The precise impact of Thursday’s referendum on the energy sector is unclear at this stage. This is mainly due to the fact that there is a wide range of possible outcomes from post-Brexit negotiations, leading to a number of regulatory and market options for the UK’s relationship with the EU.
Possible post-Brexit arrangements include the continued membership of the Internal Energy Market (“IEM”) (similar to Norway’s current arrangements, ie implementation of the EU’s energy market regime, payment into the EU with no voting rights on the relevant legislation); tracking the EU legislative and regulatory regime without any formal arrangement; and a series of sector specific bilateral arrangements similar to the EU-Swiss arrangement as alternatives to or in addition to free trade agreements with specific jurisdictions outside the EU. Each of these options will have different implications for the energy sector depending on the policy choices of the UK Parliament.
To the extent that the UK remains committed to the single European Energy Market under either of the above models, it would likely remain subject to the relevant European Energy Directives and Regulations, and to remain part of the institutions (such as ACER, ENTSO-E, and ENTSO-G) which regulate it.
If there were a more radical approach which meant leaving the single energy market, then there would be more significant issues to be dealt with, such as access to EU markets, especially through interconnectors, and access to UK markets for EU energy.
In the immediate future, we are unlikely to see any major changes to the current systems and regulation as the terms of Brexit will take a significant amount of time to negotiate.
1. Gas sector
The UK gas sector is different to that of other EU countries as the UK produces gas domestically and has a well-established hub for the LNG market and a liquid gas market at the NBP.
As between the UK and the EU, gas markets are already well integrated physically through three interconnectors (IUK, BBL and Moffat) with only small wholesale price differences and little congestion. Subject to any drastic changes in energy policy by the British government, the gas sector is therefore unlikely to suffer following Brexit.
It is possible that some proportion of the gas trading market will look to other European hubs such as Zeebrugge or TTF in the Netherlands. However, as the physical infrastructure is in place for trading across borders from the UK, it is probable that this will continue to be in demand.
2. Supply Security
The UK gas market is amongst the most mature and liquid gas markets in Europe. Brexit may, however, contribute to a shift towards other EU markets (particularly TTF in the Netherlands which outranked the UK as the most liquid market in 2015) and change expectations in respect of future infrastructure investments.
As the EU is currently undergoing a review of its gas supply security arrangements, including Regulation 994/2010, Brexit could increase UK’s supply security risk, as the UK might be excluded from the ‘solidarity principles’, in accordance with which European nations agree to supply gas to their neighbours in the event of a gas supply crisis.
It is possible that the supply security of Ireland may be affected by the terms of the UK’s exit from the EU, in particular if the governance terms of the Moffat interconnector change.
3. Electricity sector
There are some concerns that the period of uncertainty in the run up to Brexit may drive up the costs of investments generally and in the electricity sector. As the British electricity sector faces a number of investment requirements (in respect of grid upgrades and generation capacity) at present, Brexit may render these investments more costly. Economic commentators have suggested that this may well be the largest risk facing the energy sector independently as a result of Brexit negotiations.
If Brexit results in exclusion from the IEM, the UK would be excluded from the benefits of market integration initiatives, such as market coupling and cross-border balancing and capacity market integration. As this would only occur after both Brexit and the UK’s leaving the IEM, these risks are inherently more uncertain than the risk to costs of energy infrastructure.
In the long-term, significant long-term funding implications for new projects may arise if access to European Investment Bank loans is cut off following Brexit.
4. Gas and Electricity Interconnectors
Britain has a number of electricity and gas interconnectors, such as IFA (Interconnector France – Angleterre, ie the interconnector between France and England) and BritNed (the interconnector with the Netherlands) and is in the process of developing more.
It is likely that the effects of a Brexit would be most keenly felt by existing and, in particular, future interconnectors, as the relevant regulatory framework for interconnectors in the EU would fall away for UK interconnectors, and a reliable alternative regime would need to be negotiated which will likely have an impact on both costs as well as security of supply for the UK.
