Court dismissed appeal holding Carbon Revenue Levy is not a short run marginal cost for bidding.

THE SUPREME COURT

[S.C. No. 285 of 2011]

DENHAM C.J.

MURRAY J.

HARDIMAN J.

MACKEN J.

McKECHNIE J.

BETWEEN/

VIRIDIAN POWER LIMITED AND

HUNTSTOWN POWER COMPANY LIMITED

APPLICANTS/APPELLANTS

AND

COMMISSION FOR ENERGY REGULATION

RESPONDENT

AND

THE ATTORNEY GENERAL

NOTICE PARTY

Judgment of Mr. Justice William M. McKechnie delivered on the 23rd day of February, 2012

Introduction:

1. The appellants in this case are involved in the generation of electricity which they sell on a wholesale basis into the single

electricity market of Ireland, covering both north and south. This sector is regulated, in this jurisdiction, by the respondent. To

operate as such all generators must hold a licence, which the appellants do. A dispute has arisen in one particular respect arising out

of this licence. Positions were crystallised in this regard following a direction which issued by the first respondent on the 8th October,

2010. As a result, the within judicial review proceedings were instituted in which several diverse reliefs were sought. This action was

heard together with that of Endesa Ireland Limited, a fellow generator with similar interests to those of the appellants. In a judgment

delivered on the 9th June, 2011, Clarke J. dismissed both applications. Endesa has not appealed that decision.

2. Despite the scope of the Notice of Appeal filed on behalf of Viridian and Huntstown, there is, as I will demonstrate, but a single

issue for resolution in this appeal. It is whether what is referred to as the “Carbon Revenue Levy”, can be included in the bidding

costs of a generator who seeks to sell electricity into the wholesale market in Ireland. The answer to this is to be determined

exclusively by reference to the contractual relationship with exists between the parties. This in turn depends on the proper

interpretation of the Electricity Generation Licence and a document entitled “The Bidding Code of Practice”. In fact the issue can

even be more refined than what I have just described. By reference to such documents the end question is whether the levy can be

said to be part of the operators “short run marginal costs”, which in turn is dependent on whether such levy can be said to have an

“Opportunity Cost”.

3. The Attorney General was joined as a party to these proceedings following a suggestion by the first respondent that were the

review to be successful, the court’s decision in that regard would amount to a frustration of the Oireachtas’s intention in enacting the

legislation giving rise to the levy. The role of the Attorney General is a matter which I will further refer to later in this judgment.

4. A number of circumstances have converged to form the background to this case. A brief word needs to be said about each of them

so as to contextualise this judgment.

Brief Background:

5. As and from the 1st November, 2007, there has existed a single market for wholesale electricity on the island of Ireland (SEM). The

necessary legal structure, in this jurisdiction created by the Electricity Regulation (Amendment) (Single Electricity Market) Act 2007,

has made provision for a cross border regulatory framework within which, the Commission for Energy Regulation (the “Commission”),

previously established under the Electricity Regulation Act 1999 (the “Act of 1999”), and its equivalent in Northern Ireland, are the

regulatory authorities. A Committee called the Single Electricity Market (SEM) Committee, has been established to compliment these

authorities in the discharge of their various functions. In order to facilitate the operation of this market, a trading and settlement

code has been created which specifies the rules and procedures by which wholesale electricity is traded within the market. Any entity

interested in generating electricity in this jurisdiction must hold a licence from the Commission to do so. Both applicants are such

persons and each currently is the holder of what is described as the “Electricity Generation Licence” (the “Generation Licence”). All

such licences are in standard format and have what may be regarded as identical provisions.

6. In simple terms the market works like this: electricity generators will submit bids on a daily basis, offering to sell to the market

operator (acting under licence from the regulatory authorities), a certain quantity of electricity at a given price. This operator, which

will have previously assessed the amount of electricity required for any given trading day (in fact, for each half hour period of that

day), then accepts the bids which on aggregate are sufficient to supply the required amount of electricity for that trading day. The

sale prices as between operators will vary and thus are marked in merit order. Those operators whose bids are accepted are described

as being “in merit”, whereas those whose bids are rejected are described as being “out of merit”. The highest bid price in the “in

merit” category becomes the common price paid to all generators for that relevant trading period. This price is known as the “systems

market price” (SMP).

7. The bidding procedure, which I have described, is not at the discretion of the generators: they are not free to do as they wish. In

fact, there exists quite a sophisticated machinery for determining the basis on which cost items are allowed, measured and bid in. The

provisions governing such a process are contained in the Generation Licence, above referred to and also in a document entitled “The

Bidding Code of Practice” (BCOP), which by the express terms of the licence, is incorporated as part of the contractual relationship

between the parties. It is not suggested that the rights and obligations of the parties are to be found otherwise than in these

documents.

