Brexit provides an energy market opportunity4 August 2016
Britain (in the referendum on 23 June to decide European Union membership) has spoken its mind. The value proposition of Brexit was for a better future for Britain. But how does Brexit impact the UK’s energy future, and do the opportunities outweigh the risks? By Jeremy Wilcox
In truth no one knows how Brexit will impact until the terms of divorce from the EU are agreed, which could take up to two years. But we can construct different scenarios based on being inside or outside the Internal Energy Market (IEM).
Broadly speaking there are three non- mutually exclusive objectives that need to be considered; affordability, supply security and sustainability. Currently, all three are heavily influenced by the IEM but are not inextricable.
Ultimately affordability is the most critical energy objective. Higher energy prices would undermine industry competitiveness and act as a drag on economic growth, while also potentially leading to fuel poverty and increasing socio-economic risks.
We can address affordability by looking at the cost of infrastructure investment, fuel prices and the impact of electricity trading. Infrastructure investment is central to Britain’s future supply security with aged fossil fuel plant being progressively phased out, and a weaker pound would clearly increase investment costs as much of the required infrastructure is imported. Similarly a weaker pound would increase petrol (gasoline) prices (as oil is dollar-denominated) although this could be partly offset by a prolonged Brexit-induced EU economic contraction that reduces energy demand and pushes prices lower. Just look at Brent, which settled down 7.4% the day following the referendum.
While infrastructure investment presents with a medium to longer-term risk scenario, trading is very much a shorter-term risk consideration. By being part of the IEM the UK can gain from trading electricity across EU borders as part of the interconnected market, with increased trading providing more competitive prices. The risk potential presented from Britain being outside the IEM would be increased electricity price risks as it could impact both balancing and capacity markets that could also undermine supply security.
But an exit from the IEM would not just disadvantage Britain; other member states would suffer from the UK’s non-participation. A number of EU member states have challenging economic conditions that could escalate with increased electricity price risks. Would these member states be prepared to accept potentially increased risks by restricting IEM access just to spite the UK?
It should be remembered that Britain has led the EU on competitive markets for the past two decades and still remains frustrated by Brussels’ lethargy in developing a truly competitive single energy market. While British utilities were privatised and unbundled much of the EU utility market remains subject to state meddling and vertical integration.
The worthy concept of market reciprocity in the First Energy Package (1998) was warmly embraced by Britain but largely eschewed elsewhere in the EU. Indeed it took a further decade and another two energy packages to advance unbundling, yet this still involved a fudged compromise to appease some of the EU’s protectionist governments.
Consider France. The government majority owns EDF, which is the country’s largest generator (among just three major generating companies) and supplies over 80% of electricity customers. Hardly a competitive market by any definition, yet Brussels considers otherwise, with EDF also having around 12% share of UK electricity supply and ownership of the country’s nuclear portfolio. And the UK’s reciprocal interest in France is zero.
It can be further argued that the French government is placing the UK’s future supply security at risk by dragging its feet on the final investment decision on Hinkley Point as a result of EDF’s financial mismanagement, adequately assisted by its similar financial mismanagement of France’s government owned nuclear technology company Areva.
If Britain was immune from the EU’s bureaucratic meddling – the government had to seek approval from Brussels for the contract for difference to secure operating margins at Hinkley Point and had to defend the planned plant against Austria that argued Britain could not invest in new nuclear on safety grounds – then arguably Hinkley Point would already now be in the construction phase, probably with secure Chinese investment.
One of the perversities of the IEM is that while Brussels maintains that energy policy is sovereign, the myriad EU rules and regulations, from financing to renewable and emission targets, effectively constrains and dictates energy policy development. This would be more palatable if the EU energy market was truly a reciprocally competitive one.
The greatest, and unfounded, fears expressed by Brexit opponents is clearly climate change. Opponents argue that Britain’s climate action progress would be compromised by Brexit, but it would not.
As with market competition the UK is an EU climate action leader, not a laggard being kept in line by Brussels. It was the UK that created the first (voluntary) emission trading scheme in 2002, its commitment to phase out coal plant means it will exceed the rate required under the Industrial Emissions Directive (IED), and its commitment to renewables capacity exceeds that required by the EU. Also, the government’s carbon budgets are consistent with the requirements of the EU 2030 package.
Indeed Britain could maintain these climate goals and benefit further from leaving the EU, as it would have a greater flexibility over its energy technology.
Another area where Britain would be largely immune from Brexit energy risks, at least in the medium-term, is gas. The UK has good diversity of gas supplies and is well interconnected with Europe, meaning that supply security would not be compromised. Longer-term there could be risks if, for example it was excluded from any EU agreements to guarantee gas transfers between member states in the event of a supply crisis. Yet it is mainland Europe that is largely exposed to potential gas supply disruptions from Russia, not the UK. And the UK would also have sufficient time to develop its long-term supply security before such disruptions occurred, including increased investment in LNG capacity.
While Brexit presents the UK with both potential risks and opportunities, many of the potential risks would be shared with other EU member states while the opportunities would be exclusive. Leaving the IEM would not just impact the UK, other member states would suffer through Britain’s non-participation due to lower trading volumes and increased contributions to meet the EU’s renewables and emission targets.
The problem with the Brexit Doomsdayers is that they are too inward looking, blinkered by Brussels into believing the UK could not exist outside the EU’s suffocating embrace. They forget that many of the good energy policies adopted by the EU over the past two decades were championed by the UK, and free of EU diktats the UK’s inherent creativity, innovativeness and vision could be unleashed to create an energy vision that meets the affordability, security and sustainability objectives that are particular to the UK, rather than developing polices that have to meet wider EU-28 objectives.
Brexit provides the UK with a welcome energy opportunity. It should be embraced.