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UK nuclear State Aid challenge takes shape

UK nuclear State Aid challenge takes shape

Platts Power in Europe, 2014-02-17

The EU State Aid implications of the UK's new nuclear support program took shape January 31 with the European Commission's reasoning on its decision to proceed to an in-depth investigation into EDF Energy's Hinkley Point C project in Somerset.

The full extent of that impact will not be known, however, until the EC has received, studied and ruled on the UK's back-end nuclear management plans – which are yet to be notified to Brussels.

The UK's Department of Energy and Climate Change told Platts February 5 that back-end nuclear waste management plans for new-build reactors have yet to be notified to the European Commission for State Aid clearance.

A notification relating to the Hinkley Investment Contract, ancillary agreements and state credit guarantee was submitted by the UK to the EC on October 22, 2013. It is this notification that the EC has decided to put through an in-depth State Aid investigation.

Meanwhile the UK government is still preparing a separate notification to the EC of how it intends to share the costs for managing and disposing nuclear waste from Hinkley Point C and other new nuclear power plants, DECC said.

"The nuclear waste transfer contract (which is wider than just Hinkley) is a separate notification [to the October Hinkley submission]," a DECC spokeswoman said in an emailed answer to questions. "This has not yet been submitted."

The EC's guideline for the duration of in-depth investigations is six to 18 months. If this second submission also proceeds to an in-depth investigation, EDF Energy's Hinkley Point C nuclear power project could be facing fresh regulatory delays.

Whether the EC would adopt a similarly tough line on the waste transfer contract as it is doing on the Hinkley Investment Contract "remains to be seen," said Norton Rose Fulbright competition lawyer Totis Kotsonis.

"It should be appreciated that there is an unspoken dimension to the current investigation, namely the political one, and much as the European Commission would need to focus its analysis on the strength of the legal arguments and available evidence in doing so it will be all too mindful of the political tensions that surround nuclear energy", he said.

The UK's nuclear waste transfer contract is to cover both spent fuel and intermediate level waste, the DECC spokeswoman said. "We have published a waste transfer pricing methodology, which provides details of our policy in this," she said.

Operators of new nuclear power stations "must have arrangements in place to meet the full costs of decommissioning and their full share of waste management and disposal costs," the methodology says.

The policy, to be implemented through the 2008 Energy Act, requires operators of new nuclear power stations to have a Funded Decommissioning Program approved by the Secretary of State in place before construction can begin.

"The Government does not consider that taking title to radioactive waste, including spent fuel, for a fixed price is a subsidy to new nuclear power, provided that the price properly reflects any financial risks or liabilities assumed by the state," it says.

Costs 'difficult to quantify'

In its December 18, 2013 decision to open an in-depth State Aid investigation into Hinkley Point C, details of which have only recently been released, the European Commission notes that the costs of managing and disposing of nuclear waste are difficult to quantify.

The UK plans to build a geological disposal facility for the permanent disposal of spent fuel and nuclear waste, something which does not yet exist anywhere in the world, the EC says. "This project is part of the UK's set of initiatives to facilitate investment in nuclear energy, in particular given that the use of the facility will require operators of new nuclear plants to pay a price which will be subject to a maximum value, to be set in advance of construction and based on a cost model which takes into account all available information," it says.

Once notified of the UK's backend fuel management plan, the EC said it would "assess whether it involves aid and whether, if it does, such aid can be deemed to be compatible with EU rules."

Reference price

On the Hinkley Contract for Difference, meanwhile, the EC on January 31 detailed strong reservations on State Aid compatibility grounds.

In particular, the EC notes that by its very design, duration and scope, the contract had the potential "for distorting competitive conditions."

The CfD for Hinkley gives the operator, NNB Generation Company Limited (EDF Energy and partners Areva, China General Nuclear Corporation and China National Nuclear Corporation), a guaranteed, index-linked strike price for output from the facility over 35 years.

“The Strike Price [agreed at £92.50/MWh] will be fully indexed to the Consumer Price Index from the date of signature of the contract. Based on current assumptions, this would translate into a nominal Strike Price of GBP 279 per MWh in 2058, the last year of application of the CfD scheme,” the EC said.

If the market reference price is below the strike price, then the government pays NNBG the difference. If the reference price rises above the strike price, NNBG is obliged to pay back the difference to the government.

"The CfD implies that there will likely be an interaction between the strike price and the wholesale electricity prices," the EC said. "The UK has provided no evidence on the potential impact which the government-set strike price might

have on trading conditions and ultimately on retail prices.”

Neither was it clear what the market reference price would be or how it will be calculated, with the UK suggesting it might be the season-ahead, moving to the year-ahead, wholesale price of baseload electricity generation.

Depending on how the reference price is calculated, the CfD “might create an incentive for NNBG, or EDF, to behave strategically to influence the reference price,” the EC said.

“All other things being equal, NNBG, or more broadly EDF, will be interested in keeping the reference price low, in order to maximise the difference payments,” it said.

It was unclear how the operator might react to incentives to direct sales towards reference markets and away from other markets, the EC said.

