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1) British government subsidy of a forthcoming nuclear power plant at Hinkley Point C

So the British Government will guarantee to Electricite de France that if they commission a nuclear power station (which will actually be built by the Chinese) the British will buy the electricity at a price roughly double current levels. How much does this EdF/Chinese deal smell? Has anyone calculated orders of magnitude on the overt and covert subsidies yet? Bearing in mind far greater contributions in future from annually reliable but daily sporadic renewable sources, are we paying excessive subsidies to keep National Grid’s absolute minimum baseload supplied for 4 decades? And was this First Mover Advantage for EdF and the Chinese, or might we be paying this level of subsidy again and again for an entire nuclear programme? Mark

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Comment

It’s difficult to calculate the subsidies involved and reasonable people can reach significantly different estimates.  But it does seem likely that there is significant subsidy.

The Hinkley Point C strike price of £92.5/MWh, which will apply from 2023, is double current wholesale prices but is conveniently close to the figure DECC published in 2013 for the levelised price of power from a first of a kind nuclear plant of £90/MWh.  But the DECC figure assumes a 60 year operating lifetime for nuclear (compared with 25 year lifetimes for other technologies) and must be based on very uncertain estimates of decommissioning costs.  The DECC figure would be much higher if a shorter operating lifetime were assumed.   Given that the strike price is much higher than current market prices, I consider that there is a strong case for delaying any nuclear investment by several years, with a fall-back to construction of potentially expensive LNG-fired CCGT if significant capacity shortage emerges in the meantime.

In any event, there are certainly questions as to whether the terms of the Hinkley Point deal could be deemed to include an “unjustifiable subsidy” under EU law.  David Howarth, ex liberal democrat MP and law lecturer, also pointed out recently that setting the price paid for the energy produced for such a long term could also undermine the “long-standing legal doctrine that contracts which unduly bind the future discretion of governments to act in the public interest are void as being against public policy”.

I would also have though we should be very cautious about allowing foreign powers to control sensitive technology in the UK. Mike

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I’m still not clear whether Hinkley C is a one-off or the first of a whole programme of nuclear power stations, Mike. If a one-off, it’s a very expensive station that will supply perhaps 4% of the UK’s electricity – a classic white elephant, like Sizewell B. You only get any sensible costs if you can replicate the unit across a whole fleet of them. And if Hinkley C is the first of a fleet, where are the others? Or is Hinkley C the last of somebody else’s fleet? Mark

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The Hinkley Point C plant is envisaged to be one of a programme of at least two plants as the strike price for Hinkley Point C falls slightly (by about £3/MWh from memory) if a second plant is constructed.   But, given UK planning rules and limited public acceptance of nuclear, it seems unlikely that there will ever be a significant fleet of similar plants in the UK.  The DECC cost estimates referred to above are for construction of the first of a kind plant in the UK and include allowance for transfer of international experience (presumably French experience) of constructing and operating similar plants.  Mike

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On 8 October 2014, the European Commission approved the state aid underpinning the Hinkley Point C deal with minimal changes to the commercial terms of the deal. In particular, the strike price is unchanged and  it seems that the main change is a tweak to the gain share arrangements where: (i) savings made on the construction of Hinkley Point C; and (ii) on project out performance or equity sales that increase investors’ realised equity returns above the base case are shared with the tax payer.  As quoted in the Financial Times, 60% of realised returns above 13.5% will now revert to the tax payer as opposed to 50% of realised returns above 15.0% in the original deal. I still consider the commercial terms remarkably generous. Given the initial reactions, there may yet be legal challenges not least, potentially, by other EU states – for example, Austria has indicated that it is considering bringing suit against the project.  Mike

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So it’s now June 2015 and EDF has still not committed to construct Hinkley Point C.  Further delays have emerged for at least three reasons: EDF is seeking indemnification from the effects of Austria’s challenge to the European Commission’s approval of the state aid to the project; EDF has seen its profits fall considerably in 2014 not least because of issues with its existing nuclear reactor fleet; and EDF has been having difficulties negotiating with its two Chinese partners.   To nobody’s surprise, the Chinese, who were initially being presented as purely financial investors, have now signed agreements with EDF to provide equipment for the plant.  Further there have been strong rumours that the Chinese are seeking to link their participation in the Hinkley project with acquisition of the rights to develop the Bradwell nuclear site.  These latter developments worry me considerably as I simply do not trust any Chinese quality guarantees.  Mike

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Has the time come to abandon Hinkley Point C?

