What's next for the nuclear market after the NAO's latest report on nuclear newbuild?

17 minute read
27 June 2017


One year on from its last report, the National Audit Office (NAO) has released another report on nuclear newbuild . This time, it's fair to say the report probably hasn't done much to sponsor the "greater certainty" mantra.

"We had previously described the need for greater certainty in the government's and regulators' decisions to improve market confidence in the pipeline of investment and contacting opportunities" NAO (2016) Nuclear Power in the UK, HC511 Session 2016-17, 13 July 2016

Today (27 June), The Times reported that the Hinkley Point C (HPC) project is set to be years late and heavily over budget, marking another setback for the UK nuclear industry and it feels apt that this news follows the NAO's report. Here, I take a look at deeper look into the NAO's report and consider the next steps that UK government might want to take.

The headlines and plan B

I'm not going to dwell on the headlines already covered in the press[1]. I'm not going to consider, at all, whether the advance of other energy solutions (e.g. renewable, plus storage) may have now stolen the march on new nuclear.

I will have a quick look at the ways that the Hinkley Point C (HPC) delivery model could have been structured and how follow-on new nuclear in this country could be structured. These are ways which would have increased the certainty of HPC being built and commissioned (read trilemma improved certainty of energy 'security') and would have resulted in my future electricity bills being far cheaper (read trilemma improved 'affordability for consumers').

Since nuclear is a low carbon energy source, satisfying the third leg of the infamous energy trilemma (meeting long term de-carbonisation goals) is implicit in satisfying the energy security leg. And since the Queen's speech has just reiterated the UK's commitment to take a lead in the global response to climate change, how far could we get towards justifying some additional nuclear newbuild by reference to that policy alone?

Putting affordability and strike price aside for the moment, I'll pause to note that the NAO sees a risk that HPC will contribute neither to energy security nor de-carbonisation goals: the government should "maintain and update a 'Plan B' for achieving its objectives in the event that HPC is delayed or cancelled". With further bad news in this same week from South Korea about its future commitment to nuclear newbuild[2], a strong Plan B is possibly now even more important.

Indeed, the precarious position of Westinghouse[3] and uncertainty in respect of the associated North West Coast 'CATO' transmission project[4] puts a big question mark as to whether (and if so "how and when") the NuGen project will ever contribute to our future energy mix. The South Korean announcement will have done nothing to help assuage the fears about the future of this project either.

Last week also saw new questions raised about the deliverability of the Horizon project[5] - at least under the current HPC delivery model.

Plan B is essential if the government is to ensure the lights stay on in the mid-2020s. It is also essential to help protect against the HPC investors having all the commercial ace-cards to renegotiate their current deal.

The government thought risk had been transferred to the private sector, but...

Anyone who knows me professionally will be aware of my personal views on the HPC structure. One of these is that whilst contractually it may look as if construction risk sits with the private sector, it really doesn't.

On this, the recent NAO report[6] has identified four UK precedent projects where the government had contractually transferred risk or cost to the private sector, but ended-up coming to the rescue anyway. This includes the construction of the nuclear submarine facilities at Devonport where the private investors "bore all the risks, including the risk of cost overruns... but when the cost increased significantly the Ministry of Defence had to meet the extra cost".

In the context of HPC, the NAO observed:

"...there is a risk that NNBG will seek further financial support from the government, notwithstanding the contractual terms of the deal"[7]

The government's balance sheet

Was the government unduly fixated on keeping the HPC project off its balance sheet in order to stay within its own fiscal constraints? At the very least, the NAO suggests that on HPC too much emphasis was given to balance sheet (and strategic) implications to the detriment of other considerations, such as cost and value for money:

"The Department and other parts of government were concerned primarily with the strategic ramifications of not proceeding and the benefits of keeping the project off the government's balance sheet. They did not consider sufficiently the costs and risks of the deal to consumers."

"The Department has committed electricity consumers and taxpayers to a high cost and risky deal in a changing energy marketplace. Time will tell whether the deal represents value for money, but we cannot say that the Department has maximised the chances that it will be"[8]

"The Department did not assess the potential value-for-money implications for bill payers of using alternative financing models. Alternative financing models would have exposed the consumers and / or taxpayers to the risks of the project running over budget and increased the risk of the project needing to be on the government's balance sheet. But our analysis suggests alternative approaches could have reduced the project's total cost. The Department did not assess whether the reduced cost balanced against the increased exposure to risk would have resulted in better value for money for electricity consumers"[9]

The NAO goes on to highlight (implicitly considered in the next section, below) the negative cost ramifications to the consumer of structuring the HPC deal to keep it off the government's balance sheet. And all that structuring might have been in vain:

If more than half of HPC's revenues are forecast to be from top-up payments under the CfD then the "project could, however, come on to the government's balance sheet"[10] anyway.

Consider too the balance sheet implications related to HPC's nuclear waste arisings. The Public Account's Committee recently[11] observed (by reference to all the UK government's commitments): "The largest provision is for nuclear decommissioning... [which] includes the cost of dealing with radioactive waste, nuclear fuels and redundant facilities..."[12]. On HPC, whilst much of the decommissioning and fuel management cost risk is allocated to the investors (and mitigated through the establishment of a decommissioning fund), NAO points-out that some material residual risks associated with decommissioning and disposal operations remain with the government[13].

