Prior to the vote, markets had been pricing in a greater than 80% chance that the ‘Remain’ vote would prevail, so the unexpected ‘Leave’ result caused a significant sell off in the pound and has led to continued volatility for the pound sterling against such currencies as the Euro and Dollar. As the date approaches for the UK to leave the European Union, the increasing level of uncertainty as to the structure and terms of any deal between the UK and the European Union has caused the markets to remain jittery.
In the commodity markets the initial impact of the vote was the weakening pound versus the Euro and Dollar, commodities priced in these currencies overnight became more expensive to import into the UK, commodities such as; European gas, coal and carbon. The relative increase in these commodity prices impacted UK energy markets.
The decoupling of the UK from the European Union also has legislative impacts, a number of which will affect UK Energy markets, these are explored in the sections below. It must be understood that Brexit remains a moveable feast and the information below is correct to the best of LG Energy’s knowledge.
Energy Policy Implications: Internal Energy Market (IEM)
To remain part of the Internal Energy Market, is one of the key decisions which the UK has make due the potential impacts for the energy industry, which are shown below:
Benefits of remaining:
- IEM markets make it easier to trade across borders, boosting liquidity and cross-border balancing.
- Reinforcement through the EU project would also make cross border energy markets a reality, including capacity market integration.
Losing the benefits of IEM:
- Impact the cost of energy as well as our security of supply.
- Non-commodity charges, interconnector volumes and security of supplies, will only be affected if the EU decided to block the flow of electricity and gas to the UK – this is unlikely as the EU already supplies energy to countries outside the EU and would reduce revenues of countries that export to the UK.
It’s important to note that it is still possible to be part of the IEM without being an EU member, a case in point being Switzerland. This however would be difficult as the UK would still need to recognise the jurisdiction of the European Court of Justice, which in itself contradicts one of Teresa May’s so called “red lines”.
It’s unlikely that Brexit will have a significant impact on climate change policies, this is due to the fact the UK government has already gone further than the EU when it comes to reducing carbon emissions. The Government has pledged to close all coal-fired power stations by the middle of the next decade and has committed to zero carbon emissions by 2050.
Energy Investment is one of the areas likely to suffer as a result of the UK leaving the European Union, this is due to the fact that the UK requires up to £19 billion of investment in new infrastructure each year from now until 2020; equating to circa 60% of the UK’s total infrastructure costs for the rest of the decade.
National Grid (the UK’s system operator) has asked Vivid Economics to undertake analysis of the possible effects of an exit EU, in its subsequent report, Vivid Economics states:
“In the hotly contested Brexit debate, one thing is clear: Brexit will create economic uncertainty. This is because there are 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, with differing implications for investment and trade.”
The report concludes that, from an investor’s perspective, “higher returns are required to compensate them for the risk of less favourable post-Brexit arrangements. This puts upwards pressure on the cost of financing, raising the cost of investment in the UK energy sector.”
Carbon pricing options:
On 13th February 2019 the House of Lords EU Energy and Environment Sub-Committee held a stakeholder evidence session on the implications of Brexit for carbon pricing in the UK.
The UK is likely to withdraw from the EU Emissions Trading Scheme (ETS) – one of the main carbon pricing mechanisms in the UK as a result of Brexit.
In a deal situation, the government plans to create a domestic emissions trading system and link it to the EU ETS, while in a no-deal situation, the government intends to implement a UK carbon emissions tax.
Concerns have been raised as to whether a domestic ETS system will work without linking to the EU ETS, concerns being the size and liquidity of the market. On the proposed level of £16/ tonne CO2 for a carbon tax, set broadly in line with the EU ETS, its suggested in short term trying to replicate EU ETS price signals where reasonable, however, government would need to decide the purpose of the tax.
To conclude, on assumption that an EU ETS-aligned trading scheme is the least risk and most feasible option is pragmatic.
What next for the energy market?
To conclude, there will be short term uncertainty in the UK energy market due to political uncertainty and on the route that the UK will take following Brexit. This may result in the following:
- Slowdown in investment in UK energy projects and increased costs
- Maybe an increase in energy prices, this should not be long term given the global nature of the market
Medium to long term uncertainty of Brexit is also uncertain. There is no precedent for withdrawing from the EU. Membership of the IEM will be the key consideration on the effects of the UK’s energy market.