Role of economic and financial analysis in state aid assessments Prepared for VI Competition Forum of Ukraine Nicole Robins Head of the state aid team at Oxera 3 March 2017 Strictly confidential

Selected overview of Oxera’s experience Oxera is one of Europe’s foremost independent economics consultancies. We have the market-leading state aid practice. We have worked on an extensive number of state aid cases at the cutting edge of the debate. We have an unrivalled track record of success in front of the European Commission and Courts on state aid matters. expert advice on state aid matters for leading football clubs in the Netherlands and Spain advising European airports and sea ports on investment aid, operating aid and MEOP assessments of user agreements advising a large Eastern European airline on rescue and restructuring aid acting for Ryanair and Wizz Air on 30 state aid cases, including cases in Belgium, France, Italy, Germany, Poland, Romania and Spain advising a number of European banks on rescue and restructuring aid advice to the Irish Health Insurance Authority on SGEI state aid matters advice to a Polish shipyard on state aid matters expert advice to EDF in relation to power purchase agreements in Hungary and Poland advising EDF in France on tax state aid issues acting for RWE on state aid matters, leading to Commission approval advising the European Commission on ex post evaluations of aid measures ongoing advice to the French government on an ex post evaluation of a tax state aid measure advice to Deutsche Bahn on state aid matters ongoing advice to a regulator on SGEI related matters in the postal sector Strictly confidential 3 March 2017

Overview Part I: Is a measure state aid? overview of framework case study: Frankfurt-Hahn airport Part II: Is aid compatible with state aid rules? overview of framework case study: RWE’s Lynemouth biomass power plant case study: bpost Part III: Conclusions Strictly confidential 3 March 2017

Part I: Is a measure state aid? Strictly confidential 3 March 2017

State aid framework Overview 1. 2. Is it state aid? Is it compatible state aid? Yes, if all the following conditions are met Yes, if it satisfies certain economic tests Economic tests for compatibility Transfer of state resources Potential to distort competition If not an SGEI If an SGEI Potential to affect trade between member states common interest objectives need for, and appropriateness of, state intervention aid limited to minimum necessary to ensure incentive effects limited distortions of competition and trade According to the SGEI Framework: compensation should not exceed what is necessary to cover the net costs of carrying out public service obligations, plus a reasonable profit Confers a selective economic advantage Tests for economic advantage If not an SGEI If an SGEI MEOP Altmark Note: SGEI, Services of General Economic Interest. MEOP, Market Economy Operator Principle. Strictly confidential 3 March 2017 5

MEOP: is it state aid? (I) Overview of the approach would a private investor have provided the measure in question? the assessment must be on an ex ante basis social, regional or sectoral aspects not considered if the measure is consistent with the MEOP, then no state aid could the alleged aid recipient have obtained the same deal from the private sector? (comparator analysis) would the expected return from the deal with the state be acceptable to a private investor (profitability analysis) Expected profitability What is the expected profitability of the arrangement? Benchmark return What is the benchmark return required by private sector firms for a similar project? ≥ No aid Strictly confidential 3 March 2017 6

MEOP: is it state aid? (II) Profitability analysis Considered by the European Commission to be a key tool for assessing whether deals are in line with the MEOP; the Commission has used profitability analysis extensively across various sectors Step 1 ring-fence the entities’ commercial activity independent of legal/organisational structures Step 2 examine expected profitability on a forward-looking basis estimate expected revenues and costs over the duration of the arrangement Step 3 compare discounted future cash flows with an estimate of the benchmark return Strictly confidential 3 March 2017 7

MEOP: is it state aid? (III) Case study: Frankfurt-Hahn Airport the airport’s agreements with Ryanair were under state aid investigation aeronautical revenues (net of discounts and marketing payments) non-aeronautical revenues Incremental revenues incremental operating costs investment costs (where relevant to the airline’s operations from the airport) Incremental costs if value of discounted cash flows is in line with, or exceeds, the benchmark, the agreement is in line with the MEOP Benchmark cash flows “Having analysed Oxera’s profitability assessment of the 2002 Ryanair agreement … the Commission is satisfied that the agreement could reasonably be considered as contributing to the profitability of Hahn Airport … in that the expected incremental revenues were higher than the expected incremental costs. As the 2002 Ryanair agreement thus complied with the MEOP, it did not confer an advantage to Ryanair.” European Commission Decision For further details, see http://europa.eu/rapid/press-release_MEMO-14-544_en.htm. Strictly confidential 3 March 2017 8

The Altmark criteria: is it state aid? Overview the Altmark criteria1 determine whether state aid is present for services of general economic interest (e.g. postal services and certain transport services) no state aid if all of the following four criteria are met clearly defined SGEI no overcompensation compensation set in advance only efficient costs are compensated 1 Case C-280-00, Altmark Trans GmbH and Regierungspraesidium Magdeburg v Nahverkehrsgesellschaft Altmark GmbH. Strictly confidential 3 March 2017 9

Compatibility of the aid Part II: Compatibility of the aid Strictly confidential 3 March 2017

