Looming Brexit Woes, Impact on UK Power Market

Britain’s Brexit drama has been extended until 31 January 2020 amid political twists and turns, with dark clouds looming on the power sector post UK’s exit from the European Union (EU). The UK voted to leave EU in 2016, but the implementation has been delayed due to a lack of agreement in the British Parliament.

Although cancelling Brexit would mean that, the UK’s economy would avoid suffering any initial setbacks or disruption from exiting the EU, the decision would result in an extreme political crisis, which in itself would be deeply destabilizing. The more likely scenarios remain those of a “soft” Brexit, in which the UK leaves the EU under a managed deal that allows time for negotiations to form a new trade deal, or a “hard” Brexit, under which the UK leaves the EU without a deal.

The UK’s power industry continues to remain haunted by unknown risks and impacts of the post-Brexit scenario. The looming Brexit deadlock poses potential risks of higher prices for imported machinery and equipment, a shortfall in skilled and unskilled labour (given the current reliance on migrant labour from the EU) and also the ripple effects of any disruption in economic activity and decline in investor confidence.

Brexit – Will it be hard swallow or smooth gulp?

The default position will be that if no deal is passed by Parliament, the UK will leave the EU without one on 31 January 2020. Leaving without a deal (or withdrawal agreement) means the UK would immediately exit the customs union and single market - arrangements designed to make trade easier. However, the Brexit headwinds have receded as the risk of no-deal in October passed and the Brexit deadline was pushed back again. The median probability of a disorderly Brexit has dropped to 20% as per a survey of economists. With a less likely chance of a hard Brexit, any major disruption to the UK energy market is unlikely.

The energy sector is varied and the impact of Brexit will diverge for different players by technology across the industry value chain depending on market focus, energy products traded and the cost base.

? Cross-border supply chains - Border delays could arise in a no-deal Brexit, affecting the resilience of supply chains, especially in relation to critical spare parts or machinery. Chemicals, plastics and equipment are more likely to be subject to a duty cost, which could impact energy supply chains, e.g. for energy infrastructure and spare parts. Under this scenario, the movements of goods between the UK and the EU would become imports and exports, resulting in customs compliance obligations. In case of a soft Brexit, cross border supply chains are expected to operate smoothly like before.

? Electricity Supplies - A major disturbance to UK electricity supplies is unlikely due to “No-deal” fallout. That’s because the UK only imports around 6.6% of its electricity using four inter connectors. However, an impact assessment report for Ofgem found that market decoupling would reduce imports of cheaper electricity from EU countries by 34%, reduce income to inter connectors by 9%, and reduce consumer benefits by 30%.

? Carbon Markets - Brexit would also mean that Great Britain would be disassociated with the EU carbon market. The UK’s strong emission reductions in past years have generated surplus emission allowances; it is likely that UK will no longer able to sell these allowances. In case of a no-deal Brexit the UK government would then introduce a new domestic CO2 emissions tax for power utilities and industrial firms on 4 February 2020.

? Labour Market – The power industry is labour intensive and may need skilled labourers from outside in case of short supply. The UK power sector has been facing the skilled worker’s shortage and Brexit could further worsen the situation. According to the Migration Advisory Committee, which keeps a list of occupations with a shortage of workers, about 13% of Britain’s welders come from other countries in Europe and any strain on the skilled worker supply from outside is likely to hit country’s plan of revitalising the ageing nuclear infrastructure.

? Investment Scenario – Several EU schemes, financial and banking entities promote investment in energy infrastructure, which embraces funding towards projects in the UK. The European Investment Bank (EIB) for example has invested over €13bn into UK energy projects since 2010. It is estimated that Brexit could potentially result in reduction and delay of investments in the UK, however, investment banks such EIB, that have a policy to fund projects outside the EU will continue to provide the funding.

? UK’s climate change ambitions – In any form, Brexit is unlikely to change the UK’s ambitious climate change goals. The UK passed law in June 2019 to reach Net Zero carbon emissions by 2050 and all the related efforts will revolve around the law making Brexit impact insignificant.

