Utility Week

UTILITY Week 31st March 2017

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14 | 31ST MARCH - 6TH APRIL 2017 | UTILITY WEEK Policy & Regulation Market view T he clock is now ticking. The prime min- ister has triggered Article 50, formally notifying the commission and other European Union member states of the UK's intention to leave the bloc. The two-year period for any deal to be reached has begun. So what does all this mean for companies in the energy sector? The short answer is that nobody knows for sure how this will pan out. But there are some things we do know. The prime minister has made it clear that the UK will be leaving the EU single market. Little has been said about energy explicitly, but the implication is that the UK will also be out of the internal energy market, because the rules governing how that market works are set out in European legislation and sub- ject to the jurisdiction of the European Court of Justice (ECJ). The government has also said in the European Union (Notification of Withdrawal) Act that the UK will leave the Euratom Treaty. The logic of the UK government's position is that it will now need to negotiate a new free trade agreement (FTA) to ensure harmo- nised tariff-free trading of gas and electricity can continue. The government response also acknowl- edges it may not be possible for the UK to retain full membership and voting rights of the various organisations that set the rules for how these trades occur. These bodies include ACER (the organisation that brings together energy regulators from across the EU), Entso(E) and Entso(G), which govern the EU network codes for electricity and gas respectively. Assuming the UK cannot main- tain full membership, a fallback might be to secure observer status and/or participation in working groups that support these deci- sion-making bodies. The closest parallel that currently exists to such an arrangement between the EU and adjacent country is the Swiss model, in which a committee appointed by the Swiss government can decide whether to adopt new EU rules on the operation of the internal energy market on a case-by-case basis. How likely is it that such a deal can be reached? There are several reasons to be optimistic. l The UK government has made clear it wants to maintain harmonised trad- ing arrangements for energy, and that it remains committed to greater intercon- nection with the GB market. l The EU does not charge import duties on electricity. Formally, it has a tar- iff on imported gas (0.7 per cent), but does not to apply this in practice. Under WTO rules, there are no tariffs on gas or electricity. l There are strong commercial incen- tives for such trading arrangements to continue. l The French regulator has approved the IFA2 interconnector project, saying that Brexit has not changed the case for it. l The commission has draed a legislative clause about third party participation in the internal energy market. This was draed with Switzerland in mind, but could form the basis of an energy chapter in any overall FTA. l Crucially, Ireland will be pressing for such a deal to be done quickly, because the Irish energy market depends on the free flow of gas and electricity through the GB market. However, there are also reasons for pessimism: l Timescales Any FTA is likely to take more than two years to negotiate. The Canadian FTA took seven years. The Swiss have been negotiating various deals for more than 10 years. Moreover, no serious nego- tiations are likely to start until the end of this calendar year, once the outcome of the French and German elections are known. So some transitional arrange- ments will be needed. l Complexity It won't just be a case of the new FTA setting out that the tariff rate will be zero on gas and electricity. It will need to cover a range of detailed, technical issues, including arrangements for harmo- nised trading, what happens in a "system stress event", sanctions should the agree- ments be broken, and what institutions resolve any disputes. There is also the question of what arrangements are to be put in place to replace the Euratom Treaty, and whether the UK will participate in the EU Emissions Trading Scheme. l Conditions An FTA will require unanim- ity from the 27 remaining member states and agreement from a total of 38 parlia- ments across the EU. It is possible that the commission will impose some conditions for agreeing to a new FTA. This might be acceptable for rules the UK has already signed up to, but agreeing to future renewables targets may well be a red line for this government. So what happens now? In the immediate short-term, the answer is not much. In the absence of any political interfer- ence, gas and electricity should continue to flow on day one aer the UK leaves the EU, even if an overall deal has not been reached, because of the various private contracts between market participants and between National Grid and their TSO counterparts. But this position will get harder to maintain over time as policies and rules diverge. The hope remains that a technocratic solution can be found to resolve these issues quickly. However, by sweeping energy into the wider negotiation and therefore subject- ing it to the general approach of leaving the single market, there is a risk that energy gets caught up in the wider politics of the overall negotiation surrounding Brexit. Industry and investors should therefore be braced for a prolonged period of uncer- tainty, when the exact rules governing the way gas and electricity are traded, emis- sions limits are applied and the handling of nuclear fuels are subject to differing inter- pretations. Private contractual arrangements will have to be robust to ensure value is not eroded throughout this period. It could take some time for the fog to clear and we may end up back where we started with the UK part of the internal energy market. Even if that does happen, it is likely to take some years to complete the circle. Simon Virley, partner and head of power and utilities, KPMG What next after Article 50? Prime minister Theresa May has triggered Article 50, the first step in the UK's withdrawal from the European Union. Simon Virley asks what Brexit means for the UK energy market.

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