The folly of Hinkley

Anti-nuclear protesters gather outside Hinkley Point in 2011 in reaction to EDF Energy's plans to build two new reactors at the site ©Matt Cardy/Getty Images

British electricity customers will soon find out whether they will be saddled with paying for the world’s most expensive power station, Hinkley Point C. The first new nuclear station to be built in the UK for 21 years, Hinkley is the centrepiece of the government’s plan to cut carbon emissions and reduce British dependence on imported gas. In order to persuade French and Chinese investors to commit £18bn for this project the government, having repeatedly stated there would be no subsidy for nuclear energy, has promised that British electricity customers will pay for all the power the station produces at a price of £92.50/MWh (megawatt hour)—more than double the current market price of £35/MWh—for 35 years after the station is completed, and indexed to inflation (the price includes £2/MWh for decommissioning). On top of that, the government will guarantee (for a fee) that lenders to the project bear no risk. And it has undertaken that no future government can pass any law or policy that would hurt the investors, on pain of compensation.

There is no British nuclear company involved in the project because we have not had a British nuclear reactor design for 40 years. The project, if it goes ahead, will be a combination of French and German technology, funded by French and Chinese government-owned companies. The only role of the British will be to pay for the power it produces.There is a case for building new nuclear power stations in the UK, as the existing ones are nearly all scheduled to close within 15 years and it’s hard to see how we can meet the decarbonisation targets set in law by the 2008 Climate Change Act without new ones. But Hinkley is an unacceptably costly way of doing so. There are other nuclear projects in the pipeline and, while little is certain in the world of nuclear economics, there is good reason to think that the other stations will be considerably cheaper. Hinkley’s costs have risen dramatically as the new European Pressurised Reactor (EPR), the type of pressurised water reactor planned for Hinkley, has been revealed as all but unbuildable. The project sponsor, the French electricity company EDF, is now desperately short of cash and can ill afford the risk of this enormous project. What was supposed to be a privately funded project has turned into a three- way government deal. Yet we are stuck with high private sector returns which inflate the cost. The British government should cancel this project in the interests of protecting customers. But it fears that it would jeopardise the rest of the nuclear programme as well as break an agreement with the UK’s new best friend, China. So we are reduced to hoping that the French government, which is EDF’s major shareholder, will decide to scrap the project.

The problem is that the UK, for quite noble reasons, is committed to new nuclear stations as a crucial part of cutting the country’s carbon emissions. The government hoped that this could be done with private sector capital though EDF and the other nuclear developers all have actual or de facto state support. The first of these new stations, Hinkley Point C, uses a reactor type that has not yet been built on time or budget anywhere in the world. The hugely escalating costs have made a nonsense of leaving it to market forces, as EDF, financially weakened by falling prices in its French home market, now needs the British government to guarantee the project’s debts and to provide a 35-year price contract to make the investment worthwhile. Even then EDF cannot go it alone and has had to ask its Chinese partner, increasingly looking like a rival, to help fund the project. The British government dare not stop the project for fear of jeopardising the other nuclear projects in the pipeline, which offer the hope of lower costs. Without a lot of new nuclear capacity to replace the older stations, which will close by 2030, the government looks set to breach its own legally binding carbon emission reduction targets. So it is only the French government—the owner of EDF and also the promoter of the formerly very successful French nuclear industry—which might save us from Hinkley’s costs.

It’s rare for a commercial project to be bad for both sides—but Hinkley is. On one side we have an investment whose cost has spiralled out of control and now puts the financial viability of EDF at risk. That appears to be the view of Thomas Piquemal, the former Chief Financial Officer of EDF, who resigned on 7th March. It’s rare for a CFO to resign these days and this can only be seen as a mark of how risky this investment would be for the company. Indeed no ordinary company with a market capitalisation (the stock market value of the company’s shares) of around €20bn (£16bn) would risk investing €15bn (EDF’s two-thirds share of the project cost) in a single investment. No matter how high the eventual return might be, this is known in the financial world as betting the company, and a good CFO does not allow the board to do this.

The problem is that the reactor that EDF is selling looks like a dud, at least economically. The EPR was developed by the French company Areva and the German company Siemens, which realised that a new generation of safer reactors was needed to reassure public opinion after the Chernobyl disaster of 1986 (the anniversary of which is 26th April). Siemens later dropped out of the project when the German government decided to phase out nuclear power following the Fukushima disaster of 2011 (whose anniversary was in March this year). The EPR is an enhanced version of an earlier French pressurised water reactor (PWR), itself derived from the standard United States Westinghouse design which France licensed in the late 1960s with full rights to build and sell it.

