‘Energy Brexit’: What are the consequences on both sides of the Channel?

A tanker ship heads into Liverpool harbour as a pilot boats heads out. In the background. In the background, the Burbo Bank wind farm. While new facilities have increased capacity, the UK currently imports 6% of its electricity. Andrew/Flickr, CC BY

One year ago a narrow majority of the UK voters decided that the UK should leave the EU. While the leave is scheduled for March 2019, the details of Brexit are still to be worked out. Elections to the UK House of Commons on 8 June 2017 have further increased uncertainty in this matter.

A major question is whether and under what circumstances the UK will leave the European Single Market and what other forms of UK-EU cooperation will emerge. The internal EU energy market (IEM, also known as the single energy market) is a showcase for how Brexit threatens to reverse market integration between the UK and the continental EU. An “Energy Brexit” could undermine the institutional basis of already closely linked energy markets from March 2019 onwards, implying welfare losses and adverse effects for the energy transitions on either side of the Channel.

Historically, the UK has advocated the internal EU energy market

For over two decades, the UK has been a strong supporter of the European Union’s internal energy market which aims at liberalising and harmonising the energy markets of individual EU member states. Since 1996, the IEM was advanced through three legislative packages on market access, transparency and regulation, consumer protection, interconnection, and adequate levels of supply. Investments in both gas and electricity physical networks enable the free flow of gas and electricity across member states. The day-ahead auctions for electricity in Great Britain and the continent are cleared together in a coupled system spanning markets from Finland to Portugal. So what impact can we expect from Brexit on energy markets in Europe?

Will Brexit affect security of supply or prices of natural gas or electricity in France and Germany?

These questions are addressed by expert surveys in France and Germany conducted among energy professionals and academics. The French panel is hosted by Grenoble École de Management (GEM), the German panel is run by the Mannheim-based Centre for European Economic Research (ZEW). Both institutes have established a continued bi-annual survey of energy experts in the form of an “Energy Barometer” in their respective country, ZEW since 2002, GEM since 2013.

When asked about the effects of the UK leaving the EU internal energy market, the majority of experts expects that an “Energy Brexit” would have virtually no effect on electricity prices or security supply in electricity in their respective country (68% and 72% in France; 81% and 90% in Germany). At present, four interconnectors link the UK and continental electricity grids. The UK is a net importer of electricity, with net imports contributing about 6% of electricity supply in 2015. Since interconnection is still limited, and despite the coupled day-ahead auctions, electricity wholesale prices in the UK are on average substantially higher than those in France or Germany.

Most imports came via France and the Netherlands, with France accounting for about 70 percent of all UK electricity imports. France, as the largest net electricity exporter in the EU, exported about one quarter of its net energy exports to the UK in 2015. Yet, these exports to the UK account for just about 3% of total French electricity supply only, which rationalises the limited impact on France that experts foresee in case the UK leaves the IEM.

With respect to natural gas, the UK has been a net exporter for most of the time since its accession to the EU (i.e. from 1981 to 2003). After 2003, faced with declining domestic production, it became a net importer of gas again. In comparison, France imports virtually all of its natural gas consumption through various cross-border pipelines or, to a much smaller extent via LNG terminals. Almost 50% of French gas imports come from Norway, 13% from Russia, 12% from the Netherlands and 10% from Algeria. In comparison, Germany imports more than 80% of its natural gas consumption. The lion’s share of those imports come from Russia (about 40%), another 30% from Norway and some 25% from the Netherlands, while the latter might also include LNG from the Middle East that was landed on Dutch territory. Overall, UK gas prices are presently at about the same level as in Germany, but lower than in France. According to the surveyed experts, little will change when the UK leaves the Single Energy market. More than two thirds of the French and German panellists expect no noticeable effects on gas prices or security of supply for their respective countries.

Taking these numbers together, we conclude that – despite close institutional integration – the UK leaving the IEM should have only limited quantitative effect on the security of supply, or the prices of natural gas and electricity in France or Germany as the major economies on the continent.

Cooling towers at the Drax coal-fired power station in North Yorkshire. Jonathan Brennan/Flickr, CC BY

Will “Brexit” lead to divestment of French and German energy companies in the UK?

The UK electricity sector is in need for investment. An aging grid and generation infrastructure requires substantial refurbishment in the near future. The UK energy system currently relies largely on investments from foreign companies. Électricité de France (EDF), RWE, E.ON, or Iberdrola are not only among the biggest players in the EU energy market, they also bought a number of British utilities making them important players in the British energy market. EDF leads a consortium that is scheduled to build the 3.2 GW Hinckley Point C nuclear power plant, the largest project that is currently developed on the British energy market. So will these firms reconsider their activities in the UK in response to a leave of the Integrated Energy Market?

Confronted with this question, more than two thirds of the French experts expect that an Energy Brexit would lead to a partial divestment of French energy companies in the UK. Similarly, more than half of the experts in Germany believed that German energy companies will withdraw partially from the British market. However, no respondent imagined a total withdrawal. A reason for that could be that investment decisions in electricity production unit still depend primarily on national regulation. The Hinckley Point project can serve as an example.

Who would be hurt more by an “Energy Brexit”, the UK or the EU?

In contrast to generation capacities, investments in infrastructure, connecting the British to the continental energy system do depend crucially on the supranational framework. The prevailing uncertainty over the terms of Brexit puts a risk on the schedule for the six planned interconnection projects linking the UK and the continental electricity grid. In the short term, this could impact security of supply, limit arbitrage, and thus keep electricity prices diverging between the UK and its European neighbours. In the medium term, the UK leaving the IEM is expected to increase coordination costs for building and operating those interconnectors.

As discussed above, from the EU’s perspective, the link to the UK is far from critical in terms of energy security or prices. But the question remains how the costs (or benefits?) of an Energy Brexit would be distributed between the UK and the remaining EU. Confronted with this issue, the vast majority of experts in France and Germany came to the conclusion that the UK leaving the Single Energy Market would hurt the UK more than the EU. One reason for this could be the dynamic aspect: with an increase in the share of fluctuating renewable electricity in UK power generation, the economic value of interconnection and frictionless power trading is expected to grow over time to limit the cost of balancing the grid.

How will the future UK-EU energy market integration look like?

At this point, one can only speculate about the outcome of the Brexit negotiations, but the history of the EU electricity market provides two guiding examples of how participation by non-EU members in the IEM may work. First, Norway is fully integrated in the IEM. Norway is part of the European Free Trade Area and its electricity market is cleared through the pan-Scandinavian energy exchange NordPool together with EU Member States. Norway is allowed to fully participate in all committees monitoring the network codes negotiation process, and Norwegian traders may freely trade electricity across the EU. Second, Switzerland is also fully physically integrated into the EU electricity market. However, since in a referendum in 2014 a majority of Swiss voters failed to grant freedom of movement, the EU blocked full participation of Switzerland in the IEM and froze the integration process.

Akin to the Swiss example, the EU may disapprove full integration benefits, if the UK refuses free movement of labour, which the advocates of Brexit promised to prohibit.

This article is closely based on the Summer 2017 GEM Energy Barometer Report and ZEW’s Energiemarktbarometer (forthcoming).