Leaving the EU: negotiation priorities for energy and climate change policy Contents

3The Internal Energy Market

13.The Internal Energy Market (IEM), also known as the Single Energy Market,18 is a long-term project to liberalise and harmonise the energy markets of individual EU Member States, in which the UK has played a leading role.19 Between 1996 and 2009 the EU adopted three legislative packages on: market access; transparency and regulation; consumer protection and interconnection; and adequate levels of supply. These have enabled new gas and electricity suppliers to enter Member States’ markets, and have ensured that both domestic and industrial consumers are free to select their own suppliers. Related EU policies focus on the security of energy supplies and the construction of trans-European networks to transport gas and electricity.20 New ambitions to realise a “fully-integrated internal energy market” were laid out in the EU Energy Union Strategy,21 launched in February 2015.22 The fully-integrated IEM will use interconnectors to allow unconstrained trade of energy across the EU, with the intention of maximising competition.

14.Over one-third of the witnesses responding to our inquiry said that the UK should seek to remain in the IEM.23 Several listed advantages of IEM participation and the detrimental effects of leaving, but without explicitly stating that we should remain. A small number said that Brexit provided an opportunity to reform the IEM.24 No witnesses suggested that it would be preferable for the UK to leave the IEM. These views are broadly in line with the evidence provided to the ECC Committee.25

15.When asked about the implications of leaving the IEM, the Secretary of State for Business, Energy and Industrial Strategy, the Rt Hon Greg Clark MP, appeared to imply that it would be in the country’s best interests to remain in:

It is very much in our interest that we not only continue to participate in the energy market and expand those interconnections [to Europe], but especially in places like Northern Ireland that is of very great importance. It follows from that that it would be better if we continue and it would be a bad thing if that were to be disrupted.26

UK energy interconnection and trade with the EU

The European Network Codes and cross-border trading

16.The UK has been a net energy importer since 2004, in the wake of declining North Sea oil and gas production.27 In 2015, 38% of energy used in the UK was imported.28 Roughly half of our gas is imported, with typically 30% of imports from Norway, 10% from the EU, and 10% from liquefied natural gas.29 Around 6% of our electricity supply in 2015 was imported from the EU.30 The UK has 4GW of high-voltage electricity cables, and four natural gas pipelines, interconnected to the EU.31 Trading gas and electricity across these interconnectors is governed by European Regulations that underpin the IEM.32 In particular, the European Network Codes, developed by the European Network of Transmission System Operators for Electricity (ENTSO-e) and European Network of Transmission System Operators for Gas (ENSTOG), set out the detailed operational rules. This regulatory framework aims to maximise the efficient use of interconnectors for cross-border energy trading.33

17.Over a third of witnesses highlighted the importance of the IEM and the European Network Codes for energy trading via interconnectors.34 Many noted that any restrictions could reduce security of supply, increase energy costs and prices, and make it harder to achieve our decarbonisation goals cost-effectively.35 For example, Martijn van Gemert, a Committee member of the European Federation of Energy Traders, told us that

You do not want to have different rules on each side of the border. We do not want to harmonise all the rules just for the sake of harmonising but, if you harmonise the rules, it will lead to more efficiency and more use of the physical interconnection.36

18.The Government has said that it will seek to maintain efficient cross-border trading of energy and avoid any market distortions arising from differences in UK and EU rules.37

The role of increased interconnection in managing intermittent generation

19.Improved efficiency in trading gas and electricity is important not only in supporting security of supply and driving down energy prices, but also in supporting access to flexible supplies to help manage the network and support greater deployment of intermittent generation by renewable technologies.38 The Committee heard from Antony Froggatt, Senior Research Fellow at Chatham House, that interconnectors would become increasingly important in providing this flexible supply when the system is dominated by renewables:

There are times of the year when you will be wanting to get energy from other parts of the system. In terms of when the wind is blowing in Norway or Denmark, the electricity may be cheaper and it may be good for us to be able to access that. Likewise we may want to export electricity when we have particular conditions. However, in the winter months when there is less sun, if we have a system that has lots of solar on the grid, we may want to be importing more from other places. Having that flexibility to enable you to import electricity from other parts of the world or other parts of the continent is really important.39

20.These views were echoed by the Secretary of State, who told us that interconnection is important when there are lots of different sources of power that can offset some of the intermittency that comes from renewables. He said: “The ambitions are to go higher; to go more into interconnection”.40

