How will Brexit impact on the energy industry?

More than three years have passed since the United Kingdom voted to leave the European Union. Debate is still ongoing over the process of our departure, any possible “deal”, payments or a transition period. However, following his appointment to Prime Minister, Boris Johnson has hardened the UK’s negotiating position, promising that the UK will leave the EU on 31 October 2019, deal or no deal. Here we attempt to provide some insight into how this may impact various facets of the energy industry.

The energy sector in the UK had already seen significant changes with the Energy Act 2011 and various proposals for reform of the electricity market. The possible impact of Brexit on the UK and global economy could be far-reaching. However, the direct impact on the energy industry is likely to be more muted. Oil and gas markets are traded on an international level and the EU has little influence over the make-up of a member state’s energy mix. There will be no danger of blackouts or supply shortages and in the short-term you may see little day-to-day change. However, the longer-term outlook for post-Brexit energy may be altered, with one of the major issues being the UK’s relationship with, or role within, the EU’s Internal Energy Market (IEM).

The EU Internal Energy Market (IEM) – will Britain stay a part?

The IEM is a borderless network of gas and electricity transfers between EU member states. Common market rules and cross-border infrastructure allow for energy to be transferred between countries tariff-free.

Post-Brexit, Britain is likely to have less influence over EU energy regulation but will be able to adopt a different, potentially lighter, framework for its energy polices. The extent to which the UK still adheres or follows the EU energy regulation will be dependent on any ‘deal’ reached before the deadline.

Continued access to the IEM is a key priority for the UK Government in its Brexit negotiations. This would allow the country to continue to take advantage of various benefits associated with the IEM including increased security of supply, market coupling, cross-border balancing and capacity market integration.

Having recognised the benefits of the IEM the Government is seeking to retain as free as possible access to internal market and to maintain a strong influence on energy within the EU.

Plans to increase interconnectivity with the Continent are continuing and enhancing with many new interconnector links currently in development (see below). Irrespective of negotiations, this will require close co-operation with the EU Internal Energy Market going forward.

However, there are some inconsistencies in regards to UK plans encompassing full membership of the IEM. Continued participation is likely to involve the UK adopting various European legislation, which may not tally fully with UK judicial ambitions unless the UK remains part of the institutions which handle EU energy regulation (ACER, ENTSO-E and ENTSO-G for example).

Will Brexit impact on connectivity between the UK and Europe – what about interconnectors?

The ongoing negotiations regarding the UK’s 2019 exit from the E U, are having no real impact on developments, with four new interconnector links now under construction.

The Government wants to see all the current planned projects through to operation, the majority of which will not be completed until after the UK has left the EU in 2019. Former Business Secretary Greg Clark had indicated he was keen for the UK to remain in the EU’s I E M, although the final result will depend on the outcome of Brexit negotiations.

Regardless of the outcome, the UK’s energy networks’ connections to the EU will remain in place. The Government recently posted guidance on the trading of gas and electricity with the EU if there is no Brexit deal. The publication highlights that there are only small changes expected to interconnector operations. Interconnector operators have been advised to engage with relevant EU national regulators to confirm any requirements for the reassessment of their access rules.

The main area that may see impact is for proposed interconnectors, which are still in stages of project development, without final financial decisions. Uncertainty caused by Brexit, surrounding commercial, regulatory and operational impacts, will likely see planning stages re-visited to adjust for these challenges.

The UK may lose access to the Connecting Europe Facility (CEF) going forward. The CEF help to provide funding for interconnectors across Europe through targeted infrastructure investment. The Government have confirmed that any commitments that have already been made by the CEF regarding interconnectors into the UK will be safe following the UK’s withdrawal. However, it is not clear whether companies in the UK will be able to seek investments for new projects.

How will Brexit impact on the carbon market? Will the UK be part of the EU ETS?

The Government has published plans for the implementation of a UK carbon tax in the case of a ‘no-deal’ Brexit. Under a ‘no deal’ scenario, the UK would be excluded from participating in the EU ETS. This would mean current participants in the EU ETS who are UK operators of installations will no longer take part in the system.

