‘As part of our plan to help Britain succeed, after months of negotiation, today we have a deal for the first nuclear power station in a generation to be built in Britain.’ That was David Cameron in October, announcing that his government had reached an agreement with the French power giant EDF over the construction of two reactors at Hinkley Point in Somerset. The Prime Minister must have a funny idea of success, because the more we learn about the Hinkley deal, the more we can see that it is one of the worst ever signed by a British government.
Even the European Union can smell a rat. Last month, the European Commission published an initial report suggesting that the contract involves illegal back-door government subsidies to EDF, and will now carry out a full investigation. But it is already obvious that Hinkley is not a good deal for Britain.
According to the Hinkley contract, EDF and its partners will construct two reactors for £16 billion — that’s £8 billion per 1,600 mega-watt plant. The reactors are supposed to be up and running around the end of 2023. Either of these two key numbers — the £8 billion per reactor or the nine-year construction period — should have been enough to kill the project. Taken together they should have made EDF’s offer unthinkable. At £5 million per MW of capacity, Hinkley will be, by my reckoning, the most expensive conventional power station in the world. By way of comparison, a new gas-fired power station costs around £0.7 million per MW and takes two years to build. The price and the time needed for Hinkley have somehow doubled. In the initial proposal, the estimate was that it would cost less than £4 billion per reactor, and take about five years.
Full details of the commercial terms of the contract have not been released by the government, but EDF did provide its shareholders with some key details, which mean we can estimate its probable profitability. The numbers are eyewateringly attractive for EDF and its partners; not so good for the national purse.
The government has guaranteed that EDF would be able to sell the power from Hinkley Point at a price of £92.50 per MWh, which compares to a current wholesale power price of around £50 per MWh. You might think that, given inflation, such a hike is not so terrible. Think again. The £92.50 is in 2012 money: it will be inflated by the Consumer Price Index. If we assume that CPI inflation averages 2.5 per cent over the next decade, the price EDF will be guaranteed for its output in 2023 will be more like £121 per MWh, or £130 per MWh if CPI averages 3 per cent. Amazingly, the indexing continues throughout the 35 years of the contract. So by 2030 the guaranteed price would be about £150 per MWh.
Hinkley Point should be able to generate very healthy profits for EDF and an extremely attractive dividend stream. We calculate that Hinkley Point will produce annual profits before tax of up to £2 billion in its early years, rising to £5 billion by the end of the 35-year contract. Bear in mind that the combined operating profit of all the power stations owned by the so-called ‘big six’ energy companies in 2012 was only £2.1 billion.
The contract is structured so that EDF can recover the full value of its investment over the 35 years, even though the power station is likely to have an asset life of 60 years. We calculate that EDF and its partners should be able to extract £65 billion to £80 billion in cash dividends in addition to paying off all of the debt taken on to fund construction.
Based upon the financial information released by EDF, we calculate that the project should be able to earn an average annual return on equity of between 25 per cent and 35 per cent. As the European Commission pointed out, this seems a very high return given EDF has a government guarantee that it can sell its power at twice the current market price and is receiving £10 billion of financial guarantees, also from the government.
New nuclear stations don’t have to be so expensive. Late last year, Finland announced a deal to build a reactor that will be paid a power price of ‘less than £43 per MWh’. That is a staggering £50 per MWh less than Hinkley Point will be paid.By providing both a certain power price for Hinkley and £10 billion of financial guarantees, the government is effectively reducing EDF’s construction and operating risks by transferring them to the consumer and the taxpayer. Yet EDF is being allowed to earn the sort of high returns that a private company would expect if it was bearing all of those risks. This a clear case of socialising risk and privatising profits.
So why has the UK government agreed to buy electricity at twice the current market price and twice the price that Finland will pay? The main culprit is the 2008 Climate Change Act. This requires (among many other things) that the UK reduces its greenhouse gas emissions by 60 per cent by 2030. To achieve this, the government aims to move the electricity sector at breakneck speed from one that is largely based on fossil fuels, with some nuclear and some renewables, to one that is overwhelmingly based on renewables and nuclear.
To hit this self-imposed deadline, the government has decreed that a new nuclear programme must begin as early as possible, with the first reactors coming ‘on stream’ in the early 2020s. There was only one developer that could fill the breach in time — EDF. And EDF just happened to be offering the most expensive nuclear reactor in the world. If the government could have just waited a couple of years, it could have organised an open competition between various developers and thereby achieved a price much closer to that which Finland has agreed.
To meet an arbitrary environmental target, then, the UK government seems willing to lock future UK consumers into some of the highest-priced electricity in the world. The government is betting that world gas and oil prices will more than double during the time that Hinkley Point is under construction. If they don’t, it’s going to look like financial insanity.
Parliament has been promised the chance to scrutinise the Hinkley Point contract. If MPs do their job effectively, it is almost inconceivable that they will conclude this deal provides value for money. Our politicians should throw this contract out, and put in place a new nuclear programme based on open competition between multiple developers.
Peter Atherton works for Liberium Capital, which sponsored the Spectator conference ‘How do we Stop the Lights Going Out?’
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