While the Coalition partners squabble over the Energy Bill, civil servants are already negotiating with EDF Energy over the price of new nuclear reactors at Hinkley Point. The government is planning to issue long-term contracts to anyone building low-carbon electricity infrastructure: new nuclear reactors, wind turbines, solar installations, etc. Central to this will be a strike price – a guaranteed price for electricity that starts out above the market rate and is supposed to reflect the levelised cost of the specific technology.
The energy minister John Hayes expects to publish the strike price for Hinkley Point by the end of the year. But there’s much more to a contract for difference feed-in tariff than the strike price. It’s the small print that will determine whether households and businesses are being ripped off or if government secured a great deal for billpayers. Grab your best fag packet, because here are three questions to ask.
Is the strike price in today’s money – or the year generation would start?
Strike prices are expressed in real terms and would rise in line with the Consumer Price Index (CPI). You can’t build power stations overnight, so if the strike price is expressed in 2013 terms it will have risen by the time the first megawatt of electricity is generated. If the first reactor starts generating electricity in 2020, then a strike price of £100 / MWh in 2013 prices would have risen to around £115 in 2013 prices (assuming annual inflation of 2%).
What percentage of the strike price is getting inflated?
The government doesn’t necessarily intend for the whole of the strike price to rise in line with inflation. Obviously, the greater the proportion that rises with inflation, the greater the benefit to the operator. It is not yet clear whether there will be a standard percentage or if each contract will have a different percentage. If, in the above example, only half of the strike price were to rise then EDF would receive £107.50 per megawatt hour in 2020 (in 2013 prices).
What is the capital cost and how long is construction assumed to take?
This is unlikely to be on the face of the contract but it’s probably the most critical question to ask. EDF will only say that it is in the process of “cost discovery”, but rumours range from £4.5 billion to £7 billion. Equally unclear is how long it would take to build the reactor: five years is a generous estimate, seven a more realistic one. The Flamanville EPR is expected to take nine.
The two factors are inter-connected: the longer a reactor takes to build, the more it will cost. Nuclear is capital intensive, so the rate of return decreases sharply as capex rises. One calculation doing the rounds suggests every £500m increase in capital cost brings the rate of return down by .7% and each year of delay reduces the IRR by .3% or .4%. That’s an awful lot of money given the scale of investment.
How much money does EDF stand to make?
Which brings us to the really big question, which is: what rate of return would EDF get if it built Hinkley C?
This billion-pound question depends on the strike price, the outturn capital cost, how long it takes to build the plant, the percentage of time that the plant is operational for and how the project is financed. Hinkley Point is expected to have two EPRs, totalling 3.2GW of generating capacity and costing between £9 and £14 billion. That’s a lot of income potential – if EDF manages to swim against the tide of history and build on time and to budget – and avoid the outage problems that have plagued Hitachi’s ABWRs in Japan.
EDF has the option, on paper at least, of borrowing from capital markets or of financing the project from its own balance sheet. Delays to the Energy Bill are already said to have driven up the cost of capital by 1% (and that’s before the counter-party issue is resolved). On-balance sheet investments normally expect higher rates of return because there’s no interest to pay but EDF may have no choice if the market refuses to lend.
And finally...
Ultimately, whether Hinkley is the right place for EDF to spend its money may depend less on the rate of return than on the policies of its majority shareholder, the French government.
It's possible that EDF and Areva would be asked to put French industrial policy before profit, on the basis that a successful first project at Hinkley Point would unlock investment in subsequent reactors. (Of course, a project riven by delays and cost overruns would have the opposite effect.) That would be a big gamble for Hollande to take, especially as his government is also grappling with rising fuel bills and a national debate about France's energy future.
