Navigant Research Blog

Brexit and the Future of Energy in the United Kingdom, Part 2

Stuart Ravens — July 14, 2016

Bangkok SkylineIn my previous post in this two-part series, I discussed different potential scenarios for the U.K. energy sector after Brexit; here I examine Brexit’s impact on energy investment and energy industry in the country.

Brexit has caused widespread economic uncertainty and market volatility. Though the FTSE100 index has recovered from its initial decline, the pound is still trading well below its pre-election levels. While it’s not an economic disaster, Brexit-related uncertainty will expose the United Kingdom to greater instability when economic shocks do occur. The days of the country being a safe economic haven are over.

The U.K. energy industry relies heavily on capital investment to build large-scale assets—in recent years, this investment has gone into both onshore and offshore wind, the conversion of coal generation to biomass, and grid reinforcement. The United Kingdom is a 16% shareholder of the European Investment Bank (EIB), which provides ultra-low-cost funding to European infrastructure projects. In the 5 years leading up to 2015, the U.K. energy industry received more EIB funds—28% —than any other industry. However, Brexit will make it harder to access EIB funds for new projects. The bank has no provision in its statute for countries leaving the EU; the bank recently told Newsnight that “some U.K. projects, which previously would have stood a good chance, are now less likely to be approved.”

Interconnector Uncertainty

There will also be significant uncertainty regarding the country’s interconnector projects with mainland Europe. The United Kingdom’s participation in the single market provided investors with enough certainty to create a business case for interconnection. Before progressing with these projects, investors will require assurances that the country will be able to access cheap power from its European neighbors when its power prices are high, and vice versa. Future EU-imposed tariffs on the sale of electricity between a post-Brexit United Kingdom and the rest of Europe will kill interconnection projects, as without significant price arbitrage, there is no business case.

A new nuclear power station at Hinkley Point is central to the country’s long-term energy security, given the country’s rapidly decreasing capacity margin as older coal-fired generation plants are decommissioned. However, the country’s credit rating has been cut, along with many of its banks. This will likely raise the cost of capital for these large-scale energy projects, and may sound the death knell for the Hinkley Point project. The French government-owned lead partner EDF was on the verge of pulling out of the project before the Brexit vote; early indications suggest EDF will pull the plug.

Capacity Shortfalls

If Hinkley Point isn’t built, how will the United Kingdom address its falling capacity margin? One way will be to continue with its renewables program. However, the public is as hostile to onshore turbines as it is to European bureaucrats. To date, the United Kingdom has been a guiding light in offshore wind; however, these projects are more expensive per kilowatt of capacity than onshore projects. And with a higher cost of capital and an uncertain commitment to renewables, the country may find it difficult to find investment partners willing to commit to future offshore developments.

The capacity shortfall could be made up with domestic solar, but the ruling Conservative Party has already demonstrated its antipathy to subsidies by slashing the feed-in tariffs for domestic solar. With the threat of a post-Brexit recession, the government is more likely to remove incentives than introduce more generous ones.

What is more likely is a retrenchment from the country’s previous renewables obligations and a refocus on fossil fuel-powered generation—including the extension of the life of coal-fired generation—at least in the short- to medium-term. With historically low gas prices, we could see a resurgence in gas-fired generation. Fracking could also be back on the United Kingdom’s agenda: post-Brexit, the country will be free from the generally anti-fracking European body politic.

Siemens has gone on record about its uncertainty regarding future investment in the U.K. economy; this position is entirely expected. Most companies currently considering investment in the United Kingdom’s energy industry are expected to follow Siemens’ lead and wait until new prime minister Theresa May takes office and provides more clarity on what Brexit means for the country’s energy industry. While we just don’t know the extent of the fallout from Brexit on the U.K. energy sector, we do know that there will be an impact, and that it will most likely be negative—there are few positives to draw from the British public’s decision.

Potential Opportunity

So far, so gloomy. But is there a silver lining to what many see as a very gray cloud? While there is much to be pessimistic about, there are some potential positives to take from Brexit. Amber Rudd, the U.K. Energy Secretary, recently stood by the country’s commitment to address climate change, and suggested the United Kingdom could adopt more ambitious targets for CO2 reduction: 57% reduction from 1992 levels by 2032.

It can’t be disputed that Brexit has increased the risk of losing EDF as a partner for the Hinkley Point nuclear plant. However, this does not mean the project has to end. Brexit could unshackle the United Kingdom from EU regulations on nuclear power and, more importantly, wider procurement rules. The lower-valued pound will make it harder for U.K. companies to pay for goods and services beyond its own borders, but makes it cheaper for foreign companies—for instance, those in the United States or Japan—to make investments. Some may view Brexit uncertainty as an opportunity to enter the U.K. market at a lower cost.

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