In what could be seen as a lack of confidence in its European Pressurised Reactor (EPR) design, EdF is working on the design of a “new model” EPR which it hopes will be ready for ordering in five or six years.

Falling fuel prices and falling costs of other technologies mean that the proposed EPR at Hinkley Point C is increasingly being seen as an expensive white elephant.

  • In a recent report, HSBC Bank analysts see “ample reason for the UK Government to delay or cancel the project”. The report argues that the justification for the plant is “receding” and that the strike price is very difficult to justify because the UK’s energy consumption is falling and increases in interconnection capacity mean we could import energy much more cheaply than generating it at Hinkley Point.
  • Even nuclear enthusiasts, such as David Howell former Conservative Secretary of State for Energy, have called for cancellation of the project.

Delay and cost over runs caused by technical problems and tightened safety requirements for the three EPRs under construction in Finland, France and China have made it impossible to get private investors in EPRs. This has strengthened the hand of the (state-owned) Chinese investors in the proposed EPR at Hinkley Point which have obtained further concessions from the UK government. The latest news is that the UK has provided a further £2 billion government guarantee for the Chinese loans and has acquiesced to Chinese development, construction and operation of a follow-on nuclear plant to showcase Chinese technology at Bradwell. What could possibly go wrong?

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The end for Hinkley Point C? 

Further to the previous comment, now in February 2016, EDF seems unable to commit to complete Hinkley Point C.  Informed opinion suggests increasingly that the project is becoming unsupportable, as examples:

  • In a recent Radio 4 interview, David Howell suggested that, given the well documented problems with the design,  Hinkley Point C may be the last of a line of EPRs rather than the first of a fleet of EPRs and that investment in smaller capacity plants would be less risky.
  • A recent article in the Financial Times ended with the paragraph “Britain is saddled with the worst of all worlds. The government has effectively written the French a long-dated option to sell it unproven technology at an extremely generous price. Politically painful it may be, but the case for halting Hinkley Point C is becoming hard to refute.” http://www.ft.com/cms/s/0/9d484f08-d63c-11e5-829b-8564e7528e54.html#axzz41Y2Xo1M2

With EDF struggling on several fronts – its share price has halved in the past year so that its market capitalisation is less than the proposed investment in Hinkley – it may yet throw in the towel.  In my view that would be a good outcome. Mike

2) Is retail competition effective in the energy sector?

Once again we are seeing retail energy prices responding slowly to falls in wholesale energy costs.  As usual the big energy companies claim this is because much of their wholesale energy purchases are made under term contracts.  But this rarely seems to mean that retail energy prices respond slowly to wholesale price rises.  A more likely explanation is that the market is not working effectively: when input costs rise, most (or all) energy suppliers increase retail prices to maintain margins and when input costs fall most (or all) energy suppliers feel little competitive pressure and tacitly collude to maintain retail prices and increase margins.

What is to be done?  The Labour plans for a price freeze seem impractical. Do we need to regulate retail margins?

Mike

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A wasted opportunity

On 10 Mach 2016, after nearly two years of investigation, the Competition and Markets Authority (CMA) set out its provisional decision on remedies needed to reform the energy market, open up competition and help customers get a better deal from their energy suppliers https://www.gov.uk/government/news/cma-sets-out-energy-market-changes.    It is a wasted opportunity.

In my view, in seeking to address market failure, mindful of its latest strategic steer from Government, the CMA has placed undue emphasis on engendering further competition rather than on increasing regulation. In taking this position, I disagree with a collection of previous sector regulators who seem to have been unduly influenced by the industry. https://assets.digital.cabinet-office.gov.uk/media/56b9d96ced915d10bd000008/Mr_Stephen_Littlechild_et_al_submission_February_2016.pdf

The CMA acknowledges excessive profits have been made in the gas and electricity supply businesses, mostly through overcharging loyal customers on standard variable tariffs (which comprise some 70% of the residential market for the big 6 suppliers). But the CMA believes that this can best be addressed by seeking to modify the behaviour of such customers to encourage switching rather than by seeking to modify the behaviour of the supply companies which abuse their loyalty.

Nevertheless, the CMA attempts to distinguish customers with pre-payment meters,“pre-payment customers”, from other residential customers on the basis that pre-payment customers are less able to benefit from competition because it is “more difficult for their suppliers to compete, more difficult for such customers to switch, and they have far fewer tariff choices” and the CMA proposes the introduction of transitional price controls the pre-payment market . I do not find these arguments for distinction sufficiently compelling: if transitional price controls are necessary in the pre-payment market then they are also necessary in the remaining residential market.

Mike