Technical

Spanish ECT awards: how the damages were calculated

Sandy Cowan Sandy Cowan

To DCF or not to DCF – that was the question in the calculation of damages in the 13 published Energy Charter Treaty awards made against Spain. We look at the discounted cashflows method of valuation (and others) and the reasons for their choice.

To date, investors (claimants or investors) have launched at least 36 claimsi under bilateral and multilateral investment treaties against the Kingdom of Spain (Spain or respondent) following changes to its renewable energy incentive scheme. Tribunals have found against Spain in 13 out of 14 cases for which awards are publicly available, for a combined value of €999 millionii. This article considers the methods used in the calculation of damages in the 13 published awards made against Spain and the reasons for their choice.

Background

In its efforts to meet national and EU renewable energy targets, from 2004 Spain sought to attract investment in renewable energy with new legislation and an incentive scheme. Between 2010 and 2014, Spain subsequently repealed or amended the legislation on which those investments were predicated. The key legislation changes, which are set out in more detail below, have in the view of investors, negatively affected the return on the investment projects and their fair market value.

Investors argue that without the regulatory framework, which committed to a stable remuneration regime, they would never had invested. Spain, on the other hand, alleges that investors could not legitimately expect that the rules applicable to their investments would remain unchanged for the entire duration and should have been aware that the regulatory regime could be modified.

Initial Regulatory Framework

To promote investment in renewable energy, Spain developed a ‘Special Regime’ in 1997iii. The Special Regime was modified in 2004iv to improve the stability of the tariffs, and was subsequently modified again in 2007v. The latter modification specified the remuneration payable under the Special Regime as either a regulated tariff (feed-in-tariff or FIT) for the total net energy produced for the lifetime of the plants, or a premium.

Regulations adopted after 2010 (the ‘Disputed Measures’)

Beginning in 2010, Spain enacted a series of changes to the Special Regime, which included: limiting the FIT to the first 25 years of the plant’s operation rather than the lifetime of the facilityvi; capping the number of yearly production hours that would be entitled to receive the FITvii; and introducing a 7% tax on electrical energy producedviii.

From 2013, further reforms were made which eliminated the special premiums provided for in 2007ix, formally eliminated the existing Special Regime and provided for tariff revision every six yearsx, and established formulas for calculating the special payment under the new regime, limiting this special payment to certain operating hoursxi.

Energy Charter Treaty

The legal basis of the claims centre around the fair and equitable treatment (FET) standard, including the legitimate expectations of investors, under the Energy Charter Treaty (ECT), of which Spain was a signatory.

Article 10(1) ECT'sxii first sentence reads:

“Each Contracting Party shall, in accordance with the provisions of this Treaty, encourage and create stable, equitable, favourable and transparent conditions for Investors of other Contracting Parties to make Investments in its Area.”

In their claims, the investors, contend that Spain breached its duty of FET in at least three distinct ways:

1 By violating the legitimate expectation of fixed tariffs and premiums for the entire lifespan of the renewable energy facilities

2 By failing to provide a minimum standard of treatment

3 By failing to treat claimants’ investments transparently and consistently and acting in good faith

Calculation of damages

The purpose of calculating damages in these cases has been to put the investors into the position that they would have been were it not for the respondent’s actions.

The standard of damages is calculated as the difference between the value of the investment, had the initial legislation (RD 661/2007) been maintained (the hypothetical or but-for scenario), and the value of the investment under the ‘disputed measures’ (the actual scenario).

Although there are different approaches to calculate damages, the two main ones that have been adopted by the respective tribunals in the Spanish renewable energy cases are:

  • Income based method – discounted cashflows (DCF)
  • Asset based method – cost of assets plus a reasonable rate of return

DCF

Discounted cashflows is a valuation method used to estimate the value of an investment today (present value) based on projections of how much money it will generate in the future (future cashflows), adjusted for the time value of money and expected rate of return.

