Energy and infra­structure: Reflections on 2018 and a view on what 2019 may bring

Reflections on 2018

1.1 The NIS Directive

The NIS Directive (concerning measures for a high common level of security of network and information systems across the Union) came into force in 2016. EU member states were obliged to implement the Directive into their respective national laws by 9 May 2018 and to identify operators of essential services by 9 November 2018.

The Directive has been partly incorporated into various Danish acts. In so far as the energy sector is concerned, the Directive has for instance – pursuant to the Danish Electricity Supply Act and the Danish Natural Gas Supply Act – been incorporated by Executive Order no. 425 of May 2018 on IT Preparedness in the Electricity and Natural Gas Sectors.

Executive Order no. 425 imposes obligations regarding IT preparedness of IT systems that are critical in the production or supply of electricity or natural gas. It applies to companies that are obliged to obtain permission according to sections 10 and 19 of the Danish Electricity Supply Act and section 10 of the Danish Natural Gas Supply Act.

Executive Order no. 425 contains obligations regarding organisation of the company's IT preparedness and ability to receive warnings about threats to IT security, registration with an IT security service that gives notice of and reports on relevant IT security threats etc.

Energinet and the Danish Energy Agency are entitled to issue an order if a company fails to comply with the Executive Order. 

Besides Executive Order no. 425, the NIS Directive has been incorporated by Executive Order no. 424 of April 2018 on Preparedness in the Oil Sector, which applies to companies that are obliged to maintain an oil stock according to the Danish Act on Oil Preparedness. Executive Order no. 424 contains, like Executive Order no. 425 in relation to the electricity and natural gas sectors, e.g. obligations to implement security measures for IT systems that are critical to the supply of oil. 

1.2 Danish energy agreement

The Danish government signed an energy agreement on 29 June 2018 with the purpose to further improve Denmark's international position as a leading nation within renewable energy. The agreement will be in force in the period 2020-2024, focusing on renewable energy, energy efficiency improvements, research and energy regulation. 

The key initiatives are:

• more world-class offshore wind and establishment of three new offshore wind farms;
• reduction of taxes on electricity and restructuring of surplus heat utilisation;
• targeted energy savings efforts e.g. by introducing a new tender-based scheme for energy efficiency improvements in businesses and buildings;
• modernisation of the framework for the heating sector, and mitigation of the impacts of eliminating the “base subsidy";
• strengthening of energy and climate research by additional state funding; and
• reduction of Denmark's CO2 emissions on multiple fronts.

1.3 Power distribution

1.3.1 NEW EXECUTIVE ORDER ON REVENUE FRAMEWORK FOR GRID COMPANIES 

On 1 January 2018, a new revenue cap regime for electricity distribution system operators (DSOs) entered into force with the new revenue cap order issued under the Danish Electricity Supply Act.

The new regime differs fundamentally from the previous revenue cap regime where the revenue caps were basically based on revenue per delivered kWh for the regulatory year 2004 subject to additions and adjustments. 

Under the new regime, the revenue caps are basically determined with a view to cover i) the DSO's costs of efficient operation of the licensed activities and (ii) a return on the invested capital. In this connection, the revenue cap constitutes the maximum revenue that a DSO may generate from the licensed activities in any calendar year, including energy savings activities. 

The revenue caps are still determined annually by the Danish Unitality Regulator (DUR), but now on the basis of a five-year revenue cap period. The revenue caps basically consist of:

1. a cost cap (OPEX and depreciations) subject to indexation and adjustments; and
2. a return cap subject to indexation and adjustments.

The revenue caps are then adjusted for (a) imposed general efficiency requirements and individual requirements resulting from economic benchmarking (see below in this news article for a description of this topic), (b) revenue cap reductions for low levels of quality of supply, (c) cost of grid loss, (d) temporary binding deductions reported by the DSO, (e) losses from lack of payment from suppliers and (f) cost of energy savings activities.

The cost cap is basically determined by the average OPEX and depreciations, subject to certain adjustments before and after the calculation of the average, in the previous regulation period.

