Hamilcar KNOPSa,†, Piet Jan SLOTb, Kirsten WILKESHUISc, Hanneke de JONGa
a: Delft University of Technology, the Netherlands
b: Leiden University, the Netherlands
c: Vrije Universiteit Amsterdam, the Netherlands
1. Introduction
The liberalisation of the European electricity and gas industries has not only required a complete
restructuring of the industries, but has also necessitated the development of new approaches for securing the
public policy goals for electricity and gas supply. Whereas before liberalisation government could implement its
policy goals rather directly by imposing them upon the vertically integrated ‘monopolist’ utility, in the current
situation government needs instruments which allow the achievement of the policy objectives concerned within a
market environment.
For this purpose, the concept of a public service obligation (PSO) may be a very useful instrument in the
market context (Knops and Hakvoort 2002). PSOs have been labelled ‘a key element’ (EC 2001a) and ‘one of
the pillars of the European model of society’ (EC 2004a). Essentially, the concept of a PSO provides, pursuant to
Article 86(2) of the EC Treaty, an opportunity to derogate from the strict European rules on free trade and
competition in so far as such a derogation is necessary for the effective fulfilment of a service of general
economic interest. Therefore, in the liberalised electricity and gas industries, PSOs can play an important role to
secure policy goals in the competitive parts of the industries. For example, in the electricity generation market
PSOs can be used to secure security of supply or to promote the production of electricity from renewable
sources; or in the energy supply markets to protect the customers (e.g. through a ‘supplier of last resort’).
PSOs have attracted growing attention in the last years, also in the energy industries (e.g. Devroe 2000,
IE&P 2000, IEA 2002, Hammer 2002, Knops and Hakvoort 2002, and EC 1996, EC 2001a, EC 2003a, and EC
2004a). Initially, not all relevant issues concerning PSOs were clear. However, in recent years, the (European)
legal regime for PSOs has been clarified in case law of the European Court of Justice (ECJ), and documents as
well as decisions from the European Commission. This clarification concerns in particular the relation between
(compensation for) PSOs and the rules on state aid. This particular issue is an illustration of the more general
tension between allowing Member States room to impose PSOs, on the one hand, and, on the other hand, the
need to keep some control at the Community level in order to prevent that Member States can use PSOs to
‘frustrate’ the development of the free market.
The purpose of this paper is to analyse the potential of PSOs as an instrument to implement public policy
goals within a market environment in the European electricity and gas industries. First, we will sketch the
position of PSOs within the larger problem of the (re)design of the legal organisation of the energy industries:
PSOs appear to be a way to reconcile market freedoms and competition, on the one hand, with the effective
fulfilment of services of general economic interest, on the other hand (section 2). Second, the general regime for
PSOs is studied in more detail and analysed. For the analysis of the (European) legal regime for PSOs, we
analyse (European) case law and other ‘European’ decisions and documents (section 3). Third, the rules for state
aid are considered as a sort of ‘intermezzo’ (section 4). Based on the analysis of PSOs and state aid, we can,
fourth, study the relation of PSOs with the European rules concerning state aid (section 5). Then we can
determine the conditions under which the ‘PSO derogation’ may be successfully applied, as well as the criteria
for any (financial) compensation for PSOs. Fifth, the focus will be on the energy industries: for what issues
could PSOs there be an option? For this, we will also consider some ‘energy PSO examples’ from practice
(section 6). Finally, it can be concluded what potential there is for PSOs as an instrument to implement public
policy goals in competitive energy industries, and under what conditions such PSOs may actually be realised
(section 7).
2. Position of PSOs in the process of designing a new legal organisation of the energy industries
For the analysis (and the design) of the legal organisation of the electricity industry the so-called
Function-Based Legal Design & Analysis method (abbreviated: FULDA-method (Knops et al. 2005)) was
Delft University of Technology, Faculty of Technology, Policy and Management, Energy & Industry Section,
Jaffalaan 5, 2628 BX Delft, the Netherlands, +31(0)15-278 3420 (phone); +31(0)15-278 3422 (fax);
[email protected]
developed. This method provides a systematic approach to the problem of analysing and/or designing the legal
organisation of complex industries such as the electricity and gas industries. The framework of this method is a
useful starting-point for the analysis of the position of PSOs within the larger problem of the (re)design of the
legal organisation of the energy industries.
Essentially, we are concerned with the design of the ‘legal organisation’ of the electricity industry. The
looks at this problem from the perspective of ‘government’, which term we use to denote the
actor (or combination of actors) that has (or have) sovereignty to lay down official rules for the organisation of
an industry such as the electricity and gas industries. What (legal) organisation should government devise in the
new context of a complex combination of market activities and monopoly activities? What should be the
distribution of responsibilities and powers among the different actors and what rules should govern the relations
between those actors? And what possibilities to control should government implement?
The legal organisation of the energy industries should be such that the public policy goals are achieved.
These goals for the performance of the electricity and gas industries are generally acknowledged to be that
energy supply is available, affordable, and (socially) acceptable (‘triple A’ goals).
However, the EU member states do not have unlimited possibilities for the design of the legal
organisation of their energy industries. Rules of higher order, or more general rules pose constraints to the
potential legal organisation of the electricity industry. In our research, in which we have restricted our focus to
the European Union, the most important legal constraints are formed by so-called primary European law, most
notably the provisions of the EC Treaty. The European Community strives for the achievement of a so-called
‘internal market’, a Europe-wide market, and has a preference for the market mechanism and free markets.
