Comment: Will Brexit Hurt Gas Trade Between Britain and EU?

There is much uncertainty, Alex Barnes (pictured below) writes for NGW, about the impact Brexit will have on gas trade, if for no other reason that it is not entirely clear what Brexit means. However Brexit should not damage gas trading, but it could. To explain this we need to understand how gas markets have evolved on both sides of the English Channel and Irish Sea in the last few years, and to assess from first principles what is needed to enable gas trading in the first place.

Great Britain[1] liberalised its gas market in the mid 1990s with the introduction of proper regulated third-party access (the Network Code), daily balancing and the ability of consumers to choose their suppliers. Progress in the rest of the European Union was much slower and did not really make big progress until after the introduction of the Third Energy Package in 2009.

 The EU approach is heavily influenced by the Great Britain experience, including congestion management measures (Use it or Lose it), capacity auctions, daily balancing and so on. Even the nomenclature follows the British lead, as in the term Network Code. Furthermore, gas trade between Great Britain and continental Europe was well established long before 2009 thanks to the Bacton - Zeebrugge Interconnector which started operations in 1998, and later the Balgzand-Bacton Line.

Therefore not only can we see that both jurisdictions (EU and GB) have very similar frameworks, but also that gas trade started even when this was not the case. This indicates that where there is a commercial will, there is a way.

Furthermore gas is a homogenous commodity and unlikely to face the kind of non tariff barriers that will impact goods such as washing machines or cars. Gas quality standards relating to Wobbe index and so on already differ across the EU, and are unlikely to be harmonised. And the EU – and therefore also the UK at the moment – does not impose tariffs on the import of gas.

Were either side to do so on imports from each other, they would also have to impose such tariffs on all other gas imports. As both the EU and the UK are import dependent it is hard to imagine a situation where this would occur.

So the future should be rosy? Unfortunately, one should not underestimate the propensity for regulators to get “stuck in the weeds” of the detail of gas regulation. For example, the UK and EU approaches to gas market regulation are very different. While the UK legislation uses a principle based approach regarding the objective and is not prescriptive about the means to achieve it, the Third Energy Package takes a very different approach.

The EU network codes which specify how capacity auctions should work, how tariffs should be structured and so on, are part of EU legislation. The EU has taken a clear decision that it must specify not only what needs to be achieved – a competitive internal EU gas market – but also the precise way in which it must be achieved.

However, as with much in life there is more than one way to skin a cat, or enable a liberalised gas market. Therefore the question for both sides’ Brexit negotiators should be whether the conditions on either side enable gas trading, not whether the UK should continue to conform exactly to EU rules.

For example the EU has decided that it prefers floating capacity charges as a means to tackle revenue under-recovery by TSOs whilst the UK has to date used commodity charges. Both approaches have their fans, but there is no clear evidence that the use of different approaches either side of an interconnection will impede gas trade. Of far more importance to gas traders is knowing what transportation charges are and how they might evolve over time.

The UK is reviewing its charging regime and may decide to differ from the EU in the future. The risk is that the UK’s decision to follow its own approach to gas market regulation can be used as an excuse to derail future agreement between the UK and the rest of the EU, even where there is no need to do this.

Two other aspects of EU legislation impact gas trading. First there are trading regulations such as European Market Infrastructure Regulation and the Markets in Financial Instruments Directive 2. While these are important for gas trading, their fate in the UK will be determined more by concerns on the impact of Brexit on the City, than on gas trading.

Second, there is climate change legislation including initiatives such as the Emission Trading Scheme. However again the changes to this will be more determined by the UK’s overall approach to climate change: as all major parties remain signed up to combating climate change it is difficult to anticipate a major change in policy direction, even if some of the details change, such as the proposed new “total carbon price.”

Energy regulation should be one of the easier aspects of Brexit to agree so long as both sides recognise that gas trading can thrive even if the regimes on either side of interconnectors are not exactly the same. However, if either side cannot see the wood (a competitive gas market) for the trees (the detailed regulations) then discussions will be much more difficult, and the impact on gas trading more uncertain.