The return cap is basically determined as a regulated permitted return on the DSO's historical regulatory asset base (simplified being the book value as of 31 December 2018 as depreciated) as well as its new regulatory asset (simplified being the difference between the total regulatory asset base and the historical regulatory asset base). 

In addition, a number of transitional rules apply to the determination of revenue caps for the first regulatory period (2018-2022).

1.3.2 Benchmarking

On 26 October 2018, the DUR sent out a draft consultation paper on the new benchmarking method under the new revenue cap regime. 

Following the feedback from the DSOs and other relevant parties, the DUR decided to adjust the method, and, on 14 December 2018, the DUR provided the DSOs and other relevant parties with a revised method for benchmarking. The deadline for any feedback on this revised method was 14 January 2019.

In our understanding, despite the adjustments to the method, it is still the general opinion in the industry that the benchmarking method proposed by the DUR suffers from fundamental inconsistencies and model flaws, which makes the method, in its current form, unusable for determining efficiency requirements that comply with legislation.

1.4 Renewables

1.4.1 One-year anniversary of the new FIDIC suite of contracts

Approximately one year ago, Fédération Internationale des Ingénieurs-Conseils (”FIDIC”) published the new suite of the contracts Red Book, Yellow Book and Silver Book. FIDIC is an international federation of consulting engineers founded in 1913 with members in close to 100 countries. FIDIC publishes various standard contracts to be used for e.g. construction works, large-scale machinery supplies, infrastructure projects, consultancy services, etc. Each contract applies to a specific area and is characterised by an individual colour label. In particular the Yellow and the Silver Books are often used in the energy industry, for instance for offshore wind turbine contracts. The contracts aim at distributing liabilities and risks on the relevant parties, but they are not ”agreed documents”, i.e. contracts negotiated and agreed between representative organisations (contrary to e.g. AB18, the Danish general conditions for the provision of works and supplies within building and engineering).

At the annual “FIDIC International Contract Users’ Conference” in London on 4 and 5 December 2018, the agenda was set for the users' reflections on the main challenges and foreseeable benefits of the 2017 suite. A bit surprisingly, we were less than a handful out of the approximately 150 delegates and speakers who had practical experience with the new suite. Even more surprisingly, a majority of the delegates would recommend the 1999 version and not the 2017 version for a particular (fictive) case; however, FIDIC was preferred to the other standard contracts, NEC and ENAA.

There seems to be a view among many of the FIDIC users that it is better to use the 1999 version adding the good parts from the 2017 version, rather than using the 2017 version due to its length ("the 3-kilo suite" has been used to describe the contracts) and its extensive claims procedure etc. We hope to be able to share with you our practical experience in the 2017 Yellow Book later this year, but we do not generally share the view that the 1999 version is preferred to the 2017 version, as the 2017 contract closes many of the open clauses from the 1999 version. However, the 2017 version does place heavy demands on the engineer and the contract management, and it will in our view take substantially longer time to prepare tender material based on that version. 

1.4.2 Merger between Eurowind Energy A/S and Eniig Renewables A/S

Kromann Reumert has advised Eurowind Energy A/S on its merger with Eniig Renewables A/S, a subsidiary of Eniig Holding A/S, whereby, through a 50/50 ownership of EWE Holding ApS and Eniig Holding ApS, Eurowind Energy A/S will acquire and continue a position as a leading developer and operator of renewable energy parks at European and, in the long term, global level. The companies will jointly own more than 350 MW wind and solar parks, which annually produce 800 million kWh. The objective for the merged company is to develop projects that by 2035 produce 8 TWh annually. Eurowind Energy A/S develops, operates and resells wind farms and carries out asset management for wind farm owners, and Eniig Renewables A/S has for a number of years been one of Eurowind Energy A/S' primary customers. The proposed merger was announced on 28 November 2018 and completed on 10 January 2019 after approval by the Danish Competition and Consumer Authority.

Kromann Reumert team: Jan Hvarre, Partner, Matilde Juul, Senior Attorney, and Ann-Britt Roesen, Attorney.

1.4.3 Ørsted's sale of Middelgrunden wind turbines

Kromann Reumert has advised Ørsted Nearshore Wind ApS on its sale of 10 2MW wind turbines placed at Middelgrunden Wind Farm to HOFOR Vind A/S. The sale was subject to the Danish Energy Authority's approval of the transfer of the production and establishment permits for the wind turbines. The sale was completed on 13 November 2018.

