<article><p class="lead">If the UK leaves the EU without a deal, falling carbon costs would not be enough for coal to displace gas in the UK merit order, based on forward prices.</p><p>Carbon costs for power generators could <a href="https://direct.argusmedia.com/newsandanalysis/article/19494050">fall sharply</a> if the UK leaves the EU without a deal at the end of October, which would benefit coal more than gas.</p><p>The UK announced <a href="https://direct.argusmedia.com/newsandanalysis/article/1781933">in late October</a> that it will replace the EU emissions trading system (ETS) allowance with an additional tax of £16/t ($19.46/t) in the event of a no-deal Brexit, on top of the existing £18/t carbon price support (CPS). With ETS allowance prices at about £26/t, this would reduce the total carbon price for power generators by about £10/t.</p><p>A £10/t reduction in the carbon price would cut the running costs of a 49.13pc efficient gas-fired plant by £3.75/MWh and the costs of a 34pc efficient coal-fired plant by £9.74/MWh.</p><p>While this could boost coal-fired output, coal would still lag behind gas in the merit order — the clean dark spread for 34pc efficiency would still be below the clean spark spread for 49.13pc efficiency (see chart). Combined-cycle gas turbine efficiency averaged 49pc in 2018, while average coal efficiency was 34pc, <a href="https://direct.argusmedia.com/newsandanalysis/article/1946707">government data show</a>.</p><p>The power curve has been pricing in an increased risk of a no-deal Brexit in recent days. New UK prime minister Boris Johnson has committed to leaving the EU on 31 October with or without a deal and has pledged to remove the ‘backstop' for Northern Ireland, which the EU says is non-negotiable.</p><p>The winter 2019 clean spark spread adjusted for the ETS allowance and CPS fell to £4.07/MWh yesterday, its lowest since early February and down from £4.42/MWh on 29 July, which was a four-month low (see chart).</p><p>The carbon adjusted clean spark spread dipped in October 2018 when it became apparent that a no-deal Brexit would lead to the UK leaving the ETS, as traders price in the risk of a reduction in the total carbon price. It recovered with the announcement of the additional £16/t tax. ETS allowances were trading at about £15/t at the time.</p><p>Prices will likely fall further if the UK does exit the ETS. The clean spark spread in the event of a no-deal Brexit — adjusted for the CPS and replacing the ETS allowance with £16/t — was £7.65/MWh yesterday. This is much higher than the average day-ahead clean spark spread during winter 2017-18 and winter 2018-19 (see chart), while higher installed wind capacity could be expected to weigh on gas margins next year.</p><p>The demand for domestic generation could rise significantly with a no-deal Brexit as imports from continental Europe could fall. Spreads with France and Belgium are already narrow — the UK winter 2019 base-load contract was at an implied premium of €2.55/MWh to French power yesterday, while the UK fourth quarter 2019 was assessed at a €1.41/MWh premium to the Belgian front quarter.</p><p>Declines in UK power prices from lower carbon costs could prompt the UK to switch to a discount and export to these markets, an effect that could be amplified by the British pound falling against the euro.</p><p>The pound has slipped since Johnson took office, falling to a 22-month low against the euro yesterday.</p><p><div class="picture"><div><span class="pic_title">UK winter 19-20 generation margins</span> <span class="units">£/MWh</span></div><img src="https://argus-public-assets.s3.amazonaws.com/2019/07/31/winter2019coalandgasmargins31072019042142.jpg"></div></p><p><div class="picture"><div><span class="pic_title">UK winter 49.13pc clean spark spread</span> <span class="units">£/MWh</span></div><img src="https://argus-public-assets.s3.amazonaws.com/2019/07/31/frontseasoncleansparkspreadsvdadelivery31072019042303.jpg"></div></p></article>