The time value of money assumes that a euro today is worth more than a euro tomorrow because it can be invested and earn a return. DCF analysis estimates the present value of expected future cashflows using a ‘discount rate’, which is often considered as a proxy for the required rate of return that investors can expect to earn relative to the risk of the investment.

Cost of assets plus a reasonable rate of return

One alternative method to the income-based DCF is an asset-based approach. Damages may be calculated as the costs already incurred, ie, the costs to build and maintain the assets, plus a reasonable rate of return (usually based on the minimum rate of return the assets must earn to satisfy stakeholders).

Review of the Spanish awards

To date, there have been 13 published awards made in favour of Claimants. In each case the approach taken by the claimant(s) and respondent to the quantification of damages differed fundamentally, with the claimants preferring DCF and the respondent preferring an asset-based method.

In the 13 awards, the respondent’s main assertion against the use of DCF was that the future cash flows, sometimes up to 40 years in the future, were highly speculative and therefore inappropriate due to:

  • the investments were capital intensive with no relevant intangible assets
  • there was a high dependency on volatile cashflows
  • the long forecast period increased uncertainty
  • there was an insufficient history of operations
  • the economic conditions were constantly fluctuating.

The tribunal favoured the use of DCF over the cost of assets methodology in 11 of the 13 awards. While the facts and merits of each case were different, the following were the primary reasons for the use of DCF by the tribunals (majority view) based on the evidence put before them.

i) The DCF method is well established and widely accepted by arbitral tribunals in the renewable energy sector. The DCF method is universally used to value income producing assets and has been confirmed by numerous tribunals to be the standard approach for calculating the fair market value of an investment for purposes of compensation of breaches of law. Tribunals acknowledge that projecting future cashflows depend on the quality of the inputs and a careful analysis of the underlying assumptions, in order to minimise speculative elements. Additionally, DCF valuation risk is minimised by assigning distant cashflows a higher discount (and therefore a lower value) to reflect the way that uncertainty compounds over time.

ii) Plants had sufficient operational history and were operating as a going concern.

iii) Revenues and costs of plants were predictable due to operating in a regulated industry.

iv) Power stations have a relatively simple business model with readily available data. The inputs into the DCF model are primarily based on objective or actual data, such as production, electricity prices, inflation, maintenance costs, lifetime of the plants, regulatory risk and discount rate used. There is, therefore, a somewhat mathematical precision to the output, if properly exercised with a degree of skill and judgement.

These reasons for the use of DCF, i) to iv) (where provided by the tribunal in the award), have been linked to each award in the table below under ‘Tribunal method to calculate damages and reasoning’:

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Claimant Claimant approach Respondent approach Tribunal decision Tribunal method to calculate damages and reasoning Amount claimed by Claimant Amount awarded to Claimant by Tribunal
Eiser Infrastructure Ltd xiii DCF Asset-based method In favour of Claimant DCF i) & iv) €209m €128m
Novenergia II - Energy & Environment xiv DCF Asset-based method In favour of Claimant DCF i), ii) & iii) € 61.30 €53.3m
Masdar Solar & Wind Cooperatief U.A xv DCF Asset-based method In favour of Claimant DCF i), ii), iii) & iv) €179m €64.5m
Antin Infrastructure Services Luxembourg S.a.r.l and Antin Energia Termosolar B.V xvi DCF Asset-based method In favour of Claimant DCF i), ii) & iv) €148m €112m
Foresight Luxembourg Solar 1 S. µ.R1., et al. xvii DCF Asset-based method In favour of Claimant DCF i) & iii) €58.2m €39m
9REN Holding Sarl xviii DCF Asset-based method In favour of Claimant DCF iii) €52.2m €42m
NextEra Energy Global Holdings BV and NextEra Energy Spain Holdings BV xix DCF and an alternative calculation based on the cost of assets plus a reasonable rate of return Asset-based method In favour of Claimant Cost of assets plus reasonable rate of return €21.4 or €416.3m (alternative calculation) €290.6m
Cube Infrastructure Fund SICAV and others xx DCF Asset-based method In favour of Claimant DCF i), ii) & iii) €74.08m €33.7m
SolEs Badajoz GmbH xxi DCF Asset-based method In favour of Claimant DCF i) €52.7m €41m
InfraRed Environmental Infrastructure GP Limited xxii DCF Asset-based method In favour of Claimant DCF ii) & iii) €75.7m €28.2m
Schwab Holding AG (Swiss), OperaFund Eco-Invest SICAV PLC (Maltese)xxiii DCF Asset-based method In favour of Claimant DCF i) & ii) €40.1m €30m
Stadtwerke Munchen GmbH, RWE Innogy GmbH and others xxiv N/A majority Tribunal dismissed the Claimants' claims N/A majority Tribunal dismissed the Claimants' claims In favour of Respondent N/A N/A Nil
RREEF Infrastructure (G.P.) Limited and RREEF Pan-European Infrastructure Two Lux S.a.r.l xxv DCF Asset-based method In favour of Claimant A 'reasonable return' for the project based on Internal Rate of Return (IRR) €265m €59.6m
Watkins Holdings S.a.r.l and others xxvi DCF Asset-based method In favour of Claimant DCF i), ii), iii) & iv) €123.9m €77m
Total claimed by all Claimants €1,860m
Total awarded by all Tribunals €998m