General criteria for the compatibility of aid Overview 1. Common interest objectives aid is aimed at an objective of common interest 2. Need for state intervention aid is targeted at market failures and is necessary as no other sources of financing are available 3. Appropriateness of state aid alternative forms of state funding are not sufficient (e.g. repayable advances, loans and guarantees) 4. Incentive effects the aid must incentivise additional economic activity (i.e. counterfactual analysis must compare intended activity with and without aid) 5. Aid limited to the minimum aid must be proportionate (i.e. it must be limited to the minimum) 6. Avoidance of undue negative effects on competition and trade aid must be designed to limit any adverse effects on competition and trade Strictly confidential 3 March 2017 11

Proportionality of the aid Distortions to competition and trade Proportionality of aid and distortions to competition Case study: RWE’s Lynemouth power plant Proportionality of the aid Distortions to competition and trade the Commission raised concerns that Lynemouth could be overcompensated if the plant achieves higher thermal efficiency and load factor, and if, at the same time, fuel costs decline Oxera undertook financial modelling of the project’s expected returns which showed: low possibility of upsides being achieved simultaneously across the three parameters the key assumptions were appropriate thereby, limited risk of overcompensation the Commission raised concerns that Lynemouth’s fuel requirements could have distortive effects on competitors using the same feedstock raw material prices for other biomass-fired power plants and for other industries using wood pellets, such as the pulp and paper or saw timber industries, could be affected Oxera developed evidence to show that the increase of imports of wood pellets in the EU due to demand by Lynemouth would be minimal European Commission (2015), ‘State aid SA.38762 (2015/C) (2014/N)—United Kingdom, Investment Contract for Lynemouth Power Station Biomass Conversion’, Official Journal of the European Union, 10 April, and http://europa.eu/rapid/press-release_IP-15-6214_en.htm. Strictly confidential 3 March 2017 12

The SGEI Framework (I) Costs plus reasonable profit for SGEI, if the Altmark criteria are not met, the SGEI Framework applies1 compensation net cost of providing SGEI + reasonable profit ≤ the SGEI framework defines reasonable profit as the rate of return on capital; however, other metrics can be used, such as the return on sales projected profit must not exceed what would be required by a typical company considering whether to provide the service 1 European Commission (2011), ‘European Union framework for State aid in the form of public service compensation’, 2012/C 8/03. Strictly confidential 3 March 2017 13

The SGEI Framework (II) Case study: bpost Belgian postal operator, bpost, entrusted with public service obligations e.g. maintenance of the retail network, press distribution, home payment of pensions, cash at counter services and sale of stamps based on comparable parcel and logistics companies, the Commission concluded that a return on sales (ROS) of 5.4-7.4% was appropriate Study 1 Study 2 Study 3 Benchmarking group Wide parcels sector Parcels, post, logistics Postal universal service providers Database regions EU 15, USA EU, USA EU Number of companies 26 7–44 11 Time period 1998–2007 1990–2007 2000–09 ROS (median) 3.5% 5.4–7.4% 6.7% as bpost’s estimated ROS was within this range, the Commission concluded that bpost had not been overcompensated European Commission (2013), ‘State aid SA.31006 (2013/N)—Belgium, State compensations to bpost for the delivery of public services over 2013-2015’, 2 May. Strictly confidential 3 March 2017

Part III: Conclusions Strictly confidential 3 March 2017

Conclusions the EU-Ukraine Association Agreement requires compliance with state aid rules the evidence required to demonstrate MEOP compliance and/or compatibility of the aid requires sophisticated financial and economic analysis financial economics is key to determining the existence of aid (and certain aspects of the compatibility of aid) competition economics relevant to balancing the benefits and costs of state aid importance of ex-ante evidence that arrangements are underpinned by robust economic and financial rationale lack of ex ante evidence can be interpreted as a failure to comply with the MEOP Strictly confidential 3 March 2017 16

Contact: Nicole Robins +32 (0) 2 793 0714 nicole.robins@oxera.com www.oxera.com Follow us on Twitter @OxeraConsulting Oxera Consulting LLP is a limited liability partnership registered in England No. OC392464, registered office: Park Central, 40/41 Park End Street, Oxford, OX1 1JD, UK. The Brussels office, trading as Oxera Brussels, is registered in Belgium, SETR Oxera Consulting Limited 0883 432 547, registered office: Stephanie Square Centre, Avenue Louise 65, Box 11, 1050 Brussels, Belgium. Oxera Consulting GmbH is registered in Germany, no. HRB 148781 B (Local Court of Charlottenburg), registered office: Torstraße 138, Berlin 10119, Germany. Although every effort has been made to ensure the accuracy of the material and the integrity of the analysis presented herein, the Company accepts no liability for any actions taken on the basis of its contents. No Oxera entity is either authorised or regulated by the Financial Conduct Authority or the Prudential Regulation Authority. Anyone considering a specific investment should consult their own broker or other investment adviser. We accept no liability for any specific investment decision, which must be at the investor’s own risk. © Oxera, 2017. All rights reserved. Except for the quotation of short passages for the purposes of criticism or review, no part may be used or reproduced without permission. Strictly confidential