A Step Away From the Comfort Zone

April 20, 2016 | 00:00
A Step Away From the Comfort Zone
A Step Away From the Comfort Zone
The referendum on the UK's future as part of the European Union or Brexit is a burning issue among politicians and businesses across the UK. Characterised by political infighting/posturing tearing at the Conservative party and a general indifference by Labour leader Jeremy Corbyn, who supports staying in but is not really an ardent campaigner, the scene is set for a bitter mid-summer battle over the UK's future. Advice, scenarios and outright scare stories are being peddled to the 45 million ordinary people who will actually make the decision on 23rd June 2016 but most are unaware of the consequences of leaving the EU and those who do make the effort to vote might well do so with their hearts and not their heads. One of the most current polls, the Telegraph's ORB poll conducted on 5th April, shows that the gap between the 'leavers' and the 'remainers' is only 1% and the vote is expected to be close. The only truth at the present time is no one knows what will happen until June and the uncertainty is damaging investment in the UK and the EU as informed decisions are difficult and fraught with increased risk. Brussels-based Jonathan Branton, Head of EU and Competition for law firm Davies Wallis and Foyster (DWF) said “the uncertainty is making many international companies press the 'pause' button”. The atmosphere across the EU business community is decidedly nervous with BREXIT being viewed as a massive threat to the integrity of the whole EU: “The EU will be weaker and no one wants to see the EU's second largest contributor leave” said Branton.

The energy market and Brexit


Energy investment across the UK is currently in the doldrums with the energy sector mired in a 'perfect storm' of low oil price, consumer and regulatory scrutiny and now the added uncertainty of the BREXIT vote. A recent energy forum hosted by Instinctif, ‘A crude awakening: is uncertainty hampering UK energy investment?', concluded that the UK energy market has multi-faceted problems and that BREXIT is only one of the factors affecting investment in both green and conventional energy. Others include the oil crisis, the restructuring of the feed-in-tariff, the removal of subsidies for on-shore wind, solar PV and hydro-electric power generation and poor choices being made by the UK government with regard to the new nuclear installation Hinkley Point C. The British government has guaranteed a price of £92.50 per megawatt hour of electricity, which is more than twice the current strike price, for the electricity produced by Hinkley for a period of 35 years. Former UK Energy Minister, Charles Hendry, said “investors could earn a return of up to 21% over the lifetime of the project and although the UK needs this capacity it may not provide the best value”. With EDF at low ebb and relying on French state money to build the beleaguered Hinkley Point C project a Brexit leave vote may well be the final straw for the project.

Green energy will suffer?


Elisabeth Blunsdon, Of Counsel for Energy and Infrastructure in the London Office of Orrick reasons that the combination of higher financing costs and a weaker pound is likely to adversely affect investment in the energy sector, particularly in green energy. “Brexit currently means uncertainty, which is likely to affect investor confidence. Not only will investors potentially find the UK less attractive, it's likely that they will require higher returns if they do decide to invest, to reflect that additional uncertainty” said Blunsdon. At the same time Brexit uncertainty has already caused the pound to weaken against the Euro, which will make any sector that is heavily reliant on imports for its development, such as offshore wind, subject to higher costs.

What about prices and interconnection?


A major factor in the Brexit campaign is considering whether energy prices will rise. According to UK energy secretary Amber Rudd power bills could rise by more than £500 million ($704 million) if Britain leaves the EU, meaning an increase of more than £20 per year for the average UK household. The £500 million figure has been culled from the Vivid Economics report ‘The impact of Brexit on the UK energy sector’ published on 29th March 2016 and is actually based on Brexit leading to both exclusion from the European Internal Energy Market (IEM) and unsuccessful bilateral negotiations on market integration. The report concludes that although energy costs would be likely to increase because of increased risk and hence more expensive finance in the context of the whole market they would be small. Elisabeth Blunsdon from Orrick believes that higher investment costs, loss of benefit from the ability to trade in integrated markets and reduced or blocked access to market coupling in European markets may all lead to increased costs. “It’s not clear what the scale of these costs will be or how they will pass through to consumers. Indeed it’s not even clear whether there would be a greater increase if the UK remains within the EU” said Blunsdon.