In this instance, the UK government will initially meet its existing carbon pricing commitments through the tax system. A carbon price would be applied across the UK, with the inclusion of Northern Ireland, starting at £16/tCO2, less than the current EU ETS price, maintaining the level of carbon pricing across the UK economy post-Brexit.

The tax would be applied to the industrial installations and power plants currently participating in the EU ETS from 4 November 2019. The aviation sector would be exempt from this tax.

Will EU state aid rules still apply to the UK?

Unless the UK remains part of the European Economic Area (EEA), then the EU state aid rules would no longer apply. The Government has said it will transfer existing EU state aid law into domestic law after Brexit. The Competition and Markets Authority will take over responsibility of state aid enforcement. Going forward UK rules may diverge from the EU but the extent of this will be limited by the terms of a future UK-EU trade deal. In the immediate aftermath of Brexit, no significant change to state aid rules are expected.

How will Brexit affect the nuclear sector?

The UK indicated its intention to withdraw from the European Atomic Energy Community (Euratom) and the associated treaty (the Euratom Treaty) on 29 March 2017 as part of the Article 50 withdrawal process.

A report from the House of Lord’s energy sub-committee in January 2018 highlighted the potential for this withdrawal to impact UK nuclear operations such as fuel supply, waste management, and research.

However, the Government has made clear withdrawal from Euratom will not affect nuclear security and safety requirements. A Nuclear Safeguards Bill was introduced to Parliament in October 2017, highlighting how this will be achieved by amending the Energy Act 2013.

The Government will also continue to fund nuclear research in the UK, through programs like the Joint European Torus, Europe’s largest nuclear fusion device. Going forward, the UK will negotiate nuclear cooperation terms with other Euratom and non-Euratom members.

Will Brexit affect the UK’s climate change targets?

The UK passed law in June to reach Net Zero carbon emissions by 2050. The country’s climate change targets will remain unchanged, regardless of whether a Brexit deal is reached. However, there are expectations that potential economic impact from a no-deal Brexit may act as a significant hindrance to decarbonisation efforts.

Additionally, there are several international issues in this area which will need to be settled. The UK’s emissions reduction target forms part of the EU target under the Paris Agreement and this will need to be withdrawn. The UK would also need to submit its own Nationally Determined Contribution under the United Nations Framework Convention on Climate Change (UNFCCC) processes. It is yet to be determined whether the UK will continue to participate in the EU ETS post-Brexit but plans under a no-deal scenario were outlined in the October 2018 budget.

The House of Commons Business, Energy and Industrial Strategy Committee has strongly recommended remaining in the EU ETS at least until the end of Phase III in 2020. The UK’s 5th carbon budget adopted in 2016 assumes continued participation in the EU ETS, and will need to be altered if the UK leaves the EU ETS.

What about renewable energy?

After Brexit, the UK will no longer be obligated by renewable energy targets as part of the EU Renewable Energy Directive. Additional freedom from state aid restrictions has the potential to allow the Government to shape renewable energy support schemes.

The development of large scale projects may be impacted by the availability of funding from EU institutions such as the European Investment Bank. However, renewable and low carbon energy will remain a focal point of UK energy policy post-Brexit, with national and international decarbonisation obligations unaffected by their relationship with the EU.

As part of the European Union (Withdrawal) Act 2019 EU legislation will be initially transposed into UK law from 31 October 2019. For some elements of the EU law, the UK will need to reach an agreement with the EU in order to maintain the status quo.

Will coal plants stay open?

Coal-fired power plants in the UK are required to adhere to the EU Industrial Emissions Directive (IED) which places conditions on such plants in order to control and reduce the emissions and waste generated by these power plant. Strict emissions limits often require substantial investment in technology to reduce pollution. Several plant determined this was not cost effective, and will close down. All but one coal plant has chosen not to adhere to the new regulations and will close by 2023. The Cottam plant announced it will shut down at the end of the summer, while Fiddlers Ferry will close its remaining units in March 2020. Despite Brexit, these unabated coal plant will close. The Government has confirmed its policy to remove coal from the fuel mix entirely by 2025.

The Medium Combustion Plants Directive 2015 (MCP) operates in a similar manner, limiting the emissions of harmful pollutants. The UK has adopted both the IED and the MCP into its European Union (Withdrawal) Act, meaning that in the short-term these regimes will continue beyond October 2019. In the long term, the UK and EU will need to agree on common standards following Brexit.