Financial benefits

21.Several reports have sought to estimate the benefits of the improved efficiency of the IEM.41 The UK benefits from harmonised rules for trading electricity, through ‘market coupling’ whereby electricity is traded across the EU without the need to separately purchase interconnector capacity. This was estimated by a report for National Grid to be worth about £90m every year.42 This is based on current levels of UK electricity interconnection. Further benefits were estimated to be of around £80–100m every year by the early 2020s, as a result of more efficient use of interconnectors to help keep the UK network stable in real time. (This assumes that alternative bilateral arrangements are not possible.)43

22.National Grid told the Committee that the report concluded UK consumers could face £500 million a year of costs by the early 2020s as a result of being outside the IEM.44 We were told by Paul Hallas, Director of Regulation and Strategy at Centrica, that these numbers are “at the bleak end of the plausible envelope of possible outcomes”.45

23.The benefits of efficient cross-border trading are not restricted to the UK. Increased integration of the European electricity market is estimated to save about €4bn every year across the EU. Further benefits of sharing resources to balance the network in real time between countries range from €5bn to €43bn by 2030.46 Describing the mutual benefits, Martijn van Gemert told us:

You saw in one day that the power flows were such that the UK was helping the continent by exporting to France and the Netherlands during times of high demand, where they had some problems with their nuclear power plants in France. A few hours later, the direction was totally reversed to help the peak hours in the UK when demand was at its highest.47

24.The Government should be prepared to provide estimates of financial costs and benefits arising from the outcome of its negotiations regarding interconnectors.

Opportunities and risks for the UK of leaving the Internal Energy Market

Security, efficiency and competitiveness of energy supplies

25.We sought to explore the potential benefits and risks of leaving the IEM. National Grid told the Committee the decision to leave the EU presents no immediate risk to how National Grid operates the UK energy system or the UK’s security of supply.48 In terms of power supply, rather than affecting our security of supply (which could be supported through greater domestic generation) the Committee heard that the risk lies more in increasing consumer costs. Kevin Dibble, Director of Strategy and Communications at Engie UK, explained that:

There is a risk down the line, if any of those risks were to materialise, that those trading arrangements are not as efficient as they are today, which would affect the case for interconnection and would potentially impact somewhere down the line on cost to consumers.49

26.In relation to the gas market, witnesses noted that as well as the benefits of efficient trading rules the EU also supports price stability and security by negotiating with other gas producing countries and internal EU coordination.50 In particular National Grid said that a possible effect of Brexit might be exclusion from the EU’s ‘solidarity principle’,51 increasing the risk of a gas supply crisis.52 However, the University of Cambridge stated that Great Britain is one of the best-connected countries to all sources of gas, and our participation in any security of supply initiatives is a net positive for Europe which should be acknowledged as part of the negotiations.53

27.A small number of witnesses highlighted potential benefits of leaving the Internal Energy Market if the UK were no longer subject to EU state aid rules.54 This would allow greater freedom to support infrastructure investment. However, E3G warned that any relaxation of state aid rules, designed to protect competition between Member States, would likely result in the imposition of tariffs and reduced UK access to the single market.55 Some witnesses noted that state aid rules have been important for supporting efficient investment in UK renewables, which we explore further in chapter 7.

28.Some UK generators and trade associations see some current distortions in the UK power market, due to interconnectors not being subject to network charges or UK policy costs such as the Carbon Price Floor.56 Energy UK suggested that:

Whilst Energy UK members are supportive of more economic and efficient electricity interconnection [ … ] [l]eaving the IEM might present the opportunity to reconsider the policy and regulatory distortions faced by GB generators and electricity traded over the interconnectors.57

Ongoing influence over Internal Energy Market rules

29.Many witnesses highlighted the importance of retaining influence over future changes to the Internal Energy Market,58 and continuing to engage with current draft legislation, such as the “Clean Energy Package” whilst we remain in the EU.59 Several highlighted examples of changes currently being proposed by the EU that could be damaging for the UK.60 Oil & Gas UK suggested that ongoing influence would be important because the physical links between the UK and EU energy systems could mean that Internal Energy Market compliance becomes the de facto option, irrespective of our membership status.61

30.In order to maintain influence, the Government has said that Ofgem and National Grid should seek to retain membership of the Agency for the Cooperation of Energy Regulators (ACER), ENTSO-e and ENTSOG, a view shared by a number of witnesses.62 Ongoing input into the design of the European Network Codes was considered to be especially important if the UK remains in the IEM.63 It is not clear whether we would be allowed to retain full membership in practice, but alternative options could be to retain observer status in ACER,64 and to seek to participate ‘informally’ in working groups, a privilege that Norway currently enjoys.65 The UK Transmission System Operators could continue to participate in ENTSO-e and ENTSOG, although voting rights would be reduced.66

