After months of uncertainty, the result of the UK referendum will finally be known early this Friday morning. The campaign commenced with Remain ahead in all early polls. The Leave campaign then began gathering steam, building up momentum with Boris Johnson and Nigel Farage key figures in promoting the benefits of leaving the European Union. The polls then flipped with Leave campaign ahead by 4-6 points in numerous reputable polls, spooking global markets, which began to believe that Brexit was a strong possibility. Volatility gauges (also known as fear gauges) on both the UK and US markets reached levels last observed during the Lehman’s crash in 2008. The FTSE suffered heavily at the start of the previous week, with £98bn wiped off the value of the UK’s biggest companies in only four days of trading. This was replicated across global markets with Euro Stoxx 600 down €580bn in the same period. Asian and American indexes also suffered heavy losses. In commodities, oil futures slid 10% with demand destruction across the EU seen as bearish for crude products. The flight from equities and other riskier assets saw investors plough into traditional safe havens such as the yen, gold, and government bonds. The German 10-year bond saw negative yields for the first time, with investors effectively paying the German government for the privilege of parking their cash. UK-10 year bonds yields also fell to record lows without turning negative. The pound slumped to its lowest level in 2 months against a basket of global currencies as fear crept in that the UK could be close to leaving the EU.
The despicable street murder of the Labour politician and pro-EU campaigner Joe Cox last Thursday saw both campaigns suspended for 24 hours. This terrible act had a detrimental impact on the Leave campaign with many predicting a sentimental shift towards the Remain camp. Markets reacted, and numerous polls showed the Leave campaigns lead had been cut significantly, and, as such, investors began to buy back into the market. Bookmakers then began cutting odds of a Brexit and money began to flow out of safe havens back into equities and commodities. To date this week, the FTSE has gained around £75bn, recording its biggest one-day gain in four months on Monday. The pound saw its biggest one-day rise in 8 years. Oil also rallied as Brexit fears eased. Gold slid as money poured back into “riskier” assets and German bonds moved back into positive returns. The Remain campaign has recovered from its precarious polls position last week and now has the momentum going into today’s vote.
What would this all mean for the energy industry?
Interestingly, there is a split in the views of a prominent Leave backer, Energy Minister Andrea Leadsom and her boss, a strong advocate of Remain, Energy Secretary Amber Rudd!
Leave
- One of the pillars of the government’s energy trilemma policy is security, which will be in jeopardy if we remain as the EU’s “winter package” contains numerous proposals that threaten our energy security.
- One proposal is that we would need to ask the EU for approval when it comes to negotiating new bi or tri-lateral gas deals. These decisions are made by EU bureaucrats who don’t have the UK’s best interest in mind.
- A second proposal is the requirement of all EU members to take legal responsibility for each member state’s energy security. For example, if a member has difficulties in supplying its domestic market, we will be obliged to restrict supply to businesses in the UK to facilitate the export of energy to said country. Voting for the above proposals is due, and the UK has around an 8% representation in this process, which is irrelevant as the second proposal is heavily weighted towards countries with problematic energy infrastructure.
- UK generators are at a distinct disadvantage against their European counterparts. Thermal generation is cheaper in the EU with lower transmission and balancing costs as well as cheaper CO2 taxes. If we left, we could balance this out by applying import tariffs on European power generators who export power to the UK, which would reduce imports by up to a third, resulting in higher domestic generation and greater security of supply as we would be able to increase imports when demand dictates.
- We would no longer have to adopt EU regulations that are forced on us. One example is the harmonisation of the EU gas day, which cost some networks millions of pounds and required a lot of change across UK gas infrastructure.
- Scaremongering regarding us “running out of gas” if we leave the EU are unfounded, there are numerous long-term deals in place ensuring gas imports. Additionally, the LNG industry is growing and is expected to be able to greatly assist in the coming years. Lastly, fracking is now becoming a closer reality with the government creating new legislation allowing it override local councils and approve test fracking at a number of sites.
Remain
- Security of supply; The UK is forecast to double the amount of power we import from continental Europe in the next five years with savings to consumers expected to total around £12 billion pounds. This would not be possible in the event of a Brexit.
- The National Grid estimates that leaving the EU would see our energy costs rise by around £500 million a year; some estimates are much higher.
- The first effect of a Brexit would be the slide in sterling. Some forecasts predict it would immediately fall around 20% against the euro. A weaker GBP is bullish for UK gas and power products as its makes our products cheaper for those trading in euros. Conversely, any imported energy would immediately become more expensive.
- Environmentalists predict the environment would suffer if we left the EU as the stringent laws in place, some of which we tried to water down, would be ignored and new rules would be put in place that would not be as stringent and therefore have a negative impact on areas like air and water pollution.
- Contracts regarding pipelines and infrastructure that connect the UK with mainland Europe would have to be renegotiated and this would see additional tariffs and charges imposed as we are no longer an EU member.
- There will be a lack of access to EU research and development funds that facilitate investment into technologies that will support our energy trilemma.
- Staying in the EU means we still have a voice when it comes to EU energy regulation, whereas, if we left, that voice would no longer be heard. We would go from a seat at the table to the back of the room, yet we may still have to adhere to EU standards.
- Leaving the EU results in around 2 years (conservative estimate) of negotiating existing contractual arrangements. With this uncertainty comes a lack of investment in key energy infrastructure projects that are currently ongoing. This will cause significant harm to our efforts to solve the trilemma of affordability, security, and decarbonisation.
- In reference to the above, any halt in investment or regulatory uncertainty to interconnectivity with the EU could dramatically affect our power margins in light of the number of closures of coal plants in the UK. This is a serious threat to our security of supply.
As things stand currently, the implied probability of the UK remaining in the EU is 76%. Bookmakers are offering 5-1 to leave and 1-7 to remain. On Tuesday night, there was a live televised debate with prominent leave advocates Boris Johnson, Gisela Stuart, and UK Energy Minister Andrea Leadsom going up against the mayor of London, the leader of the Scottish Conservatives, and the general secretary of the Trade Union Congress. A heated debated ensued and interestingly within one hour of the debate ending, around £1million worth of bets was placed on the Betfair website. A staggering 80% of these bets were placed on the UK remaining in the EU.
