Impact of Brexit on UK Energy Security
Analysing the impact of different Brexit scenarios on the UK Energy Security of Supply.
The UK currently operates under common EU energy market rules.
As part of the EU and the Internal Energy Market, the UK energy sector complies with EU-wide rules, such as, unbundling, third party access and limitations on state aid. These rules have been introduced by the three EU energy packages and have a considerable impact on the sector and its customers.
EU rules have a real impact on how the UK fulfils its energy needs today and how it will do so in the future. Being part of the Internal Energy Market, for instance, allows for lower and more stable electricity prices for UK customers by facilitating interconnection to different countries.
Today, the UK is facing the issue of low power capacity margins; it can generate just enough electricity to meet the highest levels of demand. Low capacity margins have a negative impact on the energy security profile of the UK. The term energy security (of supply) is usually used to describe a country’s ability to access energy sources as well as its ability to supply power without disruptions under normal conditions.
To resolve the issue of low capacity margins, fresh investment in new generation capacity is needed. The economic case for this much needed capacity, however, rests on a solid and predictable set of rules that UK regulators have developed throughout the years, established on European guidelines.
A Brexit vote will mean new rules need to be established for the UK to operate in the market
In the event of Brexit the UK will have a two year window during which its political, economic and institutional ties with the EU will be untangled and redefined. As the two parties redefine their ties, existing trade arrangements and the market rules that underpin them will necessarily be abolished or rearranged.
The ultimate result of UK-EU negotiations, will be a new set of trade arrangements and market rules that would define how the UK energy sector operates.
New rule negotiations will take time causing project delays
We expect post-Brexit negotiations to last between 2 years to over a decade. These negotiations will be characterised by a set of heated debates and clashes among EU states who have diverging opinions on this matter. This brings considerable uncertainty; it takes the UK into uncharted waters.
Uncertainty, as is widely recognised, is bad for business. We expect investors and project developers to adopt a ‘wait and see’ approach to Brexit negotiations. This approach can lead to the delay or cancellation of energy infrastructure projects that are being planned or currently developed; not a good outcome for a sector in need of sizeable investment.
For the gas sector Brexit may be easily manageable
The UK gas sector is well positioned to withstand the shock of a Brexit event. Historically, the gas sector has relied on domestic North Sea production; with this area facing a decline in production, imports of gas have become prominent.
We show that the impact of Brexit on access to natural gas would be marginal. Imports are based on long term contracts with EU/EEA countries that rely on already existing pipeline infrastructure.
Furthermore, the UK can count on LNG import terminals that have the capability to process half of yearly national demand. We expect long term import contracts and liquid LNG markets to provide required natural gas supplies without the need for new infrastructure.
The electricity sector will be impacted by Brexit and affect negatively UK energy security
While the gas sector should withstand the impact of Brexit, the same could not be true for the UK electricity sector. Coal-fired power plants, which represent the backbone of the UK generation portfolio, are being decommissioned and new investment is not leading to their replacement. Much emphasis has been given to projects promising to address this issue and provide a stable source of power to the UK. Hinkley Point C is a notorious example.
Declining generation capacity has played a decisive role in low capacity margins on the electricity grid. Low capacity margins give rise to the potential for customer disconnections which, while rare, can impact the wellbeing of consumers and economic activity at large.
As more coal-fired power plants come offline, lower investment in energy infrastructure projects is set to exacerbate the weakening energy security profile of the UK. Interconnection projects are particularly at risk of being cancelled or delayed given their reliance on cross-border regulation.
Figure i- Comparing Hinkley Point C to Interconnection Projects.
Source: 4C offshore, Ofgem, Sia Partners Analysis
Interconnecting the UK power system to another country’s is an efficient way to mitigate the issue of low capacity margins. Interconnection projects amounting to 10GW of capacity (on top of the existing 4 GW) are being developed, planned or proposed to connect the UK to evermore countries.
Figure i on the right compares the cost, capacity and availability of Hinkley Point C and the planned interconnection projects. We see that the price tag for 10GW of interconnection capacity (£9.6bn) comes at slightly more than half of that for Hinkley Point C (£18bn[i]).
The third figure, showing availability, measures the percentage of time that Hinkley Point C and Interconnectors produce electricity over a set period of time (i.e. Hinkley Point will produce electricity 81% of the time over a given week/month/year). The 58% availability for interconnection capacity is an average of the availability expected by Ofgem for a range of different projects. Interconnectors with Norway are expected to have an availability factor of 96%, those with Ireland just 23%[ii]. This figure is set to improve with the introduction of EU regulation making the flows of electricity more efficient.
One thing is clear, interconnection capacity is a valid alternative to Hinkley Point and many other, more expensive, solutions to low capacity margins.
We have seen that Brexit would limit the development of important energy infrastructure. In this research we set out to answer the following question: How would Brexit impact the energy security of the United Kingdom?