EU Member States cannot negotiate their own trade agreements, so it would be a matter for the UK and the EU as a whole to decide on their future use, such as whether these interconnectors would be able to enter the capacity market auctions. Change to the current interconnection arrangements may therefore have a negative impact on UK energy security as the UK is a net importer of electricity. In addition, the UK would have to decide whether to continue to adopt EU-wide electricity regulation or to develop its own set of policies.
5. Upstream Oil & Gas
Generally, the upstream sector is less influenced by EU legislation than the downstream sector, as many of the rules of the Third Energy Package do not apply to it. As regards the UKCS (UK Continental Shelf), the UK would have to decide whether to continue to apply the (relatively few) EU Directives relating to oil and gas or whether to develop its own domestic policies. EU companies that have investments in UK waters could find themselves subject to two different regulatory regimes if the UK decides to develop its own regulatory framework.
6. State Aid
Brexit does not mean the automatic release from the EU state aid regime. The current regime will continue to apply throughout the Brexit negotiations. Thereafter, constraints on the ability of the UK Government to subsidise the energy sector as a whole or specific energy technologies are likely to remain in place as both the EEA Agreement and the Swiss sector agreements provide for prohibitions on government subsidies which are effectively equivalent to the EU state aid regime. It is doubtful whether the EU would be willing to include the UK in the IEM (or indeed the wider EU market) without requiring compliance with state aid rules.
7. Merger Control
The UK exit from the EU will have limited impact as far as the EU antitrust rules are concerned (Article 101 TFEU on anti-competitive agreements and Article 102 TFEU on abuse of a dominant position), because these rules apply equally to non-EU companies who carry on business in Europe or whose activities affect trade in Europe. In addition, the UK competition rules (the Chapter I and Chapter II prohibitions of the Competition Act 1998) completely mirror the EU antitrust rules and businesses are therefore subject to a very similar regime where conduct has an impact in the UK only. However, one impact of the UK exit from the EU will be that there will be many more cases where both the EU and the UK could in parallel open an investigation and impose fines and other remedies for anti-competitive conduct affecting both the continuing EU and the UK. While the UK is within the EU it cannot investigate where the EU Commission takes jurisdiction. This could potentially add to risk and costs for affected businesses.
In respect of merger control, again the impact of the exit is likely to be parallel investigations. The EU Merger Regulation (EUMR) introduced a so-called one stop shop regime, under which a transaction that qualifies under the EUMR is no longer subject to the merger control regime(s) of the relevant Member State(s) (subject to some exceptions). Once the UK is no longer a Member State, the EUMR and UK merger control regimes would run in parallel. A transaction that qualifies under the EUMR may also be subject to UK merger control (provided the jurisdictional threshold for UK merger control is met). This could add a burden and cost for businesses, in particular in view of the level of the UK merger fee (ranging from £40,000 to £160,000 depending on the UK turnover of the enterprises acquired) and the longer time frames for UK merger control clearance.
8. Climate Change/Carbon Price/EU ETS
In respect of climate change, even if the UK were to leave behind the EU Climate Change Package, it would still have the very stringent UK targets, as well as any commitments arising from international agreements such as the Paris Agreement.
UK regulation of many energy topics, including for example carbon capture and storage, implement the relevant Directives of the Climate Change Package and therefore conscious decisions would need to be taken to move away from them through new regulation.
The result of the referendum also has an impact on the future of the EU’s carbon market, as the UK is the EU’s second-largest emitter of greenhouse gases, with its utility companies being among the largest buyers of carbon allowances for the EU’s Emission Trading System (EU ETS). On the day after the referendum, prices for EU ETS allowances fell by more than 10 percent to their lowest level since March.
It is possible that as a consequence Brexit, the supply/demand dynamics of the EU ETS and the market reforms for the period after 2020 (when the current commitment period of the EU ETS expires) could be impacted.
It is, however, possible that the UK will continue to participate in the EU ETS without being an EU member, and follow a similar path to Norway, whose companies participate in the scheme despite not being an EU member; in this case, any impact on the EU ETS is likely to be of a short term nature only.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020