What about EU investment in energy projects?

Several EU initiatives promote investment in energy infrastructure which encompasses funding towards UK projects. The European Investment Bank (EIB) for example has invested over €13bn into UK energy projects since 2010.

The draft EU Withdrawal Treaty anticipates this funding will continue, at least for projects approved by the EIB for investment before 29 March 2019.

After withdrawal from the EU, the UK will not be eligible for specific financial operations from the EIB which are reserved for EU member states. New projects may be supported by the EU depending on the nature and whether it aligns with the EU’s own energy policy. Cross-border projects, such as interconnectors and pipelines, may be available to non-member states.

The UK Treasury has sought to boost funding certainty and has vowed to underwrite all funding obtained via a direct bid to the European Commission and has also confirmed Horizon 2020 projects will still be funded.

What about the gas market, will supplies be affected?

The UK already operates a diverse import infrastructure, consisting of interconnectors and LNG terminals to allow for the import of gas, mitigating against supply risks. Operations and gas flows are expected to continue as normal, irrespective of any Brexit.

A more significant impact is likely to come from the expiry of long term supply contracts and restrictions which allow for selling capacity on a long term basis. The tariff network coderestricts the price at which interconnectors can sell their capacity. With Brexit it is unclear whether interconnectors will continue to be bound by these restrictions.

Other benefits like the Early Warning Mechanism and the Gas Advisory Council may be lost unless the UK can negotiate to retain its role in these.

For Brexit to have a significant impact on gas prices (barring any substantial currency moves) then the withdrawal from the EU would need to lead to export tariffs on EU gas flowing to the UK.

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Pound slides to multi-year lows on Brexit concerns

Boris Johnson’s appointment as Prime Minister has seen a change in strategy regarding the UK’s negotiating stance with the European Union over its exit. The new PM has pledged to leave the EU by 31 October, deal or no deal. Furthermore, while his wish is very much for an agreed exit, Mr Johnson is taking a hard line with negotiators, refusing to meet with EU leaders until a new deal is offered, without the Irish backstop.

The heightened risk of leaving the Union without a withdrawal agreement has had a negative influence on the value of the pound. Sterling has fallen more than 2% against the Euro and 3% against the Dollar in the first week of the new PM’s premiership. The pound’s value against the Dollar is the lowest in nearly two and a half years, approaching the lows reached after Article 50 was triggered in March 2017.

Increased Costs

The weakness in the value of the pound will increase costs for consumers. British imports of energy from the Continent will require a price premium which covers the wholesale and shipping costs in delivery of supply. Weakness in the pound will make these imports even more expensive when the purchase price is converted from Euros. This would be a particular issue during periods of high demand, extreme weather or supply disruptions.

Impact on Supply

In previous blogs, we have explained how Brexit is very unlikely to mean the lights go out. The UK continues to strengthen Interconnector links with Continental Europe with the capacity for power links expected to double to over 8GW by 2022.

Britain is seeking to retain as free as possible access to the EU Internal Energy Market, post Brexit. Gas and power will still be able to flow between the EU and the UK but there is the potential for legislative issues, and trading could become less efficient while long-term security of supply is less clear.

It is a similar situation in the gas market, although the UK is much more reliant on imports, with more than half of the country’s natural gas being imported from countries in the European Economic Area – the vast majority from Norway. The UK can also import supplies of liquefied natural gas (LNG) shipped on tankers and pipeline flows from Belgium and the Netherlands.

Brexit is not expected to impact on the availability of this gas, even under no deal. However, less efficient trading, the possibility of new regulations, and heightened currency variations would all likely increase costs for consumers.

With the UK unable to meet demand with its own indigenous supply, the country is expected to become increasingly reliant on energy imports from foreign sellers, making these issues more prevalent in the day-to-day trading of energy.

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Our Market Intelligence team keep a close eye on the energy markets and industry updates. For the most timely updates you can find us on Twitter and LinkedIn Follow us today.

Visit our webpage to find out more about EIC Market Intelligence and how we keep our clients informed at a frequency to suit them.

