Top Banner
BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE ENERGY SECTOR Till Brexit do us part
28

BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

Mar 05, 2018

Download

Documents

vonhu
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Page 1: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

1Brexit Insights – The impact of Brexit on the energy sector

BREXIT INSIGHTS – THE IMPACT OF BREXIT ON

THE ENERGY SECTORTill Brexit do us part

Page 2: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

2 Brexit Insights – The impact of Brexit on the energy sector

Executive Summary 3Introduction 5International Law 6Paris Agreement 6

EU Law 8Internal Energy Market 9

EU Greenhouse Gas Emission Targets 11

EU Emissions Trading System 11

Effort Sharing Decision 12

Renewable Energy Directive 13

Energy Efficiency 14

Euratom 15

UK Law 16Climate Change Act 16

UK’s 2016 Electricity Generation Mix 17Coal 17

Nuclear 18

Gas 20

Renewables 22

Interconnectors 23

Conclusion 26

Page 3: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

3Brexit Insights – The impact of Brexit on the energy sector 3Brexit Insights – The impact of Brexit on the energy sector

Executive Summary

The UK’s exit from the EU is the defining issue of our time. The negotiations have an unprecedented complexity, and there will remain for an extended period a great deal of uncertainty over how Brexit will play out and its impact on sectors of our economy. This is as true of the energy sector as any other.Of key relevance is the inescapable truth that the UK’s energy system is heavily integrated with that of continental Europe, and Ireland. Connected by subsea electricity interconnectors and gas pipelines, the UK’s energy security of supply has a mutual dependency on that of our close neighbours. Furthermore, as a result of the liberalisation of the energy markets across Europe, the key players in the UK’s energy sector are typically pan-European utilities, with interests across the Continent.

It is also noteworthy that the UK has played a pivotal role in the development of many of the EU’s policies in this area. In particular, it was an early mover in decarbonisation efforts and especially in the deployment of renewable energy, notably offshore wind, helped by a domestic agenda which includes self-imposed long term binding targets, very much in alignment with EU targets.

So with all of this in mind, what priorities do we see for the UK’s negotiating team, and what changes might we expect to see as the UK adapts its domestic energy policy agenda to align with a post-Brexit world?

We think this much is clear:

• Due to the UK’s Paris Agreement climate change commitments, it is unlikely that the UK will decide to reverse moves to decarbonise its economy. Post-Brexit, the UK will either need to submit its own National Defined Contribution or agree with the EU to enter into a joint fulfilment agreement.

• As the EU’s second largest greenhouse gas emitter, if the UK left the EU Emissions Trading System (EU ETS) it would either need to increase its carbon price floor or set up its own system in order to secure continued decarbonisation.

Page 4: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

4 Brexit Insights – The impact of Brexit on the energy sector

• The UK’s carbon price floor (a UK-only top-up tax to the EU ETS) has resulted in the rapid demise of coal as a source of electricity generation. The growth of renewables (other than offshore wind) has been stunted by the reduction in government subsidies, resulting in a greater reliance on gas. However, as the carbon price floor only applies in the UK and not elsewhere in Europe (where generators are only subject to the EU ETS) gas fired power stations are not being built as the (less taxed) European electricity is cheaper. This is leading to a greater reliance on the interconnectors and a net energy deficit. Due to the deficit, the UK will have to interface with European electricity markets post-Brexit for the foreseeable future.

• Given the UK government’s anti-renewables and pro-nuclear decarbonisation policy, an association of some kind with Euratom will be necessary for (at least) an extended transitional period whilst the UK builds up its own nuclear regulatory capability. France in particular should be keen to ensure that a deal is done given its commercial interests in the UK’s nuclear industry.

• The benefits of remaining part of the Internal Energy Market (IEM) are so significant that staying in should be regarded as a priority. However, in the absence of a special deal as a non-EU member of the IEM the UK would lose voting rights and influence.

• The Republic of Ireland in particular should be keen to ensure that an IEM accommodation is reached given its reliance upon power imported from the UK.

• Brexit without IEM participation will make the construction of new interconnectors more difficult and expensive.

• The UK is unlikely to want to follow further iterations of the Renewable Energy Directive due to its nuclear-led decarbonisation policy and its aversion to mandatory renewables quotas.

• The UK is likely to follow EU product-related energy efficiency initiatives, but (due to the associated cost of compliance) not those that relate to the energy performance of buildings.

• What is unknown is the extent to which the EU will require compliance with the acquis (e.g. the Renewable Energy Directive) as a condition to any future trade deal.

In this paper, we provide some insights on these and other issues, and from the vantage point of the date of publication (August 2017) predict the key discussion points for the Brexit negotiators.

Page 5: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

5Brexit Insights – The impact of Brexit on the energy sector

Introduction

This critical linkage between our energy needs and decarbonisation efforts is in fact foreshadowed in European law. It is no coincidence that the energy section of the Treaty on the Functioning of the European Union (TFEU) (Title 21) immediately follows the environmental section (Title 20) – energy generation makes the single largest contribution to the EU’s (and the UK’s) Greenhouse Gas (GHG) emissions.

The Institute of Mechanical Engineers have estimated that the shutdown of the UK’s coal generators by 2025 (due to the Industrial Emissions Directive 2010) and the closure of the majority of our ageing nuclear power stations left a potential energy supply gap of 40%-55% in 2025 (“Engineering the UK electricity gap”, January 2016).

The National Infrastructure Commission (July 2015) identified an investment requirement of around £14-19 billion per annum in the electricity sector in the period to 2020, around 50% of which is in new capacity which, if delayed, could reduce supply security.

In determining how to meet its future energy requirement, the UK needs to work within the parameters of the Paris Agreement, EU law, and its domestic law. This paper seeks to explore the impact of Brexit in the context of these constraints and the UK’s resultant energy mix. Each section concludes with a number of key issues drawn from the analysis that will need to be addressed as part of the Brexit process.

Over the last decade, UK energy policy has been defined by reference to the trilemma of maintaining energy security whilst keeping energy affordable and achieving decarbonisation to slow the rate of climate change.

UK LAW EU LAW

EU targetsUK targets

Securityof supply

Nationaldefined

contribution

PARIS AGREEMENT

Decarbonisation

Mto

e

Transport 24%

Agriculture 10%

Wastemanagement

4%

Other4%

Residential 13%

Business 17%Energy supply 29%

0%Q1

2013 2014

Source: BEIS

20162015Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

5

10

15

20

CoalGasRenewablesNet importsOil and otherNuclear

UK 2015 GHG Emissions. Source: BEIS

Page 6: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

6 Brexit Insights – The impact of Brexit on the energy sector

which parties’ performance will be assessed. Each successive NDC has to progress beyond the previous one – this is the “no-backsliding” principle.

