Impact of Brexit on the energy sector

Increasing interconnectivity with continental Europe will necessarily require cooperation with the EU internal energy market in any Brexit scenario. Because the Government has been at the forefront of efforts to liberalise and develop cross-border energy markets, we envisage that this cross-border policy direction is likely to endure.

The issue is particularly important in relation to the electricity sector in Northern Ireland which is highly integrated with that of the Republic of Ireland – through the existing Single Electricity Market (SEM) and the new I-SEM (Integrated Single Electricity Market), which is under development and scheduled for go-live in October 2018¹. Whilst the Government has stated in its position paper on Northern Ireland and Ireland that it is seeking the continuation of the SEM, the framework for doing so would need a special arrangement to be found. Indeed, in the draft of 19 March 2018 of the EU Withdrawal Treaty² (the draft Withdrawal Treaty), the EU and the UK have agreed in principle that certain EU laws governing wholesale electricity markets shall continue to apply in respect of Northern Ireland following Brexit (although notably the relevant annex is yet to be published).

In relation to Great Britain, the Government has recognised the benefits of coordinated energy trading arrangements in helping to ensure lower prices and improved security of supply³ and is therefore, seeking to retain as free as possible access to the IEM and to remain an influential player on energy in the EU⁴. However, a number of UK Government negotiating positions appear incompatible with full membership of the IEM (for example, leaving the internal market, ending the authority of the Court of Justice of the European Union and repatriating regulation to the UK). Continued participation in the IEM following Brexit would require an appropriate partnership with the EU and would be likely to involve the UK adopting - and complying with - the relevant European legislation. The UK may not have a say in the formulation and interpretation of the rules, unless the UK negotiates to remain part of the institutions which coordinate EU energy regulation, such as ACER, ENTSO-E and ENTSO-G. Any failure to cooperate might result in divergence of the British and EU energy regulatory regimes.

The Commission notice to stakeholders on the withdrawal of the UK and the IEM⁵ outlined some of the immediate implications if the UK withdraws from the EU without such a new agreement. For example the UK is expected to cease to participate in the allocation platform for forward interconnection capacity, the European balancing platforms and in market coupling. In addition, transmission system use fees are expected to be payable on all electricity imports and exports from the UK and participants based in the UK who wish to continue trading EU wholesale energy products will need to register with the Member State where they are active to ensure compliance with the regulation on wholesale energy market integrity and transparency (REMIT).

For Brexit to have an effect on UK prices, it would need to lead to consequences such as export tariffs imposed on EU gas flowing to the UK.

LNG import capacity is not fully utilised at present, but this is more of a supply and demand issue and unlikely to be connected to Brexit. LNG accounted for only 15 per cent of UK gas supply in 2017 compared to 23 per cent in 2016, but there is room for this to increase given current spare capacity. Whether or not the UK will be an attractive destination for spare LNG volumes is more likely to be driven by the price of gas in the UK market than any other factor.

Given the UK‘s liberalised energy policy, we expect that the UK will continue to implement and be supportive of many aspects of the EU’s Third Energy Package (an EU legislative package with the central aim of liberalising European gas and electricity markets). For example, the ownership unbundling requirements, which require the separate ownership and operation of electricity/gas transmission systems from any generation, production and supply interests, the level playing field and the standards of transparency. The Government also appears committed to market-based interventions in energy markets. We therefore consider that businesses should plan to continue to comply with these requirements.

If, as now seems likely, the UK does not remain part of the EEA, the EU State aid rules would no longer be directly applicable in the UK in their current form. However, the Government has indicated that it will transpose existing EU State aid law into domestic law following Brexit and that the Competition and Markets Authority will assume responsibility from the European Commission for State aid oversight and enforcement in the UK. There may be some scope for the UK to diverge from the EU rules over time, although this freedom might be constrained by the terms of a future UK-EU free trade agreement. Therefore, in the immediate aftermath of Brexit, we do not expect to see any significant change to the substance of State aid rules relating to energy infrastructure and support schemes.