For example, if the reference price is calculated based on the daily price averaged over a longer period of time, NNBG would have an incentive not to participate in longer term markets. If based on the month-ahead baseload price, then NNBG would have an incentive to participate in month-ahead markets only, “to the extent that it can lower the average price which is formed in them,” the EC said.

“For nuclear energy, in practice this could mean selling more in the season-ahead forward market, and less on the spot market or over the counter, compared to a situation without CfDs," the EC said. "A related question is how EDF, as a vertically integrated operator which is active in both generation and supply, might react to such an incentive framework.”

Retail, de-carbonisation, links

The contract could have knock-on effects in the retail market too, the EC said.

Its design “relies on the twin premises that electricity suppliers fund difference payments to generators, whichthey are most likely to pass on to customers, but also that they will pass on to customers any difference payments paid by generators when the reference price is higher than the Strike Price, the EC said.

“It is not clear to the Commission that such an arrangement might not result in larger profitability margins for suppliers. Suppliers might simply decide not to pass on lower generation prices, in the form of difference payments from generators, or they might be only willing to do so partly or with a time lag compared to the payments. In such cases, the aid provided by the UK government would indirectly benefit suppliers in addition to direct beneficiaries.

In addition to its market concerns, the EC was not convinced of the environmental case for new nuclear support. A nuclear-specific CfD “might crowd out alternative investments in technologies or combinations of technologies, including renewable energy sources, which may have occurred in the absence of the notified measure,” it said.

It was not clear at this stage, then, that the notified measure “can be argued to be aimed at a common EU objective in terms of environmental protection in general, and decarbonisation in particular.”

Finally, the EC noted that the UK had not taken into account future interconnection capacity in its modelling work, based on the fact that it believes flows will be difficult to predict.

“The Commission questions this approach and invites comments from third parties on the degree to which interconnection can play a role, and how its contribution to the objectives being sought by the UK can be quantified over the time scale being considered for the HPC [Hinkley Point C] project.”

In summary, Norton Rose Fulbright competition lawyer Totis Kotsonis said the UK would "need to come up with robust evidence and arguments that back up its case and respond adequately to the Commission’s concerns. Alternatively, it would be necessary for the UK to make key changes to the proposed support measures. Absent one or both of the above, the notified State aid measure faces a real risk of being rejected as incompatible with EU State aid rules.”

‘EC has no choice’

Independent analyst and EC policy expert Mark Johnston said the EC has no choice but to defend core single market principles. “If it doesn’t, who will? If the UK sets a bad example by disregarding the law, and the EC does not act swiftly to quash that, then others will follow suit.”

There are indications that Poland and Hungary are lining up similar projects, Johnston said. PGE’s Opole coal plant could go ahead on the UK contract model, a long term PPA – it’s uneconomic otherwise,” Johnston said. “If the EC lets the UK get round market rules for Hinkley, then the Poles could follow with Opole.”

How Hungary intends to pay for the two-unit Paks II nuclear extension is less clear, but another long term contract is in the offing. The project is to be financed with the help of a 30-year interstate loan of up to €10 billion provided by Russia, with the signing of a deal with vendor Rosatom in January overriding earlier plans for an international tender.

“How the interstate loan is to be repaid and how cost recovery is distributed among customers, and not taxpayers, remains to be seen,” Johnston said.

Law vs politics

“The law is clear but the politics are wide open on Hinkley,” Johnston concluded. “Since December 2011, when David Cameron vetoed the EU’s fiscal pact, the UK electricity story and the UK membership story have been inter-twined. We’ve seen this train wreck coming down the line since 2010, when the incoming UK coalition government agreed to proceed with new nuclear. In Brussels we’ve all been scratching our heads and asking how are they going to do that?"

As well as the EC's electricity and gas market rules, Europe has a harmonized carbon mitigation scheme in the form of the Emissions Trading System, Johnston said. "I accept that there is a wider debate about securing investment, but at least let's have it in a structured way rather than ‘anything goes’," he said.

Doubts extend to renewables

Meanwhile the EC is reported to have voiced its concerns that UK projects lined up for early state CfDs (Final Investment Decision Enabling for Renewables) may also contravene State Aid rules. The Financial Times reported February 13 that informal talks are focusing on the nine projects the government wants to award early stage CfDs to in April. These include biomass projects at Drax (two units), Teesside and Lynemouth; offshore wind projects at Burbo Bank, Dudgeon, Hornsea and Walney; and onshore wind at Beinn Mhor and Heckington Fen. The EC is concerned that contracts are to be awarded without a price auction or an open technology neutral tender. Brussels has informally warned the UK that the projects appear to involve heavy subsidies that may be overgenerous and harmful to competition. The UK government has yet to submit a formal application for the schemes.

Munir Hassan, head of clean energy at law firm CMS said it was not clear why the UK government “has waited so long before formally seeking clearance of the proposed investment contracts for renewables projects. The lack of momentum behind the process means that there will be a period of uncertainty for projects until we have formal confirmation of the Commission’s position. It is not clear that any of the Commission’s comments to date [on Hinkley] should automatically affect the terms of the proposed contracts for renewables projects, which are granted for a much shorter period.”