U.K. Energy Costs Headed Higher With Plan to Leave Single Market

(Bloomberg) -- Britain’s paper on leaving the European Union raised more questions for the energy industry than it answered, setting up the risk that the legal arrangements allowing power and gas to flow across borders could come unraveled and drive up the cost of doing business.

The government for the first time raised the possibility of leaving the EU’s single market, though it also said it wants to maintain a trading relationship with neighboring nations. The policy was short on the details needed to reassure utilities like Centrica Plc and SSE Plc that they will have access to energy supplies through three international power cables and three gas pipelines after the U.K. leaves the union in March 2019.

U.K. Energy Costs Headed Higher With Plan to Leave Single Market

The trading arrangements matter to both sides. The U.K. is Europe’s third-biggest energy user and a net importer of energy, taking in gas valued at more than 10 billions euros ($12 billion) a year. London is also an important trading hub, particularly for gas, hosting one of the biggest exchanges, ICE Futures Europe Ltd.

The U.K.’s negotiating position on energy isn’t yet clear, and the ongoing uncertainty is the biggest risk to markets and investment, according to Andrew Perry, a principal focused on utilities at Oliver Wyman LLC in London. Britain has 11 new electricity interconnectors to Europe planned, and investment in these could be at risk.

Trade Barriers

There’s a risk “either the arrangements we have post-Brexit become barriers to interconnectors working efficiently, or there’s so much uncertainty about the rules that investment doesn’t happen because people are so unsure about what’s going to happen,” he said.

It’s a bad time to have investors uncertain about whether British projects will pay off. The government has estimated it needs to find 100 billion pounds ($132 billion) to keep the lights on after 2020. More than a dozen aging power plants are due to drop out of service within the next decade. Governments from both of the main political parties have sought encouraged companies to invest in a new generation of atomic plants.

If the uncertainty coming from Prime Minister Theresa May’s government over Brexit is unpalatable, the alternative of a government led by Jeremy Corbyn’s Labour Party isn’t any better for utilities. Corbyn has talked about nationalizing parts of the utility industry. May’s ministers are seeking to limit the amount utilities can charge customers at a time when the cost of gas, coal and electricity all are rising in wholesale markets across Europe.

U.K. Energy Costs Headed Higher With Plan to Leave Single Market

Brexit’s biggest impact may be on the natural gas industry. While only a small proportion of the U.K.’s electricity is imported, more than half of its gas supply comes from abroad. The industry is asking how the rules for trading will shape up after Brexit and whether taking flows from these connections will be more cumbersome in the future.

Utilities buy and sell power, gas and permits to emit carbon dioxide from smokestacks years in advance, and investment is made decades ahead. Another concern will be additional costs for energy trading that could occur by being outside the internal market.

“If you’re thinking of buying and selling power and gas two years out, companies don’t have a firm view of what the rules will look like,” said Richard Black, director of the Energy and Climate Intelligence Unit. “The instinct will be to play safe, not innovate and companies may end up paying more to play it safe.”

None of these concerns have been resolved by the government’s white paper published Thursday.

“It tells industry there’s still no answer,” Alex Harrison, energy partner at Hogan Lovells International LLP said. It’s not clear how much thinking has been done on our side.”

Most analysts seem to agree that energy trading arrangements will be easier to agree on than other aspects of the Brexit negotiations as they benefit both sides. The main worry still remains that energy gets dragged down by bigger political sticking points or isn’t properly considered in a no deal scenario.

“I find it hard to envisage a set of circumstances where the relationship is going to get so bad that both sides would accept energy supply disruptions rather than come to some kind of agreement,” said Neil Cornelius managing director at the Berkeley Research Group LLC. “The high level objective is clear and consistent -- a high level of harmonization between the U.K. energy sector and EU energy sector.”

©2018 Bloomberg L.P.