Regardless of Brexit, the GB energy sector remains robust and we are not facing imminent blackouts and price spikes. At the same time, it’s also reasonable to say that developments have not quite turned out as policy makers predicted over the past eight years.
Gas supplies are not at threat and prices have not skyrocketed (remember Ofgem’s Project Discovery?). The Hinckley Point nuclear project faces challenges, delays and may not even proceed. New emerging developments in the waste-to-gas sector and a significant increase in solar generation could transform the energy industry landscape.
The government is also committed to phasing out all coal-fired power generation by 2025, a commitment that will be a challenge if Hinckley Point does not proceed.
So the question is, do we need to start thinking about a new energy policy in the wake of these developments? Our contention is that we do not need a new policy, it would only lead to further delay and uncertainty.
However, we do need to progress quickly with managing the impact of Brexit on the energy sector, particularly with a generation gap emerging and capacity margins tightening.
One critical area that needs to be addressed immediately is the impact of Brexit on planned electricity interconnection projects. Interconnection will pay an increasing role in meeting our future generation requirements, particularly in relaxing tight capacity margins.
Interconnection is a viable, and realistic option to address the generation gap and improve capacity margins
At present, nine interconnectors are being planned or developed for the GB market. They would allow us to trade electricity with Denmark, Norway, France, Belgium, Iceland and Ireland. These projects have the potential to supply 10GW at a price tag just shy of £10 billion, by 2024. By comparison, Hinkley Point would supply around 3GW at a cost of £18 billion; this highlights the economic case for further interconnection.
Interconnectors have gained momentum in the past decade as a real solution to meet the UK’s energy needs. Not only they help to lower electricity bills, sourcing electricity from lower-cost areas, they also improve the take-up of renewables and improve the country’s energy security profile.
Brexit limits interconnection development
Brexit adds another layer of uncertainty to the energy market. In our latest research paper titled “Impact of Brexit on UK Energy Security”, Sia Partners looked at the potential developments in the UK energy sector as a result of Brexit.
Our research highlighted the substantial impact that Brexit is set to have on UK power supplies. We found that interconnection projects are set to be among the most profoundly affected infrastructure projects as a result of reliance on cross-border regulatory frameworks and EU-wide network codes.
The impact of Brexit on interconnection projects will come from two main factors: regulatory and financial uncertainty. The latter is naturally tied to bond, equity and foreign exchange market developments. Our models show that the returns that investors will require to invest in such projects are more likely to decrease rather than increase with respect to a pre-Brexit scenario.
Our study also demonstrates the importance of a robust set of rules and regulation for investment decisions on such projects. In recent years, Ofgem has developed the cap and floor framework to incentivise the development of interconnection. Meanwhile, the EU has introduced numerous rules and guidelines to facilitate cross-border electricity flows, to improve their efficiency and enable projects to deliver on their promise of improved welfare for all.
Brexit puts the current set of rules and regulation under scrutiny; their evolution depends on the outcome of negotiations that will take place between the UK and its European counterparties. Will interconnectors be eligible to receive capacity payments in the UK? Will UK interconnection projects benefit from PCI (Project of Common Interest) funding from the EU? How will the regulatory framework change as a result of Brexit? These questions loom large in an investor’s mind. They will not commit to multi-billion infrastructure projects before these questions are resolved.
Forgone benefits from interconnection development are substantial
To grasp the impact of cancelled interconnection projects on capacity margins, we have modelled three different Brexit scenarios with varying degrees of uncertainty. The ‘Norway’ case envisages an EEA-type outcome to Brexit, while the ‘Switzerland’ scenario sees the UK relying on the lengthy negotiation of Bilateral Agreements to deal with its EU counterparts. The No-Brexit scenario serves as a point of reference.
Our study has found that:
- By 2020, in any Brexit scenario, capacity margins will be between 2 per cent and 6 per cent lower than they would have been in a No-Brexit scenario.
- By 2030, in the Switzerland scenario, capacity margins will be between 6 per cent% and 12 per cent lower than in a No-Brexit scenario.
- The yearly forgone benefits of interconnection are quantifiable in the neighbourhood of £430m/y.
To sum up, the only certain outcome of Brexit is the uncertainty that comes with it. Unless we act expediently, it could slow investment in the energy sector and prolong the issue of low capacity margins. In particular, planned interconnection projects will be affected by uncertainty surrounding regulation that underpins their economic case. It is crucial to move quickly to ensure there is a smooth transition from the current rules to a new set of stable regulatory arrangements.