31.Chatham House suggested that the UK’s influence would be further eroded were the UK to leave the Internal Energy Market:

the only remaining formal channel of influence for the UK would be ENTSOE/G: [the Transmission System Operators], which are independent of government and [the regulatory authority], and would only be able to influence technical matters, which could in any case be overturned by ACER, where Ofgem would have no influence. This could lead to the UK Government losing its voice entirely in EU regulatory matters.67

32.Both the Secretary of State and Nick Winser, Deputy President of the Institution of Engineering and Technology and a former President of ENTSO-e, were more optimistic about our ongoing influence. Nick Winser told us:

ENTSO-E has 34 countries in it, so it already includes six non-EU countries [ … ] those organisations are absolutely critical to [the Internal Energy Market]. They have put in place the markets; they have put in place the codes; they put in place system-operation co-operation, and they take a view on long-term system planning.68

33.The Secretary of State focussed on opportunities to retain influence in technical areas, explaining:

When it comes to some of these technical matters, the UK’s expertise and standing has proved very useful, by common consent, to everyone in these arrangements. I do not think it is necessarily the case that we would not be able to continue to have an influence where we have things to contribute and in an area in which we can do it, as energy is, in a constructive way, such as the technical codes. I think it is the case that in some of the interconnections with nonEU member states—Norway, for example—they do have some influence on the codes.69

34.Alongside the EU’s official groupings of energy regulators and system operators (ACER, ENTSO-E and ENTSOG), several witnesses suggested that the UK could seek to retain influence through participation in organisations such as the Council of European Energy Regulators (CEER), Gas Infrastructure Europe (GIE), and the European Standards bodies (which fall outside the EU).70 More generally, National Grid suggested that the UK should aim to work closely with countries that still have EU voting rights.71

Alternative arrangements

35.Some witnesses noted that if membership of the Internal Energy Market is not feasible, a second-best option would be to retain unrestricted energy trade between the UK and Europe, or seek ‘third party’ access to the Market.72 Some witnesses suggested that the UK could also seek to remain a member of the Energy Community73 or to expand the membership and remit of the Energy Union.74 The University of Cambridge suggested that energy cooperation could be reframed as an issue of security rather than trade, and an energy security treaty could be established with neighbouring countries.75 Several witnesses were, however, concerned that it could take a long time to set up new trading arrangements if we leave the IEM, and that this would be a complex process.76

36.It is not obvious that alternative arrangements to the IEM would provide any particular opportunities or benefits. As Paul Hallas, Director of Regulation and Strategy at Centrica, told us:

The arrangements that we currently have, and that the Government intend to retain through the Great Repeal Bill [ … ] look like the most efficient ways to trade energy cross-border, with benefits on both sides.77

Conclusions on membership of the Internal Energy Market

37.We have heard evidence from across the energy and wider industries that access to the Internal Energy Market is important for secure, clean, and affordable UK energy supply, and that it is in the interests of both UK and EU consumers to facilitate the most efficient sharing of energy resources established through the Internal Energy Market.

38.There are some technical differences between the UK and EU energy systems, and therefore there is a potential long term risk of the UK losing influence on the design and detailed rules underpinning the Internal Energy Market in order to access and share energy resources. Some witnesses have also raised concerns that network charges and the UK Carbon Price Floor may be distorting competition in favour of interconnection and continental generation.

39.We believe that membership of the Internal Energy Market has been beneficial to UK and EU consumers and has helped provide flexibility and certainty to the supply of energy. We therefore agree with the Government’s intention to retain as free as possible access to this market and the intention to remain an influential player on energy in the EU.

40.We recommend that the Government seeks continued access to the Internal Energy Market, with no accompanying tariffs or barriers to trade. This should include continued participation in the trading arrangements established by the European Network Codes to ensure the most efficient operation of UK interconnectors.

41.We recommend that the Government should seek continued UK influence over the rules of the Internal Energy Market. In particular it should explore continued full membership of the technical institutions for developing the detailed rules of the Internal Energy Market.

18 The term ‘single energy market’ is interchangeably used by respondents to denote the IEM in its current form, and the IEM in its future fully-integrated status. For clarity we use the terms IEM and fully-integrated IEM throughout this report.

