Brexit: what does the UK’s future in Europe mean for the energy sector?

The precise shape and impact of an eventual Brexit is as yet unclear, largely because there is a wide range of possible outcomes from post-Brexit negotiations, leading to a number of regulatory and market options for the UK’s relationship with the EU.

Possible post-Brexit arrangements include membership of the European Economic Area, (similar to Norway’s current arrangements), tracking the EU legislative and regulatory regime without any formal arrangement, and a series of sector specific bilateral arrangements similar to the EU- Swiss arrangement as alternatives to or in addition to free trade agreements with specific jurisdictions outside the EU. Each of these options will have different implications for the energy sector depending on the policy choices of the UK Parliament.

If UK remains part of the single Internal Energy Market (IEM) under either of these models, it would likely remain subject to the relevant European legislation.

Gas

In contrast to other EU countries, the UK produces gas domestically and has a well-established hub for the LNG market and a liquid gas market at the national balancing point. As between the UK and the EU, gas markets are already well integrated physically through three interconnectors (IUK, BBL and Moffat) with only small wholesale price differences and little congestion. Short of any drastic changes in energy policy by the British government, the gas sector is therefore unlikely to suffer following Brexit.

The UK gas market is amongst the most mature and liquid gas markets in Europe. Brexit may, however, contribute to a shift towards other EU markets (particularly TTF in the Netherlands which outranked the UK as the most liquid market in 2015) and change the expectations of future infrastructure investments. However, as the physical infrastructure is in place for trading across borders from the UK, it is probable that this will continue to be in demand.

As the EU is currently undergoing a review of its gas supply security arrangements, Brexit could increase UK’s supply security risk, as the UK might be excluded from the ‘solidarity principles’, whereby European nations agree to supply gas to their neighbours in the event of a gas supply crisis.

Electricity

There are some concerns that the period of uncertainty in the run up to Brexit may drive up the costs of investment in the electricity sector. The British electricity sector needs a good deal of investment, particularly in generation capacity and grid upgrades – Brexit may render these investments more costly. Economic commentators have suggested that this may well be largest risk facing the energy sector independently the result of Brexit negotiations.

If Brexit results in exclusion from the IEM, the UK would be excluded from the benefits of market integration initiatives, such as market coupling and cross-border balancing and capacity market integration.

Gas and electricity interconnectors

Britain has a number of electricity and gas interconnectors, and is in the process of developing more. It is likely that the effects of Brexit would be most keenly felt by existing and, in particular, future interconnectors. The relevant regulatory framework for interconnectors in the EU would fall away for UK interconnectors, and a reliable alternative regime would need to be negotiated which will likely have an impact on both costs as well as security of supply for the UK.

Change to the current interconnection arrangements may therefore have a negative impact on UK energy security as the UK is a net importer of electricity. In addition, the UK would have to decide whether to continue to adopt EU-wide electricity regulation or to develop its own set of policies.

EU ETS

UK climate change regulation implements the EU Climate Change Package, so the UK would have to make conscious decisions to move away from them through new regulation.

The result of the referendum also has an impact on the future of the EU’s carbon market, as the UK is the EU’s second-largest emitter of greenhouse gases, with its utility companies being among the largest buyers of carbon allowances for the EU’s Emission Trading System (EU ETS).

On the day after the referendum, prices for EU ETS allowances fell by more than 10 percent to their lowest level since March. Brexit could affect the supply/demand dynamics of the EU ETS and the market reforms for the period after 2020 (when the current commitment period of the EU ETS expires).

However, even if the UK were to leave the IEM, stringent UK climate targets, as well as commitments arising from international agreements such as the Paris Agreement would continue.

Outlook

It may be some time until the impact of the referendum on the energy sector will be known. Whilst we are unlikely to see any major changes in the immediate future as the terms of Brexit will take time to negotiate, now is the time for the energy sector to identify priorities for the negotiations and communicate those to Government.