How will Brexit affect the funding and operation of UK interconnectors?

What will leaving the EU mean for the functioning of the UK energy market, especially the building and funding of electricity interconnectors? Andrew Whitehead reads the runes.

Earlier this year, Ofgem gave preliminary approval to a cap and floor funding regime for three new electricity interconnector cables to France, Norway and Germany, with a final decision promised for September but at the time of writing still awaited.

These, and other, planned interconnectors – not to mention the existing operational 4GW of interconnection between Britain and its neighbours – bring the complexity and potential problems for the UK’s energy sector presented by Brexit into sharp focus.

The traditional model in Europe is for domestic transmission system operators (TSOs) to build interconnectors as part of their network investment, with the cost and revenues socialised across their consumer base. This “regulated” model reflects the EU legal framework underpinning the internal energy market (IEM), which anticipates ownership of interconnectors as part and parcel of a TSO’s regulated asset base, and requires third party access, regulated pricing and restriction on use of revenues.

However, EU rules allow a developer to become an interconnector TSO and apply for exemption from these requirements. This enables interconnectors to be built on a “merchant” basis, with full revenue (price and volume) risk taken by the developer outside of the TSO regulatory regime. This merchant route has been popular in the UK.

The cap and floor regime is a third approach, introduced by Ofgem and its Belgian equivalent in 2014 to facilitate the development of the Nemo link. This regime sits alongside the merchant route, and is designed to achieve a sharing of risk between the developer and consumers on one or both sides of the link.

The EU’s Energy Union Energy Strategy, launched by the Commission in 2015, includes a minimum 10 per cent electricity interconnection target for all member states by 2020, and 15 per cent by 2030. Since the current UK interconnectors represent around half this 2020 target, and one-third of the 2030 target, the promotion of UK interconnectors has been a priority of the EU.

And that’s been backed up by hard cash. The Trans-European Networks for Energy (TEN-E) strategy identifies the need for infrastructure development to strengthen cross-border interconnections, and every two years a list of projects of common interest (PCIs) is drawn up. These projects benefit from access to billions of pounds of European funds.

Back in Westminster, new power interconnectors have also been a priority.

The National Infrastructure Commission’s report “Smart Power” (March 2016) emphasised the importance of interconnection. Imports offset the need to build power plants and enhance security of supply, which is of particular significance given the nuclear new-build delays, and the speed at which the UK is weaning itself off coal.

How will all this be impacted by Brexit?

Crucially, existing interconnectors allow the UK to participate in the IEM, delivering tariff-free cross-border trading, and give consumers access to cheaper supplies from neighbouring countries. That also enhances security of supply, and not just for the UK – we’ve seen that recently in France. Interconnector flows are optimised by market coupling, a key feature of the IEM, which provides for the implicit allocation of day-ahead capacity – and, in due course, within-day capacity. If the UK comes out of the single market and hence the IEM, it is very hard to see how its power markets can remain coupled.

In any event, even if the UK continues to interact with the IEM on some basis, it will likely lose influence. Acer and the European networks of transmission system operators (ENTSOs) have key roles to play under the IEM rules, yet ongoing participation by non-member states or their TSOs is currently limited, either to observer status or by restricted voting. The UK would surely need to negotiate some form of ongoing participation, at the very least membership of the various working groups.

Furthermore revenues, and of course consumer prices, might be expected to be impacted by any imposition of tariffs on cross-border flows. New tariffs are perhaps unlikely, not least because tariffs are set at zero for electricity imports under WTO rules (and 0.7 per cent for gas, which is not applied by the EU), but other forms of non-tariff restrictions on cross-border trading are a possibility.

Perhaps more significantly, unless the UK remains bound in some way by the IEM rules, it is difficult to see how any new interconnectors can be built by independent developers other than through the merchant exempt route. That would probably require developers to sell long-term bankable capacity rights under open season processes.

And then, of course, there is the funding. The PCI list is due to be updated this year, and it is conceivable that UK projects might lose their PCI status. The impacts in terms of loss of CEF and other EU funding and commitments are unclear. Furthermore, the EIB has invested more than €31.3 billion in the British economy, of which €9.3 billion was invested in the energy sector (more than any other sector in the UK). While the EIB does lend outside the EU, that is currently limited to only 10 per cent or so of its current lending. Given that the Energy Union Energy Strategy is primarily concerned with the promotion of interconnection between member states, it is perhaps unlikely that post-Brexit EIB funding lines would be made available for UK interconnector projects unless, as part of a Brexit deal, the UK remains a shareholder of the EIB and the EIB remains appropriately mandated.

With Brexit negotiations now underway, albeit substantive trade talks still yet to begin, the energy sector will come to the fore at some point soon, and in every physical sense interconnectors are at the sharp end. With a high degree of mutual benefit, especially around security of supply, a “technocratic” solution is to be hoped for. However, the EU has consistently warned that the UK will not be allowed to “cherry pick”, and it is not presently clear to what extent the UK’s ongoing involvement with the IEM can be disentangled from freedom of movement, the ECJ and the other political hot potatoes.