The UK submitted a joint NDC together with the other member states of the European Union (Member States). The EU’s NDC is to achieve an economy-wide reduction in domestic GHGs of at least 40% of 1990 levels by 2030. The Paris Agreement specifically requires that, when submitting its NDC, the EU had to notify the emission levels allocated to each Member State. However, in the event this was not done; the Council of the European Union’s decision on the ratification of the Paris Agreement merely stated that “the joint action by the Union and its Member States

International Law

Paris AgreementThe United Nations Framework Convention on Climate Change (1994) (UNFCCC) established a framework for how future international treaties (called “protocols” or “Agreements”) would be structured to set binding limits on greenhouse gases whilst setting no binding limits on GHG emissions for individual countries or enforcement mechanisms. This led to the Kyoto Protocol (dealing with GHG emissions in the period 2008-12), the Doha Amendment (for the period 2013-2020, which is not yet in force due to an insufficient number of ratifications) and most recently the Paris Agreement (for the period 2020 onwards), which entered into force on 4 November 2016 and has the target of reducing the global average temperature increase to below 2˚C above pre-industrial levels and working towards a limit of 1.5˚C by setting a further target for net zero global emissions in the second half of the century.

The Paris Agreement is legally binding in forcing governments to accept and cater for the 2C limit. However, the commitments on curbing GHG in line with that goal are not legally binding, and there are no sanctions for breach.

Although signed in 2016, the Paris Agreement commitments are framed in cycles that begin in 2020, allowing a 4 year period in which to negotiate the rules on implementation. National Defined Contributions (NDC) are submitted every 5 years, and represent the benchmark against

The key piece of international law affecting the energy sector, underpinning national efforts to combat climate change through both mitigation and adaptation, is the United Nations Framework Convention on Climate Change, and the Paris Agreement which derives from it. Since the UK’s international commitments here are heavily entwined with those of its fellow EU member states, Brexit will require some effort to disentangle and restate the UK’s obligations.

Low carbon electricity’s share of generation in the UK

55%

50%

45%

40%

35%

30%

25%

0%Q1

2013 2014

Source: BEIS

20162015Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Page 7: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

7Brexit Insights – The impact of Brexit on the energy sector

will be agreed in due course”. Member States are currently still engaged in internal negotiations over their respective allocations within the EU’s NDC.

Once it officially leaves the EU, the UK will need to submit its own NDC, unless the UK and the EU agree on a joint fulfilment agreement. This will depend on whether the UK remains part of the EU Emissions Trading System (EU ETS). If it does, then a joint fulfilment agreement will be necessary unless and until Paris Agreement accounting rules are set up under Article 6 to allow the UK to bring its EU ETS trading activity directly into account. The joint fulfilment approach was the one taken by Iceland when it ratified the second commitment period of the Kyoto Protocol; Iceland participates in the EU ETS through its membership of the European Economic Area (the EU plus Iceland, Liechtenstein and Norway) (EEA).

The Paris Agreement does not provide the option for parties to resubmit their NDCs. It only provides that parties may “adjust” their existing NDCs “with a view to enhancing its level of ambition” (Article 4.11). This would suggest that, if the UK chose not to follow the joint fulfilment option, its NDC would need to commit to more than the joint EU NDC. However, the UK has adopted a 57% GHG reduction target for 2030 through its fifth carbon budget under the Climate Change Act 2008, so (compared to the EU’s 40%) this should not cause a problem – apart from the fact that the UK currently has no effective strategy to meet it (see Climate Change Act below).

The EU has committed to an NDC covering the period to 2030. Whilst there are some legal uncertainties relating to parties withdrawing from a “regional economic integration organisation” such as the EU, there would appear to be nothing to stop the UK deciding to complete the first Paris cycle in joint fulfilment with the EU without changing anything, and then submit its own NDC in 2025 to cover the five years from 2030 (NDCs have to be updated every five years, the first such update required in 2025, five years after the Paris Agreement’s operational commencement date).

Key issues for the Brexit negotiators:

• Will the UK enter into a Paris Agreement joint fulfilment agreement with the EU or submit its own NDC ?

• Will the UK leave the EU ETS?

Given the United States’ newly hostile policy towards climate change, in a post-Brexit world it is conceivable that the UK government might follow its lead – at least to the extent that UK shale gas reserves offer the UK a cheap and plentiful carbon-based fuel supply (there is understood to be a plentiful supply but it may not all be economically accessible). However, there is currently no indication that the UK government intends to do so, and has repeatedly reaffirmed its commitment to the Paris Agreement and combatting climate change.

In the unlikely event that the UK did decide to withdraw from the Paris Agreement, it could do so in a number of ways. It could continue to participate in the process but not implement any of the necessary domestic policies to reduce emissions. It could also withdraw from the Paris Agreement on giving 12 months’ notice, but as notice to quit cannot be served until the Agreement has been in force for three years, the UK could not pull out until November 2020 at the earliest.

Page 8: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

8 Brexit Insights – The impact of Brexit on the energy sector8

EU Law

Against the backdrop of international obligations derived from the UNFCCC, the EU has sought to play a pivotal global role in driving forward decarbonisation efforts, but as part of a much more comprehensive drive towards the creation of a fully functioning internal energy market. After three successive packages of legislation, the internal energy market is well established but not yet complete, and for the UK the effects can be felt across a range of policy areas, not least in the integration of its power markets and infrastructure ownership, which makes the Brexit process particularly complex.

EU policy is derived from Article 194 of the TFEU, paragraph 1 of which is in the following terms:

1. In the context of the establishment and functioning of the internal market and with regard for the need to preserve and improve the environment, Union policy on energy shall aim, in a spirit of solidarity between Member States, to:

(a) ensure the functioning of the energy market;

(b) ensure security of energy supply in the Union;

(c) promote energy efficiency and energy saving and the development of new and renewable forms of energy; and

(d) promote the interconnection of energy networks.

Page 9: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

9Brexit Insights – The impact of Brexit on the energy sector

Internal Energy Market (IEM)Electrical and gas interconnection between countries enables the trading of energy across the borders. The EU’s IEM strategy aims to achieve the harmonised, tariff-free trading of gas and electricity across Europe.

The Third Energy Package 2009 (which has the central aim of liberalising the European commodity markets) included the following measures:

• the unbundling of energy suppliers from the network operators

• strengthening the independence of national regulatory authorities (NRAs) from industry and government

• establishing the Agency for the Cooperation of Energy Regulators (ACER) – an EU body with legal personality which monitors the internal markets in energy and gas and has a role in market monitoring under the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT). It also makes recommendations to the Commission regarding market regulation and priorities for transmission infrastructure

• cross-border cooperation between transmission system operators through the European Network of Transmission System Operators for Electricity (ENTSO-E) and European Network of Transmission System Operators for Gas (ENTSO-G). These produce the Network Codes i.e. the connection codes relating to connection to the transmission grids, the operating codes relating to the operation of the pan-European electricity systems, and the market codes facilitating electricity trading across European borders. These are based upon framework guidelines developed by ACER, and the codes are subject to ACER’s approval prior to their adoption. ENTSO-E and ENTSO-G also coordinate the planning of new network investments and monitor the development of new transmission capabilities.

The liberalisation of the energy market is a work in progress, and the UK has been a leading force in designing the IEM and liberalising European energy markets. The UK has made it clear that it wants to maintain harmonised trading arrangements for energy post-Brexit, and as such, it is unlikely that it would wish to reverse any of the measures introduced to date.

The core institution of the IEM is the market coupling mechanism, which couples the cross-border trading of energy and the allocation of the necessary transport capacity together in one implicit auction, allowing energy availability in one country to cover energy demand in another country with a higher price level, thereby optimising the use of lower cost available power generation plants at the most efficient price.

