July 26, 2016 By FTI Consulting
The United Kingdom’s (UK) historic vote to leave the European Union (EU) has raised more questions than answers. As the world tries to digest the referendum’s outcome, FTI Consulting looks at the potential implications of Brexit on various energy and climate change policies.
Not long before the referendum, the European Commission presented a proposal for the EU to ratify the COP 21 Agreement. The European Parliament and the Council of the European
Union now need to adopt it. In parallel, the EU Member States will need to ratify the Paris Agreement individually, in accordance with their national parliamentary processes. So how could Brexit impact this process?
As put by Christiana Figueres, the outgoing Executive Secretary of the United Nations Framework Convention on Climate Change, a Brexit “would require a recalibration.”
Why? The UK has been more successful than other Member States at reducing its greenhouse gas emissions, which, in 2014, were reportedly down 35% below 1990 levels. As part of an exit agreement, the UK could agree to maintain its existing commitments within a European framework – safeguarding efforts that have been made until now. Alternatively, should the opposite happen, other Member States would need to make deeper cuts in order to meet the overall EU targets.
In the UK, Prime Minister Theresa May’s premiership began with the creation of the Department for Business, Energy and Industrial Strategy (BEIS); a department borne out of the now dissolved Department for Business, Innovation and Skills and the Department of Energy and Climate Change (DECC). The move prompted a mixed reaction from parliamentarians, industry, trade bodies, and campaigners on all sides of the energy debate. Many welcomed the holistic approach to creating a joined-up industrial strategy that balances the need to create the conditions for growth with the demands of a low carbon agenda. Others strongly disagree.
They argue that the dissolution of DECC and the consequent lack of a dedicated cabinet secretary to champion the energy agenda will push energy issues, in particular climate change, to the bottom of the government’s agenda. The department’s newly appointed Secretary of State, the Rt Hon Greg Clark MP, has attempted to reassure all sides of the debate that energy policy will be an integral part of BEIS’s agenda, and that the government’s commitment to tackling climate change remains unchanged. Wholesale unravelling of existing legislation is unlikely as the government’s majority is razor thin and the UK still needs the capital investment in energy infrastructure, which in turn relies on regulatory and policy stability.
Following the Brexit vote, one of the main questions raised has been about the UK’s future involvement in the EU’s primary tool to tackle climate change: the Emissions Trading System (ETS).
Being an EU member is not a prerequisite to participate: Iceland, Liechtenstein and Norway all partake. The UK could follow this model. Alternatively, it could look into creating its own system and link it with ETS. However, while this would enable the UK to have more control over its own policy, it would create additional administrative burdens for businesses. Another scenario would be if the UK chose to drop emission trading as a policy option altogether. However, given that the UK has been going above and beyond EU ETS requirements as the only Member State with a (self-imposed) carbon price floor, it is unlikely to pursue such a dramatic policy shift.
EU Emission Allowance (EUA) prices have declined sharply post-Brexit. This decline has undermined efforts to bring prices up in the already over-flooded ETS market. The uncertainty around the UK’s inclusion in the ETS and specifically whether or not Brexit will result in a proportionate number of allowances being removed from the market is likely to undermine the system – at least in the short- term.
Energy security takes on different priorities for different countries. The EU imports more than half of the energy it consumes. As a result, it continuously strives to ensure a stable and abundant supply of energy to keep the lights on. For some Member States, energy security is also about reducing reliance on a single gas supplier. An example of this is the debate about the expansion of the Nord Stream pipeline, which would enable the import of further Russian gas into Europe, bypassing Ukraine. Many Eastern European Member States are fiercely opposing the project due to fears that it may increase energy dependence on Russia. Could Brexit have an impact? With the UK being a strong advocate of being tough on Russia, they have lost a key ally as a counterweight to the softer views from Germany and Italy.
The UK is also leading the charge in terms of shale gas development in Europe and is one of the strongest and most vocal supporters of exploring and exploiting the unconventional resource potential within the EU. Therefore, Brexit undoubtedly will see the loss of a crucial voice advocating for this secure and indigenous energy supply.
With 17 separate pieces of EU legislation, the exploration and production of natural gas in Europe is highly regulated. In the UK, this is further complemented by a robust national legal framework. Brexit will probably mean that any future regulations adopted in Brussels concerning hydraulic fracturing or shale gas are not automatically adopted in the UK.
In the UK, securing electricity supplies continues to dominate the government’s energy agenda due to the imminent closure of multiple end-of-life power stations. National Grid forecasts five gigawatts of fossil-fuelled power plants – enough to power 10 million European homes – will shut this year.