The EPR, like other so-called Third Generation reactors, is intended to be extremely safe. It has multiple back-up safety systems and defence in depth against failure, so that any known risk is dealt with. But all of this adds cost and complexity. It is increasingly clear that the EPR was designed to be operated but not to be built. There are four EPRs under construction—all are behind schedule and over budget. The first to start construction was Olkiluoto 3 in Finland. Power was originally scheduled to begin in 2009, but is now expected in 2018. Project costs have increased from €3.2bn to €8.5bn. (The Finnish customer and the French supplier, Areva, are locked in multi-billion euro compensation claims which have, in effect, bankrupted the French nuclear developer and contractor. Areva is also owned by the French state and far too important to be allowed to fail so the government has forced EDF to buy its reactor business.)

The second EPR is being built by EDF at Flamanville in Normandy, next to two existing nuclear stations. Intended to start operating in March 2012, the latest forecast date for completion is late 2018. Construction costs have risen to €10.5bn. The first EPR to generate power will almost certainly be in China, where two units are under construction at Taishan in the south of the country. One is now ready for testing. These are less delayed than the European reactors but then the Chinese, who have lower labour costs and a great deal of experience in building infrastructure, are now very efficient at building nuclear power stations, with 24 currently under construction.

The cost of the EPR at Hinkley has escalated from £8bn to £18bn partly as EDF has learned from the EPR projects elsewhere. It’s unlikely that Hinkley would see a further tripling of costs because much of that has already been priced in. Of the latest £18bn estimate, £2bn has already been spent, on a combination of site preparation and the maintenance of a large team of engineers and contractors.

But the price of persuading EDF and its Chinese partners to take the construction risk is an exceptional package of financial support from the British government, in contradiction of statements made by previous governments. The White Paper of 2008, which officially approved plans for new nuclear builds in the UK, was carefully worded. Gordon Brown, then Prime Minister, wrote that: “We have... decided that the electricity industry should, from now on be allowed to build and operate new nuclear power stations.” The report gave the government’s preliminary view (followed by a consultation) that “it is in the public interest to give energy companies the option of investing in new nuclear power stations.”

The government saw itself as merely removing an obstacle to one type of energy, reflecting a private sector keen to invest in nuclear, without subsidy (other than some form of compensation for the carbon dioxide emissions saved). In line with the ideology of leaving energy policy to the market, begun by Nigel Lawson in the 1980s and largely intact until the present, the government would let private investors choose where to place their money, leaving the government above the fray.

This policy was unrealistic on several grounds. The first was that the government was adding policy goals, first for renewable energy as required by the European Directive of 2009 and then the UK’s self-imposed Climate Change Act of 2008. How to combine central targets with a market-driven energy industry? The government tried to keep as much of the energy market intact as possible but there has been a growing contradiction between ends and means.

Secondly, nuclear is not a technology that was ever likely to be delivered by the market alone. It is too large, costly and risky for any normal private company to fund without some form of state support or insurance. Private energy companies in the oil and gas sectors do manage investments on the scale of Hinkley Point C but they do so with relatively proven technology and by sharing costs between the world’s largest corporations. Even then there is often a degree of government support through state development banks. And the rates of profit needed to compensate for the risk are far higher than in electricity projects.

The biggest obstacle to private investment in nuclear is its exceptionally bad track record of construction risk, going back to the 1970s. Nuclear projects routinely overran, partly owing to legal challenges (especially in the US) and partly because each station is a cathedral-like structure of complex, bespoke engineering requiring exceptional project management and coordination of multiple contractors. These problems are magnified when the reactor is of a new kind. It is too expensive to build a full prototype to check the feasibility of construction and operation. So the first few are, in effect, prototypes. No private company could justify taking that risk, no matter what the possible returns if all went well. And no bank would lend to such a project without guarantees. And only a large creditworthy state could make such guarantees credible.

The field of nuclear reactor vendors is dominated by either state-owned companies (French, Chinese, Russian) or state-backed (Japan and South Korea). The US is not currently a major player because low gas prices make new nuclear development completely uneconomical in the US. The two key competing designs to the EPR are the AP1000 and the Advanced Boiling Water Reactor (ABWR). Both were developed by American companies but are now built only by Japanese companies (Toshiba and Hitachi respectively). These ostensibly private companies are backed by the Japanese government and have access to state funding through the Development Bank of Japan. It is inconceivable that either company would be allowed to fail by the Japanese government if it got into trouble, especially when that government is committed to a long term restoration of the Japanese nuclear industry.