Without market coupling, trading can continue on a bilateral basis, but many of the potential trade gains are lost. Without automated arrangements the arbitrage is inaccurate, leading to larger and more volatile price differentials. As generation from intermittent sources such as low carbon renewables increases, so will the necessity for market coupling to accurately match supply and demand as cost-efficiently as possible.

If the UK stays in the IEM, then nothing much will change other than it will have less influence in relation to its future development. Both the key regulatory body ACER and the Council of European Energy Regulators (CEER), (a not for profit association under Belgian law whose objective is to facilitate co-operation among Europe’s energy regulators in promoting a single electricity and gas market that works closely with ACER), do allow non-EU/EEA countries to participate, but only as observers without voting rights.

Whilst the UK’s membership of ENTSO-E and ENTSO-G is not conditional upon the relevant Transmission System Operator’s (TSO) home state being a member of the EU, there are limits to the voting capacity of countries from non-EU members, namely they cannot exceed 28% of the

Page 10: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

10 Brexit Insights – The impact of Brexit on the energy sector

first part of the voting power (one country, one vote) and/or 35% of the second part (population-based) on day-to-day activities. Further, only Member States can vote on “All TSO” decisions, which cover proposals, methodologies and implementing measures for the Network Codes.

If the UK leaves the IEM, an alternative mechanism will need to be devised for the UK to gain access to EU energy markets. Whilst the EU does not impose tariffs on the import of electricity from outside the Customs Union, it does in relation to the import of LNG (and nominally in relation to the import of gas).

Switzerland has over 120 bilateral agreements with the EU to secure Swiss access to the EU’s markets for goods but not most services. Subject to exceptions, Switzerland does not accept EU competition and state aid rules, but does contribute to the EU budget.

Negotiations are ongoing in relation to the bilateral deal to secure Swiss access to the EU’s energy market. The agreement would regulate cross-border electricity trading, harmonise safety standards, secure free market access and secure Switzerland’s membership of the various committees, and include the Third Energy Package.

However, the negotiation of any such arrangements can take a considerable amount of time. Negotiations with Switzerland had taken 7 years before they stalled following the 2014 Swiss anti-immigration referendum initiative (leading to Switzerland refusing to sign a free movement deal with new Member State Croatia) – a block that has recently been removed after the Swiss government decided in December 2016 to give up its EU quota proposal but instead require employers in sectors or regions with high unemployment to advertise vacancies to Swiss residents before they are allowed to recruit from abroad. The EU Commission has accepted that this proposal does not contravene the freedom of movement principle that “is the cornerstone of Union citizenship” and negotiations have

Key issues for the Brexit negotiators: • Will the UK be permitted to remain in the IEM?

• If so, what level of influence can it retain, or will it become a passive “policy taker”?

• Which parts of the acquis would the UK be required to adopt as a condition of IEM membership?

• Would the UK seek to emulate the Swiss IEM negotiation package to save time, or would it seek to negotiate its own deal from scratch?

• How will the island of Ireland be accommodated?

• If IEM membership is not possible, what alternative arrangements can be put in place to access the European energy markets in the time available?

now resumed, the results of which should help to inform any negotiation the UK will be having once negotiations on Brexit start in earnest.

The Republic of Ireland will be particularly keen for an IEM deal to be concluded quickly as it depends upon the flow of electricity and gas through its (direct and indirect) interconnectors with the UK. The island’s Single Electricity Market (SEM), established in 2007, operates as an integrated market under the bespoke but EU-compliant Trading and Settlement Code and is regulated by the Irish Commission for Energy Regulation in the Republic.

Post-Brexit, either the all-Irish energy market could continue to be subject to EU law on an exception basis, or the SEM could be granted a special status which would not subject Northern Ireland to the jurisdiction of the European institutions. Both solutions raise their own constitutional and political problems, linked not only to Brexit but also to the prospect of reunification.

Page 11: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

11Brexit Insights – The impact of Brexit on the energy sector

EU Emissions Trading System (EU ETS)The principal policy instrument for addressing climate change in the EU has been the EU ETS. It covers emissions from power stations and industrial plants, and operates a “cap and trade” mechanism. A cap on the total amount of greenhouse gases that can be emitted by all participating installations is set and allowances for emissions are then auctioned off or allocated for free and can subsequently be traded. If emissions exceed an installation’s allowances, it must purchase allowances from others who have a surplus. This allows the system to find the most cost-effective way of reducing emissions without significant government intervention.

The price of allowances in the system has historically been low and therefore had limited impact, but is expected to rise in future as the cap tightens to meet the EU’s 2030 target for an overall reduction in emissions of 40% below 1990 levels.

As the second-largest emitter, a withdrawal by the UK from the EU ETS would depress demand for allowances, and thereby exert downward pressure on the price of carbon. In the week following the Brexit referendum, the price of allowances dropped 25%.

The UK could remain a full part of the EU ETS if it joined the EEA, as Norway and Iceland have done. However, as a non-EU member, the UK would not be able to influence its evolution, and the negotiation of a linking agreement could take a significant amount of time.

If the UK left the EU ETS, the UK could resurrect its own Emissions Trading System (which it set up as a pilot scheme prior to the start of the EU ETS) and negotiate with the EU to link this to the EU ETS, as Switzerland is planning to do, or alternatively increase the carbon price floor (see Climate Change Act below) to increase the overall carbon price to its pre-exit level.

Key issues for the Brexit negotiators: • Will the UK seek to stay within or leave the EU

ETS?

• If the UK seeks (or is required) to leave, will the UK set up its own ETS, or otherwise adjust its carbon price floor to pursue its decarbonisation policy?

EU Greenhouse Gas Emission TargetsThe EU has committed to three targets for 2020:

• reduce emissions by 20% on 1990 levels (see EU ETS and Effort Sharing Decision below)

• provide 20% of its total energy from renewables (see Renewable Energy Directive below)

• increase energy efficiency by 20% from 2007 levels (see Energy Efficiency below).

These are examined in turn.

Page 12: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

12 Brexit Insights – The impact of Brexit on the energy sector

Effort Sharing Decision 406/2009/EC (ESD)Under the ESD, Member States have taken on binding annual targets for reducing their GHG emissions from the sectors not covered by the EU ETS. This includes transport, buildings, agriculture and waste (representing roughly 60% of the EU’s total GHG emissions).

Each Member State has an ESD target set according to its economic capacity. The wealthiest Member States are required to reduce their emissions by 20% below 2005 levels by 2020, and the poorest are allowed to increase their emissions by 20%. The overall EU target under the current ESD is a 10% reduction in GHG emissions by 2020 compared to 2005 levels. Subject to a limited degree of flexibility between years, if a Member State exceeds its annual emission allocation a deduction to its following year’s allowance is made equal to its excess emissions multiplied by 1.08. It is also required to submit a corrective action plan.

Member States are currently negotiating their national emission reduction targets for the period 2021-2030. The proposals currently envisage that the UK will reduce its non-EU ETS emissions by 37% by 2030 compared to 2005 levels.