Cases where the tribunal rejected the use of DCF

Only in 2 of the 13 cases did the tribunal reject the use of DCF method.

In the NextEra case the plants had been in operation for less than one year (and therefore less than one year of actual profits), which the tribunal considered to be an insufficient basis for the application of DCF. While NextEra sought to contend that the initial regulatory framework (RD 661/2007) provided a basis for calculating future profits (the ‘premium’ option), the tribunal disagreed and found that NextEra did not have a legitimate expectation of an entitlement under the initial framework; instead they just had a legitimate expectation that there would not be a material change to it. The tribunal determined the appropriate method for quantifying damages was the capitalised costs of the assets plus a reasonable return. The tribunal considered that the alternative damages calculation proposed by the claimants was ‘not dissimilar’ to the asset-based approach proposed by the respondent.

In the RREEF case the tribunal decided that the valuation should be analysed by reference to the internal rate of return (IRR). The IRR of a project measures the average annual returns of a project, based on the cash flows generated by the project over its entire lifespan. In RREEF, the tribunal rejected the use of the DCF method because they found that “the only legitimate expectations the claimants had was to obtain a ‘reasonable’ return that the respondent was committed to”xxvii and the ‘reasonable’ return by Spanish law was the project IRR. The RREEF tribunal found that comparing the income or asset valuation under the old and new regime made it possible to calculate a difference but gave no indication as to whether the two remunerations were ‘reasonable’ or not.&

Amounts claimed vs amounts awarded

From the table above we can see that the total amount claimed by all the claimants was €1.86 billion, and the total amount awarded by all the tribunals was €998 million, or 54% of the total amount claimed by all the claimants.

As well as the valuation method, the tribunal also considered and analysed the following criteria, based on the evidence put before them by the claimants and respondents, in deciding how much to award the claimants in each of the 13 cases:

  • Operational lives of the plants – 40 years (claimants) vs 25 years (respondents); the majority of tribunals agreed that 25 years was more appropriate
  • Valuation date - appropriate for the purpose of evaluating the impact of the Disputed Measures on claimant’s investments
  • Interest on the award – whether any award should include interest from the valuation date to the date of the award
  • Tax ‘Gross-Up’ Claim – whether any amounts awarded should be net of taxes
  • Liquidity discount – whether a discount should be applied based on the marketability of the plants (how long it would take to sell the assets) and the potential discount required to facilitate the sale
  • Cost of capital and discount rate (to be applied to DCF valuation) – to appropriately reflect market risk and regulatory risk in Spain

Conclusion

Based on published decisions in renewable energy cases brought against Spain, arbitral tribunals appear to have a significant preference for the use of DCF to calculate the damages. In the cases analysed, tribunals have appeared to focus on the quality of the inputs and a careful analysis of the underlying assumptions, in order to minimise speculative elements.