8. The second set of circumstances underpinning this case have as their foundation, Council Directive 2003/87/E.C. of the 13th

October, 2003, “establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council

Directive 96/61/EC”, O.J. L275/32 25.10.2003 which was transposed into Irish law by the European Communities (Greenhouse Gas

Emissions Trading) Regulations 2004 (S.I. No. 437 of 2004). The essential purpose of the Directive and Regulations was to cap the

amount of greenhouse gases which certain activities emit within the E.U. Electricity generators were within those whose activities

were sought to be regulated in this way. Consequently, the regime required such operators, including the appellants, to surrender

emission trading allowances, (also known as “carbon allowances”) to cover the greenhouse gases that are produced when a relevant

electricity generation station is operated. Such allowances can be purchased on the open market but a large proportion were required

to be issued free to affected operators. As originally adopted the Directive provided that for the years 2005-2007, all member states

were to allocate 95% of allowances “free of charge” dropping to 90% for the years 2008 - 2012, ending on the 31st December, of

that year. Council Directive 2009/29/E.C. of the 23rd April, 2009, amending directive 2003/87/E.C. as to improve and extend the

greenhouse gas emission allowance trading scheme of the Community, O.J. L140/63 5.6.2009, provides that as and from the 1st

January, 2013, allowances are to be allocated by auction. It is accepted that the appellants cannot generate electricity, at their

plants, with the use of fossil fuels, without emitting greenhouse gases.

9. This background leads directly to the third event of relevance to this case.

10. The Electricity Regulation (Amendment) (Carbon Revenue Levy) Act 2010 (“the Act of 2010”), inserted a new Part VIB into the

Electricity Regulation Act 1999 (“the Act of 1999”). By virtue of ss. 40B to 40M as so inserted, each electricity generator, including

the appellants, must pay in respect of a levy period, a levy, described as a “carbon revenue levy”, “on such amount of the revenues

received during that levy period by the electricity generator concerned, through participation in the Single Electricity Market, as is

attributable to the emissions from each installation of which the electricity generator is the operator, which amount is calculated in

accordance with the formula – E x P…”. Definitions are then given for the value of “E” and for the value of “P”. In effect, the levy is

based on carbon emissions calculated by multiplying the amount of emissions (E) of each operator (in tonnes of carbon dioxide

equivalent) by the average price (P) of the allowance for one tonne of carbon dioxide equivalent, further multiplied by a percentage

(X) which currently stands at 65%. In essence, what it means is that for every tonne of carbon dioxide equivalent used by the

appellants in generating electricity, they must surrender one carbon allowance under the emission trading regime (which may have

been purchased or allocated for free) and also pay 65% of the market price of one such carbon allowance. It is said that the

estimated cost of this levy to the appellants is in the order of €18M per annum. The issue on this appeal is whether such levy can

form part of the “bid in” costs of the generators when offering electricity to the wholesale market. This, as stated, depends on the

proper and correct interpretation of the contractual documents which create the legal relationship existing between these parties.

Decision of the 8th October, 2010:

11. Following the enactment of the Act of 2010, correspondence took place between the applicants and the Commission during which

it was indicated by the generators that it was their intention to incorporate the levy as a cost item in the bid in costs. The

Commission took the view that they could not do so and in furtherance of this opinion, caused a direction to be issued on the 8th

October, 2010, under Condition 15(7) of the Generation Licence, in which they prohibited such inclusion. That decision was the

immediate cause of the institution of these proceedings. While some debate was had as to the validity of the justifying reasons for

such decision, and to what was described as the “shifting position” of the Commission in this regard, nothing turns on that point in

the instant appeal. The reason is that, the Commission has not challenged the judge’s rejection of their submission that the review

standard should be one of unreasonableness, in the O’Keeffe sense. That being the position but otherwise expressing no view on it,

the approach which I propose to adopt, as agreed by the parties, is therefore one of “legal correctness”. As a result, the question is

which of the conflicting interpretations as advanced is the correct one.

Contractual Documents:

12. The documents which therefore must be considered are the Generation Licence and the BCOP which is dated the 30th July, 2007.

Unfortunately, the relevant sections of both Licence and Code are lengthy but given their central importance, their recital in this

judgment is unavoidable. Condition 15 of the licence is the relevant condition and reads as follows:-

“Condition 15: Cost Reflective Bidding in the Single Electricity Market

1. The Licensee shall ensure that the price components of all Commercial Offer Data submitted to the Single

Market Operation Business under the Single Electricity Market Trading and Settlement Code, whether by the

Licensee itself or by any person acting on its behalf in relation to a generation unit for which the Licensee is the

licensed generator, are cost-reflective.