In summary, the constraints set out by the EC Treaty are as follows. The starting-point is that the
European Community and its Member States adopt an economic policy which is based on the ‘internal market’
and which is conducted in accordance with the principle of an open market economy with free competition.1
This internal market means that within the European Community there should be free movement of goods,
persons, services and capital. Moreover, competition law should ensure effective competition, and state aids to
(specific) companies are prohibited.
But what can be done if the free market is not to be expected to guarantee the achievement of a particular
public policy goal? In such circumstances the concept of public service obligations could be helpful as they
appear to be a way to reconcile market freedoms and competition, on the one hand, with the effective fulfilment
of services of general economic interest, on the other hand. PSOs are right in the middle of the ‘triangle’ of
policy, law and economics: a public policy objective needs to be involved, it has legal relevance as it allows for a
derogation of the rules, while the economic analysis governs to a large extent the scope and application of that
PSO derogation.
3. Public service obligations: the legal regime
The notion of public service (obligations) or services of general economic interest has become a key
concept in European Community law and politics. Although the term ‘public service obligation’ is rather popular
in literature (and used also in documents of the European Commission as well as in the Electricity and Gas
Directives), the EC Treaty only uses the term ‘services of general economic interest’. Initially, these ‘services of
general economic interest’ were only mentioned in Article 86(2) (then: 90(2)) of the EC Treaty, which clause has
the character of a derogation to the (general) EC Treaty rules and has therefore been interpreted strictly. Later (in
the Treaty of Amsterdam in 1997), when the scope of the European (Economic) Community had expanded, the
position of services of general economic interest was given more explicit reference, in a new Article 16 of the
EC Treaty, stating:
“Without prejudice to Articles 73, 86 and 87 [EC], and given the place occupied by services of general economic
interest in the shared values of the Union as well as their role in promoting social and territorial cohesion, the
Community and the Member States, each within their respective powers and within the scope of application of
this Treaty, shall take care that such services operate on the basis of principles and conditions which enable them
to fulfil their missions.”
This Article 16 EC places services of general economic interest in the heart of the European Community
and the European Union. Since the adoption of Article 16 EC, public service obligations have indeed gained
importance, in particular at the European Community level2 and also the ECJ appears to acknowledge more the
Article 4 EC.
For example, in the telecommunications sector and the electricity sector universal service obligations have been
introduced at the Community level. Moreover, since its 2003 Green Paper on services of general interest (EC
special position of public service obligations. Article 36 of the (EU) Charter of Fundamental Rights recognises
and respects services of general economic interest, while Article III-6 of the Treaty Establishing a Constitution
for Europe expands the text of Article 16 EC even further. (However, the entry into force of this Treaty seems
currently a rather remote possibility.)
Article 86(2) EC is the central provision concerning public service obligations. It is addressed to both
Member States and undertakings, and reads:
Undertakings entrusted with the operation of services of general economic interest or having the character of a
revenue-producing monopoly shall be subject to the rules contained in this Treaty, in particular to the rules on
competition, insofar as the application of such rules does not obstruct the performance, in law or in fact, of the
particular tasks assigned to them. The development of trade must not be affected to such an extent as would be
contrary to the interests of the Community.
Article 86(2) EC is the central provision for reconciling the Community objectives of competition and market
freedoms on the one hand, with effective fulfilment of the missions of general economic interest entrusted by
public authorities on the other hand. A public service obligation could be defined as (i) an obligation imposed on
(an) undertaking(s), (ii) with a view to a service of general economic interest (iii) by the competent authority
(Knops and Hakvoort 2002).
The possible exception from the Treaty rules provided by Article 86(2) EC can be relied upon by both the
Member States and individual undertakings. The State can call upon the exception to justify legislative or
administrative measures concerning public undertakings (or those granted exclusive or special rights) that would
normally amount to an infringement of the rules of the EC Treaty. This was in issue in the series of Energy cases
decided by the ECJ in 1997.3 To take the case brought by the Commission against the Netherlands4 as an
example, Article 34 of the Dutch Electricity Act 1989 prohibited the importation of electricity into the
Netherlands except where this was carried out by the SEP, which was the association of co-operating electricity
producers. This prohibition was clearly at odds with Article 31 EC, which forbids all discrimination concerning
the conditions of sale and supply. The Dutch government relied upon Article 86(2) EC to justify this statutory
prohibition on imports, arguing that without such a prohibition the planning of electricity supply within the
Netherlands would be rendered excessively difficult. The ECJ upheld this argument and found the Dutch rules to
be justified under Article 86(2) EC.
In the Almelo case, the energy company IJsselmij relied upon Article 86(2) EC to justify contracts that
would normally have infringed Articles 81 and 82 EC.5 Here, the competition law issue concerned exclusive
contracts, under which the customers of the IJsselmij energy company were required to source all of their
electricity requirements from IJsselmij. Such contracts are prohibited under normal competition rules. Although
the ECJ accepted that in this case Article 86(2) EC could give some scope for an exception from competition
rules, on the case’s return to the national court this exception was not upheld on the facts.6
Criteria for applicability of Article 86(2) EC
From case-law of the ECJ four criteria can be derived for the applicability of Article 86(2) EC. First, it
must concern a service of general economic interest. This term is not defined in the EC Treaty or secondary
legislation, nor has the ECJ ever given a general definition of this concept. According to the European
Commission services of general economic interest refer to services of an economic nature which the Member
States or the Community7 subject to specific public service obligations by virtue of a general interest criterion.
This definition would tend to cover such things as transport networks, energy and communications.8 In its case
law, the ECJ has, for example, accepted the following services as services of general economic interest:
2003a) the Commission argues that public service obligations can be defined not only by Member States, but
also by the Community. Cf. Slot and Skudder 2001.
