It wouldn't surprise me if what they were quoting was factually incorrect. I'm sure I heard Martin Lewis on 5 live a couple of weeks ago saying that people would be entitled to a full refund if the airline cancelled your flight.
It looks to me like straight forward breech of contract. They were unable to provide with the service you contracted for (whatever the reason) so you should be entitled to your money back. Mind you, I've never liked Michael O'Leary.