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Feb 01, 2017

Supreme Court Ruling on Brexit—Implications and Next Steps for the UK Energy Sector

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The Supreme Court has given its much anticipated majority[1] ruling on whether the UK Government has the power to give notice pursuant to Article 50 of the Treaty on European Union of the United Kingdom’s intention to withdraw from the European Union, without an Act of Parliament providing prior authorization. Answering that question in the negative is perhaps the first concrete step in starting to give effect to the June 23, 2016 referendum decision to leave the European Union. 

In making its ruling, certain of the Lords[2]  made it clear that the case had “nothing to do with issues such as the wisdom of the decision to withdraw from the European Union, the terms of withdrawal, the timetable or arrangements for withdrawal, or the details of any future relationship with the European Union. Those are all political issues which are matters for ministers and Parliament to resolve.”

The majority also pointed out that “It is common ground that UK domestic law will change as a result of the UK ceasing to be party to the EU treaties and the rights enjoyed by UK residents granted through EU law will be affected.” This article briefly considers this from the perspective of the energy sector—what is currently in place and how it will be affected as these political issues start to be debated, negotiated and ultimately resolved.

Development of Extensive Links With the EU

On 22 January 1972, the United Kingdom signed the Treaty of Accession pursuant to which it acceded to the European Communities Treaties on 1 January 1973. On that date, EEC law took effect as part of the domestic law of the United Kingdom, in accordance with the European Communities Act 1972 which had been passed only ten weeks earlier.

Since then, the UK energy sector has developed extensive links with the EU through trade, directives and interconnection. It is well understood how successive UK Governments championed both liberalization and decarbonization agendas within the EU, including the development of the single market in energy. 

The 2013 House of Lords EU Sub-Committee D report, No country is an energy island: Securing investment for the EU’s future, concluded that there were “clear benefits to be derived from working within the EU on the energy challenge” and a larger, harmonized energy market with fewer trade barriers was understood, in theory, to promote competition, reduce consumer prices, and increase security of supply. 

In practical terms, the UK is (currently) part of the EU’s Internal Energy Market, which enables harmonized, tariff-free trading of gas and electricity across Europe. According to energy regulator Ofgem, the market appears to be competitive and outperforms virtually all relevant European and US benchmarks, with low levels of concentration, robust market entry and exit, and low levels of vertical integration.[3] 

The UK’s gas market is amongst the most mature and liquid gas markets in Europe and is physically integrated through three interconnectors (IUK, BBL and Moffat) with only small wholesale price differences and little congestion. The UK is a net importer of gas and therefore security of gas supply will be a consideration. As for the upstream sector, this is less influenced by EU legislation than the downstream sector, as many of the rules of the Third Energy Package do not apply to it. The UK will have to decide whether to continue to apply the (relatively few) EU Directives relating to oil and gas to the UK Continental Shelf or whether to develop its own domestic legislation.

The UK’s electricity sector is mature, unbundled and interconnected to the EU, even though it is “relatively illiquid” (although this is something the regulator is looking to improve). The UK has been an active supporter of the EU’s Third Energy Package, committed to decarbonization, demand reduction and supporting the integration of renewables into the system. It has supported market-based interventions such as market coupling, which is aimed at using cross-border transmission capacity efficiently. It is also physically interconnected through four interconnectors (IFA, BritNed, Moyle and East West) and is still planning further links.[4] 

As for nuclear energy however, there is the potential for a significant impact. The European Atomic Energy Community (Euratom) has a separate legal personality from the EU, but its Member States and institutions are the same.[5]   Changes to the current status will require detailed and considered transitional arrangements as new agreements with the various EU Member States and other countries who have Nuclear Cooperation Agreements within the Euratom framework.[6] 

The value of EU membership and participation in the IEM for the UK energy sector can therefore be understood at both a macro and micro level. Internal energy market participation has brought advantages in terms of investor confidence and certainty and access to and influence on energy policy, amongst other benefits. At the sector level, it has provided access to lower-priced gas, maintained security of gas supply, provided liquid markets and trading hubs, optimized the use of UK electricity assets through market coupling, cross-border balancing and capacity market trading and supported the investment arguments for new interconnectors.

Considering the Implications—the Government Consults the Energy Sector

Therefore, as part of efforts to understand the wider implications, the Government’s Energy and Climate Change Select Committee opened an inquiry[7]  to look specifically at the implications for UK energy policy of leaving the European Union. In particular, it was interested in the extent to which Government energy policies had been driven by the EU and whether any policy areas were now at risk, what the priorities should be for the Government in negotiating the UK’s exit from the EU (separate to questions regarding the mechanism for actually effecting the notification for exit) and what a successful negotiation outcome would (or should) look like and what aspects of existing EU energy policies and directives are beneficial to the UK and what should be the Government’s priorities in deciding which EU-led energy policies and legislation to retain.

