Navigant Research Blog

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

— 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.

 

Brexit and the Future of Energy in the United Kingdom, Part 1

— July 12, 2016

Energy CloudThe world is still reeling after the United Kingdom’s shock vote to leave the European Union (EU). So what does this mean for the country’s energy policy? And what does this mean for companies seeking to do business in energy in the United Kingdom?

The short answer to the first question is nobody knows, but it will either stay the same or get worse. Only a few short weeks after the world woke up to the reality of Brexit, there is far too much uncertainty to form a considered opinion about the extent to which the United Kingdom’s energy sector will be affected by the vote. However, it is worth taking a step back to assess the different scenarios that may evolve during the Brexit negotiations.

Period of Uncertainty

Until the U.K. government invokes Article 50 and formally notifies the EU about its intent to leave, the United Kingdom remains a full member. Article 50 will not be invoked until the new Prime Minister Theresa May enters Downing Street; however, there may be legal hurdles and a vote by Parliament before Article 50 can be invoked. There may even be a snap general election, further extending the period of uncertainty.

Brexit will either look very similar to the current state of affairs (although the United Kingdom will no longer participate in the European Parliament, it will still enact its laws), or the United Kingdom will cut itself off completely and face many years of trade renegotiations. So what can we expect the impact of Brexit to be on the U.K. energy market?

A Potential New Direction

The United Kingdom’s energy policy has been closely tied to wider EU policy for the last couple of decades. EU policy is heavily influenced by a low-carbon future and a pan-European energy market. The United Kingdom’s renewables, smart meter, and air quality targets were all set by Europe; a full departure from the EU via Brexit would mean the United Kingdom could tear up its commitments and choose its own direction.

Given the impending start of the United Kingdom’s smart meter rollout, this is probably an unstoppable train that has already left the station. However, if Brexit leads to a recession and higher fuel bills, there will likely be pressure on government to delay the smart meter deployment or rescind the legal obligation that forces suppliers to deploy meters. The United Kingdom has lagged behind many European countries in its commitments to improve air quality; a full Brexit from the EU will likely see the country delay further, given a likely shift back to fossil fuel-powered generation.

The short answer to the second question of what Brexit means for companies doing business in energy is “wait and see.” Look for more on this topic in the next post in this two-part series.

 

The Automotive Industry and Brexit

— July 1, 2016

Electric VehicleThe referendum on the United Kingdom’s membership in the European Union (EU) had been a long time coming. In 1975, the country voted to join what was then the Common Market. Despite multiple treaty changes and political promises, no referendum was offered until June 23, 2016, when the majority (52%) of voters chose to leave the EU.

The EU was established as a customs union to set tariffs on goods coming from outside the EU, with member states not allowed to negotiate their own trade deals. Every deal made by the EU is binding on all members. The EU is a tariff-free trading area among the member states.

Because of the need to wait for a new prime minister and extensive treaty negotiations, the Brexit process is expected to take 2 years or more. The biggest unknown facing business is the nature of trade after the exit. Will there still be free trade between EU countries and the United Kingdom, or will tariffs be introduced? If tariffs, at what rate? If no new deal is made, the World Trade Organization (WTO) rules mean the United Kingdom and EU would be obliged to apply to each other the tariffs and other trade restrictions they apply to the rest of the world. Other possibilities include membership of the European Free Trade Association and/or the European Economic Area, or even a unilateral free trade policy (e.g., Hong Kong). All of the options must be considered by the U.K. Government, so a quick decision is unlikely.

The Automotive Impact

A free trade deal for goods between the EU and the United Kingdom would allow OEMs and suppliers to continue business pretty much as usual. European manufacturers are likely to lobby hard for such an arrangement, both to continue selling U.K.-built vehicles in the EU and to retain access to the lucrative U.K. market for vehicles assembled on the continent. Car buyers in the United Kingdom may benefit from lowering or eliminating tariffs from countries outside the EU, putting downward pressure on pricing.

In a scenario where WTO tariffs are imposed between the United Kingdom and the EU, new free trade deals could cause changes in business processes across Europe. The United Kingdom has the potential to become a European hub for international trade, building cars mainly for local sales and export to non-EU countries. If that happens, in the longer term there will be a need for suppliers to invest in parts manufacture in the United Kingdom. No longer restrained by EU state aid rules, the U.K. government would be able to offer additional support to companies that wish to open new facilities. Factories within the EU could then focus on producing vehicles for the internal market.

