Is RAB the key to de-risking nuclear?

Proposals for a new way to fund nuclear projects last month have provided some welcome positivity to a part of the market all too accustomed to criticism. David Blackman looks at how the use of the Regulated Asset Base (RAB) model could impact nuclear’s role in the energy market.

Andrea Leadsom was seen as a fan of nuclear energy during her spell as minister of state for energy from 2015 to 2016.

However, during the recently appointed business and energy secretary’s time away from the portfolio, little progress has been made on nuclear.

EDF’s plant at Hinkley Point is finally being built after receiving the sign off from ex-prime minister Theresa May. However, proposals for new power stations at Wylfa and Moorside have both bitten the dust after their backers, Hitachi and Toshiba respectively, decided not to proceed. The withdrawal of the two multi-nationals has left the UK nuclear industry uncomfortably close to the last chance saloon.

A way out though may be found in one of the many items left in Leadsom’s in-tray by her predecessor Greg Clark.

This is a consultation paper outlining how the Regulated Asset Base (RAB), a mechanism which has been used to finance many infrastructure projects like the Thames Tideway ‘super sewer’, could be extended to nuclear power stations.

The idea of deploying the RAB is chiefly driven by the desire to cut costs by mobilising relatively low return seeking pension fund capital.

Institutional investors have a growing appetite for infrastructure assets, which offer steady returns that are healthier than those on offer from bonds these days.

However, pension funds only tend to take an interest in infrastructure once it is operating and generating revenues. This cautious group of investors generally shies away from any kind of construction project because of the risk that they will be left empty pocketed if it is uncompleted.

The RAB model is designed to de-risk nuclear projects and offer these institutions the kind of return profile they crave.

Under the RAB model, a regulator sets the returns that a project can generate for its investors. According to the BEIS consultation paper, the regulator would determine the ‘allowed revenue’ developers of nuclear project could earn, using a WACC (Weighted Average Cost of Capital) formula that the water industry is familiar with.

Pension funds like this kind of arrangement, because if offers a good match for their liabilities which involve pay-outs to investors stretching out over many decades.

In addition, under the government’s blueprint, investors can start to recoup revenues before their asset is up and running. This is unlike conventionally financed projects, like Hinkley Point C, where they must wait until it is operating before getting paid.

But Labour’s energy spokesperson Dr Alan Whitehead expresses reservations about the idea investors could be paid for yet to be completed projects.

“If there was a substantial delay, which is a hallmark of nuclear installations, the public could find itself paying large amounts of money for nothing, which would not be an appropriate outcome”, he warns.

Helping hand

In a further bid to reassure pension funds, the government’s consultation paper moots the creation of what it calls a Government Support Package (GSP).

This would be utilised in certain circumstances such as a cost overrun or disruption to the debt markets.

If costs exceeded a pre-defined threshold, known as a Funding Cap, the regulator would have the option of calling on the GSP or hiking charges for the plant’s customers, according to the government’s RAB paper.

Richard Black, director of the Energy and Climate Intelligence Unit (ECIU), believes that the mooted offer of this additional support fuels a narrative that nuclear gets special treatment vis-a-vis other energy technologies.

“There’s no question of that happening with wind farms or interconnectors or anything else”, he points out.

On the other hand, mobilising lower return seeking pension fund capital could enable nuclear projects to access cheaper finance.

According to a research paper, published this month by Cambridge University’s Energy Policy Research Group, the WACC over the lifetime of a Sizewell-sized power station would be 3.5%, which would work out at a strike price of £53/MWh.

However, loading all of the risk onto the developer, such as with Hinkley Point, would require a Contract for Difference with a strike price of £96/MWh.

As well as the steady returns, EDF has also been emphasising nuclear’s credentials as a low carbon source of power that can align with the ESG (environmental, social and governance) criteria, which an increasing number of pension funds have signed up to.

While many such funds have been sceptical about nuclear because of the bad reputation the technology acquired following high-profile disasters at Chernobyl in the Eighties, they have been asked to reappraise it in the light of growing concerns surrounding climate change.

EDF is confident, having taken soundings from institutional investors, that there is appetite for new nuclear projects if the terms and conditions for securing finance are right.

The department for Business, Energy and Industrial Strategy (BEIS), which has had a team of officials working on the RAB models since last year, agrees, according to the consultation paper.

EDF is keen to secure a final investment decision on Sizewell by the end of 2021 or the beginning of 2022.

Pressing the button by that point would enable the company to shift teams from Hinkley to Sizewell, cutting the risk that they will disband during any hiatus.

Last month’s publication of the consultation allows the RAB model to be developed to fit this timescale although a decision has yet to be taken by BEIS on whether it will require full blown primary legislation, which would inevitably prolong the process.

However Tim Yeo, a former chairman of the House of Commons energy and climate change select committee, worries that introducing the RAB model could prove more difficult than its enthusiasts admit.

No simple solution

He says: “It’s complicated and will need lot of work.

“If RAB allows that to happen it’s good but if it just means more arguments that’s bad.”

Alongside the RAB consultation, BEIS announced support for Rolls Royce’s work on developing small modular reactors.

But Yeo, who also chairs the Nuclear Watch Europe thinktank, is sceptical that this new breed of smaller nuclear plants will come on stream in time to plug the looming capacity crunch that faces the grid by 2030.

“They are not going to be a big enough solution in the short term so we still need to press ahead with bigger sites as well,” he says, adding that the UK will require more nuclear power stations than the two in EDF’s pipeline.

Three or four more large sites will be required to deliver the 15GW programme which will be required to fulfil nuclear’s contribution to the 30 to 40 GW worth of ‘firm’ low carbon power capacity that BEIS estimates the UK will need by 2050.

Delivering this scale of programme can only be done if the government is willing to embrace Chinese or Russian bids to build nuclear power stations, Yeo says: “That way you could get a really big cut in prices.”

But the ECIU’s Black says that BEIS estimates suggest that officials have not fully internalised the impact that demand side response or interconnectors will have on supply.

“It’s systems that count. There is a massive amount of evidence to suggest that that is an out of date way to think about this.”