Kromann Reumert team: Anders Stubbe Arndal, Partner, Maria Holst Levin, Director, Rikke Holmgaard-Poulsen, Attorney, and Nicolai Veistrup Helms, Assistant Attorney.

1.4.4 Athena Investments' sale of its Danish onshore wind farms

Kromann Reumert has assisted Athena Investments A/S (formerly named Greentech Energy Systems A/S) in its sale of its wind activities in Denmark to Wind Estate A/S. Closing took place at the end of December 2017. The deal included the wind farms Oppelstrup, Hannesborg, Milbakken and Frørup with a capacity of 15.5MW, all established back in 2000/2001. The purchase price was DKK 24,400,000.

Kromann Reumert team: Jørgen Kjergaard Madsen, Partner, and Maria Holst Levin, Director.

1.5 District heating

1.5.1 Cessation of subsidy scheme 

At the end of 2018, the Danish government subsidy scheme for decentralised combined heat and power plants ("CHP plants") expired. The scheme, which allowed for natural-gas-fired CHP plants to receive a subsidy for electricity production, could not be renewed due to non-compliance with EU State Aid rules. The cessation is expected to have an adverse impact on especially small CHP plants and the price payable by consumers for district heating produced at the affected CHP plants. 

To counter some of the adverse effects, the Danish government has launched two new schemes for the impacted CHP plants:

1. A subsidy scheme for electric heat pumps for CHP plants outside the quota sector (in Danish "kvotesektoren"); and
2. An advisory scheme for the most adversely impacted CHP plants.

The two new schemes will be administered by the Danish Energy Agency (DEA), which is also expected to conduct an analysis of the framework conditions under which the CHP plants will now have to operate.

In the period leading up to the end of 2018 we saw an increased interest in exploring possibilities of consolidation among the heating companies.

1.5.2 Connection obligations abolished 

As of 1 January 2019, Danish municipalities can no longer impose new obligations on consumers within a municipality's heat supply area to either connect to or remain connected to the heat supply grid. However, obligations already in force are not abolished. 

The rationale behind this is to offer the consumers a free choice of heat supply, and to ensure that consumers are not bound to purchase heat from companies that cannot offer competitive prices. 

An analysis of the consequences is expected to be conducted in 2019 and will among its topics seek to cover the consequences of abolishing connection obligations already in force.

1.5.3 Merger between Sønderborg Fjernvarme A.m.b.a. and Gråsten Fjernvarme A.m.b.a.

Kromann Reumert has advised Sønderborg Fjernvarme A.m.b.a. and Gråsten Fjernvarme A.m.b.a on a merger (both consumer-owned). The two companies and their owners voted in favour of the merger in August 2018 in an effort to keep the consumer prices low in 2019 and onwards despite the cessation of the subsidy scheme at the end of 2018. The merger was completed on 27 November 2018. 

Kromann Reumert team: Anders Stubbe Arndal, Partner, Maria Holst Levin, Director, Rikke Holmgaard-Poulsen, Attorney, and Nicolai Veistrup Helms, Assistant Attorney.

1.6 The water sector

1.6.1 Danish Supreme Court rules in landmark cases concerning the market value of water and sewerage companies' infrastructure assets 

The Danish Supreme Court recently held 7-0 against the Danish Revenue in two major transfer pricing cases argued by Kromann Reumert's tax team, setting aside the valuation method applied by the Revenue in those matters. 

The Supreme Court concurred with the companies that the market value of water and sewerage companies' infrastructure assets cannot meaningfully be established using a DCF method, i.e. a cash-flow-based valuation method, given that the companies are subject to Danish regulation prohibiting any profit to be made by an investor in such infrastructure assets. 

The cases serve as pilot cases for more than 270 cases currently pending before the Danish National Tax Tribunal and are referred to as the "largest Danish tax matters ever", a reference to the total tax value of the depreciations involved amounting to DKK 36 billion.

Kromann Reumert team: Arne Møllin Ottosen, Partner, and Stine Andersen, Director.

