OPINION: Beware the effect of a ‘hard’ Brexit on the energy market

Alex Harrison, partner at Hogan Lovells, sees little clarity yet on the UK energy industry’s interactions with the Internal Energy Market post-Brexit. Be prepared for a crash

The UK government published its White Paper on the future relationship between the UK and the EU on 12 July. In that White Paper, the government reaffirmed its commitment to broad co-operation on energy after Brexit, but there continues to be uncertainty as to the form that this co-operation will take.

The White Paper contemplates the UK leaving the EU’s Internal Energy Market (IEM), but somehow ensuring continued energy trade over our inter-country interconnectors without automatic capacity allocation through the IEM system. Alternatively, the White Paper contemplates the UK continuing to participate in the IEM, using a common rulebook, to preserve existing trade over the interconnectors.

In effect, that means that all options for continued co-operation remain on the table and worryingly there is no indication of the UK’s preferred option, how it would work or the extent to which there is any sort of EU buy-in to the proposals.

The market expects power and gas to continue to flow between the UK and the EU 27 post-Brexit, but there is, as yet, no clarity on how this will work, how frictionless these trades will be and whether the result will be increased energy prices or energy price volatility.

Don’t forget, this all assumes that a “no deal” crash landing can be avoided and that is by no means certain in the current political climate.

Given what is happening at a macro-political level, a Brexit crash landing looks increasingly possible. It’s the worst case scenario for the UK’s energy markets.

UK electricity and gas trade with the EU 27 is worth approximately џ6 billion annually. About 80% of that trade is natural gas, but GB also imports electricity from the EU 27 (currently from France, Ireland and the Netherlands) with net imports equal to about 7.5% of total UK consumption and expected to increase if planned new interconnector capacity is delivered.

The UK exports some gas to Belgium and a significant amount of gas to Ireland (56% of its consumption) as well as electricity to France, Ireland and the Netherlands – although electricity exports are usually lower than electricity imports from these countries because UK wholesale electricity prices tend to be higher than those in the EU 27.

A bespoke solution will be needed for Ireland. Gas will need to continue to flow given Ireland’s high historic dependency on imports of UK gas and a solution will have to be found to avoid the collapse of the Single Electricity Market on the island of Ireland.

London had a leading role in electricity, gas, coal, oil and emission rights trading in Europe. Approximately 25% of global oil trading is conducted in London and the UK hosts one of the most liquid gas and electricity markets in the EU, covering physical trading, energy derivatives and clearing services. The London-based InterContinental Exchange (ICE) is one of the leading global energy exchanges and a main trading place for European energy futures. London also plays an essential role in determining essential energy market reference prices.

If the UK leaves the EU and Euratom on 29 March 2019 without a deal on transition or future trading arrangements – and unless both sides agree otherwise – all EU rules in the field of energy market regulation will cease to apply to the UK. UK-based operators will cease to participate in the rules that allow for physical interconnection of our electricity and gas markets, UK guarantees of renewable origin will no longer be recognised by the EU 27; and the UK will have to agree a new nuclear safeguarding regime to replace Euratom.

A Brexit crash landing will have a number of impacts on energy. It’s unlikely to mean that the lights go out, but it may well result in an increase in wholesale electricity prices and wholesale electricity price volatility. Interconnectors are not expected to stop flowing, but they will no longer do so on a frictionless basis. The UK will be free to choose its decarbonisation trajectory and pathway.

The EU may allow some level of access to the Internal Energy Market, but this is likely to be on a rule-taker basis. The EU has no tariff on electricity or gas imports from other WTO members, and as such flows of electricity and gas between the UK and the EU 27 would be tariff-free. However, this does not automatically extend to the supply of energy plant and materials across EU/UK borders, which would be subject to tariff barriers.

The continuation of London’s leading role in European electricity, gas, coal, oil and emissions trading will depend on whether a market-access solution can be agreed for financial services, but on a crash-landing the immediate consequence is that UK authorised firms may be unable to trade freely in the EU single market.

First published in the August 2018 issue of New Power Report

Further reading

The UK faces a bleak energy future outside the EU’s internal market

Neuconnect takes forward plans for Germany-GB Interconnector

A Brexit conundrum for the electricity sector

Don’t let Brexit lead to offshore skills shortage, MPs warned

Brexit ‘could expose companies to costly IT changes’

Clean energy is the UK’s biggest Brexit opportunity