A recent EU Commission-funded study (EU Climate Leader Board Policy Briefing, March 2017) indicates that only Sweden, Germany and France are “pushing in the right direction” on the proposed apportionment, with all the others trying to introduce loopholes, by starting from a misleading baseline, abusing forestry credits or exploiting the large surplus in the EU ETS. The UK comes a creditable fifth in the table after Cyprus (however, both the UK’s and Cyprus’ efforts are still deemed to be “insufficient”), with Spain, Italy and most of the East European Member States at the bottom.

Key issues for the Brexit negotiators: • If the UK enters into a joint fulfilment

agreement with the EU under the Paris Agreement, and remains in the EU ETS, would it also seek (or be required by the EU) to comply with the ESD?

What is apparent is that since the Brexit vote the UK is not taking a back seat but instead playing a full part in EU climate change negotiations, a prudent course of action given the possibility of the UK’s future participation in EU mechanisms post-Brexit.

Page 13: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

13Brexit Insights – The impact of Brexit on the energy sector

Renewable Energy DirectiveThe UK is also currently subject to EU-imposed renewables targets. The EU Renewable Energy Directive 2009 (RED) requires the UK to generate 15% of its energy from renewable sources by 2020, and at least 10% of final energy consumption in the transport sector must come from renewables.

A recast Renewable Energy Directive (RED II) is currently under discussion to update the RED for the period after 2020. It proposes an EU-wide target of 27% to replace the national targets, but with no binding Member State quotas (although Member States may not fall below their 2020 targets set under RED).

Renewable Energy Directive (to 2020) Renewable Energy Directive II (draft)

Renewables quota per Member State No binding Member State quotas

10% transport quota for biofuels 1.5% (2020) to 6.8% (2030) quota of low-emission renewable fuels in the transport sector including CO2-based fuels

Indicative target for advanced biofuels (0.5%) Minimum share of advanced biofuels 3.5% by 2030

7% cap on biofuels produced from food or feed crops Further reduction down to 3.8% by 2030

Sustainability criteria only for liquid biofuels Extension of sustainability criteria to biomass-based heating/cooling and electricity, as well as for forest biomass

Aviation fuels excluded from binding quota Aviation fuels now included in the transport quota, on the basis of 1.2x their energy content

In November 2016, a letter from Amber Rudd whilst she was Secretary of State at DECC (now BEIS), was leaked indicating that the UK might fail to meet its RED target by 3.5%. As such, and given UK law’s emphasis on the achievement of GHG reductions rather than the use of renewables as the means to meet those reductions, RED is likely to be one element of EU law which the UK is unlikely to wish to adhere to post-Brexit.

Although RED II does not further tighten the renewables quota obligation, this was largely due to the UK’s opposition to its inclusion and once the UK has left the EU further iterations of RED could reintroduce them. Further, whilst not increasing the overall quota obligation, RED II does tighten the sub-quotas. If the EU made it a condition to IEM membership that the UK complied with RED II, the UK might find itself subject to regulations over which it had no influence and which run counter to its domestic nuclear-led decarbonisation policy.

Key issues for the Brexit negotiators: • Will the UK abandon RED/RED II post-Brexit?

Page 14: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

14 Brexit Insights – The impact of Brexit on the energy sector

Energy EfficiencyThe Energy Efficiency Directive 2012 establishes a set of binding measures to help the EU meet its 20% energy efficiency target by 2020. All Member States are required to use energy more efficiently at all stages of the energy chain, from production to final consumption. On 30 November 2016 the EU Commission proposed an update to the Energy Efficiency Directive, including a new 30% energy efficiency target for 2030.

Many aspects of EU policy will need to be preserved or replicated at the UK level post-Brexit. The Ecodesign Directive 2009 sets standards for energy consumption across a wide range of domestic products, and the Energy Labelling Directive 2010 required products to display their energy consumption. Whilst UK manufacturers selling into the EU will need to continue to meet EU standards in any event, if the UK chose to relax the applicable domestic standards EU manufacturers may design and sell less energy efficient products into the UK market, especially where such products had a significantly lower capital cost.

The market for vehicles is EU-wide and regulations apply to the average of manufacturers’ sales across the EU and EFTA areas rather than by Member State. Therefore it is likely that the design of new vehicles sold in the UK will continue to comply with future EU standards to the extent that these require all vehicles to become more fuel efficient. However, manufactures may sell fewer low-emission vehicles in the UK if these do not count towards compliance with EU standards. Manufacturers may also not include some efficiency improvements if these are no longer mandated.

It is therefore thought unlikely that the UK would adopt sub-EU standards and is likely to track EU standards as they are introduced, the only possible exception being where, on the principle of diminishing returns, the necessity for further improvement in standards could not justify the resultant increase in capital cost.

Key issues for the Brexit negotiators: • To what extent will the UK allow domestic

product energy efficiency standards to deviate from EU standards?

• To what extent will the UK shadow EU building efficiency performance standards?

The Energy Performance of Buildings Directive 2010 puts in place measures to improve knowledge of buildings’ energy performance, and requires all new buildings to be “nearly zero energy by 2020”. Given that in July 2015 the UK abandoned its proposals to make new buildings “zero carbon” by 2016 (for domestic buildings) and 2019 (for non-domestic buildings) with applicable energy efficiency standards still currently “under review”, it is likely that this Directive will not find favour post-Brexit.

Page 15: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

15Brexit Insights – The impact of Brexit on the energy sector

which is leading research into nuclear fusion, is based in the UK and hosts the world’s largest operational nuclear fusion device. It also receives £48 million per year from the Euratom research fund. UK fusion research is likely to collapse unless an accommodation is reached to maintain future funding, collaboration and to allow the movement of specialist staff from Europe.

Post-Brexit, Euratom could establish an “association” with the UK (Article 206, Euratom), which is what it did with Switzerland in 2014. As an “Associated Country”, Switzerland pays a contribution to the EU budget and researchers and institutions in Switzerland are treated in the same way as any other partner from a Member State and able to receive EU funding. If the UK became an Associated Country, JET would stay in the UK and continue to be funded by Euratom.

Alternatively the UK could enter into a lesser form of cooperation through an “agreement or contract” with Euratom (Article 101, Euratom), and has been done with Russia and China on “research topics of mutual interest”. The difference between being Associated and having a cooperation agreement is that in the latter case the UK would not pay into the EU budget or receive access to EU funding.

EuratomThe European Atomic Energy Community (Euratom) was founded by the Treaties of Rome in 1957, with the aim of creating a European market for nuclear power for nuclear knowledge and resources in the peaceful pursuit of science and nuclear energy. All Member States automatically become members of Euratom.

Its functions include:

• the promotion of research on nuclear energy

• establishing and enforcing safety standards

• ensuring the supply of nuclear fuels to Member States

• ensuring non-proliferation of nuclear materials

• ensuring free movement of capital for investment in nuclear energy and free movement of employment for nuclear specialists.

The Euratom Supplies Agency owns and controls the supply of all fissile materials in Euratom’s Member States, and guarantees equal access to nuclear materials to Member States. The Euratom Safeguards Directorate ensures that nuclear materials are not diverted from their intended use.