These concerned various national import and export monopolies in electricity and (in one case) in natural gas:
Cases C-157/94 Commission v. Netherlands [1997] ECR I-5699, C-158/94 Commission v. Italy [1997] ECR I5789, C-159/94 Commission v. France [1997] ECR I-5815 and C-160/94 Commission v. Spain [1997] ECR I5851, on which see Slot (1998) 35 Common Market Law Review 1183.
Case C-157/94, [1997] ECR I-5699.
Case 393/92 City of Almelo v. IJsselmij [1994] ECR I-1508.
The Arnhem court held (judgment of 22 October 1996, rolnr. 87/280) that the parties had not adduced any
evidence on which it could be concluded that the statutory task (electricity distribution) would have been
impossible to carry out in the absence of the conclusion of the exclusive contracts.
‘[O]r the Community’ was introduced in the Commission’s definition in the Green Paper on services of general
interest (EC 2003a).
OJ 2001 C 17/23.
• telecommunications services;9
• radio and television broadcasting;10
• transport services on not commercially viable routes;11
• harbour services such as mooring services;12
• electricity supply.13
The scope of public service obligations can be broad. With respect to network based industries, such as
the electricity industry, a distinction can be made between general interests concerning the essential service
which that sector offers and interests pertaining to citizens’ concerns about that sector. The basic needs of
consumers encompass: universal access; high quality; and affordability. Examples of citizens’ concerns that can
give rise to services of general interest are: a high level of environmental protection; specific needs of vulnerable
groups; complete territorial coverage of essential services in remote or inaccessible areas (Knops and Hakvoort
2002; cf. EC 2003a and EC 2004a). A special type of public service obligation is the universal service
obligation, the obligation to provide a certain service throughout a territory at affordable tariffs and on similar
quality conditions, irrespective of the profitability of individual operations.
Second, the specific task with respect to that service must have been commissioned explicitly (i.e.,
through an act of public authority, including contracts) by the competent authority. Defining services of general
interest and imposing public service obligations is left to public authorities at the appropriate level. 14 This level
is primarily the national, regional or local level, but can, if necessary, also be the Community level.15 According
to the European Commission, it is apparent from the case-law of the ECJ that with the exception of the sectors in
which there are Community rules governing the matter, Member States have a wide margin of discretion
regarding the nature of services that could be classified as being services of general economic interest.16
Public service obligations are imposed on undertakings. Pursuant to Article 295 of the EC Treaty these
undertakings can either be public or private. This distinction is not relevant in the context of Article 86(2) EC.17
The way in which a public service obligation is attributed (including the selection of the undertakings), and the
way in which compensation is granted to the undertaking(s) entrusted with the operation of a public service
obligation, are both a point of concern. These issues will be further discussed below.
Third, the derogation must be necessary and proportional to fulfil the entrusted task. The necessity
criterion has been clarified in the ‘energy cases’ (which were already discussed above): if the application of the
EC Treaty rules obstructs the performance, in law or in fact, of the particular task (the public service obligation)
assigned to the undertaking concerned, this undertaking may be exempted from these EC Treaty rules to the
extent necessary. In this respect, it is not necessary that the survival of the undertaking be threatened.18 It is
sufficient that the derogation of Article 86(2) EC is necessary to enable the undertaking entrusted with the
operation of services of general economic interest to perform these (special) tasks under economically acceptable
conditions.19 The party which invokes the derogation of Article 86(2) EC has to prove that the derogation is
necessary, i.e., that the specific tasks entrusted cannot be performed in compliance with the EC Treaty rules
concerned. It is not needed to prove that there is no other conceivable measure.20 Moreover, it appears that the
ECJ is (becoming) more receptive where it concerns universal service obligations and related measures against
The measure should not only be necessary, but it may also not be disproportional, meaning that the
derogation from the rules of the EC Treaty may not exceed what is necessary to guarantee effective fulfilment of
the mission. The undertakings entrusted with a public service obligation must be able to carry the specific burden
E.g. Case 18/88 RRT [1991] ECR I-5941.
E.g. Case 127/73 BRT/SABAM [1974] ECR 313.
E.g. Case 66/86 Saeed [1989] ECR 803.
E.g. Case C-266/96 Corsica ferries (II) [1998] ECR I-3949. Some other harbour services were not qualified as
services of general economic interest, see e.g. Case C-179/90 Port of Genoa [1991] ECR I-5889.
E.g. Cases C-393/92 IJsselmij and C-157/94 Commission v. Netherlands.
EC 2004a, p. 5-6.
Although Article 86(2) EC only refers to Member States, the competence of the Community has been based
upon Article 16 EC.
See e.g. EC 2005b.
Case 127/73 BRT v. SABAM [1974] ECR 313, para 20.
Case C-157/94, Commission v. Netherlands [1997] ECR I-5699, para 43.
Case C-157/94, Commission v. Netherlands [1997] ECR I-5699, para 53.
Case C-157/94, Commission v. Netherlands [1997] ECR I-5699, para 58.
E.g. Case C-320/91 Corbeau [1993] ECR I-2533.
and net extra costs of the particular task assigned to them. This last point relates to the issue of compensation for
public service obligations, in particular the relation with state aid, which issue will be discussed below.
