WTO Appellate Body affirms Canadian renewable energy measures illegal

Appellate Body affirms Canadian renewable energy measures illegal
Published in SUNS #7581 dated 8 May 2013
The Appellate Body (AB) of the World Trade Organisation (WTO) on 6 May largely upheld an earlier panel ruling that had found that certain measures imposed by Canada relating to the feed-in Tariff (FIT) programme established by its province of Ontario that affects the country's renewable energy generation sector were inconsistent with its WTO obligations.

However, in its overall findings and conclusions (issued separately for the complainants Japan and the European Union), the AB, amongst others, reversed the Panel's finding that both Japan and the EU failed to establish that the challenged measures confer a benefit within the meaning of Article 1.1(b) of the SCM (Subsidies and Countervailing Measures) Agreement and that thereby Canada acted inconsistently with Articles 3.1(b) and 3.2 of the SCM Agreement.

[The Panel ruling - issued on 19 December 2012 - on the question of "benefit" in relation to the "subsidy" complaint under the SCM Agreement was by a majority. The majority had held that the complaint has not been established on the issue of subsidy, while the dissenting member had held that the programme provides a benefit, and thus constitutes a subsidy in terms of the SCM Agreement. (See SUNS #7507 dated 24 December 2012).]

In its ruling on 6 May, the AB said it is unable to complete the analysis as to whether the challenged measures confer a benefit within the meaning of Article
1.1(b) of the SCM Agreement and whether Canada acted inconsistently with Articles 3.1(b) and 3.2 of the SCM Agreement.

The AB recommended that the Dispute Settlement Body (DSB) request Canada to bring its measures found in its report, and in both Japan's and the EU's panel reports, as modified by its report, to be inconsistent with the TRIMs Agreement and the GATT 1994 into conformity with its obligations under those Agreements.

"Today's ruling is good news for everyone caring about clean energy and the environment: it has been made clear that use of quality, cost-effective technologies should not be hampered by protectionist measures," said John Clancy, EU Trade spokesman, in a press release by the European Commission's Directorate-General for Trade.

"The EU supports the promotion of renewable energy but considers this must be done in a manner consistent with international trade rules," he added.

In a statement issued on 7 May, Japanese Minister of Economy, Trade and Industry, Toshimitsu Motegi, said: "This is the first case that a measure providing preferential treatment to domestically manufactured goods under the Feed-in Tariff Program is WTO-inconsistent. Japan considers this ruling can be highly evaluated from the viewpoint of preventing protectionism in renewable energy sector, which can be regarded as a major growth industry."

Meanwhile, the Canadian grassroots organisation The Council of Canadians, in a media release on 6 May, encouraged the Ontario government "to stand by its landmark renewable energy policy and, if necessary, ignore the WTO ruling in the interests of sustainable development."

"The use of local content should be a tool available to all governments, globally, to get the most bang for the public buck on major public projects," said Stuart Trew, Trade Campaigner with the Council of Canadians.

"Combining job creation and environmental priorities is the definition of sustainable development. If global trade rules outlaw sustainable development, then there is something seriously wrong with them. It's not surprising the WTO is suffering a crisis in confidence. This ruling is bound to worsen that crisis," he added.

In the media release, noting that other countries, including member states of the EU, have ignored WTO rulings that they feel hurt the public interest, The Council of Canadians urged the Canadian and Ontario governments to do likewise if necessary.

In the dispute, Canada, Japan, and the European Union each appealed certain issues of law and legal interpretations developed in the panel reports.

In its analysis on the issue of the applicability of Article III: 8(a) of the GATT 1994 to measures falling under Article 2.2 of the TRIMs Agreement and the Illustrative List annexed thereto, the AB considered that the Panel correctly rejected the EU's argument that Article III: 8(a) of the GATT 1994 is not applicable to measures that fall within the scope of Article 2.2 of the TRIMs Agreement and the Illustrative List annexed thereto.

