How to finance the Hinkley Point C nuclear plant?

The proposed development of Hinkley Point C nuclear electricity generation plant in Somerset, in discussion since 2010 was labelled the biggest white elephant ever by Simon Jenkins in a devastating article in the Guardian this week.

How much electricity does the UK need?

The choice for additional reliable electricity generating capacity is still between continuing to invest in carbon belching coal and gas for electricity, or to invest in carbon-free nuclear. Together they still make up more than 70% of the UK’s electricity generation capacity. Renewables amount to one quarter of the total, made up of the more reliable biomass and hydro on one hand. On the other hand, the remainder of renewable electricity production is intermittent wind and solar power.

elec_gen

Source Office of National Statistics

There is still a need to provide up to 50GW of electricity in peak times (cold winter evenings) to meet demand, although that can drop to 25GW in the summer during the night.  And it could well be that during peak times it is not only dark (no solar power), but that there is no wind and hence no wind power.

At the moment there is no way to store huge amounts of electricity beyond the small pumped hydro stations (about 2 GW for a few hours), so the majority of reliable supply will need to come from coal, gas or nuclear.  In fact, last night solar and wind will only have contributed less than 1%, only about 1/2 a GW of our electricity production just before 8pm last night, when around 35GW of electricity was required in the UK. The wind only became a little bit stronger afterwards, and wind electricity production increased.

So of a total of 5GW installed capacity for solar (at optimal summer sun), and 13GW potential capacity for windpower (at optimal wind-speeds), pretty much none was available last night between 6 pm and 8pm, before the wind picked up slightly.

energymix2

Contributions of nuclear, coal, gas and wind to total electricity generation 26th/27th Sep 2015

Source: Gridwatch

How to build a new nuclear power station?

Britain has not invested in a new nuclear power station for thirty years. It lost all its expertise in that sector. It is still running plant which was designed ages ago, and they are all coming to the end of their economic live. In those 30 years, the Chinese have built about 30 nuclear plants. The French have 80% of their electricity produced by nuclear energy, the rest is hydro-electric power sourced from the foot-hills of the Alps. They are the experts. If we want to buy nuclear, we have to buy from them.

So it is natural that the new design for Hinkley C should come from a French-Chinese joint venture.  So, no argument there. The argument comes over the price and the financing of the energy.

Instead of paying them for the contract of building the plant on completion, the state-owned French/Chinese builders will run the plant as well  and will be paid over 35 years for the electricity it produces, at a rate agreed at £92.50 per MWh (November 2011 price plus inflation, now over £100 already), which is about twice the market rate for electricity.

At a nominal output of 3.2GW Hinkley C will provide about 6% of electricity if it is run, on average, on 70% capacity, as other nuclear plants are. If that is is the case, and Britain in 2024 has a demand of 340 TWh of electricity per year (same as this year), the cost of buying electricity from Hinley Point C would be just under £2bn per year.

So is Hinkley Point C too expensive?

It first seems that it is. Why should we pay twice the market rate for something which we could have for less? The price briefly touched that high level in 2008, but for most of the last 7 years, we have seen a major fall, and then a very slow increase in wholesale electricity prices, with them mainly hovering around £50/MWh. So I have previously (on other blogs) said the idea of Hinley C is bonkers. But is it?

elec_prices

Wholesale electricity prices since 2008  

Source:  energybrokers.co.uk

The marginal cost of something new

If we buy a new car, rather than keep the old one, that is almost always a choice for the much more expensive option. Even if our old car is broken down, we could always repair it, and often it will be cheaper to do that. But we would like the convenience of something new, which is better equipped, more economical, and more reliable and which will impress the girlfriend or neighbour.

For that we will pay a premium, quite a large one, if we buy a brand new car. It might turn out to be twice as expensive to run per year (including depreciation) than the 10 year old car (which is largely depreciated).

Same for nuclear power. If we want less carbon, and reliable supplies, that is the only option.

Design and finance issues

Clearly there are some issues about the reliability of this particular nuclear plant design, from previous experience in Finland and France where the building of this plant has resulted in a right shambles. But that seems to have been overcome in China. But we have yet to see a plant of this type in operation. In addition, the government will take on a large risk to indemnify the providers of finance, which had to be cleared by the EU, should the project be cancelled. A fee of 2.95% will need to be added by the vendors to the cost of the project, as that is the guarantee fee to the government, which will in turn indemnify the providers of finance, should the project be cancelled. And a return on capital of 11% is allowed by the vendors.

But let us assume that £25bn is a rational price for building the plant, and if we pay about £2bn per year back over 35 years via our electricity bills, that will be about 70bn which we will need to pay for electricity.

A large portion of this will be made up of financing the plant. But probably all of the capital will need to be borrowed in pounds sterling by the French-Chinese company constructing the Hinkley C plant., to protect themselves against exchange rate fluctuations.

Let us assume that the money will be borrowed at 3% interest, which is probably the minimum rate for such a long term project. Even at that low rate, over a 35 year term, the interest will add a substantial percentage to the cost of the new plant.

So if interest 3% was paid on the £25bn loan at commercial terms to a bank, annual repayments would make up £1,163 million each year.

If the UK borrowed, at the current minimum interest rate, currently 0.5%, the annual repayments would be £780 million, a saving of £383 million. Over 35 years the savings would be £13.4bn.

If no interest was paid, however, financed by PQE, the cost would be even less, at £714 million a year. a saving of £449 million per year. Over 35 years, the savings would be 15.7bn.

So each year we could save £449 million a year, almost £0.5billion, if we were to finance Hinkley C through PQE. That is about one quarter of the annual payments for electricity, which we said will amount to £2bn.

Or, let us put it another way. If we used PQE to finance Hinkley C, instead of a loan of 3%, electricity produced from there could be 1/4 cheaper. Not double the current market price, but only 50% more than the current market price.

No matter how this plant is financed, it would generate the same amount of additional demand in the real economy, and possibly inflation, if demand for labour and materials was tight. The way it was financed, whether through a loan or PQE, would not make a difference. Financing through PQE would, however, deflate the potential income for the financial sector by the £449 million of interest per year, a saving to electricity users.  A further 2.95% (close to £750m) of the project cost could be saved, as no indemnity to finance providers would now be payable. This loss of income to the finance sector is a saving for the taxpayer.

To summarise, if we want nuclear power, and decide to build Hinkley C, we should finance it through PQE, as that would allow Hinkley C to charge a 25% cheaper price for the electricty it will generate.

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