We examined three potential scenarios
We modelled three different outcomes of the referendum to gauge the impact of Brexit on the UK’s energy security:
- Norway Scenario – This case hypothesises that the UK will join the EEA after withdrawing its membership to the European Union. We applied the trade and regulatory arrangements that underpin Norway-EU energy trade and applied them to the UK.
- Switzerland Scenario – In this case we assume that the UK will leave the EU and rely on bilateral trade arrangement to deal with the Union, just as Switzerland does.
- No Brexit Scenario – To deliver a full picture of the possible outcomes we forecasted the UK’s energy security profile should Britons choose to remain in the EU.
As a result of our analysis we have found that:
- Any scenario of Brexit would not affect the UK’s ability to access primary energy sources, such as natural gas, coal and petroleum products.
- Brexit would impact electricity capacity margins. The impact on interconnection investment stemming from cross-border regulatory uncertainty would be a major driver of this problem.
Brexit would have a negative impact on the energy security profile of the United Kingdom
If Britain was to leave the EU it would no doubt have implications for the energy market and energy security. The uncertainty created by leaving the EU would impact on investor confidence and the funding and development of new electricity projects, particularly interconnectors with Europe, currently in the pipeline. These projects have been in planning for quite some time, are complicated with numerous counter parties, funding arrangements and regulations.
The extent of the impact will be determined by how quickly UK and the EU can agree on new rules and the relevant interconnection project model. Our assessment tell us this is unlikely to be an expedient process. Changes to the UK’s relationship with the EU energy market will be just one of numerous issues which need to be changed in the event of a Brexit vote. The implications are that this will have a negative impact on the UK’s electricity security of supply.
Improving capacity margins will require the continued operation of coal and oil power stations which have been scheduled for decommissioning; this will have an adverse effect on the environment. Alternatively, it will require the usage of expensive emergency measures that limit industrial power consumption; this will have a negative impact on industrial output.
Brexit stalls investment on projects that would otherwise stimulate economic activity, employment and consumer welfare.
Please find a list of conclusions and the full study in .pdf form below.
List of Conclusions
A Norway-type Brexit would imply a soft landing for the UK energy sector.
- Over a two year period, we expect the EU and UK to rearrange existing ties to match EEA membership requirements.
- The UK would retain access to the IEM. This would imply no-to-little detrimental effect to the UK energy security profile.
- The UK would retain access to PCI funding. It would be set to secure a substantial amount to develop projects improving its energy security profile and access to the IEM.
- Upon joining Norway in the EEA the UK would have to accept all significant internal market legislation.
- There would be uncertainty in the short term around the rules that will govern and regulate UK-EU energy trade.
- We expect investors and developers to adopt a ‘wait and see’ position in case of Brexit. No new interconnection capacity developed for two years after the referendum.
- Norway-type Brexit would weaken the electricity security of supply in the short term but should have no major impact in the medium run.
- Should Brexit not happen de-rated capacity margins would be between 2% to 6% higher by 2020 (with respect to the Norway case).
In the Switzerland scenario the UK’s energy security profile would be heavily impacted throughout the medium term.
- Exclusion from market coupling: renders markets less liquid, yields a non-efficient flow of power lowering economic welfare, and limits downward pressure on wholesale prices.
- Exclusion from cross-border balancing increases costs to consumers and negatively impacts the resilience of the UK system.
- Exclusion of interconnectors from capacity markets weaken the security of supply profile of the UK by excluding a valuable source of supply diversification.
- Foregone benefits: £430m pounds yearly by the early 2020s
- No new interconnection capacity up to 2030, due to uncertainty on cross-border regulation.
- De-rated margins are strongly impacted in the short and medium run. In 2030 margins would be between 5.5% and 11.9% lower with respect to the No Brexit scenario.
By not exiting the European Union the UK will be able to improve, or by the least, not worsen its electricity security of supply profile.
- The most important element of the No Brexit case is the low uncertainty level with respect to the Norway and Swiss scenarios.
- In the No Brexit scenario, spare capacity margins of electricity are between 5.1%-3.4% higher with respect to any Brexit scenario in the short- run
- Spare capacity margins are between 5.5% and 11.9% higher with respect to the Switzerland case by 2030.
Our analysis has shown that a 20% fluctuation in both Risk Free Rates and Expected Market Returns could change an investor’s required return on investment by the following range: -1.84% to + 1.78%.
- Changes in required return will impact the realisation of projects depending on the prevailing market dynamics.
- Projects deemed profitable prior to the Referendum could be cancelled or delayed based on a deteriorating economic case. Conversely, should require return decrease, more projects would become economically feasible.
- The financial impact on interconnection investment would impact significantly future interconnection capacity. It would be secondary with respect to the impact of regulatory uncertainty.
Copyright © 2016 Sia Partners – Alessio Villanacci. Any use of this material without specific permission of Sia Partners or its author is strictly prohibited