After hearing evidence from a wide range of interested parties, the Committee reported on the implications for UK energy and climate change policy of leaving the EU as part of a wider report on the energy revolution and future challenges for UK energy and climate change policy.[8] 

The UK government has suggested that “Links with the EU market are likely to continue,”[9]  although the exact details of how this will be managed are yet to be clarified. The links themselves, however, are well established, and there are many hundreds of EU laws, relevant to the UK energy sector, that are directly applicable.

So How Much Legislation Is There?

According to the Directory of EU legislation, there are some 379 separate pieces of EU legislation relating to the energy sector alone, broken down further into legislation on:

  • Energy statistics – 7 
  • General principles and programs (including rational utilization and energy conservation) – 116 
  • Coal (including promotion of the coal industry, competition rates and other conditions of sale, coal products and other measures relating to coal) – 36
  • Electricity – 24 
  • Nuclear energy – (including fuel supplies, power stations and joint undertakings, safeguards, nuclear research and other measures relating to nuclear energy) – 169
  • Oil and gas (including supplies and stocks, intra-Community trade and other measures relating to oil or gas) – 22 
  • Other sources of energy – 12 

Under the European Communities Act 1972 (ECA), the UK’s Parliament voluntarily gave effect to the UK’s obligations and duties under the former Community (and now EU Treaties) in national law. The ECA defined the legal relationship between the two otherwise separate spheres of law, and without it EU law could not have entered into national law. Section 2(1) of the ECA establishes the authority for directly applicable EU law to have legal effect in UK law without needing further UK enactment.

Several different types of EU law are directly applicable: EU Treaty provisions, EU regulations and EU decisions. “Directly applicable” means that the EU law applies in the Member States without further national implementing measures, and these usually also have a direct effect, which creates rights that individuals can rely on before national courts. These are said to “pose a particular problem,” as “there are a great many of them, they may be difficult to identify and therefore to ‘disentangle’, and many are not laws at all in the UK, but administrative rules or other ‘soft law’ measures.”[10] 

The Government has said[11] it intends to “convert” EU laws into UK law “wherever practical,” so they can continue to operate in the UK until the Government and Parliament decide what to do with them. If there is no specific provision for them, they will no longer apply in the UK as soon as the ECA is repealed.

In the energy sector, some 61 separate Regulations have been identified as being “directly applicable.” The Commons Briefing Paper on directly applicable EU law made the point that what the Government and Parliament do with the directly applicable EU law “will depend largely on the outcome of the EU-UK withdrawal negotiations and the UK’s future relationship with the EU.”

It has been suggested, therefore, that the most likely approach will be the use of transitional legislation (which will have the effect of retaining much of the legislation derived from EU law) to bridge any voids in domestic legislation until the gaps can be analysed and appropriate legislation can be enacted to meet the objectives of Brexit.

Areas of Particular Concern?

Various themes or areas of particular concern for the energy sector were identified over the course of the Committee’s hearings. These included:

  • the EU Emissions Trading System;
  • the EU Effort Sharing process (emissions reduction in non-traded sectors);
  • the Paris Agreement and future international climate negotiations;
  • the Internal Energy Market (IEM);
  • security of supply and the role of EU interconnection;
  • EU funding streams; and
  • investor confidence.

Of particular interest here are issues concerning the IEM, interconnection, funding and investor confidence.


IEM

On the question of the UK’s access to the IEM, the weight of evidence from interested stakeholders was in favor of maintaining access. In deciding the nature of the UK’s future relationship with the market, the Committee said the Government will need to weigh the costs of associated legislation and regulation against the economic, security of supply and carbon reduction benefits afforded by IEM membership. It recognized, however, that negotiations around this are likely to be affected by broader issues, including freedom of movement.

IEM

The Committee suggested that if IEM participation is to be pursued, the Government should explore “potential membership models,” such as the Energy Community Treaty.[12]   However, if continued IEM is not possible, then the Government should undertake a thorough assessment to ensure that policy risks are understood and minimized.