Therefore, the AB upheld the Panel's finding that "Paragraph 1(a) of the Illustrative List in the Annex to the TRIMs Agreement d[id] not obviate the need for [the Panel] to undertake an analysis of whether the challenged measures are outside of the scope of application of Article III: 4 of the GATT 1994 by virtue of the operation of Article III: 8(a) of the GATT 1994."

"As we have upheld the Panel's finding, there is no basis for us to entertain the European Union's request that we complete the analysis and find that Article III: 8(a) of the GATT 1994 is not applicable in the present case because the measures fall within Article 2.2 and the Illustrative List of the TRIMs Agreement."

The AB then turned to Article III: 8(a) of the GATT 1994, whereby the three participants challenged on appeal different aspects of the Panel's interpretation and application of this provision.

According to the AB report, Canada alleged that the Panel erred in finding that the FIT Programme and related FIT and microFIT Contracts are not covered by Article III: 8(a) and that, consequently, Canada cannot rely on that provision to exclude the application of Article III: 4 of the GATT 1994 to the Minimum Required Domestic Content Levels.

Canada requested the AB to reverse this finding, complete the legal analysis under Article III: 8(a), and find that the FIT Programme and Contracts fall within the scope of Article III: 8(a). Consequently, Canada requested the AB to find that the FIT Programme and Contracts do not breach Article III: 4 of the GATT 1994 or Article 2.1 of the TRIMs Agreement.

The AB noted that this is the first time that it is called upon to interpret Article III: 8(a) of the GATT 1994.

Article III: 8(a) of the GATT 1994 stipulates: "The provisions of this Article shall not apply to laws, regulations or requirements governing the procurement by governmental agencies of products purchased for governmental purposes and not with a view to commercial resale or with a view to use in the production of goods for commercial sale."

In sum, the AB considered that Article III: 8(a) sets out a derogation from the national treatment obligation contained in Article III of the GATT 1994. The provision exempts from the national treatment obligation certain measures containing rules for the process by which government purchases products. Under Article III: 8(a), the entity procuring products for the government is a "governmental agency".

The AB said it had found that a "governmental agency" is an entity performing functions of government and acting for or on behalf of government. Furthermore, it had found that the derogation of Article III: 8(a) must be understood in relation to the obligations stipulated in Article III. This means that the product of foreign origin must be in a competitive relationship with the product purchased.

Furthermore, Article III: 8(a) is limited to products purchased for the use of government, consumed by government, or provided by government to recipients in the discharge of its public functions. On the contrary, Article III: 8(a) does not cover purchases made by governmental agencies with a view to reselling the purchased products in an arm's-length sale and it does not cover purchases made with a view to using the product previously purchased in the production of goods for sale at arm's length.

On whether the Panel erred in finding that the FIT Programme and related FIT and microFIT Contracts are not covered by Article III: 8(a) and that they are therefore subject to the disciplines of Article III: 4 of the GATT 1994, the AB noted that it had found that the conditions for derogation under Article III: 8(a) must be understood in relation to the obligations stipulated in the other paragraphs of Article III.

"This means that the product of foreign origin allegedly being discriminated against must be in a competitive relationship with the product purchased. In the case before us, the product being procured is electricity, whereas the product discriminated against for reason of its origin is generation equipment. These two products are not in a competitive relationship. None of the participants has suggested otherwise, much less offered evidence to substantiate such proposition."

Accordingly, said the AB, the discrimination relating to generation equipment contained in the FIT Programme and Contracts is not covered by the derogation of Article III: 8(a) of the GATT 1994.

"We therefore reverse the Panel's findings, in paragraphs 7.127, 7.128, and 7.152 of the Panel Reports, that the Minimum Required Domestic Content Levels of the FIT Programme and related FIT and microFIT Contracts are laws, regulations, or requirements governing the procurement by governmental agencies of electricity within the meaning of Article III: 8(a) of the GATT 1994. Instead, we find that the Minimum Required Domestic Content Levels cannot be characterised as ‘laws, regulations or requirements governing the procurement by governmental agencies' of electricity within the meaning of Article III: 8(a) of the GATT 1994."

