Written evidence submitted by the UK Energy Research Centre (EUE0026)

The EU has had considerable influence over UK energy policy. This can be most keenly observed in the area of electricity supply: for example, policies on the growth of electricity generation from renewable sources (Renewable Energy Directive, 2009) and the phase out of coal fired power generation (Large Plant Combustion Directive, 2001, and Industrial Emissions Directive, 2010). Direct impacts on gas policy to date have been more limited, although the progressive liberalisation and integration of gas markets under successive reform packages have also worked to the UK’s benefit as it has moved from being a net exporter to a net importer. These high-level energy policies sit alongside policies for greenhouse gas emissions reduction and Directives on environmental habit protection, water quality, and air quality.

The Renewable Energy Directive

The 2009 Renewables Directive (2009/28/EC) set an EU-level target of a 20 per cent share of energy consumption to be from renewable sources by 2020; the UK adopted a national target of 15% by 2020. It built on the previous 2001 Directive on the promotion of electricity produced from renewable energy sources (2001/7/EC), which had set a Community-wide target of 22% by 2010, and an indicative target of 10 per cent for the UK. The UK’s Department of Energy and Climate Change anticipated at the time that to meet the target 30% of electricity demand would need to be from renewables by 2020, with 12% in heat demand and 10% in transport.

Although it is not the only reason for the expansion of renewables in the UK, the Renewables Directive has provided a significant driver for stronger incentives during the past few years – especially in the electricity sector. These incentives have delivered a large increase in renewable electricity over the past five years, from 9% of generation in 2011 to 25% in 2015[1]. However, it is expected that the UK will not meet its share of the EU renewables target unless there is a significant change in policy. This is because of weak incentives for the expansion of renewable heat and a lack of progress (albeit for understandable reasons) with the use of renewable transport fuels[2].

Large Combustion Plant Directive (LPCD)

The 2001 LCP Directive sought to end the operation of industrial plants with a rated thermal unit equal to or greater than 50MW – which came online before 1987 – in an attempt to reduce sulphur dioxide, nitrogen oxide, and particulate emissions. The directive applies to all UK fossil fuel power plants of 50 MW or over, and other large thermal plants such as refineries and steel works, and gave three options: comply with the emissions limits specified in the Directive; enter a National Emissions Reduction Plan where participants would meet collective emissions reduction targets and trade emissions allowances; or remain operating for a maximum of 20,000 hours between 1 January 2008 and 31 December 2015 – known as ‘opting-out’[3]. The Directive was replaced and strengthened by the Industrial Emissions Directive (2010/75/EU), increasing the scope and depth of regulation through drawing together seven Directives, which came into force on 1 January 2016. Under the LPC Directive, six of the UK’s seventeen operational coal fired plants opted-out, which removed 8GW of capacity from the 28MW pool that was online in 2008[4]. In 2011 the more stringent Industrial Emissions Directive came into effect, which will see further closures. Even though the environmental aspect of this should be welcomed, it has been argued that the policy has negatively impacted the power generation industry to such an extent that there could be security of supply risks ahead, as investment in new plant has been de-incentivised[5]. In the last 12 months coal plant equivalent to 9% of the total electricity generating capacity has come offline, while the seven remaining coal plants in the UK are set to come offline by 2025.[6]

Are any policy areas currently at risk?

Simultaneously the UK has also had a significant influence on energy policy at the EU level. The market liberalisation and ownership restructuring policies of the 2009 Third Energy Package drew on the UK’s own experience of privatisation and market opening in the late 1980s and 1990s.[7] Similarly, during the UK’s 2005 EU presidency then Prime Minister Tony Blair pushed for deeper market integration, harmonisation, and a collective approach to tackling climate change.

This move to a more internationalised approach on energy via the EU coincided with the UK becoming a net energy importer in the mid-2000s. The UK’s Climate Change Act (2008) was also regarded as front runner to the EU’s own Climate and Energy Package of 2014, which includes a binding 40% reduction in greenhouse gas emissions from the EU by 2030. Because of the UK’s global and interventionist role, climate change has been viewed through the lens of foreign security policy as much as environmental protection. Whether the UK maintains this type of diplomacy as an independent country remains to be seen, but its negotiating position on the international stage could be weakened through leaving the collective EU bloc.

Given the UK’s role in championing market liberalisation and climate change mitigation within the EU, the referendum result will also have consequences for the rest of the EU. Once the UK leaves, the EU will lose a powerful advocate in these policy areas, both of which are the subject of significant disagreement and debate among Member States. Arguably, the EU has already lost ground when it comes to leadership on climate change. Much of the momentum for the recent Paris Agreement was provided by the United States and China. Ambitious EU policies to reduce emissions may be even harder to achieve in a future EU without the UK as a member.