19 Chatham House (EUE0016); UK Energy Research Centre (EUE0026); EDF Energy (EUE0033); Renewable Energy Association (EUE0066); E.ON UK (EUE0073); Oil & Gas UK (EUE0075); University of Cambridge (LEU0005); National Grid (LEU0026); Ofgem (LEU0031); Aldersgate Group (LEU0038)

20 European Parliament, Fact sheets on the European Union: Internal Energy Market, accessed 27 September 2016

21 The EU Energy Union Strategy aims to coordinate the transition of the European energy system to one that is low carbon, competitive and secure. It is based around the five interrelated principles of: security of supply, a fully-integrated internal energy market, energy efficiency, climate action - emission reduction, and research and innovation. European Commission, Priority: Energy Union and Climate, accessed 27 September 2016.

22 European Commission, A Framework Strategy for a Resilient Energy Union with a Forward-Looking Climate Change Policy COM/2015/080, February 2015

23 Aldersgate Group (LEU0038); British Ceramic Confederation (LEU0020); Centrica (LEU0042); Dairy UK (LEU0027); DONG Energy UK (LEU0021); E3G (LEU0017); EDF Energy (LEU0024); Interconnector UK (LEU0023); New Nuclear Watch Europe (LEU0033); Nuclear Industry Association (LEU0013); Polar Research and Policy Initiative (LEU0016); Renewable Energy Association (LEU0009); RSPB (LEU0011); University of Cambridge (LEU0005)

24 Energy UK (LEU0040); Interconnector UK (LEU0023)

25 The ECC Committee noted that: “Almost 70% of witnesses highlighted the UK’s relationship with the IEM as an importance influence on the future cost, security and decarbonisation objectives of the British energy system. 53% of witnesses were in favour of continued access to the IEM or the single market more broadly. 17% noted the importance of the issue, but did not provide a clear preference for the UK’s future relationship. No witnesses suggested that the UK should leave the IEM.” Energy and Climate Change Committee, Third Report of Session 2016–17, The energy revolution and future challenges for UK energy and climate change policy, HC 705.

26 Q249

27 UK Energy Research Centre (EUE0026)

28 Digest of UK Energy Statistics (DUKES) 2016, p11

29 Q6 [Paul Hallas]

30 Digest of UK Energy Statistics (DUKES) 2016, p115

31 Ofgem (LEU0031)

32 Ofgem (LEU0031)

33 Q7 [Phil Sheppard, Martijn van Gemert]

34 Chatham House-UKERC (LEU0006); Institution of Engineering and Technology (LEU0010); Royal Society for the Protection of Birds (LEU0011); Prince of Wales’s Corporate Leaders Group (LEU0012); Nuclear Industry Association (LEU0013); E3G (LEU0017); British Ceramic Confederation (LEU0020); Interconnector UK (LEU0023); EDF Energy (LEU0024); National Grid (LEU0026); Ofgem (LEU0031); New Nuclear Watch Europe (LEU0033); Aldersgate Group (LEU0038); Centrica (LEU0042)

35 Chatham House-UKERC (LEU0006); Royal Society for the Protection of Birds (LEU0011); Prince of Wales’s Corporate Leaders Group (LEU0012); E3G (LEU0017); British Ceramic Confederation (LEU0020); Dong Energy (LEU0021); Interconnector UK (LEU0023); National Grid (LEU0026); Oil & Gas UK (LEU0032); New Nuclear Watch Europe (LEU0033); Energy UK (LEU0040); Centrica (LEU0042)

36 Q7

37 Department for Business, Energy and Industrial Strategy (LEU0036); Business, Energy and Industrial Strategy Committee, Fourth Special Report of Session 2016–17, The energy revolution and future challenges for UK energy and climate change policy: Government Response to the Energy and Climate Change Committee’s Third Report of Session 2016–17 HC 945

38 E3G (EUE0011); Energy Networks Association (EUE0041); Dong (EUE0051); Renewable Energy Systems Ltd (EUE0059); Vattenfall (EUE0074); Chatham House UKERC (LEU0006); E3G (LEU0017); National Grid (LEU0026)

39 Q184

40 Q230

41 Chatham House UKERC (LEU0006); Table 1: Economic Impacts of Internal Energy Market

42 As above

43 As above

44 Q10 [Phil Sheppard]

45 Q11

46 D. Newbery, G. Strbac, I. Viehoff (2015), The benefits of integrating European electricity markets, Energy Policy Research Group, Working paper 1504, University of Cambridge, cited by Chatham House UKERC (LEU0006); Table 1: Economic Impacts of Internal Energy Market. This estimate is based on implementation of ‘market coupling’ whereby electricity is traded across the EU without the need for a separate purchasing of interconnector capacity.

