This is the first in a series of client alerts discussing the potential impact of Brexit on energy trading in the UK. This alert will focus on general trading and contractual issues, providing a high-level overview of the immediate and potential long-term repercussions of Brexit, at a time when the UK is still in the process of negotiating a permanent deal with the EU.
The EU's internal energy market
The EU Customs Union and internal energy market (IEM) provide for an immediately accessible energy market, without internal borders or other regulatory obstacles, so as to ensure the proper functioning and security of the energy supply within the territory of the EU.
With Brexit now just over seven months away, the UK is in the process of negotiating a withdrawal agreement with the EU, which would include a transitional period during which the UK would continue to be treated in almost all respects as if it were an EU member state. Based on the text of the draft withdrawal agreement, published on 19 March 2018, the UK would be allowed to retain single market access and membership of the IEM and Customs Union, until the end of the transitional period on 31 December 2020. However, the UK government's Brexit White Paper, published on 12 July 2018 (the White Paper) considers both leaving and remaining within the IEM post-Brexit. The details surrounding the alternative arrangements to IEM membership remain unclear, the White Paper noting only that such arrangements would need to be explored. Should the UK decide to remain within the IEM, the White Paper suggests that it would need a common rulebook with the EU regarding the technical standards required for the functioning of the market.
Negotiations notwithstanding, it must be noted that, given the divided opinions within the UK parliament, an accidental 'no deal' scenario remains a potential outcome. However, energy remains a sector where the European Commission is optimistic about reaching a positive, and mutually constructive, arrangement. Although the specifics of such a deal are still unclear, there are important issues that need to be considered in relation to the trading of energy products (such as gas and power).
The Brexit effects
The UK's membership of the IEM permits seamless trading of electricity and gas across the EU, via interconnectors or hubs, allowing countries to either supplement existing supply with imports (the UK is a net importer of electricity, for example), or export surplus to areas with excess demand. In the absence of a deal on the UK's membership of the IEM, Brexit could impact such trading in several ways, examples of which are set out below.
Import declarations (currently only required for products imported from outside the EU) may be required for products that are traded across a future 'UK-EU border'. Such measures could have the effect of stifling the bilateral free-flow of energy products into and out of the UK, due to the additional administrative burden this would involve.
The WTO MFN regime
Should the UK exit the EU without a trade deal in place, the World Trade Organization (WTO) 'most favoured nation' (MFN) tariffs would replace the existing free trade position. Despite the name, the MFN tariff system is designed to ensure that all WTO members are afforded the same treatment regarding import and export tariffs. The maximum WTO MFN tariffs in the EU stand at 0 per cent for the import of electricity and crude oil, so these would not be affected. However, the EU has a maximum WTO MFN tariff of 0.7 per cent on natural gas, which it could choose to adopt. It is anticipated that, irrespective of whether a deal is reached, neither the UK nor the EU would impose direct tariffs on gas imports, as both are net importers and any tariff imposed by the EU would simply also be levied by the UK.
Interconnector and hub trading
The balancing of the physical flows of both gas and electricity is also another important facet of the IEM. National regulators must ensure supply and demand are balanced appropriately through interconnectors and hubs, to facilitate the efficient functioning of the gas and electricity supply networks across the EU. Should the UK no longer hold IEM membership post-Brexit, there may be an impact on the balancing market due to the potential divergence between the EU and UK of the regulatory regimes that govern the operation of interconnectors and hubs. The UK's national regulator, Ofgem, also may cease to be a member of the EU Agency for the Cooperation of Energy Regulators, thereby losing influence over the interpretation of new regulations, becoming a 'rule-taker' instead of a 'rule-maker'. However, the White Paper does convey an aspiration for continued close cooperation with the EU on various technical and regulatory energy arrangements, for example by exploring the potential of remaining within European Networks of Transmission System Operators for Electricity (ENTSO-E) and Gas (ENTSO-G), and participation in the Inter-Transmission System Operator Compensation mechanism and the Emissions Trading System.