The UK, as a WTO member, will also continue to be bound by the terms of the WTO Agreement on Subsidies and Countervailing Measures. The WTO regime disciplines the use of subsidies and regulates the actions which WTO members can take to counter the effects of subsidies. This regime, however, is not as onerous as existing EU State aid rules and we consider there to be at least a theoretical risk that enforcement action under WTO law would be taken in respect of subsidised energy which is exported from the UK.

Please see our Inside Brexit blog post for further discussion of State aid in the UK following Brexit.

When the UK commenced the Article 50 withdrawal process on 29 March 2017 by formally serving notice of its intention to leave the EU, it also initiated in parallel its withdrawal from the European Atomic Energy Community (Euratom) and the associated treaty (the Euratom Treaty).

The House of Lords’ EU Energy and Environment sub-committee report on the impact of Brexit on the UK’s energy security, published in January 2018, highlights that leaving Euratom’s regulatory umbrella has the potential to impact the UK’s current nuclear operations; including fuel supply, waste management, cooperation with other nuclear states and research. Changes to immigration policy may also adversely impact the availability of skilled labour, particularly engineers and professionals within the nuclear industry.

The draft EU Withdrawal Treaty includes proposals for the treatment of Euratom related issues in Articles 75 – 81. For further information, please see our blog post The Euratom aspects of the EU draft Withdrawal Treaty.

Government policy is to ensure the UK’s withdrawal from Euratom will not affect the robust nuclear security and safety requirements currently in place. The Nuclear Safeguards Bill, introduced to Parliament in October 2017, will set the framework for achieving this objective, by amending the Energy Act 2013. For more information, see our blog The plan for nuclear safeguarding post Brexatom. The Government has also asserted an intention to continue to fund nuclear research in the UK such as the Joint European Torus, Europe’s largest nuclear fusion device. In the future, the UK will need to negotiate the terms of nuclear cooperation with other Euratom members, and non-Euratom members (such as the USA and Japan) that the UK currently works with under frameworks established through Euratom.

Brexit, in whatever form, is unlikely to change the UK’s climate change goals; these are established at a national level under the Climate Change Act 2008. But there will, nevertheless, be important issues to settle. For example, at an international level the UK’s emissions reduction commitment would need to be disentangled from the EU target under the United Nations Framework Convention on Climate Change (UNFCCC) and the Paris Agreement. The UK would also need to submit its own Nationally Determined Contribution in respect of its intended climate actions under the UNFCCC processes.

Industry will wish to understand whether the UK will still be able to participate in the EU Emissions Trading Scheme (EU ETS). EEA members, like Norway, Lichtenstein and Iceland, participate in the EU cap and trade scheme, despite not being EU Member States. If the UK did not participate in the EU ETS, transitional and linking arrangements would be required, which would be particularly important for companies holding a surplus of allowances. The House of Commons Business, Energy and Industrial Strategy Committee⁸ has strongly recommended remaining in the EU ETS at least until the end of Phase III in 2020 (for more information, see our blog post on What to negotiate on energy and climate change?). As the 5th carbon budget adopted in 2016 assumes continued participation in the EU ETS, this will need to be revised if the UK leaves the EU ETS⁹.

Following Brexit, unless the UK remains part of the EEA, the UK would be released from its renewable energy targets under the EU Renewable Energy Directive and from EU State aid restrictions- potentially giving the Government more freedom both in the design and phasing out of renewable energy support regimes. The availability of funding from EU institutions may impact the deployment of innovative or capital intensive projects (for more information see below). However, given that the UK would still be bound by national and international decarbonisation obligations (see further above), it is anticipated that renewable and low carbon energy development would continue to form part of Government climate change policy.

The Government’s Withdrawal Bill will transpose EU-derived legislation into UK law upon withdrawal from the EU (for further information please see our Q&A on the UK and EU legal framework). Where EU law provides for the mutual recognition by EU Member States of rights derived under EU law, the UK will need to secure agreement from the EU in order to maintain the status quo. For example, this agreement will be necessary in relation to renewable energy guarantees of origin (REGOs) used as proof of an energy supplier’s fuel mix. Following the UK’s withdrawal from the EU, the UK would no longer constitute a Member State for the purposes of REGO recognition.

