Out-Law Analysis | 08 Jul 2016 | 1:00 pm | 4 min. read
This is part of Out-Law's series of news and insights from Pinsent Masons experts on the impact of the UK's EU referendum. Watch our video on the issues facing businesses and sign up to receive our 'What next?' checklist.
In many respects, the UK energy sector has always been shaped more by domestic policy than by EU mandates. The energy mix is particularly susceptible to changing political priorities, with the withdrawal of financial support for onshore wind and solar being a recent example. This will not change as a result of the referendum.
In the energy sector, we saw the beginnings of a potential investment hiatus in the lead up to the referendum as many held off progressing energy projects until the UK's decision was known. We can now expect a prolonged period of uncertainty as we wait to find out what the UK's future relationship with the EU will look like.
These issues are not insurmountable. However, in order to take advantage of the opportunities as they present themselves in these uncertain times, it will be more critical than ever to scrutinise project economics and ensure that there is a robust financial model in place before deciding to invest.
Impact on investment
Investors do not like uncertainty. A number of commentators have already highlighted the risk of project delays or cancellations, project cost inflation and the risk that major energy sector players - many of whom are from mainland Europe – will pull out of the UK altogether as a result of the vote.
One of the biggest questions for the industry is where the money for projects will come from in the future. The European Investment Bank (EIB), which has been quick to offer reassurance that it is business as usual until a decision is made by other member states on the UK's shareholding in the bank, is currently an important source of project finance. The UK is the currently the largest beneficiary of EIB funds into renewables, receiving 24% of the €7.2 billion loaned since 2007. The EIB also lends to non-EU member states so cannot be ruled out as a source of funding post-Brexit, although the scale of support would undoubtedly fall against current levels.
For investors from outside of Europe, a devalued sterling may persuade investors that projects in the UK are good value for money even while accepting that project revenues may also be in sterling. However, in the short term, the political and economic instability in the UK may put off investors.
In any case, funding is likely to be more expensive. Funders can also be expected to demand higher returns to reflect the current climate of uncertainty, while equity funders may well also consider that they are being asked to take on additional project risk.
A devalued sterling will also make projects more expensive due to the increased cost of hedging currency exposure and where goods and services are imported, as is often the case. Project costs may also increase should freedom of movement be curtailed post-Brexit, where personnel with the requisite skills and experience for a project are sourced from outside the UK. These costs will be offset by any measures taken by the UK government to incentivise continued investment in the UK - for example, recently-announced plans to reduce corporation tax to 15%.
Decarbonisation to continue
While the UK remains part of the EU and bound by its commitments under EU law, investors can take comfort that the status quo will persist. There is no suggestion that the government has either the capacity or the appetite to plot a different course for the future of UK energy policy during the transition to a post-Brexit world.
Investors can also be confident that any financial support awarded to energy projects before the UK exits the EU will not be unwound - for example, that awarded via contracts for difference (CfDs) or capacity market auctions. We would expect the government to 'grandfather' support awarded to projects ahead of any regulatory reforms, as any other approach would seriously damage investor confidence at a time when investment in energy infrastructure is much needed.
In the longer term, policy can be expected to continue to develop in a similar manner if the UK elects to remain within the EU's internal energy market (IEM). Outside the IEM, the UK's energy policy might diverge from that of the EU over time. However, the focus of government energy policy in recent years has been to encourage investment in energy infrastructure to tackle the so-called 'trilemma': security of supply, decarbonisation and affordability. The recent Electricity Market Reform (EMR) programme, billed as the biggest shake-up to the market since privatisation, is specifically aimed at addressing these challenges.
Although some fear that, in time, a Brexit may open the door to a softening of the UK's drive to decarbonise, this seems unlikely. The UK has been at the forefront of promoting the green agenda in Europe – and, moreover, will continue to be bound by its domestic and international commitments. The government's fifth carbon budget, published on 30 June, was also welcomed by the industry as providing further evidence of its long-term commitment to emissions reductions – to 57% of 1990 levels by 2032, in line with the recommendations of its climate change advisers.
Perhaps a further compelling reason for confidence that the UK will continue its commitment to decarbonisation is the contribution of the low carbon sector to the economy. According to figures published by the ONS in May, low carbon industries generated more than £46 billion in turnover for the UK economy in 2014. As the global move to decarbonise gathers pace, some commentators believe that the UK has the opportunity to be a true climate leader by investing in innovation in low carbon technologies, goods and services.
Over the years, the UK energy sector has demonstrated remarkable resilience at dealing with market disruption. We expect that, after a pause for reflection, the sector will show once again its ability to adapt to a changing landscape and enable much-needed investment in energy infrastructure to be unlocked.