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Published: 13 July 2016
Sector: Energy

Brexit: The scale of the challenge ahead for the Energy sector

Energy is admittedly not one of the mainstream topics in the Brexit debate; the implications of the UK’s departure from the EU are potentially far-reaching for the sector.

A good benchmark by which to measure the pros and cons of Brexit is the energy “trilemma”; maintaining energy security, keeping bills down so energy remains affordable, and decarbonisation. With many arguing that our EU membership has had a positive impact against these objectives, and that Brexit is now a real problem. Here we explore the issues in more detail.

The trilemma

On security of supply, the investment need for the UK electricity sector is considered to be around £100 billion by 2020. Investment from EU companies into the sector has been significant over the years. Putting aside EdF’s role in the country’s nuclear power capacity, a good example is Siemens and its investment in turbine manufacturing in Hull.

When it comes to bills, few would argue that the Commission’s policy of strengthening interconnections between member states to facilitate greater cross border energy trading is not a good thing. Over the years, multibillion pound interconnector infrastructure projects, linking the UK’s power and gas grids to mainland Europe, have been commissioned to improve energy security throughout Europe, and these have undoubtedly had an impact on prices. Currently the UK has four interconnector links with more in the pipeline; one to France, one to Netherlands, one to Ireland and one between Northern Ireland and Scotland.

As to the third limb, decarbonisation, the UK’s own domestic policy agenda, set by our Climate Change Act 2008, is not radically different to that of the Commission. Where there has been a divergence – for example on flexibility for member states to meet carbon reduction targets with a mix of measures that suit it best, rather than adherence to fixed quotas – the UK has been successful in influencing policy change. Good examples are the latest incarnations of the Renewables and Energy Efficiency Directives, which have UK fingerprints all over them.

However, in other areas the UK has seemingly been out of kilter with mainstream EU thinking, notably the UK government’s enthusiasm for fracking for shale gas. More fundamentally, there is a view held by many that, outside of the UK, the country’s energy security can be best guaranteed by decisions made in Westminster rather than by those in Brussels with a broader remit to secure supplies for the EU as a whole.

The energy challenge

For the energy sector, it is relevant to note that this is one area of our economy where EU law and policy has been pervasive. For any UK business active in the sector, the list of European Directives and Regulations which have a significant impact on business is a long one, and includes:

• The “Third Package” of 2 Directives and 3 Regulations - which seek to build a single market for energy notably by establishing the European regulator ACER and by introducing the EU Network Codes. Changes here are evolutionary, but are already influencing our domestic codes and agreements looking to improve security of supply. The Emissions Trading Directive - establishing the EU Emissions Trading Scheme;
 

• REMIT - the market abuse regime for energy markets;

• The Renewables Directive - establishing legally binding targets for renewable energy across the power, transport and heat sectors;

• The Energy Efficiency Directive - establishing certification of energy efficiency performance of buildings, and requirements on public sector building owners and energy suppliers; and

• The Large Combustion Plant Directive - which has driven the closure of coal fired power stations across the continent.

There are also significant pieces of domestic law and policy which have not emanated from Brussels, and these include:

• The Climate Change Act 2008, which sets the UK on a path towards an ambitious 80% reduction in carbon emissions by 2050;

• The UK government’s ambitious smart meter roll out programme; 

• The extensive regulation of energy supply companies by Ofgem through licence conditions, in areas such as tariff regulation, protecting vulnerable customers and ensuring fair contract terms, not to mention the social and environmental schemes which are implemented through supplier mandates such as ECO, the Green Deal and the Warm Homes Discount; and

• The government’s onshore gas licensing initiatives to encourage the exploration and development of shale gas.

There are also international treaty obligations, which can include EU-wide targets and measures which are subject to burden sharing arrangements amongst EU members, the most notable of which is the UN Framework Convention on Climate Change and the Paris Agreement on climate change.

Unpicking the detail

As with any sector, the process of unpicking all of this, to identify and assess legislation which derives directly or indirectly from Brussels, and to decide whether to leave alone, amend or re-enact as domestic legislation, is a mammoth task. And it can’t begin until some fundamental, and ultimately political, questions are resolved and we have clarity around the nature of the UK’s relationship with the EU.

For the energy sector, one of the fundamental questions will be around single market issues, and the extent to which the status quo will be preserved. This includes activity such as cross border trading between market participants and transmission system operators across interconnectors, but also how the UK will continue to adapt to, and influence, the rules that govern such activity as they continue to evolve. It is notable that ENTSO-e and ENTSO-g, the groupings of electricity and gas transmission system operators across Europe established by, and with functions derived from, the Third Package, have a key role to play here, and a Brexit will not preclude National Grid from continuing to play its part as the UK’s principal transmission system operator.

An immediate tangible expression of energy market harmonisation is the set of emerging EU Network Codes, which derive from the Third Package, and which will take the form of EU Regulations. Work has been ongoing across Europe to “make space” for these new rules and requirements in domestic legal and regulatory regimes. In the UK that has meant detailed analysis of the myriad codes and agreements which establish the legal relationships between generators, suppliers, network owners and other key players, to determine what changes need to be made to the domestic arrangements. The extent to which that harmonisation exercise in the UK carries on, is put on hold, or goes into reverse, is inextricably linked to the position the UK decides to take in relation to the EU’s single energy market. This is most easily understood by the current use of the cross border interconnectors to deliver benefits for UK consumers in terms of lower prices and security of supply.

Perhaps, most immediately, the impact of Brexit for the energy sector is no different to other parts of our economy. Uncertainty abounds, and market conditions are in a state of flux. Financing costs for investors are set to rise, and those looking for long term political and regulatory stability will need to hear, very soon, from new political leaders that the UK has a clear vision for the future.

For more of our thoughts around Brexit read here.

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"This is exactly why we like to work with people who understand the industry and can identify potential issues and create solutions."

Jon Saltinstall, Senior HealthCare Banking Consultant, Lloyds Bank