18/03/18 – The impact of Brexit on the UK Energy Sector

Speakers: Gwyn Dolben, past Head of European Affairs at Energy UK; Patrick Heren, energy commentator and adviser;  and Robert Sale, Chief Regulation and Strategy Officer, Interconnector.

28 March 2018

All-Party Parliamentary Group on Energy Costs

The impact of Brexit on the UK Energy sector

Chair: Lord Palmer

Speakers: Gwyn Dolben, the recently retired Head of European Affairs at Energy UK; Patrick Heren, energy commentator, adviser to the Crown Commercial Service and the founder of ICIS Heren; and Robert Sale, Chief Regulation and Strategy Officer, Interconnector.

Chair’s Opening remarks

I’d like to extend a warm welcome to you all to this, the 41st meeting of the All-Party Parliamentary Group on Energy.

Our meeting this evening is to discuss ‘The impact of Brexit on the UK Energy sector’. There are some very big questions and a lot of uncertainty and guesswork. For example, what will happen about the EU Emissions Trading Scheme? And what are the implications for interconnectors?

Fortunately, we have three excellent speakers tonight who can take us through the issues. I have asked them each for no more than 7 minutes opening remarks after which we will go on to our normal Q&A.

Gwyn Dolben

I think there will be a deal, although the politics will be difficult and it will take a lot of discussion and 3 or 4 years to reach agreement.  I want to touch on three elements today: one is the benefits of trade and cooperation on energy, the second to look at the current position of the EU 27 and the UK Government, and finally to look at where we’re likely to end up.

Energy is unlike quite a lot of other sectors, in that there really are clear benefits from a more integrated market and close cooperation. From a UK perspective, trade plus interconnectors is helping to keep wholesale prices down; it has a number of security-of-supply benefits; it will in future allow us to accommodate more renewables on the system, and of course for Northern Ireland which is quite a small system there are definite benefits in being part of a wider energy system.

The EU side also benefits from trade and is currently promoting an initiative called “Energy Union”, which is aimed at greater energy security in the broader Europe, and a post-Brexit UK fits very well into that framework.

The UK is viewed as a trusted and reliable energy supplier compared to other countries, and when you think about concerns about Russian dominance in gas in some areas, the UK is a positive influence. Even if the EU did want to take a punitive attitude, Ireland is connected to the UK both in electricity and gas, so that doesn’t really seem likely. What I would expect to see is some recognition of a common interest in an integrated market, and actually when you look at the current positions they’re quite surprisingly close in a number of ways: Theresa May’s recent speech talked about frictionless trade and exploring participation in the internal energy market. She’s pretty much given a commitment to maintaining the single electricity market on the island of Ireland. In nuclear energy the UK has said it’s going to maintain a Euratom-equivalent regime, and it will maintain the framework of energy market integrity and transparency (REMIT for short).

Very importantly I think, Theresa May also said that there will be no reduction in the Marnet standards and, as you know, the Paris agreement will be one of the major drivers of policy both here and in the EU. Finally, Theresa May also said that she will consider binding commitments on state aid policy and on competition law.

Those statements, of course, are not legally binding at this stage but they do seem to speak to some of the concerns of the Commission. If you look at the EU negotiating documents, the big concern, really, is that level playing field, e.g. the prospect of the UK reducing environmental standards or employee protection and gaining a competitive edge in that way.

So in a lot of ways the positions are quite similar, but it won’t be plain sailing and I think there are two potentially quite difficult areas.

One is that the UK is asking for recognition of standards, and a right to derogate from them when it’s beneficial for the UK. I think it’s very unlikely that the EU 27 would accept that as they’ll see it as cherry-picking and they’ll be very concerned about any areas where the UK could get a competitive edge from deregulating. I think the conclusion you can draw from that is that the EU 27 are likely to ask us to implement a package of energy measures, and not just the internal market rules and regulations but also environmental regulations – things like the Industrial Emissions Directive, climate change legislation, and so on.

What it means is that we might be in the uncomfortable position of being a rule-taker after the past 20 years of being very influential in energy.

Partly as a result of that influence, the EU and UK energy policies are currently very well-aligned, but once we’re not there things will change. You can see this already happening: if you look at the negotiations on renewables directives you’ll see a rather stronger push on renewables than would have been the case had the UK been as much involved as before.

