as dominant sources, which currently drive up the final electricity price.
Turkey’s Inframarginal Price Cap
In Turkey, due to the increases in electricity prices and cost disparities related to electricity generation, with the aim of ensuring supply security and protecting the consumers, a price cap was introduced for generation companies utilizing what are referred to as “inframarginal technologies” such as renewable energy generators. Such ceiling is called the “Maxi- mum Settlement Price” and any profit between the such Maximum Sett- lement Price and the Market Clearing Price (“MCP”) will be distributed to high-cost generators. The difference between such a price cap and the market clearing price is defined as the Turkish Electricity Market as the Support Fee on the Basis of Source (“Support Fee”).
As expected, it resulted in many administrative lawsuits against the regu- latory authority in order to annul the regulation. For instance, the Board of Directors of the Association of Electricity Producers filed a lawsuit on May 16, 2022, for the annulment of the regulation imposing the Support Fee. After the introduction of the Support Fee, fixed-price contracts were initially considered exempt from this scope with an amendment in the regulation. However, a second subsequent amendment was made to the regulation, specifying that in order for fixed-price contracts to qualify for the exemption, they must be conducted “up to the end-user” at fixed prices. This second amendment was applied retroactively so that many exemptions were annulled retroactively on the ground that their fixed price was not retained until the end-user. This situation also resulted in numerous administrative lawsuits.
Generation companies not only engaged in administrative lawsuits but also attempted to pass on the burden of the Support Fee, which was im- posed on them, to their counterparties in bilateral agreements. They did this by either claiming hardship or seeking adaptation through arbitration or litigation proceedings. Many of the companies cited the inframarginal price cap as a reason to break their contractual commitments and take advantage of the high market prices.
Is it Unforeseeable?
The formulation and legality of these price intervention and tax policies can be complex and may give rise to many disputes. These governmental interventions may trigger investment treaty violation claims on inter alia expropriation or fair and equitable treatment, as it was the case in the past (See Murphy Exploration & Production Company International v. Republic of Ecuador, PCA Case No. 2012-16; Perenco Ecuador Limited v Republic of Ecuador, ICSID Case No. ARB/08/6; and Burlington Resources Inc. v. Republic of Ecuador, ICSID Case No. ARB/08/5). Broadly, investment arbitration tribunals acknowledge that tax laws do not typically amount to an indirect expropriation. However, there are specific instances where they may do so, such as when a tax is deemed confiscatory, mea- ning it severely impairs the continued economic feasibility of the invest- ment (Burlington Resources, Inc. v. Republic of Ecuador, ICSID Case No. ARB/08/5, Decision on Liability).
The prevailing legal precedent underscores that if an investor has not se- cured a commitment regarding tax stabilization, it would be unreasonable for them to anticipate that the State’s tax regulations will remain un- changed in the future. In such cases, it is generally accepted that it is the investor who assumes the risk associated with potential alterations and therefore it is less likely to constitute a breach of legitimate expectations. Indeed, in the context of the current legal framework concerning windfall taxes in the resources sector, arbitral tribunals have frequently empha- sized that when there are “substantial unexpected surges in commodity prices,” investors should be prepared for the potential scenario where a host State aims to increase taxes within that specific sector. That is why it is less likely for a windfall tax to constitute a breach of the Fair and Equi- table Treatment (FET) standard.
It may raise claims against European Union (“EU”). For instance, in its claim against the EU, ExxonMobil argues that the EU exceeded its legal jurisdiction by imposing a windfall tax on oil companies, marking a subs- tantial response from the industry. This legal action questions the viability of the tax and was initiated by Exxon’s German and Dutch subsidiaries. It also contests the EU Council’s ability to enforce the recent tax, a capa- bility traditionally held by sovereign nations, as well as its utilization of emergency measures to obtain member States’ consent for the policy.
It may also give rise to constitutional claims. For instance, in Germany, introducing a new sector-specific windfall profit tax faces a significant challenge due to the German constitution’s comprehensive list of permis- sible tax forms that legislators can enact. Creating an entirely novel form of taxation or combining multiple tax types into a new hybrid tax system is prohibited. This stringent framework is in place to prevent uncertainties related to legislative and administrative authorities or the allocation of tax revenues among different levels of government in Germany. Any new windfall profit tax would need to adhere to these principles. Past efforts to circumvent these rules, such as the nuclear fuel tax, which was dee- med unconstitutional, demonstrate that introducing new sector-specific systems for additional profit taxation can lead to substantial issues in this regard.
Electricity prices can be influenced by a range of factors, including geopolitical events, shifts in macroeconomic conditions like pandemics, economic sanctions, and financial crises, as well as alterations in global energy supply routes. The energy market is exposed to inherited risks stemming from global and local energy policies and regulatory changes. While government interventions can lead to disputes, it’s important to acknowledge that the energy industry inherently carries these risks.
As commonly recognized by arbitral tribunals in investment arbitration cases, in cases of significant unexpected spikes in commodity prices, investors should be prepared for the possibility that a host State may seek to raise taxes or intervene in the prices within that particular sector.
ABOUT THE AUTHORS
Değer Boden is the managing partner of Boden Law and practices in energy, infrastructure, climate change and arbitration matters. She assists clients in avoiding or resolving disputes through negotiation, mediation, arbitration and litigation. Her experience embraces international commercial and invest- ment treaty arbitration. She also advises clients in relation to the structuring of their overseas investments to benefit from investment treaty protection. She acts as arbitrator in disputes, publishes, teaches and speaks extensively on arbitration, climate change and energy matters. She is lecturing on ‘Energy Project Management and Law’ at Kadir Has University, Energy Engineering Department. She received her law degree (LLB) from Galatasaray University, School of Law (2000). She is a member of Istanbul Bar since 2001. She holds an LLM degree in International Business Law from the University of Minnesota, School of Law (2005) and another LLM degree in Law of Economics from Istanbul Bilgi University, School of Law (2004).
Ceren Saraçgil is an associate at Boden Law. She practices in energy transactions and projects including energy trade, EPC contracts, O&M agreements and regulatory advisory services.
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