2. For the purposes of this Condition, the price component of any Commercial Offer Data shall be treated as cost-

reflective only if, in relation to each relevant generation unit, the Schedule Production Cost related to that

generation unit in respect of the Trading Day to which the Commercial Offer Data submitted by or on behalf of the

Licensee is equal to the Short Run marginal Cost related to that generation unit in respect of that Trading Day.

3. For the purposes of paragraph 2, the Short Run Marginal Cost related to a generation unit in respect of a

Trading Day is to be calculated as:

(a) the total costs that would be attributable to the ownership, operation and maintenance of that

generation unit during the Trading Day if the generation unit were operating to generate electricity

during that day;

minus

(b) the total costs that would be attributable to the ownership, operation and maintenance of that

generation unit during that Trading Day if the generation unit was not operating to generate electricity

during that day.

the result of which calculation may be either a negative or a positive number.

4. For the purposes of paragraph 3, the costs attributable to the ownership, operation and maintenance of a

generation unit shall be deemed, in respect of each relevant cost-item, to be the Opportunity Cost of that cost-

item in relation to the relevant Trading Day.

5. The Commission may publish and, following consultation with the holders of Generation Licences and such other

persons as the Commission considers appropriate, from time to time by direction amend, a document to be known

as the Bidding Code of Practice, which shall have the purposes of:

(a) defining the term Opportunity Cost;

(b) Making provision, in respect of the calculation by the Licensee and other generators of the

Opportunity Cost of specified cost-items, for the treatment of:

(i) the costs of fuel used by generators in the generation of electricity;

(ii) the value to be attributed to credits issued under the Emissions Trading Scheme established

by the European Commission;

(iii) variable operational and maintenance costs;

(iv) start-up and no load costs; and

(v) any other costs attributable to the generation of electricity; and

(c) setting out such other principles of good market behaviour as, in the opinion of the Commission,

should be observed by the Licensee and other generators in carrying out the activity to which

paragraph 1 refers.

6. The licensee shall, in carrying out the activity to which paragraph 1 refers, act so to ensure its compliance with

the requirements of the Bidding Code of Practice.

7. The Commission may issue directions to the Licensee for the purposes of securing that the Licensee, in carrying

out the activity to which paragraph 1 refers, complies with this licence and with the Bidding Code of Practice, and

the Licensee shall comply with such directions.

8. The Licensee shall retain each set of Commercial Offer Data, and all of its supporting data relevant to the

calculation of the price component of that Commercial Offer Data, for a period of at least four years commencing

on the date on which the Commercial Offer Data is submitted to the Single Market Operation Business.

9. The Licensee shall, if requested to do so by the Commission, provide the Commission with:

(a) a reasoned explanation of its calculations in relation to any Commercial Offer Data; and

(b) supporting evidence sufficient to establish the consistency of that data with the obligations of the

Licensee under this Condition.

10. In any case in which Commercial Offer Data are submitted to the Single Market Operation Business which are

not consistent with the Licensee’s obligation under paragraph 1 of this Condition, the Licensee shall immediately

inform the Commission and provide to the Commission a statement of its reasons for the Commercial Data

submitted.

11. In this Condition:

‘Bidding Code of Practice’ means the document of that title published by the Commission in accordance

with paragraph 5, as it may be amended from time to time;

‘Commercial Offer Data’ has the meaning given to it in the Single Electricity Market Trading and

Settlement Code;

‘Opportunity Cost’ shall have the meaning set out in, and the value calculated in accordance with, the

terms of the Bidding Code of Practice;

‘Schedule Production Cost’ has the meaning given to it in the Single Electricity Market Trading and

Settlement Code:

‘Short Run Marginal Cost’ means certain costs attributable to the ownership, operation and

maintenance of a generation unit, as calculated in accordance with paragraph 3 of this Condition;

‘Single Market Operation has the meaning given to it in the

Business’ licence granted pursuant to section 14(1)(j) of the Act; and

‘Trading Day’ has the meaning given to it in the Single Electricity Market Trading and Settlement Code.”

13. At para. 2 of Annex A, forming part of the BCOP, it is stated that “for the purposes of the licence conditions

under which it is made…this code defines the concept of opportunity cost, makes provision for the calculation of

cost items and sets out other principles of good behaviour in a single electricity market”. Under the following

heading, paras. 6 – 8 read as follows:-

“DEFINITION OF OPPORTUNITY COST

General Principles

6. When calculating the Short Run Marginal Cost of a generation set or unit in respect of a Trading Day,

constituent cost-items are to be valued at their Opportunity Cost, and so that a reasoned explanation of the

calculation of that Opportunity Cost is capable of being given to the Authority of the Commission (as appropriate)

on request.

7. The Opportunity Cost of any cost-item shall comprise the value of the benefit foregone by a generator in

employing that cost-item for the purposes of electricity generation, by reference to the most valuable realisable

alternative use of that cost-item for purposes other than electricity generation.

