The future of the UK-EU energy market: What the draft UK and EU agreements can tell us

The post below was first published on our Beyond Brexit blog

On 18 March 2020, the European Commission published a draft text of the Agreement on the New Partnership with the UK (the EU’s “draft agreement”); a previous draft of which had been published on 12 March 2020.

Following the third negotiating round on the UK exit from the EU on 15 May 2020, the UK published on 19 May 2020 draft legal texts of a comprehensive free trade agreement (the UK’s “draft CFTA”) and a suite of accompanying, but separate, draft international agreements, two of which were a draft agreement on energy (the UK’s “draft energy agreement”) and a draft agreement on civil nuclear (the UK’s “draft civil nuclear agreement”). These drafts had been shared with the Commission during the preceding weeks, but not the Member States.

The EU and the UK have published these draft documents as negotiating documents to, in the case of the EU’s draft agreement, serve “as a tool to support the negotiations and to enable progress with the UK”; and in the case of the UK’s draft energy agreement and draft civil nuclear agreement, to form the basis for discussions “with the EU on an agreement on energy” and “on an agreement on cooperation in the peaceful uses of nuclear energy” respectively.

Looking briefly at some of the areas addressed within these draft documents gives us a sense of the relationship forming between the EU and the UK as the negotiations proceed on what follows the current status quo transition period.

Single agreement v suite of agreements

The EU’s draft agreement proposes a single framework for the future relationship with the UK with a single governance system. It is even expressly provided that future agreements between the EU and the UK will be treated as supplemental agreements governed by the common framework.  The UK proposes a “suite of proposals” (including the UK’s draft energy and civil nuclear agreements) negotiated, applied and therefore enforced separately.

See our 27 May 2020 View from Brussels - The negotiation of the future partnership between the EU and the UK for further discussion of this as well as the proposed approach to dispute settlement amongst other matters.

Energy - objectives

The EU’s draft agreement sets out its objective “to facilitate trade and investment between the Parties in the areas of energy and raw materials, and to improve environmental sustainability, support security of supply and contribute to the fight against climate change in these areas”.

The EU’s draft lists energy goods as including coal, crude oil, oil products, natural gas whether liquefied or not, hydrogen and electrical energy; hydrocarbons as including crude oil and natural gas; and a list of raw materials is noted as “to be further defined, but [to include] unprocessed and semi-processed products”.

The UK’s draft energy agreement sets out its objective as “to recognise the Parties’ respective commitments to combating climate change, to establish the bases on which the Parties shall trade natural gas, electricity and electricity interconnector capacity, to cooperate on trade in energy and to link their Emissions Trading Systems”. There is no definition of ‘energy goods’ and no mention of raw materials in the objectives or in the body of the UK draft energy agreement.

The UK draft agreement does, however, refer to processing in its definition of ‘LNG facility’, under which it notes that this means “a terminal which is used for the liquefaction of natural gas or the importation, offloading, and re-gasification of liquefied natural gas, and includes ancillary services and temporary storage necessary for the re-gasification process and subsequent delivery to the transmission system, but does not include any part of liquefied natural gas terminals used for storage”.

Processing is also referred to in the definition of ‘upstream pipeline network’, which is noted as meaning “any pipeline or network of pipelines operated and/or constructed as part of an oil or gas production project, or used to convey natural gas from one or more such projects to a processing plant or terminal or final coastal landing terminal”.

The UK draft agreement also refers to ‘production’ in, for example, its definition of ‘natural gas undertaking’, noting that this “means a natural or legal person carrying out at least one of the following functions: production”; however, again in reference to ‘production’, in relation to storage facilities for LNG, the definition of ‘storage facility’ includes “the part of LNG facilities used for storage, but [excludes] the portion used for production operations”.

Energy - exports and imports

Under the EU’s draft agreement, no party will “impose a higher price for exports of energy goods or raw materials to the other Party than the price charged for those goods when destined for the domestic market, by means of any measures such as licenses or minimum price requirements”.

On a similar vein, the UK’s draft energy agreement sets out that the wholesale price of electricity and natural gas is market-based.

The EU’s draft agreement sets out that “[e]xcept as otherwise provided for in this Agreement, customs duties on goods originating in the other Party shall be prohibited“ and that “[a] party shall not introduce or maintain any duty, tax or other charge of any kind imposed on, or in connection with, the exportation of a good to the other Party; or any internal tax or other charge on a good exported to the other Party that is in excess of the tax or charge that would be imposed on like goods when destined for domestic consumption”. The EU draft agreement further notes that both parties “shall accord national treatment to the goods of the other Party in accordance with Article III of GATT 1994, including its Notes and Supplementary Provisions. To this end, Article III of the GATT 1994 and its Notes and Supplementary Provisions are incorporated into and made part of this Agreement, mutatis mutandis.”

