While important, there doesn’t seem to be very much surprising about yesterday’s announcement from the UK government about the agreement for EDF and friends to finance, build and operate a nuclear power plant. (As I said below, they will get about a ten per cent return.) With one exception.
The main focus of news coverage has been the “strike price” which the plant’s owners will be guaranteed to get paid per unit of electricity. However one of the factors governing that price was the risk they were taking in delivering the project – the ‘risk premium’ is the return they get for taking on that risk and forms a part of the financial return they forecast for themselves.
As nuclear power plant projects go, the risk allocation is mostly as I’d expect: EDF will (as they’ve said in the past) absorb any cost overruns in the construction phase, including from the timescale being exceeded. They will also take the risk on the plant being shut down on most obvious grounds, such as health and safety or environmental concerns, and will share some refinancing gains with consumers (similar to PFI projects where such savings are shared with the public authority). Since the government has offered a loan guarantee to reduce the cost of the project’s debt finance and make it less risky for investors (see below), the government is also taking on insurance premium risk associated with a) losing the guarantee for any reason and b) any shutdown of the insurance market for nuclear projects. But not, it seems, changes to insurance premiums while the project is in development, which they could have done.
Curiously however, EDF et al – the project developers – will not have to take operation and maintenance risk once the plant is up and running. Instead, if O&M costs increase, they will be able to claw back this increase in costs, not regularly but at two fixed review periods. An energy department spokeswoman told me:
“At 15 and 25 years after the Contract for Difference payment begins for the first reactor the Strike Price could be adjusted, upwards or downwards, in relation to various operational costs. This covers the plants Operating and Management [probably meant maintenance] costs as well as items outside their control like business rates and transmission charges and prevents the developer adding a risk premia to these costs. Any adjustment to operating costs would be benchmarked to above average performance against comparator projects.”
The last bit about benchmarking isn’t entirely clear but suggests that the developers couldn’t simply ask to increase the strike price because their O&M contractor was asking for more money. On the other hand, if the contractor did do this, it would likely be because of market forces such as an increase in the cost of materials, labour etc – which would affect those “comparable projects” (and what projects do you compare the first nuclear reactor to be built in 30 years to?)
Anyway, this is curious because the operational phase is the one where the plant’s overall risk profile should be lowest. The riskiest phase of delivering a power project is the development (pre-construction) phase, when permits need to be secured and land acquired – and this phase alone is going to cost the developers a cool £2 billion excluding any construction costs. At that stage, it’s unclear whether the project will happen at all. After that, the construction phase is the next riskiest. The idea of not trying to hold down O&M costs in an operational infrastructure project is a strange one in my experience.
When the plant is operational, while things can of course go wrong (and seriously wrong), the range of things is more limited, and the contractors and staff carrying out the O&M ought to be able to manage the risk – in which case, according to industry practice and common sense – they should take responsibility for it. A report last year by the World Nuclear Association suggested that developers usually bear operational risk. So I’m not sure why the government were persuaded to let the strike price be raised if the O&M costs go up. That should have been an easy battle to win, unless the operational risks of this power plant will be rather special.