Brexit: Energy market liberalisation implications

08 June 2017

Peter Willis

On 29 March 2017, the UK Government served formal notice under Article 50 of The Treaty on European Union to terminate the UK's membership of the EU (following the June 2016 UK referendum on EU membership). Based on Article 50, the EU Treaties shall cease to apply to the UK and the UK exit will take effect in March 2019 (subject to the unlikely possibility of the withdrawal agreement being concluded sooner and unless all Member States agree to extend the period). Negotiation of a new trade agreement with the EU could take several years beyond 2019 although the Prime Minister has declared the objective of achieving such an agreement within the two-year period.

This briefing note anticipates how Brexit will impact on the electricity regulation framework. Significant parts of UK electricity regulation either implement EU Directives, or are imposed directly by EU Regulations. The UK Government has indicated that it will freeze into UK law the EU legislation in force at the point of the UK's exit to ensure continuity, but may choose to amend such law in due course. As a result of the decision to leave the EU, much of the UK's energy regulatory framework will now therefore require re-assessment.

This note outlines the key consequences, both for the GB market (England, Wales and Scotland) and for the separate Northern Ireland (NI) market, which is integrated with the electricity market of the Republic of Ireland to form the Single Electricity Market. While the notice period required means that the actual Brexit date cannot be before March 2019, there are numerous policy and technical issues to resolve before then.

The EU electricity regulatory framework
Effect on national implementing rules
Effect on REMIT
Effect on the Electricity Regulation and the ACER Regulation
Effect on the EU electricity Network Codes
Effect in Northern Ireland
Conclusions

The EU electricity regulatory framework

A series of EU Directives and Regulations adopted over the past few years have created a liberalised and largely harmonised EU electricity market. Particularly significant measures are those adopted as part of the Third Energy Liberalisation Package in 2009: the Electricity Directive, the Electricity Regulation and the Regulation creating ACER, the Agency for the Cooperation of Energy Regulators. The European Commission's "winter package", published in November 2016, proposes significant modifications of all of these measures, together with a number of new pieces of legislation. Of particular relevance, it proposes closer cooperation between transmission system operators and regulators at a regional and EU level.

The European Commission is also in the process of adopting a series of EU Network Codes. These are EU Regulations setting out detailed rules for the operation of and connection to energy networks, and for the operation of energy markets. Some of these are already adopted and the remainder are nearing finalisation.  Other particularly important measures are the Regulation on Energy Market Integrity and Transparency (REMIT), and the Renewables Directive. The Commission proposed a revised Renewables Directive as part of its winter package. 

The Directives have been implemented into UK law, either through amendment of primary legislation such as the Electricity Act 1989, which (among other things) implements the unbundling requirements of the Electricity Directive, or by means of statutory instruments. EU Regulations are directly applicable and generally require no implementation, although the government adopted GB and NI statutory instruments to give the energy regulators the necessary powers to enforce REMIT.

The effect of Brexit on this body of EU energy law depends very much on the nature of the UK's future relationship with the EU. On 17 January, Prime Minister Theresa May specifically ruled out continued UK participation in the single market post-Brexit, indicating that the UK would seek to negotiate some sort of tailor-made relationship. The White Paper published on 2 February also provides some indication of the government's aspirations in the energy sector. As a result, the impact on the electricity market becomes a little clearer.     

It is worth noting that Switzerland, which is outside the EU, had been seeking to negotiate an energy agreement with the EU for several years, but negotiations had stalled following the Swiss decision to impose limits on immigration from the EU in 2014. It was only after the Swiss decision in late 2016 to accept free movement of workers (subject to certain limitations) that the way reopened for the country to restart its negotiations on bilateral relations with the EU, including arrangements to join the EU electricity market. EU insistence on free movement of workers is likely to prove a similar stumbling-block to any UK attempt to retain access to the EU integrated energy market.

This note does not consider the separate security of energy supply implications.

Effect on national implementing rules

Brexit will result in the repeal of the European Communities Act 1972. The ECA 1972 gives ministers the power to adopt secondary legislation in the form of statutory instruments (SIs) to implement requirements of EU law. The consequence of repealing an enabling statute such as the ECA 1972 is that SIs made under it lapse, unless the legislator at the same time enacts a "saving" provision.  In this case, however, the UK government has promised a "Great Repeal Bill" which will, at the same time as repealing the ECA 1972, import the entire acquis (the body of existing EU law) into UK law. The government will then review individually those rules that have been imported wholesale, and will then decide which ones to keep and which ones to repeal. This is clearly a more manageable prospect than replicating the entire body of EU law in the period before Brexit, although the complexity of even this exercise should not be underestimated, as we shall see from the handful of illustrations of the issues below. The term "acquis" is generally held to include the relevant case-law of the European Court of Justice – so that the imported EU law is interpreted in the same way as it is in the EU. However, the government has already rejected the concept of the UK being subject to rulings of the Court of Justice, so even if the case-law is imported as part of the acquis, there will presumably be no scope for references to the Court of Justice for rulings on the interpretation of EU law, so divergence from the EU is possible over time.

