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Briefing: European Commission decision on UK state aid for Hinkley Point C nuclear plant

Energydesk
License: All rights reserved. Credit: Wiki

The European Commission (EC) has delivered a fiercely sceptical initial take on the UK Government’s deal with French state owned EDF to build the first new nuclear reactor in the UK for a generation, concluding the measures definitely categorise as state aid.

In it’s initial analysis - published on the commission website  - the EC suggested that the deal may not be proportionate and risked substantially over-compensating EDF. Indeed the commission suggested additional support to EDF (on top of market prices) could wind up between £5bn and £17.6bn (in NPV terms, a variation of £13bn).

The commission has now launched a full investigation into the package of measures supporting Hinkley including an investment contract providing a  fixed price for power, guarantees for lending to the project and political guarantees.

The UK government hopes the EC will report in the summer. However the sceptical nature of the initial analysis suggests the EC will not approve the deal without major changes.

In particular the commission is fiercely critical of the Contract for Difference (Cfd) awarded to Hinkley. If this is not allowed it could undermine the entirety of the UK’s Electricity Market Reform (EMR) package.

In particular the commissions says (everything not in bold or italics a direct quote):

The support may be needless

Private investors are forecast...  to invest in nuclear energy by 2027 and by 2030 respectively in the absence of CfDs or Investment Contracts

But is quite expensive 

The measure, moreover, could hardly be argued to contribute to affordability – at least at current prices, when it will instead and most likely contribute to an increase in retail prices.

The NPV of difference payments, which is the most direct measure of the overall amount of aid disbursed, is highly sensitive to wholesale electricity prices and discount rate assumptions. In particular, with a price of GBP 89.50 per MWh and everything else being equal to NNBG's baseline scenario, the (post-tax, nominal) NPV of difference payments is GBP 4.78 billion when using the medium prices of the UK notification forecasts and assuming rising carbon prices ("Central fossil fuel price and rising carbon price"), GBP 11.17 billion when using the medium prices of DECC's forecasts ("DECC central"), and GBP 17.62 billion when using the medium prices of the UK notification forecasts and assuming constant carbon prices ("Central fossil fuel price and constant carbon price"). In other words, the overall amount of aid can vary by as much as GBP 13 billion depending on the assumptions taken. 

But investors are protected from risks with a guarantee 

The EC isn’t convinced the UK is charging enough for this guarantee,

The UK claims that NNBG will pay a commercial rate for the guarantee, however this cannot be verified at the moment, because no data are available on the guarantee, and because it is not clear that a definite benchmark exists….  the current approach seems lenient and incomplete.

Which means that along with the investment contract the UK may be paying too much for the plant - because EDF can borrow money more cheaply

Based on the information set out above, the Commission considers that NNBG might face a lower cost of capital than the one proposed by the UK, as a result of the combined effect of the credit guarantee and the CfD.

Which doesn’t just protect investors, it turns out EDF is also protected by the UK taxpayer

Moreover, the debt guarantee referred to in the Notification seems to differ from ordinary debt guarantees in that it would be drawn before equity, apart from equity already spent [for example in construction]

All of which means the CfD and the guarantee could overcompensate EDF at the expense of the bill payer or taxpayer 

Depending on the evolution of wholesale electricity prices in the post-CfD period, NNBG’s profits might be substantially higher than those resulting from the negotiated rate of return.

In particular, the Investment Contract might result in a substantial transfer of wealth from consumers to NNBG if the actual cost of capital for nuclear energy turned out to be lower than the one the UK authorities have  negotiated.

The terms of the Investment Contract communicated to the Commission do not contain a correction mechanism that would take account of the effect of developments after the end of the CfD in order to ensure that no overcompensation has taken place overall.

As the Investment Contract does not contain any correction mechanism, it does not account for that uncertainty and does not ensure that the even for the duration of the Investment Contract, the project will not yield more than a reasonable rate of return on capital.

This could be more of an issue because there wasn’t a tender for Hinkley 

From this perspective, the Commission notes that tendering for low-carbon generation sources in a technologically neutral does not appear to have been considered as a realistic alternative… The lack of a  tender could also lead to violation of Article 8 of the Electricity Directive 2009/72/EC. The Commission would require further clarification in this respect.

The UK has claimed it needs the deal to keep the lights on - the commission isn’t convinced

 It appears difficult to argue that the measure can help the UK achieve security of supply, given that the plant will not be operational before 2023.. ) and that capacity levels are forecast by Ofgem to be relatively low before 2020.

It also isn’t sure it’s the only way to decarbonise the power sector and, did the UK government actually commit to that anyway?

Firstly, the UK argues that the emission level of 220g of CO2 per kWh in 2030 is not in line with their objectives in terms of decarbonisation of the electricity system. However, such an objective has not yet been set.

The measure is argued to contribute to the objective of decarbonisation, but it would merely do so on a different time scale compared to the one which would be provided by the market according to DECC’s own forecasts

The Commission notes in this regard that a support mechanism which is specific to nuclear energy generation might crowd out alternative investments in technologies or combinations of technologies, including renewable energy sources.

The Commission notes that the UK has not taken into account future interconnection capacity in its modelling work, based on the fact that it believes that the flows will be difficult to predict.

So the commission concludes the package, especially Contracts for Difference, could severely distort the market and take a huge amount of risk away from EDF 

The Commission believes that such an instrument is capable of severely distorting market dynamics, precisely because it shields the beneficiary from risks which other market operators need to face.  If the CfD is provided together with a credit guarantee, in addition to a compensation for political risk and the indexation of the cash flows to the consumer price index, as the UK intends to do, it can be safely concluded that the activity undertaken by the beneficiary, NNBG, is not far from being risk-free at the level of operations. NNBG is left with some of the construction risk, but as noted above it appears to have a […]-year window to complete construction.

Ultimately it’s not sure nuclear deserves state aid

It is not clear to the Commission that nuclear technology is immature enough to warrant State aid, or that it is characterised by specific market failures or other features which make State aid in the form of revenue support, or revenue certainty, necessary

However at the same time the Commission understands that the EPR technology power plants in Flamanville and Olkiluoto have been undertaken without any support. The Commission cannot at this stage explain why the HPC project should be fundamentally different from the two EPR plants currently being constructed.

If aid is given the commission suggests it will not accept operational aid - with a contract for difference.

However, to the extent that any such market failure arises, the Commission would in principle consider that the provision of a credit guarantee could address it, and in fact might remove altogether any existing market failure in investments in nuclear energy, in particular in the post-construction period and when the plant becomes operational.


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