Having found that the Minimum Required Domestic Content Levels do not fall within the ambit of the derogation in Article III: 8(a), the AB declared that it need not address the further allegations of error raised by the European Union and Japan seeking reversal of intermediate findings by the Panel. These findings are moot, it added.

On Canada's claims that the Panel erred in finding that the Government of Ontario's purchases of electricity under the FIT Programme are undertaken "with a view to commercial resale", the AB said its conclusion that the measures at issue are not covered by Article III: 8(a) of the GATT 1994 is not premised on a finding that the Government of Ontario's procurement of electricity under the FIT Programme is undertaken "with a view to commercial resale".

"Rather, it is based on our finding that Article III: 8(a) does not cover discriminatory treatment of the equipment used to generate the electricity that is procured by the Government of Ontario. Furthermore, we have mooted the Panel's intermediate findings, including the finding that the Government of Ontario's procurement of electricity under the FIT Programme and Contracts is undertaken ‘with a view to commercial resale'. Thus, we do not consider it necessary to address further Canada's claims."

In the light of its finding that the Minimum Required Domestic Content Levels do not fall within the ambit of Article III: 8(a), and in the light of the fact that Canada has not appealed the Panel's finding that the FIT Programme and Contracts are inconsistent with Article III: 4 of the GATT 1994 and Article 2.1 of the TRIMs Agreement, the AB said that the Panel's conclusion that the Minimum Required Domestic Content Levels prescribed under the FIT Programme and related FIT and microFIT Contracts are inconsistent with Article 2.1 of the TRIMs Agreement and Article III: 4 of the GATT 1994 stands.

On whether the Panel properly exercised judicial economy when it declined to make a finding under Japan's "stand-alone" claim under Article III: 4 of the GATT 1994, the AB said that in sum, it is not persuaded that the Panel's failure to make a finding on Japan's stand-alone Article III: 4 claim provided only a "partial resolution of the matter at issue" or that an additional finding on Japan's stand-alone Article III: 4 claim "is necessary in order to enable the DSB to make sufficiently precise recommendations and rulings so as to allow for prompt compliance" by Canada with those recommendations and rulings.

"Therefore, we reject Japan's claim that the Panel failed to fulfil its obligations under Article 11 of the DSU and exercised false judicial economy by declining to make a finding on Japan's stand-alone Article III: 4 claim," said the AB, adding that given that it had found that it was not improper for the Panel to have declined to make a finding on Japan's stand-alone Article III: 4 claim, it need not further consider Japan's request.

On whether the Panel erred in finding that the FIT Programme and Contracts are government "purchases [of] goods" under Article 1.1(a)(1)(iii) of the SCM Agreement, the AB noted that on appeal, Japan challenged the Panel's interpretation and application of Article 1.1(a)(1) of the SCM Agreement.

With respect to the interpretation of Article 1.1(a)(1), Japan argued that the Panel erred in finding that subparagraphs (i) and (iii) are "mutually exclusive". In Japan's view, after concluding that the measures at issue are properly characterised as government "purchases [of] goods", the Panel, in effect, made such finding of mutual exclusivity by rejecting the complainants' argument that the measures at issue may also be legally characterised as "direct transfer[s] of funds" or "potential direct transfers of funds".

Canada argued that there is no merit to Japan's claim that the Panel erred by finding that subparagraphs (i) and (iii) of Article 1.1(a)(1) are mutually exclusive. Canada submitted that the Panel correctly found that the FIT Programme and Contracts could not be properly characterised as "direct transfer[s] of funds" as well as government "purchases [of] goods", and that this finding is entirely consistent with the Appellate Body report in US-Large Civil Aircraft (2nd complaint).

In its analysis, the AB believed that the Panel's finding that subparagraphs (i) and (iii) are mutually exclusive is not consistent with the Appellate Body's interpretations in US-Large Civil Aircraft (2nd complaint).