Power Sector Outlook Across the UK

Renewables have rapidly increased their share in electricity generation during the last century. From the early 2000s, wind power began to take off; by 2011, solar PV panels were being widely installed on the roofs of residential properties and then turned in to large-scale solar installations. The share of renewables (excluding small hydro) in the overall capacity mix has increased from 1.7% in 2000 to 40.1% in 2018.

As the likelihood of a hard Brexit diminished, the investors and industry have regained the confidence of a favourable Brexit deal. Under this scenario, the renewable power sector is set to grow at an average CAGR of 5.4% from 2019 to 2030, with the wind power market expected to have the largest capacity among renewables by 2030 with an installed capacity of around 50 GW, owing to the UK’s wind power potential and the government’s push for wind energy expansion. As the country is set to phase out coal power by 2025, gas-based power generation is expected to constitute almost the entire thermal power fleet in the country by 2030, with a residual oil capacity. This will help fill up the capacity vacuum due to absence of coal power post 2025 and ensure grid stability in times of high peak demand and continued decarbonization.

The UK power industry’s growth trajectory has already derailed since the announcement of the UK’s exit from the EU. After three Brexit extensions, the power sector was haunted with the uncertainties and risks of further erosion of market attractiveness. Now with the less likelihood of a harsh Brexit the market is expected to undergo a short-lived slowdown with the return of the growth curve. The below diagram depicts the multiple scenario of the UK’s power market landscape under the different market conditions.

? Nuclear - The UK’s exit would mean withdrawal from the European Atomic Energy Community (Euratom) and the associated treaty (the Euratom Treaty); however, the UK’s policy and deal makers have clearly stated that withdrawal from Euratom will not affect nuclear security and safety requirements. The Nuclear Safeguards Bill, introduced in the Parliament in October 2017, will set a robust framework for achieving the safeguards similar to Euratom treaty.

? Thermal - There is not expected to be any change in the prevailing stance towards the unabated coal-fired plants closure despite Brexit, particularly as the Government has confirmed its firm view to close all unabated coal-fired power stations by 2025.

Since the government is firm on its plan for coal-fired power plants closure, gas-fired generation is the quickest to fill the gap. However, Brexit is unlikely to create any disruptions towards the new gas fired project build-up; also, the supply of gas is not a key concern. Europe and the UK are profoundly connected through their energy infrastructure, which is not expected to change tangibly in the future.

The UK currently imports gas from a variety of sources across the globe, facilitating a successful mitigation against any security of supply risks. It is expected that a no-deal Brexit will place a greater reliance on LNG arrivals into the UK.

? Wind - Offshore wind, is likely to get hit the hardest, as new tariffs will affect the supply chain for wind turbines, thereby posing a risk for the cost of wind energy in the UK. The growing geo-political tensions between the US and China, and uncertainties around Brexit have decelerated the investments and a potential short-term slowdown in the new capacity additions is likely to be witnessed.

The situation for wind turbine and equipment is complex because the global supply chain can often stretch and spread across several continents. WindEurope, European wind energy association, warned that these additional EU safeguards, if adopted, would push the cost of wind turbines in Europe up by 10%.

? Solar PV - The Solar PV installation growth was largely driven by government support schemes, mainly through Renewable Obligations (RO) and Feed-in–Tariffs (FiT). However, since 2015, the UK has pushed restrictions on the subsidies granted and recently abandoned its past renewable energy subsidy schemes.

This closure of the schemes has already influenced the growth of the solar PV industry and any impact of Brexit outcomes is less likely to make any amendment in the state of the solar PV market conditions.

Determining the specific impacts of these issues remains a guessing game while the final conditions and outcome to the Brexit remain unclear, but it is clear that - like many sectors - the energy market is also going to be negatively impacted by the effects of Brexit, regardless of whether the UK leaves with or without a deal.

The elusive future of carbon pricing, cross-border energy flows, negative investor sentiments and the potential for new energy tariffs are all among the issues under consideration that will affect the future direction of UK power market.