1.7 Biogas

Investment consortium acquired a European leader in the production of green gas to grid

Kromann Reumert has assisted an investment consortium in acquiring NGF Nature Energy; the largest producer of biogas in Denmark, and a leading producer of green gas to grid in Europe from farm and food waste. The investment consortium consisted of the European private equity energy investment specialist Pioneer Point Partners, the global investment firm Davidson Kempner and the pension fund Sampension. The enterprise value was DKK 1.1 billion.

Read more.

Kromann Reumert team: Anders Stubbe Arndal, Partner, and Maria Holst Levin, Director.

What 2019 may bring

2.1 Cyber security in the Danish energy sectors 

On 7 January 2019, the Danish government published a cyber security strategy intended to protect the Danish energy sectors (and five other vulnerable sectors) against cyber attacks. The strategy includes 68 specific initiatives, of which 10 concern the energy sectors. The background for the initiative is, among others, the increased digitization that enables us to use the renewable energy when the sun is shining and the wind is blowing. An attack on the Danish energy sectors can have serious consequences, and recent years have seen an increasing number of cyber attacks on critical infrastructure. The Centre for Cyber Security under the Ministry of Defence has recently assessed that the cyber threat to the Danish energy sectors is increasing and very high. The strategy supplements the implementation of the NIS Directive as described above in this news article.

The 10 specific initiatives for the energy sectors include:

• systematic and frequent measurements of maturity and resilience towards e.g. a cyber-attack, 
• improved knowledge sharing, 
• requirements for supplier relationships, 
• sectorCERT (a sector-specific competence center as seen in the US and Norway),
• secure exchange of information,
• training,
• securing digital components – Industrial IoT,
• standards and best practices, 
• strengthened basis for threat assessments, and 
• "the secure employee" (i.e. requirements for awareness-training and security clearance of employees). 

As regards the requirements applicable to suppliers of critical IT in the energy sectors, the initiative will facilitate and improve the work on contracts, e.g. by ensuring that a number of best practices will be prepared by the sector as part of the initiative. 

Such best practices will apply e.g. to the wind turbine manufacturers' supply of SCADA systems and ancillary OT and IT infrastructure and should be used by the energy companies as supplements to international standards and practices. We have already seen an increased focus on cyber security in the energy sectors during recent years, including in their sourcing contracts; however, there is still a somewhat reluctant response from the suppliers to such requirements, and the development of best practices will be a welcoming initiative.

There is no doubt that OT/IT security will play an even bigger part of supply- and service contracts in the energy sectors in the time to come.

Read the government's strategy for the energy sectors (in Danish). 

2.2 Legislative program for 2019

The Danish government has issued a legislative program for 2019, where the following bills related to the Danish Ministry of Energy, Utilities and Climate are in the pipeline:

1. Amendment of the Danish Subsoil Act (termination of permits for exploration and extraction of hydrocarbons onshore and in Danish nearshore waters, as well as subsidiary liability for expenses related to the decommissioning of plants also when permits are indirectly transferred)
2. Amendment of the Danish Act on Energinet, the Danish Electricity Supply Act and the Danish Natural Gas Supply Act (transfer of supervisory authority to the Danish Energy Authority regarding the electricity and natural gas sector, amendment of the corporate structure of Energinet and supplementary rules for the European Parliament's and the Council's regulation on measures to maintain gas supply security)
3. Amendment of the Danish Act on promoting renewable energy (support schemes for test wind turbines, termination of support scheme for household wind turbines in 2020 and extension of the municipal right of opposition)

2.3 Offshore wind power – new markets

For the past many years, offshore wind has been limited to the European market in which the industry has built a mature supply chain and has relied on subsidies, shallower water depts and risks that to a large extent can be foreseen and distributed amongst developer and supplier. In 2018 we saw new markets emerging and maturing in countries such as the USA and Taiwan, and 2019 will surely bring new markets to the table, such as Japan, China, South Korea etc. With such new markets follow new risks (e.g. climatically and politically) as well as the simple challenges of deeper waters and an immature supply chain. We will continue advising our clients in these new markets and where ever offshore wind develops going forward.

Kromann Reumert's energy and infrastructure team

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