Similarly, the UK CFTA sets out that both parties will “eliminate customs duties on all goods originating in either” Party” and neither party can “adopt or maintain any duties, taxes or other fees and charges imposed on, or in connection with, the export of a good to the other Party, or any internal taxes or fees and charges on a good exported to the other Party, that is in excess of those that would be imposed on those goods when destined for internal sale”. Further, both parties “shall ensure, in accordance with Article VIII of GATT 1994, that all fees and charges of whatever character, other than customs duties, export duties and taxes in accordance with Article III of GATT 1994, imposed by that Party on or in connection with importation or exportation are limited to the amount of the approximate cost of services rendered, which shall not be calculated on an ad valorem basis, and shall not represent an indirect protection to domestic goods or a taxation of imports for fiscal purposes”.

Under the UK’s proposed external tariff from the end of transition for all imports for all countries that it does not have a free trade agreement with, the UK proposes zero rates for electrical energy and natural gas (in line with the EU).

On export and import monopolies, under the EU’s draft, no party can “designate or maintain an import or export monopoly for energy goods or raw materials”; export and import monopolies are not addressed under the UK’s draft energy agreement.

Third party access

For third party access to transmission and distribution networks, the EU’s draft agreement sets out that a system of third party access is to be implemented to each party’s “transmission and distribution networks based on published tariffs, applied objectively and without discrimination between entities in each Party’s market”.

Non-discriminatory third party access is also addressed under the UK’s draft energy agreement, which sets out that both parties “shall ensure that [Transmission System Operators] and other operators of energy transport infrastructure in its territory grant non-discriminatory access to the energy transport infrastructure for the transport of natural gas and electricity of any undertaking of the other Party”.

Emissions trading system

On the emissions trading system ("ETS"), the EU’s draft agreement requires the UK to “implement a system of carbon pricing of at least the same scope and effectiveness as that provided by the EU [ETS]”. The EU draft agreement further notes that in the event the UK creates “its own emissions trading system and request it to be linked to the EU ETS, the Union shall give serious consideration to such request, provided that it does not risk affecting the integrity of the EU ETS, in particular its balance of rights and obligations, and that an increase in scope and effectiveness is ensured”.

The UK’s draft energy agreement notes that the UK has set out in its publication The future relationship with the EU: the UK’s approach to negotiations that it is “open to considering a link between a UK ETS and the EU ETS, if it suits both sides’ interests”.

On 1 June 2020, the UK announced the setting up of a new UK ETS to replace the EU ETS (a UK ETS had previously existed pre-EU ETS). A link to the EU ETS is possible in the future and indeed some of the features (eg the cost containment mechanisms) of the future UK ETS seem to have been specifically designed for such a link to occur. The creation of a link between the UK and the EU ETS is subject to the ongoing trade negotiations between the UK and EU.

One of the issues with the future UK ETS is that it seems to be UK-wide, ie it includes Northern Ireland ("NI"). This may have implications for the Irish single electricity market ("iSEM") that are currently not an issue in relation to the EU ETS. For example, it is not clear how the UK ETS and EU ETS will interface in NI and the iSEM; there is potential for misalignment here which needs to be clarified. A UK-wide ETS may also have implications for the UK carbon floor price; the carbon floor price does not apply in NI, this is to allow for the seamless running of the iSEM. Under the new UK ETS, there will be a floor price of £15, which is slightly lower than the previously suggested carbon tax of £16 and it is not currently clear how the floor price would interact with the EU ETS. Timing will also be critical and the transition from EU ETS to UK ETS will need to be seamless to avoid gaps in carbon accountability.

Climate change

Under the EU’s draft agreement, both parties “shall respect the Paris Agreement and the process set by [the United Nations Framework Convention on Climate Change], and refrain from any acts or omissions that would undermine its adherence to or materially defeat the object and purpose of the Paris Agreement”.

The scope under the UK’s draft energy agreement is wider and sets out that “each party retains the right to establish its own climate change priorities, and to adopt or modify its laws and policies accordingly in a manner consistent with international climate change agreements to which it is a party”.

See also the section on level playing field provisions below.

Renewable energy

On renewable energy, the EU, under its draft, “reaffirms the target for the share of gross final energy consumption from renewable energy sources in 2030 as set out in Directive (EU) 2018/2001 on the promotion of the use of energy from renewable sources” and specifically sets out that the UK will establish:

• targets for the share of energy from renewable sources in gross final energy consumption not lower than those in the National Energy and Climate Plan submitted by the United Kingdom to the Commission on [date of submission of final plan]; and
• targets for the absolute level of primary and final energy consumption not higher than those in the National Energy and Climate Plan submitted by the United Kingdom to the Commission on [date of submission of final plan].

The EU’s draft also notes that both parties “shall ensure that electricity market rules enable the integration of electricity from renewable energy sources and shall remove barriers that could prevent access to the electricity network of electricity from renewable energy sources”.

The UK sets out under its draft energy agreement that both parties “shall, consistent with their international obligations, pay special attention to facilitating the removal of obstacles to trade or investment in goods and services of particular relevance for climate change mitigation and in particular trade or investment in renewable energy goods and related services”.