The UK is becoming more and more reliant on interconnection with mainland Europe for both gas and electricity. Amber Rudd believes that the UK is stronger within the EU with the best bargaining position for wholesale gas and electricity and in a recent Parliamentary debate said: “We can't let our energy security be hijacked as a political pawn to bring Europe to its knees. By working together in the European Union each Member State can stop this becoming a reality.” Elchin Mammadov is a European Utilities analyst at Bloomberg Intelligence and agrees that Europe and the UK have interdependency and need each other with interconnections being crucial in the next decade to offset capacity closures and guarantee energy security. “I think the effect of a Brexit ‘leave’ on energy trading would be limited although there could be temporary effects including slowing of GDP growth, increased inflation and investment decisions put on hold – the UK and the EU need to be close” said Mammadov. Mark Cummings, Managing Director of Invicta Public Affairs, believes withdrawing from the EU could be incredibly damaging to both investment in the wider energy sector and the long-term prospects for the UK’s energy mix. “We cannot hope to achieve the same level of influence over import prices when we have chosen to walk away from the discussion table. History has shown us that any hike in the overall cost of gas will translate very quickly into increased energy bills for the consumer” said Cummings.

What will happen if the UK leaves?


If the Brexit vote compels the UK to leave then it is certain that a period of uncertainty would result while new energy partnerships are established. There is no precedent set for a country leaving the EU and the relationship between Norway and Europe is a possible model for the energy future of the UK. Norway has a ‘special relationship’ with Europe as a key energy partner for the EU and a major supplier of oil, gas and electricity. Norway is a member of the European Economic Area Agreement and has adopted EU energy market rules into its legislation arrangement. Elisabeth Blunsdon believes that if Brexit were to occur, the UK’s position would have certain parallels with that of Norway, given the similar levels of physical interconnection and the fact that both countries export energy to the EU. "Norway participates in the EU single market and as a result is subject to the same regulatory regime as EU member states. On the flip side, it gains the benefits of trading within the single energy market" said Blunsdon. Alex Harrison, Counsel for Hogan and Lovells, believes a Brexit leave vote would leave the UK’s energy security in question and that there would have to be a long transitional period to establish new trade agreements. “A lot of EU law is embedded in the UK and this would not be easy to reverse – it would be foolish to cut off interconnection in a post-Brexit world as the UK energy market needs both security and talented people from across Europe”, says Harrison. Griffin Carpenter, Economics Modeller at New Economics Foundation, believes that the UK might scrap the EU Renewable Energy Directive in the event of a successful Brexit leave and ease off its investment in renewable energy. “This would have disastrous implications and the UK government has made it clear that it does not agree with a ‘technology-specific’ approach to climate change and an mandate from the EU on renewables and the UK is already way off track (currently at 7%) to meet the 15% 2020 requirement” said Carpenter.

Has the process been well thought out?


The UK's energy infrastructure is in dire need of investment, with the closing of all coal fired power stations and some energy policy still uncertain the UK needs Europe for both investment and interconnection and security of supply. Mark Cummings of Invicta Public Affairs believes that the UK is stronger in Europe: “The UK’s existing energy infrastructure is in urgent need of continued investment if we are to keep pace with energy demand and sustainability targets. In 2014 alone €3.5bn of much needed investment was poured into UK energy infrastructure via various EU funding mechanisms”, said Cummings. Economist Griffin Carpenter agreed, saying “A direct threat to investment in UK renewable energy sector is that the UK will no longer be eligible for funds from the European Investment Bank (EIB). Currently the UK is the largest (by far) recipient of EIB Climate Awareness Bonds that fund renewables and energy efficiency.” Politicians and companies in the main European countries are perplexed by the sudden desire by some in the UK to leave the European Union and are worried by the implications. James Douglass, Energy Partner at King & Wood Mallesons (KWM) London office, believes that there would be no orderly exit from the EU and it might be made difficult as setting an exit precedent would be dangerous. “There would certainly be a short-term destabilisation of the energy market and possible application to join the Economic Area Agreement as well as some changes in the law, which all adds up to increased risk and uncertainly and consequently less investment – the UK would also lose a lot of research funding... If the UK wants to reform the EU it can only do so from the inside” said Douglass.

Brexit consequences


The unfolding of a relationship that has been established since the referendum of 1975 will never be easy. Given the complexity of the UK's energy market there is now genuine uncertainty in the market and this is not good for investment. The UK should look to the positive aspects of its relationship with Europe such as the leverage gained in trading as a partnership. Gas imports are an excellent example of how the UK may well ‘feel it in the pocket’ if it chooses to pull out of Europe, higher gas prices could certainly add up to the perfect political storm. Guy Winter, Energy Partner, Addleshaw Goddard believes the reality is that we're all in this together and some form of European Energy Union is an inevitability – that's just the way power markets have been moving. “The big impact of Brexit would be the need for a bewildering range of new trade and energy deals – just to achieve some semblance of the current status quo. In energy terms, the great fallacy of Brexit is that it will cut through red tape. You need regulations for complex international energy transmission and trading. You don't want to cut through the tape that is helping to keep the lights on!” he said.
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