Furthermore, it’s quite likely that bodies like ACER (Association for the Cooperation of Energy Regulators) will get more powers and increase the scope of its work and while I think that the UK will have some involvement in ACER in the future, it will clearly not be with the same level of influence as before.

The second difficult area also relates to the internal market. The EU 27 have said that a non-member can’t have the same access to the European market access as a member. It’s not entirely clear what that means in energy, but certainly in the area of short-term trading (what’s called coupling) particularly in electricity we know that the Swiss have been excluded from market coupling, which of course does impose some additional costs. In the future we’ll see the development of trading and balancing products in electricity, which could be very beneficial. So there are some question marks there as to whether the UK will have a reduced degree of access.

So just concluding, I think there are more negatives than positives from Brexit for the energy sector, but having said that I don’t think that the impacts are likely to be drastic. Basically the trade-off that the UK will have to make is whether the benefits of trade and increased liquidity of supply and so on are worth the reduction in influence that comes with no longer being an EU member.

Patrick Heren

Gwyn has said much about regulations but I’m going to talk about gas, because that’s what I know about. To give some historical context, 25 years ago we were going full pelt for competitive gas and electricity markets and we were watched with horror by the Europeans, but then the idea gradually spread as time went on, particularly when the interconnector opened up in 1998 enabling a degree of competitive trading going backwards and forwards.

Whatever the apparent difficulties on paper, there’s an immense community of interest between us all in maintaining a trade, especially gas where systems are so carefully aligned and integrated, first of all with the interconnector but also through the Norwegian exports coming into Britain and also into mainland Europe, which through energy trades can often end up via interconnectors from Britain into Europe.

There is also the BBL pipeline from Holland. This is an export pipeline into Britain but as the Netherlands have begun to decline as gas suppliers, the BBL will become a two-way pipeline by the end of this year.

Coming to the physical changes that have been taking place in the British and European gas markets, Britain originally depended entirely on North Sea supplies, plus a little Norwegian gas which came into Scotland, and that gas, particularly in the southern basin and Morecambe field, was highly flexible with high swing production. In this way Britain could cover its own peak needs from these resources, which minimised the need for storage. The only storage of any consequence that was ever developed was the Rough field which closed a few months ago.

By the same token in the Netherlands, the huge Groningen field, discovered in 1960, was the absolute foundation of the European gas business, not only because of the immense amount of gas but also because of its high swing capability. 10 or 20 years ago when Dutch gas consumption was about 40 bn m3 a year, the Groningen could go up to 80 bn m3 a year. With that swing production it helped to balance the German, French and Belgian markets. All that is now going. Over the years this massive extraction has led to many earthquakes, resulting in the Government gradually reducing production. The latest Government decree limited it to 12 bn m3 a year.

Both Britain and Europe are in need of flexibility and I think one of the problems that we’re seeing already is not that we’re going to run out of gas, but of shortage at peak times. We’ve had two very large spikes this year in Britain, both of which were evened out by the promise of liquefied Russian gas. On the continent, despite the efforts of the European Commission to roll out the single energy market, storage is not really fully integrated into competitive markets yet. In France and to some extent in Germany we have situations where storage holders are not free to sell their gas at peak times because they are required to hold strategic storage and certain amounts of seasonal storage at different times in the winter. Speaking recently to a German gas-man friend, I was told that in his company when British traders were trying to buy gas from German storage (in the last 3 or 4 years) they were unable to do so. German traders wanted to sell but the managements of the companies did not: they wanted to hold onto it. So these are the sorts of things that are still to be ironed out as part of the ongoing European regulatory evolution.

The other thing that is bothering people is reliance on Russian gas. I’ve always maintained that the Russians have always been immensely reliable counter parties. Ukraine is a very special case, but the Russians have always believed in the law of contracts and tend to stick to them, and also they depend desperately on exports. As to whether any Russian gas comes here, well, we all know that when Gazprom or Gazprom Export as it will become in the future, sells gas to Britain, it sources that gas from the European market, and it probably comes mostly from Norway. Looking from a British security-of-supply point of view, our consumption is now probably down to around 80 bn m3 a year, of which half is produced by us and the other half is imported. We also export to Ireland via the interconnector, and to service that we have the most terrific infrastructure: something like 164 bn m3 per year pipeline, and LNG structure. The LNG structure is underused: only about 13% last year was used, so there is no shortage of capacity to get it in. It seems to me that the LNG trade post-Brexit will be outside the scope of EU regulations as far as British imports are concerned. Europe itself is also trying to increase its reliance on LNG, in order to minimise reliance on Russian gas.

