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COSTS TO BUSINESSES & HOUSEHOLDS OF NEW FUNDING ARRANGEMENTS AT HINKLEY POINT: PART II

Various cost scenarios can be run, based on projected compounding rates of inflation and forward base-load electricity prices. However, here a snapshot of the ‘net present cost’ in 1st April 2020 ‘money of the day’ can be calculated simply, if just to give the reader ‘a feel’ of the cost of the arrangements. The calculation is based only on publicly available information. Referencing data freely available online, offered by the Office of National Statistics, the Bank of England and the 451 page contract itself, posted up on the UK Government website here

Some important, certainly wished-for information seems to be missing, unclear or redacted. So the calculation below may not give a completely reliable picture just yet. Although they will hopefully give the reader a good idea of the figures UK consumers could be looking at.  

Let’s consider a successfully-completed project; a twin 1,600 Mega Watt reactor power station which generates electricity at a rate of 3,200 MW over 35 years, 24 x 365 x 35 hours in total, operating on average 91% of the time (the load factor depicted in the CfD contract). The developers, CGN & EDF finally secured a strike price of £89.50/MWh though the prevailing strike price is guaranteed to have rise with CPI, escalating every six months, backdated to October 2012 and compounding thereafter ’til the natural termination of the Contract in 2059/60. In this case, consumers effectively pay to CGN and EDF the difference is between the prevailing strike price (£89.50/MWh in 2012 money) and the wholesale market price for base-load electricity. But since October 2012, the operative strike price has already risen, quite significantly. As of 1st April 2020, it is already calculated to have climbed past £121.50/MWh.  With the contract due to run ’til 2060 and compounding inflation in the interim, the accent Hinkley’s strike price looks set to climb looks a steep one, under all scenarios in fact.  

Base-load prices went on to fall further but even on 1st April this year Forward Season Contract was already languishing at £32.00/MWh on the O.T.C. market. It is important to note that base-load electricity is still being downgraded, regarding by some in trading circles as a ‘residual’ or ‘nuisance’ commodity’ to trade relative to ‘peak-load’ and prized ‘shape’ volumes so the gap between strike and base-load prices may also widen for this reason alone and base-load prices could continue to stagnate and fall in value relative to inflation, whatever the fiscal or monetary environment. Indeed, the gap between the operative HPC strike price and market price is already quite substantial and it could widen in the years ahead, especially if inflationary conditions change at points over the four decades ahead of us. Consequently, the estimated figure calculated, in today’s money (or 1st April, 2020), should be treated with caution, conservative as they are. However, below is one estimate of the direct cost element of Hinkley’s funding arrangements, based just on the CfD contract.  

Scenario calculations are more precise. But to illustrate simply, the cost to UK consumers in subsidising this one power station through the CfD surcharge added to electricity bills can be estimated as:     

(£121.50/MWh – £32.00/MWh) x 3,200 MW x 24 x 365 x 35 x 0.91 (load factor) = £ 79,907,318,400

This estimate is in ‘today’s money’ or start of current tax year 6th April, 2020. By the time the power station comes on-line, likely in 2025, the estimate could be markedly higher; the strike price escalating a further twelve of thirteen times in the interim.

The estimate considers direct funding i.e. through the CFD alone. It excludes any separate taxpayers’ contribution or liability by way of construction costs (circa £25 billion), project default risk, waste disposal and clean-up or plant decommissioning.

Given the further escalation and separate costs questions above, the estimated cost is likely to be a conservative figure. One scenario being modelled just now (a High Case but perfectly plausible) envisages a significant further loosing of fiscal policy and, in particular, monetary policy by central banks in response to the current pandemic, leading to higher inflation which an become difficult to control above 3.5% . Higher CPI rates feed directly into the strike price, pushing the final cost of Hinkley’s price support towards £115 billion by the time the power station is fully online during 2026.    

To the outside world, this order of subsidy might seem a high price to pay for any new power station, barely supplying 5% of national electricity demand on an average basis in this case and inflexible base-load power at that, which will not address the principal security of supply challenge ahead, i.e. to offer both reliable & flexible volumes to manage peaks and troughs in wind, solar and other renewable generation.