So it was naive and unrealistic for the UK government to believe that nuclear investment would be forthcoming in just the same way as for gas power stations or renewable energy, both of which attract private capital readily and willingly.

When it started developing the Hinkley Point C project in 2007, EDF probably really thought that it could finance the project itself, without any government subsidy (but with some form of carbon pricing) and make a reasonable profit. That’s certainly what the British government believed anyway. So why did the project reach the point where it has a 35-year fixed price contract, EDF depends on Chinese funding and the project still looks questionable?

Aside from the huge increase in the costs of the EPR, EDF has suffered a major reversal of financial fortune. Back in 2008 EDF was the world’s most valuable utility company, with a market value of over €140bn, based on investor confidence in its ability to generate safe, sustainable cashflows. It could certainly afford to finance the then €8bn Hinkley project cost. But the company is now worth a fraction of that value: barely €20bn. This is mainly because of a fall in income in its French business, as the government has cut the price it allows EDF to charge for its power. On top of that, EDF needs to fund a large capital programme to extend the lives of its existing nuclear station. The upshot is that the company has had negative net cashflows in recent years and has had to borrow to pay its dividend, something that is clearly unsustainable (the dividend was cut in February 2016).

Around 2011, the combination of worsening news on EPR construction in Finland and France and the company’s deteriorating financial position led to the awkward conclusion that EDF needed partners. But who would have the financial means and nuclear skill to be a suitable investor? EDF turned to the two nuclear companies with which it had been working in China for 20 years. China National Nuclear Corporation (CNNC) and China General Nuclear (CGN) are, like EDF, state-owned corporations which operate in some degree as commercial businesses, but firmly under the policy guidance of central government. CNNC, which later dropped out of the Hinkley project, not only operates nuclear stations but is responsible for nuclear waste and decommissioning as well as China’s military nuclear activities. CGN, based far from central government in the commercial hub of Shenzhen, is somewhat more profit-minded and, without military activities, is a less problematic partner for western investments. Having learned how to build and design nuclear reactors from the French, CGN knows EDF well.

But why would CGN (and the Chinese government) want to invest in Hinkley? Because China is a new entrant into the global nuclear reactor industry and wants to build its own reactor in the UK. Hinkley would be the first step, a minority investment (CGN would take a 33.5 per cent stake) that would establish a Chinese presence in the British nuclear industry. The real prize would be if CGN could become the majority investor and operator of a project using China’s own new Hualong 1 reactor. If the Hualong 1 can get generic design approval from the UK’s Office for Nuclear Regulation (a roughly four-year process likely to start this year) then CGN hopes to build the reactor at Bradwell in Essex (EDF is supposed to be a minority investor in this project). In asking CGN to help fund Hinkley, EDF has allowed what may be its biggest competitor into the market. If Hualong is built and operated successfully it will be a tremendous boost for China’s hopes of leading the growing international nuclear power industry. EDF, if it keeps backing the EPR, could find itself excluded.

British government support for the Hinkley project remains solid. On 12th March the Department of Energy and Climate Change (DECC) published “Five reasons why we are backing Hinkley Point C.” Amber Rudd, Secretary of State for Energy and Climate Change, gave a speech on “a new direction for energy policy” in November 2015 which reaffirmed Hinkley and nuclear more generally as central to the government’s decarbonisation goals. It is widely believed in Whitehall that George Osborne, the Chancellor, is in favour of Hinkley, even while he has cut support for onshore wind (which is pretty much economic without subsidy but unpopular with Conservative Party members in the rural areas where they are typically sited).

The government is a prisoner of a policy created by the former Labour government, with overwhelming cross-party support and particularly from David Cameron, then Leader of the Opposition. The Climate Change Act of 2008 began life as the Big Ask campaign led by Friends of the Earth and a coalition of environmental groups in May 2005. They sought a legally binding commitment to greenhouse emission cuts with annual targets. David Cameron, seeking to detoxify his party’s “nasty party” brand, aligned himself and his party with the campaign. The campaign was spectacularly successful. A draft bill was passed in 2007 and unlike most legislation actually got stronger during its passage. The original target was a 60 per cent cut in the UK’s emissions by 2050. By the time the Act was passed in November 2008 it was 80 per cent. Only three MPs (all Conservative) voted against the bill. It was a remarkably ambitious and far-reaching piece of legislation. But most British people, watching the global financial crisis unfold, didn’t notice what was being committed to in their name.

