Evaluating the Impact of Brexit on Natural Gas Trade between the UK and the EU: A Spatial Equilibrium Analysis

The United Kingdom (UK) and the European Union (EU) engage in significant natural gas trade through the Internal Energy Market (IEM). As the UK exits from the EU however, it is likely to also exit from the IEM given the seemingly intractable positions of both parties. Exit of the UK from the IEM would likely cause an increase in natural gas trade costs between the two. The increased trade costs result from a number of channels including (1) loss in trade efficiency arising from loss of EU financing previously aimed at improving efficiencies in trade between the two; (2) loss in trade efficiency arising from loss in the sophistication of financial instruments that are linked to the UK’s membership of the EU and the IEM; (3) rising costs of doing business in the UK for many EU energy companies due to the effects of possible regulatory divergence between the UK and the EU; etc. We use a spatial equilibrium model to examine the trade flow, price and welfare implications of these cost effects on global natural gas trade, with a focus on the UK and the EU. We find that cost increases in the UK-EU natural gas trade links would result significant trade flow changes, with the UK and the EU reducing overall exports and increasing internal trade. As a result, there would be significant underutilisation of existing pipelines linking both parties. The Republic of Ireland would also form a significant number of new trade links to compensate for its reduction in imports from the UK. Total welfare losses in the UK and the EU are in the order of $479million and $602million respectively, which is equivalent to about 3.69% and 0.59% of the total value of natural gas trade for the respective parties in 2017. In the UK, the producer welfare loss is significantly higher, highlighting the vulnerability of the UK natural gas industry to cost increases in trade with the EU.