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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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