The paper does not in any way profess to be ‘the final word on the matter’. Base-load or not,  there is no doubt that the UK needs significant new ‘low carbon’ electricity anyway to replace retiring nuclear power stations. However, given the sheer scale of cost involved in supporting this nuclear and others planned soon, it is vital to keep the debate open.

Certain other contract considerations (e.g. a limited degree of possible profit-sharing or cost-sharing with the developers) may need to be considered too and incorporated in the cost estimates predicted. They will still remain high however. Nit all these details are clear or available from the information available to date but this paper should still give the reader an impression of the cost to expect and the impact on finances or electricity bills. As things stand, it does look like ‘the balance’ in terms of market and inflationary risk has been left firmly with the consumer, who will subsidise this and potentially other EPR1 projects to  2060 or beyond in the case of any second such power station.

It would be fair of the consumer to ask why so high degree of inflation (a 100% quotient in this instance) was used for the contract price indexation formula, rather than a typical varied basket of commodity indices, as is normal for any term exceeding 10 or 15 years, 35 in this case. Generally, the negotiators on the seller’s side push for as high an element of inflation as possible and the negotiators on the buyer’s side seek to keep it to a minimum, who would seek to include indices that are directly related to the commodity they are buying as well as the product they go on to produce with this feedstock. Equally, the unusual was the agreement to allow such indexation to CPI to escalate upwards twice each  year, rather each year which more usual; especially given  such a long period; potentially 48 years in this case over 2012 to 2060 so 96 upwards-only and compounding re-adjustments to the strike price.

Equally to ask why, in the case of the near identical EPR1 project at Olkiluoto  which started construction before Hinkley Point C, was able to proceed although without the same concessions made by the Finnish taxpayer or consumers in terms of their expected scale.

Such questions are important given discussions taking place now with the same developers in respect of a second such power station destined for Sizewell, albeit based on an alternative Return on Asset Base (RAB) model. Although very little information is still available and the actual details are unclear at the moment. In conjunction, such talks will include discussions over a third new-build plant, a ‘first of its kind’ thorium nuclear reactor of Chinese design which CGN wants to take a lead in building at EDF’s Bradwell facility in Essex.

About the Author

Dominic Whittome is an economist with 25 years of commercial experience in oil & gas exploration, power generation, business development and supply & trading. Dominic has served as an analyst, contract negotiator and Head of Trading with four energy majors (Statoil, Mobil, ENI and EDF). As a consultant, Dominic has also advised government clients (including the UK Treasury, Met Office and Consumer Focus) and private entities on a range of energy origination, strategy and trading issues.

Prospect Law is a multi-disciplinary practice with specialist expertise in the energy and environmental  sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, surveyors and finance experts.

This article remains the copyright property of Prospect Law Ltd and Prospect Advisory Ltd and neither the article nor any part of it may be published or copied without the prior written permission of the directors of Prospect Law and Prospect Advisory.

This article is not intended to constitute legal or other professional advice and it should not be relied on in any way.

For more information or assistance with a particular query, please in the first instance contact Adam Mikula on 020 7947 5354 or by email on adm@prospectlaw.co.uk.

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COSTS TO BUSINESSES & HOUSEHOLDS OF NEW FUNDING ARRANGEMENTS AT HINKLEY POINT: PART I

Hinkley Point C (HPC) is a nuclear power station based on the French European Pressurised Reactor design, code-named the EPR1. The project involves the commissioning of twin 1,600 MW reactors which will ultimately deliver a final output of 3,200 MW (3.2 GW).

The plant is being constructed in Somerset by developers, CGN (China General Nuclear Corporation) and EDF. The plant could meet up to 6% of the UK’s electricity needs. However, it should be pointed out that this output is predominantly inflexible base-load which cannot be used to balance swings in demand or to off-set changes in renewable generation. Nonetheless, with seven of the UK’s eight remaining reactors due for retirement soon, base-load as well as peak-load generation will be required, especially where it is ‘low carbon’.

Background

HPC’s building programme has been dogged by delays. Although similar delays have been reported at the two other sites where EPR1 reactors are being built, at Olkiluoto in Finland and at Flamaville in France, both of them started construction before Hinkley and each should have been working by now. Such have been the delays and the extent of cost over-runs at EDF’s Flamaville plant in Normandy that France’s own National Assembly voted this year to block any new projects, in France, based on the EPR1 design. Possibly awaiting an alternative design (code-named the EPR2) which the same French manufacturer, Areva, is understood to be working on; of modular construction and mooted to offer enhanced construction reliability and reduced costs.