More specifically, the UK’s draft energy agreement also sets out that both parties, in recognition of the “specific decarbonisation challenges they face” will cooperate to facilitate:

• the cost-effective deployment of renewable energy, including offshore energy and in particular offshore wind generation and interconnection in the North seas; and
• the decarbonisation of gas, including through exploring the further integration of the gas and electricity sectors, the development of hydrogen networks and the development of carbon capture, utilisation and storage, with a focus on the North Sea.

Civil nuclear - objectives

The EU’s draft agreement sets out its objective in relation to civil nuclear energy as “to provide a framework for co-operation between the Parties in the peaceful uses of nuclear energy on the basis of mutual benefit and reciprocity and without prejudice to the respective competences of each Party”.

The UK’s draft civil nuclear agreement reaffirms “the support of the Parties for the objectives of the [Treaty on the Non-Proliferation of Nuclear Weapons] and their desire to promote universal adherence to the NPT”. The draft civil nuclear agreement also notes the desire “to maintain conditions consistent with the commitment of the Parties to non-proliferation under the NPT under which nuclear material, non-nuclear material and equipment can be transferred between the Parties for peaceful purposes”.

Forms of cooperation

Under the EU’s draft agreement, civil nuclear cooperation between the EU and the UK includes, but is not limited to:

• trade and commercial cooperation relating to the nuclear fuel cycle;
• the supply of nuclear material, non-nuclear material, and equipment;
• safe management of spent fuel and radioactive waste;
• nuclear safety and radiation protection, including emergency preparedness and monitoring of levels of radioactivity in the environment;
• use of radioisotopes and radiation in agriculture, industry and medicine;
• geological and geophysical exploration, development, production, further processing and use of uranium resources;
• regulatory aspects of the peaceful uses of nuclear energy; and
• research and development.

Similarly, under the UK’s draft energy agreement, civil nuclear cooperation includes, but is not limited to:

• transfer of nuclear material, non-nuclear material and equipment;
• exchange of scientific and technical information, data, and documentation;
• exchange, visits and training of personnel and experts, including professional and advanced training for administrative, scientific, and technical personnel;
• education in nuclear-related fields, including between academic institutions;
• organisation of symposia and seminars, and other forms of provision of information to the public;
• provision of relevant technical assistance and services;
• commercial cooperation relating to the nuclear fuel cycle;
• organisation of, and participation in, joint projects, research infrastructure and joint undertakings and establishment of joint ventures; and
• participation by scientific and technical staff of one Party in research and development activities conducted by the other Party.

Level playing field provisions and State aid

The EU negotiating mandate requires the Commission to seek an agreement that “should uphold common high standards, and corresponding high standards over time with Union standards as a reference point”.  This is taken to mean securing dynamic alignment of UK legislation with that of the EU.

In the fields of taxation, social rights, environmental protection and climate action an obligation of non-regression from existing standards is combined with a kind of ratchet mechanism. When a party increases its standard of protection it may not subsequently lower it below the level achieved by the other party. This is described in slightly varying terms in the EU’s draft agreement for labour and social protection, for environmental protection and for climate action.

The UK drafts do not contain these provisions and provide only that the parties “shall strive to continue to improve such laws and policies and their underlying levels of protection”.

In the field of subsidy control, however, the EU proposes to go much further and would require the UK to adopt changes to EU State aid law and policy and provides for the EU to be able to adopt appropriate “interim measures” until the UK does so.

The UK draft avoids all references to State aid, preferring to employ the notion of subsidy as understood in the WTO Agreement, although it does propose a system of control (applicable equally to both parties) going beyond that of the WTO.

The differences between the two sides on these issues is quite stark as shown by the terms used in the public letter of the UK  negotiator to his EU counterpart, where the EU proposal on State aid is described as “simply not a provision any democratic country could sign” and the public letter in response describing other UK demands as “unprecedented” and its approach as “cherry picking”.

See also our 27 May 2020 View from Brussels - The negotiation of the future partnership between the EU and the UK for further background.

 Future EU-UK relationship

Following a fourth round of negotiations, the Commission noted on 5 June 2020 that there had been “no substantial progress” in relation to the issues discussed during that round (ie fisheries, the level playing field, governance of the future EU-UK relationship, and police and judicial cooperation in criminal matters).

The negotiating road ahead therefore currently appears long and unyielding, and where energy sits along this road is not as yet marked out – the coming months will, however, of necessity cast a brighter light on future negotiations and on the relationship developing between the EU and the UK even if that includes the very real possibility that the transition will end on 31 December 2020 without agreement on the future relationship.

Our 19 December 2019 View from Brussels – Brexit: next steps and options to reconcile haste with ambition sets out some ways in which it could be possible to reach an agreement in a short space of time while leaving details to be worked through later (for example, a work programme approach). We await to see how negotiations unfold.