Implications of Brexit for Energy
David Buchan and Malcolm Keay, Oxford Institute for Energy Studies
We are grateful to Lauren McKee for her generous review of our book ‘Europe’s Long Energy Journey: towards an Energy Union’ ( https://www.h-net.org/reviews/showpdf.php?id=46932 ). We do not wish to take issue with the content of Dr McKee’s article, but rather to add some thoughts on the question she raises at the end of her review – what implications will the Brexit vote have for energy and the Energy Union?
We must stress at the outset that no-one knows exactly what is going to happen, and that it will be some time before the position is clear. At the moment we are in a sort of ‘phoney war’ – formal negotiations will not start until next year and will take many years to conclude. Furthermore, the uncertainty is likely to be particularly protracted with energy – the issues are complex but not at the top of politicians’ priority list. There is a risk that significant quantities of energy investment will be put on hold until matters are clarified, with possible consequences for energy security and climate change targets.
However, despite the uncertainty we believe that we do now have a clear enough picture of the UK government’s overall negotiating stance to permit some informed speculation – though we must stress that it is only speculation. It seems likely that the dominant theme (as with the referendum debate itself) will be sovereignty – ‘taking back control’. This means that the UK is unlikely to be able to negotiate a deal which leaves it within the existing trading arrangements – whether the Single Market, the Customs Union or the existing free trade area (the European Economic Area, which extends free trade to a few countries on the periphery of the European Union – EU – like Norway). Of course, this does not mean that trade with Europe will cease – it will continue but probably at a lower level than would otherwise have been the case. It may even be possible for the UK to negotiate its own special free trade agreement – that is the government’s broad aim – though at the moment this seems unlikely.
As far as energy is concerned, since tariffs are not a likely problem, the main direct issues will probably be in relation to market structures, standards and regulation. There may also be indirect consequences for the development of energy and environmental policy, and from possible changes in other areas, such as restrictions on the free movement of labour.
Energy markets and security
In some areas (eg oil) Europe is part of a global market and Brexit is unlikely to make much difference. However, with gas and electricity, the EU has been moving towards single, Union-wide markets with their own structures and regulations. The process is far advanced but not yet fully complete – for instance, in relation to the Single Electricity Market, although there is widespread ‘market coupling’ to link national markets, this applies mainly to the ‘day ahead’ market, and not yet to other markets such as short term balancing markets. The UK is arguably not fully compliant at present with the EU’s ‘electricity target model’ – it does not have a sufficiently developed day ahead market to provide a benchmark price as the model requires. It is unlikely to have much enthusiasm for completing the process post Brexit and will probably not be prepared to commit to future changes such as the new EU wide market design proposals expected later this year.
The likely outcome is that while electricity trade will continue after Brexit, it will, as with trade in general, be at a lower level than would otherwise have been the case, and the UK will probably not be fully integrated into the Single European Market for electricity. There is a possible model in the current position of Switzerland – it trades electricity extensively with the European Union but without any formal agreement to apply European rules (though it has been trying, since 2007, to negotiate such an agreement; the process is on hold at the moment, partly because of the sort of sovereignty issue which are likely to arise in the UK case).
Trade in natural gas is somewhat less complex than with electricity and takes place on longer time scales. While the UK does trade with Europe, its main sources are indigenous production, Norwegian gas and liquefied natural gas (including LNG from the US – the first cargo arrived earlier this year). These sources are flexible and secure; the UK therefore tends to be less concerned about gas security issues than some other European countries (see below). Furthermore, the UK has no problem conforming to one key aspect of the EU’s ‘target model for gas’, which is that the basic building block of the EU gas market should be so-called entry-exit zones. These EEZs are in a sense a miniature gas version of Europe’s single market, in that they create a single price for gas anywhere in the zones, regardless of transport costs. The model for the EU model, so to speak, was in fact the UK which had turned itself into a single gas trading market.