One thing I must add before closing is that, for security of supply, we really must start fracking properly. We know there is a huge resource, and we just need to find out if it’s economically viable.

Robert Sale

My focus will also be on gas, and I feel that gas hasn’t had the attention it needs in the Brexit debate: all the focus has been on electricity generation. The gas interconnection with Europe is more than 10 times larger than electricity – which is not to diminish the importance of electricity but more to emphasise how important gas is. We will have gas for many years yet, as a partner to renewables and as part of affordable heat, so it is and will remain important.

With reference to how we trade gas with Europe, Patrick has covered a number of the key facts. There are two large pipelines, IUK  and BBL. IUK was up and running 20 years ago and is capable on its own of supplying a third of UK gas if it runs flat out, so these are very large assets, jointly regulated by authorities in the UK and Europe. These are cross-border assets and are very much in the front line of Brexit, so making a success of Brexit is crucial to the future of our business.

I have three points, one of which has already been touched on. There are very tangible benefits to UK and European consumers to having close bilateral access to each other’s markets. So as part of Brexit we want to maintain that close access, although it doesn’t have to be through participation of the IEM.  It is not stressed enough that there are other ways to maintain that bilateral access, and indeed there are policy opportunities out there to make the trade of gas easier and cheaper.

So let’s drill down on those three points. Prices –  so interconnection makes prices for the UK consumer more stable, and lower, especially in winter when the bulk of gas is consumed. Gas comes in to the UK when it’s most needed e.g. winter, and is exported when we make too much.  In summer a lot of LNG comes in to the UK, over and above what is needed by consumers and to replenish storage stocks, and the surplus is exported which benefits UK market liquidity.  So think of interconnectors together acting as a mega storage site: in summer gas is taken out and put into the continent, i.e. “storage”, and in winter it comes back in the form of imports. It doesn’t work exactly like that, but that’s a good shorthand approximation of how the interconnectors work functionally in the market.

Security of supply has been touched on, but just a few points. The great beauty of interconnectors is that they allow the sharing of assets. The UK has a wealth of energy import facilities, and Europe has a surplus of storage facilities, much more than they need. There are some problems with accessing them but not much, to be honest, and they need more custom and are very happy to supply storage facilities to the UK consumer. So through these large interconnection assets for the benefit of consumers you have mutual sharing of assets across a wider region. Both UK and continental consumers get security of supply at a much lower cost than if each country had to invest in the full panoply of gas assets: their own LNG, their own storage, their own transmission necessary to access it, etc.

In the latest cold spell, the National Grid was forced to issue a gas deficit warning, which is essentially a signal from the System Operator saying that the market is very tight and asking everyone to provide as much flexibility as soon as possible. Just as an example, we, on the following day met 16% of the total UK gas demand . . . so the gas does flow.

So, there are a lot of benefits to consumers to having this close bilateral access, and as part of Brexit we want to maintain that, but the question is how? The solution that most people advocate is that the UK continues to participate in the internal energy market. It needs to be recognised that in this pathway we would continue to be bound by EU network codes, come what may, including any future changes. That’s what participation in the IEM means.

Or, we could trade gas with EU, with the UK being a third country, officially outside the internal energy market. That would work perfectly well for gas, so long as there were no tariffs or other penalising barriers put in place. Gas could be traded through the interconnectors perfectly well with the UK not being part of the internal energy market. Indeed, we can see some benefits of this solution: it’s not a second best solution, certainly not from the gas point of view. As already alluded to, the European rulebook will continue to change. Right now they are doing four or five big economic studies to formulate the next wave of reform. That wave of reform may not be the market-led type of reforms that the UK favours and it’s inevitable in the future that the UK and the 27 may well have different priorities, and I think it’s also wishful thinking that the UK can retain a strong influence on the direction of future IEM policies after Brexit. In the past we’ve had quite a good influence, although not overwhelming, but this will diminish enormously. Therefore the IEM route is troublesome as it looks like a route where the UK would have to blindly accept IEM rules, and that doesn’t seem to us to be the right way forward.

