The looming EU referendum has caused sweeping uncertainty across Britain, and one sector facing significant disruption from a ‘yes’ vote in June is the energy market. Today differences in carbon taxation and charges levied on generators between Britain and other EU markets amount to a subsidy on electricity imports into Britain. This creates a situation in which British electricity generators are not on a level playing field with regard to competition to their EU counterparts and creates distortions in trade in electricity. In light of this, Britain may choose to mitigate such distortions by imposing tariffs on imported electricity in the event of a Brexit, although this in turn would make any agreement on trade with the EU much more difficult to realise.
REM talked to Vladimir Parail of global economics consultancy, Oxera to find out more about the potential impacts of each of the two possible outcomes on energy in Britain, including potential impact on renewables and climate change.
What is Oxera and what does it do?
We are a consultancy that was started by a number of Oxford University academics in the 1980’s, just around the time when Britain’s utility industry was undergoing a process of privatisation, with a view in mind of applying their knowledge of economic regulation in a practical sense to the regulation of the privatised industries. We’ve expanded and grown since then, so now we’re around 100 consultants altogether. We have four offices. The ‘mothership’ of the company is in Oxford but we have a London office which I work in, that’s a similar size to Oxford. We also have offices in Brussels and Berlin.
We are all economists. Everyone who works at Oxera is economist-trained and we pride ourselves in applying fundamental economic thinking to all problems. The areas in which we specialise are areas of competition economics, the economics of regulation, corporate finance and modelling of economic problems. The sectors we cover are energy, which is my focus, and other sectors include communications and media, water, financial services, healthcare and transport. So we’re a fairly broad group and we have a lot of economists working under the Oxera brand.
In terms of Brexit we are aiming to highlight the potential economic impacts in particular sectors, a bit different from the discourse you would normally hear in the public media and offer a bit more insight that’s a bit more specialised but still containing interesting and maybe quite surprising information.
How would you describe the state of Britain’s market at the moment?
There are lots of things to focus on. I guess the things that everyone will agree on [include the fact] that we are undergoing a period of change, from a situation where the margin of available capacity to generate electricity was quite high relative to demand, especially after the financial crisis, and through a process of, (mostly) retirement of old power plants, partly forced by economics and partly forced by legal frameworks around emissions, we’re moving into a position where that margin is very tight. Now we are in a period where investment does need to take place if we are to maintain security of supply. I think we all pretty much agree on that.
In terms of interaction of electricity with other commodities, there is one interesting development which happened last week, the first time since the 1880’s when we started to burn coal to produce electricity, there was no coal generation in Britain for a number of overnight hours. Now, for the vast majority of power plants that we have in Britain, there is a gap where it’s cheaper to burn gas to produce electricity than to burn coal. That has pretty profound implications for the energy mix, for when old coal plants can be expected to retire and, perhaps because they are less economic than they were a couple of years ago, it might be tempting to retire them sooner than later. Also, the amount of carbon dioxide emissions that we keep producing will be substantially reduced if we use a lot less coal. That is a broad overview of the key issues as we see them.
In our analysis, we want to highlight the relationship between the British energy market and markets in other EU countries and to highlight that essentially we are in a situation where the single market in electricity in Europe is supposed to be a close to completion and Britain is supposed to be an integral part of the single European electricity market. However, there are differences that exist which have significant potential to distort trade. These are differences in the extent of taxation levied on carbon emissions and also the way in which transmission, distribution and balancing charges are levied on generators in Britain and other countries. Essentially what it means is that the like-to-like costs for a gas power plant in Britain are something like £8 to £8.50 per megawatt hour (MWh) higher than in the connected markets with which Britain trades electricity. The implications of that are not good because it is a distortion, so in theory we are using less efficient power plants on the continent and importing that energy, and switching off more efficient ones in Britain which results in a higher overall cost of generation and higher emissions.
How does that affect the debate around Brexit? Does that mean Britain would be better off outside the EU or remaining in?
We haven’t looked at it in a way to make a final assessment of whether Britain should be in or out. That is out of our remit. We’re looking at this particular problem and looking at a situation where, if there is a vote for Brexit, and attempts to negotiate a free trade agreement with remaining parts of the EU fail. We are in a world where essentially we would have to rely on WTO rules and some degree of tariffs on trade are inevitable. As economists would tell you, if you have a world where you have to levy tariffs, say tariffs on imports, it is best to levy them in a way that alleviate existing distortions than create new ones. It is possible to do in this context. If we are in a position of having exited the EU and failed to get a free trade agreement with the rest of the EU, it would reduce economic distortions overall and improve trade in the sense of putting generators in different countries on a level playing field by levying an import tariff on electricity imports into Britain to the same extent as that distortion I mentioned earlier, so £8 to £8.50 per megawatt hour (MWh) for an average gas plant.
The estimated result of such a levy is that energy imports to the UK would fall by roughly one-third. Lower imports would need to be compensated by higher domestic generation, allowing room for new capacity investment or delayed retirement of old capacity. By using the levy to reduce reliance on imported energy, the UK government would be ensuring greater security of supply through additional flexibility to increase imports if a supply crunch occurred.
