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Energy: life beyond Brexit

What just happened?

At 10 pm on 23 June 2016, polling stations closed for the referendum to decide whether the UK should leave the European Union. Opinions polls, which had been predicting a tight race, were moving into Remain territory, while betting shops were offering considerably longer odds on a Leave vote than Remain. A few minutes after 10 pm, Nigel Farage, head of the pro-Leave UK Independence Party (UKIP), told a TV news reporter that he thought the Remain campaign had “edged it.” The following morning, the UK, and the rest of the EU, woke up to discover that the British electorate had voted by a margin of 52% to 48% to withdraw from the EU.

Nobody really yet knows what this will all mean for energy markets in Britain and the remaining EU. A large proportion of the UK’s trade with the EU takes the form of energy and many EU rules are related to this market.

There are a number of possible options for the UK’s continued engagement with the EU. In general, however, the greater the access to the EU single market, the greater will be the pressure for the UK to conform to EU standards and regulations.

We at DNV GL Energy don’t claim to have all the answers, but we intend to make a start by asking the right questions.

Who will speak for Britain?

These are questions which go beyond the referendum itself; we still don’t even know who will represent the UK in forthcoming negotiations with the EU, much less the terms of any divorce settlement.

UK Prime Minister David Cameron has announced that he will resign, and the Leader of the Opposition Jeremy Corbyn is currently battling a sustained putsch attempt from his own backbenchers. Nicola Sturgeon, the First Minister of Scotland, is pushing for a new independence referendum and there is already speculation about another country-wide general election.

What we can be reasonably certain about is that the UK is, and will remain, a member of the EU for at least another two years. EU rules require at least a two year negotiation period after the UK has formally applied to withdraw by invoking Article 50. So far, it has not actually made this application and will most likely not do so until the current PM has stepped down, probably in September 2016.

How does the EU influence energy policy in the UK?

It is important to understand in general the ways in which the EU influences policy in its member states. EU laws are implemented by means of Regulations or Directives.

A Regulation is a binding legislative act which must be applied in its entirety across the EU. For example the EU regulation on energy market integrity and transparency (REMIT), passed by the European Parliament in 2011, provides a consistent EU-wide regulatory framework specific to wholesale energy.

A Directive is as an instruction for a national EU government to implement certain laws. For example, the Renewables Directive establishes an EU renewable energy policies policy and sets national renewable energy targets. In order for any Directive to become effective in the member state, that state must pass legislation in its own parliament.

Until it formally withdraws from the EU, the UK must abide by EU Regulations. Any laws passed by the UK government as a result of EU Directives remain law in the UK even after exit from the EU, unless the government changes or repeals these. The degree to which the UK will need to retain EU laws in order to be allowed to continue to engage with the European single market is still a topic of much debate and uncertainty. It is likely that at least some EU laws will remain valid in the UK for the foreseeable future. The UK will, however, be increasingly less able to influence these laws in the future.

What could be the implications for investment?

In the short to medium term, the general sense of political uncertainty is not likely to be conducive to capital investments in the UK. This may be the case with all forms of investments, ranging from renewable energy projects, electricity network upgrades to new nuclear facilities.

The current market uncertainty may lead to asset financing deals being paused, delayed or potentially cancelled. In the medium term, if Brexit leads to a recession, this will dampen investment in energy and renewables in the UK.

The Brexit decision has already driven down the price of Sterling. As the UK is a net importer of gas, this is likely to have a short term impact on the price of energy. In principle, this could help to promote renewable generation. However, this must be offset against increased capital costs for renewable energy generating equipment which must be imported into the country.

How will this affect the UK within EU energy markets?

It is the EU’s stated objective that energy should flow freely across the EU without technical or regulatory barriers. The EU Third Energy Package is a collection of Regulations and Directives intended to harmonise energy markets by setting gas and electricity markets rules, establish an agency for regulatory cooperation and specify the rules for market access. Brexit will lead to questions regarding the UK’s commitment to ongoing integration of EU energy markets. This has potential ramifications for all of Europe, and not just the UK. The UK has traditionally been seen as a driver of open and deregulated markets in the EU and it remains to be seen how such projects will progress.

As a major importer of electricity and gas, the UK will wish to continue to trade electricity with its EU neighbours and will need to maintain and increase interconnectivity with the rest of Europe. In order to achieve this, the UK will need to maintain close relations with the operators of other networks so as to coordinate market and technical rules. Whatever happens, the UK will remain physically interconnected with the EU energy markets, and as such, market interactions will continue.

Remaining outside the EU has not prevented Norway from creating an integrated electricity market with EU members in the Nordic region or from building interconnectors to the wider EU. Indeed, a UK-Norway interconnector is already planned to come online in 2020.

Similarly, the UK will continue to import gas from Norway and the EU. However, Brexit could lead traders to moving from trading against the NBP to the TTF index when trading North Sea gas.

What will happen to renewable energy, environmental and efficiency targets?

The Renewables Directive specifies national renewable energy targets for each country; the UK 2020 target for energy from renewable sources is 15%. Brexit does not necessarily mean that the UK would discard or adjust this target. The UK has ratified the Kyoto Protocol and Paris Agreement on greenhouse gas emissions and there is no particular reason to believe this will change. It has not been suggested that the UK would cease to honour the various existing renewable energy support schemes. In fact, the UK is the only EU country so far to have enshrined 2050 carbon reduction targets in legislation. It is however less certain what policies future UK governments will implement related to renewable energy.

The UK was a pioneer in emission trading, running, as it did, a UK Emissions Trading Scheme (ETS) for three years before the EU ETS commenced in 2005. The UK could, in principle, continue to participate in EU ETS. It has already implemented a carbon price floor policy, which was not related to EU regulations. The UK is a large purchaser of EU ETS credits and any move by the UK to leave the scheme will have an impact on the scheme as well as on UK CO2 producers.

The UK has already passed laws and implemented initiatives pertaining to energy efficiency. These, in part, implement targets which were set by the EU Energy Efficiency Directive. There is no particular reason to believe that these targets will not be maintained. However, as was the case with its renewable energy obligations, the UK may not be bound by future EU energy efficiency laws.

What will happen to R&D spending on energy projects?

The EU controls a large block of research and development funding. The EU Horizon 2020 project is making €7.6 billion of funding available for secure, clean and efficient energy projects between 2014 and 2020. A separate fund supports nuclear energy research activities.

The control of the UK’s contributions to the EU budget was a recurring theme in the referendum campaigns. Part of this budget is dedicated to supporting environmental and energy related R&D. Under Brexit, the UK would have a much greater say in how state funds will be spent in future. There could potentially be changes to state aid regulations which would remove restrictions on the type and level of certain types of funding.

Now what happens?

It is not hyperbolic to say that the UK, Europe and possibly the world has found itself at a genuine historical tipping point as a result of recent events. This applies generally to the EU single market and political project, but in particular to energy markets in the EU.

How things turn out is genuinely unforeseeable and highly dependent on the political wrangling still going on within the UK political establishment. The possibilities range from an associate relationship between the UK and EU, virtually indistinguishable from full membership, to a full severance and restructuring of trading relationships.

However, whatever happens, DNV GL will be there to help guide market participants, as it has done though the many shocks and crises experienced in its 150 year history.

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