Dr. Peter Zeniewski
Chancellor’s Fellow, University of Edinburgh
Scotland’s new Energy Strategy was drafted in the wake of momentous political change; the initial consultation document was published a mere seven months after the UK’s decision to leave the European Union in June 2016. Since then, the issue of Brexit has loomed large as a spectre of uncertainty over any new policy initiative put forward by the UK government and/or its devolved institutions. The draft Scottish Energy Strategy is no exception, and unlike Westminster’s Industrial Strategy there is a recognition therein that Europe’s single energy market has been “vital to delivering affordable energy and to driving decarbonisation and investment in renewables. EU legally-binding renewable energy and energy efficiency targets have played a defining role in stimulating the huge growth in renewable energy in Scotland, which has seen significant inward investment flows into Scotland.”
In many ways Scotland’s energy priorities are captive to wider ‘landscape pressures’ over which it has little control. Over the past year, initial optimism that the UK could retain post-Brexit single market (SM) access has been heavily eroded. Many players are now working under the assumption that the conservative UK government will fully withdraw from the SM, thereby losing both access and influence over the single energy market, as well as foregoing European regulatory and financial support for low-carbon energy.
Despite this bleak prospect, some analysts contend that much of the UK’s high level energy policy architecture is likely to stay intact following Brexit. This is because the majority of key legislation involving the energy sector is underpinned by national policies or at least nationally-transposed EU directives. Moreover, the UK remains both formally and ideologically aligned with the broad contours of EU energy policy-making, particularly on aspects related to market opening and climate change mitigation. Some have even gone as far as arguing that departure creates opportunities, for example by giving the UK more freedom to intervene in the market (following withdrawal from state aid and competition rules) as well as an ability to redesign the more contentious policies passed down from the EU (e.g. the Industrial Emissions Directive, or the regulated model of electricity interconnection projects).
In general, however, it appears neither in the UK nor the EU’s interest to roll back common regulatory arrangements in the field of energy, given the largely mutually beneficial interdependencies created by decades of cooperation. A cautious approach would favour continued regulatory convergence in the first instance, ensuring that any eventual break in alignment would be carefully evaluated in terms of both direct and indirect impacts. It will be the job of both the Holyrood and Westminster Parliaments to ensure that such evaluations are properly carried out.
Sitting prominently alongside the question of regulatory convergence is the issue of financing: to what extent will the UK have access to public and private European money after Brexit? This is all the more pressing considering that most investments in the downstream energy sector require active public support, either through regulated returns or some form of direct state intervention (e.g. think state guarantees for Hinkley Point C or capacity markets to support thermal generation, and the fact that most renewables continue to require state support even with sinking costs).
In the case of Scotland, its energy sector is a recipient of European bank loans, grant funding and other forms of financial support for innovation, research and development of clean energy technologies. As noted by a government document on Scotland’s place in Europe, the European Investment Bank (EIB) has awarded funding to Scottish marine pilot projects such as MeyGen phase 1B and the Sound of Islay (€37.4m), as well as a £525m loan to support the construction of the Beatrice offshore wind farm in Outer Moray Firth – the largest EIB loan for an offshore wind project. Horizon 2020 funding of €10m has also been awarded to Scotrenewables Tidal Power for its Floating Tidal Energy Commercialisation (FloTEC) project. European Structural and Investment Funds are also a source of co-financing for Scotland’s Low Carbon Infrastructure Transition Programme (LCITP), providing match funding for investments in low-carbon infrastructure programmes and sustainability initiatives over the period from 2014-2020. The LCITP has directly awarded more than £43m to such projects. In addition, six UK electricity interconnector projects have been awarded around €70m in funding from the Connect Europe Facility (CEF) over the past three years to support pre-planning development costs. Among these is the 1.4 GW Norway-Scotland interconnector project, NorthConnect, which was awarded up to €10.5m in February 2017. A second prospective interconnector, IceLink, would carry Icelandic geothermal and wind power to the north of Scotland. Although this project hasn’t received European funding, its status as a Project of Common Interest makes it eligible for future CEF funding – at least while Britain formally remains a member of the EU.
