Brexit, short circuits across the English Channel
Share
The effect on the energy sector is still coming into focus. The fate of the U.K.'s participation in the Energy Union project and the liberalization of the EU energy market will be crucial

The dust still needs to settle - and this could take many more months, perhaps years - before it will be possible to assess the full impact of Britain’s decision to leave the European Union on the U.K. economy and its all important energy sector. One thing is certain: The future will depend on the skill of the new Conservative government led by Prime Minister Theresa May to negotiate an acceptable arrangement with the rest of the European Union after a short but particularly bitter leadership contest that has left deep scars inside the party. The ongoing turmoil in the opposition Labor Party also risks unsettling the situation further, as does the attitude of Scotland, which wants to remain in the E.U. and may seek a new referendum to split from the UK. Will many of the “Leave‘ voters start having second thoughts should the U.K. economy come under increasing pressure with the possibility of falling into recession? So far, the stock market and the economy have resisted quite well although the pound has inevitably suffered a sharp decline against the dollar and the Euro. Mrs. May does not seem in any great hurry to invoke Article 50 of the Lisbon treaty that would trigger the two year process for Britain’s exit out of the E.U. As Home Secretary (the equivalent of Interior Minister in E.U. countries), she had backed former prime Minister David Cameron’s unsuccessful campaign to remain in the EU. But she has always been tepid about the EU. She has also appointed in her government a number of pro-Brexit influential Conservative members, not least one of the leaders of the Brexit campaign, former London Mayor Boris Johnson, who has become Foreign Secretary. She has underlined her commitment to Brexit, and some of her cabinet members suggested the government was planning to trigger Article 50 early in the New Year after extensive consultations with European governments. Mrs. May has already had quite positive talks with Germany’s Angela Merkel and somewhat frosty ones with France’s Francois Holland. Mr. Johnson has so far shown some unexpected diplomatic skills and avoided the polemics for which he is well known. After all, he is only too pleased to have been given such a big role in the new government after being betrayed by his closest Brexit ally, former Justice Minister Michael Gove, during the leadership contest that followed Mr. Cameron’s resignation. He now has a strong platform from which to launch his own bid to become Prime Minister in the future.

An internal party showdown

The #Brexit effect on the #energy sector is still uncertain: will #TheresaMay negotiate a good arrangement with #EU?

The tensions and divisions within the Conservative Party have shown in broad daylight how the Brexit referendum was, at the end of the day, an internal party showdown. The sad thing is that such a crucial issue as Europe and the U.K.’s membership of the EU boiled down to a dirty internal political squabble in the Conservative Party as well as in the Labour Party, which was supposed to have backed Mr. Cameron’s bid to remain in the EU But the controversial Labour leader Jeremy Corbyn made it clear he was extremely reluctant to back Mr. Cameron and did little to fire the Labour Party base to vote to remain. Indeed, the leadership contests in both the governing Conservative and the opposition Labour Party have been widely compared to a political soap opera that has the makings of a big budget sequel to the blockbuster “House of Cards" television series. In fact, there are two - the first set in London and the successful American adaptation in Washington DC. These are all gripping stories of personal political ambition and betrayal that have been played out for real in the fallout of the unexpected Brexit vote. Although Theresa May ultimately won the Conservative leadership contest with an overwhelming majority and is generally considered as “a safe pair of hands‘ with considerable political experience, she will still need to navigate difficult waters both within her own party and country and with Europe. The Brexit hardliners are frustrated that the new Prime Minister is not an out and out pro-Brexit supporter, and those left out of her cabinet will watch and wait for her to trip up. As for the Labor Party, the situation is a complete shambles, and that is no exaggeration. The vast majority of Labor Members of Parliament as well as the shadow cabinet want the current party leader Jeremy Corbyn to resign after his feeble support to stay in the EU in the recent referendum. He has lost a vote of confidence from his own parliamentary members, but under the arcane rules of the Labour Party, he has resisted resigning and suggested he would soldier on. All this goes to show how deeply divided are the Labour Party and the Conservative Party, for all the current efforts to rebuild party unity, England and the United Kingdom as a whole. After the initial knee-jerk reaction following the largely unexpected victory of the “Leave‘ camp, the financial markets have recovered some composure and the Bank of England has so far resisted making an immediate interest rate cut. The mood, however, remains nervous and volatile. This is all principally due to the uncertainty created by the UK’s decision to leave the E.U. that in turn risks spreading more economic instability, and undoubtedly weakens the U.K.’s negotiating position and, at least in the short term, discourages investment. In short, the referendum and its outcome have introduced a severe source of new turbulence and confusion to both the U.K. and E.U. economies, not least in the energy sector.

The referendum and its outcome have introduced a severe source of new turbulence and confusion to both the UK and EU economies, not least in the energy sector

