What Will It Take to Make New Nuclear Happen?

Electricity price risk is not the whole story

It is not clear whether there will be new nuclear build in the UK without some form of government support. Although nuclear power station can provide electricity to society at a reasonable cost 24/7, it is not a generation type suited to varying the amount electricity produced. So nuclear can be a risky investment if the price of electricity is very volatile and falls below the level need to make interest payments.

Prof David Newbery has recently written an article “Be Creative, Reduce the risk of nuclear investment” http://www.econ.cam.ac.uk/eprg/pubs/misc/Newbery_NuclearInvestmentRisk_FT_080109.pdf

In it, he suggests that the risk of a volatile electricity price, faced by new investors in nuclear can be mitigated by generators selling bonds which pay according to the electricity price.

On Wednesday afternoon I had a meeting with a city financier, about the idea. His thoughts were that the financial risks associated with new nuclear are more fundamental than just the risk of a volatile electricity price.

The main problem with financing nuclear are the long-term liabilities and the fundamental absence of trust in the nuclear industry.

I discussed the kWh Bond The kWh bond is a way to finance a new fleet of new nuclear reactors. In essence, instead of a usual interest payment, the bond would pay the variable price of electricity, as viewed by retail customers (so if the price is 7p/kWh, the bond would pay a coupon of 7%). Since the price of electricity fluctuates significantly, whereas the interest payments for a new nuclear provider are fixed, a new nuclear constructor faces significant risk that the price of electricity would fall below the cost of production. This is what happened in 2002, when British Energy went bankrupt had to be supported by the British government. In the future there might be even more volatility, should there be a large expansion in wind energy, because the price would crash in the event of a windy day. The advantage of an electricity-linked bond is that it would ensure that nuclear operator’s costs fluctuated in line with their costs, so that their profits would be more stable. This considerably reduces the risk for nuclear investors. The main point David made is that the instrument has to be well designed to cover multiple contingencies – such as the market ceasing to exist..

My contact’s initial comments were negative – he couldn’t see the idea flying. He thinks that the main risks for nuclear are those associated with the ‘toxic’ asset of the power station. The important area was project finance and, in particular long-term credit risk, associated with the risks concerning nuclear waste disposal and decommissioning costs. He thought that derivatives on the retail price of electricity are already quite a developed market.

We also spoke about the taxes versus quotas debate. The main argument in favour of a tax is the reduced volatility. However, a cap and trade scheme might be less susceptible to government manipulation and also potentially easier to set up internationally.

The following interesting points were made in the course of our discussion:

· There are lots of Nuclear Power Stations in Alsace – this may be a way to prevent German bombs!

· I need to look up Irish-Swiss Economist with a Dutch-sounding name

· M3 money supply forecast asset values

· Asset value inflation matters.

· Terra — new global currency. Basket of world economy

· Santa Fe institute

· National institute for renewable energy

· Large investment programme- sulphur based batteries.

How the city works:

· In a closed society people tell the truth.

· In an open society people tell you what you want to hear.

“Medium is message” – needs translation.

The implication is that financial folk are feeding John Hutton (the Business Sector) what he wants to hear.

My contact’s thoughts on nuclear were quite dismissive. “Nobody in the city has any interest in nuclear.”

· Decommissioning costs

· Lack of faith in government

· Project finance

· Nobody wants to own the plant if it goes bust

· Credit risk over the long term

CONCLUSION

In conclusion, my friend was not convinced that price risk is the problem and he was not convinced that the electricity price indexed bond was new: this risk may be hedged elsewhere. There is the interesting question as to how to extend timing and financing.

He thanks that new nuclear is not going to happen. For it to happen, we need assurances on decommissioning, waste, and most fundamentally trust.