This site is part of the Informa Connect Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 3099067.

Competition Law
search
Energy

A Surge in Uncertainty – the Impact of Brexit on the Energy Sector

Posted by on 31 August 2016
Share this article

On 23 June 2016, the UK voted to leave the European Union (EU). Despite widespread coverage of the broader implications of Brexit, the ramifications for the energy sector have received relatively limited coverage in the EU referendum debate and aftermath.
The UK Prime Minister, Theresa May, has insisted that “Brexit means Brexit”.  However, what Brexit may entail, and the form and consequences of the eventual Brexit model, will have fundamental implications for UK energy supply and policy.

This article examines what Brexit may mean for the UK energy sector.  From the impact on the UK’s involvement with the Internal Energy Market (IEM), to the effect on regulation, funding and climate change, the consequences will be wide-ranging.

Internal Energy Market

The UK has long been committed to the single European energy market and has played an instrumental role in supporting the IEM.  As one of the first European markets to be liberalised, the UK experience influenced the EU’s Third Energy Package – the legislative framework which underpins liberalisation of the EU’s gas and electricity sectors.

Interconnectivity – reliance on cross-border networks may continue to affect UK energy policy

Whilst the outcome of any exit negotiations are not known, it seems unlikely that the UK Government would seek to sever completely its ties with the EU. Such a move would put at risk the UK’s ability not only to access international energy at competitive prices, but also to benefit from greater market efficiency and improved security of supply.

UK energy markets are deeply integrated with that of its European counterparts.  Supply security is assured, at least in part, through physical links to the EU via a number of electricity and gas interconnectors, such as IFA (the interconnector between France and England) and BritNed (the interconnector with the Netherlands). Several more projects remain in the pipeline.

Consequences of leaving the IEM

Should the UK withdraw fully from the IEM – a radical, but not implausible eventuality – existing and future UK interconnectors may be affected. As well as clear financial and commercial consequences, interconnector contract terms would likely also need to be renegotiated. Interconnectors would no longer be caught by the applicable regulatory framework; alternative bilateral arrangements would be needed to address questions such as whether UK interconnectors could enter the EU capacity market auctions and whether or not they would continue to be bound by restrictions on selling capacity on a long-term basis.

Interconnectors also play a key role in enabling more efficient renewables integration in the UK, allowing access to cheaper sources of renewable generation. Renewable technologies, such as offshore wind and solar, are intended to allow the UK to increase power exports via interconnectors. Continued access to, and expansion of, interconnectors and the IEM are critical to the current and future success of UK energy policy and security.

In a ‘hard exit’ scenario, the UK may also be excluded from “market integration initiatives”, such as market coupling (packaging electricity together with interconnection capacity), cross-border balancing (the process whereby TSOs balance the differences between supply and demand by accessing energy in other Member States) and cross-border participation in capacity mechanisms (measures taken by Member States to ensure sufficient electricity supply to meet demand).

In combination, the political, economic and regulatory uncertainties associated with Brexit have the clear ability to increase investment costs in interconnector projects; deferral or abandonment of investments is also possible.  In turn, such an outcome could negatively impact UK energy costs and security of supply resilience.

Regulatory Bodies – continued influence in the institutional pillars likely to be difficult

Irrespective of the form Brexit eventually takes, it is difficult to conceive that the UK could continue to influence future European energy codices and regulatory instruments with which it will be required to comply.

In other words, unless the UK negotiates continued membership of the EU energy institutional framework – for example ACER (the Agency for the Cooperation of Energy Regulation), CEER (the Council of European Energy Regulators), ENTSO-E and ENTSO-G (respectively, the European Network of Transmission System Operators for Electricity and Gas), UK influence over the institutional architecture of EU energy policy will disappear.

Third Energy Package

Given UK commitment to a liberalised energy policy, continued adherence to the key provisions of the Third Energy Package is likely. Indeed, if the UK wishes to retain full access to the IEM, full compliance with key Third Package measures – including separation of Transmission System Operators (TSOs) from generation, production and supply interests, and enhanced transparency requirements – will be required.

Even in a “hard exit” scenario where the UK remains outside of the IEM, it is reasonable to expect that UK energy rules and policies will remain largely aligned with those of the EU for a variety of practical and economic reasons. Nevertheless, the UK may seek to modify certain aspects of the regulatory framework in order both to reflect UK-specific policy considerations, and to ensure that the energy market liberalisation envisaged by the Third Energy Package can be achieved through more flexible rules.

Energy Trading – continued adherence to EU rules is likely

Businesses wishing either to transport gas or electricity to the EU via interconnectors, or to continue trading energy on a pan-European basis, will remain bound by the relevant EU rules. Not least, UK companies wishing to trade in European energy products post-Brexit will need to comply with the EU Regulation on Energy Market Integrity and Transparency (REMIT).