Whilst technically Euratom is separate from the EU, since 1967 it has shared the EU institutions such as the EU Commission and European Court of Justice. The ambiguous manner in which Article 50 Treaty on European Union cross-applies to Euratom means that it might be possible to leave the EU without also leaving Euratom – but in order for this interpretation to make sense clarificatory amendments would have to be made to prevent the UK continuing to have full participation rights in the shared EU institutions following its exit from the EU. In any event, the UK has signalled its intent to withdraw from Euratom as well as the EU, so the debate on whether the UK could stay in Euratom post-Brexit would appear to be largely academic.

Britain’s nuclear facilities are currently monitored by inspectors from Euratom, which has a permanent monitoring presence at Sellafield. Euratom also reports to the International Atomic Energy Agency (IAEA) (which oversees global nuclear safety and security) on the UK’s behalf. Post-Brexit, the UK could set up its own monitoring function, seek to replace the Euratom inspectors with IAEA inspectors, or pay Euratom to continue to undertake its monitoring and reporting role.

One of Euratom’s most important research institutions, the Joint European Torus (JET),

Key issues for the Brexit negotiators: • How can the UK preserve the supply

of fuel, components and people to support its nuclear build programme?

• Will the UK seek Euratom “Associated Country” status?

• How will the UK fusion research be protected?

• How will the UK maintain its nuclear monitoring activities?

Page 16: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

16 Brexit Insights – The impact of Brexit on the energy sector

Climate Change ActThe UK’s non-EU domestic climate change legislation revolves around the Climate Change Act 2008, which established a long-term target for the UK to reduce its net GHG emissions in 2050 by 80% (from a 1990 baseline). The Act established a system of carbon budgets, each one spanning five years and set with a view to keeping the UK on track to its 2050 target. The fifth carbon budget was approved in the summer of 2016 (after the Brexit vote), and commits the UK to a 57% reduction in emissions by 2030 (from a 1990 baseline).

The Committee on Climate Change (CCC) is an independent statutory body established under the Climate Change Act to advise UK and devolved administration governments on setting and meeting carbon budgets, and preparing for climate change. It considers that the UK’s carbon budgets are at least as challenging as the EU’s commitments (see the CCC Report “Meeting Carbon Budgets”, October 2016).

The UK met the first carbon budget and is projected to meet its second and (by a narrow margin) third carbon budgets. However, there are projected shortfalls against the fourth and fifth carbon budgets of 146 MtCO2e and 247 MtCO2e, respectively. According to the CCC’s “Meeting Carbon Budgets” report (October 2016), current policies are likely to deliver only half of the required emissions reduction to 2030, with a policy gap for the remainder. An Emissions Reduction Plan is

UK Law

Like the EU, the UK has sought to play a leading role on the global stage in its response to the climate change threat. By creating its own legally binding carbon reduction target, separate to the EU targets, the UK has sought to foster a stable long term political framework for the deployment for renewables and other low carbon technologies, which should bring some degree of certainty to investors during the disruption of the Brexit process. However, it remains to be seen whether this groundbreaking domestic legislation will remain unscathed when the EU energy aquis comes to be reviewed post-Brexit.

Key issues for the Brexit negotiators: • To what extent will the UK seek to follow or

abandon EU-led initiatives and rely upon the Climate Change Act and the carbon price floor to meet its decarbonisation goals?

expected during the course of 2017 to address how the shortfall will be met.

In response to a continued low EU ETS price the UK has introduced its own top-up carbon price floor to set a minimum level for the total carbon price, intended to be consistent with the decarbonisation path in UK targets. However, this is causing problems for the development of gas fired power stations as well as exporters of energy-intensive products such as steel and there are calls for it to be relaxed post-Brexit. The carbon price in the UK is around five times higher than the rest of the EU, which only has to pay for allowances under the EU ETS and currently cost around €5 per tonne of CO2.

The CCC recommends that the UK should not alter its Climate Change Act targets but should implement new policy to improve on EU-level approaches. It advises that the UK should either remain in or replicate those EU schemes which are currently working efficiently.

Page 17: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

17Brexit Insights – The impact of Brexit on the energy sector

UK’s 2016 Electricity Generation Mix

Mto

e

0%Q1

2013 2014

Source: BEIS

20162015Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

5

10

15

20

25

CoalGasRenewablesNet importsOil and otherNuclear

Coal – 9.1%Consumption of coal for electricity generation in 2016 was 59% lower than in 2015. This was due to the conversion of a third unit at the Drax power station from coal to biomass in July 2015 and an increase in the carbon price floor in April 2015 (see Climate Change Act above), which made coal-fired generation more expensive relative to gas-fired generation.

In 2012, 22% of electricity was generated by coal. In 2016, this had reduced to 9.1%. Indeed, 21 April 2017 (when the coal-fired West Burton 1 went offline for the day) was the first coal-free day since use of the fossil fuel for electricity generation in the UK began.

The Industrial Emissions Directive 2010 imposes strict emission targets that have to be achieved. The UK’s coal-fired and older gas-fired plants are expected to close by 2023 when their limited life derogation expires.

The carbon price floor has largely failed in its original goal of mobilising investment in clean energy such as wind and solar, but has resulted in shifting the energy mix from high-carbon coal to lower-carbon gas.

It is the carbon price floor that makes gas generation cheaper than coal; if it were removed, coal would be cheaper. However, once the coal-fired stations have been phased out there is a case for removing the carbon price floor as it adversely affects UK’s global industrial export competitiveness (see Policy Exchange’s “Next Steps for the Carbon Price Floor”, November 2016).

Key issues for the Brexit negotiators: • Will the UK seek to extend the life of UK coal

plant to maintain security of supply pending the construction of replacement generation units?

Interconnectors5.8%

Nuclear21.6%

Coal9.1%

Source: BEIS

Renewables22.3%

Gas 41.2%

Page 18: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

18 Brexit Insights – The impact of Brexit on the energy sector

14,0001 2 8 10 11 13 16 16 16 15 12 10 8 7 5 2 1

12,000

10,000

8,000

6,000

4,000

2,000

0

Inst

alle

d n

ucle

ar c

apac

ity,

MW

Source: BEIS

20352030202520202015201020052000199519901985198019751970196519601956

Nuclear plants online

Capacity

Approved

Nuclear – 21.6%The government announced the construction of eight new nuclear plants in October 2010 to replace the UK’s coal-fired plants and ageing nuclear fleet which is due to be decommissioned. Once built the new power stations will greatly assist the UK in decarbonising its economy and help meet its various GHG emission reduction targets.

Hinkley Point C (the UK’s first new nuclear power station for 30 years) now appears to be progressing and should provide 7% of our base-load when it opens in 2025, but it is too late for any of the other seven announced by the government in 2010 to be planned and built before the coal shut off target of 2025 (as required by the Industrial Emissions Directive).

Of these seven, five are under current development with the Toshiba NuGen plant at Moorside, Cumbria and the Hitachi Horizon plant at Wyfla, Anglesea the most progressed. However, the NuGen plant is now

Interconnectors5.8%

Nuclear21.6%

Coal9.1%

Source: BEIS

Renewables22.3%

Gas 41.2%

Page 19: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

19Brexit Insights – The impact of Brexit on the energy sector

in doubt following Toshiba’s $63 billion writedown on its nuclear business, and the other plants may not materialise as the government has indicated that the (in 2017 prices) £100/MWh promised to Hinkley Point C (double the average strike price) will not be repeated with the other plants, which the government expects to offer strike prices in the region of £80/MWh. Whether these can be delivered for that price will depend upon the level of public sector risk and financial support to offset the cost of capital (which in Hinkley Point C’s case was underwritten by EDF and China General Nuclear).

