Trading places – energy co-operation in a post-Brexit world

Whether or not Big Ben bongs to mark Brexit Day, celebrations could be shortlived because the pressure is on to agree a new trading relationship with the EU – quickly, says David Blackman.

It may seem as if Brexit is all over bar the shouting. And there wasn’t even much of that last week when the House of Commons nodded through the government’s EU Withdrawal Bill with barely a murmur.

The muted tone was in stark contrast to the dramatic scenes last spring when millions were tuning into the televised parliamentary debates on ex-prime minister Theresa May’s attempts to push through her withdrawal deal.

However, this apparent calm could prove deceptive as the EU and the UK gear up to negotiate the trade deal that will determine future relations between their economies.

For utilities, this will be a far more important stage than the wrangling over the ­withdrawal agreement.

The mist surrounding the negotiation process will start to clear next week, at least on the other side of the English Channel, with the European Commission due to publish its draft negotiating mandate.

Once it has been considered by the European Parliament, this document is on track to be signed off towards the end of the month. But the picture is less clear from the British side, says Sarah Williams, head of the Greener UK unit at the Green Alliance: “The way the negotiations are going to be structured is pretty unclear at the moment.”

Here, Utility Week explores the key issues that will be at stake over the course of this year as Brexit enters its next stage.

The internal energy market

Energy companies would ideally like to retain the closely intertwined relationship that the UK enjoys with the rest of the EU through its participation in the internal energy market (IEM).

However, this goal is complicated by the British government’s insistence that the trade deal should be concluded by the end of the year. In practice, this means a sketch agreement must be in place by the middle of this year, in order to give the EU’s various parliaments enough time to ratify it.

Silke Goldberg, a partner at solicitors ­Herbert Smith Freehills, is sceptical a deal can be concluded by prime minister Boris Johnson’s mooted deadline, which she labels “disastrous posturing”.

“It would help if the government didn’t stand around posturing and saying it will get it done in a year with no extension: by doing that they are effectively prolonging the pain,” she says.

The compressed timetable puts the onus on resolving the most pressing issues and kicking other matters into the long grass, which will probably include energy.

Shane Tomlinson, deputy chief executive of environmental consultancy E3G, says the concentrated timeframe will limit the scope of what can be achieved. “On timing, there is going to be a real sprint to conclude something by the summer.”

The logic of the timetable suggests this year’s negotiations will be the first of several phases over a five- to ten-year period.

Even though Goldberg sees “no ­insurmountable problems” in the way of concluding an energy deal, she agrees that the future UK-EU energy relationship will be dealt with in this first round. When negotiations start, the main issue will be how close the UK remains aligned to EU rules and regulations.

Most experts believe the outcomes for energy will closely reflect the nature of the broader deal on issues such as standards and trade that the UK eventually agrees with the EU.

Chancellor of the Exchequer Sajid Javid has signalled that UK companies must be ready for divergence from EU regulations.

And matters could be further complicated by Ursula von der Leyen’s decision to make her European Green New Deal the centrepiece of her five-year programme as ­president of the European Commission.

Tomlinson says: “The really important choice emerging for the UK government is about whether it wants to continue to play a part in that or diverges.”

The extent to which the government opts to prioritise the US or the EU when negotiating its trade deal will be the other key part of this equation, he says: “The question mark is whether the UK wants to pivot towards the US.”

Maximising the scope for co-operation between the UK and EU is important for ambitions to decarbonise the grid, says Tomlinson: “The ability of the UK to continue to trade freely with the EU is really important for maximising the potential of renewables.

“The real risk is of this becoming a drive for deregulation in the UK. From our perspective, prioritising a deal with the EU Green New Deal would be desirable.

“Given the quite tight timescale, there are going to be binary choices for the UK on whether it is prepared to access level playing field conditions or prioritise divergence and deregulation.”

The industry shouldn’t give up on hopes of close co-operation with the EU on energy matters, insists Tim Yeo, former chairman of the House of Commons energy and climate change select committee.

Pointing out that energy has historically not been subject to tariffs, he argues that the size of the Conservative majority gives the government a “huge opportunity” to ­preserve collaboration on energy.

“They ought to be able to say that energy is an area where we don’t need to have the same distance from the EU. It’s in the interest of both sides for it to be treated in a very different way. It wouldn’t be difficult for the government to depart from EU rules on manufacturing and services, but not on energy.

“Energy quite logically could stay in a separate silo – and it needs to. It’s not a good or a service like financial services.”

And Yeo, who now chairs the New Nuclear Watch Institute, says the EU and UK have shared geopolitical interest in co-­operation around energy security.