Renewables sector development

The EU renewables directive may no longer apply to the UK after Brexit, but the government will still be legally bound by its own Climate Change Act (2008) which requires an 80% reduction in carbon emissions by 2050. Because of this the UK renewables sector may continue to grow despite leaving the EU. The UK’s domestic fossil fuel resources are in decline, so increasing the share of renewables could also help to support energy security. Furthermore, the rapidly falling costs of some renewable technologies and the prospect of more cost effective storage technologies mean that technologies could become viable without government support in the medium term. In the run up to the referendum it was reported that as part of the political restructuring after Brexit the government could remove so-called green taxes and subsidies put in place to achieve the EU renewables target. However, although there is an EU-wide target for renewable energy that is binding, Member States’ targets for renewable energy were set by themselves, along with the means of achieving it. This means that existing support schemes for renewable energy in the UK could also remain.

Energy sector investment and costs

Prior to the referendum, National Grid commissioned analysis of potential effects of Brexit on energy investment and costs from Vivid Economics.[8] The report concluded that threats to physical supply of energy were of a lower risk, but higher costs of investment in energy infrastructure pose the more significant risk to the energy sector after Brexit. It also argued that any sustained period of uncertainty could lead to a deferral of investment in the sector. Increased costs were also expected because of a devaluation of sterling. This would raise the cost of imported equipment and services that are needed to upgrade networks and infrastructure for more renewables, replace closing electricity generation plants, and developing a decentralised energy system. Any delay in critical energy investment could reduce energy security further ahead.  The report gave an estimate of a potential increase in costs of £500m, which was cited by the then Secretary of State for energy and climate change, Amber Rudd.  The report to which Rudd was referring, produced by Vivid Economics for National Grid, looked at a wide range of risks posed by Brexit to the energy sector.  The analysis by Vivid Economics is broadly plausible, uncertainty has increased and certainly immediately after the referendum result there were some reports of investment decisions being deferred, although due to the nature of these effects a lot of weight should not be put on a precise figure at this stage.

Although the UK has not left the EU, the referendum result had an immediate impact on the value of  sterling which has fallen by about 15% against both the euro and dollar since before the referendum. This has had an impact on fuel import prices, for example, on wholesale gas prices at the UK’s National Balancing Point (NBP) trading hub[9].

Trade at the NBP is priced in sterling but European hubs such as those in the Netherlands and Germany are priced in euros. Contracts for longer-term supply and those delivering in the winter months are typically priced in euros, as the UK imports gas from the continent though winter. Following the vote and sterling’s fall against the euro there was a jump in gas prices at the NBP, although prices have since eased. Over the longer term, if sterling drops further in response to the terms of Brexit (for example if single market access is lost), such effects have the potential to feed in to domestic energy costs and consumer bills.

1.      What should be the Government’s priorities on energy when negotiating the UK’s exit from the EU? What would a successful negotiation outcome look like?

Post-Brexit single market access

Retaining access to the European single market is of concern to many sectors of the UK economy. While in the run up to the referendum senior Leave campaigners assured voters and businesses alike that leaving the EU would not remove the country’s access to the single market, there is clearly a great deal of uncertainty about what the actual terms of Brexit will be.  There is a fundamental difference between ‘access to’ and ‘membership of’ the single market, with the former being an option available to any World Trade Organisation (WTO) member. And though tariff free access to the single market could well be agreed between the UK and EU in the years ahead, it is unclear which non-tariff barriers, such as product standardisation, would remain in place. The Vivid Economics report on the impact of Brexit also suggested that if the UK is excluded from the single market for energy it could lose the financial benefits that market integration offers. These benefits include market coupling for gas and electricity and cross-border balancing and capacity market integration which are particularly important for electricity given that it is currently still very costly to store it.[10] Looking just at energy, it thus clear that continued membership of the single market would be a highly desirable outcome for a negotiation.

The incorporation of existing EU policy post-Brexit could also arise with cooperation arrangements for oil and gas in the North Sea. For example, the UK and Norway are signatories of a framework agreement relating to cross-border cooperation that includes fields that may straddle the border between the two countries and the pipelines that deliver gas to the UK – which in 2015 accounted for 61% of total UK gas imports.  Although signed bilaterally, the terms and conditions for access to pipelines – including the setting of entry and exit tariffs – are set out in accordance with EU law on the single market.[11] Therefore if the UK did not maintain its membership of the single market, it is likely the agreement would need to be renegotiated or replaced.

As a European Economic Area (EEA) member Norway has access to the internal energy market (in the case of electricity it is also part of a wholesale market (Nordpool) that includes EU member states), but also has to adopt nearly all EU energy policy requirements. Norway maintains a mission to the EU to exert considerable lobbying pressure on EU decision makers, as under the terms of the EEA agreement it can comment on Commission proposals but does not have a vote or formal representation in the European Commission, Parliament or Council of Ministers. Norway has around 60 diplomatic staff in Brussels with four people specifically working on energy and environment issues, and its mission shares a building with four energy companies and the trade body that represents some 270 electricity companies[12]. By comparison, the UK has 84 people with diplomatic accreditation at its representation in Brussels, with just the one person designated to energy matters.

