When does UK/EU law permit environmental subsidies?

In this blog, we explore the key legal considerations surrounding subsidies and examine some recent case studies to illustrate how these issues play out in practice.

Under UK and EU competition law, governments are generally restricted from offering subsidies or state aid that favour certain businesses, as such interventions can distort free market competition.

In the UK, that means public authorities must not usually give subsidies unless they’re consistent with the subsidy control principles set out in schedule 1 of the Subsidy Control Act 2022.  In addition to those, subsidies in relation to energy or the environment must also be consistent with the relevant principles set out in schedule 2 of the Act. Environmental subsidies must fulfil a long list of criteria. Some of the key criteria include requirements that the subsidy:   

• Pursues a specific policy objective to remedy an identified market failure; 
• Changes the economic behaviour of the beneficiary in a way that would not have happened without the subsidy, and which helps to achieve the policy objective; 
• Incentivises the beneficiary to increase the level of environmental protection than would be achieved in the absence of the subsidy; and
• Is proportionate to its specific policy objective and limited to what is necessary to achieve it. 

Although the EU’s legal regime isn’t quite the same as the UKs, both include the notion that subsidies may be an acceptable response to market failures that result in an insufficient level of environmental protection.

One example of a market failure – in the eyes of much of the political establishment in the UK and the EU, is the failure of transport companies to transition towards sustainable fuels. The thinking is that fossil fuels are artificially cheap because their negative effects on the environment and human health aren’t priced in. One approach to this market failure is for governments to cover the difference in price between fossil fuels and a sustainable alternative – aiming to incentivise companies to make some of the other investments that would be needed to decarbonise transport. Two recent Danish state aid schemes, approved by the EU Commission on the 29 of July, exemplify this approach:

• The Sustainable Aviation Fuel Scheme will allocate €36 million to reduce greenhouse gas emissions in domestic aviation by promoting the use of sustainable aviation fuel (SAF). This is the first EU-approved scheme specifically supporting SAF and marks a significant step toward decarbonising the aviation sector. Airlines will receive monthly direct grants to cover the cost difference between SAF and conventional kerosene, determined through a competitive bidding process to ensure cost-effectiveness. To prevent overcompensation, the scheme excludes SAF already subsidised under other EU or national programs and ensures emissions reductions are genuine.
• The Industrial Decarbonisation Scheme will allocate €134 million to enable the transition to more environmentally friendly fuels and reduce greenhouse gas emissions linked to industrial activities and ferries. Under the scheme, the aid will be granted directly via a competitive bidding, where companies will compete on their bid price per ton of CO2 avoided. The grants will cover the additional costs incurred when using more environmentally friendly fuels and will only be paid if the beneficiaries would not be able to switch to those more environmentally friendly fuel without public support. The scheme will be in place until September 2028 and grants will be paid annually for a period of up to 10 years.

In the UK there have been a number of subsidy schemes introduced by UK public authorities aimed at environmental policy objectives, for example:

• UK Research and Innovation’s DRIVE35 Scale-Up Grants; and
• Department for Business and Trade’s Automotive Transformation grants.  

Together, both the UK and the EU schemes reflect a growing consensus that environmental sustainability and economic competitiveness can coexist within the bounds of competition law. They underscore a broader policy trend. Climate-aligned subsidies are increasingly regarded as an essential tool to accelerate the transition to a net-zero economy.    

Comment

Providing legal advice in this area requires an appreciation of the interplay between law and politics. Although the law confers powers on governments’ in the UK and the EU to grant environmental subsidies (and they are making increasing use of this power), deploying public funds in this way isn’t universally popular. This makes it crucial to ensure that any such schemes are designed effectively, meet their objectives in a proportionate way and otherwise comply with all aspects of competition law. 

Interestingly, the UK Government has recently side-stepped any need to have its new Clean Energy Car Grant Scheme be referred to the Subsidy Advice Unit for its report on whether the scheme was compatible with the subsidy control principles by the Secretary of State giving a direction under section 64 of the Act.  This is the first use of this power. The Secretary of State can only do so where they’re satisfied that “there are urgent and exceptional circumstances that justify the direction being given in the public interest”.