Hinkley Point – Try to Ignore Politics, Is It A Good Deal?

We haven't written about the proposed Hinkley Point nuclear power station up until now because it is very complicated and we don't have any great experience in the nuclear industry or in long-term energy issues, contracts or agreements.

But after last week, we feel we should look at the situation, perhaps from a more general commercial and procurement point of view. To recap on last week, just when the Board of French power company EDF (who are the prime contractor and financing much of the cost too) finally give the agreement to proceed, the British government announced that the expected contract signing would not go ahead. Ministers wanted more time to consider the decision. We have a new Prime Minister and Cabinet of course so it is not unreasonable that they might want to look carefully at the deal.

So our two most basic "buyer" type questions would be - does it look like a good deal? And how is risk allocated - clearly a key issue in any long-term construction project, let alone one that also involves procurement of a volatile commodity (electricity).

Is it a good deal? Well, the UK government has committed to buy the output of the plant from EDF at a price of £92.50/MWh (in 2012 prices) at the time of agreement, now inflation adjusted to some £99.  That is around double the current price. Now if you assume that energy prices "must go up because we're using up all the oil", which seems to be the level of debate from some politicians, then it might prove to be a very good deal.

However, given the oil price collapse of 2015, and an outlook that does not see any great increase soon, it looks less good. The other big unknown is how other energy sources might develop in the ten years plus before Hinkley comes on-stream. In the Times last Friday there was an article about a revolutionary new process that mimics chlorophyll production in plants. Who knows - ideas like that may develop and make nuclear obsolete by the time the plant is built. Other experts suggest that smaller nuclear plants are now a better bet if you want to go down the that route.

Anyway, back to the "good deal" question. At the moment, the UK taxpayer would pay some £30 billion over the market price for the electricity during the contract. So the answer to is it a good deal? Probably "we can't possibly tell with any degree of certainty, but on the balance of probability, we think not".

The risk aspect is fascinating. The risk on energy pricing is being borne by the UK as per the previous discussion, although you might argue that EDF are taking the risk that the market price is above the contract price by the time they are supplying, and they then miss out on the opportunity to sell at higher prices. But EDF are apparently taking the construction risk - so will have to pick up any additional costs through the construction process. Indeed, many EDF staff and shareholders are dead against Hinkley because they believe it could bankrupt the commonly. Several of their own directors resigned because of their fears over the project.

However, that means there is risk for the UK too. If EDF went bust, who finishes the project - or pays the cost of knocking it down and building something else to provide the power needed? The UK taxpayer. And the UK bears the risk of power shortages if the project fails or is delayed. And note that EDF have not yet completed any plant to this spec. It is an unproven design really, the first of this type in Finland was supposed to be finished in 2009 and still is not yet commissioned. And it has cost many times the €3.7 billion initial estimate, with legal claims likely to play out for years.

What about the financing, a third of which comes in part from China? I have not been able to establish the details here, there is a healthy return to EDF and Chinese investors if all goes well but if EDF and the project failed, would the Chinese and French financiers lose out? I guess so. But as the UK government can borrow at record low rates, why not raise the money ourselves?

All in all, and stressing that we are not deep experts here, it looks like a pretty poor deal for the British taxpayer, even before we get into the security implications of major input from China into this and perhaps two subsequent reactors. Let's just hope the decision makers understand that potential for political embarrassment is not a good reason for going ahead, and also understand the sunk-cost fallacy - what has happened and been spent up to now should have no bearing on the decision at this point in time.

Simon Jenkins in the Guardian called this the "worst deal in the history of procurement". I suspect there are a few corrupt "procurement" deals around the world that might claim that title over Hinkley, maybe even our last UK aircraft carrier contracts. But we're tending towards the view that other UK infrastructure projects would make more sense in terms of using taxpayer’s money wisely.

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