As a ‘third party’ country Norway relies predominantly on soft power rather than the hard negotiations that Member States have with EU policy makers. Because of Norway’s importance to EU energy supply – and indeed, the EU’s economic and political importance to Norway – the two have strategic cooperation on a range of energy issues, including policy developments and the implementation of EU energy rules in Norway. Given the UK’s importance in petroleum products, gas supply and gas trading, one objective for negotiations should be for the UK and the EU to have an enhanced relationship in this area after Brexit.

The ‘hard Brexit’ option of reaching a non-EEA / European Free Trade Area (EFTA) agreement with the EU is sometimes suggested as model  for negotiation, with the free trade agreement between the EU and Canada, the Comprehensive Free Trade Agreement (CETA),  as one possible example. However this ignores the fundamentals of the agreement. CETA took seven years to negotiate and its scope is far more limited than a UK-EU one would need to be. Although it prioritised the trade of commodities and minerals it made scant reference to the service sector. While the focus of the agreement reflects the EU’s dependence on imported energy and minerals – and Canadas’s desire to sell them – the UK’s declining fossil fuel and mineral production means this does not transfer directly. Equally, there is no common agreement in CETA on setting standards and regulation, and therefore it does not offer the same degree of access to the single market that the UK enjoys now or would have under EEA or EFTA membership.[13] This relates to energy efficiency, product standards and labelling, and other non-tariff barriers to single market access. Ironically, if the UK leaves the EU after CETA has been ratified it could end up having to subsequently renegotiate an agreement with Canada, even to secure what had previously been agreed under CETA.[14]

In other areas, such as financial services, it has also been suggested that the UK could follow the example of Switzerland (a member of EFTA but not the EEA), which has attempted to negotiate separate arrangements for market access for each sector. Since 2007, Switzerland has been negotiating with the EU on an electricity agreement trading. The Swiss model has some appeal, and may offer the possibility of negotiating a way through the difficult high-level political trade-off between market access and freedom of movement. However, not only does it show similar problems of time frame as CETA, but also the difficulty in practice of isolating particular sectors or issues, as the electricity agreement negotiations has recently been suspended because of disagreements between Switzerland and the EU over freedom of movement.

2.      What aspects of existing EU energy policies and directives are beneficial to the UK? What should be the Government’s priorities in deciding which EU-led energy policies and legislation to retain?

The UK benefits greatly from being part of the single market for energy. It has been a net importer of energy since 2004, following the peak in North Sea gas production in 1999. There are four high-voltage electricity interconnectors between the GB system and the EU, with more at an advanced stage of development. There are also five natural gas pipelines running to other countries: three to the EU and two to Norway. Oil and gas production from some North Sea fields is also delivered directly to non-UK facilities.

As well as being dependent on coal and oil imports from elsewhere in Europe and further afield, imports make up a substantial amount of the gas the UK uses for electricity generation and domestic heating. In 2015 imports accounted for 40% of gas supply, with nearly 70% of this coming from Norway (the largest source of imports), the Netherlands and Belgium.[15] However, the UK is also important for EU energy supply because of these connections. Gas from North Sea fields and that arriving on LNG (liquefied natural gas) tankers at UK terminals can be sent to the EU via these pipelines. Ireland is almost entirely dependent on gas from the UK via the Moffatt pipeline for its supply, and it also imports 4% of its electricity from the GB system. Although the UK is a net importer of electricity, electricity interconnectors between the GB system and the EU also export electricity, depending on demand and wholesale prices.

Electricity market interconnection

In 2015 around 6% of UK electricity demand was covered by imports through high-voltage interconnectors with other EU countries. There is currently 4GW of interconnection capacity and a further 2GW of capacity to Belgium and France is currently under development, and there are plans to add at least another 5.8GW by 2022.[16] Planned interconnectors to Norway and Iceland would deliver electricity from hydro and geothermal sources, while further connection to Ireland and northwest Europe would allow the import and export of electricity and also help balance the electricity system as the share of intermittent renewables continues to rise.

Leaving the EU is unlikely to prevent the building of new interconnectors, but it is uncertain what legal arrangements would need to be in place for both these and existing interconnectors. Although Ofgem’s regulatory regime for interconnectors differs in some respects from that in other European countries, GB interconnectors are regulated in accordance with EU rules for the single market. A situation could arise after Brexit whereby the current EU regulations and network codes that govern cross-border electricity market transactions and system operation must remain in place to ensure the GB electricity market remains operationally integrated with that of the EU. However, in a worst-case scenario where the new interconnection capacity does not get built, the task of balancing the UK electricity system could be more difficult and expensive.  Although the government’s pledge in late 2015 that it will ensure the phase out of unabated coal by 2025, this pledge could come under pressure if other options for system flexibility such as interconnection are not available.

September 2016