The Committee also suggested that if the UK does lose its membership in, but retains access to, the IEM, then the Government should identify new options for shaping the development of IEM policy. It warned that without this, the UK risks losing its role as an IEM “rule-maker,” instead becoming a “rule-taker.”[13]

If the UK wishes and is able to continue participating in the IEM, then it will be expected to continue to comply with the European Network Codes (ENCs). If that happens, it was suggested that energy regulators Ofgem and National Grid should seek to retain membership of ACER,[14]  ENTSO-E[15]  and ENTSOG[16]  so that the UK can continue to shape the development of new codes. The Committee suggested, however, that if the UK sought to resign from the European Network Codes, then the Government would need to “ensure that resultant gaps in domestic network codes are filled.” 

The Government has given some indication as to its thinking when it said that in negotiating the nature of the UK’s future relationship with the IEM, it “will need to weigh the costs of the associated legislation and regulation and broader issues against the benefits afforded by various models of membership,” and that “whatever the future relationship may be we will seek to ensure that we maintain the efficient cross-border trading we have today which increases security of supply, reduces costs for consumers and increases the efficiency of low carbon generation.”[17]

It said it will pay particular attention to the impact that a different relationship with the IEM may have on the Single Electricity Market (SEM) in Northern Ireland and the Republic of Ireland and “seek to ensure that the SEM continues to operate efficiently, bringing security of supply and reduced costs for consumers in both Northern Ireland and the Republic of Ireland.”[18]

Interconnection

In terms of security of supply, the Committee warned about the level of dependence on both imported gas and electricity and highlighted the benefits that pan-European coordination has brought to ensuring security of supply. It said the Government should “seek to build investor confidence, to avoid exacerbating difficulties in bringing forward investment in new electricity capacity and new indigenous resources.”

It also called on the Government to examine the role of the “solidarity principle”[19] in managing potential gas crises, specifically how the UK can continue to participate, and said if the UK were excluded then the Government “must urgently investigate alternative back-up arrangements to ensure security of supply in the event of a crisis.”

The status of the UK in terms of its membership in various EU bodies responsible for European energy transmission systems remains uncertain. Non-Member States are currently represented on ENTSO-E and ENTSOG, but not ACER. However, observer status is open to certain non-Member States. Much will depend on the final terms for Brexit as to what extent the UK sees its future connected with the still-emerging single European energy market. 

That said, it is likely that the UK will continue to be involved in some capacity with these bodies (and also in the single European energy market) given both its existing interconnectors and the potential stranding of Ireland from the rest of the EU (although work in relation to an electricity interconnector between Ireland and France is underway). At this stage, however, there still remain many more questions than answers.

Having acknowledged the importance of trading across interconnectors, the Government intends to “seek to ensure that arrangements are in place that facilitate efficient cross-border trade and avoid any market distortions arising from differences in UK and EU rules.”[20]

Funding

On funding for projects, the Government has committed to underwrite competitive EU funding where recipients bid directly to the European Commission for funds and HM Treasury has provided assurances related to funding for structural and investment fund projects which are signed before the UK’s departure from the EU, and which continue after departure from the EU. Funding for these projects will be honored by HM Treasury “so long as they provide strong value for money and are in line with domestic strategic priorities.”[21]

Furthermore, it has said that over the coming months it will consult with stakeholders to review all EU funding schemes to ensure that any continuing funding commitments best serve the UK’s national interest, whilst ensuring appropriate investor certainty.[22]

Investor Confidence

Underpinning a number of the Committee recommendations was the recognition of the importance of maintaining and developing further investor confidence by providing “clear signals on the direction of domestic energy policy” and “avoid exacerbating difficulties in bringing forward investment in new electricity capacity and new indigenous resources.” 

The Committee suggested that the UK’s departure from the EU is “not expected to change the general direction of UK energy policy, since this is perceived to be driven primarily by the Climate Change Act 2008, and domestic concerns about supply security and affordability.” However, it warned that “the absence of external enforcement and accountability mechanisms could weaken the imperative to deliver on policy targets. EU energy and climate change policies have historically played an important role in underpinning UK policy and providing a ‘double-lock’ to decarbonization commitments. This has bolstered investor confidence by providing policy stability beyond the five-year domestic parliamentary cycle.”

However, as the Supreme Court acknowledged, these will be determined by political choices, and the outcome remains to be seen.

Summary

It has been suggested that in terms of the energy sector, there are certain UK sectors where some legal changes may be advantageous. In upstream oil and gas, EU competition law has been described as an obstacle to attempts to create the collaborative approach needed to ensure the North Sea’s future development, and state aid rules and EU-wide public accounting standards have restricted the UK’s flexibility to support a nationally determined fuel mix. It is also well known that capacity margins have been decreasing as older coal and oil-fired power stations are closing due to age and the need to comply with European environmental regulations.[23]

The key, therefore, will be what these domestic strategic priorities actually are. However, as a result of the Supreme Court judgment, Parliament will have the opportunity to ratify the referendum, which may result in further debate into the manner in which the UK’s exit negotiations progress. It is also hoped that clarification as to many of the important questions which will affect the UK energy sector will also continue to be addressed as the Government’s statement of intention is given detail in the delivery.