However, as noted in the NextEra and RREEF cases, tribunals may use an alternative valuation method such as cost of assets or IRR depending on the tribunal's decisions as to the legitimate expectations of the investors. As ever, tribunals will focus on the particular facts of each case to determine the most appropriate measure of damages. 

This report was written by: Sandy Cowan, Emma Jarman and Nilesh Mehta. It was first published 05/08/2020.

For more information, please contact Sandy Cowan.

References

i Based on awards published by ICSID and SCC

ii On 11 June 2020, the ICSID committee annulled the award in favour of the claimant in the case Eiser Infrastructure Limited and Energia Solar Luxembourg Sarl v Kingdom of Spain (ICSID Case No. ARB/13/36). The value of the award was €128 million. Excluding this award there are 12 published awards against Spain for a combined value of €871 million

iii Law 54/1997 (27 November 1997)

iv Royal Decree 436/2004 (12 March 2004)

v Royal Decree 661/2007 (25 May 2007)

vi Royal Decree 1565/2010 (19 November 2010)

vii Royal Decree 14/2010 (23 December 2010)

viii Law 15/2012 (27 December 2012)

ix Royal Decree-Law 2/2013 (1 February 2013)

x Law 24/2013 (26 December 2013)

xi Royal Decree 413/2014 (10 June 2014)

xii Energy Charter Treaty, Article 10(1)

xiii Eiser Infrastructure Limited and Energia Solar Luxembourg Sarl v Kingdom of Spain, ICSID Case No. ARB/13/36

xiv Novenergia II – Energy & Environment (SCA) (Grand Duchy of Luxembourg), SICAR v Kingdom of Spain, SCC Case No. 2015/063

xv Masdar Solar & Wind Cooperatief U.A. v. Kingdom of Spain, ICSID Case No. ARB/14/1

xvi Antin Infrastructure Services Luxembourg S.à.r.l. and Energia Termosolar B.V. (formerly Antin Infrastructure Services Luxembourg S.à.r.l. and Antin Energia Termosolar B.V.)​ v Kingdom of Spain, ICSID Case No. ARB/13/31

xvii Foresight Luxembourg Solar 1 S. Á.R1., et al. v Kingdom of Spain, SCC Case No. 2015/150

xviii 9REN Holding S.a.r.l v Kingdom of Spain, ICSID Case No. ARB/15/15

xix NextEra Energy Global Holdings B.V. and NextEra Energy Spain Holdings B.V. v Kingdom of Spain, ICSID Case No. ARB/14/11

xx Cube Infrastructure Fund SICAV and others v Kingdom of Spain, ICSID Case No. ARB/15/20

xxi SolEs Badajoz GmbH v Kingdom of Spain, ICSID Case No. ARB/15/38

xxii InfraRed Environmental Infrastructure GP Limited and others v Kingdom of Spain, ICSID Case No. ARB/14/12

xxiii OperaFund Eco-Invest SICAV PLC and Schwab Holding AG v Kingdom of Spain, ICSID Case No. ARB/15/36

xxiv Stadtwerke München GmbH, RWE Innogy GmbH, and others v Kingdom of Spain, ICSID Case No. ARB/15/1

xxv RREEF Infrastructure (G.P.) Limited and RREEF Pan-European Infrastructure Two Lux S.à r.l. v Kingdom of Spain, ICSID Case No. ARB/13/30

xxvi Watkins Holdings S.à r.l. and others v Kingdom of Spain, ICSID Case No. ARB/15/44

xxvii RREEF Infrastructure (G.P.) Limited and RREEF Pan-European Infrastructure Two Lux S.à r.l. v Kingdom of Spain, ICSID Case No. ARB/13/30. Decision on Responsibility and on the Principles of Quantum, 30 November 2018, 545

Quantum matters

Summaries of the damages aspects of recent arbitral awards.

Providing you with an overview of current practice and the approach of different tribunals on similar issues.

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