47 Q12

48 National Grid (EUE0079)

49 Q23

50 Chatham House (EUE0016); Storengy UK (EUE0028); Centre for Energy, Petroluem and Mineral Law and Policy (EUE0044); EEF, the Manufacturers Organisation and UK Steel (EUE0062); AES UK & Ireland (EUE0065); E.ON (EUE0073); Dong (LEU0021)

51 The ‘solidarity principle’ is a policy designed to ensure that Member States receive immediate assistance in the event of a gas supply crisis.

52 National Grid (EUE0079)

53 University of Cambridge (LEU0005)

54 VPI Immingham (EUE0012); Rolton Group Ltd (EUE0018); Ricardo Energy & Environment (EUE0035); Centre for Energy, Petroleum, and Mineral Law and Policy (EUE0044); InterGen (EUE0049); EEF, the Manufacturers Organisation and UK Steel (EUE0062); Energy Institute (EUE0063); New Nuclear Watch Europe (LEU0033); University of Cambridge (LEU0005)

55 E3G (EUE0011)

56 ENGIE (EUE0043); InterGen (EUE0049); ADBA (EUE0053); ScottishPower (EUE0067); E.ON UK (EUE0073); Dong (LEU0021); Energy UK (LEU0040)

57 Energy UK (LEU0040)

58 National Farmers Union (EUE0013); ELEXON Limited (EUE0014); Chatham House (EUE0016); School of Law, University of Reading (EUE0024); Gemserv (EUE0025); EDF Energy (EUE0033); Energy Networks Association (EUE0041); Aldersgate Group (EUE0050); European Federation of Energy Traders (EUE0056); EEF, the Manufacturers Organisation and UK Steel (EUE0062); Energy Institute (EUE0063); ScottishPower (EUE0067); UK Onshore oil and gas (UKOOG) (EUE0072); Vattenfall (EUE0074); Oil & Gas UK (EUE0075); National Grid (EUE0079); Institution of Engineering and Technology (LEU0010); Interconnector UK (LEU0023); National Grid (LEU0026); Oil & Gas UK (LEU0032); Energy UK (LEU0040); Centrica (LEU0042)

59 Gemserv (EUE0025); Energy Networks Association (EUE0041); National Grid (EUE0079); Renewable Energy Association (LEU0009); Energy UK (LEU0040)

60 These include proposals for harmonising gas quality and the time periods for settling power trades across the EU, and concerns of growing activism in the upstream oil and gas sector that could affect the North Sea industry. Gemserv (EUE0025); E.ON UK (EUE0073); Oil & Gas UK (EUE0075); Energy UK (LEU0040); Centrica (LEU0042)

61 Oil & Gas UK (LEU0032)

62 Business, Energy and Industrial Strategy Committee, Fourth Special Report of Session 2016–17, The energy revolution and future challenges for UK energy and climate change policy: Government Response to the Energy and Climate Change Committee’s Third Report of Session 2016–17 HC 945; University of Cambridge (LEU0005); Chatham House-UKERC (LEU0006); Institution of Engineering and Technology (LEU0010); Interconnector UK (LEU0023); National Grid (LEU0026); Ofgem (LEU0031); Energy UK (LEU0040); Centrica (LEU0042)

63 ELEXON Limited (EUE0014); EDF (EUE0033); Energy Networks Association (EUE0041); European Federation of Energy Traders (EFET) (EUE0056); ScottishPower (EUE0067); Energy Institute (EUE0063); Chatham House-UKERC (LEU0006); Centrica (LEU0042)

64 Chatham House-UKERC (LEU0006); Ofgem (LEU0031) Plans are underway to extend the option of full ACER membership to national regulators from non-EU Member States, but progress with this has stalled in recent months.

65 Ofgem (LEU0031)

66 Chatham House-UKERC (LEU0006)

67 As above

68 Q206

69 Q239

70 Institution of Engineering and Technology (LEU0010); Interconnector UK (LEU0023); Ofgem (LEU0031)

71 National Grid (LEU0026)

72 New Nuclear Watch Europe (LEU0033); Oil & Gas UK (LEU0032); Renewable Energy Association (LEU0009)

73 E3G (LEU0017); Institution of Engineering and Technology (LEU0010); University of Cambridge (LEU0005). The Energy Community is an international organisation dealing with energy policy, established by an international treaty in 2005. The Energy Community aims to extend the EU internal energy market to South East Europe and beyond on the basis of a legally binding framework.

74 Q211 [Antony Froggatt]; Q218 [Antony Froggatt]. The Energy Union is an EU strategy to improve the security, affordability and sustainability of energy supplies.

75 University of Cambridge (LEU0005)

76 Vattenfall (EUE0074); Institution of Engineering and Technology (LEU0010); National Grid (LEU0026)

77 Q31

4 May 2017