Stocktake a year on: how the UK National Security regime applies to the energy sector

The UK Government views the energy sector as a critical part of the economy. Despite the National Security and Investment Act 2021 (“NSIA”) only having been in full force for just over a year now (from January 2022), we have already seen the Investment Security Unit (ISU) taking a keen interest in energy deals across the sector. Below, we set out some key observations emerging from the interventions and guidance to date on how the NSIA is being applied to the energy sector.

Overview of the UK national security regime

The NSIA came into full force over a year ago on 4 January 2022. This legislation introduced a hybrid system allowing the UK Government to review proposed transactions impacting on the UK’s national security on the following bases:

• Mandatory regime: a pre-closing notification is required if there is a mandatory “trigger event” (i.e. an acquisition of a certain level of control) and the target entity is active in one of the 17 “specified sectors”. These include the energy sector.
• Voluntary regime: a voluntary notification to the Government can be made for transactions that do not fall within the scope of the mandatory regime, but where parties are concerned there may be potential national security issues (providing there is a relevant “trigger event”). A voluntary notification can be made in relation to the acquisition of entities and assets.
• Call-in power: Even if a transaction has not been notified under the mandatory or voluntary regime, the Government can call in the acquisition of an entity or asset for assessment if it is concerned about a possible risk to national security.

For a more detailed overview of the NSIA and notification requirements, please see our previous Law-Now.

Until recently, the Investment Security Unit (ISU) responsible for screening transactions under the NSIA was within the Department for Business, Energy and Industrial Strategy (“BEIS”). Following the recent Government reshuffle, it has moved from BEIS to the Cabinet Office.

Energy transactions falling within the mandatory notification requirement

The NSIA contains a complex and industry-specific definition of energy activities that fall within the scope of mandatory notification. There are a number of nuances when applying the definition to energy transactions, including for example:

• Differences in the geographic scope of the relevant assets. Sometimes the NSIA captures assets in the UK (as in the case of upstream petroleum facilities), but in other cases only assets located in Great Britain, excluding Northern Ireland (as in the case of downstream gas or relevant generating capacity), are caught.
• The threshold for “owning” relevant energy assets extends to percentages below the thresholds for control in the NSIA.
• Non-operational generating assets and assets that are exempt from the requirement for a generation licence may be captured by the mandatory notification requirement in certain circumstances.
• A careful assessment may be needed to determine the entities that should be included in the cumulated generation or aggregation capacity for the purposes of the 1GW threshold. This extends to the acquirer’s “group undertakings”, which has a specific definition under the NSIA.

These nuances serve to highlight the need for careful assessment of all energy transactions against the mandatory notification requirements.

Guidance on new build gas and electricity assets

In the case of an acquisition of an energy asset that has not yet been constructed, or is still in an early phase of development, it can often be difficult to ascertain the point at which a “trigger event” occurs.  In order to provide further guidance on the application of the NSIA to new build energy infrastructure, the Government published specific guidance on this subject on 22 July 2022. This provides helpful clarification on the types of energy transaction that would be caught by the Secretary of State’s call-in power (the “Guidance”).

The Guidance lists the following examples of “qualifying assets” in the downstream gas and electricity sectors:

• new transmission infrastructure
• new electricity generation infrastructure
• new distribution infrastructure
• new gas processing infrastructure
• new gas import or export facilities
• new energy storage infrastructure.

Considering the wide definition of the term “qualifying asset”, it is unsurprising that this infrastructure falls within the scope of the Secretary of State’s call-in power.

Under the NSIA, a “trigger event” in relation to a “qualifying asset” occurs when the acquirer is able to use, or direct or control the use of, that asset, including where it can do so to a greater extent than prior to the acquisition. The Guidance confirms the wide reach of the call-in power in the context of new build infrastructure, which can apply to both qualifying acquisitions (involving a qualifying asset and trigger event) and “contemplated” qualifying acquisitions. In particular, the Guidance emphasises that:

• An acquisition of control occurs when an acquirer gains the right to operate the asset and / or connect it to the network.
• The right to operate the asset could be acquired through (but is not limited to) the grant of an operating licence, a licence modification, an operating contract or network connection agreement.
• The trigger event occurs at the point at which the licence (or similar) is granted, even if the relevant asset has not yet been constructed.
• A “contemplated” qualifying acquisition can occur at an earlier stage, for example, on the application for a licence or network connection agreement, or the entering into of a tender round that will result in the grant of a licence or contract, if the bidder is successful.

Through this Guidance, the Government has highlighted its powers to call-in energy projects at the very earliest stages of development, well before construction has taken place, and even as early as invitation to tender stage. What this makes clear is that falling outside of the mandatory notification requirement does not provide a “safety net” for companies. Instead, the Government is signalling that energy projects have the potential to be scrutinised at an early stage of their development if they are considered to pose a threat to the UK’s national security.

Application of the Guidance in practice

Recent cases indicate that, as signalled through the Guidance, the Government is not shying away from intervening in deals involving potential threats to the UK’s national security.

The acquisition of the Stonehill project asset development rights by Stonehill Energy Storage Limited is a case in point. The transaction related to an existing Minety project in Wiltshire. The Stonehill project was an extension to one of Europe’s biggest battery storage facilities, aimed at improving the National Grid’s ability to use renewable energy. The purchaser was acquiring the entirety of development rights in the Stonehill project.

On 14 September 2022, BEIS issued a final order under the NSIA. While there is limited information available about BEIS’ assessment of the transaction, it was deemed by BEIS to constitute an acquisition of control of a qualifying asset. This is because the acquirer would be able to direct or control how the asset is used, or direct / control how it is used to a greater extent than prior to the acquisition.

It is unclear from the final order whether the acquisition of control occurred as a result of the grant of a licence or otherwise. It is also not evident whether the parties voluntarily notified the proposed acquisition or whether BEIS proactively intervened.

In any event, BEIS considered that there was a national security risk relating to (i) the security of an important UK asset and (ii) services provided to the National Grid.

Interestingly, the ultimate parent company of the acquirer, Stonehill Energy Storage Limited, was China’s state-owned China Hua Neng Group. Although BEIS made no reference to this fact in the final notice, a Chinese government department (the State-Owned Assets Supervision and Administration Commission) owns, either directly or indirectly, 75% of more of the shares in the acquirer. The UK Government is likely to have had concerns about the level of Chinese involvement in an acquisition relating to such a key energy asset, which resulted in the imposition of two conditions on the deal:

1. A requirement on Stonehill Energy Limited to obtain UK Government approval before appointing a power offtake operator; and
2. a restriction on the sharing of information from the power offtake operator to Stonehill Energy Limited.

Comment

Although the NSIA remains a relatively new piece of legislation, it is increasingly apparent that the energy sector is considered a key area of focus for the UK Government. The Guidance and the UK Government’s interventions to date confirm the Secretary of State’s ability to “call-in” energy projects for scrutiny at development stage. In practice, this means that where a project gives rise to a perceived national security concern, for example, as a result of an acquirer’s links to a “hostile state”, companies should consider at the outset of the project whether, and at what point, to approach the Government. Some comfort however might be sought from the fact that to date, no outright prohibition has yet been imposed on a transaction within the energy sector. This suggests that perceived national security risks in this sphere may be more easily manageable with conditions than in other sectors, such as the Advanced Materials and Military and Dual Use sectors.