REMIT is a central aspect of energy trading regulation in the EU.  It aims to detect and deter market abuse and insider trading in the European wholesale energy market.  REMIT requires energy market participants, whether or not established or resident in the EU, to register and report wholesale energy market transactions.

State Aid and EU Funding – uncertainty for transitional and future funding

EU state aid rules affect renewable energy subsidy regimes, including contracts for difference and capacity mechanisms. Under all Brexit models save for the EEA option (the “Norway” option), EU state aid rules would no longer apply to the UK, and subsidies granted by the UK Government would not be prohibited.  Nevertheless, and irrespective of the post-Brexit model, any arrangement will undoubtedly involve some acceptance of state aid rules. Indeed, even the WTO option contains a WTO subsidy regime, albeit that the relevant provisions are narrower in scope than EU state aid rules. This would therefore make it easier for the UK Government to intervene to subsidise domestic undertakings.
The more immediate questions facing UK businesses, however, concern the status of financial support awarded to energy projects prior to Brexit, as well as the continued role of the European Investment Bank (EIB).

Whilst it is unlikely that any UK funding for existing projects would be unwound – indeed, the expectation is that the UK Government would “grandfather” such support to minimise the damage to investor confidence – the position is less clear for UK projects funded by EU institutions. Much will depend on the terms of the credit or investment agreements, and whether Brexit has rendered the EU funding in question unlawful.

Similarly, whether or not the EIB will continue to fund key projects in the UK remains to be seen. With a 16.11% shareholding, the UK is one of the main shareholders in the EIB (whose shareholders comprise the 28 EU Member States). According to a statement issued by the bank following the UK’s vote to leave, “at present the UK shareholding in the EIB remains and the EIB’s engagement in the UK is unchanged”.  The EIB will therefore continue to lend money to UK projects until the remaining Member States reach a decision on the UK’s EIB shareholding. Post-Brexit, the EIB would still be permitted to fund projects in the UK; however, precedent suggests that the extent of the EIB funding for UK projects would fall in favour of support for projects in the remaining Member States.

There is also some uncertainty around the Commission’s position in respect of ongoing state aid investigations and the UK’s approach to past state aid enforcement decisions. However, the usual timeframe for in-depth state aid investigations is approximately 18 months and the UK’s withdrawal from the EU will take two years once Article 50 of the Treaty on European Union is triggered.

As such, we would expect the Commission to adopt a “business as usual” stance toongoing state aid investigations. In turn, the UK is unlikely to retroactively change its approach to any adverse state aid decisions, not least because of the influence these decisions will have had on investment decisions and contractual arrangements.

Climate Change – UK commitment to emissions reduction likely to remain

Emissions

The EU Emissions Trading Scheme (ETS) has been a central market-based mechanism aimed at reducing emissions cost-effectively in the EU. To the extent that the UK is outside the IEM, it would no longer be able to participate in the ETS. Transitional and linking arrangements would need to be negotiated, whereby a UK emissions trading scheme is linked to the ETS. Conversely, under the EEA model the UK would retain access to the EU cap and trade scheme.

Renewables – business as usual or does decline of DECC signal a change of course?

The EU Renewable Energy Directive requires the UK to generate 15% of its energy from renewable sources by 2020. There is also an EU-wide target for reducing carbon emissions by at least 40% from 1990 levels by 2030. Whilst leaving the EU would release the UK from these targets and therefore give the UK greater flexibility to shape its energy policy, the impact on the UK’s climate change objectives is unlikely to be significant: the UK would still be bound by both national and international obligations.

(i)    National
At the national level the Climate Change Act 2008 commits the UK to achieving an 80% reduction on 1990 greenhouse gas emissions levels by 2050, and to supplying 15% of domestic consumption from renewables by 2020. This domestic obligation would continue to apply in any Brexit scenario.

Future carbon reduction targets have also been recently endorsed. Even in the midst of the political and economic uncertainty following the EU referendum, the UK Government reinforced its commitment to the UK’s climate change goals by adopting the legally binding Fifth Carbon Budget. This Carbon Budget set a target of reducing carbon emissions 57% by 2030 on 1990 levels, contrasted with the EU’s target of 40% by 2030.
Despite the reiterated commitment to the Carbon Budget, one of the first acts of the new Prime Minister, Theresa May, was to abolish the Department of Energy and Climate Change (DECC).  DECC’s functions and staff have been transferred to the newly created Department of Business, Energy and Strategy.  This decision has been criticised for raising questions as to who should be responsible for ensuring compliance with the statutory requirements to reduce carbon emissions and which Government Department would take responsibility for the energy and climate aspects of negotiations to leave the EU. It remains to be seen how these issues will be addressed and the impact they will have on the UK energy sector post-Brexit.