The approval of the investment in the Hinkley Point C reactor by the European Commission involved regulation from Euratom and competition issues from the EU in relation to agreeing a guaranteed high strike price. Leaving the EU could make investment rules more flexible for the UK, and allow the UK to offer more support to future projects without reference back to the European Commission, but this will have to be balanced against the increased difficulties for the nuclear supply chain working in the UK and the decreased mobility of qualified staff needed from the EU. It is also likely that compliance with EU’s state aid rules will be made a condition of IEM membership, as state aid can have a distorting effect on the energy market.

The builders of the UK’s new nuclear reactors will need to be sure they can get their fuel, components and people into the UK – currently all matters guaranteed by the UK’s membership of Euratom. Without transitional arrangements in place, the construction of the new power stations will inevitably stall.

Further, new trading arrangements will be essential for the existing fleet of power stations, which use imported fuel and components. Without the bargaining power of Euratom behind it, the UK is likely to be offered worse terms than it currently enjoys. There is also the timing issue; it will take years for these new arrangements to be

Key issues for the Brexit negotiators:

• How can the UK preserve the supply of fuel, components and people to support its nuclear build programme?

• Will the UK seek to resist state aid rules in the retained aquis in order to retain flexibility to support that programme?

• To what extent will France’s vested interest in the UK nuclear industry assist in reaching a deal?

negotiated. By way of example, it took 4 years in the 1990s to upgrade the Euratom-US co-operation agreement, and even then the deal could not be ratified before the previous agreement lapsed, which led to a three-month period when there was no transatlantic nuclear trade.

The (largely state-owned) French utility EDF is the sole operator of existing nuclear plants in Britain, and is also contracted to build Hinkley Point C. As such, for purely commercial reasons France (the driving force behind Euratom and which has 59 nuclear power stations – the second largest number in the world) has a vested interest in at the very least allowing sensible post-Brexit transitional arrangements between Euratom and the UK and in forging a future ongoing working relationship with the UK.

Page 20: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

20 Brexit Insights – The impact of Brexit on the energy sector

Gas – 41.2%Production of UK North Sea oil and gas has reduced by two-thirds over the last 17 years, in spite of new fields coming on stream and enhanced production efficiency.

Exploration drilling is at an all-time low, whilst the average discovery size has fallen dramatically, indicating that the UK North Sea is now becoming “super mature”. The low oil price has also hit company revenues and impacted upon the ability of the oil companies to invest, with nearly all discretionary expenditure being cut.

The strategic importance of oil and gas production to the UK’s security of supply led to the Infrastructure Act 2015 requiring all relevant persons, including industry and regulators, to “take the steps necessary to ensure the maximum value of economically recoverable petroleum is recovered from the strata beneath relevant UK waters”. Activities, behaviours and regulations which prevent this objective are now contrary to UK law.

In addition to conventional oil and gas, the UK has very large reserves of shale gas both onshore and offshore. Reserves of UK offshore shale gas may eventually exceed 1,000 trillion cubic feet, roughly the current gas consumption in the UK of 3.5 tcf each year. This would group the UK alongside Argentina, the US and China, which currently lead the world in terms of shale gas potential.

The extraction of onshore shale gas is currently cost-efficient using existing technology, but in a densely populated country such as the UK it can meet considerable local opposition. The UK government has however pushed ahead and granted drilling licences in spite of the objections from local communities and environmental groups.

The costs of extraction of offshore shale gas are far higher and meet the same barriers to exploration and extraction as conventional offshore oil and gas. Should the price of oil and gas rise this will change, and it is also hoped that in the course of time new technology will bring costs down to make offshore drilling more feasible.

Source: BEIS

Domestic

Others

Industries

Electricity generation

180

160

140

120

100

80

60

40

20

0Q1

2013

TW

h

2014 20162015Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

UK demand for natural gas

Interconnectors5.8%

Nuclear21.6%

Coal9.1%

Source: BEIS

Renewables22.3%

Gas 41.2%

So whilst shale gas (alongside nuclear power) may represent the UK’s future in terms of meeting its energy needs, it will not ease the UK’s energy gap in the short to medium term.

Page 21: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

21Brexit Insights – The impact of Brexit on the energy sector 21

Whilst depressed oil and gas prices have had an adverse effect on offshore exploration, the low gas price (combined with higher carbon taxes, which make it more expensive to produce power at coal-fired plants in the UK) have pushed UK gas-generated electricity output close to peak levels last recorded in 2010.

However, the (UK only) carbon price floor makes UK gas-fired electricity generators less competitive than their European counterparts which are not subject to this levy and can sell their power more cheaply to the UK over the interconnectors. This is acting as a brake on further investment in new gas-fired power stations in the UK, leading to a greater reliance on the interconnectors to meet the UK’s electricity needs.

In terms of access to gas supplies, unlike in the electricity sector, gas markets are already well integrated between the UK and Europe. Price differentials are small and the interconnection is not congested. The UK also has a diversified source of supply with varied import facilities accepting supplies from non-EU sources such as pipeline gas from Norway and LNG from Qatar.

The EU gas supply market is less integrated than the electricity market; there is no equivalent in gas of market coupling. As such, and given the UK’s location and supply sources, the cost of exclusion from the internal gas market post-Brexit is likely to be limited, with a couple of exceptions.

Key issues for the Brexit negotiators: • How will the UK protect its LNG trade if it

leaves the IEM?

• Would the UK wish to be part of the solidarity mechanism?

The first relates to import tariffs. The EU Customs Union imposes a tariff of 0.7% on gas imported from outside the union, although it does not apply the tariff in practice. However, it does impose a tariff on LNG imports at a rate of 4.1%, and given that the UK is currently running a £2.9 billion trade surplus with the EU in relation to LNG, without a deal the UK would find itself in a less competitive position compared to exporters from countries with which the EU has signed a free trade agreement.

Secondly, the UK could find itself excluded from EU solidarity principles proposed under the revision of the security of supply regulation (994/2010), which proposes that in the case of a severe crisis in one Member State, neighbouring Member States have to help ensure gas supplies to households and essential social services in the affected country.

CoalGasRenewablesNet importsOil and otherNuclear

Blane (UK)Field0.0 TWh

4.6TWh

5.9TWh

LNG7.0 TWh

LNG0.0 TWh

LNG Out1.1 TWh

LNG6.8 TWh

Source: BEIS

8.2 TWh

UK-BelgiumInterconnector

15.3TWh

NominatedBBL export,

Chiswick, Grove,Markham, Minke,

Windermere & Windgate

BBL 19.3 TWh

Langeled Pipeline68.1 TWhNTS

UK-IrelandInterconnector

Tampen Link & Gjoa/Vega

24.0 TWh

Vesterled Pipeline23.0 TWh

Ula Field(Norwegian)

Exports

NTS — National Transmission System for gas, including link to N. Ireland

Imports

Page 22: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

22 Brexit Insights – The impact of Brexit on the energy sector

Source: BEIS

Shoreline wave/tidal

Solar PV

40

35

30

25

20

15

10

5

0Q1

2013

Inst

alle

d C

ap

acit

y (

GW

)

2014 20162015Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Offshore wind

Onshore wind

Hydro

Bioenergy

Renewables – 22.3%The government’s Green Paper “Building our Industrial Strategy” (January 2017) stressed that it intends to move to an operating model which did not rely on subsidy but rather on “competitive markets”. The UK objected to the introduction of new mandatory renewables targets in RED II (see Renewable Energy Directive above) as this prejudices countries such as the UK which wish to decarbonise using nuclear power.