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UK and Europe strengthen electricity links against backdrop of Brexit uncertainty

The UK continues to press ahead with plans to significantly increase its Interconnector links with Continental Europe.

Negotiations over the UK’s exit from the European Union, currently scheduled for 29 March, have been turbulent to say the least, with the Prime Minister’s Brexit deal twice rejected by the House of Commons. However, this is having no real impact on energy infrastructure, with new developments strengthening electricity links across the Channel. More information on the impact of Brexit on the energy industry can be found here.

The first electricity link connecting Britain with Belgium became operational on 31 January 2019. The 1GW power link had been under construction since 2016, with funding provided by a joint venture between Britain’s National Grid and Belgian system operator Elia.

The Government wants to see all the current planned projects through to operation, the majority of which will not be completed until after the UK has left the EU. Business Secretary, Greg Clark had indicated he was keen for the UK to remain in the EU’s Internal Energy Market, although the final decision will depend on the conditions of any final withdrawal agreement.

 

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Following on from the Belgium link, two more links with France are under construction – ElecLink and IFA2 – with both scheduled to be operational by 2020. A North Sea Link with Norway is also progressing, expected to be fully commissioned in 2021.

As a consequence, over the next three years, Interconnector capacity between the UK and Europe is expected to more than double to over 8GW.

This will provide the British power market with access to greater supplies and improved flexibility in meeting peak demand. Tight surplus power margins triggered sharp spikes in Day-ahead power prices last winter, particularly during the Beast from the East cold snap. The threat of cold, windless days will remain a problem for the UK going forward. The incentive for investment in increased interconnection for the UK is clear.

 

Interconnectors

The UK now operates five interconnector links, including the Nemo Link. Three are with mainland Europe via France, Belgium and the Netherlands, and two are with Ireland. Total capacity across the links is now 5GW, with the completion of Nemo. A further 3.4GW of interconnector capacity is currently under construction.

 

UK links target France and Ireland

In addition to those under construction, a further four additional interconnectors with France are in the pipeline. A new 1.4GW FAB cable to Devon was granted planning approval earlier last year. The 2GW AQUIND Interconnector, planned for Portsmouth, received approval from energy regulator Ofgem in September 2017. Further connections include two 1.4GW projects, the GridLink Interconnector in Kent and the Channel Cable. Both are hoping to be online by 2022.

Developers are also looking to take advantage of high renewable availability in Ireland. Utilising the short distance between Wales and the Republic of Ireland, four interconnectors are planned across the Irish Sea. The GreenConnect, Greenlink and Greenwire North and South developments could add 3.5GW of transmission capacity between Britain and Ireland. Ireland is also planning its own direct link with France, but the Celtic Interconnector is only in the early planning stages.

 

Scandinavian connections

The UK also has early plans to tap into the Scandinavian energy market, hoping to take advantage of high levels of installed renewable capacity as well as hydropower reserves in the region. Two interconnector links are in planning with Norway. These will run to Peterhead in Northeast Scotland and Blyth in northern England – both with a capacity of 1.4GW.

A further 1.4GW Viking Link is in planning that will connect the UK with Denmark. Just last week the UK Government gave final approval of the project, which is scheduled to come online in 2023. Developer National Grid Viking Link Limited (NGVL) has explicitly stressed that the UK’s decision to leave the European Union “does not influence the plans to build and operate Viking Link between the UK and Denmark.”

An ambitious 1,000km IceLink interconnector is also in planning and will connect Scotland with Iceland. However, the €3.5bn project is only at the concept stage and it is expected to be at least ten years until this link could be operational.

How will Brexit affect the UK energy industry?

The energy sector in the UK had already seen significant changes with the Energy Act 2011 and various proposals for reform of the electricity market. The potential impacts of Brexit on the UK and global economy could be far-reaching. However, the direct impact on the energy industry is likely to be more muted.

Oil and gas markets are traded on an international level and the EU has little influence over the make-up of a member states energy mix. There will be no danger of blackouts or supply shortages and in the short-term you may see little day-to-day change.

However, the longer-term outlook for post-Brexit energy may be altered, with one of the major issues being the UK’s relationship with, or role within, the EU Internal Energy Market (IEM).