The Act requires Parliament to set five-year legally binding carbon budgets (annual targets were too inflexible) on the path to 2080 and created the independent Committee on Climate Change (CCC) as auditor of progress and advisor on how to achieve it. From its first report in December 2008, the CCC envisaged a major role for nuclear power in hitting the targets. It also saw a large amount of carbon capture and storage (CCS), a technology that would allow the continued burning of gas and coal but with minimal carbon emissions. But that technology remains unproven and the CCC’s estimates of its contribution to hitting the carbon budgets of the 2020s now look highly optimistic. So nuclear is even more important in achieving the carbon cuts, which already envisage a huge increase in offshore wind power, currently in progress.

New nuclear is at least four years behind the schedule envisaged by the CCC. Further delays risk the government missing its fourth and fifth carbon budgets (2023-27 and 2028-32). If this happens, the Secretary of State for Energy at the time is, in theory, in breach of the law. It’s not entirely clear what would happen then. Parliament made the law and could amend or even scrap it. But for David Cameron in particular, who lent considerable support to the Act, it would be embarrassing if the current government looks likely to miss its target.

So if the government were to unilaterally scrap the Hinkley project, it would risk missing its own carbon targets. And it’s not just Hinkley. The other nuclear projects in the pipeline, all led by Japanese companies, would also be vulnerable. Horizon Nuclear Power, a fully-owned subsidiary of Hitachi, aims to build two ABWRs (a jointly owned design with the US company General Electric), one at Wylfa in Anglesey and one at Oldbury in Gloucestershire. Both are sites of former nuclear stations (the original Wylfa Magnox station closed only in December 2015).

Hitachi’s rival Toshiba is promoting its own AP1000 reactor at Moorside in Cumbria through a joint venture with the French company ENGIE (formerly GDF-Suez). The AP1000 was developed by the American company Westinghouse, which is now owned by Toshiba, having briefly belonged to British Nuclear Fuels, the government-owned company that ran the Sellafield nuclear site in Cumbria.

Acquiring and developing the sites has cost the Japanese companies millions of pounds. They depend on British government policy remaining pro-nuclear and not changing any of the rules. An abrupt cancellation of Hinkley would cast doubt on the viability of these other nuclear projects, potentially leaving the UK with a very large hole in its decarbonisation strategy. If the claims made by the Japanese for their reactor types are confirmed, then they could be considerably cheaper than the Hinkley EPR. It is clear that, at present, the investors expect a similar type of contract to that of Hinkley, though the price is obviously negotiable. The increased political risk arising from a Hinkley cancellation would make the investors ask for even higher prices from the government in any future power contracts they sign.

The Hinkley site was chosen for the first new reactor in 20 years because it is in the south (where the demand is), it has seawater for cooling, good transport links and already has a grid connection. It also has local acceptance, in part owing to the two previous stations on the site. All of these would be true for an alternative reactor type. If the current Hinkley Point C project were to be cancelled then eventually somebody would build another reactor there. It could be EDF, or they could sell the site and recover some of their costs. The scale of new nuclear needed to meet the CCC’s visions for the early 2030s carbon targets, when nearly all of the UK’s existing nuclear stations will be shut, makes sites a valuable resource. So cancellation of Hinkley might not affect the total amount of nuclear built in the next 20 years, just the timing. Cancellation might lead to the Secretary of State asking parliament to approve a temporary exemption from the Climate Change Act without prejudicing the longer-term goal.

Later nuclear reactors should be somewhat cheaper than the EPR. It is currently about the same price per unit of energy generated as offshore wind but with the advantage that nuclear, once built, is generally reliable and can produce steadily through those days when wind turbines are idle. Until large-scale electricity storage becomes workable, nuclear seems essential to hitting our carbon targets.

It is not clear that the UK’s well-intended but somewhat vainglorious attempt to cut its carbon emissions is the best way for the country to help newly industrialising nations to grow safely. A big boost to research into more advanced clear energy sources might have been a better way to help the world and to boost British industry. New nuclear will help the UK construction and engineering industries, but the intellectual property and export value lies elsewhere. The UK abandoned its own nuclear designs four decades ago. Using French, Japanese or Chinese nuclear stations to hit the carbon targets seems a sadly inefficient way to meet the nation’s obligations.

There has been a remarkable degree of policy consistency and continuity on new nuclear, through three different governments (Labour, Coalition and Conservative). Governments are routinely criticised for lacking a long-term perspective. It is deeply ironic that in this one area where successive governments are committed to a very long-term goal, the outcome could be a costly blunder that will impose unnecessarily expensive power on an entire generation of British customers.