An Industry in Flux

It is, however, important to recognize that this new European trading issue comes at a time when the industry is facing major changes due to other factors such as stricter emissions regulations, greater powertrain electrification, autonomous driving, wireless connectivity, and the growth of carsharing and ride hailing. The Navigant Research white paper Transportation Outlook: 2025-2050 offers more insight on these changes. The United Kingdom could become a test bed for new technology before it is rolled out globally.

While industry waits for the U.K. Government’s detailed trade negotiations with the EU, automotive companies can take advantage of the short-term business-as-usual to analyze their engineering and business processes and value chains so that they are prepared for any outcome. There is potential for increased efficiency and profitability in the long term for those companies that adapt best to embrace the future of clean mobility on demand. Brexit may turn out to be a catalyst for positive change.

 

What Does Brexit Mean for the United Kingdom’s Energy Policy?

— June 27, 2016

Energy CloudOn Thursday of last week, Britain voted to leave the European Union (EU) in a referendum known as Brexit. The vote to leave won 52% to 48%, with 17.4 million voters in favor of leaving the EU and 16.1 million voting to remain. In the wake of the vote, the world has expressed mixed feelings on the outcome, including rage, frustration, excitement, anger, pride, and sadness. While the vote may not mean a huge shift for in the energy field, it is a historically significant event, not only in Britain, but for the rest of the world as well. One of the largest initial changes to occur as an outcome of the vote is that Prime Minister David Cameron, a leader of stay campaign, will resign. The pound plummeted to its lowest level since 1985, and further economic impacts are yet to be determined. Britain is the first nation to leave the EU, and one thing is clear: the vote means significant global change and uncertainty.

The EU’s Energy Directives

The EU has been a leader in energy efficiency regulations and requires its member states to create and update their own National Energy Efficiency Action Plans every 3 years. The requirements set forth by the EU have pushed member states to proactively create and enforce their own policies surrounding increased energy efficiency, greenhouse gas (GHG) emissions reduction targets, and increasing renewable energy.

Navigant Research’s Global Energy Efficiency Policy Analysis report discusses the role of the EU in driving global energy efficiency policy. The United Kingdom’s GHG emissions target is to reach 80% reductions below 1990 levels by 2050, in compliance with the EU’s minimum regulations of 20% below 1990 levels by 2020. The EU’s Renewable Energy Directive aims to minimally fulfill 20% of its total energy needs from renewables by 2020, which is set to be achieved through the accomplishment of individual member targets. Even within the EU’s already notable energy efficiency requirements, the United Kingdom is a leader in many policies, having surpassed many base requirements.

Brexit and the EU’s Energy Policies

The EU’s targets for GHG emissions and renewables are based on all member states achieving their individual goals. The exit of Britain from the EU does not mean the EU will no longer be able to achieve its targets, but increased targets will need to be met in the remaining member states to make up for Britain’s portion. In 2010, only 7% of the United Kingdom’s electricity came from renewables, but this increased to 18%-19% by 2014 and is on target to reach 30% by 2020.

While Brexit would mean the United Kingdom can relax on some efficiency policies, overall, it would not drastically affect the country. The Climate Change Act requires tougher GHG emissions targets than the base EU requirements. In order to hit the 30% renewable goal, many projects, such as new wind farms, have been given subsidy contracts and granted planning authorization. The vote won’t affect the project to build the Hinkley Point nuclear power station, as EDF CEO Jean-Bernard Lévy stated that, “We think that this vote has no impact on our strategy.

Leaving the EU will make it easier in the future for Britain to relax its energy policies and emissions targets, as these changes would only require domestic legislative approval. Even if Britain does not change its policies after its exit from the EU, it will lose other valuable assets, such as negotiating support with Russia, which supplies the country with 16% of its energy imports.

With the all the uncertainty surrounding Brexit, there is no way to predict the impact this vote will have on energy policies in the United Kingdom and the EU, but they could become a dominant subject in the years to come.

 

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