 

The EU Internal Energy Market (IEM) – will the UK stay a part?

The IEM is a borderless network of gas and electricity transfers between EU member states. Common market rules and cross-border infrastructure allow for energy to be transferred tariff-free between countries.

Post-Brexit, the UK is likely to have less influence over EU energy regulation but will be able to adopt a different, potentially lighter, framework for its energy polices. The extent to which the UK still adheres or follows the EU energy regulation will be dependent on any ‘deal’ reached before March 2019.

Continued access to the IEM is a key priority for the UK Government in its Brexit negotiations. This would allow the country to continue to take advantage of various benefits associated with the IEM including increased security of supply, market coupling, cross-border balancing and capacity market integration.

Having recognised the benefits of the IEM the Government is seeking to retain as free as possible access to internal market and to maintain a strong influence on energy within the EU.

Plans to increase interconnectivity with the Continent are continuing and enhancing with many new interconnector links currently in development (see below). Irrespective of negotiations, this will require close cooperation with the EU Internal Energy Market going forward.

However, there are some inconsistencies in regards UK plans encompassing full membership of the IEM. Continued participation in the IEM is likely to involve the UK adopting various European legislation, which may not tally fully with UK judicial ambitions unless the UK remains part of the institutions which handle EU energy regulation (ACER, ENTSO-E and ENTSO-G for example).

 

Will Brexit impact on connectivity between the UK and Europe? What about Interconnectors?

The ongoing Brexit negotiations are having no real impact on developments, with four new Interconnector links now under construction.

The Government wants to see all the current planned projects through to operation, the majority of which will not be completed until after the UK has left the EU. Business Secretary Greg Clark had indicated he was keen for the UK to remain in the EU’s Internal Energy Market, although the final result will depend on the outcome of Brexit negotiations.

Regardless of the outcome, the UK’s energy network connections to the EU will remain in place. The Government recently posted guidance on the trading of gas and electricity with the EU if there is no Brexit deal. The publication highlights that there are only small changes expected to Interconnector operations, advising operators to engage with relevant EU national regulators to confirm any requirements for the reassessment of their access rules.

The main area that may see impact is for proposed Interconnectors; those which are still in the stages of project development, without final financial decisions. Uncertainty caused by Brexit, surrounding commercial, regulatory, and operational impacts, will likely see planning stages revisited to adjust for these challenges.

The UK may lose access to the Connecting Europe Facility (CEF) going forward. The CEF help to provide funding for Interconnectors across Europe through targeted infrastructure investment. The Government has confirmed any commitments that have already been made by the CEF regarding Interconnectors into the UK will be safe following the UK’s withdrawal. However, it is not clear whether companies in the UK will be able to seek investments for new projects.

 

Will EU State Aid rules still apply to the UK?

Unless the UK remains part of the European Economic Area (EEA), then the EU State Aid rules would no longer apply. The Government has said it will transfer existing EU State Aid law into domestic law after Brexit. The Competition and Markets Authority (CMA) will take over responsibility of State Aid enforcement. Going forward, UK rules may diverge from the EU but the extent of this will be limited by the terms of a future UK-EU trade deal.

In the immediate aftermath of Brexit, no significant change to State Aid rules is expected.

 

Will coal plants stay open?

Coal-fired power plants in the UK are required to adhere to the EU Industrial Emissions Directive (IED) which places conditions on such plants in order to control and reduce the emissions and waste they generate. Strict emissions limits often require substantial investment in technology to reduce pollution. Several plant determined this was not cost effective, and will close down. All but one coal plant has chosen not to adhere to the new regulations and will close by 2023, and several have already done so.

Despite Brexit, these unabated coal plant will close. The Government has confirmed its policy to remove coal from the fuel mix entirely by 2025.

The Medium Combustion Plants Directive 2015 (MCP) operates in a similar manner, limiting the emissions of harmful pollutants. The UK has adopted both the IED and the MCP into its European Union (Withdrawal) Act, meaning that in the short-term these regimes will continue beyond March 2019. In the long-term the UK and EU will need to agree on common standards following Brexit.

 

What about EU investment in energy projects?