The Great Repeal Bill will therefore save the UK legislation implementing the Electricity Directive. Much of this legislation is likely to remain in the longer term.  The UK has led the way in the EU in terms of energy market liberalisation, and it is very unlikely that it will reverse the separation of transmission from generation interests, for example (particularly in the light of its ongoing consultation on separating National Grid's system operation and system ownership businesses), or the principle that energy prices should be set by the market rather than by regulators. In contrast, the fate of the UK legislation implementing the Renewables Directive is less certain – it is possible that a post-Brexit UK government will now wish to relax some of the renewables targets contained in the Directive. 

Effect on REMIT

The substantive prohibitions in REMIT (market abuse and insider trading), as well as the requirement to publish inside information, will be preserved. So will the three regulations (one GB, one NI and one UK) that provide for the civil and criminal enforcement of REMIT. 

Having gone to the lengths of imposing criminal sanctions for energy market abuse in 2015, it is likely that a future UK government following the exit will wish to retain the substantive prohibitions of REMIT. However, it would not, without entering into a specific bilateral energy agreement with the EU, be able to access the EU-wide energy market monitoring and cooperation arrangements set out in REMIT, and these provisions of REMIT, although imported as part of the acquis, will presumably be repealed. Conversely, ACER would no longer obtain access to UK electricity data and market monitoring under the REMIT framework.

Effect on the Electricity Regulation and the ACER Regulation

The Electricity Regulation will be imported as part of the acquis.  However, the rules contained in it, for example relating to the certification of transmission system operators, the development of EU network codes, the approval of interconnectors, the inter-TSO compensation mechanism for hosting cross-border electricity flows, interconnector congestion management and transmission charges, are a complex mix of substantive rules and procedures for issues to be agreed or decided at an EU level.  Maintenance of these rules will require ongoing interaction with EU bodies. 

While many of these arrangements are now so closely enmeshed in the GB electricity framework that it might be thought desirable to retain them following the vote to leave, much of the institutional framework requires some form of agreement between the UK and the EU in order to function. 

The government may of course decide not to replicate every part of the Electricity Regulation framework. The European Commission has compelled the UK to make a number of changes to the GB electricity framework in order to comply with the Electricity Regulation, and a future government may decide that national interests are better served by reversing them.  One example is the removal of charges on interconnectors for the use of the transmission system, for transmission losses and for balancing costs, in response to threatened infringement proceedings by the European Commission. The Electricity Regulation also limits the extent to which Member States may curtail interconnector flows to resolve national issues.  

While the government and Ofgem currently consider that interconnectors can play an important part in ensuring GB system adequacy, they also recognise that price-driven interconnector flows may sometimes result in exports rather than imports from GB at times of system stress, and they may be tempted in future to permit curtailment of interconnector exports in order to resolve GB system margin or balancing issues. 

The UK will now also be free to return to its historically preferred "merchant" approach to interconnector regulation, in place of the regulated approach imposed on it by the Electricity Regulation, which has led to the development of a complex "cap and collar" model. In practice, of course, the UK will need to strike a balance between preferring its own energy policy interests and entering into arrangements acceptable to its neighbours and other partners. However, outside the EU there is likely to be greater scope for a GB-specific regime to emerge, with the resulting increase in uncertainty for businesses. 

As in the case of REMIT, even if the UK government wishes to continue to align GB energy policy closely with that of the EU post-Brexit, a number of the institutional arrangements under the Electricity Regulation, and certainly the entire ACER framework, will be difficult to replicate without some sort of specific agreement between the UK and the EU. As in the case of Switzerland, an energy agreement is likely to be conditional on acceptance of at least some of the fundamental EU freedoms. This currently appears to be out of the question for the UK government, and it remains to be seen what alternative arrangements can be put in place.

Effect on the EU electricity Network Codes

Similar considerations apply to the EU electricity network codes. These are a series of EU Regulations, adopted by the Commission under a procedure set out in the Electricity Regulation. They will set common rules for the connection to and operation of electricity networks across the EU, and for the operation of forward, day-ahead, intraday and balancing electricity markets across the EU. 

Implementation of these rules in GB will be via a number of routes – legislation where necessary (for example a proposed amendment to the Electricity Act 1989 to give Ofgem the power to monitor the activities of NEMOs), but more often via licences and national codes. There are large parts of the EU network codes that will not be the subject of specific national implementation, but will in the normal course of events be effective as a result of their direct applicability as EU Regulations. 