Investment in energy infrastructure, which in turn may impact trading activity, also may be affected post-Brexit, as the UK would potentially no longer have access to such incentives as European Structural and Investment Funds, and Projects of Common Interest. Currently, the UK is set to more than double its electricity interconnector capacity by 2022, which may be put at risk without the right incentives for private investors. Notwithstanding that, security of supply in the physical energy markets continues to be a regional issue governed by supra-national issues that are perennial and 'longer' than Brexit. Hence, it is in the interests of both sides to sing from the same hymn sheet on this as an area of continued concern and communality.
The UK has an open access regime in energy and energy-related markets. However, some EU markets impose restrictions, or more stringent licensing requirements on non-EU firms than those established in the EU. Historically, this has been a greater issue in Central and Eastern Europe, but such issues can arise even in long-standing EU members.
One of the main issues concerning energy trading agreements following Brexit will be the choice of governing law for new contracts, and the effect of Brexit on existing contracts with an English governing law clause.
Governing law clauses
The choice of governing law may need to be reviewed, according to the new trading preferences of firms, following implementation of a post-Brexit transitional deal. Presently, standard documents provided by organisations like the European Federation of Energy Traders (EFET), such as EFET master agreements, allow for two choices of law: English and German.
An English governing law clause is construed to mean English law incorporating applicable EU law. Post-Brexit, this situation would change, as the UK would no longer be subject to EU law. However, during any transitional period, EU law would continue to apply as if the UK were an EU member state. Once the transitional period is completed, pursuant to the European Union (Withdrawal) Act 2018, EU law would be transcribed in full onto the UK statute book, mitigating the immediate risk of a particular piece of EU legislation suddenly disappearing from English law. However, absent any deal on these matters, this would not result in any mutual recognition by the EU and UK of their respective laws enacted after the transitional period.
Following Brexit, the courts of England and Wales will no longer be bound by any principles laid down, or any decisions made, by the Court of Justice of the European Union. However, any EU law retained by the UK will likely continue to be interpreted in accordance with any retained case law and general principles of retained EU law. The only court to which this rule will not apply is the Supreme Court, which must apply the same test as it would apply in deciding whether to depart from its own case law. Therefore, the courts of England and Wales (and the courts of the remaining EU member states) will, at least in the short term, be applying the same rules to determine the outcome of EU law related disputes post-Brexit.
The EFET standard-form master agreements for gas and power provide for dispute resolution via the London Court of International Arbitration or the German Institute of Arbitration, depending upon the parties' choice of governing law. Therefore, the commercial preferences of the parties as to governing law are likely to continue to influence their decision on the forum for dispute resolution. However, due to the reputation of the London arbitral institutions for reliability, neutrality and confidentiality, parties to such agreements may decide, post-Brexit, to retain English governing law in order to utilise the proven expertise of the London arbitration market. In addition, when a party seeks the recognition and enforcement of an English arbitration award in another jurisdiction, they generally do so under the New York Convention, whose operation is not contingent upon EU membership.
Considering the foregoing, Brexit is unlikely to require the wholesale renegotiation of gas and power trading contracts that are entered into prior to Brexit but, wholly or partially, fall to be performed post-Brexit. Specific trades on hubs and interconnectors, performed at the conclusion of the aforementioned transitional period, may have to be reviewed, but the detail on exactly what amendments (if any) may be required will depend upon the final arrangements reached between the UK and EU regarding technical and regulatory obligations. As noted above, the White Paper conveys a desire to remain fundamentally aligned with the EU on technical and regulatory rules for energy and emissions trading, so any major departure from the status quo seems unlikely. However, parties have the freedom to renegotiate and amend contracts subject to English law, both pre- and post-Brexit, and may wish to do so depending on the detail of the transitional agreement reached, and individual business needs.
As at the date of writing, there is still uncertainty as to the permanent goals of the UK government and those of the European Commission when reaching a permanent deal. The issues identified in this client alert will be key considerations in reaching consensus between them, and establishing a sustainable and workable relationship.
The next client alert in this series will address the important topic of the impact of Brexit on the regulatory landscape within the energy trading industry.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.