Will the price be right?

Few companies are even contemplating building new nuclear plants in the UK, and without the right strike price, the field could be reduced to zero. By Nigel Hawkins

Following the Department for Transport’s disastrous handling of the West Coast Main Line franchise, there will be some very nervous officials at the Department of Energy and Climate Change (Decc) as they attempt to determine appropriate strike prices for output from new low-carbon power plants.

These figures will form the core of Energy Market Reform (EMR) policy, whose legal backing – the Energy Bill – is beginning to wend its way through the parliamentry proceess. Its complexity is staggering and it will be subject to many amendments.

The nuclear strike price figure is crucial in determining whether new plants are built in the UK. If too low a figure is prescribed, potential investors – in essence, EDF – will walk away. If it is set too high, the UK consumer will be paying over the odds for expensively generated nuclear power.

Hence, this price-setting process, which also encompasses new renewables generation, will be pivotal in framing the UK’s future energy policy. Otherwise, it might constitute an unhealthy gamble on new gas-fired plant with all the attendant gas supply risks.

Recent European Union nuclear projects have suffered from serious cost and time overruns, which bode ill for the UK’s nuclear new-build programme, even if the traditional first-of-a-kind excuse is pedalled endlessly by vendors.

Finland’s Olkiluoto project has fallen way behind as costs have soared. EDF’s key third-generation project at Flamanville has suffered similarly. A figure of around €8.5 billion (£7.4 billion) is now being quoted as the final cost of this 1,630MW plant. It, too, is way behind schedule.

Of course, the Fukushima disaster – and its global safety implications – has pushed up nuclear costings, along with other factors. But for EDF to proceed with its Hinkley Point project, an attractive strike price will be vital. Not only is EDF’s French business struggling as regulated electricity tariffs are depressed, but – with net debt of around £35 billion – its balance sheet is anything but strong, despite the French government’s c84 per cent shareholding.

Moreover, Centrica’s confirmed withdrawal from UK nuclear new-build has seriously dented any remaining confidence about the financial case for new nuclear investment.

Significantly, after the exit of Eon and RWE from the Horizon consortium, Japan’s Hitachi is the only other nuclear company that may invest in new UK plant. Its boiling water technology is impressive but it is somewhat of a “Johnny-come-lately” to the UK’s nuclear new-build scene.

Central to the finances of new low-carbon plants will be the various Contracts for Difference (CfDs), under which payments will either be made or received by generators. These payments will comprise the difference between the reference price per megawatt-hour (in essence, the market price) and the predetermined strike price, which will be indexed annually to the CPI inflation rate.

As such, when the strike price is above the reference price during a settlement period, the CfD counter-party will be obliged to make payment. Similarly, when the strike price is below the reference price for a settlement period, the generator will be required to make payment. Differing figures will apply to intermittent power generated by renewable plants – which will have 15-year CfDs – and baseload output from nuclear plants.

Within the basic premise of setting a floor to underpin the generation price for new nuclear, without which it would probably be unfinanceable, there is a raft of other issues, some of which will be subject to amendment as the Energy Bill goes through the legislative process.

Back in 2008, EDF forecast that its production cost for nuclear new-build would be around £45/MWh, which is broadly equivalent to around £65/MWh today, with some adjustments including inflation. EDF’s UK chief executive Vincent de Rivas recently suggested that a strike price of below £140/MWh was expected – in many people’s minds, “below” meant “well below”.

At the other end of the spectrum is SSE’s pugnacious chief executive, Ian Marchant, who recently announced his forthcoming retirement. His view of a fair strike price was very different. He stated in a Daily Telegraph article that “as a country, we should walk away at anything over £90 per MWh, if not less”.

When comparing – and contrasting – EDF’s two per MWh estimates, Marchant also addressed the impact on consumer prices. “The difference between paying £65 per MWh for new nuclear versus £140 per MWh for new nuclear, assuming we decide to build two reactors, will amount to over £2 billion each and every year. That is around £70 for every household on top of the current electricity bill.”

These are chunky numbers, which only goes to underline the overriding importance of the strike price decision that will be announced by Ed Davey, secretary of state at Decc.

Despite the absence of reliable information, recent indications suggest the government may have narrowed down its base price range to between £90 per MWh and £110 per MWh. Clearly, EDF will be arguing for the highest possible figure, all the more so given its weak financial performance, especially in France – and commensurate with the considerable investment risks that it would be taking.

The government, for political reasons, will be keen to keep the strike price in double figures rather than breaching the £100/MWh threshold. Moreover, under this scenario, it would be set at a slight discount to its long-term £100/MWh offshore wind cost target.

Indeed, the chief executive of the Energy Intensive Users’ Group, Jeremy Nicholson, says: “It would be difficult to justify a strike price over £100’/MWh as representing good value for money.”

Of course, ministers may be so worried that EDF will simply walk away that they feel constrained to agree a strike price of over £100/MWh. However, it may be some time before the actual strike price is confirmed. There will be many conditions attached to it, which may include underwriting by the government.

Neither is it clear for for how long nuclear new-build operators will benefit from the effective underpinning of its supply price – the period may exceed 30 years. In time, the theory goes, once new nuclear plants become heavily cash generative, they should be able to make healthy inroads into reducing their accumulated debt.

Undoubtedly, the next few months will be a testing time for the UK energy sector and specifically for EMR. They may determine whether nuclear power in the UK eventually disappears, as is seemingly its destiny in Germany, or has a Phoenix-like rebirth.

Nigel Hawkins (nigelhawkins1010@aol.com) is a director of Nigel Hawkins Associates which undertakes investment and policy research

This article first appeared in Utility Week’s print edition of 1st March 2013.

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