EU Renewable Energy Financing Mechanism - What you need to know ahead of 1 January 2021

In January 2021, the European Commission’s Renewable Energy Financing Mechanism (“the Mechanism”) will come into effect. The Commission has established the Mechanism, which is a new means of financing renewable energy projects in EU Member States, as part of the Clean Energy Package.

The Mechanism has two objectives:

1. to support Member States in achieving their renewable energy generation targets in a cost-effective way. In this respect, the Mechanism could provide a further boost to the deployment of renewable technologies – in particular offshore wind and solar – in Member States where their deployment is most cost-effective.
2. to reduce cost of capital where this is a barrier to investment in renewable energy investment by having grants awarded under the Mechanism be allocated in accordance with an “enabling” objective. This could support projects involving innovative technologies.

Legislation implementing the Mechanism was passed in the Brexit transition period, so applies to the UK. Nevertheless, the Mechanism will not come into operation until 1 January 2021, at which point the UK transition period will be over. Therefore it is unlikely that the UK will participate in the Mechanism as an EU Member State. But as a third country, it may take part in joint projects with Member States that could benefit from funding provided under the enabling objective.

Context

EU Member States have made binding commitments to increase the proportion of their energy consumption which comes from renewable sources. To help achieve this, Member States must put in place 10-year climate plans covering the period up to 2030.The EU has a target of reducing its greenhouse gas emissions by 40% by 2030, with the European Parliament having voted to adopt a 60% reduction target in October 2020.

The Commission assesses progress towards renewable generation targets at regular two-year intervals and where insufficient progress is being made, the Member State must take action to stay on track. The Mechanism provides a new means of the Member State taking such action.

At present, Member States have two options to make progress towards their targets: they can increase their domestic renewable energy generation; or they can cooperate, making use of measures under the Renewable Energy Directive. For instance, Luxembourg and Lithuania adopted an arrangement whereby renewable energy generated in Lithuania contributes to Luxembourg’s targets. This “statistical transfer” allowed Lithuania, which had already met its target, to transfer a specified volume of renewable energy generation to Luxembourg in exchange for payment. There was no physical transfer of energy, but Luxembourg was entitled to count the energy “transferred” towards its own renewables target.

The Mechanism introduces a third route: Member States can make financial contributions to renewable energy projects in other Member States, allowing both contributing and host countries to share the progress towards renewable generation targets.

How does the Mechanism work?

If a Member State is making insufficient progress towards its renewable energy targets, it can make a voluntary “gap-filling” payment under the Mechanism towards renewables projects in other Member States. Member States can make further payments (outside of the “gap-filling” exercise) to support the enabling objective of the Mechanism.

The Mechanism can also receive funding from EU sources and the private sector. Private investors may indicate a preference for which call for proposals they intend to support and may request that guarantees of origin are issued for the renewable energy generated. The Commission may take these preferences into account, but is not obliged to.

Competitive tenders will be used to allocate funding under the Mechanism, which may take various forms, including low-interest loans and grants. A wide variety of non-fossil fuel technologies are eligible, although energy storage is eligible only if deployed in combination with additional renewable energy capacity. Funding can be used to support new projects or operational projects (in which case it would offer a premium on top of market revenues). Funding provided under the Mechanism will generally be allocated to projects bidding at the lowest cost or premium (and gap-filling payments must be allocated to lowest-cost projects).

The Commission may design some funding rounds to be technology neutral, or could choose to include specific technologies, specific projects or specific end-uses (like heating or transport). The approach to seeking proposals and allocating funding is a matter of the Commission’s discretion. It may take into account factors like the preferences of contributing and host Member States and the state of the renewables market.

Please see the process chart below, which summarises how the Mechanism works.

Contributing and Host Member States

Where the Commission considers that a Member State is falling behind its required trajectory in terms of bringing sufficient renewable generation capacity online to meet its target, the Mechanism means that that Member State can finance projects elsewhere. Statistically, the additional capacity brought online in a call for proposals will count towards the renewable energy targets of both the contributing and host Member States taking part in that call for proposals. These statistical benefits will be distributed between host and funder countries to reflect their participation – but generally contributing Member States will be entitled to apportion 80% of the additional capacity against their own targets.

How will this impact the Renewable Energy Sector in the EU and UK?

Gap-filling payments under the Mechanism must be allocated to projects with the lowest cost bids. This will benefit the renewables sector in regions where it is more developed and cost-effective. Member States will be able to make progress towards their renewable energy targets more efficiently by investing in projects here.

Funds distributed under the Mechanism’s enabling objective could be allocated to small-scale or innovative projects in regions with emerging renewables sectors. Here, loans and grants could significantly reduce the cost of capital, therefore overcoming barriers to investment and supporting the growth of the renewables sector. In turn, this may pave the way for a greater expansion in capacity further down the line, to the benefit of developers of emerging technologies. However, Member States may be less likely to make additional investments under this limb, compared to gap-filling payments, because this funding does not count towards meeting their renewable energy deployment targets.