Brexenergy: a roadblock for the European Energy Market?

Increasing interconnectivity with Continental Europe will necessarily require co-operation between UK and EU Internal Energy Market in any Brexit scenario. If the UK is permitted to participate in the Energy Union following Brexit, it would need to negotiate an appropriate partnership with EU and adopt - and comply with - the relevant European law.

The questions to be addressed are: can the UK continue to participate in the liberalisation of the European Energy Market (EEM), can the EEM continue the liberalisation process without the UK ?

It’s important to underline the extent to which EU and UK energy policies are closely aligned: in many respects, the UK has taken the lead in shaping EU energy policy, with its focus on open and transparent markets, energy security, low carbon energy sources, energy efficiency and high levels of environmental protection. If the UK was to stay within European Economic Area (EEA) as a Member of the European Free Trade Associatiobn (EFTA), most of these objectives and constraints would remain.

Given to the UK’s liberalised energy policy, we expect that the UK will continue to implement and be supportive of many aspects of the EU’s Third Energy package (an EU legislative package with the central aim of liberalising European gas and electricity markets).  For example, the ownership unbunding requirements, which require the separate ownership and operation of electricity/gas transmission systems for any generation, production and supply interests; the level playing field; and the standards transparency. The UK Government also appears committed to market-based interventions in energy markets and supports EU initiatives such as market coupling. We therefore consider that business should plan to continue to comply with these requirements.

Consequently, if the UK remains part of the EEA, the EU State Aid rules will continue to apply to the energy infrastructure and support schemes as today, since the EEA Agreement contains a similar prohibition. However, any subsidy will also need to comply with the WTO subsidy regime which is similar in its intentions to the EU State aids rules. The WTO regime disciplines the use of subsidies and regulates the actions which WTO members can take to counter the effects of subsidies.

From a legal point of view, one of the most important question needing a quick answer is how the UK would join the EEA Agreement given its more advanced implementation of EU Law. The answer will only be known as part of the Brexit negotiations, after the triggering of the famous Article 50 of the Treaty of Lisbon. In fact, the exact nature of the exit and the future UK-EU relationships is still to be negotiated and it is expected that the United Kingdom will attempt to extract favorable terms in a a new trading arrangements that still provides the country access to a single market^[1], while the European Union will resit such an arrangement.

As this is the first time that a Member State has left the “28-Countries Club”, there are many significt uncertainties over substance, process and timelines. In the interim period and while negotiations are ongoing, the legal status of the EU-UK relationship (and all attendant rules and regualtions) will remain unchanged. But there will be political changes: the UK will not participate in the next European Councils and Councils of Ministers. Over the near term, uncertainty will be the defining feature of the direct and indirect impacts on energy markets. Nonetheless, it is possible to begin to outline some of the impacts on the energy system.

The Brexit impact on Energy Markets

Concerning the Direct Impact, as evidenced in the immediate reaction to the Brexit vote, and because the status quo will remain in place on the regulatory and trade front, the direct impact on energy markets in the short term will be supposely “..limited to the volatility of commodity prices, most prominently the orice of crude oil”^[2].

The Indirect Impact on Energy Markets is perhaps more significant in the near and medium term than the direct impacts and moderated through the effect the British referendum will have on global economic growth. An example of indirect impact is the cost of access to credit. The risk premium on investments will likely rise, both in the UK and elsewhere, but “investors will remain risk averse until the long term is more predictable, and this will likely stiffen investments and rescricts the flow of capital even further across global markets”^[3].

There is also the possibility of Uncertain Impact on Energy Markets. Going forward, much of impact on energy markets will be determined by the future contours of the UK relationship with the European Union and even more on the shape of the Union itself, which will be determined in the months ahead by a complex web of political and technical factors. There are three major areas of uncertainty when it comes to the Brexit’s impact on energy and climate policy that will be influenced by these negotioations: the future of climate policy, the future of British access to the EU market, and additional potential EU exits.  These areas are by far most consequential for energy markets and policy, but are by no means the only areas of uncertainty.

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Climate Policy and multilateral agreements

When it comes to multilateral climate policy, the United Kingdom - the European Union’s second largest emitter of CO2 – has partecipated in UN climate negotiations as part of the broader EU bloc, and its climate commitment to the recent Paris Treaty was submitted as part of the broader European commitment. What will happen to the EU target – will it need to be resubmitted, and would any submission need to be more or less stringent without the united Kingdom -  remains to be seen. Likewise, whether they will submit a new climate pledge, and the shape and scope of that pledge, is also up in the air. However, the United Kingdom is on the path to cut emissions by 2030 under a domestic law. The broader EU negotiating dynamic on climate moving forward may also change. The United Kingdom is often credited with both pushing for more stringent climate targets and for the adoption of market-based mitigation (rather than top-down-wide stadards and goal setting). How the European approach to climate negotiations may change without the presence of the British remains to be seen.

Access to EU Market : the Framework

A considerable impact of a potential Brexit for energy markets will be determined by the shape of the future EU-UK economic relationship (as well as the political future of the United Kingdom itself). There are, essentially, five possibilities for the relationship: 1) status quo – the United Kingdom does not leave the European Union and remains part of the common market; 2) the United Kingdom leaves the Union but retains full access to the EU single market (the Norway model); 3) the United Kingdom has restricted but significant access to the common market on a bilateral basis (the Swiss model); 4) the United Kingdom does not have acces to the common market but negotiates a separate free trade agreement with the Union (the Canada model); 5) the United Kingdom and the European Union are not able to negotiate preferential trading terms, and access to the common market would be premised on the World Trade Organization rules.

Access to EU Energy Markets

While it would make economic sense for the United Kingdom to remain part of Europe’s internal markets for electric power and natural gas (50% of UK imported gas comes through the Union), that outcome remains to be negotiated. What is less clear, however, is whether the United Kingdom would drop some specific European measures, such as imposed renewable energy targets and Europe’s Industrial Emissions Directive, which controls emissions on power plants. The regulatory upheavel could be significant for energy development in the United Kingdom, with energy regulations currently set by the European Union likely to be the subject of future negotiations. Moreover, the status of access to the common market is also likely to impact the decision of whether the UK continues to participate in the EU emission trading system, which regulates greenhouse gas emissions.

Finally, the broader energy market impacts may be determined by the future of the European Union itself. The British vote to leave the Union is likely to propt other anti-EU forces in other EU countries to hold similar referenda. If the Union were to break apart - either marginally or more substantially, or dissolve altoghether - the consequences for energy markets could be profound.

It is uncertain how the outcome of the referendum will affect political fragmentation across the European Union. A number of countries, including Poland and Hungary, have incumbent euroskeptic governments, while many other member states have growing ranks of opposition parties to current governments who share a skeptical view of the European Union as an institution. If there are other referenda or movements toward exit aming these member states, it is likely to have major impacts on global economic growth and confidence in the markets in general, which in turn would have severe effects on energy markets.

[1] Andrew Stanley, Centre for Strategic Studies.

[2] Global Fossil Energy and Climate Change mitigation, in Climate Change, May 2016, volume 136, Issue 1, pp. 69-82

[3] See and read in following pages: Norvegian Model, Swiss Model etc.