Funding for existing projects in Scotland, which have already been committed, are unlikely to be encumbered by Brexit, particularly since HMS Treasury has committed to underwriting all funding awarded through these bodies, even after the UK’s formal departure from the EU. However, there is a possibility that some provisions contained in the credit agreements require compliance with EU law, exposing the projects to the risk of eventual regulatory mismatch between UK and EU regimes. But the greatest risk is for projects that have not yet secured funding, such as IceLink, as there is greater uncertainty about the extent to which final investment decisions will be made in an entirely new regulatory context. Projects which have not yet been conceived – e.g. future investments in a hydrogen economy in Scotland or any number of heat decarbonisation schemes – may have higher costs of capital as a result of restricted access to European public funding sources.
But what about private investment, which ultimately remains the key source of capital inflows into the UK? Many energy firms who warned against a UK departure from the European Union have since claimed that Brexit is unlikely to significantly affect their business developments. Take the example of the offshore wind industry, of which the UK is currently a global leader with 5 GW installed capacity. A great deal of future investment in offshore wind is forecast for the UK, particularly in Scotland where there is a project pipeline of 6 GW out to 2030. The Scottish Energy Strategy notes that “there is huge optimism for further development of offshore wind in Scotland. Scottish waters remain open for business and the pipeline of development continues to grow.”
European utilities active in this space, such as Iberdrola, Siemens, Vattenfall, and DONG have all variously sought to reassure shareholders that the regulatory risks of Brexit are manageable, that currency devaluation has been hedged, and that investments planned before the 2016 referendum are likely to continue, if not enjoy further expansion. In the absence of any certainty about a future UK/EU trading relationship, this general emphasis on ‘business as usual’ belies a far more fundamental choice about whether to locate supply chains inside or outside the UK. For offshore wind at least, it appears that these firms believe the UK will retain its role as a world-class development hub.
Although there is already a relatively high level of local content in the industry, a Crown Estate study finds that the majority of the lifetime cost of a UK wind farm is still spent outside the country. In this case a sensible commercial strategy for utilities investing in offshore wind would be to frontload capital investment while the UK remains a member of the EU, thereby laying the foundations for a robust domestic manufacturing industry that can insulate itself from exposure to potentially higher future trade costs. Recent multi-million pound investments in a tower assembly facility at Campbeltown by DONG and a rotor blade factory in Hull by Siemens, can both be seen as evidence for such a strategy. In doing so, moreover, companies would be better positioned to export from the UK, taking advantage or at least hedging currency risks if Sterling is further subjected to devaluation or volatility over the course of Brexit. As DONG mentions in its written response to the UK Parliamentary Inquiry on leaving the EU, “we have a number of UK suppliers from component manufacturers to specialist wind service companies that are starting to grow and export their goods and services to other markets, including European markets.”
In this blog I’ve focused on only a subset of a vastly complex set of political, regulatory, and financial entanglements between the energy sectors of Scotland, the UK, the EU and wider Europe, all of which will be reshaped by Brexit. Over the next two years, much of the success of Scotland’s draft Energy Strategy will be determined by the ‘landscape pressures’ of Brexit as well as the associated possibility of a second Scottish independence referendum. The effectiveness of specific policy interventions will rest in large part on Scotland’s continued access to both UK and European support instruments, both of which will be influenced by the outcome of these political negotiations. As such, the draft energy strategy is in the unenviable position of having to create a stable long-term policy framework that is able to transcend future political contestation between multiple levels of governance. The impacts of Brexit on Scotland’s energy strategy will determine its ability to effect a ‘stable, managed transition’ and likely reverberate all the way down to its ambition to deliver ‘smart, local energy systems.’ In this case, the eventual strategy adopted by the Scottish Government should take into account the potential impacts of Brexit wherever possible, performing sensitivity analysis on the main assumptions that rely on continued access to European investment and support.