Operators of specified industrial and combustion plants are required under the EU Industrial Emissions Directive 2010 (IED) to hold environmental permits that are granted subject to conditions seeking to control, and gradually reduce, emissions/discharges into the environment and the generation of waste. Within the energy sector, the IED imposes strict emission limit values that have to be achieved (through permit conditions) which may require investment in pollution abatement equipment or where it is determined this is not cost effective, the plants will close down. This is having an impact on coal-fired power plants and many older gas plants which are expected to close by 2023 as they have selected a limited life derogation and can operate without abatement equipment until the end of 2023. Despite Brexit, it is nevertheless likely that unabated coal-fired plants will close, particularly as the Government has confirmed its policy to close all unabated coal-fired power stations by 2025. Similarly, the Medium Combustion Plants Directive 2015 (MCP) sets limits on emissions such as sulphur dioxide, nitrogen oxide and dust in relation to a smaller plant with a thermal input up to 50 MWth. Both the IED and the MCP have already been implemented into national legislation and therefore, the effect of the European Union (Withdrawal) Bill will mean that, in the short term, these regimes are expected to continue to apply to the UK following the UK’s withdrawal from the EU. In the long term the UK and devolved administrations will need to agree how to provide common frameworks to agree common standards following Brexit.  It is unclear at this stage how this will impact on the IED and MCP regimes.

There are a number of EU initiatives to promote investment in energy infrastructure which represent an important source of funding for UK projects. For example, European Investment Bank (EIB) investments in UK energy projects has been EUR 13.334 billion from 2010 to present¹⁰.

The draft EU Withdrawal Treaty currently envisages the continuation of such funding in respect of projects approved by the EIB before the date of the UK withdrawal. Following the withdrawal date, the draft Withdrawal Treaty envisages that the UK will cease to be eligible for new financial operations from the EIB reserved for EU Member States.

The impact on proposed new projects will depend on the project’s nature, including if it furthers EU policy. For example, the European Fund for Strategic Investment supports cross-border projects (such as interconnectors and pipelines) and such funding may continue to be available to third states.

In order to provide greater funding certainty, the UK Treasury has committed to underwriting all funding obtained via a direct bid to the European Commission and has expressly confirmed Horizon 2020 projects will continue to be supported, as well as structural and investment fund projects (such as the European Regional Development Fund and the Cohesion Fund), subject to certain conditions.

Without freedom of movement of persons, it may be more difficult to manage a flexible workforce, which can currently be moved from project to project within Europe depending on need. Industry body Oil and Gas UK are actively campaigning for a special immigration process for North Sea workers. It is unclear the extent to which Brexit would have an impact on employment laws which are derived from EU Directives. In the short term, very little is likely to change and although, in the medium to long term, UK and EU labour laws may well diverge to some extent, there is likely to be political and commercial pressure to retain, for example, anti-discrimination legislation and the key aspects of rules on the transfer of employees. One area which is likely to be reformed however, is the rules on holidays and working time which have had a particular impact on the off-shore sector.

In practice, the UK already has mitigation against security of supply risks built into the system. The existing import infrastructure allows multiple sources of supply via its three gas interconnectors and three liquefied natural gas (LNG) import terminals. As the infrastructure is already in place, we would expect operations and gas flows to continue as normal, irrespective of any Brexit.

Of greater significance will be issues such as expiry of long term supply contracts and restrictions, under the current regulations, on selling capacity on a long term basis. The tariff network code, which is being phased in from the 6 April 2017, restricts the price at which interconnectors can sell their capacity. Brexit may give rise to complex issues such as whether or not the interconnectors continue to be bound by such restrictions. Also of importance is the potential for the UK to lose the benefits of being part of key energy security mechanisms and institutions, such as the Early Warning Mechanism and the Gas Advisory Council, unless it can negotiate to retain its role and benefits in these.

For Brexit to have an effect on UK prices, it would need to lead to consequences such as export tariffs imposed on EU gas flowing to the UK.

LNG import capacity is not fully utilised at present, but this is more of a supply and demand issue and unlikely to be connected to Brexit. LNG accounted for only 15 per cent of UK gas supply in 2017 compared to 23 per cent in 2016, but there is room for this to increase given current spare capacity. Whether or not the UK will be an attractive destination for spare LNG volumes is more likely to be driven by the price of gas in the UK market than any other factor.