Canada: The WTO Report On Local Content Requirements For Canadian Renewables Programme – MENA Implication

A recent ruling by the WTO panel on the legality of the local content requirements for renewable energy schemes could mean that such requirements should be withdrawn from those adopted or currently being developed by WTO Members including countries in the Middle East and North Africa.

In brief

On 19 December 2012, the World Trade Organisation (WTO) issued panel report that found that the Canadian "local content requirement" scheme's violates the WTO's non-discrimination principle enshrined in the General Agreement on Tariffs and Trade (GATT) and the WTO Agreement on Trade-Related Investment Measures (TRIMS).¹

In a nutshell, the local content requirements (LCRs) are scheme that require renewable energy producers to source a certain minimum amount of their project costs from local providers in order to qualify for a feed-in tariff programmes, which create a barrier to entry to foreign energy suppliers. LCRs are typically introduced by local governments with a view to helping boost growth in domestic manufacturing and the job market. However, these measures are commonly viewed as anti-competitive (and for that reason are prohibited in the EU). On this basis, Japan has requested that the WTO look into these measures adopted in Canada.

Canada has now appealed against the report. If the report's findings on local content requirements are upheld by the WTO Appellate Body, this would in effect mean that such requirements must be withdrawn from the Canadian scheme as well as other similar feed-in tariff programmes including those adopted or currently being developed by WTO Members in the Middle East and North Africa (MENA Region).

Background

On 13 September 2010, Japan requested consultations with Canada regarding the LCRs in Canada's feed-in tariff program (the FIT Programme).

The dispute concerned the Province of Ontario where local content requirements were imposed on certain generators of electricity utilizing solar photovoltaic (PV) and windpower technology. The requirements were that these generators must source a certain minimum amount of the costs associated in the design and construction of electricity generation facilities from the local Canadian market in order to qualify for guaranteed prices offered under the FIT Programme.

By June 1, 2011 Japan (joined by the EU) found initial consultations to be unsuccessful and requested that the WTO Dispute Settlement Body (DSB) set up a panel to review Canada's FIT measures.

Notably, Saudi Arabia (together with a number of other WTO Members) reserved its third party rights

On 6 October 2011, the Director-General composed the Panel, which reported its findings on 19 December 2012. On 5 February 2013 Canada filed a notice of appeal in the dispute cases.

The FIT Programme

The province of Ontario is most advanced Canadian province in implementing renewable energy subsidy mechanisms.

According to the WTO Panel report, the installed power generation capacity in Ontario can be separated into three groups of generators : (i) the government-owned assets of the Ontario Power Generator (OPG) which is a wholly-owned electricity corporation of the Government of Ontario; (ii) Non-Utility Generators (NUGs), which are private generators that entered into supply contracts with Ontario Hydro in the 1980s and 1990s; and (iii) Independent Power Producers (IPPs), which comprise all the other generators in Ontario that have started to operate since the wholesale market was restructured. The IPPs include generators operating under the FIT Programme.²

Electricity prices in Ontario are determined through a complicated process. Considering the similarities between the electricity generation and pricing system in Ontario and the electricity generation and distribution schemes in some of the countries in the MENA Region,³ the pricing process will briefly be examined below.⁴ This should also help the readers gain a better understanding of the linkage of the FIT Programme to the electricity pricing system.

Essentially, electricity prices in Ontario are determined as follows:⁵

• Electricity produced by facilities classified as "OPG Regulated Assets", i.e. the OPG's nuclear and base-load hydroelectric generation facilities: These prices are set by the Ontario Energy Board (OEB) on the basis of the principle of "cost recovery and a margin of return".
• Electricity produced by OPT's other "unregulated" hydroelectric and coal-fired facilities. Here the prices are not guided by the principle of cost recovery and margin. These assets receive the Hourly Ontario Electricity Price (HOEP), which is generally lower than the regulated price obtained by the OPG's regulated assets.
• Electricity produced by the IPPs, which generate around 40% of Ontario's electricity supply, receive prices that are negotiated or set under different types of OPA initiatives and contracts including the FIT Programme.

In a nutshell, the FIT Programme is a scheme implemented by the OPG which enables the OPG to guarantee electricity purchase prices, grid access, and long-term contracts (20 years or 40 years) to renewable energy producers. The OPG guarantees the recovery of costs plus a return on investment over the contract period.⁶

Participation in the FIT Programme is open to facilities located in Ontario that generate electricity exclusively from one or more of the following sources of renewable energy: wind, PV, renewable biomass, biogas, landfill gas or waterpower . The Programme is divided into two streams: (i) the FIT stream - for projects with a capacity to produce electricity that exceeds 10 kW, but is no more than 10 MW for solar PV projects or 50 MW in the case of waterpower projects; and (ii) the microFIT stream - for projects having a capacity to produce up to 10 kW of electricity (typically small household, farm or business generation projects).⁷

The FIT Programme is implemented through the application of a standard set of rules, standard contracts and, for each class of generation technology, standard pricing. The standard rules are found in a number of instruments, with the most specific being the FIT Rules and the microFIT Rules developed by the OPA.⁸ 