We appreciate this is a hypothetical situation so we might not vote for Brexit, or if we do vote for Brexit we might be successful in getting a free trade agreement that covers energy, in which case none of this applies and in that world we are highlighting that we still don’t have free trade as it should be, without distortions. We have significant distortions in the system as is. In the case where there is Brexit and these import tariffs are imposed, we don’t want to go so far as to say we should definitely do this because there are other non-economic considerations to take into account, particularly it could be seen as an antagonistic step that makes any agreement more difficult to reach in the future. As economists, we wanted to highlight the distortions that exist and how they might play out in the context of Brexit.
If Britain remained in the EU, how could those distortions be alleviated?
It’s a difficult question. I guess there is a reason why they exist, and they have existed for some years now. The biggest of them, the difference in carbon prices, which has existed since the carbon price support scheme in Britain came in. There are two ways to alleviate them. Britain could move towards the position adopted by the EU, or the rest of the EU to move towards Britain’s position. For Britain to move towards the EU, essentially there would have to be a reduction in carbon taxation, which some people from the renewable industry or those who campaign for tough measures on climate change would say is a regressive step. In terms of the quality of trade it would be a beneficial step. In terms of the way the tariff, the cost of transmission systems and balancing systems are charged, this would have to be shifted more towards consumers rather than producers as is in Britain. There is some possibility that the reverse might happen. The EU might move towards Britain and there is a promising sign in that regard in that Francois Hollande recently announced that France is thinking about the first steps in implementing a policy to underpin the carbon as in Britain. If that were to happen this would alleviate a great deal of the distortions happening today because France is the country that we’re connected to the most and the difference in carbon prices is the biggest aspect of the distortion. Those are the kind of pathways to reduce distortions without Brexit, but it’s problematic in that, in reaching any kind of change like this, there are always winners and losers and the losers will fight it. There are always strong distributional impacts of these things. Equally, if on carbon policy there are any changes in France and not in the rest of the EU, so if the EU allowance price stays low but France implements a carbon price support policy, that shifts the distortions away from the British border but towards, say, the France and Germany border.
What are the various impacts on the British renewable energy market, and energy efficiency and related areas?
If we are talking about Brexit and import tariffs, there wouldn’t really be any impact, primarily because of the new renewables at the moment - being built on the basis of the Contracts for Difference framework, introduced as part of the Electricity Market Reform. There, the renewable generators are not affected by fluctuations in the wholesale price. To the extent that levying import tariffs make a difference to prices, that shouldn’t affect new renewables. There is a broader question of, if Britain was to exit the EU, would it no longer be bound by the EU renewable targets. There are two interesting things to say here. The first one is that the binding targets on nation states are to 2020. We’re quite close to 2020, so the projects that are being built in advance of 2020 should already be in planning or construction at this stage. So incremental change after the Brexit vote in June would be quite minor. The targets that are in place for 2030 and beyond 2020 are not binding on any nation states and it’s arguable whether they really exist in a true form because there are no sanctions in place for not meeting them. So again Brexit in that context might not make any difference.
If Britain left the EU and that prompted a vote in favour of independence for Scotland, how would that affect renewables, given that many of the country’s wind farms are located there?
It’s complicated. It depends on what measures for renewable support are introduced in an independent Scotland, which of course we can’t tell at this stage. Certainly the SNP government in place in Scotland at the moment is fairly supportive of renewables, but there’s a question of whether they would have funding for renewables, because renewables can be expensive, but it’s quite difficult to speculate. In terms of renewable development in the rest of Britain, given that [in this situation] a bulk of the renewable resources would have been taken out, because Scotland does have a lot of it, if England and Wales and Northern Ireland wanted to be equally as ambitious and wanted to meet renewables targets after Scotland’s exit, the chances are that it would be more difficult to achieve because the resource base would have shrunk quite significantly.
How do these issues play out with regard to electricity bills for both households and business?
Broadly speaking, the work that we have done on Brexit and the scenario where levies are imposed on electricity imports, it’s pretty unambiguous that electricity for consumers would increase in price. It would essentially be a distributional impact which would make producers better off and consumers worse off. Now with the question of whether the present situation is sustainable given the distortions and the subsidy on imports essentially, just the static effect of us imposing levies on imports would make consumers worse off. If we were to remove the distortions that exist today, we estimate that the additional cost for consumers would be something in the order of £140 million a year, which, translated into domestic bills, and given the proportion of electricity consumed by domestic customers, translates into something like £2 per year on the average electricity bill. We haven’t done the same thing for business, but it’s determined by the relative shares of business and domestic customers and how much electricity they consume. We did estimate the impact overall to be £140 million per year and for domestic consumers to be £2 per year on the average electricity bill.
In terms of the Scottish situation, it is really difficult to say, it really depends on how much is built in terms of renewables, because renewables support does cost money and consumers would end up paying for it. Large industrial consumers may not face those costs necessarily but small consumers would probably face the bulk of that cost. If Britain or the rest of Britain after a Scottish exit were to abandon being a significant renewables producer - that would notionally be good for consumers just in terms of price paid although the electricity would be, on average, dirtier.
Oxera advises companies, policymakers, regulators and lawyers on any economic issue connected with competition, finance or regulation. The company has been doing this for more than three decades, gathering deep and wide-ranging knowledge on a number of sectors, including energy, from its offices in Oxford, Berlin, Brussels and London.
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