From the end of 2010 to the end of 2016 nearly all new power generation that came online was renewable. However, the growth in renewable generation slowed as subsidies for green energy were cut back following a marked policy shift away from renewables (except offshore wind) since the last general election in 2015. Offshore wind is the exception to this; in the first 6 months of 2016, the UK attracted more than £10 billion of investment into the offshore wind sector - three-quarters of all European investment.

The intermittent nature of renewables means that reserve sources of power need to be made available at short notice to cover periods when the renewables are not delivering, and this is expensive. Renewables can look particularly poor value when the price of carbon-based fuels is low, in relation to which the output from US’ shale oil producers is having a intermittent disruptive effect on OPEC’s (and Russia’s) attempts to keep prices high. Whilst nuclear power is more expensive still, it operates as base load and as such does not suffer renewables’ intermittency problems.

Key issues for the Brexit negotiators: • Will the UK abandon RED/RED II post-Brexit ?

Interconnectors5.8%

Nuclear21.6%

Coal9.1%

Source: BEIS

Renewables22.3%

Gas 41.2%

Page 23: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

23Brexit Insights – The impact of Brexit on the energy sector

Interconnectors – 5.8%The National Infrastructure Commission’s Report “Smart Power” (March 2016) emphasised the importance of interconnection with our continental neighbours.

The necessity for building additional generation capacity ourselves can be partially offset by importing electricity from other countries through interconnectors. A National Grid analysis presented to the House of Lords Science and Technology Committee in 2015 showed that each 1GW of new interconnector capacity could reduce wholesale power prices by up to 1-2%. 4-5GW of new interconnector capacity could unlock £1 billion of benefits to energy consumers per year.

Interconnectors allow electricity to flow between countries, with power flowing to the market which offers the best return at any point in time. The electricity prices of a country under energy stress such as the UK are generally higher and therefore the flow to date has been primarily inward-bound. Indeed, as the energy problem gets bigger interconnectors become more and more attractive both as a quick fix for the government and as an opportunity for investors. The more interconnectors there are, the less the differential in prices across the markets will be and the less power will flow. In a perfectly interconnected world the price across all the markets would be the same, and no power would flow across the interconnectors at all, although the difference in fuel mixes and usage, together with different operational costs, make this unlikely ever to occur in practice between the UK and continental Europe.

Examples of the few occasions when the UK became a net exporter to France include:

• November 2011 - following Germany’s post-Fukishima nuclear plant shutdown (losing 8 GW of supply), which cut French power imports from Germany to the point where France had to import power from elsewhere

• January/February 2012 - during a 3-week cold spell that stressed electricity supply all over Europe, at which point the UK was often exporting over 3 GW during peak winter demand periods.

• November/December 2013 - again during a cold/stormy spell in Germany (though less severe and of shorter duration than in 2012)

• October 2016 – February 2017 - due to a combination of storm damage to the French interconnector cables (thought to have been

caused by a ship’s anchor dragging on the seabed) which reduced the interconnector’s capacity by 50%, and outages at several of France’s nuclear reactors whilst they underwent safety checks.

By allowing excess capacity to be used across jurisdictions, interconnections put downward pressure on energy prices, reduce the need to build new power plants, reduce the risk of black-outs or other forms of electrical grid instability, provide back-up cover for intermittent renewables, and encourage market integration.

The UK currently has 4 GW of interconnection capacity through four interconnectors; this equates to roughly 5% of UK generation capacity (by way of comparison, the planned Hinkley Point C nuclear reactor will have a capacity of 3.2 GW).

However, a further 20.2 GW is either under construction or being planned (equivalent to six Hinkley Point Cs). Not all of these will necessarily be built, as they will need to attract funding.

Interconnectors5.8%

Source: BEIS

Exports Imports7

6

5

4

3

2

1

0

-1

-2Q1

2013

TW

h

2014 20162015Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Net imports

Source: BEIS

Renewables22.3%

Gas 41.2%

Nuclear21.6%

Coal9.1%

Page 24: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

24 Brexit Insights – The impact of Brexit on the energy sector

The Energy Union Energy Strategy was launched by the European Commission in 2015 to coordinate the transformation of European energy supply, with the aim of providing secure, sustainable, competitive, affordable energy throughout the Union. The strategy includes a minimum 10% electricity interconnection target for all Member States by 2020, and 15% by 2030.

As the current UK electricity interconnectors provide roughly half the level of interconnection the strategy requires for 2020, and a third of that required for 2030, the EU has been actively promoting the development of interconnectors to the UK.

The TEN-E strategy identifies areas that require infrastructure development to strengthen cross-border interconnections and integrate renewable energy and funds feasibility studies. Every two years, the EU draws up a list of Projects of Common Interest (PCIs). These projects benefit from faster permitting procedures and the right to apply for funding from the Connecting Europe Facility (CEF) – a €30 billion fund to boost energy, transport and digital infrastructure between 2014 and 2020.

In addition to the CEF, financial support is also available from the EU Cohesion Policy Funds, the EIB’s Project Fund Initiative, the European Energy Programme for Recovery, the European Fund for Strategic Investment and the European structural and investment funds.

The PCI list is due to be revised this year (2017), and it is possible for all or any of the UK projects to lose their PCI status. It is unclear whether any UK interconnector projects would be required to repay any financial support afforded to them from the CEF and other EU funds. This will depend upon the investment criteria of the specific fund(s) in question and the terms of the particular financing.

Over the past 5 years (2012-16) 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 in any other sector of the UK economy). The EIB does lend outside the EU but that is currently only about 10% of its current lending, so it is not significant.

Given that the Energy Union Energy Strategy is primarily concerned with the promotion of interconnection between Member States, it is unlikely that post-Brexit EIB funding lines would be made available to assist in the funding of interconnector projects with the UK, unless as part of the Brexit deal the UK remains a shareholder of EIB and the EIB remains mandated to support the further integration of the UK into the European energy network.

The different investment models available for interconnectors are as follows:

• Regulated asset base: Most of the interconnectors built by the Transmission System Operators (TSOs) use this model and on balance sheet. The interconnector has to comply with all aspects of the EU regulatory regime in relation to cross border electricity infrastructure e.g. offer full third party access, comply with the congestion management guidelines, and use their revenues for specific purposes. In return, the project receives a regulated return.

• Cap and Floor: Under this model, the project is guaranteed a minimum return (thereby making interconnector projects bankable), but also puts a cap on the total return that the interconnector can make. This model is a regulated regime, and depends upon the interconnector operating under the Network Codes/Guidelines and participating in the market coupling mechanism.

• Merchant: This exposes the project to full market risk. In order to make these projects bankable, they need to enter into long term capacity supply contracts, and in order to do this they need to apply for exemption from the regulatory requirements relating to third party access, as well as the congestion management guidelines and the restriction of the use of revenues for specific purposes.

