Gas sector braces for Brexit [NGW Magazine]
Time is running out for UK and European Union (EU) negotiators to strike a trade deal before the transition period expires January 1, 2021. Media reports have suggested energy supply is being used as a bargaining chip by the EU to strike an agreement with London on fishing rights. It is hard to see how the EU could stop gas flowing between the UK and continental Europe – or why it would want that to happen in the first place.
Europe is already importing gas from a number of third countries including Algeria and Russia plus a number of LNG suppliers from non-EU nations.
Norway – which is a member of the single electricity market but not the gas market as it uses almost none of it – is also exporting plenty of gas to Europe. Even Switzerland imports and transits gas through its network to and from neighbouring countries.
Hence few would expect cross-border trading of gas between the UK and continental Europe to break down in the event of a no-deal Brexit. Higher tariffs on imports via the interconnectors linking the UK with the Netherlands, Belgium and Ireland are a possibility, but this is unlikely to pose a real threat to security of supply. For example, all four nations will continue to use the EU’s Capacity Allocation Mechanism Network Code (CAM NC) as the basis for booking capacity on cross-border interconnectors, according to British energy regulator Ofgem. And that in itself has been criticised for its inflexibility.
Brexit will have an impact
Yet there are sticking points that – if unresolved – could significantly alter energy markets in the UK and EU over time. One of them is EU state aid rules which set out guidelines for national subsidy regimes in an attempt by the European Commission (EC) to prevent overcompensation and market distortion. The current Guidelines on State Aid for Environmental Protection and Energy expire this year. However, the EC is expected to continue reviewing the guidelines until the end of 2021 in order to better align them with the European Green Deal.
For the gas sector, one of the key subsidy regimes to look out for is the national capacity mechanisms which offer payouts to operators of power plants, including gas-fired plants. Such capacity payments are designed to avoid plant closures and aim to bolster security of electricity supply at a time of unattractively low prices. In Britain’s capacity market, operators can bid for capacity contracts with a duration of up to 15 years in auctions in return for committing to supply the grid in the future.
The British scheme has previously been challenged before the European Court of Justice (ECJ) by Tempus Energy, which instead of building plant offered demand-side response (DSR) co-ordination. It said the auctions were discriminatory and they were suspended for almost a year in 2018/19. The ECJ’s ruling put the government under pressure to amend the system and to offer better terms for DSR operators. In a no-deal Brexit, the UK’s state aid regime will likely fall under World Trade Organization rules and it will be difficult if not impossible for energy companies to turn to the ECJ to challenge any shortcomings in the UK’s state aid policy.
“If there is no deal, it is not obvious how the ECJ will have any jurisdiction over new state aid regimes in the UK,” Frontier Economics director Dan Roberts told NGW.
By July 2023, allowing foreign participation in capacity auctions will become mandatory under EU rules. That means Dutch, French, Irish and Belgian power plant operators should be able to participate in the British auctions since their markets are physically connected. Plant operators in Britain should in theory also be able to participate in French, Belgian and Irish auctions and so on. But with a no-deal Brexit, Britain could block foreign participation in capacity auctions and it risks being denied access to European auctions. That means gas-fired power plants could lose an important revenue stream.
This scenario is only theoretical and, as Roberts points out, would not sit well with the government’s priority of building more electricity interconnectors with neighbouring countries. But it does exemplify how a no-deal scenario could affect investor confidence in the UK gas and power sector.
"State aid is definitely a critical area in relation to the energy sector. The EU wants some sort of oversight but the UK is reluctant to give in to that,” a senior associate with law firm Clifford Chance Andreas Formosa told NGW. “At the same time, the UK is one of the most pro-market economies when it comes to energy markets. I would not expect a divergence from EU market-based principles under a Conservative government."
Carbon market or taxation?
Another pressing issue for the gas sector is whether the UK will establish its own cap-and-trade carbon market in January 2021 or revert to a carbon tax, or both. Higher prices for EU carbon allowances under the EU’s Emissions Trading System (EU ETS) coupled with the carbon price floor has helped gas and renewables gain market share in the British power mix. Coal is now almost completely phased out of power generation in Britain.
The government has sent out very mixed signals. For example, a stakeholder consultation outlining a possible carbon tax of £16/metric ton closed in late September. To this end, a number of energy companies, including the German majors RWE and Uniper, recently wrote to the prime minister Boris Johnson urging the government to opt for cap-and-trade rather than a tax.
"It appears that the UK will have its own ETS from January – instead of a carbon tax – although the government hasn’t definitively confirmed this. If we do start off with an ETS, the government may replace this with a carbon tax at a later stage,” said Formosa.
Linking a national ETS with that of the EU is a possibility, bearing in mind that it took Switzerland and the EU around 10 years to link their respective carbon markets.
“But I see no good reason why the UK cannot reach an agreement to link its national ETS with that of the EU. The price of carbon will dictate many things as we move forward such as CCS and hydrogen," said Formosa.
Brexit has already had a tangible impact on gas trading in the UK. Hub liquidity at the NBP has been declining in recent years partly because of the volatile currency exchange-rate fluctuations. Traders are wary of currency risks and continental shippers have been flocking to the Dutch TTF in ever greater numbers. It overtook the NBP in terms of volume some time ago and is Europe’s leading hub by a wide margin.
If there is no-deal by January, the pound may lose further value against major currencies and this would make gas imports more expensive, both for piped gas and LNG. That is bad news for UK industries and could give other energy technologies such as nuclear power a competitive advantage over gas.
But it is not just the UK energy sector that will be negatively impacted by a no-deal scenario. The EU will lose a strong voice on pro-market competition and climate. It is worth noting, for example, that while the EU-27 is discussing raising the 2030 GHG reduction target from 40% to 55% compared with 1990 levels, the UK has already set a target of 57% reductions.
Of course, the UK’s ability to influence Europe’s future energy policy will also diminish – notably the EU Green Deal and its 2050 climate neutrality goal – if it leaves industry groups that it was instrumental in setting up.
In its latest Gas Ten Year Statement – a document whose November 30 publication preceded Brexit by a bare month – National Grid writes: “As members of the European National Transmission System Operators - Gas and of Gas Infrastructure Europe, we support the important input these organisations have into shaping these future gas market developments. We are working closely with Ofgem, the government and stakeholders in preparation for EU Exit, and will continue to engage with domestic and European stakeholders to prepare for the future UK/EU relationship.”
It also said that preparations for the end of the Brexit transition period “are likely to contemplate the requirements of a ‘no deal’ scenario.” It suggests incorporating into domestic law the EU regulations that were in place on the day prior to exit, as well as the statutory instruments “to address any inoperabilities that would arise from application of this broad approach.”
But other aspects of life will continue as before. Ofgem says monitoring of UK gas markets under the principles of the EU’s Regulation on Energy Market Integrity and Transparency – which prohibits insider trading and manipulation based on early knowledge of field and pipeline outages and so on – will remain virtually the same after Brexit. Market participants will have to register with regulatory authorities in an EU member state and with Ofgem depending on whether they trade in UK or European energy markets, or both.
As for Ireland, the Single Electricity Market (SEM) between Northern Ireland and the Republic of Ireland will continue as before, but special arrangements have been implemented for trading between the SEM and Britain.