8. In calculating the value of the benefit foregone in employing a cost-item for the purposes of electricity

generation, the following principles shall, unless it can be demonstrated to the satisfaction of the Authority or the

Commission (as appropriate) that there is good cause not to, be applied:

(i) where there exists a recognised and generally accessible trading market in the relevant cost-item,

the Opportunity Cost of that item should reflect the prevailing price of the cost-item, which may be

for immediate or future delivery or use as appropriate to the circumstances of the relevant generator,

having regard to:

(a) costs the relevant generator would incur in offering that cost-item for sale, or acquiring that

cost-item, on a recognised and generally accessible trading market;

(b) reasonable provision for the variability of the prevailing price of a cost-item on a recognised

and generally accessible trading market;

(ii) where no recognised and generally accessible trading market exists in the relevant cost-item the

Opportunity Cost of that item should reflect the costs which would be incurred by the relevant

generator in replacing that cost-item; and

(iii) reasonable provision for increased risks to plant and equipment as a result of the operation of a

generation set or unit may be included.”

The Submissions:

14. The principal submission on behalf of Viridian, which in all respects can be treated as also applying to Huntstown, is that the bid in

costs must be cost reflective. Since the amount of the levy is calculated in direct proportion to the fuel used and thus the electricity

generated, it must follow that it is a cost incurred. When the plant is producing electricity the liability ensues. When it is not so used,

there is no liability. Consequently, it must be included. Unless it is, it cannot be recovered: it must therefore be borne by the

generators. This could never have been intended as it runs directly contrary to the fundamental principle and requirement, that

bidding should be cost reflective.

15. The High Court judge is criticised for only going part of the way with this argument. He held that the levy is a cost in the

“ordinary sense of that word” and that it is undoubtedly a cost attributable to the operation of the plant. The appellants assert that

this finding is equivalent to saying that the levy is part of the short run marginal cost. That being so it is argued that, the judge’s

ultimate decision to disallow its inclusion, is in error in that:-

(a) the terms of the BCOP could not validly have the effect of precluding the bidding in of the levy, once it is part of short run

marginal costs, and

(b) paragraphs 7 and 8 of the BCOP were misconstrued as allowing only the bidding in of costs which are “inputs” and/or are

“employed” in the generation of electricity.

In essence, but for these errors the levy should, indeed, must be part of the bidding costs.

16. The Commission stands over the judgment of the trial judge in all respects, insofar as it relates to the issue under appeal. Its

submissions, which touch on the broader issues as well as the specific one in question, largely outline why, in its view, the learned

judge was correct in concluding as he did. The crucial phase for interpretation is “short run marginal costs”, which in turn involves a

determination as to what the “opportunity costs”, of a cost item means. This requires a consideration, in particular of Condition 15(3)

of the Generation Licence as well as paras. 7 and 8 of the BCOP.

17. By reference to these documents it is asserted that the levy is not part of short run marginal costs in that:-

(a) it is a liability which arises “further to” or as a “consequence of” electricity generation but not one incurred for the “purposes” of

generation,

(b) it has no “realisable” alternative use, for purposes other than electricity generation, and

(c) as a result, no value can attach to any “benefit foregone”.

Consequently, it has no opportunity cost and therefore, cannot be part of short run marginal costs.

18. The Commission goes on to say that the applicants, in essence, are arguing that all costs associated with electricity generation,

are costs which are not only capable of , but which must be, bid in and be contained in the commercial offer document. This could

not be so, for example in the treatment within the bidding mechanism of carbon allowances. They go on to argue that the applicants

attempt to assign to the judge’s remarks that the “levy was a cost in the ordinary sense of the term…”, a meaning which renders his

conclusion in that regard incorrect, is misguided.

19. In the circumstances outlined at para. 3 of this judgment, the Attorney General was joined to these proceeding as a Notice Party,

apparently to protect the public interest. At first glance it is difficult to understand why this was thought necessary, given the nature

of the issues in dispute. Be that as it may, submissions were filed and were spoken to by counsel on her behalf.

20. At the outset the Attorney makes clear, quite properly in my view, that she remains detached from both parties in this commercial

litigation. She concedes that the issue is one of construction, having regard to the Licence and to the BCOP. Furthermore she does

not assert that the Act of 2010 sought to, or has in any way altered, the terms or the correct meaning of these contractual

documents. What she does seek to do, is to make submissions as to the purpose and nature of the levy, suggesting in the process

that a proper understanding of its character is essential in determining the construction issue.