The fourth and final condition for the application of the derogation of Article 86(2) EC is that the
development of trade must not be affected to an extent that is contrary to the interests of the Community. This
criterion requires that something more must be shown than a mere effect upon inter-Member State (which serves
as the jurisdictional criterion for the EC competition rules to apply): the effect on trade must be an adverse one
when examined in the light of the Community interest. This element was also discussed by the ECJ in the
Energy cases, where it was held that the Commission had failed to define the Community interest in relation to
which the development of trade must be assessed. Further, the ECJ emphasised that the Commission had to take
care to establish how trade might have taken place: this was a particularly important element in the Energy cases
due to the nature of the industry and the fact that most cross-border exchanges up to that time had been for the
purposes of balancing between national systems, rather than for normal trading reasons.22
The special regime the EC Treaty allows for PSOs, makes a PSO an instrument for (national)
governments to reconcile market freedoms and competition, on the one hand, with the effective fulfilment of
services of general economic interest (intended to secure public policy goals), on the other hand. However, from
the fact that the imposition of PSOs is generally in the hands of Member State authorities it is apparent that there
is may be a risk that Member State authorities can frustrate the development of the internal market, with the use
of PSOs. Therefore, from the Community perspective, there may be a need for possibilities to control to some
extent the PSO practice of Member States. One of the starting-points of such control is the role the Commission
has as the European authority supervising and enforcing the rules for state aid. in the next section, we will
discuss the regime for state aid, after which we will analyse the relation between (compensation for) PSOs and
state aid.
4. Intermezzo: State aids
As the development of true competition in the common market can also be hindered by states’ granting
special benefits (‘state aid’) to certain undertakings, thus providing them a competitive advantage, it does not
come as a surprise that the EC Treaty contains a section on ‘aids granted by states’. Article 87 EC lays down the
substantive rules on state aid, while Article 88 EC provides for the procedural rules. The guiding concept of the
rules on state aids is Article 3(1)(g) EC: a system ensuring that competition in the internal market is not
distorted. This is reflected in the case law of the Court of Justice and in numerous Commission decisions. The
rules on state aid have taken shape only slowly. For many years, the major developments took place in the
decisional practice of the Commission and in the case law of the ECJ (and latterly also the Court of First
Instance (CFI)), rather than in the form of legislation: indeed, for many years there was very little legislation in
the state aid field.23
The central provision is Article 87(1) EC, which provides that “any aid granted by a Member State or
through State resources in any form whatsoever which distorts or threatens to distort competition by favouring
certain undertakings or the production of certain goods, shall, in so far as it affects trade between Member States,
be incompatible with the market.”
Any measure which fulfils the following elements qualifies as a state aid measure under Article 87(1) EC.
First, it must concern state aid, which is any benefit granted directly or indirectly out of state resources,24 where
aid could be, for example, financial support, but also preferential tariffs.25 If the ‘aid’ in question could also have
Although note that the first Directive on the internal electricity market (Directive 96/92/EC [1997] OJ 27/20)
had been adopted the year before the judgments in the Energy cases were handed down, making it surprising that
the ECJ did not see fit to refer to the Directive’s provisions requiring significant market opening and the
concomitant increase in the scope for trade in electricity to develop (see Slot (1998) 35 Common Market Law
Review 1183 for discussion). The sector is now covered by a more-far reaching Directive, which mandates
greater and more rapid market opening than originally foreseen in the 1996 rules: see Directive 2003/54/EC
[2003] OJ L176/37.
The only legislation was in field of shipbuilding where there have been several directives succeeded by
Regulation 1540/98/EC [1998] OJ L202/1.
Cases C-72&73/91 Sloman Neptune [1993] ECR I-887, paragraph 19.
E.g. Cases 67/85, 68/85 and 70/85 Van der Kooy [1988] ECR 219, Case C-169/84 Chimie [1990] ECR I-3083,
Case C-56/93 Belgium v. Commission [1996] ECR I-723.
been obtained from the ‘market’, the measure is not considered to fall within the scope of Article 87(1) EC,
which is called the ‘market economy investor principle’.26
Second, the benefit must be provided to certain undertakings or the production of certain goods. A
general measure, aimed at ‘all’ undertakings, would not be a state aid measure under Article 87(1) EC.
Third, to qualify as state aid, the measure must be “granted by a Member State or through State
resources”. The ‘state’ character is obvious when the aid is directly financed from the State's budget. But also
actions by ‘public undertakings’ could invoke the EC state aid rules, as the ECJ has held that, in determining
whether a measure is state aid, ‘no distinction should be drawn between cases where aid is granted directly by
the state and cases where it is granted by public or private undertakings established or appointed by the state’.27
Funds of such public undertakings can be ‘attributed’ to the state if these funds are under the state's control.
However, a statutory obligation to purchase electricity produced from renewable energy sources at fixed
minimum prices does not invoke a transfer of state resources. Neither does the allocation of the financial burden
of that obligation between the electricity undertakings involve state resources. That is, as long as these
undertakings are private companies.28
Fourth, distortion of competition is necessary. As its test the European Commission examines whether the
aid measure ‘distorts or threatens to distort competition [by providing] an economic advantage to certain
undertakings vis-à-vis their competitors’.29 Again, the competence of the European Commission is limited to
those aid measures which affect trade between Member States, which is interpreted very broadly and which
requirement is easily satisfied.