The UK meanwhile is believed to be advancing its discussions with EDF and CGN over final consent and government support for a second new-build nuclear power station project, this one at EDF’s Sizewell plant, based on the same EPR1 still under construction at Hinkley.

Subsidy Arrangements

The Hinkley Point C project will include the developers being paid a guaranteed strike price, giving rise to a surcharge added to consumer bills. This is revised every six months but in upwards-only movements, as will be discussed shortly. This direct funding part of the government support is based on the Contract for Differences (CfD). This provides for a surcharge to be added to consumer bills under the 35 year term agreement, payable from the time that the plant starts to produce electricity, a date now expected to near the end of 2025. However, the strike price itself (£89.50/MWh in 2012 prices) is calculable from the date of the original signing of the heads of terms. In other words, the strike price against which the subsidy is calculated (vs. the wholesale market price for base-load) has already started rising, backdated to October 2012, and will continue rising forthwith every six months.

Unusually it was agreed that the operative strike price be linked exclusively to inflation or the consumer price index (CPI). Equally unusually, it was also agreed for the indexation to be bi-annual rather than yearly. Consequently, if HPC were to start generating in 2025/2026 as now expected and it fulfils its 35 year contract term at or around 2060, the strike price will have increased with inflation over 95 times, in upwards-only price revisions, carrying forward and compounding spikes in or periods of inflation along the way.  

CfD – Possible cost to consumers

This article will not detail the various scenarios being modelled and refined just now. However, it will offer the reader a simple estimate, a ‘present value calculation’ if you like, of the expected minimum cost to the UK consumers, or the direct subsidy element of the  Contract for Difference contract which was originally negotiated and, after a rethink, was finally signed off in 2016.

The cost estimate given below is based on a provision calculation only. The figure is also based on a comparatively limited and a ‘historically low’ period of inflation. The final value of the CfD to the developers will remain sensitive to the CPI index, before HPC comes online as well as thereafter.  Just now, our compound inflation model and calculations currently estimate that the extra cost to bills by way of the CfD will be £80 billion, in today’s money.

The initial estimate given looks at direct UK funding only. It does not consider indirect nor unquantifiable costs, such as loan guarantees backed by the Treasury or potential other ‘de facto’ contributions by the taxpayer towards the construction costs or insurance, nuclear waste disposal and final decommissioning of the nuclear power station itself.

Secondary Costs

Of course, the estimate is of the cost of CfD subsidy only. It excludes the actual cost of the electricity generated which will be traded on and repurchased off the wholesale market in the usual way. If we wish to include the ‘final cost’ of the electricity volume and add that to the cost of the price support then the ‘all in’ cost of the project rises to £109 billion. In fact, this second estimate is easier still to calculate accurately because constantly-changing electricity market prices are now absent from the calculation. This ‘all in’ calculation is then a simple case of multiplying the inflation-adjusted strike price (in £/MWh) by the output (3,200 MW) of the power station and by total running time (in hours) of the 35 year contract, adjusted for load factor to be conservative.   

The CfD surcharge is an item that is already present in business and household electricity bills today, providing support for renewable projects generally. However, this quotient will be a ‘step jump’ once HPC and possibly other nuclear plants start up in the years ahead.   

Negotiations with the developers had been temporarily suspended whilst the project was reassessed in 2016 and the agreement was re-negotiated amid industry and also public concern about the perceived ‘overly generous’ terms afforded to the developers. However, the project was finally signed off. Most changes made to the contract were in fact only peripheral and other still not totally clear now.

Following the renegotiation, the strike price was reduced, from £92.50/MWh (at the 2012 base date) to £89.50/MWh. However, it was agreed that the base date (to which the strike price is indexed) will remain the same, in spite of delays and much firmer power market, so operative strike prices will still be backdated to the 4th quarter of 2012, rendering the headline reduction in strike price quite superficial in mathematical terms. More to the point, the bi-annual indexation to CPI provision also emerged from the discussions unscathed before the final contract was signed off.