Several EU initiatives promote investment in energy infrastructure which encompasses funding towards UK projects. The EIB, for example, has invested over €13bn into UK energy projects since 2010.

The draft EU Withdrawal Treaty anticipates this funding will continue, at least for projects approved by the EIB for investment before 29 March 2019.

After withdrawal from the EU, the UK will not be eligible for specific financial operations from the EIB which are reserved for EU member states. New projects may be supported by the EU depending on the nature and if it aligns with the EU’s own energy policy. Cross-border projects, such as Interconnectors and pipelines, may be available to non-member states.

The UK Treasury has sought to boost funding certainty and has vowed to underwrite all funding obtained via a direct bid to the European Commission and has also confirmed Horizon 2020 projects will still be funded.

 

What about the gas market, will supplies or prices be affected?

The UK already operates a diverse import infrastructure, consisting of Interconnectors and Liquefied Natural Gas (LNG) terminals to allow for the import of gas, mitigating against supply risks. Operations and gas flows are expected to continue as normal, irrespective of Brexit.

A more significant impact is likely to come from the expiry of long-term supply contracts and restrictions which allow for selling capacity on a long-term basis. The tariff network code restricts the price at which Interconnectors can sell their capacity. With Brexit it is unclear whether Interconnectors will continue to be bound by these restrictions.

Other benefits like the Early Warning Mechanism and the Gas Advisory Council may be lost unless the UK can negotiate to retain its role in these.

For Brexit to have a significant impact on gas prices (barring any substantial currency moves) then the withdrawal from the EU would need to lead to export tariffs on EU gas flowing to the UK.

 

How will Brexit affect the nuclear sector?

The UK indicated its intention to withdraw from the European Atomic Energy Community (Euratom) and the associated treaty (the Euratom Treaty) on 29 March 2017 as part of the Article 50 withdrawal process.

A report from the House of Lord’s energy sub-committee in January 2018 highlighted the potential for this withdrawal to impact UK nuclear operations such as fuel supply, waste management, and research.

However, the Government has made clear withdrawal from Euratom will not affect nuclear security and safety requirements. A Nuclear Safeguards Bill was introduced to Parliament in October 2017, highlighting how this will be achieved by amending the Energy Act 2013.

The Government will also continue to fund nuclear research in the UK, through programs like the Joint European Torus, Europe’s largest nuclear fusion device. Going forward, the UK will negotiate nuclear cooperation terms with other Euratom and non-Euratom members.

 

What about environmental impacts?

We’ve taken a look at the potential affect of Brexit on the UK’s climate change and renewable energy targets – find out more at our blog.

 

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What impact will Brexit have on UK climate change targets?

The energy sector in the UK had already seen significant changes with the Energy Act 2011 and various proposals for reform of the electricity market. The potential impacts of Brexit on the UK and global economy could be far-reaching. However, the direct impact on the energy industry is likely to be more muted.

 

How will Brexit impact on the carbon market and the EU ETS?

The Government has published plans for the implementation of a UK carbon tax in the case of a ‘no-deal’ Brexit.

Under a ‘no-deal’ scenario, the UK would be excluded from participating in the EU Emissions Trading Scheme (ETS). This would mean current participants in the EU ETS who are UK operators of installations will no longer take part in the system.

In this instance, the UK Government will initially meet its existing carbon pricing commitments through the tax system. A carbon price would be applied across the UK, with the inclusion of Northern Ireland, starting at £16/tCO2, marginally less than the current EU ETS price, maintaining the level of carbon pricing across the UK economy post-Brexit.

The tax would be applied to the industrial installations and power plants currently participating in the EU ETS from 1 April 2019.

The House of Commons Business, Energy and Industrial Strategy (BEIS) Committee has strongly recommended remaining in the EU ETS at least until the end of Phase III in 2020.

The UK’s 5th carbon budget, adopted in 2016, assumes continued participation in the EU ETS, and will need to be altered if the UK leaves the EU ETS.

 

Will Brexit affect the UK’s climate change targets?

The UK’s climate change targets are expected to continue unaffected by whatever Brexit deal is reached. The Climate Change Act 2008 established that such goals are undertaken on a national level.