(ii)    International
At the international level, the UK would be subject to the United Nations Framework Convention on Climate Change and the recent Paris Agreement.  However, Brexit would require the UK to separate its own emissions reductions targets from those of the EU because it would need to have bilaterally agreed targets without EU membership. The UK will also be required to submit its own Nationally Determined Contribution (NDC), and the EU to re-submit its NDC to reflect the end of the UK’s contributions, unless the UK and EU reach an agreement on joint fulfilment.

Fundamentally, the UK has a long-standing commitment to climate action, illustrated by the fact that the UK’s requirements for setting carbon emissions are undoubtedly tougher than those set at EU level. Whilst it remains to be seen whether or not emissions targets will be adhered to as vehemently if the threat of EU-imposed fines is removed, the UK’s support for renewables is likely to continue.

Environment – UK commitments likely to persist post-Brexit

Since joining the EU, the UK has implemented a series of EU Directives on environmental issues, ranging from habitats and birds through to air pollution.

Of particular relevance for power generators is the EU Industrial Emissions Directive 2010 (IED), which has been implemented into UK law.  The IED requires operators of certain industrial and combustion plants to obtain environmental permits regulating emissions into the environment and waste disposal. If power generators are unable to meet the strict emission limits on pollution through abatement technology or if such investment is not considered cost effective, plants will be required to close down.

The provisions primarily affect UK coal-fired power plants and older gas plants which are expected to close by 2023. The extent to which the IED will continue to apply post-Brexit remains uncertain because the UK could choose to dis-apply certain aspects in order to meet revised energy policy goals.  However, air pollution is high on the UK political agenda making it probable that the IED would remain in force. The UK Government’s recent announcement that it intends to close all coal-fired power stations by 2025 suggests that, even if the UK does not retain access to the IEM, the impact of Brexit is likely to be limited.

Leaving the EU will cause significant uncertainty in terms of environmental policy and legislation in the UK. Whilst there is the potential for repeal or significant amendment of many of the UK’s environmental laws, the UK will remain bound by international agreements to which it is a party in its own right, such as the Kyoto Protocol and the Aarhus Convention. As such, while the source of any future environmental regime may change, the fundamental principles are likely to remain broadly similar.

Oil and Gas – less impact than some areas

Ostensibly, Brexit will have less impact on the UK’s oil and gas industry as a result of the relatively limited scope of EU regulations.

The upstream oil and gas markets are predominantly regulated by well-established UK legislation and international agreements, which would continue to apply post-Brexit.
In the downstream markets, however, the EU plays a key role in both the export and import of oil and gas to / from the UK. In the absence of a free trade agreement between the UK and the EU, these trades may be subject to tariffs.

Employment – can your business retain and attract the workers it needs?

The implications of Brexit in the energy sector will be far-reaching and not simply confined to sector specific concerns. Issues such as data protection, intellectual property and employment law will also be affected. For example, employment in the energy sector is heavily influenced by EU laws, including anti-discrimination legislation and the rules on the transfer of employees.

The freedom of movement of persons has been a prominent feature of the Leave campaign, leaving in question the degree to which the UK will agree to the continued free movement of workers. Such an arrangement will make it more difficult not only to move employees between projects in Europe as required but also to attract new skilled workers.
BLP’s detailed analysis of the key issues facing employers in the energy sector as a result of Brexit can be read here.

What next?  Risk assessment and proactive engagement are crucial

The full impact of Brexit on the UK energy sector remains uncertain. What is clear, however, is that the vote to leave the EU has created great political, economic and regulatory uncertainty for the energy sector.  This uncertainty is compounded somewhat by the possibility of a second Scottish independence referendum.

In the short term, the implications will be limited, with existing EU rules and legislation continuing to apply while the UK Government negotiates the terms of exit. In the medium to long term, however, the impact remains less clear.  Much depends on the terms on which the Brexit occurs, and whether there is a ‘hard’ or ‘soft’ exit.

To minimise uncertainty, industry participants should ensure that they take steps now to identify the key areas of EU legislation applying to their business, prioritise those areas and engage proactively with government and industry stakeholders – both in London and Brussels – to influence the final shape that Brexit takes.


James Marshall and Sonja Hainsworth

James Marshall is a Partner, and Sonja Hainsworth is an Associate in the award-winning Antitrust & Competition team at Berwin Leighton Paisner LLP.

Share this article

Sign up for Competition Law email updates

keyboard_arrow_down