21. The direct background to the Act of 2010, followed a decision of the SEM Committee, (SEM-08-32), which allowed the

opportunity cost of carbon allowances to be bid in. As under the Directive and the Regulations above mentioned, such allowances for

the most part, were obtained by the generators free of charge. This decision created a windfall which the Act of 2010, at least in

part, sought to redress. The extent of the unearned income can be seen from the evidence in the case, which shows that about 80%

of the allowances, which the appellants were required to surrender in respect of their emissions for 2008/2009, were obtained free of

charge. This it is said, is the context in which the Act of 2010 was enacted.

22. The Attorney then complained that the appellants have consistently misdescribed the nature of the levy: it is not a charge on

carbon, rather, as is evident from its long title and the inserted section into the Act of 1999, it is a charge on revenue which is

attributable to emissions. Prior to the Act of 2010 generators were receiving revenue for their emissions allowances, even though a

significant portion of these had been received free of charge. The levy was intended to capture these. It is therefore a levy on

revenue, and not on allowances, emissions, electricity or any other form of operational costs.

Decision:

23. May I first deal with the position of the Attorney General and say that the direction of the submissions made, can have little if

any significance, to the disputed issue. An understanding of the levy is of course important as it may be an understanding of

legislative intent or purpose. However, such can only be reached by accepted canons of construction. To that end I would discount

any attempt to shape an approach or seek to influence such matters, by any means other than those historically available and

normally applied. The Act of 2010 is not truly central to this case: it is acknowledged by all, that it did not alter the rights or

obligations of the parties, which have been established since 2007. What will determine this dispute is the Generation Licence and

BCOP. If the effect of the court’s judgment is that the so called “windfall “revenue will be recouped, that is because the provisions of

the Licence permit it, not because the Act says so. If the finding should be to the contrary then, whatever the intent of the Act

might be will not alter the result. Therefore, whilst valuing the submissions made, I do not believe that the contribution of the

Attorney was essential to this case.

How do you Interpret?:

24. Very little argument has been addressed to this issue. This is because there is very little dispute about it. No special or adapted

principles are sought to be utilised. It is accepted that the front line rules of construction are applicable. In present context what

does that mean? The starting point, although historically basic, remains very much apposite. Give the words a meaning which they

obviously appear to have, but in the context in which they are used. Geoghegan J. in Analog Devices B.V. v. Zurich Insurance [2005]

1 I.R. 274, at p. 279-280 when speaking of contractual interpretation, referenced what Lord Hoffman had said in I.C.S. v. West

Bromwich B.S. [1998] 1 W.L.R. 896. In particular the learned judge highlighted the following:-

“13. In modern times, these principles have received further expansion from the House of Lords. Lord Hoffman in

I.C.S. v. West Bromwich B.S. [1998] 1 W.L.R. 896 considered that quite a radical change had come about, the

result of which, "subject to one important exception", was to assimilate the way in which such documents are

interpreted by judges to the common sense principles by which any serious utterance would be interpreted in

ordinary life. He then set out the modern principles at p. 912 as he saw them and which I would accept:-

‘(1) Interpretation is the ascertainment of the meaning which the document would convey to a

reasonable person having all the background knowledge which would reasonably have been available to

the parties in the situation in which they were at the time of the contract.

(2) The background was famously referred to by Lord Wilberforce as the 'matrix of fact' but this

phrase is, if anything, an understated description of what the background may include. Subject to the

requirement that it should have been reasonably available to the parties and to the exception to be

next mentioned, it includes absolutely anything which would have affected the way in which the

language of the document would have been understood by a reasonable man.

(3) The law excludes from the admissible background the previous negotiations of the parties and their

declarations of subjective intent. They are admissible only in an action for rectification. The law makes

this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from

the way we would interpret utterances in ordinary life. The boundaries of this exception are in some

respects unclear. But this is not the occasion on which to explore them.

(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not

the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and

grammar; the meaning of the document is what the parties using those words against the relevant

background would reasonably have been understood to mean. The background may not merely enable

the reasonable man to choose between the possible meaning of words which are ambiguous but even

(as occasionally happens in ordinary life) to conclude that the parties must for whatever reason, have

used the wrong words or syntax; see Mannai Ltd. v. Eagle Star Ass. Co. Ltd [1997] A.C. 749.

The ‘rule’ that words should be given their ‘natural and ordinary meaning’ reflects the commonsense

proposition that we do not easily accept that people have made linguistic mistakes, particularly in

formal documents. On the other hand, if one would nevertheless conclude from the background that

something must have gone wrong with the language, the law does not require judges to attribute to

the parties an intention which they plainly could not have had. Lord Diplock made this point more

vigorously when he said in Antaios Compania S.A. v. Salen A.B. [1985] A.C. 191, 201:

‘If detailed semantic and syntactical analysis of words in a commercial contract is going to

lead to a conclusion that flouts business commonsense, it must be made to yield to

business commonsense.’”

I respectfully agree with this.

