Kow-towing: politically risky and economically stupid

Today the UK government will sign declarations with the Chinese, asking them to build and finance our nuclear power stations, high-speed railway lines and other infrastructure. These are potential investments of up to £100 billion. The cost: we will have to become “best friends” with a totalitarian regime. A regime which only a few years ago froze us out completely for a couple of years, because David Cameron had the temerity to meet with the Dalai Lama, the leader of China occupied Tibet.

The aim of foreign policy is to stand up for our national interest.This kow-towing, also known as the Osborne doctrine is nothing of the sort.  We are having a country build our strategic electricity supplies, which a few years ago would not even speak to us? Have we gone completely bonkers?

Political risks

The political risk is the inability to take a stance against China, which is aggressively pursuing its military dominance in South East Asia, for example. This is clearly against the interest of the UK’s main ally, the USA.  We are restricting our ability to criticise China from now on, as the Chinese might turn around and stop building our power station, or stop it from running, once it is installed.

I will come back to the political risks in another post, but first let us try to make an economic case, and the alternatives.

The case for engineering expertise

Despite of the political risks, that is not to say that Chinese expertise and know-how in building nuclear power stations is not welcome. Chinese engineers, who built 28 plants in China in the 30 years in which the UK ran down its old plants, will the be world experts. Their help is needed, if the UK is to build its own nuclear power station.

The case against Chinese financial involvement

But to ask them to finance and build power stations by themselves here in the UK is really mad. Allegedly, the Chinese have a lot of money to finance our infrastructure. “A jolly huge amount of money”, as John Humphries of Radio 4’s Today programme said yesterday. I beg your pardon?

Do they? The Chinese are on average as wealthy as the Romanians. Their GDP per head is about the same. We would never think of Romania giving us the finance to build our infrastructure, but for the Chinese it is not supposed to be a problem? This is simply nonsense. But comments like this pass nowadays as thorough analysis in our broadcasting studios.

One thing is true, though. The Chinese run a current account surplus with the rest of the world, as they are exporting more than they are importing. So, yes, they have foreign currency earnings with which they might want to buy foreign assets. Traditionally they bought $ denominated government bonds. But increasingly the Chinese are looking to buy real assets, for example in Africa, in real estate, or in strategic industries.

But Germany has a current account surplus which is much larger (as a percentage of GDP) than the Chinese. Yet, the Germans are not queuing up to invest in UK infrastructure. So what is the obsession with the Chinese?

The financial costs of the £25bn Hinkley C nuclear power project

All these political considerations should perhaps not really be a problem, if we obtain cheap electricity through the contract, if everything “works out” politically. In other words, let us not worry too much about it, let us hope for the best, and enjoy the cheap electricity. Hinkley C is the first such nuclear power venture.

Currently the cost of the Hinkley C project to the electricity consumer is around £2bn a year, based on the agreed electricity buying price (twice the current market price) and the estimated amount of electricity for the Hinkley C power station. Hinkley C which will be 1/3 owned by the Chinese, with a further 2/3 being owned by the French state owned power companies.

Please look up any mortgage calculator, and try to estimate for yourself how much it would cost the UK if we were to build it ourselves and borrowed £25bn on a repayment basis over 35 years. Let us say the UK commissioned and ran, as the project manager, the building of Hinkley C, which would be delivered as a turn-key project.

Option 1: The UK asks the builders to build the nuclear plant, buys it for £25bn, and borrows for 35 years at 2.5%

Annual repayments over 35 years: £1,070 milion per year

Option 2: Same as Option 1 but government borrows at cheapest short term interest rate (currently 0.5%)

Annual repayments over 35 years: £780 million per year.

(Rationale for short-term borrowing: Although it is a 35 year project, it is sensible for the UK to issue cheaper short term debt, which it can always roll over. There is a risk that interest rates will rise, but they will only do so if there is inflation, which will reduce the real value of the debt. Short-term borrowing and roll-overs are therefore the most sensible way to finance ANY government borrowing. This would protect the project against deflation risks, too)

In addition to Option 1 and Option 2, the UK would have the cost of running Hinkley C (employees wages, mainly) which would add perhaps £10 million to the annual cost, (1,000 employees at £100,000 per year) plus the cost of the uranium fuel (£5 per MWh) (another £100 million per year). Plus the cost of plant maintenance.

Option 3:

In comparison, the all-in cost of Hinkley C is estimated to be about £2bn a year, based on a contract to buy electricity at £92.50 per MWh (2011 prices plus inflation) for the next 35 years. This is the contract currently on the table which will be signed.

So we have a cost of Hinkley C of either:

Option 1: £1,180 million per year (1,070m capital borrowing cost, 10m labour, 100m fuel)

Option 2: £890 million per year (780m capital borrowing cost, 10m labour, 100m fuel)

Option 3: £2,000 million per year (all in cost)

Not surprisingly, because the UK does not want to borrow £25bn construction cost, it will pay instead about twice the amount of money for its electricity at Hinkley C. The only option on the table is currently Option 3.

Going for Option 1 would result in a 40% saving, going for Option 2 would result in a 55% saving. (Although plant maintenance costs are not included in Options 1 and 2.)

Sadly,  Options 1 and 2 are not even being discussed.

Summary

Hinkley C is the most expensive power station ever being constructed anywhere in the world.

The UK could borrow the money cheaply, but will not, as that would increase the deficit.

The fact that it will be financed by the French/Chinese, who are guaranteed 11% return on equity, will make it extremely expensive.

The UK will become politically dependent on the Chinese, with whom, following the Osborne doctrine, it will have to stay “best friends” to ensure the UK’s strategically important electricity supply will be built.

The UK will become dependent on China during the time the nuclear power station will be run.

The Labour opposition, as well as the National Infrastructure Commission, and the National Audit Office should ask for a review of the Hinkley C contract. The aim should be to ask for contract amendments to ensure the public reduces its political risks of being dependent on the Chinese, and, just as importantly, the costs of Hinkley C are reduced.

UPDATE-UPDATE-UPDATE-UPDATE-UPDATE

News update following press conference on 21st October in afternoon:

The figures I have used, the cost of Hinkley C at £25bn (a figure in the news over the last weeks) has, now, that the deal has been signed, updated to £18bn. Here is the BBC news report.

“The mainly state-owned EDF said the final cost would be £18bn. State-owned CGN will pay £6bn for one third of it.”

That is surprising, a project which comes down in price by about 1/3? We never have had that before!

Now, what does that mean for the calculations above, £18bn, instead of £25bn?

It will make the figures:

Option 1: £880 million per year (770m capital borrowing cost, 10m labour, 100m fuel)

Option 2: £670 million per year (560m capital borrowing cost, 10m labour, 100m fuel)

Option 3: £2,000 million per year (all in cost)

So basically, if previously the British public was just being ripped off badly, the new costs  of only £18bn now make this deal absolutely ridiculous. The British public is “taken to the cleaners”. We could, had we financed Hinkley C by ourselves, through deficit financing, have had the electricity produce by Hinkley for about 1/3 of the cost what it will cost us now.

I am sure “taken to the cleaners” will be an idiom the Chinese will be keen to learn and repeat in future. Osborne should resign, of course.

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