Following Brexit, only the merchant route will be available for UK-interfacing interconnectors, unless the UK remains part of the IEM. Without EIB support, any financing arrangements for the interconnectors will be both more difficult and more expensive.

Page 25: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

25Brexit Insights – The impact of Brexit on the energy sector

16

12

10

8

3

5

6

7

14

1311

1

94

2

15

Project Country GW Ready Company PCI ?

1 National Grid, RTE France 2 1986 National Grid (NG)

2 Moyle N. Ireland 0.5 2001 Mutual Energy

3 BritNed Netherlands 1 2011 NG, TenneT

4 EastWest Ireland 0.5 2012 EirGrid

5 Nemo Link Belgium 1 2019 NG, Ella Yes

6 ElecLink France 1 2020 Eurotunnel Group Yes

7 IFA2 France 1 2020 NG, RTE Yes

8 North Sea Link Norway 1.4 2021 NG, Statnett Yes

9 Greenlink Ireland 0.5 2022 Element Power Yes

10 Vikinglink Denmark 1.4 2022 NG, Energienet.dk Yes

11 FAB Link France 1.4 2022 Transmission Investment, RTE Yes

12 NorthConnect Norway 1.4 2022 NorthConnect

13 Aquind France 2 2022 Aquind

14 Gridlink France 1.5 2022 Gridlink

15 NeuConnect Germany 1.4 2022 Frontier Power, Meridiam, Greenage

16 Atlantic Superconnection

Iceland 1.2 2023 Atlantic Superconnection

UK landfall location not known

IceLink Iceland 1 2027 NG, Landsnet, Landsvirkjun Yes

TOTAL 20.2

Key issues for the Brexit negotiators: • Will tariff-free cross border flows be part of

the over-arching trade deal?

• Will existing funding be preserved for interconnector projects?

• Will new EU funding for future interconnectors be made available ?

Key: •Operational •Under construction •Planned

Page 26: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

26 Brexit Insights – The impact of Brexit on the energy sector

With declining North Sea oil and gas reserves, uncertainty over how much of the UK’s shale gas can be recovered at an economic rate and delays to the nuclear roll out, the UK is neither independent in energy terms now nor is it likely to be so in the short to medium term. The availability of the electricity interconnectors has meant that the UK has not needed to build as much domestic generation capacity as it otherwise would have had to. As a result, now that the UK is leaving the EU its net energy deficit means that it cannot turn its back on the European energy markets for the foreseeable future even if it wanted to. The UK is also reliant upon European expertise to keep its existing nuclear fleet of power stations operating.

Conclusion

The integration of the European markets benefits everybody with greater security of supply and lower prices. Further, the UK’s domestic energy policy is closely aligned to that of the EU and the UK has been a driving force in the liberalisation of European energy markets. Its non-EU international obligations on climate change means that it will continue to adopt similar policies to those in the EU irrespective of whether the UK is in or out.

For these reasons, staying in the IEM (and associating with Euratom) is the obvious preferred route for the UK post-Brexit. However, the EU has consistently warned that the UK will not be allowed to cherry-pick. In a draft motion of the European Parliament (29 March 2017), the UK is required to continue to adhere to EU standards and policies in laws governing “the environment, climate change, the right against tax evasion and avoidance, fair competition, trade and social policy” if it wants a future agreement with the EU. What is unclear is precisely how much of the non-energy related regulation will be made a pre-condition of access to the IEM and Euratom.

The UK has also made it clear that it has a number “red line” issues as part of Brexit negotiations. The first of relevance to the energy sector is that post-Brexit the UK will retain the right to restrict the free

movement of people from the EU into the UK. This is exactly what Switzerland threatened to do (albeit in breach of its 1999 Bilaterals I agreement with the EU), as a result of which the EU stepped back from negotiations until Switzerland moderated its position. However, with the appropriate political will, this can be finessed – as was almost achieved in the run-up to the Brexit vote in June 2016.

There have been proposals circulating in European capitals for over a year contemplating allowing the UK to have an emergency brake on immigration for up to seven years whilst retaining its access to the single market. This would limit the economic shock to the EU economy by keeping the UK in the single market, and lessen the political damage to the European project that would result from complete divorce. Beyond that, under current EEA rules, there is already an option to apply “safeguard measures” in the event of “serious economic, societal or environmental difficulties of a sectorial or regional nature liable to persist”, so the precedent is already there that could be adapted to give the UK the required degree of autonomy.

The second red line of relevance is that the ECJ should no longer have jurisdiction over UK laws. However, this too could be finessed, as treaties are not laws but agreements between nations

Page 27: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

27Brexit Insights – The impact of Brexit on the energy sector

over which UK courts have no jurisdiction. So, the UK could bind itself to the IEM (and any other applicable areas of EU law) by treaty, and an independent body could be set up to monitor compliance and settle disputes. The applicable EU law could then be passed down into domestic legislation over which the UK courts would have sole jurisdiction.

Alternatively, and as mooted by Chatham House (“Staying Connected”, May 2017) the UK could seek to establish a new pan-European partnership as a platform for aligning EU policies with those of third countries whilst allowing them to fully access the IEM. The EU prefers to negotiate multilaterally rather than bilaterally, but the problem with such multilateral proposals is the sheer time they take to

set up and the complexity of doing so, even if they seek to expand on pre-existing arrangements.

Other non-IEM solutions are not ideal as everybody both in the UK and the EU would end up materially and adversely worse off, and as such should be avoided – to the mutual benefit of all parties.

Due to the sheer size of its EU-facing economy, the UK should have a stronger negotiating position than any of the EFTA countries (Norway, Iceland, Switzerland, Liechtenstein), and if the solution is simple and politically flexible enough to allow all sides to claim to have won a fair deal, it should not take decades to formulate and enact. The negotiations are simply too big to fail – although we can expect a lot of grandstanding and brinkmanship in the interim.

Our energy Brexit specialists

John Chandler Partner

T: +44 (0) 207 264 4422 E: john.chandler@shma.co.uk

John is a project finance specialist, with many years’ experience advising clients in the renewables and waste management sectors, including Energy from Waste (EfW) projects. As well as having an in depth knowledge of the regulatory regimes governing the full range of such projects, John’s experience includes advising energy suppliers and providers.

Andrew Whitehead Head of Energy & Projects

T: +44 (0) 121 214 0528 E: andrew.whitehead@shma.co.uk

Andrew Whitehead is the head of our energy and projects team. Andrew has over 20 years of experience in the sector, including drafting and advising on the energy industry codes and agreements. He provides contractual and regulatory support for a number of our energy sector clients, with particular specialisms in balancing services, electricity interconnectors and wholesale trading arrangements.

Page 28: BREXIT INSIGHTS – THE IMPACT OF BREXIT ON THE …shma.co.uk/web/FILES/Brexit/Brexit-energy-sector-insights-August... · Brexit Insights – The impact of Brexit on the energy sectorBrexit

Contact us

brexit@shma.co.uk

03300 240 333© August 2017 Shakespeare Martineau.

All rights reserved. This publication has been prepared only as a guide. No responsibility can be accepted by us for loss

occasioned to any person acting or refraining from acting as a result of any material in this publication