If Brexit leads to a withdrawal from the European Union’s internal energy market, the UK’s unwillingness to cooperate with its neighbours will come at a very high price
With the UK now officially out of the European Union, an 11-month transition period has commenced. Amid the multitude of details that still need to be negotiated, the UK’s presumed exit from the European Union’s internal energy market is a particularly important one. Exiting this highly beneficial arrangement could come with an unnecessary increase in the cost of electricity and hinder the UK’s decarbonisation efforts.
Efforts to connect the EU’s many electrical grids have been underway since the 1990s. By 2015 a cross-border energy market, named the internal energy market, had largely been implemented. From a trading perspective, the internal energy market creates a lot of benefits for all involved by ensuring the most electricity possible is sent from lower-priced markets to higher priced ones. If it’s a sunny day in France and the country’s solar network is operating at maximum capacity, the UK can purchase excess power at a beneficial rate.
This system is successful thanks to the sharing of information. In coupled markets, such as the arrangement the British electricity market currently has with France, information about how much electricity costs in both regions, as well as how much networks are willing to pay for electricity, is released to energy traders at the same time. Traders make an informed decision as to whether to buy or sell, and computer algorithms automatically handle the shifting of power from lower to higher priced markets. The only limiting factor is the transmission infrastructure available.
France frequently generates electricity more cheaply than the UK, meaning the UK benefits quite a bit from this arrangement. However, thanks to Brexit, the UK’s ongoing participation in this scheme, as well as the planned construction of additional interconnectors between Britain and Europe, is very much in doubt. It’s not even clear if an agreement to remain in the internal energy market is even possible under an exit from the EU.
The alternative is how things were before the internal energy market. In uncoupled markets, where two markets are connected but trade takes place in an uncoordinated way, there is room for costly mistakes. Traders know the price of electricity generation and how much consumers are currently willing to pay for it in their own market, but don’t have a clear idea of how things are on the other side. As a result, they will sometimes “buy dear” and “sell cheap”, moving electricity to the country where it is less valuable. With significant differences in price possible, mistakes can be very costly. To reduce the risk of this, energy traders often make very conservative decisions around buying and selling electricity, leaving the interconnectors under-used.
British firms and households would pay more for their power – by €2.4 billion a year in our worst scenario
Our recently published research sought to estimate the additional costs that would accompany leaving the internal energy market – a “Hard Elecxit”. We based our calculations on trading behaviour from 2009, back when Britain and France’s electricity markets were decoupled, and the assumption of only a modest increase of interconnector capacity.
Compared to a “Soft Elecxit” (where the current system is maintained), we estimated the increase of inefficiencies would result in an increase in the cost of generation between the two countries of €692 million a year – two per cent of the wholesale market value – by the year 2030. This cannot be avoided by building more interconnectors, as an increase in capacity would only present more opportunities for traders to make mistakes.
Cost of Hard Elecxit
These costs are greater than past estimates of the internal energy market’s benefits, as changes to the composition of both the UK and France’s energy mixes due to decarbonisation and investment in renewables will also affect prices and supply. Wind and solar generation are far more variable supplies than gas or nuclear, making well-coordinated trade more valuable while also giving traders more opportunities to sustain losses.
The scale of the costs of a Hard Elecxit depends on what happens to the mix of power stations in each country. France might retain more of its low-variable-cost nuclear capacity, making low prices common. Trade then would be more valuable, making disrupting it even costlier. In this scenario, a Hard Elecxit would cost the two countries approximately €2.7 billion annually by 2030.
From a trading perspective, the internal energy market creates a lot of benefits for all involved
If the UK drastically slows its decarbonisation initiatives and abandons its carbon tax, British and French power prices would converge, making trade less valuable and disrupting it less expensive. But, in most of our scenarios, Britain is a net importer of electricity, and a Hard Elecxit means British firms and households would pay more for their power – by €2.4 billion a year in our worst scenario.
As renewable energy generation progresses, the benefits of shared energy infrastructure become increasingly apparent. After all, you can’t rely on perfect conditions for renewables everywhere. But should the UK leave the internal energy market, decades of progress towards controlling the cost and supply of power will be lost.
This article draws on findings from the paper "Elecxit: The Cost of Bilaterally Uncoupling British-EU Electricity Trade" by Joachim Geske (Imperial College Business School), Richard Green (Imperial College Business School) and Iain Staffell (Faculty of Natural Sciences, Imperial College London).