25. The purpose of such an interpretive exercise is to ascertain what contractual rights and obligations the parties have bound

themselves to. The more formal the contractual context the more a court can be satisfied that, the concluded document, signed up

to by the parties, reflect what their bargain is. Not simply in a factual sense but also as to the manner in which they seek to have the

underlying events regulated by law. When a dispute arises, quite frequently, either one or all of the parties, disavow what might

appear to be the obvious and manifest meaning of the document in issue. Positions are therefore stood on, impasse prevails and

litigation follows.

26. In performing the function called upon, the court will firstly consider the document and any and all other documents, properly

attached to or incorporated within it: each clause, part, chapter or section will be looked at individually, and if required, collectively.

(The People (Attorney General) v. Kennedy (No.1) [1946] 1 I.R. 517 at 536). Its nature and purpose will form part of the background.

Where the parties have defined or described a term, which is used in the document, that meaning will be ascribed to it and not any

other, either ordinary or otherwise. This is to reflect the freedom of choice expressed by the parties. In addition, such interpretation

is designed to ascertain what meaning the document has, for a reasonable person who has a knowledge of and an interest in the

subject area covered by the document. Or, as Lord Hoffman said in I.C.S., “he who will have” of all the background, reasonably

available. This input into construction is critical as otherwise it may be impossible to read the document in its proper context. In

addition however, the actual words used, must never be lost sight of and must never be forced to yield to speculation or conjecture.

27. These principles are those which generally apply to commercial contracts negotiated freely in both the public and private sector. I

have not considered any subsidiary aids to interpretation or examined any exceptions which may be available: it has not been

necessary to do so. Although the relationship between the parties in the instant case did not crystallise in what may loosely be

described as the free market place, nonetheless I see no reason why such rules should not equally apply here. Notwithstanding the

fact that the licensor is a statutory body, that the terms are in statutory form and that the market place is regulated, all participating

generators are fully aware of these matters at the time of their contract. Having chosen to enter the sector against such

background, which is public knowledge, I see no reason to depart from the standard interpretative rules above mentioned. In fairness

it should be said that the court has not in any substantive way been invited to do so.

28. Before reverting to Condition No. 15 of the Generation Licence, which as I will show incorporates the BCOP, which as a result

must also be looked at, it is of the first importance to realise what is not in issue in this case. By this I mean events or circumstances

which, noteworthy as they are in establishing background knowledge to the case, are nonetheless not of interpretive relevance to the

documents in question. These include the following:-

1. that the market is regulated in all respects of its organisation: nothing is added by saying “highly” or “rigidly”

regulated, or by the use of similar terms,

2. that participation in this market is mandatory for the applicants: thus they do not have the freedom of

commercial choice which otherwise they may have,

3. that the licensor is the Commission, a statutory authority, with extensive functions of a regulatory and

enforcement nature,

4. that the licence document is in a standardised form, reflecting the regulatory framework with no meaningful

possibility of amendment at individual level, and

5. that the BCOP is similarly circumscribed.

In addition, it must also be noted that the validity of the Generation Licence is not in issue, neither is the validity of BCOP. It not

suggested that either its definitional or measuring scope is outside the parameters permitted by the Licence. Furthermore, the

provisions of the Act of 2010, as such, are not being challenged and neither is the legislative framework underpinning the levy. Finally,

there is no cross border element or competition issue in this case.

29. By virtue of Condition No. 15(5) of the Generation Licence, the Commission is given a discretion to publish, be it noted that this is

after full consultation with licence holders, a condition which undoubtedly has been satisfied, a document known as BCOP, which inter

alia may define the term “opportunity cost” and may make provision for calculating the opportunity cost of specified cost items. Such

a document, as we know, has been created: accordingly, under sub-condition (6), licence holders must comply with its terms. As a

result it forms part of the contractual arrangements between the parties. It matters not that its existence has resulted from the

exercise of a discretion: the generators were put on express notice of this reserved power. They bound themselves to the BCOP, if

established. That has come to pass and they are therefore contractually committed to its terms.

30. That being so, the only way in which the terms of BCOP could be construed as being subsidiary or ancillary to the terms of the

Licence is that, if there was a provision in either document to that effect. Unarguably so, this is not the case. Therefore, I cannot

see any legal basis to support the suggestion that, where applicable and within their meaning, as determined by the normal rules of

construction, the terms of BCOP should be viewed, somehow, as being secondary in importance to the terms of the lease. In my

opinion, such terms are to be regarded for what they are, namely as being part of the overall terms governing the relationship

between the parties. Given this unconditional manner of incorporation, it must be that such terms have parity of status with and an

equivalence in importance to all of the other terms of the agreement. Consequently, the submission that BCOP cannot, as a matter of

principle, as distinct from interpretation, affect Condition 15(1), (2), (3) and (4) of the Licence is in my view, incorrect.