If the UK leaves the internal energy market – the EU legislative framework that aims to build a single, liberalised and interconnected European energy market – the country will still need to cooperate with the EU to ensure that energy systems remain interoperable. For this to be the case, which is in the UK national interest, they may have to accept policies agreed among the 27 other Member States without having much opportunity to influence them – in particular the rules regarding interconnectors. On the other hand, the EU could also lose the important expertise that seasoned UK energy regulators have brought to the table. Although it remains likely that relationships will be strong enough to protect this sharing of best practice, even if the UK is outside the EU.
More generally, the Brexit vote could delay publication of two key energy initiatives intended to shape Europe’s future energy market. This includes the Commission’s expected proposal for a new Energy Market Design. This would govern how market players generate, trade, supply and consume electricity and use the electricity infrastructure. The other initiative the reform of the Renewables Directive, will set-out a new approach how to meet the EU’s 27% renewable energy (of final energy consumption) target by 2030.
There is also the question of UK compliance with the EU’s State Aid rules. This will depend largely on the outcome of any Brexit negotiations. Any form of access to the single energy market is likely to require compliance with EU State Aid rules or at least an approach that is broadly consistent with them. Even in a scenario where the UK does not have access to the single market, World Trade Organization (WTO) rules would still apply to the UK thereby limiting certain types of State subsidies.
When discussing the terms of an exit, it will be important for the negotiating team to consider the number of UK energy projects that have secured EU funding and signed contracts. It remains to be seen how the UK can secure the funding for these projects.
In accordance with the Renewable Energy Directive, the UK set a target to achieve 15% of its energy consumption from renewable sources by 2020. While this is lower than the average EU target of 20%, it is a significant jump compared to the UK’s 1.5% share in 2005. The Directive has already been transposed into UK national law; therefore pursuing this goal is no longer a function of EU membership, but of UK Government policy. The real question is what will happen in the event that the UK misses its target, as current National Grid projections suggest. Post Brexit, it is unlikely the European Commission will be able to take legal action and impose penalties, but whether there are any other ramifications for the UK will depend on the final negotiations between London and Brussels.
Another major question will revolve around the way in which the UK structures its renewable energy support schemes going forward. This will very much depend on the new UK Government administration.
On energy efficiency, the UK set a target of 18% relative to the 2007 business-as-usual projection and has transposed elements of this Directive into national legislation. It remains to be seen whether the Commission can or will bring forward infringement procedures or take the UK to court in the event that it fails to meet its obligations in advance of Brexit taking place.
Questions have also been raised on whether the Brexit vote will or will not have an impact on the Hinkley Point nuclear power station proposals. The project already had a number of problems before the referendum and the final investment decision had been postponed several times. In April 2016, the French energy company EDF announced that it was delaying a final investment decision (FID) until September. At the time of writing the decision was brought forward to July.
From the UK perspective, the construction of EDF’s Hinkley Point C has been positioned as part of the UK government’s solution to provide security of supply by ensuring ongoing supply of low carbon baseload power. Despite delays to the FID, the new Chancellor Philip Hammond re-iterated in his first day in office, the government’s determination to make it happen.
In the first instance, the UK government will need to decide who will be responsible for negotiating the energy and climate change aspects of leaving the EU, particularly in light of the recent joint climate targets agreed in the Paris Agreement. This could be BEIS or the new Department for Exiting the European Union or more likely a combination of both.
Being part of the Internal Energy Market is critical to the UK and it will most likely try to maintain access as an outcome of the exit negotiations.
The EU will certainly aim to keep the UK as a strong partner. Countries such as France, Belgium and the Netherlands have a particular and vested interest in maintaining their strong links. As such, there should be no seismic changes to the current systems and regulations in the immediate future.
While the UK has ambitious climate targets of its own, it has also been a strong industry ally on more controversial energy issues such as shale gas and offshore safety. With the UK out, industry will lose one of its strongest and most pragmatic allies at the EU decision making table. However, the likely ongoing collaboration between energy leaders in the EU and the UK should minimise the loss of expertise and understanding that can at least still contribute to the debate.
Overall, the UK’s vote to leave creates uncertainty for the future of most of the EU’s energy policies. Although Brexit is unlikely to significantly change already existing energy legislation either in the EU or in the UK in the short term, this is much less certain in the longer term. This uncertainty may have the strongest impact and could hamper investments in the UK electricity system.
Whatever happens at the negotiating table, our view is that energy remains a sector where the European Union and the UK have a vested interest in continued cooperation.