So a solution where the bespoke trading rules across the neighbouring countries are agreed bilaterally could work perfectly well.

My last point is to do with whether we could we make gas trade better than it is today. Brexit is often seen as a threat, but there are several ways that we can go forward to maintain gas trade despite Brexit. There are opportunities also to make it easier and cheaper. First of all, rather than defining exactly how gas could be traded, we would recommend legal and regulatory reform to give to the authorities (Ofgem in the UK and CREG (Commission for Electricity and Gas Regulation) in the case of Belgium) the authority to find the most appropriate rules that best suit and benefit the consumer, rather than locking down in a hard and fast way the exact timetable and the exact products over which gas has to be traded.

Secondly, National Grid’s penalty charges do impose a significant penalty on anyone trying to access European (as opposed to British) storage, so we would advocate the removal of these penalty charges. And through these routes there are ways, despite Brexit, to make gas trade easier and cheaper.

To sum up, there are real benefits to the UK and all across Europe from the close bilateral access to each other’s markets. Let’s keep that, but let’s not jump to conclusions that that has to mean the IEM, as trading that’s based on bespoke bilateral rules agreed with the NRAs would probably be even more effective, so let’s not lose sight of the opportunities here to make gas trade cheaper and easier.

Questions and Comments

Clive Ferrey, Alfa Energy: I have a couple of questions: firstly what, if anything, can we do to improve liquidity in gas? Secondly, following Brexit do you see reduced liquidity because of what is coming in terms of Brexit?

Patrick Heren: Addressing the first question, in gas procurement activities, it is difficult to buy more than two years out. I suppose we would need to have some kind of regulatory stasis across Europe for people to be willing to take a position 5-10 years out. It’s still very much an industry-oriented market and it’s not like the crude oil market where you have huge hedge fund interest: yes, that produces a lot of liquidity, but it also produces a lot of different sorts of problems and an ingrained proclivity to bullishness where they want prices to go up. I can’t see that happening, except possibly post-Brexit perhaps the NDP will become more liquid again. In recent years the NDP has lost ground to the TTF in the Netherlands and that could change, although I’m not a forecaster and I don’t really know.

In answer to the second question, no, I do not think liquidity will reduce. My instinct is that it will increase.

Philipp Erdmann, Papierfabrik Palm: I work at a paper mill in Kings Lynn and as a German company we see a huge disparity of electricity prices between the UK and the continent, whereas in the gas market there is quite a level playing field. Our fear is that post-Brexit there could be constraints on flow between the continent and the UK, which would lead to a decrease in that level playing field. Due to the equal gas prices in Europe we have a chance to be competitive and our concern is that there is a threat to industries. What can we do so that our businesses won’t be disturbed?

RL: There is very, very little talk about tariffs. Although one individual is pushing it a bit, my understanding is that it’s not really being talked about. So I think the outlook for ongoing gas trade is fairly benign. There’s a theoretical possibility, of course, of all sorts of barriers being put in place, but I think that’s unlikely. This is partly because of the strong mutual benefit in trade: as we’ve already discussed, the gas flows both ways and the beneficiaries of gas trade are not just in the UK but also in Germany, Belgium, the Netherlands, etc. When supplies from Russia were cut off a few years ago, what’s sometimes called the West-East route gas landed in the UK and the flow of LNG eastwards was very beneficial to European consumers. So, whilst it might be a scenario that you should prepare for, I think the likelihood is quite low. In terms of ongoing market functioning, we’re really quite optimistic

Gwyn Dolben: A quick comment on electricity prices. Electricity does have to bear quite a lot of policy cost, particularly development of low-carbon energy, most of the efficiency surcharges and so on, which I think is one reason why electricity costs are higher than they should be. There is one bit of good news from a UK perspective and that is that we are building further interconnection for electricity. We currently have 4 GW and we have 4 GW in construction, so by 2020 we will have doubled the amount and that will increase electricity liquidity and competition. It will depend on how the trading arrangements are agreed, but in principle it should be a good development.

Andrew Large, Confederation of Paper Industries: Broadening out from what Philipp has just said to a more general set of debates, I was surprised that no one mentioned the Euratom treaty and what will happen with regard to UK nuclear power, and the regulatory issues around that. I’d like to hear some comments on that.