31. Apart from the point last mentioned, it is I think correct common case that the principles governing the price at which generators

may bid to sell electricity into SEM, are laid down in the Licence and BCOP. Both of these documents are based on the regulatory

principles governing wholesale electricity prices in the SEM. It is also common case that the fundamental principle of bidding is that,

the price components of each cost item, referred to in the commercial offer data, must be “cost reflective” as Condition 15(1)

specifies. However, this concept is not free standing, in fact it is heavily circumscribed by and through the elaborate machinery set

out in the Generation Licence and BCOP for determining the basis on which cost items are allowed in and valued. It has within that

framework an autonomous meaning. This in my view inescapably follows from the sequential structure of Condition 15 itself.

32. As can be seen from para. 12 of this judgment, where Condition 15 is quoted in full:-

(a) subpara. (1) of the Condition, declares that the price components of, in effect, each relevant cost item, must

be “cost reflective”,

(b) subpara. (2) ordains that such price components will be treated as being cost reflective only if the scheduled

production costs of the specific unit on a specific trading day, is equivalent to the short run marginal cost of that

unit for that trading day, and

(c) subpara. (3) provides that for the purposes of subpara. (2), short run marginal costs are to be calculated as the

total costs attributable to the ownership etc. of the unit during a trading day if operating to generate electricity,

minus the total costs attributable to the ownership etc. of that unit for that trading day when not operating to

generate electricity.

33. The steps in the definitional process however do not end there. Subpara. (4), by its express terms, is created specifically “for the

purposes of (sub)para. 3”, so of course, a meaning, in context, must be given to its words. There is a reason for this: it brings us to

the next step in the tiered process, it gives a direction as to what the costs in subpara. (3) are or more accurately, what they are

“deemed to be”, which is, in respect of each cost item, the opportunity cost of that item for that unit for that day’s trading.

However, the task is not yet complete, for up to this point, one does not know what “opportunity costs” are or how such will be

determined and measured. Hence, BCOP.

34. Whatever about ambiguity existing elsewhere, Clause 6 of BCOP, in clear terms, indicates that for the purposes of calculating

short run marginal costs, each cost item must be valued at its opportunity cost. This leads directly back to the fundamental principle

of costs being cost reflective, recalling that price components can only be regarded as such, if they are equivalent to short run

marginal costs. There is therefore, a direct and immediate connection between cost reflective bidding and opportunity costs.

35. Clause 7 and 8 of BCOP then established how the opportunity cost of cost items are to be calculated. Clause 7 determines that

such cost shall comprise the value of the benefit foregone, by reference to the most valuable realisable alternative use of that cost

item, for purposes other than electricity generation. Clause 8 determines the manner in which the benefit foregone is to be

calculated: where a market exists, the opportunity cost of a cost item shall be the prevailing price of that item; where no such

market exists, it shall be its replacement cost. Those are terms which I will come back to again in a moment.

36. Therefore, as can be seen, the framework is multi-stepped and provides that:-

(i) cost reflective bidding takes place by reference to short run marginal costs,

(ii) short run marginal costs are determined by reference to opportunity costs,

(iii) opportunity costs are determined by reference to value of the benefit foregone, and

(iv) value of the benefit foregone is determined, where there is a market, by the prevailing price of the item in

question, and where no such market exists, by its replacements cost.

Consequently, given the express terms of the Licence and BCOP, it is impossible to accept, what in essence is the core submission of

the appellants, that notwithstanding the provisions above described, all costs incurred by or associated with generation, are or must

be included in the commercial offer data. Such a conclusion in my view is not deducible from the provisions identified. Even if

Condition 15 rested at the end of subpara. (3), I doubt if such a proposition could stand. However, certainty in my opinion, once the

remainder of that condition, in conjunction with the terms of BCOP (as integrated in the manner indicated) is considered for the

purposes of determining what cost reflective bidding truly is, the suggested conclusion is simply not possible.

37. During the course of submissions some discussion took place about the true nature of the imposition created by the Act of 2010

and the legitimacy of its purpose, if it be as submitted, namely to recoup what has been described as the “unearned windfall

revenue”, resulting from the Directive and Regulations above mentioned. As no challenge has been advanced to the levy on this or on

any ground, I will express no comment on these matters, save to say that, the use of the description “windfall”, is at least

unfortunate. There cannot in my view be any question about the right of the appellants to receive, free of charge, the percentage of

carbon allowances which they have. Such has resulted from community legislation which this Member State is bound by, as it is of

course, by its own domestic obligations. Whatever was received by the generators, was received in accordance with law.

Consequently the use of the phrase, as mentioned, is apt to mislead. However, I do not think that the issue on this appeal should in

any way be influenced by the use of such terms, however marginal or inappropriate they might be.

