Brexit means greater flexibility on energy policy

Clive Moffatt argues that UK membership of the EU has not impacted on the UK energy market to the same degree as Brussels directives on the freedom of movement of labour, employment and industry standards. However, what it has done in recent years is limit Britain’s freedom to decide how best to achieve the three key objectives of UK energy policy, namely: reducing CO2 emissions, securing adequate supply to meet demand for electricity, and keeping costs to industrial and residential consumers as low as possible.

Background

In the 1980s and 90s, the UK energy market was regarded as the model for the rest of the EU. We led the way on denationalisation, the removal of price controls, the establishment of an independent transmission network, the launch of retail supply competition and the creation of an independent industry regulator. The EU tried to mimic what was happening in the UK across all member states. Various EU energy directives have had some success in delivering market liberalisation but member states have, on the whole, been reluctant to let energy policy slip from their grasp. The Brussels vision of a single energy market is thus very unlikely to be realised.

This unravelling of EU energy policy has become much more acute since the EU decided that decarbonisation of the electricity market should sit above the aims of wider market liberalisation. The overall targets for emissions, renewable energy and energy efficiency were agreed for 2020. In pursuit of these targets, member states have often pursued individual and often conflicting policies such that across the EU markets have ceased to function to provide adequate investment signals for new capacity and a myriad of subsidies and penalties has led to a huge hike in energy costs for all consumers. The original goal of market liberalisation has been overtaken by growing economic nationalism.

The UK government is also struggling with trying to balance its three key policy objectives (see above) and indeed led the way in the EU with its unilateral commitment in 2008 to reducing CO2 emissions by 80% on 1990 levels by 2050. This is a very ambitious target – we are about 30 per cent of the way there – but it is becoming clear that with capacity margins at a record low of 2 per cent and heavy industry unable to defray the rising cost of our low carbon policies, the 2050 target may need to be postponed. To reach them, much greater emphasis must be placed on ensuring security of supply and minimising the cost of the UK’s low carbon ambitions. However, to allow us the flexibility to tackle these issues in a coherent and rational way we need to unlock ourselves from the constraints imposed by the EU and Brussels.

These constraints impact on all the three key objectives of UK energy policy.

Decarbonisation

Over the last ten years, the EU has focused policy almost exclusively on imploring member states to underpin a massive growth in renewable energy and curtail fossil fuel generation (in particular the enforced closure of coal plant). The potential contribution of flexible and efficient new gas generation, greater demand efficiency, interconnection and, to some extent, new nuclear generation have not been ignored but they have been marginalised. This EU obsession with intermittent renewable energy (wind and solar) operating at zero transmission cost has meant that the wholesale electricity market does not generate high enough prices over a long enough time span to support any new investment in gas or nuclear generation.

As a result, no new generation of any kind can be built without some form of government intervention. The EU hoped that the level of “green” subsidies could be contained by encouraging a rising price for carbon but the so-called EU Emissions Trading Scheme (ETS) has been a disaster, with member states keen to ensure that more than enough CO2 certificates to their own coal plant and heavy industry. Because of the very low level of the EU ETS price the UK has seen fit to introduce a Carbon Support Price (CSP) to help defray the cost to the Treasury of direct subsidies.

Brexit will now allow the government to adopt a more cohesive and longer term approach to the question of subsidies and CO2 pricing which is in the best of interests of the environment, industry and consumers.

Energy Security

The political desire to ensure the lights stay on has forced the UK and a dozen other member states to try and offset the negative price impact of renewable energy by introducing some form of Capacity Market to in essence provide some subsidy payment to existing generators and new investors to ensure that there is enough capacity on the system to meet future demand. However, till now, these Capacity Markets or Mechanisms have been governed by the EU “state aid guidelines”, which means that governments cannot distinguish between different types of generation or be seen to favour new over old technology.

In the case of the UK, this has meant that the capacity auction clearing price provides a windfall gain to old gas, nuclear and coal plant but is too low to support new investment in flexible, cleaner and more efficient gas plant needed to support the demise of old coal plant and keep the lights on when the wind is not blowing or the sun is not shining. Meanwhile, the government has to date looked at supporting large scale nuclear plant eg EDF’s Hinkley Project as a way of providing base load security of supply but with Brexit this very expensive project is unlikely to see the light of day.

After Brexit, there is now the opportunity for the government to review what and how it supports new electricity generation to ensure that the right sort of capacity is in place to meet base and peak load demand. Intermittent renewable energy and flexible distributed energy (i.e. small scale diesel and gas generation), supported by more baseload CCGT gas generation and smaller scale nuclear reactors, could well be the most likely and cost effective outcome.

Affordability

It is an inescapable fact that renewable energy sources (e.g. offshore wind) and new nuclear have a very high capital cost and high operating volumes are required to ensure commercial viability and minimise costs to consumers. The UK government, like the rest of the EU, has taken the view that some level subsidy is therefore required to encourage the roll out of low carbon electricity generation until such time as new technologies can become competitive with existing fossil fuels.

In short, a policy of decarbonisation increases energy costs to consumers via the levy framework. Each government in the EU decides how the additional cost burden should be shared, for example in Germany industry is shielded for competitive reasons and the consumer is paying for the massive investment in wind and solar power. In the UK, industry shares more of the burden, which has raised public concern (e.g. Port Talbot) about the impact of low carbon policies on the viability of UK heavy industry.

Post Brexit, a fairer and longer term period of adjusting to a low carbon economy could be devised viz reform of the Capacity Market. The UK could place less emphasis on direct subsidies to promote renewable energy and new gas generation, with more emphasis on a longer term and more gradual trajectory for the price of carbon, with tax breaks for heavy industry and fuel poor consumers. This would help restore the role of the market in energy policy – an approach that has till last Thursday been constrained by EU rules.

Conclusions

The vote on 23 June to leave the EU will not have any major impact on the overall objectives of UK Energy Policy. The struggle to square the circle of low emissions, security of supply and affordability will continue and the UK will continue to make the most of physical and commercial power and gas connections with continental Europe because these links make commercial sense to all parties.

However, it is very clear that the original EU vision of a single energy market was neither in the interests of the EU or the UK. Leaving the EU will remove the current restrictive measures and release our ability to devise the best mix of policies, which in the long term will deliver lower CO2 emissions whilst ensuring security of supply and affordability for all consumers. We led the way with energy market reform. The market is not dead and given the freedom of manoeuvre created by exiting the EU we can restore the operation of the UK energy market.