An unclear effect on the energy sector

The precise impact on the energy sector is unclear at this stage. However, as the legal firm Herbert Smith Freehills put it in a recent note: “One certainty is that in the immediate future we are very unlikely to see any major changes to the current systems and regulations. The exit will take a significant amount of time to negotiate and plan, and the E.U. and the U.K. will have to decide how access to each other’s energy markets would continue, if at all." The key issue is whether the U.K. will be able to retain its access in the single market without having to comply fully with the obligation of freedom of movement for E.U. citizens. Migration was from the very start one of the main issues of the referendum, and whatever government is formed in London this autumn, migration will remain at the top of the agenda of negotiations with the E.U. That does not mean, as Mrs. May has suggested, that the new government will invoke Article 50 of the Lisbon Treaty straight away. All the signs are that the new Prime Minister will try to delay this until the end of the year to test the negotiating climate and assess the economic environment. At present the other E.U. countries are suggesting that the U.K. would be given no favors - “no cherry picking‘ Mrs Merkel told Mrs May - and if it wants continued access to the single market, it will have to comply with the quid pro quo of freedom of movement, capital, goods and services. This would apply in a Norwegian style solution with the U.K. remaining part of the European Economic Area. However, negotiating positions can evolve, especially as many other EU countries have similar worries and domestic pressures over controlling migrant flows that could lead to a broad reassessment of E.U. migration policies. These might help open the way towards a compromise with the U.K. which would be able to adopt what some commentators are already calling a “soft Brexite‘ or “Brexite lite‘ option, the UK would be allowed a certain control on migration through, say, a quota system, to allow its continued participation in the single market. These are very early days, but ideas are already being floated about. They have important implications for the U.K. and E.U. energy sector because they will ultimately determine the U.K.’s continued participation (or not) in the Energy Union project and its participation in the liberalization of the European energy market. Britain has a number of electricity and gas inter connectors with continental Europe and is currently developing more. This will inevitably require co-operation with the E.U. internal energy market in any Brexit scenario. The U.K. is also likely to continue implementing and backing many of the E.U.’s Third Energy Package given the country’s commitment and track record in energy liberalization.

Impacts on utility bills, green energy and nuclear projects

The UK National Grid has also already warned that domestic energy bills would rise and energy security would fall if the U.K. does not retain access to the Internal Energy Market (IEM) when it negotiates Brexit. In a statement after the referendum vote, the company said: “It is vital the U.K. retains access to the IEM which provides stability for energy companies and helps keep household bills down. U.K. energy security depends on gas and electricity from the IEM and it is essential therefore that we take no risks with that. The issue of energy needs to be treated with the highest importance by the government as the negotiations on Britain’s exit begin." According to an analysis from the Vivid Economics research group, the cost of reduced collaboration with Europe would be significant. "The potential impact from the IEM could be up to £500m a year by the early 2020s, "the group’s analysts said, adding that further costs would come from investors demanding higher returns as the risks of new projects rise. With dirty aging power plants closing down, the UK now needs to invest about £20bn a year over the next five years, says the National Infrastructure Commission. This amount would make up about 60% of all planned infrastructure spending in the UK." Indeed, Brexit is likely to make the UK’s challenge to build a clean, secure, affordable energy system even harder. In a Brexit scenario, Britain would no longer be bound by the EU. requirement to produce about 30% of its electricity from renewable sources. It would also give the UK greater freedom to pursue nuclear projects such as the controversial £18bn Hinkley Point C nuclear power station led by the French state controlled utility EDF. After the referendum, French political leaders confirmed they continued to support this project that is important for both countries. The plant would provide low carbon electricity to meet 7 percent of the U.K.’s total needs from 2025 onwards while it would help support France’s nuclear industry that has faced increasingly difficult times of late and is in the midst of significant restructuring. But Brexit is also likely to make it harder for the U.K. energy sector to secure loans from the European Investment Bank and the European Fund for Strategic Investment to help fund much needed new energy infrastructure investments. The scientific community is also concerned about the implications of Britain leaving the E.U. on funding research programs and U.K. collaboration in pan-European projects. Professor Steve Cowley, the head of the U.K. Atomic Energy Authority, told the BBC that researchers were afraid that annual European Commission funding would be withdrawn. This also risks affecting the oil and gas industry that has benefitted from working closely with research institutions in both the U.K. and the EU. This cooperation has allowed companies in the North Sea to maintain their competitiveness over the years and become leaders in the field of new offshore technologies. Compared to the power utilities, the oil and gas industry appears to be in a better position to weather the Brexit storm, according to industry analysts and executives. Nonetheless , the question of a possible second Scottish independence referendum is creating more uncertainty for the oil sector and could induce companies to delay or cancel projects until the full outcome of Britain’s exit negotiations are known. But one big worry of the multinational oil and gas companies is the possible loss of cross-Channel freedom of movement arrangements between the E.U. and the UK. Many U.K. workers employed by European oil companies work in E.U. countries and vice-versa. Non E.U. status for these workers could increase bureaucracy and hence costs to employers. Shell has underlined this issue, warning that trade barriers and movement restrictions would negatively impact its UK operations. Such restrictions would also undoubtedly affect the U.K.’s ability to attract highly skilled oil and gas workers to its shores. This would represent a further blow to the mature U.K. North Sea industry that has already lost 8000 jobs since 2014 as a result of the oil price slump and has, as a result, seen a sharp rise in labor tensions and strike action.

The key issue is whether the UK will be able to retain its access in the single market without having to comply fully with the obligation of freedom of movement for EU citizens

The future, looking also at the US

Mrs. May and her new government have so far adopted a cautious, constructive and pragmatic stance to its commitment to take Britain out of the E.U. The question is whether the new government will be able to maintain this approach in the face of the inevitable political and economic turbulence ahead. Mrs. May will hope her opposite numbers in the E.U. also adopt a constructive and pragmatic approach to exit negotiations when they eventually start after the U.K. invokes Article 50 of the Lisbon Treaty. At the end of the day, it is in both the U.K.’s and the E.U.’s long term interest to come to an acceptable arrangement, however long that might take. The outcome of the forthcoming U.S. Presidential election could make the need for such an arrangement all the greater.