Only projects that satisfy all of the specific eligibility requirements set out in the FIT and microFIT Rules, and that can be connected to the Ontario electricity system, will be offered a contract, and thereby permitted to participate in the FIT Programme.⁹

Under the FIT and microFIT Rules, in order to qualify for the FIT Programme, renewable energy projects must achieve a minimum LCR as follows:¹⁰

Summary of the parties' arguments

The claimants argued that the "Minimum Required Domestic Content Level" adopted under the FIT Programme unfairly discriminates against foreign renewable energy products and therefore place Canada in violation of: (i) the national treatment obligation under Article III:4 of the GATT 1994; (ii) the prohibition that is set out in Article 2.1 of the TRIMs Agreement on the application of any trade-related investment measures that are inconsistent with Article III of the GATT 1994; and (iii) the prohibition on import substitution subsidies prescribed in Articles 3.1(b) and 3.2 of the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement).

Canada, however, argued that its FIT Programme is a form of government procurement designed to ensure the affordable generation of clean energy in Ontario and is consequently not subject to GATT national treatment
requirements, TRIMS Agreement provisions, or the SCM agreement.

Summary of key findings of the WTO panel report in relation to "Local Content"

In its report in DS412, the Panel:¹¹

• upheld Japan's claims under Article 2.1 of the TRIMs Agreement and Article III:4 of the GATT 1994;
• found that Canada had not established it was entitled to rely upon Article III:8(a) of the GATT 1994 because the Government of Ontario's procurement of electricity under the FIT Programme was undertaken "with a view to commercial resale"; and
• concluded that Japan had demonstrated that the challenged measures were inconsistent with Canada's obligations under Article 2.1 of the TRIMs Agreement and article III:4 of the GATT 1994.

The Panel majority dismissed Japan's allegations that the challenged measures constitute subsidies on the grounds that Japan had failed to establish the existence of a subsidy under the SCM Agreement.

Recent increase in WTO disputes on subsidy and local content requirements relating to renewable energy programmes

While the report in "Canada – Renewable Energy Measures" is the first WTO panel report concerning a renewable energy support program was challenged under the WTO, policies and programs relating to renewable energy are increasingly brought before the WTO dispute settlement system for consultation and, failing resolution through consultation, for settlement by the DSB.

In September 2010, the United Steelworkers (USW) filed a petition with the United States Trade Representative (USTR) requesting that it investigate China's violation of its WTO commitments in clean energy. While the USTR decided to proceed with an investigation in October 2010, in December 2010 they announced that out of the long list of Chinese policies and programs mentioned in the USW petition they would only proceed with investigating one Chinese wind subsidy program. The wind subsidy dispute was resolved a few months later, with USTR claiming success on June 7, 2011 after China agreed to remove the subsidy program in question.¹²

In November 2012 China requested consultation with the EU and certain EU Member States concerning their renewable energy generation measures. China alleges that certain measures affecting the renewable energy generation sector relating to the feed-in tariff "programmes" of EU Member States, including but not limited to Italy and Greece, include domestic content restrictions and are inconsistent with WTO obligations (not to mention EU competition rules). Japan, Argentina, and Australia subsequently requested to join the consultations. So far, the EU has only accepted the request from Japan to join the consultations.

More recently, on 6 February 2013, the US notified the WTO Secretariat of a request for consultations with India on certain measures of India relating to domestic content requirements under the Jawaharlal Nehru National Solar Mission (NSM) for solar cells and solar modules.

Implications for Renewable Energy programs in the MENA Region

While it might be too early to determine the practical implications of the Panel's findings in Canada – Renewable Energy Measures until the Appellate Body issues its own report, some preliminary observations may be made at this stage. This is particularly important as governments in the MENA Region have developed or are currently considering large-scale renewable energy programmes with various mechanisms to determine the feed-in tariff.

For instance, in Saudi Arabia, the King Abdullah City for Atomic and Renewable Energy (KA-Care) is preparing to invite bids to develop 2,850MW of renewable energy projects. The first bidding round will not include any local content requirements. However, it has been stated that in the second full-scale bidding round, the bidders must satisfy the local content requirements.

In Jordan, a feed-in tariff of USD 0.12/ kWh was introduced in December 2012 (the first in the MENA Region) by the local electricity regulatory commission, which includes a 15% local content requirement.

The United Arab Emirates has also developed ambitious solar power generation goals as well as evolving policies and regulatory frameworks (which include the application of feed-in tariff levels and local content premiums) to support these goals.
It may be difficult for these governments to support their projects with local content requirements given the recent challenges against such requirements at the WTO.

 In Morocco, the "Ouarzazate I" the concessional loan of the World Bank is structured as a "feed-in tariff component", where the World Bank loan will finance Government of Morocco's coverage of the difference in price at which MASEN (state agency) buys from Solar Power Company (SPC) and sells to ONE (state power utility), the kilowatt-hours produced by the project. The selling price by SPC to MASEN reflects the Levelised Cost of Energy (LCOE) for SPC, once the capex grants are factored in to reduce the investment cost. The selling price set by MASEN to ONE reflects the wholesale price of electricity in Morocco which is essentially driven by the levelised cost of coal generation.¹³ This price support may be prohibited under the WTO law (the SCM Agreement) if it is found to confer a benefit on the recipient (e.g. the government).

