September 2016 was supposed to herald the dawn of a new era for the nuclear power industry in the United Kingdom. The UK Government had confirmed its support for the Hinkley Point C nuclear power project and EDF, the project’s lead developer, had taken its final investment decision. What’s more, Hitachi’s Horizon project at Wylfa, Anglesey and Toshiba’s NuGen project, at Moorside, Cumbria were both under active development, with the potential for further large nuclear projects at Oldbury and Sizewell C.
Today, things stand in stark contrast. In November 2018, following the Chapter 11 bankruptcy of Toshiba’s nuclear arm, Westinghouse, and months of failed attempts to find new investors for the project, Toshiba took the decision to wind-up NuGen and cease the development of the Moorside project. Now, Hitachi has reached the same conclusion with respect to Wylfa – leaving its second prospective project at Oldbury looking doomed. Sizewell C, being jointly developed by EDF and China General Nuclear, remains the only large project under active development.
This is not the first time that the Horizon and NuGen projects have encountered troubles. The Horizon project was originally a joint venture between German utilities E.ON and RWE. However, with concerns over the strains that the project would put on their respective balance sheets, and against the backdrop of Germany’s decision to end domestic nuclear power generation in the wake of Fukushima, E.ON and RWE exited the project and sold out to Hitachi. NuGen began life as a three-way joint venture among ENGIE, Iberdrola and SSE. SSE was the first sponsor to exit, selling its stake to the remaining two sponsors in 2011. Then Iberdrola exited in 2014, selling its stake to Toshiba, which acquired the remaining shares from ENGIE in 2017, leaving Toshiba, through its Westinghouse subsidiary, as the sole shareholder.
This time, however, is different. Both Hitachi and Toshiba tried and failed to find new investors for their respective projects, leading both to conclude that it was better to accept a loss of several billion dollars and abandon the projects. Why? Because they concluded that continuing to develop the projects meant running a risk of even greater losses. Hitachi’s share price rose on the announcement that it had booked a two billion loss and abandoned the project.
What changed?
It is no secret that the effects of electricity market liberalisation, rising capital costs and risk of delays and cost overruns have made nuclear new build in the UK a challenging investment proposition. The policy and regulatory landscape mean that private investors are required to fund new projects. But the costs and risks are high, and favourable returns are not guaranteed. The UK’s Electricity Market Reform agenda, implemented through the Energy Act 2013 and subordinate legislation, introduced a package of policy measures designed to attract private sector investment to nuclear new build. These measures included the flagship Contract-for-Difference (“CfD”), a fixed term contract between a qualifying generator and a government counterparty with a two-way payment mechanism guaranteeing top-up payment when the prevailing electricity market price falls below a notional ‘strike price’.
But the CfD awarded to the Hinkley Point C project came in for a lot of political scrutiny. Critics felt that the strike price, set at an initial £92.50/MWh, was unjustifiably high and the CfD constituted a ‘sweetheart deal’ for EDF and its partner, China General Nuclear. For other technology types, such as offshore wind, CfDs are awarded on the basis of a reverse auction, diving down the strike price to ensure value for electricity consumers (who indirectly fund the top-up payments made pursuant to CfDs). But, the scarcity and complexity of large nuclear projects mean that a CfD auction is not viable. This leaves developers, such as EDF, free to bilaterally negotiate the strike price with the Government.
So whilst Hitachi and Toshiba would understandably expect support for Hinkley Point C equivalent to that enjoyed by EDF, the Government has been forced to look again at the support it can offer. The details of the negotiations have not been made public, but it can be safely assumed that the Government was not prepared to agree to a strike price for Horizon and NuGen at the same level as Hinkley Point C.
Alternative Approaches
From the investor perspective, a CfD is only as good as the strike price it provides. If the strike price is too low, then a new approach is required. One alternative reportedly considered for Horizon was the UK Government’s taking a significant stake in the project in order to provide equity funding for construction and to share the construction risk with the investors. Such an approach, whilst successfully deployed in other jurisdictions, would have very likely run into challenges given EU competition and State-Aid rules and government policy, enduring for last 30 years, against State-ownership of energy infrastructure.
The more likely alternative is the so-called Regulated Asset Base (“RAB”) model. In its current manifestation in the UK, it was pioneered on the Thames Tideway Tunnel ‘super sewer’ project, but the concept has for many years been used for the privatisation of water utilities in the UK, as well as for electricity utilities in the U.S. The model seeks to guarantee a return on investment based on total capital expenditure, which mitigates market risk and effectively passes cost-overruns through to consumers. The model also allows the recovery of costs during construction. However, this model is arguably not fit-for-purpose for use in Great Britain’s wholesale electricity market as currently structured because a RAB model is a monopoly-based model – consumers would pay costs passed through to them because they would have no alternative. For example, in the UK consumers cannot switch suppliers of water or sewerage services. Similarly, utilities are granted regional monopolies and consumers have no alternative choice of supplier for electricity in most U.S. States. The quid pro quo is that the utility company/investor invests private funds into infrastructure that benefits consumers by providing essential facilities and the consumers are protected from market-abuse through regulatory controls.
In contrast, Great Britain’s wholesale market is liberalised and ostensibly operates on an output-based model – generators must find their own route to market and their income is, as a general rule, a function of the market price for electricity and the volume of electricity they deliver into the system. The CfD, together with the Backstop PPA, was specifically designed to mitigate this risk by ensuring that a generator would have a guaranteed route to market and price certainty. Whilst the RAB model seems to be gathering momentum as a viable option for supporting the financing and development of new build nuclear power projects in the Great Britain, some further reform of the electricity market would be necessary in order to make it legally possible. In his press statement, announcing the winding up of the company, NuGen CEO Tom Samson alluded to this saying “…the RAB model is still in early stages of development, has not been determined as policy yet and still faces a lengthy legislative process before it can be applied to new nuclear.”
The Future
Brexit does not help. Whilst uncertainty over the UK’s future role in the European Atomic Energy Community will have a tangible impact on the development of a nuclear power projects in the UK , Brexit is not a major direct contributing factor to the challenges facing nuclear new build in the UK. But, from a practical perspective, as Brexit has become ‘all consuming’, there has been little space left on the political agenda for anything else, including nuclear power. The demise of Toshiba’s Moorside project sadly appears to be terminal. If there is any glimmer of hope for Horizon, and perhaps also Sizewell C, it appears to lie in the implementation of a new government support mechanism as an alternative to the CfD. The RAB model may be the solution. But making this or any other solution available to the investor community involves a long political process and further legislative reform, which have not yet formally begun.
