Owners and developers of the UK's cross-border energy infrastructure are once again facing an anxious wait for the outcome of UK-EU trade negotiations, which will establish the terms on which electricity and gas can move between the UK and mainland Europe post-Brexit.
Having avoided a no-deal Brexit in October 2019, more than nine months later there are few signs of meaningful progress on trade talks, and energy market participants have been told to prepare again for abrupt changes to trading arrangements on 1 January 2021.
Within energy markets, those likely to be most affected by a no-deal Brexit include the owners and operators of UK-EU interconnectors – the physical structures that enable energy to flow across borders between international transmission systems.
The UK currently has 5GW of interconnector capacity, providing 5-10% of UK electricity supply and 12% of gas.
The UK's active electricity interconnectors comprise:
- 2GW to France (IFA);
- 1GW to the Netherlands (BritNed);
- 1GW to Belgium (Nemolink);
- 500MW to Northern Ireland (Moyle); and
- 500MW to the Republic of Ireland (East West).
Market coupling is an agreement between transmission system operators (TSOs) and market operators of two or more countries to use a common algorithm to set prices and allocate capacity.
Market coupling and implicit auctions help optimise the use of interconnector capacity by allowing capacity to be sold together with the energy in a single day-ahead auction (the auction is referred to as implicit, because the trader does not have to make assumptions about what the day ahead power price will be).
The UK government has expressed a preference for continued access to the EU's internal energy market (IEM), enabling participation in the market coupling system, even if the outcome of trade negotiations means the UK falls outside the IEM. The EU does not currently share this view, however.
When the UK looked set for a cliff-edge Brexit at the end of October 2019, Ofgem moved quickly to approve new access rules and a charging methodology for continued use of the IFA interconnector.
Interconnector operators and Britain’s two power market exchanges, Nord Pool and EPEX SPOT, also hastily prepared for separate day-ahead interconnector capacity auctions.
The separate model involves market participants bidding for interconnector capacity first, then participating in power auctions to determine electricity prices – a system that was in place before the implementation of EU market coupling arrangements. Reverting back to this less efficient way of trading energy looks set to drive up power prices in the UK.
While these clunky default provisions remain ready to launch in the absence of a UK-EU free trade agreement (FTA), many in the industry hope that more satisfactory arrangements can still be approved during what remains of the transition period – although optimism on this point is waning rapidly.
In anticipation of the UK's exit from the market coupling system, on 10 July 2020, the Department for Business, Energy and Industrial Strategy (BEIS) issued new guidance on the UK's post-Brexit electricity trading, stating: "Interconnectors, code administrators and market participants may need to carry out contingency planning for 1 January 2021, depending on the outcome of FTA negotiations".
Among its recommendations, BEIS urges interconnector owners/operators to prepare alternative trading arrangements and updated rules to enable each connected market to continue trading as "efficiently as possible".
It also directs those affected to engage with relevant EU national regulators regarding potential reassessment of TSO certifications, and with British administrators of the various industry codes to ensure these are updated.
As well as making changes related to market coupling, UK market participants that wish to continue trading with EU energy markets (including all interconnector operators) will also need to register under the EU’s Regulation on Energy Market Integrity and Transparency (REMIT) with an EU regulatory authority to allow market monitoring and avoid disruption to electricity trading.
The situation in Northern Ireland is different, as the island of Ireland's Single Electricity Market is set to continue in accordance with current arrangements under the Ireland/Northern Ireland Protocol.
How interconnectors are preparing
Although interconnectors only supply a relatively modest amount of the UK's energy, they play a vital role in ensuring security of supply and efficiency – which they are able to do largely because of their currently frictionless trading arrangements.
Interconnectors provide an efficient way of balancing supply and demand for electricity and gas within the EU, as they can smooth out local pinch points by allowing energy to be transmitted from areas where there is an excess to where it is most needed.
In the UK, a high proportion of the domestic energy mix is powered by gas, which has a relatively high carbon cost (set by the EU Emissions Trading System (ETS)). This can drive higher electricity prices compared to parts of continental Europe, where a larger share of electricity is sourced from nuclear and renewable energy projects, incurring lower carbon costs.
As a consequence of this price difference, interconnectors between mainland Europe and the UK tend to flow from Europe to the UK, rather than in the other direction, enabling cross border arbitrage and allowing interconnector operators to maximise congestion revenues.
Existing interconnectors will not be disconnected as a result of Brexit, and given the shared economic interests in maintaining energy trade between the UK and the EU, trading across interconnectors will continue to operate, albeit under more cumbersome and ultimately more expensive arrangements.
As a result of the first Brexit cliff edge in 2019, interconnector operators have already been through the process of consulting on rules that will apply if no trade deal is reached. These rules can be found on the operator's websites and broadly state that they will revert to wholly explicit auctions.
Looking forward to the medium and longer term, there are concerns that UK leaving the IEM will increase prices for energy consumers in the UK, and that security of supply may be adversely affected. It is also possible that imports of energy (and exports to the EU) will be subject to tariffs, further increasing costs and impairing the efficiency of UK-EU energy trading.
Lis Blunsdon is a partner specialising in energy regulatory matters at European law firm, Fieldfisher.
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