Consequently, it declared moot and of no legal effect the Panel's finding that "government ‘purchases [of] goods' could [not] also be legally characterized as ‘direct transfer[s] of funds' without infringing [the] principle [of effective treaty interpretation]", inasmuch as it negates the possibility that a transaction may fall under more than one type of financial contribution under Article 1.1(a)(1) of the SCM Agreement.

On Japan's challenge on the Panel's finding that the FIT Programme and Contracts are government "purchases [of] goods" within the meaning of Article 1.1(a)(1)(iii), the AB said it does not consider that the Panel erred in its characterisation of the measures at issue under Article 1.1(a)(1) of the SCM Agreement.

"Accordingly, we uphold the Panel's finding, in paragraphs 7.243 and 7.328(i) of the Panel Reports, that the FIT Programme and related FIT and microFIT Contracts are government ‘purchases [of] goods' within the meaning of Article
1.1(a)(1)(iii) of the SCM Agreement."

Having upheld the Panel's finding that the measures at issue are properly characterised as government "purchases [of] goods" under Article 1.1(a)(1)(iii), the AB then examined Japan's alternative claim that the AB modify the Panel's finding in this regard to find that these measures may also be characterised as "direct transfer[s] of funds" or "potential direct transfers of funds" under Article 1.1(a)(1)(i) of the SCM Agreement, as well as to find that the FIT Programme and Contracts may be characterised as "income or price support" under Article 1.1(a)(2) of the SCM Agreement.

The AB said it does not believe that the arguments advanced by Japan are sufficient to demonstrate that the measures at issue are "direct transfer[s] of funds" or "potential direct transfers of funds", and it rejected Japan's appeal that the FIT Programme and FIT and microFIT Contracts may also be characterised as "direct transfer[s] of funds" or "potential direct transfers of funds" under Article 1.1(a)(1)(i) of the SCM Agreement.

On whether the Panel erred in exercising judicial economy with respect to the allegations that the measures at issue constitute "income or price support", the AB said it does not believe that an additional finding by the Panel that the challenged measures constitute "income or price support" within the meaning of Article
1.1(a)(2) was necessary to resolve fully the dispute.

"Accordingly, we reject Japan's claim that the Panel failed to fulfil its obligations under Article 11 of the DSU [Dispute Settlement Understanding] and exercised false judicial economy by declining to make a finding on Japan's claim that the measures at issue constitute ‘income or price support' under Article 1.1(a)(2) of the SCM Agreement."

"Given that we have rejected Japan's claim that the Panel exercised false judicial economy by declining to make a finding on Japan's claim that the measures at issue constitute ‘income or price support', we decline to make a finding on whether the FIT Programme and Contracts may be characterised as ‘income or price support' under Article 1.1(a)(2) of the SCM Agreement," said the AB.

The AB then turned to the identification of what it considered would be in the circumstances of these disputes the appropriate benchmark for the benefit comparison under Article 1.1(b) of the SCM Agreement.

On the identification of a benefit benchmark for electricity produced from wind-power and solar PV (photovoltaic) technologies, the AB said that although the Panel defined the relevant market as a single market for electricity generated from all energy sources and engaged in an in-depth analysis of all market benchmarks for blended electricity put forward by the complainants, the Panel stated in its conclusions on benefit that, in the case of electricity, the competitive wholesale electricity market is not an appropriate benchmark, given that government intervention is required to achieve certain policy goals, such as ensuring a stable and reliable supply of electricity, including from renewable sources.

According to the AB, a benefit analysis under Article 1.1(b), read in the context of Article 14(d) of the SCM Agreement, involves a comparison with a market benchmark or proxy.

Article 14(d) states, on the one hand, that purchases of goods should be considered as conferring a benefit if "the purchase is made for more than adequate remuneration" and, on the other hand, that the adequacy of remuneration has to be determined in relation to the "prevailing market conditions" for the good or service in question in the country of purchase. The adequacy of remuneration is only one aspect of the Article 14(d) comparison, the other being the "prevailing market conditions" in the country of purchase, which requires a comparison with a market benchmark.