Measures which fall within the scope of Article 87(1) are in principle incompatible with the common
market. Pursuant to Articles 87(2) and 87(3) (jo. 88) EC notified measures can be found to be compatible with
the common market. The exemptions of Article 87(2) EC are of an exceptional nature and will not be further
discussed here. Article 87(3) EC is more relevant and lists a number of categories of aids which in the discretion
of the European Commission may be exempted. As with most exemptions to the general rules of the EC Treaty,
this exemption has been interpreted in a restrictive manner. The ECJ has backed the Commission’s restrictive
interpretation of Article 87(3) EC, in that state aid measures can only be allowed in so far as they are necessary
for the achievement of the objectives accepted under Article 87(3) EC.30In summary, the requirements are as
(i) the aid must promote or further a project that is in the Community interest as a whole;
(ii) the aid must be necessary for the achievement of this result, and the objective could not have been obtained
in the absence of this measure;
(iii) the duration, intensity and scope of the aid must be proportionate to the importance of the intended result.31
In order to provide guidance as to how it will apply the exemptions of Article 87(3) EC, the Commission
has traditionally published guidelines, codes, frameworks, communications and notifications. Although the
designations are not consistent these instruments all serve the same purpose. They can be classified as rules for
sectoral,32 general or specific, regional and other horizontal aid.33
The procedural side of the state aid regime is based upon Article 88 EC. The most important rule is that
new aid measures must be notified to the Commission prior to their ‘application’. If aid has not been notified
then it is unlawful. If aid has been notified, the Commission can assess the proposed scheme and decide whether
the aid measure is compatible or incompatible with the EC Treaty.
5. PSOs and State aid
A PSO is a service that ‘by definition’ cannot be provided under normal market circumstances. Therefore
in many cases some form of compensation is necessary. Compensation could take the form of direct or indirect
subsidies from government, of payments from a special fund, but could also come from cross-subsidies.
Cf. Case C-305/89 Italy v. Commission [1991] ECR I-1613, paragraph 19, and Case C-56/93 Belgium v.
Commission [1996] ECR I-723, paragraph 10. See generally, e.g., Abbamonte 1996.
Case C-305/89 Italy v. Commission [1991] ECR I-1603, paragraph 13.
Case C-379/98 PreussenElektra [2001] ECR I-2099, paragraphs 59-60.
E.g. OJ 1999 C 220/15.
Case 730/79 Philip Morris [1980] ECR 2690, paragraphs 16-17.
See the Commission’s 12th Report on Competition Policy (1983), paragraph 160.
In 1998 the Commission published a single text of its guidelines on regional aid [1998] OJ C74/9. It also
published a multisectoral framework on regional aid for large investment projects, [1998] OJ C107/7.
Examples of the latter are: rules for R&D and environmental protection aid.
Moreover, undertakings charged with a PSO could also be given exclusive or special rights which enable them to
recover the costs incurred for discharging the PSO. Concerning the compensation, the question arises what the
relation is between the PSO regime (Article 86(2) EC) and the state aid rules. For a long time this relation was
unclear. Should all compensation related to PSOs be considered ‘state aid’ (provided that it satisfied the
definition of state aid) and should such compensation schemes therefore be notified to the Commission for
approval, or should Article 86(2) EC be interpreted such that it can exempt – under circumstances –
compensation measures for PSOs from the state aid regime (and even exempt them from the notification
obligation). In recent years, since the Altmark ruling34 of the ECJ this issue has been clarified to some extent, in
case law of the ECJ and documents of the European Commission.
In Altmark the ECJ ruled that:
“public subsidies intended to enable the operation of urban, suburban or regional scheduled transport services are
not caught by that provision [Article 87(1) EC] where such subsidies are to be regarded as compensation for the
services provided by the recipient undertakings in order to discharge public service obligations. For the purpose of
applying that criterion, it is for the national court to ascertain that the following conditions are satisfied:
- first, the recipient undertaking is actually required to discharge public service obligations and those obligations
have been clearly defined;
- second, the parameters on the basis of which the compensation is calculated have been established beforehand in
an objective and transparent manner;
- third, the compensation does not exceed what is necessary to cover all or part of the costs incurred in discharging
the public service obligations, taking into account the relevant receipts and a reasonable profit for discharging those
- fourth, where the undertaking which is to discharge public service obligations is not chosen in a public
procurement procedure, the level of compensation needed has been determined on the basis of an analysis of the
costs which a typical undertaking, well run and adequately provided with means of transport so as to be able to
meet the necessary public service requirements, would have incurred in discharging those obligations, taking into
account the relevant receipts and a reasonable profit for discharging the obligations”.
This implies that, if all Altmark criteria apply, there is no state aid. The compensation measure is not caught by
Article 87(1) EC. As a consequence, there is no obligation to notify the compensation scheme concerned.
The Altmark judgment has raised questions about the interpretation of the four conditions that it laid down,
but also about the relationship between those conditions and Article 86(2) EC. And what is the situation if not all
the Altmark criteria apply? For such a situation there is no case law of the ECJ yet, but the European
Commission, who is charged with the enforcement of the state aid rules, considers that Article 86(2) EC can play
a role here. The Commission’s interpretation has been laid down in two general documents (a Commission
Decision35 and a Community Framework36) as well as several decisions. Basically, the Commission holds the
view that in those instances where the Altmark conditions are not fulfilled an exemption of Article 87(1) may be
possible on the basis of Article 86(2) EC, provided that the compensation is commensurate with the extra cost of
providing the public service.
First, the Commission has adopted a Decision based upon Article 86(3) EC that deals with cases where the
Altmark conditions are not met. This Decision exempts compensation of less than Euro 30 million per annum for
public service obligation granted to undertakings with an annual turnover of less than 100 million. It also excludes
compensation granted to hospitals and social housing. If the ‘aid’ measure is covered by the Decision, then it is,
on the procedural side, already exempted from the obligation of notification and, on the substantive side, it is
compatible because of Article 86(2) EC.