There are many other examples of local content requirements being used to promote the development of domestic renewable energy industries in this region.

The way forward

As already stated, it may be premature to suggest a complete overhaul in governments' renewable energy policies with respect to local content at this stage when the report of the Panel is yet to be considered by the Appellate Body. If the Appellate Body agrees with and upholds the Panel's interpretation of the relevant provisions in the GATT and TRIMS in relation to local content, then those findings may have significant implications for the FIT policy mechanisms including those that have been adopted or are currently being developed by the governments in the MENA Region. In fact, the implications of the Panel's findings may go beyond the renewable energy industry to affect local content requirements commonly used in other projects such as power and oil and gas projects.

The reality is that we are witnessing a splurge of trade disputes wherein renewable energy programs across the world based on local content requirements are challenged at the dispute settlement mechanism. A decision of the Appellate Body that substantially approves the Panel's findings may further contribute to the surge in this type of disputes or requests for consultations.

However, litigation is not always the most useful tool and does not always provide the best solution. Be it as it may, the challenges already brought forth by WTO Members on the legality of local content requirements produces a constraint on policy space for renewable energy programmes. In this light, as the governments in the MENA Region are considering the development and implementation of various FIT programmes, it is important that governments consider alternative approaches to LCRs.

Perhaps a more crucial set of questions should be asked about the goals of creating the renewable energy industry, the models to pursue and the period of time needed to achieve those goals. The design of the policy incentives used to achieve the specific goals will vary depending on these factors. Non-mandatory LCR¹⁴, tax incentives, research and development funding, mandatory renewable targets and guaranteed energy purchases can be used (each on its own or in conjunction with other incentives) are examples of such incentive measures.¹⁵

However, in order to comply with international trade rules, it is important that those incentives should be specific and targeted and apply to everyone equally. Furthermore, if any transfer of funds is involved, in order to ensure compliance with the SCM Agreement, those funds should be "ring-fenced" and only be paid to qualifying electricity suppliers for the electricity that is delivered to the country's electricity grid.¹⁶ In other words, such payments should not be made in the form of a grant, loan, or up front lump sum advances to the generators under the FIT programme.

There is little doubt that rigid local content policies and trade barriers tend to raise costs, reduce innovation and slow the uptake of clean-energy technologies. Successful renewable energy can bring significant benefits to the host country's economy and the community where primary resources are located, and create long-term local jobs. A regional perspective instead of a purely nationalistic approach can secure both jobs and a lower cost of energy. One such regional approach may include developing a regional renewable energy best practice rules for the MENA Region and offering incentives to investors who demonstrate maximum compliance with those broader regional (rather than selected local) rules.

Footnotes

^{1"Canada - Certain Measures Affecting the Renewable Energy Generation Sector" (complaint by Japan, DS412) and "Canada - Measures Relating to the Feed-in Tariff Program" (complaint by the European Union, DS426) (together, Canada – Renewable Energy Measures). 
2Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Para 7.26.
3The proposed feed-in tariff programmes in the MENA Region will be implemented through governmental entities. Also, I(W)PP is well established in the MENA Region. Only in the GCC (Gulf Council Corporation), 44 planned power and water projects are valued at USD 31.9 billion. http://arabnews.com/saudiarabia/article518627.ece . Last visited 10 February 2013.
4Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.26 -7.29.
5Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.26 -7.29.
6Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.64.
7Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.66 (Footnotes omitted).
8Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.67 (Footnotes omitted).
9Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.68 (Footnotes omitted).
10Panel Report, Canada – Renewable Energy Measures, WT/DS412/R, WT/DS426/R 19 December 2012 Paras 7.158 (Footnotes omitted).
11The findings of the Panel report in DS426 that are relevant for the purpose of this article are substantially the same as those stated in DS412.
12Office of the United States Trade Representative 2011.
13Climate Investment Funds, October 26, 2011, http://www.climateinvestmentfunds.org/cif/sites/climateinvestmentfunds.org/files/SREP%20Inf%203%20subsidy%20paper.pdf . Last visited 10 February 2013.
14For example, in KA CARE project in Saudi Arabia, developers bidding in the first full scale procurement round are incentivised to use local content. If a bidding developer opts to incur "allowable local expenses" (to be defined in the relevant request for proposals) in the context of either of these procurement rounds, then the developer will be awarded extra bid points.
15See Local Content Requirements in British Columbia's Wind Power Industry, University of Victoria, Faculty of Business December 2010, http://pics.uvic.ca/sites/default/files/uploads/publications/WP_Local_Content_Requirements_December2010.pdf (Last visited, 10 February 2013).
16It has been argued that LCRs could even have adverse economic consequences. See, for example, http://www.ebrdblog.com/wordpress/2012/11/local-content-requirements-for-renewable-energy-an-unnecessary-evil/ . Last visited 10 February 2013.}