That Article 14(d) requires a comparison with market conditions was confirmed by the Appellate Body in US-Softwood Lumber IV. The Appellate Body found that, in cases where the private prices of the goods in question in the country of provision are distorted, it is possible to resort to an out-of-country benchmark or to a constructed benchmark, provided that the necessary adjustments are made to reflect conditions in the market of purchase. The very purpose of resorting to an out-of-country or to a constructed benchmark is to replicate competitive market conditions that are absent in the country of purchase.

Nevertheless, said the AB, while introducing legitimate policy considerations into the determination of benefit cannot be reconciled with Article 1.1(b) of the SCM Agreement, "we do not think that a market-based approach to benefit benchmarks excludes taking into account situations where governments intervene to create markets that would otherwise not exist."

For example, governments create electricity markets with constant and reliable supply. By regulating the quantity and the type of electricity that is supplied through the network (base-load, intermediate-load, or peak-load) and the timing of such supply, governments ensure that there is a continuous supply-demand balance between generators and consumers, thus avoiding imbalances that would destabilise the network and cause interruptions of power supply. Although this type of intervention has an effect on market prices, as opposed to a situation where prices are determined by unconstrained forces of supply and demand, it does not exclude per se treating the resulting prices as market prices for the purposes of a benefit analysis under Article 1.1(b) of the SCM Agreement. In fact, in the absence of such government intervention, there could not be a market with a constant and reliable supply of electricity.

Similarly, considerations relating to the choice of energy supply-mix by a government, including wind- and solar PV-generated electricity, may be crucial to the viability and sustainability of the electricity market in the long term. Governments intervene by reducing reliance on fossil energy resources and promoting the generation of electricity from renewable energy resources to ensure the sustainability of electricity markets in the long term. Fossil energy resources are exhaustible, and thus fossil energy needs to be replaced progressively if electricity supply is to be guaranteed in the long term.

The AB said that government intervention in favour of the substitution of fossil energy with renewable energy today is meant to ensure the proper functioning or the existence of an electricity market with a constant and reliable supply of electricity in the long term. Like the government regulation that ensures the stability and reliability of supply in the electricity market, a government's choice to include wind-power and solar PV generation in the energy supply-mix should not be considered as preventing the identification or adaptation of competitive benefit benchmarks for purposes of an analysis under Article 1.1(b) of the SCM Agreement.

"Government intervention ensures that electricity markets may exist in the current form where consumers have a constant and reliable access to electricity. However, the regulation of electricity markets by governments is guided not only by immediate and short-term considerations relating to the nature of electricity and electricity systems, and requiring the management of ‘dispatchable' and ‘non-dispatchable' generators and loads, but also by long-term considerations aimed at ensuring that consumers have stable access to electricity in the coming years and increasingly from renewable sources. It is in the latter situation that the government's management of the energy supply-mix plays a key role."

Nevertheless, the AB stressed, a distinction should be drawn between, on the one hand, government interventions that create markets that would otherwise not exist and, on the other hand, other types of government interventions in support of certain players in markets that already exist, or to correct market distortions therein.

Where a government creates a market, it cannot be said that the government intervention distorts the market, as there would not be a market if the government had not created it. While the creation of markets by a government does not in and of itself give rise to subsidies within the meaning of the SCM Agreement, government interventions in existing markets may amount to subsidies when they take the form of a financial contribution, or income or price support, and confer a benefit to specific enterprises or industries.

"We further note that a comparison between renewable energy electricity generators and conventional energy electricity generators requires consideration of the full costs associated with the generation of electricity. In this respect, if, on the one hand, higher prices for renewable electricity have certain positive externalities, such as guaranteeing long-term supply and addressing environmental concerns, on the other hand, lower prices for non-renewable electricity generation have certain negative externalities, such as the adverse impact on human health and the environment of fossil fuel energy emissions and nuclear waste disposal. Considerations related to these externalities will often underlie a government definition of the energy supply-mix and thus be the reason why governments intervene to create markets for renewable electricity generation."