There could however be problems in relation to Interconnectors with the rest of Europe. There are a number of proposals on the table for interconnection with the EU and Norway, particularly for electricity, where they are important for the government’s decarbonisation strategy. At present, the UK has four interconnectors – one each with France, the Netherlands, Northern Ireland and the Republic of Ireland, with three more under way (with France, Belgium and Norway), and a further five planned for the 2020s. But before they part with their money investors want to see stable regulatory and judicial frameworks, and both are cast into doubt by Brexit, in which the UK is freeing itself of the rules and the jurisdiction of the EU. All this may delay the construction of new interconnectors. This will create extra problems for the UK in meeting its decarbonisation targets. (Indeed, one company, Scottish and Southern Energy, recently delayed plans for a pumped storage scheme in view of the uncertainty).
Special cases – the home nations
There is a special problem in relation to Northern Ireland, which is part of the United Kingdom but also of the All Island Electricity Market in Ireland – and well on the way to meeting the target electricity model. Northern Ireland is likely to wish to continue this process – it is very reluctant to see borders of any sort with the Republic of Ireland. Northern Ireland is already outside the main British electricity and gas markets and this is likely to continue: anomalous though it may be, NI will probably stay within the All Island Market and thus effectively within the EU as far as electricity is concerned.
Scotland will probably want to do something similar – ie to retain virtual membership of the EU in energy and other policy areas – but in its case the practical problems will probably make this unnegotiable, at least in the immediate future. There is however a big question mark over the longer term – preparations are under way for a possible second independence referendum. While many consider it unlikely that Scotland will move to full independence as long as the oil price remains low, this may provide a further level of uncertainty and complication in relation to the Brexit negotiations once they get under way.
Product regulation and standards
Standards for energy using equipment (for instance, maximum power limits for vacuum cleaners) were occasionally a matter of controversy in the debate on the Brexit referendum. The UK will almost certainly not be prepared to accept Brussels regulation on an automatic basis, and would regard this as compromising its sovereignty. Nonetheless, UK manufacturers will no doubt want to continue to export to Europe and will thus probably press for equivalent standards in many areas (to keep out cheap competition from outside the EU). The likely result is a patchwork of regulation, most but not all in line with EU standards. The problem for Brexit Britain will be that it will be the European Commission, and maybe EU courts, that will be the judge of what constitutes equivalence to gain access to the market of the post Brexit EU – the EU-27.
In terms of policy regulation, after Brexit, the UK regulator, Ofgem, would only be able to stay on in Europe’s Agency for the Cooperation of Energy Regulators if the UK were to promise to abide by EU energy rules, which is most unlikely – though the UK could apply to be an observer at ACER like Switzerland. By contrast, National Grid should be able to stay on in the European Network of Transmission Operators for electricity and gas (Entso-e and Entso-g), though this may become more difficult if the Commission goes ahead with proposals to upgrade these organisations into quasi-legislative bodies.
Overall decarbonisation strategy
The implications for decarbonisation policies in the UK and EU were a frequent topic of speculation during the Brexit referendum discussions. However, there are unlikely to be direct impacts, at least in the UK (for the impact on the EU, see below). Contrary to what some of those arguing for leaving the EU were claiming during the referendum debate, most of the impetus behind UK strategy comes either from wider international conventions (like the Kyoto Protocol and the Paris Agreement), or from UK sources (and in particular the Climate Change Act 2008, which sets binding national targets and ‘carbon budgets’) not from Brussels. It is unlikely that the UK government will withdraw from these arrangements – for instance, after the referendum it confirmed its commitment to the ‘carbon budget’ for the late 2020s. We should not therefore expect any wholesale reversal of policy.
The UK will probably take the opportunity to be a bit more flexible post Brexit (eg with less emphasis on specific renewables targets and more on the overall carbon reduction target). However, this would not be a fundamental change – it is the direction in which the EU is moving anyway, with UK support. The UK was already likely to fail to meet its EU target of a 15 per cent renewable share in overall energy consumption by 2020, and, before the Brexit referendum, the UK had campaigned successfully for national renewable targets to be abandoned after 2020. Other changes may be that post-Brexit the UK will no longer have to worry about European ‘state aid’ guidelines and will henceforth be legally free to subsidise whatever energy source it wants by whatever amount of money it wants; whether it will have the financial means to do this is another matter, though in any competitive scenario with continental Europe the depreciation of sterling will help. And of course it will not be subject to Commission reviews of its energy policy. But these would all be minor tweaks in policy rather than a change of direction; overall, there could be a loss of momentum in some areas and some shifts of emphasis, leading to a gradual but increasing divergence between UK and EU policy approaches – further complicating the market and trading issues.