Second, the Commission has also adopted a Community Framework for state aid in the form of public
service compensation. The framework addresses situations that do not fall within the scope of application of the
Decision. Measures covered by the Framework need to be notified to the Commission and will be examined on a
case-by-case basis. However, if all the conditions (of the Framework) are fulfilled the measures will be
considered compatible with the common market.
The criteria that the Commission has formulated in the decision and the framework are to a large extent
similar. The main criteria focus on, first, a proper entrustment and a clear definition of the public service
obligation, and, second, the limitation of the amount of compensation to (only) what is strictly necessary.
Concerning the entrustment of the PSO, the Commission requires that “responsibility for operation of the service
Case C-280/00 Altmark-Trans [2003] ECR I-7747.
EC 2005a.
EC 2005b.
of general economic interest […] be entrusted to the undertaking concerned by way of one or more official acts,
the form of which may be determined by each Member State. The act or acts must specify, in particular:
(a) the precise nature and the duration of the public service obligations;
(b) the undertakings and territory concerned;
(c) the nature of any exclusive or special rights assigned to the undertaking;
(d) the parameters for calculating, controlling and reviewing the compensation;
(e) the arrangements for avoiding and repaying any overcompensation.”37
Regarding the amount of compensation the main rule is that “the amount of compensation may not
exceed what is necessary to cover the costs incurred in discharging the public service obligations, taking into
account the relevant receipts and reasonable profit for discharging those obligations.”38 Any over-compensation
is not considered necessary for the operation of the service of general economic interest and, hence, cannot be
exempted based on Article 86(2) EC, so that it constitutes incompatible State aid that must be repaid to the
From the Altmark criteria it can be concluded that there is a preference for a tender as the method by
which the undertaking is selected who is going to be entrusted with the PSO. Apparently, the presumption is that
a tender would also lead to a ‘market-based’ amount of compensation necessary for properly discharging the
PSO concerned.
6. PSOs in the energy industries
The analysis of PSOs in this paper has until now been rather general. In this section, we want to focus
upon the potential of PSOs in the energy industry. From the nature of a PSO allowing a derogation from
competition rules, it is evident that PSOs are particularly interesting as an instrument to implement public policy
goals in the context of market activities. In the electricity and gas industries, these market activities concern
mainly the production and supply of energy.
The Electricity and Gas Directives (2003/54/EC and 2003/55/EC respectively) acknowledge the
possibility of imposing public service obligations. These PSOs “may relate to security, including security of
supply, regularity, quality and price of supplies and environmental protection, including energy efficiency and
climate protection. Such obligations shall be clearly defined, transparent, non discriminatory, verifiable and shall
guarantee equality of access for EU electricity companies to national consumers.”40 In its Explanatory Note41 the
Commission tries to clarify what interests – in the Commission’s opinion – are covered by the abovementioned
list of public policy goals. When Member States grant financial compensation, other forms of compensation or
exclusive rights for the fulfilment of public service obligations, this shall be done in a non-discriminatory and
transparent way.42
For electricity supply, the Directive itself already elaborates a particular PSO, namely the ‘universal
service obligation’. Member States shall ensure that (at least) all household customers enjoy universal service,
that is the right to be supplied with electricity of a specified quality within their territory at reasonable, easily and
clearly comparable and transparent prices.43 Outside the electricity industry, universal service obligations have,
for example, been implemented in the telecommunications and postal sectors. However, the Electricity Directive
remains rather unclear as to the implementation of the universal service obligation, except that the universal
service obligation shall be implemented in a transparent and non-discriminatory way and shall not impede the
opening of the market envisaged in the Directive. Unclear remains, for example, when (eligible) customers will
enjoy a right to be supplied, who will be the supplier upon whom they can exercise their right? Two solutions are
possible. First, for every territorial area one company can be designated as the sole universal service provider.
Second, more companies per area can be designated as universal service provider; in this case customers can
choose upon whom they will exercise their right to universal service. The Electricity Directive contains no
provisions concerning the designation of the undertakings entrusted with the universal service obligation.
The Electricity Directive only stipulates that “Member States shall impose on distribution companies an
obligation to connect customers to their grid under [regulated] terms, conditions and tariffs.” Moreover, “to
EC 2005b, no. 12 (p. 297/5), EC 2005a., Article 4.
EC 2005b, no. 14 (p. 297/5); EC 2005a., Article 5.
EC 2005b, no. 20 (p. 297/6).
Article 3(2) Directive 2003/54/EC, cf. Article 3(2) Gas Directive 2003/55/EC.
DG TREN 2004.
Article 3(4) Directive 2003/54/EC.
Article 3(3) Electricity Directive 2003/54/EC.
ensure the provision of universal service, Member States may appoint a supplier of last resort.”44 Such a supplier
of last resort has, for example, been implemented in the Netherlands.45
Moreover, the Directive urges Member States to take appropriate measures to protect final customers. In
particular they shall ensure that there are adequate safeguards to protect vulnerable customers, including
measures to help them avoid disconnection. In this context, Member States may take measures to protect final
customers in remote areas.46
Another market activity for which public service obligations may be imposed, is the production of
electricity. For instance, obligations can be imposed for the aspect ‘fuel security’ of security of supply. Examples
are the obligation (in Ireland) to generate a certain amount of electricity from the domestic fuel peat, or the
compensation for a power plant in Slovenia that is fired with lignite from local mines.47 Interestingly, for the
interest concerned there is some Community legislation: the Electricity Directive provides that Member States
may decide that “priority be given to the dispatch of generating installations using indigenous primary energy
fuel sources, to an extent not exceeding in any calendar year 15 % of the overall primary energy necessary to
produce the electricity consumed in the member State concerned.”48 Consequently, the European Commission
decided that aid for the Slovenian power plant cannot be accepted in so far the compensation is meant to offset
operational losses of the concerned power plant corresponding to output exceeding that 15%.