So the blinkered pursuit towards off-balance sheet treatment will result in a much more expensive nuclear newbuild project; one which will cost the consumer significantly more. It will result in a pyrrhic victory where the contractual construction risks seem to have been pushed on to the private sector only to spring-back to the government when the private side either (i) is unable to manage them (see Westinghouse insolvency arising out of the $6.1 billion cost overruns on two US nuclear projects[14]) or (ii) is commercially positioned to renegotiate the terms of that risk allocation at a later date.

The (better) ways it could be done

As a precursor to these next few paragraphs, I should state my basic proposition. If the government wants new nuclear to be in the UK energy mix then the government must enter negotiations (with any UK follow-on new nuclear projects) prepared to accept that the government support required to deliver the project will almost certainly result in the project coming on to its balance sheet (at least during the construction phase). If the government isn't prepared to accept this proposition, then it should go elsewhere (now) to ensure that energy supply and demand can been matched from the mid-2020s. This is not just the case of having a Plan B now, but of implementing it now too.

I would add: other major UK infrastructure projects (such as HS2) are financed on-balance sheet - so this is a matter of choice and prioritisation for UK government.

So is there a better model for nuclear newbuild in the UK? One that will be acceptable to investors, whilst also helping to address all three elements of the energy trilemma? The NAO report considered a few variants:

  • A regulated asset base model providing investors with a return during the construction phase.

    Of course, this was integral part of the success of the Thames Tideway model.

    The NAO report suggests that "providing investors with a return during the construction phase would decrease the strike price by at least £20/MWh" - a strike price range of £63.50 to £67.50 against the HPC strike price of £92.50.
  • As a variant to the above, the government additionally shares some of the construction risks with the investors.

    This was another feature of Thames Tideway model. The NAO report assumes that by the government sharing some of the construction risks this would lower the required rate of return for the investors from 9% to 7%, resulting in a strike price range of £51 - £58/MWh.
  • The government co-invests alongside other investors.

    Thameslink and Eurostar are given as an example of this sort of co-investment. Given the very low cost of government capital, the strike price impact of government co-investment will be heavily impacted by the extent of the government's equity commitment. Based on the UK government investing 25% this results in a strike price range of £69.50 to £76/MWh. At 75% this goes to a range of £25 to £44/MWh
  • The government contracts a company to construct and commission the nuclear plant under a turnkey EPC arrangement under which it agrees to buy the plant at a pre-agreed price at the end of the construction period.

    HS2 is given as an example of this sort of project.

    Depending on various assumptions, NAO models strike prices as low as £11.50/MWh and as high as £52/MWh.

There are other alternative financing options beyond those that NAO has modelled. There are, of course, also many variants on those it has presented - perhaps the most obvious being a RAB-type model under which the government also co-invests. It would also be a reasonable exit strategy for the UK government to assume that it could exit any equity position at value, post-commissioning given that operating, revenue yielding nuclear assets have proven to be of interest to a much wider pool of capital, such as Bruce Power has demonstrated in Canada by attracting long-term investment from the likes of Borealis.

What next?

  1. The government urgently needs to deal with the point post-scripted below.
  2. The government needs to decide, in tandem:
    • How much additional nuclear capacity this country should procure (a capacity commitment), taking into account the comments made in the NAO report (and elsewhere) about alternative sources of affordable, dependable and low carbon capacity and based on an assumption that any additional new nuclear capacity is likely to require delivery on the government's balance sheet.
    • What Plan B is.
  3. For any follow-on nuclear newbuild project the government needs to look at revising the HPC delivery model with a view to ensuring that the capacity commitment is delivered when needed (energy security, de-carbonisation) and at a more affordable cost to the consumer (energy affordability).

Post script...

There are other matters that are integral to the successful roll-out of new nuclear in this country, which have not been considered here. This includes the challenges surrounding the UK's proposed withdrawal from Euratom when it quits the EU.

As a matter of urgency, the government also needs to review and deal with the NAO's suggestion that withdrawal from Euratom might be interpreted as a change of law under the HPC delivery model which, in turn, could result in the adjustment to the terms of the HPC CfD (e.g. price) or even an event which could trigger termination and compensation under the Secretary of State Investor Agreement arrangements.


[1] e.g. Hinkley deal 'cost public £15 billion more than it should', The Times, Friday June 23 2017
[2] South Korea Steps back from nuclear power, Financial Times, June 19, 2017
[3] Toshiba left holding the baby as NuGen partner backs out of Moorside nuclear project, The Telegraph, 4 April 2017
[4] http://www2.nationalgrid.com/UK/In-your-area/Projects/North-West-Coast-Connections/
[5] https://www.nytimes.com/reuters/2017/06/19/business/19reuters-britain-nuclear.html
[6] Figure 12, page 47
[7] NAO, Hinkley Point C, Summary, 12 June 2017, para 20
[8] Amyas Morse, head of the National Audit Office, 23 June 2017
[9] NAO, Hinkley Point C, Summary, 12 June 2017, para 9
[10] NAO, Hinkley Point C, HC40, Session 2017-18, 23 June 2017, para 2.24
[11] House of Commons Committee of Public Accounts, The Government Balance Sheet, Nineteenth Report of Session 2016-17, HC485, 14 October 2016
[12] para. 15
[13] NAO, Hinkley Point C, HC40, Session 2017-18, 23 June 2017, para 3.21
[14] Westinghouse shattered the US infrastructure dream, Financial Times, April 13, 2017

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