An open question is whether the UK will stay in the EU’s Emission Trading Scheme (ETS). It is an open question because the UK government could argue that emissions trading is not something imposed on the UK, which in fact operated a national emissions trading system before the EU one was launched, and because emissions trading is, in theory, an efficient market mechanism to get least cost decarbonisation, rather than a piece of Brussels bureaucracy. Like many EU states, the UK has found the EU ETS a disappointment because of the low carbon price, but uniquely it has done something about this failure by instituting a national minimum carbon price for electricity. However, the UK would reap dis-economies of scale by returning to a purely national ETS. Likewise, the EU would lose if the UK, currently the second largest carbon emitter and a major importer of carbon allowances from its fellow EU states, were to quit the system.
For Brexit Britain, a possible political virtue of the ETS is that it only sets one overall target for power and industrial sector emission reduction across the whole EU - without any national targets. However, the 60 per cent of total EU emissions which are produced by sectors outside the ETS such as transport, agriculture, services and waste management are supposed to conform to national targets for individual states. As it happened, a month after the Brexit vote in June, the Commission came out with its proposals for non-ETS sector reductions up to 2030, and these included a 37 per cent cut in the UK’s non-ETS emissions (from the 2005 level) by 2030. The Commission had no choice but to include the UK in its targets; to have omitted it would have conceded a definitive final UK decision to quit the EU that had then not yet taken place. However, the non-ETs target will be irrelevant for Brexit Britain which probably from 2020 onwards will be running its own emission reduction policies outside the ETS.
Implications of non-energy developments
There could in addition be ‘spillover’ from discussions in other policy areas. For instance, the UK, until recently the only large European state not to have a public investment bank of its own, is likely to lose access to funds from the European Investment Bank. Lending by the EIB between 2011 and 2015 totalled €29.1bn, of which 28 per cent was for energy. Once Brexit happens, this will inevitably decline; Turkey, the largest non-EU recipient of EIB funding, received €2.3bn in 2015, compared to the €7.8bn that the UK got in the same year. There is a smaller amount of EU infrastructure grant money for Projects of Common Interest that the UK could lose. The UK could also say goodbye to some research funding; and restrictions on the free movement of labour could lead to a loss of skills in sectors such as oil. However, it is very difficult to gauge how significant such impacts might be – the UK government is likely to seek to use the negotiations to mitigate so far as possible any harmful effects,
Impact on EU-27
If the impact on the UK is uncertain, the implications of Brexit for the rest of the EU are even more speculative. While there have been some indications of the likely shape of the UK negotiating stance, virtually no consideration has been given within the EU to its own position.
What can be said is that the UK has been influential in developing EU energy policy approaches, particularly in relation to liberalisation and climate change, while being resistant to any direct Commission control. With its influence removed there may therefore be shifts in emphasis (though probably not wholesale reverses) in relation to energy policy. In particular:
- Energy security The Energy Union discussions initiated with a proposal for common purchasing of gas, from Russia in particular. While that specific proposal is unrealistic, a greater degree of coordination between national positions may be possible after Brexit.
- Carbon targets The EU has prided itself on being a global leader in this area and it is unlikely that it will change direction. However, it will face some difficult decisions in the wake of Brexit – the UK is in fact well ahead of the rest of Europe in terms of emissions reduction and is aiming to achieve reductions of over 50% by 2030 as compared with the EU target of 40%. If the EU wants to maintain its 2030 target, there will need to be difficult negotiations over the allocation of extra cuts – unless it can reach some sort of agreement with the UK to continuing counting the UK’s reductions.
- Energy Union Our book identified the problem of governance as one of the main obstacles to achieving a meaningful Energy Union. The UK has long been very resistant to any significant powers for the European Commission in relation to energy; it is possible that Brexit will actually facilitate progress.
 The distinction between these three configurations is real but not critical in relation to energy, for which tariffs are not a significant issue