Part II of this article will put forward a costs scenario analysing the possible costs of the arrangements set out above.

About the Author

Dominic Whittome is an economist with 25 years of commercial experience in oil & gas exploration, power generation, business development and supply & trading. Dominic has served as an analyst, contract negotiator and Head of Trading with four energy majors (Statoil, Mobil, ENI and EDF). As a consultant, Dominic has also advised government clients (including the UK Treasury, Met Office and Consumer Focus) and private entities on a range of energy origination, strategy and trading issues.

Prospect Law is a multi-disciplinary practice with specialist expertise in the energy and environmental  sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, surveyors and finance experts.

This article remains the copyright property of Prospect Law Ltd and Prospect Advisory Ltd and neither the article nor any part of it may be published or copied without the prior written permission of the directors of Prospect Law and Prospect Advisory.

This article is not intended to constitute legal or other professional advice and it should not be relied on in any way.

For more information or assistance with a particular query, please in the first instance contact Adam Mikula on 020 7947 5354 or by email on adm@prospectlaw.co.uk.

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EPR PROJECTS: WILL HINKLEY POINT C MEET ITS MILESTONES?

China recently released a positive update on the second EPR reactor at Taishan, some 90 miles to the west of Hong Kong, with the announcement that it had achieved criticality. This follows on from the first unit becoming operational in December 2018, which marked a world first for the design.

Why is this important?

The EPR design (originally the European Pressurised Water Reactor) is under construction at Olkiluoto in Finland, Flamanville in France and, of course, Hinkley Point in Somerset.

The Finnish and French projects have been subject to significant delays: Olkiluoto 3 construction began in 2005 and was initially due to be commissioned in 2009. However, fuel loading is expected in the near future and power production is expected to start early next year, concluding a 15 year project. In France, Flamanville 3 construction began at the end of 2007 and was due to become operational in 2012. Nevertheless, fuel loading is now due towards the end of this year, 13 years later.

Similarly, construction of the Taishan EPR units began in 2009 and 2010 respectively and were supposed to complete in less than four years each, instead becoming 10-year projects. Therefore, while there have been significant improvements in construction schedules, delays and cost overruns have still been significant.

The nuclear industry is not known for delivering big projects to time and cost. Each of these ventures has had its own reasons for delays and cost overruns.

How does this reflect on Hinkley Point C?

Construction of the two EPRs here officially started in December 2018, following significant groundwork preparation, and the first reactor is expected to be connected to the grid in 2026. This appears to be a more realistic 7-8 year project timescale than the overly ambitious four-years of Taishan and it is to be expected that EDF will apply the learning from its other projects to Hinkley Point C.

Hinkley Point C itself was on track to achieve “Jalon Zero” at the end of May; this being a French term meaning “milestone zero”. This was intended to mark the final pour of concrete to construct the nuclear island on which the reactors will be built, which required some 5.6 million m3 of rock to be excavated and 9,800m3 of concrete to be poured.

Only time will tell if Hinkley Point C will achieve all of its milestones and budgets. In future articles, we will look more closely at the reasons for the cost and schedule overruns inherent in this family of EPRs.

About the Author

Prospect Law is a multi-disciplinary practice with specialist expertise in the energy and environmental  sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, surveyors and finance experts.

This article remains the copyright property of Prospect Law Ltd and Prospect Advisory Ltd and neither the article nor any part of it may be published or copied without the prior written permission of the directors of Prospect Law and Prospect Advisory.

This article is not intended to constitute legal or other professional advice and it should not be relied on in any way. 

For more information or assistance with a particular query, please in the first instance contact Adam Mikula on 020 7947 5354 or by email on adm@prospectlaw.co.uk.

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HINKLEY POINT GO-AHEAD: HAS THE “GOLDEN ERA” IN UK/SINO RELATIONS BEEN MAINTAINED?

The UK government has given the go-ahead for construction of the nuclear power station at Hinkley Point.  Although there is to be no amendment to the commercial terms of the project, to be built by EDF with co-investment from the China National Nuclear Corporation (CNNC) and China Guangdong Nuclear Power (CGNP), there are to be “new rules governing foreign investment in critical infrastructure”.

In undertaking a review of the “public interest” test in the Enterprise Act 2002, determining when Government can intervene in significant deals, the impact of the nuclear programme is uncertain.