On this point, the AB agreed with the Panel's statement that, where government intervention that internalises social costs and benefits is limited to defining the broad parameters of the market, "significant scope will remain for private actors to operate within those parameters on the basis of commercial considerations".

In the light of the above, and in particular in view of the fact that the government's definition of the energy supply-mix for electricity generation does not in and of itself constitute a subsidy, the AB believed that benefit benchmarks for wind- and solar PV-generated electricity should be found in the markets for wind- and solar PV-generated electricity that result from the supply-mix definition.

Thus, where the government has defined an energy supply-mix that includes wind-power and solar PV electricity generation technologies, as in the present disputes, a benchmark comparison for purposes of a benefit analysis for wind-power and solar PV electricity generation should be with the terms and conditions that would be available under market-based conditions for each of these technologies, taking the supply-mix as a given.

The AB also considered that the approach and the benefit benchmarks advanced by the European Union and Japan are not appropriate to determine the existence of benefit for wind-power and solar PV generation under the FIT Programme.

In its overall conclusions under Article 1.1(b) of the SCM Agreement, the AB said that in its benefit analysis, on the one hand, the Panel correctly considered that the need to secure a reliable supply of electricity through an energy supply-mix that included wind-power and solar PV generation rendered inappropriate a comparison of the FIT remuneration with the terms and conditions available on the competitive wholesale electricity market. On the other hand, the Panel accepted the complainants' line of argument, including their market definition, and proceeded to evaluate whether a benefit had been conferred based on benefit benchmarks for a single market for electricity generated from all sources of energy.

The AB considered that the Panel committed an error in not conducting the benefit analysis on the basis of a market that is shaped by the government's definition of the energy supply-mix, and of a benchmark located in that market reflecting competitive prices for wind-power and solar PV generation.

"We, therefore, reverse the Panel's findings, in paragraph 7.328(ii) of the Panel Reports, paragraph 8.3 in the Japan Panel Report, and paragraph 8.7 in the EU Panel Report, that Japan and the European Union failed to establish that the challenged measures confer a benefit within the meaning of Article 1.1(b) of the SCM Agreement and thereby that Canada acted inconsistently with Articles 3.1(b) and 3.2 of the SCM Agreement."

Having reversed the Panel's finding that the complainants failed to establish the existence of benefit, no determination exists as to whether or not the challenged measures confer a benefit within the meaning of Article 1.1(b) of the SCM Agreement, the AB added.

It then went on to consider whether it can complete the legal analysis and determine first whether the FIT Programme and related FIT and microFIT Contracts confer a benefit within the meaning of Article 1.1(b) of the SCM Agreement.

Following from its analysis, the AB said: "In sum, we have found evidence on the Panel record that is relevant to a benefit analysis based on a benchmark that takes into account the Government of Ontario's definition of the energy supply-mix. Based on this evidence, we have considered that RES [Renewable Energy Supply] prices for wind-power generation contracts awarded through competitive bidding may qualify as benchmarks for a benefit comparison and seem to suggest that benefit may exist in the case of FIT wind-power generation contracts. We conclude, however, that such evidence was neither sufficiently debated before the Panel, nor before us. Moreover, the Panel did not make factual findings on this evidence that would assist us in completing the analysis."

In the light of the above, the AB said it does not consider that there are sufficient factual findings by the Panel and uncontested evidence on the Panel record that would allow it to complete the legal analysis and conduct a benefit benchmark comparison between the prices of wind-generated electricity under the FIT Programme and the prices for wind-generated electricity under the RES initiative.

"Consequently, we cannot determine whether the challenged measures confer a benefit within the meaning of Article 1.1(b) of the SCM Agreement and whether they constitute prohibited subsidies inconsistent with Articles 3.1(b) and 3.2 of the SCM Agreement," it added. +