“We don’t know what is happening as far as Russia is concerned and east and central Europe remains quite exposed: we have a strong common interest which should transcend parochial concerns about Brexit.”

A senior legal source believes both parties would be cutting off their nose to spite their face. “On a common-sense basis, it would be really surprising if something sensible is not done,” they say. “In all areas, [the EU is] shoulder to shoulder with us. It’s hard to think they would want to create something different.”

But the Green Alliance’s Williams is less optimistic that the UK will be able to remain inside the IEM.

A presentation by the Commission’s taskforce for future relations with the UK concludes that Britain will leave the single electricity market and that the two parties will need to develop new mechanisms to govern relations in this area.

“If we are going for increased divergence, I don’t see how that will be possible. Participation depends on accepting certain rules and regulations. That will be one of the big questions. How that will be squared is ­difficult to see,” says Williams.

Interconnectors

The most tangible manifestations of the EU-UK energy relationship are the gas and electricity interconnectors, which have ­multiplied in recent years. Great Britain has five completed electricity interconnectors with mainland Europe and the island of ­Ireland, providing around 5GW of electricity interconnector capacity.

In 2018/19, the UK imported 5.4 per cent of its electricity demand through interconnectors with EU or EEA countries (Norway), and 40.7 per cent of its gas. This reliance looks set to increase as the UK becomes more reliant on intermittent renewable generation.

The growth of trade across interconnectors, which work on the basis that electri­city flows across borders wherever prices are higher, has been facilitated by the UK’s ­participation in the IEM.

Tariffs are unlikely to be a headache, given that the EU does not currently apply tariffs to energy imports from other countries within the WTO.

But with the UK no longer a member of the IEM, trading of electricity across the interconnectors will become less efficient, especially as the EU moves to allow hour-by-hour trading of electricity across its member states’ interconnectors.

The level of energy co-operation between the EU and the UK, which is currently embodied in the IEM, will be crucial for the “economic case for future interconnectors going forward”, says E3G’s Tomlinson.

Already, relationships between French and British regulators have deteriorated, with the former discouraging their system operators from engaging on interconnector schemes.

“They’re probably the most sceptical of all [the EU regulators],” says Herbert Smith Freehills’ Goldberg.

However, so far there has been little tangible impact on plans for future interconnectors, says a senior legal source. “There were a couple of projects that could have been canned and weren’t. It’s surprising that people are so gung-ho and basically assuming that it’s going to be okay.”

Goldberg agrees, but with a caveat. “It will happen eventually but it will take longer. Energy trading will be much more inefficient.”

Ireland

Northern Ireland is the part of the UK where concerns about post-Brexit power arrangements will be most acute.

The province could be heavily exposed by a collapse of the all-island Single Energy Market (SEM).

However, because the SEM is based on a bilateral co-operation agreement between the UK and Irish governments, rather than on EU legislation, trading should be able to continue if the UK leaves the IEM.

In a letter to former European Council chair Donald Tusk, Johnson included a UK commitment to “retaining the benefits of the Single Electricity Market”.

However, even if it doesn’t collapse, the operation of the SEM could become a lot more complicated in a post-Brexit world, warns Goldberg.

“If Ireland implements the Green Energy for All package and the UK is on an entirely different timetable, questions nobody has seriously addressed so far, the UK is at risk of being more quickly misaligned than it thinks.

“Northern Ireland is much more urgent than people think. I’m always astonished at how blasé people in Great Britain are about what is happening in Northern Ireland.”

The EU Emissions Trading System

Also on the industry’s agenda will be the extent to which the UK continues to participate in the EU Emissions Trading System (ETS). Like the IEM, the industry wants to remain closely aligned to what is now the world’s biggest ETS.

The government agrees but has a fallback position, mooted during the no deal preparations, which is for the UK to tax carbon. The industry is reluctant to go down this route, though, because of fears that this mechanism is more prone to political interference by chancellors tinkering with tax rates.

However, if the UK is to establish its own ETS, it must be established sometime this year, says E3G’s Tomlinson: “The timescales are really quite tight.”

Josh Burke, a fellow at the London School of Economics’ Grantham Institute, agrees that the best outcome would be to stay in the EU ETS if possible, but this will become more difficult the more that EU and UK rules diverge.

But the EU should want to retain UK participation, he says, pointing out that UK emissions account for around a tenth of all those traded within the ETS – a powerful contribution to the depth and liquidity of the mechanism.

The same logic makes it less worthwhile for the UK to set up its own emissions ­trading arrangements, Burke says: “If it’s a UK-only ETS it can be costly because it’s difficult to find counterparties to trade with and the volatility will go down as transaction costs go up. A standalone ETS would be the worst outcome.”