Footnotes

[1] R (on the application of Miller and another) (Respondents) v Secretary of State for Exiting the European Union (Appellant) [2017] UKSC 5—see here for the judgment (by a majority of 8 to 3).
[2] The majority—Lord Neuberger, Lady Hale, Lord Mance, Lord Kerr, Lord Clarke, Lord Wilson, Lord Sumption and Lord Hodge.
[3] Ofgem Report, Wholesale Energy Markets in 2016, 3 August 2016.
[4] A 1,000 MW interconnector with Belgium is under construction for 2018 commissioning, and a 1,400 MWe link over 750 km with Norway is under construction for 2021 commissioning. A further 2,000 MW connection to Normandy was approved in September 2016 to enable the import of French nuclear power from 2022.
[5] The Government’s view is that withdrawal from the EU “includes the European Atomic Energy Community (‘Euratom’), as the European Union (Amendment) Act 2008 sets out that the term “EU” includes (as the context permits or requires) Euratom.” The Government said leaving the EU means leaving Euratom as well, because “they are uniquely legally joined.”
[6] Eight agreements are in place (with the US, Japan, Canada, Australia, Kazakhstan, Ukraine, Uzbekistan and South Africa), which vary in scope.
[7] The inquiry, Leaving the EU: Implications for UK energy policy, was opened on 7 July 2016. Its terms of reference were intended to inform the Committee about the policy areas that will need to be addressed during the exit negotiations.
[8] House of Commons Energy and Climate Change Committee Report, The energy revolution and future challenges for UK energy and climate change policy, 14 October 2016. This report was a combined report on three separate energy and policy enquiries—it was published as a combined report following changes to the UK government and various government departments in the aftermath of the Brexit vote. The new Prime Minister announced the creation of a new Government department, the Department for Business, Energy and Industrial Strategy (BEIS), which brought together all of DECC with parts of the former Department for Business, Innovation and Skills (BIS) and the work of the Committees, whose structures “mirror” Whitehall and were similarly reorganized.
[9] House of Commons Library Briefing Paper, 26 August 2016.
[10] House of Commons Library Briefing Paper, Legislating for Brexit: directly applicable EU law, Number 7863, 12 January 2017.
[11] Theresa May’s Speech to Conservative Party Conference, 2 October 2016; David Davis, Secretary of State for Exiting the EU, Statement to House of Commons, 10 October 2016.
[12]The Energy Community Treaty sees the Contracting Parties agreeing to implement core parts of the EU acquis communautaire, both sector-specific and general. The Contracting Parties also adopt development plans with a view to bringing their energy sectors in line with generally applicable standards of the EU. It provides for the free movement of network energy and allows for further measures to be taken with a view to creating a single energy market and also establishes an external energy trade policy and provides for a mechanism of mutual assistance between the Parties in the event of energy disruption.
[13] House of Commons Select Committee Report, The energy revolution and future challenges for UK energy and climate change policy, 14 October 2016.
[14] The Agency for the Cooperation of Energy Regulators, which was created by the Third Energy Package to further progress the completion of the internal energy market both for electricity and natural gas.
[15] The European Network of Transmission System Operators for Electricity, which represents 42 electricity transmission system operators (TSOs) from 35 countries across Europe, and which was established and given legal mandates by the EU’s Third Legislative Package to shape policy for energy security, market integration, sustainability and network adequacy.
[16] The European Network of Transmission System Operators for Gas, which was also legally mandated by the Third Energy Package; it facilitates and enhances cooperation between national gas transmission system operators (TSOs) across Europe “in order to ensure the development of a pan-European transmission system in line with European Union energy goals.”
[17] 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, 24 January 2017.
[18] Ibid.
[19]This is a policy designed to ensure that Member States receive immediate assistance in the event of a gas supply crisis.
[20] 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, 24 January 2017.
[21] Ibid.
[22] Ibid.
[23] However, the vote to leave the EU does not change the UK’s requirement to reduce emissions in line with the Paris Agreement and domestic legislation. The required levels of emissions reduction through to the early 2030s, during the fifth carbon budget period, have already been set by the UK Parliament.

Authors and Contributors

Iain Elder

Partner

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Sarah Kirkness

Professional Support Lawyer

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