The second is that from the point of view of the energy-intensive industries, we are very interested in the relationship between gas and electricity. 45% of UK electricity is generated from gas, and our members are using gas for their own electricity generation and boiler capacity. What we’re seeing is that electricity and gas are not two separate potential arms of energy supply to the UK – they are interconnected and disruptions in one have knock on effects for the other.

The third issue where I would be interested in comment is that our experience of what happened at the beginning of March was different from what you said. Members felt very much that price spikes that occurred in that period were not reflective either to the speed of response to the gas deficit warning, or the ability of the interconnectors or LNG to be able to provide the UK’s diversity of supply.

Obviously Brexit is an overlay over that, and we as a sector are concerned that we have a very, very delicate energy system in the UK, and interconnections literally and metaphorically between the different elements of it, and Brexit becomes a little extra weight, knocking the balance out of kilter and the end result could be a forced disconnection of gas from a large industrial user because of the need to maintain supply to domestic users.

We see closure of Rough as very challenging and we would be interested in the Government holding an enquiry to understand whether in view of the changes whether gas storage would not be a sensible thing for us to do to ensure that in the future we have the right mix of supply sources for the UK economy.

Patrick Heren: Gas storage has been discussed for at least 10 or 15 years, and the problem as you know is that there isn’t sufficient summer/winter spread for any commercial developer of any size to be interested. The York field has been mentioned, which is a depleted offshore field that is smaller than Rough, and politically if the Government wants to promote that then either they’ve got to build it themselves, which is not on the table at the moment, or incentivise the potential, which as I understand it has always been regarded as a political no-no.

I agree about the effect of spikes: because we don’t have storage we have a hyper-sensitive gas market.

Robert Sale: Electricity and gas interaction is an under-explored area, but my understanding is that following 1st and 2nd March BEIS will do further work on it – Ofgem is on board and we as a market participant would be very much on board, so I think there are takeaways. 1st and 2nd March didn’t kick off badly and the system was not really tested, but it could have been.

Rightly or wrongly, gas volatility and these short-run spikes are features of the market and it makes sense to hedge: it’s quite a risky strategy to buy gas on the day. Now and again you’ll get these big exposures so as far as the market response, maybe there should be more hedging to be done as the UK market is now very sensitive.  Someone made the point at the recent BEIS/Ofgem seminar that even if the UK had substantial storage the spike would still have happened, because we still needed to suck in the margin of supply. Even if Rough had still been on the system, it would not have solved the problems caused by events from the Beast from the East. It might have helped but strictly, in economics terms, prices would still have needed to get up to that sort of level to trigger the extra supply. So it’s a complex thing and I think there will be some changes, especially in the gas/electricity area which will be one thing that will be reviewed by BEIS and Ofgem.

Gwyn Dolben: I think you’re right to raise Euratom, which I did mention in passing earlier. It’s a crucial issue because it governs not only UK trade with the EU but all and other countries which have nuclear activity. I think BEIS is very alive to this (we’ve just published a review of their activities on our web site) and the UK Government has said that they will publish an equivalent regime to Euratom.

Simon Harpin, BEAMA: Regarding fracking, do you think there’s a likelihood of it increasing in the UK after Brexit, and how does it align with our national clean growth industrial strategies?

Patrick Heren: I suppose in terms of how it aligns with clean growth, under any scenario this country is going to have to go on burning a lot of gas for at least 20 or 30 years. In power generation you can see gas primarily as the back up to intermittent renewables.

I remember writing several articles 5 or 6 years ago where I was completely astonished at the attitude of the then Coalition Government. I think the LibDems in the Energy Department were constitutionally opposed to the idea of fracking, but nonetheless the potential for a very large resource which the British Geological Survey has said geologically is there (although it might not be economically viable) – for that government to be so cowardly in its attitude was astonishing. They were basically too afraid of protests to want to find out about the economic potential. Also, when you are drilling up in Lancashire, which is where it’s going on, the potential for skilled industrial jobs in that region must be something of interest to both Conservatives and Labour.

I suggest at the moment, Cuadrilla have started their operations and the Government is waiting to see if it’s properly prospective. If it is then they’ll have to put some political capital in to get it done.

The meeting closed at 7 pm