Another aspect of security of supply is generation adequacy. Instead of the central, long-term planning of
the past, new mechanisms need to be devised in order to secure that also in the long term sufficient generation
capacity will be available (De Vries 2004). These mechanisms need to secure generation adequacy within a
market environment. Therefore, the form of PSOs seems an option for such mechanisms (Knops and Hakvoort
2002 and Knops 2003b). For instance, capacity mechanisms such as ‘capacity obligations’ or ‘call options’ can
be considered public service obligations.
The European Commission has examined two interesting examples in this field, concerning Ireland. First,
the Commission considered an Irish measure involving a ‘Public Service Obligation in respect of new electricity
generation capacity for security of supply’.49 In this scheme, up to 10 years long ‘Capacity and Differences
Agreements’ (CADA) would be granted to generators that would undertake the construction of (necessary) new
generation capacity. Effectively, CADA would compensate the fixed costs of the new generation capacity,
whereas the variable costs ought to be recovered from the ‘market’ (electricity pool). The CADA for new
generation capacity had to be awarded through a tender procedure. The Commission examined this scheme
under the Altmark criteria and concluded that all the Altmark conditions had been met, so that the compensation
provided in the context of this public service obligation does not constitute state aid.
However, in the meantime that the new Irish generation capacity is being built, there was yet a need for
additional reserve capacity on a short notice. For this, the Irish authorities charged the (Irish) Electricity Supply
Board with the obligation to procure temporary stand-by peaking capacity.50 As there had not been a tender to
select ESB, nor did the Irish authorities provide information which would allow the Commission to determine
whether the costs incurred by ESB correspond with the costs of a typical undertaking, well run and adequately
provided with means to meet the necessary public service requirements, the fourth criterion of Altmark did not
apply. Therefore, the Commission continues to assess the measure under Article 86(2) EC. It concludes that
provided that the recovery process is regularly monitored on an ex post basis, all conditions of Article 86(2) EC
are met and that the PSO measure is therefore compatible with the EC Treaty.
A further interest concerning electricity production for which public service obligations seem imaginable,
is environmental protection and the promotion of renewable energy sources. The measure of a ‘renewables
obligation’ (the obligation for suppliers to have a certain minimum percentage of renewables in their energy
portfolio) is clearly a public service obligation. Such renewables obligations have been implemented in some
Member States. Whether such schemes constitute state aid, or to what extent they can benefit from Article 86(2)
EC depends largely on the actual form of implementation of the scheme (Knops 2003a). For this ‘interest’ of
environmental protection and promotion of renewables there is an increasing body of Community legislation,
which thus gradually limits the margin of discretion for the Member States in this area.
Article 3(3) Electricity Directive 2003/54/EC.
See Knops 2004 and Knops and Wenting 2004.
Article 3(5) Electricity Directive 2003/54/EC; Article 3(3) Gas Directive 2003/55/EC.
EC 2001b and EC 2005c.
Article 11(4) Electricity Directive 2003/54/EC.
EC 2003b.
EC 2004b.
In its preliminary ruling in the case between the Vereniging voor Energie, Milieu en Water (VEMW) et al.
and the Dutch energy regulator DTe the ECJ touched upon the possibility for public service obligations in the
area of access to the infrastructure (networks).51 The case concerned preferential access to the Dutch electricity
interconnectors that had been granted to the incumbent (Dutch) electricity producers in order to enable them to
carry out long term import contracts that had been concluded prior to liberalisation of the industry. It appeared
that the incumbent producers had concluded the concerned contracts because of the public service obligation
entrusted to them under the Electricity Act 1989 to guarantee a well-functioning public electricity supply in the
Netherlands in the time prior to liberalisation. However, for two reasons these circumstances did not suffice in
this case to justify the preferential access within the European legal framework. First, according to the ECJ,
Electricity Directive 96/92/EC did not allow to derogate from the principle of non-discriminatory access to the
network (as laid down in Article 16 of that Directive) because of a public service obligation. Second, the issue of
dealing with guarantees and commitments that pre-dated the moment of liberalisation, had already been
regulated at the Community level in Article 24 of Directive 96/92/EC, which provided a procedure for approval
by the Commission for such measures. According to the ECJ it should not be allowed that Member States would
bypass that procedure of Article 24, which would be possible if – in such cases – they could have recourse to
Article 86(2) EC directly, i.e. without going through the Commission process. Following this line the ECJ
concludes that the measure at issue (preferential access) cannot be allowed, as it had not been approved within
the framework of approval by the Commission (as it had not been notified in time).
7. Conclusion
The special regime the EC Treaty allows for PSOs, makes a PSO an instrument for (national)
governments to reconcile market freedoms and competition, on the one hand, with the effective fulfilment of
services of general economic interest (intended to secure public policy goals), on the other hand.
Governments of EU member states have in principle a wide margin of discretion in the definition of
PSOs, with the exception of the sectors in which there are Community rules governing the matter.
The exception from the EC Treaty rules which Article 86(2) EC provides for for PSOs, is only applicable
if four criteria are met. First, there must be act of entrustment by which the state concerned has explicitly
imposed a certain PSO upon one or more undertakings. Second, the obligation imposed should concern a real
public interest. Third, the exception from the general EC Treaty rules which is sought, has to be necessary for the
performance of the PSO assigned and proportional to that end. Fourth, the development of trade must not be
affected to such an extent as would be contrary to the interests of the Community.
