On (Hinkley) Point

As I suspected would be the case, the UK government last week went ahead with its plan to approve the Hinkley Point nuclear power station. I touched on some of the cost issues back in August. But what I find interesting is that no-one is talking about the demand-supply balance in the electricity market. UK electricity consumption, for example, declined by 13% between 2005 and 2015, with industrial demand down 21% and domestic demand falling by 14%, despite all those new gadgets which are now such a feature of our homes. One reason for this is that EU legislation requiring us to install low energy lighting has had a significant impact on reducing consumption (the pesky EU!). Interestingly, domestic output has fallen even faster (by 15%) and imports now make up 6% of consumption, compared with 2% a decade ago.

The collapse in demand is not just a UK phenomenon – it is evident in Germany too, on roughly the same scale. So why do we need such a costly new power station, particularly since we can get a lot of our energy from renewables? One reason is that the UK has to replace its ageing nuclear capacity and is also committed to phasing out coal-fired stations by the middle of the next decade, so it does need to bring new capacity onstream. Why not from renewables? One answer is that sources such as wind and solar cannot be guaranteed to provide the steady baseload which industrialised societies need.

Germany, for example, which has massively ramped up its renewables capacity over the last decade has experienced periods when there is so much electricity coming onstream from wind sources that other sources have to curb output in order to prevent the grid from overloading. This also means great peaks and troughs in wholesale prices, which play havoc with the planning decisions of utility companies. Moreover, the German government is granting huge subsidies to green energy, but has not been successful in reducing carbon dioxide emissions because at those times when green sources cannot meet demand, the grid has to turn to coal-fired stations.

The argument often used by environmental groups that the planned output of Hinkley could be met by building four large offshore wind farms is arithmetically correct, but it is unlikely to operate at the same efficiency and would thus not be able to meet baseload demand. It is thus illustrative to look back at the British experience with nuclear generation plans to see that much of the over-optimism which accompanied plans for nuclear expansion in the 1970s is being rehashed today. Thirty to forty years ago, the CEGB (which was then responsible for the UK’s electricity output) argued that many of the overruns in completing nuclear plants on time, which was responsible for so much of the cost overrun, could have been avoided if the UK had bought the US pressurised water reactor rather than developing its own. The PWR has always been dogged by safety concerns (Three Mile Island, anyone?). And plans for the European PWR, expected to be used at Hinkley, are experiencing similar concerns. One of the suppliers at EDF’s facility in Flamanville in Normandy, has already informed the French nuclear inspectorate that anomalies have been detected in the nuclear reactor vessel, resulting in “lower than expected mechanical toughness values.”

Such issues contribute to the cost problems associated with nuclear generation. In 1967, the CEGB argued that nuclear could deliver energy for as little as 0.48p/KWh. By 1979 that estimate had more doubled. Today, EDF is being guaranteed a minimum of 9.25p/KWh – roughly double the current wholesale price. One reason for the substantial markup is to allow for the almost inevitable cost overruns: EDF’s Flamanville facility is already six years and three times over budget.

Then there is the issue of importing and disposing of the fuel used in the process. Security of supply used to be one of the main considerations determining whether to choose between coal and nuclear. With no large scale coal mining now occurring in the UK, this has dropped off the agenda as most solid fuel now has to be imported (the UK currently imports most of the uranium used in power generation from Australia). Getting rid of spent fuel is more problematic: High level waste is stored for 50 years at the Sellafield plant in north-west England and it is planned to be deposited in a deep mined geological facility. Unfortunately, no suitable site for such a facility has yet been found. We may enjoy the benefits of Hinkley Point’s electricity today (or more likely tomorrow) but it is future generations which will have to work out what to do with the waste.

The nuclear option

The recent decision by the new British prime minister to put the decision to build a nuclear power station at Hinkley Point on hold highlights a number of weaknesses in key areas of British policy. The fact that the Cameron administration wanted to go ahead with it at all, on the basis of the cost structure put forward, was bad enough. But this was compounded by Mrs May’s decision to freeze the project just after the EDF had agreed to go ahead with the deal. To compound this triumph of diplomacy, Mrs May’s government managed to annoy Chinese investors by citing security concerns arising from Chinese involvement in such a sensitive infrastructure project. And this in the wake of a Brexit referendum which will leave the UK ever more dependent on non-EU investment. You almost could not make it up. 

To put this deal into context, the UK has agreed to phase out all coal-fired power stations by 2025. That is all well and good, except for the fact that we will need to make up the shortfall by generation from other sources. According to DECC, last year the UK produced 22.6% of its energy from coal so in simple terms the UK will phase out almost a quarter of its generation capacity within a decade. No wonder the government was desperate to bring Hinkley Point online. But in their haste to do a deal, the Cameron government realised that it would be virtually impossible to assemble a UK team to do the job in the decade or so that it would take, and turned to EDF – which is 85% owned by the French government – to do the job for them.

In order to sweeten the deal, the government offered a guaranteed fixed price of £92.50/MWh (2012 prices) which will be adjusted for inflation over the 35 years of the contract. The difference between this strike price and the market price will be made up by the UK taxpayer. Earlier this year, the National Audit Office calculated that with the price of electricity having fallen to £45/MWh since the deal was agreed in 2013, this would raise the cost to the taxpayer from an original estimate of £6.1bn to £29.7bn. As far as EDF is concerned, this would generate a double-digit return on equity (estimates vary from 13% to 20%), which in essence makes this a project largely funded by the UK taxpayer  to support a French state owned enterprise. So where, you may ask, do the Chinese fit in? Back in 2015, the Chinese state-owned CGN agreed to fund one-third of the expected £18bn construction costs, thus easing the burden on EDF, and in return would be considered for the provision of reactor technology at the planned Bradwell nuclear station.

A cursory glance at the headline economics suggests that the finances of Hinkley Point simply do not stand up. But the reason why they are so bad is that they reflect the desperation of the Cameron government, aided and abetted by George Osborne, to scramble together a deal to get a nuclear station online by 2023 (a deadline which everyone now knows will not be met) in order to meet carbon emissions targets whilst managing to keep the lights on. It is the product of policy on the hoof. To compound the problems, the reactors proposed for Hinkley have run into technical difficulties, which has raised doubts about their suitability. Add in the fact that the costs of building Hinkley recently exceeded the entire market cap of EDF and that numerous European states have filed objections on the grounds that the government is breaching EU rules on state aid, and it is understandable why the project remains beset by doubts.

Theresa May’s objections to the deal on national security grounds are surely to miss the point. If she were to object on financial grounds, surely that would be sufficient. But then that would be to admit that the government of which she was part has committed an act of fiscal stupidity (doubly ironic when you think of George Osborne’s austerity mantra) and would annoy the French even more than this delaying tactic has already. Whilst it is understandable that the government might have concerns about allowing the Chinese to have a big say in a crucial infrastructure project, citing these concerns in public is no way to win friends and influence people (let alone win foreign investment deals). In any case this eleventh hour delay, which smacks of capriciousness, makes life more difficult for foreign investors looking for certainty in the wake of the Brexit vote.

What the government needs to do – and fast – is to come up with a credible energy policy. The UK needs Hinkley if it is to close its coal-fired stations by 2025. My guess is that this won’t happen and their life will be prolonged. I also suspect that the government will agree to go ahead with Hinkley, albeit on altered financial terms. Though whether the French and Chinese will be willing to go through all the negotiations again is a lot more doubtful.