We are told that in future there will be:

  • …[a]…”legal framework for foreign investment in critical infrastructure”; and
  • “…additional security scrutiny to which the government plans to subject future nuclear projects…”.

The first of these, whereby the government will in future hold a golden share in all nuclear power projects, is unexceptional.  But of more concern, potentially to Beijing, is the as yet unclear nature of additional security scrutiny.

China agreed to invest £6bn into Hinkley Point so as to be able to build its own reactors in the UK as a shop window for its capabilities.  None of the major components in the Hinkley power plant, all of which have already been procured, will come from China. Should additional regulatory scrutiny restrict China’s other nuclear ambitions in the UK, notably a planned power plant at Bradwell, it could jeopardise the rationale for Chinese investment at Hinkley Point.  EDF has warned that, without Chinese money, it may not proceed with the Hinkley scheme.

Although the concerns of security chiefs and Nicholas Timothy, the prime minister’s adviser, have been addressed with a compromise that avoids an outright block, there is no clarity on the extent to which China is to be encouraged to play a strategic role as an investor in the UK nuclear programme.

Prospect Law and Prospect Advisory provide a unique combination of legal and technical advisory services for clients involved in energy, infrastructure and natural resource projects in the UK and internationally.

This article is not intended to constitute legal advice and Prospect Law and Prospect Advisory accepts no responsibility for loss or damage incurred as a result of reliance on its content. Specific legal advice should be taken in relation to any issues or concerns of readers which are raised by this article.   

This article remains the copyright property of Prospect Law and Prospect Advisory and neither the article nor any part of it may be published or copied without the prior written permission of the directors of Prospect Law and Prospect Advisory.

For more information please contact Edward de la Billiere on 01332 818 785 or by email on: edlb@prospectlaw.co.uk.

For a PDF of this blog click here

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HINKLEY NUCLEAR DEAL: A GOOD MOVE FOR BRITISH NUCLEAR?

The deal has finally been struck, with the Chinese agreeing to fund about one-third of the £18bn cost of EDF’s Hinkley Point C reactor, which aims to be operational by 2025. Prime Minister Cameron announced the “historic” deal, which will see the new station supply enough electricity to power six million homes and create 25,000 jobs. As anticipated, the deal also included investment decisions surrounding the financing of EDFs Sizewell C and a planned Chinese reactor at Bradwell in Essex. But two further pieces of the jigsaw must still be put in place before construction at the Somerset site can begin. These are the Final Investment Decisions by the boards of EDF and CNG, the Chinese partner. However, these are seen as just a formality; it appears unthinkable that they would be anything other than positive given the degree of political commitment.

It is worth noting that the partnership between EDF and the Chinese is nothing new. The French have been involved in the Chinese nuclear programme for some 30 years and are involved in the construction of the Taishan 1 and 2 EPR plants in Guangdong province. The reactors here are of similar design to those at Hinkley Point C, and unlike the projects at Flamanville and Olkiluoto, this project is going very well and is reportedly 40 months ahead of schedule. Something to be said about working with the Chinese?

Prospect Law and Prospect Energy provide a unique combination of legal and technical advisory services for clients involved in energy, infrastructure and natural resources projects in the UK and internationally.

For more information, please contact Edmund Robb on 07930 397531, or by email on: er@prospectlaw.co.uk.

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CHINESE STATE VISIT: IMPLICATIONS FOR UK NUCLEAR STRATEGY

There is much anticipation surrounding the upcoming visit of Chinese President Xi Jingping.

He will no doubt face press coverage on a number of controversial issues, from the ivory trade to human rights. However, the pending nuclear deal between Chinese partners and EDF on the financing of the Hinkley Point C European Pressurised Water Reactor (EPR) is coming under a particularly bright spotlight.

On Tuesday or Wednesday, President Xi Jingping is expected to sign an agreement that will pave the way for EDF’s Final Investment Decision. This may also see funding put in place for a new EDF reactor at Sizewell in Suffolk and a Chinese built reactor at Bradwell in Essex.

Notwithstanding EDF’s construction delays on building similar EPR reactors in Flamanville (France) and Olkiluoto (Finland), the security implications of Chinese written software running the new stations is also raising anxiety in certain quarters. But should we be overly concerned? The Office for Nuclear Regulation will, as part of its independent scrutiny of the construction and operation, be supported by cyber-security experts in analysing the software for suspicious code.