38. The Act of 2010 is entitled “Electricity Regulation (Amendment) (Carbon Revenue Levy) Act 2010, the long title shows that its

subject matter is the imposition of a levy, to be known as a “carbon revenue levy”, on so much of the revenues received by

electricity generators who participate in the SEM, as is attributable to emissions from their generation units. The inserted s. 40(D) in

the Act of 1999 is in much the same vein. Whilst it cannot be doubted but that the revenue identified, is directly related to the

emissions resulting from the generation of electricity, nonetheless I cannot agree that it is a levy on carbon or on the generation of

electricity as such. Whilst I note those who are exempt from the levy and the period of its application, I do not find it necessary to

further analyse the provisions of the Act of 2010, as in my view, such is not required so as to determine whether or not the levy can

be “bid in”, in the process under discussion.

39. Following on from the above analysis the key question is whether the levy has an opportunity cost, for in my view if it has not, it

cannot form part of short run marginal costs. In this regard, I do not accept that the trial judge in the same breath included it as part

of short run marginal costs and then excised it by reason of the BCOP. This in my view is to misunderstand paras. 7.13 and 7.15 of

the judgment.

40. In 7.13 the learned judge said that the levy was a cost in the “ordinary sense of that word”, a proposition from which I would not

demur. However, in judging what cost items are deemed part of short run marginal costs, one does not do so by reference to “the

ordinary meaning” of costs. In addition, he said that the levy was a cost attributable to the operation of the plant, in that it was

incurred once operational and not when idle. Again, that may be so but likewise it is subject to the same qualification. Quite correctly

in my opinion, the learned judge immediately followed these observations by referring to Condition 15(4) of the Licence and thereafter

by applying its provisions, arrived at the point where unless the levy had an opportunity cost it could not be bid in. This manner of

approach is entirely consistent with his judgment and contrary to what has been inferred, if not expressed, at no time did he make a

finding that the levy was part of short run marginal costs. Therefore, the question of exclusion never arose, quite simply the levy was

never deemed to be part of such costs in the first place.

41. In the same context reference has also been made to a passage in the judgment where the learned judge referred to “working

backwards through the various conditions”, when considering this issue. When viewed as a whole, I regard such an exercise as purely

one of cross reference and not one of approach error. Therefore, I would reject the criticisms made of the judgment in such respects.

42. There can be no doubt but that when a “cost item” has an “opportunity cost”, the value of that item is deemed to be the

“benefit foregone” by reference to the “most valuable realisable alternative use for purposes outside electricity generation”. Clause 8

of BCOP informs us that the value of the alternative use is the prevailing price of the cost item if there is a market and if there is not,

its replacement cost. In my view the levy cannot fall within this contractual description of a cost item. In the first place, the levy

must be understood for what it is: it is a statutory liability imposed on revenue earned in a particular way. To say that such a levy

has a value or has an alternative value, is self contradictory. To suggest that it has a use and an alternative use is likewise not

meaningful. Quite evidently one cannot speak of a market place or of replacement cost.

43. When contrasting the position of the levy with say, carbon allowances, it is immediately obvious that there is a market for the

latter, in which such allowances can be sold and purchased. When looking at labour or fuel, including the taxes inextricably linked with

such items, it is also the case that both may be put to profitable use in areas outside of electricity generation. On the other hand,

the levy has no existence or life of its own, in this type of way. In addition, the levy is not money and cannot be regarded as such. It

is not permissible to substitute the cost of discharging the statutory duty for the levy itself. It could never be that when paid the

levy becomes an inclusive cost item but when remaining undischarged is not so. It is therefore in my view incorrect to suggest that,

the value of any benefit foregone equals the cash value of the sum of the levy. To do so is to conflate two entirely different items.

Consequently, I cannot see how in these circumstances the levy can be said to be part of short run marginal costs.

44. This conclusion will be sufficient to dispose of the appeal. However, there is one further aspect of Clauses 7 and 8 of BCOP which

I wish to refer to. In both clauses, reference is made to the cost items being “employed…for the purposes of electricity generation”.

It is said that this phraseology is unacceptably wide in that it goes further than simply determining the measure or value of the items

in question. It is claimed that, it has the capacity for including or rejecting cost items per se. In this regard the learned judge is

criticised for supporting his conclusion by indicating that the levy could not be said to be either “employed” in or constitute “an input”

into, electricity generation.

45. In my view the subject phrase is but expressly stating what otherwise is implied within Condition 15. It seems to me that the

essence of the contractual concentration is on the cost items which form an integral part of the generation of electricity. In that

regard, I would also agree that the levy cannot be so regarded. It is in my view, as previously stated, a cost incidental to or

consequential upon, but not a direct input cost into, the generation of electricity. Accordingly, for this reason I also would dismiss the

appeal.