As PSOs are imposed if the ‘market’ is not expected to provide that (level of) public service by itself, it
can be expected that in most cases the imposition of PSOs must be accompanied by the payment of some
compensation to the undertakings entrusted with the PSO concerned. Such compensation is not considered to be
state aid if four criteria are met, which follow from the Altmark Trans judgment of the ECJ. (Within the EU it is
in principle prohibited to provide state aid.)
If not all four of the Altmark Trans criteria are met, the compensation for a certain PSO can still be
allowed, as the European Commission has made clear in recent documents. The criteria formulated by the
Commission include conditions for the specification of the PSO, as well as the rule of thumb that compensation
may not exceed what is necessary to cover the costs incurred in discharging the PSOs, taking into account the
relevant receipts and reasonable profit for discharging those obligations.
In the liberalised energy industries, PSOs can play an important role to secure policy goals in the
competitive parts of the industries. This has been acknowledged in the European energy directives (2003/54/EC
and 2003/55/EC), which explicitly refer to the possibility of the imposition of PSOs. PSOs may prove a powerful
instrument to, for instance, ensure security of supply in the electricity generation market, as the example from
Ireland shows (EC 2003b). Moreover, PSOs can be used for the promotion of renewable energy sources or
consumer protection.
However, in all these instances, the economic assessment of the situation remains highly relevant. First, to
show that it is necessary to derogate from the general free trade and competition rules, and, second, to
demonstrate that the compensation granted for discharging the PSOs is just the compensation for the ‘extra
costs’ incurred for the PSO concerned.
Case C-17/03 VEMW et al. v DTe, 7 June 2005, <>.
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hand and the copper plate, (PhD thesis TU Delft), Delft
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market in electricity and natural gas Public Service Obligations, Brussels, 16.01.2004.
European Commission (EC 1996), Communication on services of general interest, OJ 1996 C 281/3.
European Commission (EC 2001a), Communication from the Commission on Services of General Interest in
Europe, OJ 2001/C 17/04.
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electricity out of peat, C(2001)3265 fin, Brussels, 30.10.2001.
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C(2003) 4488 fin, 16.12.2003.
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General Interest, COM(2004) 374 final.
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C(2004) 2632 fin., Brussels, 14.07.2004.
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application of Article 86(2) [EC] to State aid in the form of public servce compensation granted to certain
undertakings entrusted with the operation of services of general economic interest, OJ 2005 L312/67.
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compensation, 2005/C 297/04.
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Stranded costs in Slovenia, C(2005)172 fin., Brussels, 02.02.2005.
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functional approach", Journal of Network Industries, Vol. 3 Iss. 1, pp. 39-76
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Short CV authors
Hamilcar KNOPS
Hamilcar P.A. Knops (1975) graduated from Leiden University in the Netherlands in theoretical physics (1998)
and law (1999; cum laude). In 1998, he studied at Harvard University in Cambridge, Mass.. After his
graduation he worked for the law firm Houthoff Buruma in The Hague, the Netherlands. In 2000, he received
a grant from the Netherlands Organization for Scientific Research (NWO) to carry out a Ph.D. research
concerning the legal organisation of the electricity industry in the light of the technical aspects of the
electricity supply system. For this research he joined the International Institute of Energy Law of Leiden
University and the Faculty of Policy, Technology and Management of the Delft University of Technology. In
his dissertation, which is expected to be finished in 2006, he focuses on finding the design criteria for the
(design of) the legal organisation of the electricity industry, given the technical constraints and characteristics
of the electricity supply system. Further research interests include complex legal issues concerning the
energy sector as well as market design issues for complex industries.
Piet Jan SLOT
Piet Jan Slot (1944) is Professor of European and Economic Law, at the Law Faculty, University of Leiden in
the Netherlands. Prof. Slot has a long professional experience in the academia which includes the position of
a Visiting Jean Monnet professor at the Reinische Friedrich Wilhelms University Bonn, Germany, Visiting
professor at Paris II, Panthéon-Assas, and Visiting Professor Stanford University, Law School (2000-2001).
Prof. Slot is also a Fellow of the Society for Advanced Legal Studies London. Prof. Slot’s teaching has been
focused on matters pertaining to the law of the European Communities in general and EC competition law in
particular. Prof. Slot possesses significant expertise in drafting legislation in the field of competition law,
transport law and the energy sector. From 1993 to 1995, Prof. Slot was heading a group of experts to assist
the PHARE countries to assess the compatibility of their national legislation with the Energy Charter Treaty.
Kirsten Wilkeshuis (1979) graduated from the Free University (Vrije Universiteit) in Amsterdam in law (2004;
cum laude). In 2004 she studied one semester at McGill University (Montreal). After her graduation she
started to carry out a Ph.D. research on guaranteeing public interests in network sectors. In this dissertation,
which is expected to be finished in 2009, the energy industry, regional public transport and parts of the
telecommunications industry will be analysed and discussed.
Hanneke de JONG
Hanneke M. de Jong (1979) received her M.Sc. degree in 2003 from the Faculty of Technology, Policy and
Management of the Delft University of Technology. Currently, she works for the Dutch Office for Energy
Regulation (DTe) and she is a Ph.D. student at the Delft University of Technology. Her areas of interest
include the administrative framework for European market integration in the energy industries, including
market design and network access regulation. She is particularly interested in the development of
interconnection in the European eleectricity and gas system.