Moreover, would the Chinese hide malicious code and thereby threaten their investment in the UK and its wider nuclear exports markets? Time will no doubt tell, but the risk on our side seems to be worth taking; at least the Prime Minister and EDF seem to think so.

Prospect Law and Prospect Energy provide a unique combination of legal and technical advisory services for clients involved in energy, infrastructure and natural resources projects in the UK and internationally.

For more information, please contact Edmund Robb on 07930 397531, or by email on: er@prospectlaw.co.uk.

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ENERGY NEWS FROM CHINA

 

Jonathan Green, Prospect Law

The CIA estimated that in 2013 China generated 69.1% of its power from fossil fuels, 1.2% from nuclear fuel, 22.5% from hydro-electric plants, and 7.2% from other renewable sources. Although China is the world’s largest user and producer of coal and the world’s largest emitter of CO2 and other greenhouse gases, in 2013 China led the world in renewable energy production. Today that lead has increased.

Since 2009 the Chinese leadership has declared its intention to reduce its carbon emissions by 45% from 2005 levels. The common assumption is that the expansion of renewable energy generation is driven by concern over climate change. This is only partly true.

Perhaps a more important consideration is China’s goal of energy security, and reducing its reliance on imported oil and coal. China has developed the largest high speed electric rail network and is working hard to secure a viable future for electric vehicles. The need to import oil and coal are a strategic weakness which is regarded internally as incompatible with China’s status as the new superpower.

A third factor is the appalling levels of airborne pollution in the major cities. China’s official sensors measure pollution on a scale up to 500, which is known, in classic doublespeak, as the Air Quality Index. The WHO advises 25 as the safe limit, but Beijing regularly deals with levels over 400. People wear masks and schools close. Beijing is now regarded as a hardship posting for expats. Many runners dropped out of the 2014 Beijing marathon when their face masks turned grey. In January this year the readings hit 500, and the US embassy in Beijing even recorded 545. The US government (http://www.stateair.net/web/post/1/1.html) advises that when the levels are between 301 and 500 “Everyone should avoid all outdoor exertion.”

For the Asia-Pacific Economic Cooperation meeting in Beijing last year, factories were closed within a 125 mile radius, banks and schools were closed, public sector employees were sent home, half the cars in the city were banned from the roads, bodies were not cremated, no weddings were licensed, no passports issued, and no fresh produce was delivered to the city. The skies became blue, which the locals called ‘APEC blue’.

In March this year Chinese journalist Chai Jing published an online documentary in China which went from viral internet sensation to being banned in three weeks. Called ‘Under the Dome’, the documentary is a brilliant analysis of the scale of China’s problem with pollution and a clear indication of the depth of anger the new middle class feel about the damage to their health. When questioned about the documentary by a reporter from the Huffington Post, Premier Li Keqiang did not challenge the documentary, and replied:

“I want to tell you that the Chinese government is determined to tackle environmental pollution, and tremendous efforts have been made in this regard. The progress we have made still falls far short of the expectation of our people. Last year I said that the Chinese government would declare a war against environmental pollution. We are determined to carry forward our efforts until we achieve our goal.

We must get the focus of our efforts right. This year our focus will be to ensure the full implementation of the newly revised environmental protection law. All illegal producers and emitters will be brought to justice and held accountable. We need to make the cost for pollution too high to bear. More support, including capacity building, needs to be given to these environmental law enforcement departments.”

China’s energy policies will be crucial in tackling the massive pollution problem. We can expect China’s global lead in all forms of renewable and clean energy use to increase for the foreseeable future.

This is the first of a series of articles on China’s energy sector.

 

Introduction to Prospect Law and Prospect Energy

Prospect Law is an energy specialist law firm which is based in London and the Midlands of the UK. It is a sister company of Prospect Energy which is a technical consultancy company. The two firms provide advice on energy development projects and energy related litigation concerning onshore oil and gas, nuclear and renewable energy schemes for clients in the UK and internationally.

 

For a PDF of the blog click here

For more information, please contact Edmund Robb on 07930 397531, or by email on: er@prospectlaw.co.uk.