As in the case of the Electricity Regulation itself, these provisions will apply in GB post-Brexit by virtue of the Great Repeal Bill. However, while this will work for many of the substantive elements at a GB level, the day-ahead and intraday markets will rely in particular on price-coupling processes carried out at an EU level, on the basis of common methodologies and processes. It would be possible to provide for some of this process contractually, as between the GB Nominated Electricity Market Operators (NEMOs) and transmission system operators (TSOs) and their EU counterparts. Indeed the Capacity Allocation and Congestion Management (CACM) Network Code that creates the EU intraday and day-ahead markets to a large extent formalises arrangements that are already being developed voluntarily between the TSOs and power exchanges of North-Western Europe. 

However, the fact that this framework has now been given legal force will give rise to a degree of asymmetry post-Brexit that may be difficult to overcome.  For example, CACM contains methodologies for allocating the costs of market coupling as between NEMOs and TSOs, and for those costs to be determined by the relevant national regulators. If the GB TSOs and NEMOs are not formally bound by these arrangements, some alternative method of linking them in will presumably be required. Again, a bilateral energy agreement will be the most logical approach, although the Swiss experience shows that this might take time to negotiate and might require UK concessions in other areas. The government's Brexit White Paper published on 2 February 2017 acknowledges the importance of interconnectors and market coupling for lowering GB energy prices and ensuring security of supply, and explains that the government is "considering all options" for the future relationship between the UK and the EU on energy. However, there is as yet no indication of what concrete options it will seek, or indeed what the EU will accept. 

Effect in Northern Ireland

As mentioned above, NI is a separate market from the rest of the UK for electricity purposes. Together with the Republic of Ireland, it forms the Single Electricity Market (SEM). For SEM issues, the Irish and NI regulators work together through a joint SEM Committee.

The Irish and NI governments and regulatory authorities are now engaged in a programme to align the SEM with the EU Network Codes, creating the Integrated Single Electricity Market (I-SEM). Essentially a single set of markets (forward, day-ahead, intraday and balancing) will cover both Ireland and Northern Ireland with a number of the key roles being carried out on an all-island basis by EirGrid, the holder of the Irish TSO and market operator licences, and SONI, its NI subsidiary that holds corresponding NI licences. 

Brexit raises the same issues for NI as it does for GB, with the added dimension that the NI markets will be very closely integrated with the Irish electricity markets, which will remain in the EU. The government's White Paper recognises "the importance of ensuring that [the SEM/I-SEM] is secured following [the UK's] departure from the EU". As in the case of the GB market, some of the coordinated EU-wide and regional cooperation in determining methodologies can probably be carried out contractually as between post-Brexit NI market participants and their EU counterparts.  But some degree of institutional cooperation is likely to be needed. 

One option might be for Irish participants and authorities to be delegated to represent their NI counterparts in the various operational and regulatory frameworks created under the EU Network Codes. This might be achievable as between Ireland and the UK, by means of a bilateral arrangement. However, it is likely that further arrangements between the UK and EU institutions would be needed in order to give EU authorities the power to make determinations in respect of issues relating to the NI part of the I-SEM. 

A further issue to consider for the I-SEM is that until the development of interconnectors with countries other than GB, the I-SEM is dependent on the GB market for its access to the coupled EU electricity markets. Although the White Paper indicates that the government will at least seek to ensure continuation of current trading arrangements, if it unsuccessful or if the UK intentionally pulls back from full market coupling with the continental EU following Brexit, the I-SEM may also become uncoupled.

Conclusions

It is clear that while large parts of the EU-derived UK energy framework will remain intact, other major parts will now fall away in their entirety. To the extent that the government of the day wants to retain a degree of alignment with EU energy law, some of the substantive EU rules can be replicated, with appropriate modifications to reflect shifts in UK policy. To what extent this can be done, and how, will take many months to assess and consult on. 

The operational arrangements under the Electricity Regulation and the EU Network Codes can probably be partially replicated by contractual means, but full effectiveness of the governance arrangements that underpin or will underpin electricity markets will require specific agreement between the UK and the EU.  This is not likely to be a straightforward process, and it will probably take some time for the electricity regulatory framework to reach some measure of stability.

Given the current uncertainty, there is little that can be done to prepare for any possible changes, other than to ensure that where possible, contracts relating to any of the requirements of EU electricity rules are drafted in sufficiently flexible terms that they can be adapted, or terminated, if required once the final outcome of this process is known.

We intend to update our guidance in this area as the implications for energy liberalisation become clearer.

This article is part of our Brexit series.

Authors