However, there are several international issues in this area which will need to be settled. The UK’s emissions reduction target forms part of the EU target under the Paris Agreement and this will need to be withdrawn. The UK would also need to submit its own Nationally Determined Contribution under the United Nations Framework Convention on Climate Change (UNFCCC) processes.

 

What about renewable energy?

After Brexit, the UK will no longer be obligated by renewable energy targets as part of the EU Renewable Energy Directive. Additional freedom from State Aid restrictions has the potential to allow the Government to shape renewable energy support schemes.

The development of large-scale projects may be impacted by the availability of funding from EU institutions such as the European Investment Bank (EIB). However, renewable and low-carbon energy will remain a focal point of UK energy policy post-Brexit, with national and international decarbonisation obligations unaffected by their relationship with the EU.

As part of the European Union (Withdrawal) Act 2018, EU legislation will be initially transposed into UK law from 29 March 2019. For some elements of the EU law, the UK will need to reach an agreement with the EU in order to maintain the status quo.

 

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The future of the carbon market beyond Brexit

EU carbon allowances are bought and sold as part of the European Emissions Trading Scheme (EU ETS). Currently the UK is part of the EU ETS, but continued participation is contingent on a deal with the European Union.

 

What are carbon allowances?

EU carbon allowances, or European Allowances (EUAs) serve as the unit of compliance under the European Emissions Trading Scheme (EU ETS). EUAs are auctioned for use by energy-intensive industries that fall under the scheme, namely power generators, oil refiners, and steel companies, entitling them to emit one tonne of CO2.

The EU ETS works on the ‘cap and trade’ principle. A limit has been set on the amount of EUAs made available, capping the total amount of greenhouse gases that can be emitted by installations that fall under the system. As the cap decreases with time, total emissions fall.

These emission allowances work as tradeable goods, allowing companies to receive or buy them. After each year a company must use enough allowances to cover all its emissions, otherwise they will be heavily fined. Spare allowances can be saved to cover future needs or sold onto other companies that are short of allowances.

 

Overcoming the oversupply

The 2008 global financial crisis and the recession that followed saw a large oversupply of carbon allowances build up, which in turn saw prices reach all-time lows for an extended period. At the end of 2016 the EU ETS had an oversupply of 1.7bn tonnes worth of EUAs, which significantly weakened the incentive to reduce emissions.

In response, the European Commission has introduced a long-term solution known as the Market Stability Reserve (MSR), which will begin operations in January 2019. The purpose of the MSR will be to address the current surplus of allowances and to improve the system’s resilience to major impacts by adjusting the supply of allowances to be auctioned.

This will see 900 million allowances, which were back-loaded between 2014 and 2016, transferred to the Reserve, rather than be auctioned in 2019-2020. After this, unallocated allowances will also be transferred to the Reserve.

To improve regulation, the Commission will publish the total number of allowances in circulation by 15 May each year. They will then examine whether more allowances should be placed into the Reserve or released.

 

 How will Brexit affect these plans?

With Brexit looming, there’s uncertainty as to whether these changes will affect the UK. Under current plans the UK will remain a member of the EU ETS until at least 2020, almost a full year after its scheduled departure from the EU in March 2019.

Experts have warned that exiting the scheme before 2020, in the middle of an ETS trading phase, would cause disruption for both UK businesses and EU firms. However, staying within the scheme is contingent on a deal with the EU, something which the Energy and Climate Change Minister, Claire Perry, has acknowledged is yet to be formally agreed with EU policymakers.

 

What if there’s no deal?

Under a ‘no deal’ scenario, the UK would be excluded from participating in the scheme. This would mean current participants in the EU ETS who are UK operators of installations will no longer take part in the system. The UK government plans to remove the requirements relating to the surrender of emissions allowances as, post-Brexit, the European Commission will invalidate any allowances issued by the UK in 2019, such that they would have no value on the carbon market.

In this instance, the UK government will initially meet its existing carbon pricing commitments through the tax system, taking effect in 2019. A carbon price would be applied across the UK, with the inclusion of Northern Ireland.

 

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Further details on how the Government intends to apply this carbon price will be covered in next week’s Budget. For the most timely updates you can find us on Twitter. Follow @EICinsights today.