UK nuclear deal with EDF could waste 17.6bn, says Brussels

By Alex Barker in Brussels and Guy Chazan and Jim Pickard in London

Financial Times, 2014-02-02

The site of Hinkley Point C, EDF Energy's proposed nuclear power station. The reactors of Hinkley Point A and B loom in the distance

Britain is potentially wasting up to £17.6bn of taxpayer support on a new nuclear plant that would be profitable without it, according to Europe's top competition authority.

In a scathing 68-page initial assessment published on Friday, the European Commission raises fundamental concerns about the UK contract with French utility EDF, for Hinkley Point C nuclear power station in Somerset.

While Brussels is now undertaking an in-depth review of the project, that aims to provide 7 per cent of the UK's electricity, the severity of its initial concerns will cast a shadow over government hopes to win approval for the deal without major revisions.

The commission questions whether the deal addresses a genuine market failure and suggests the terms will overpay EDF, shield it from almost all operational risk and crowd out alternative sources of energy supply.

Notably the commission uses EDF's maximum expected cost of capital to show the project will be profitable under all price scenarios, and without a revenue guarantee from the government worth up to £17.6bn.

The report comes at an awkward moment, with David Cameron meeting François Hollande for a Anglo-French summit where civil nuclear energy co-operation will be discussed. France owns a major stake in EDF.

Downing Street said it was unconcerned: "We remain confident in their [Hinkley's] case as we have from the outset."

In his letter to ministers, Joaquín Almunia, the EU competition chief, writes that by providing a fixed, certain level of revenues over 35 years, as well as additional credit guarantees "it would appear to be difficult for the UK to provide a greater degree of certainty".

He also points out that two models used by the government - including an internal Whitehall calculation - show that there would be investment in a new nuclear plant by 2027 or 2030, even without government guarantees. "It is therefore unclear why state aid would be necessary," he writes.

The letter notes that the decision not to tender the contract in a "technology neutral" way may be illegal and that alternatives such as large-scale biomass could "conceivably have competed against nuclear in a tender".

Information provided by the UK "does not substantially support" the view that the measure would improve security of supply. It notes generation adequacy problems materialise before 2020, yet the nuclear plant will only become operational after that date. It also questions why the UK is planning to provide substantially more in state support than the expected cost of power outages, in an unlikely worst-case scenario.

As the EU's top competition authority, Brussels is empowered to police state support for private companies to ensure the interventions are necessary, proportionate and not harmful to the market. It can block a deal or require significant revisions to the terms.

Michael Fallon, the energy minister, said: "This process is normal and we built it into our planning for Hinkley Point C. We'll be using the consultation period to show that this project meets state aid rules, that it will cut carbon in Britain's energy sector and improve our energy security in a way that's good value for money."

A particular concern for Brussels is the combination of price guarantees and credit protection provided by the UK government, which they find to be potentially inappropriate, disproportionate and in breach of EU law.

The main price support mechanism is the contract for difference, or CFD, which stabilises revenues for low carbon generators at an agreed "strike price".

EDF is offered an investment contract for Hinkley Point C that establishes a strike price of £92.50 - roughly twice the current wholesale price of power. In nominal terms, this rises to £279 per MWh in 2058, the last year of the scheme.

The level of support under the CFD could be as much as £17.6bn, which is greater than the expected £16bn cost of building the plant. This provides EDF with roughly a 10 per cent rate of return. The commission questions the appropriateness of the discount rates used in the model to predict cash flows.

It models an alternative 7.3 per cent rate, which is the maximum estimated weighted cost of capital for EDF. From this, the commission found the project "would be profitable under all price scenarios considered and in the absence of a contract for difference".

"It seems very likely that discount rates lower than those proposed by the UK authorities are realistic," Mr Almunia says. "Such changes would influence the profitability of the project significantly."

It notes that other instruments may be preferable to the CFD. "The CFD seems to provide the utmost certainty of a stable revenue stream, under rather lenient conditions . . .[that] is conceived to entirely eliminate market risks from the commercial activity of electricity generation" for 35 years.

The commission noted that the CFD was only one of the measures Britain had introduced to support Hinkley: it had also agreed to index the strike price to inflation and provide EDF with a credit guarantee, while the UK's carbon tax would also support the economics of the project.

The commission questioned the reasons "which lead the UK to deploy various instruments aimed at the same objectives". It said it doubted whether the measures chosen were "appropriate, in particular when they are used together".

Brussels also said it was concerned that aid to Hinkley might displace investment in renewables, and could also undermine the trade in electricity between the UK and its neighbours by squeezing out investment in interconnectors - the cables that link British and continental energy markets.

Mr Almunia writes that at this point he cannot see why the project is fundamentally different from plants in Flamanville in France and Olkiluoto in Finland "which have been undertaken without any support".

EDF said the contract for Hinkley was the first example of a new kind of agreement to unlock investment in low carbon energy, and it was "right that the commission should investigate the far-reaching market reform which makes this and future contracts possible".

The company said it would co-operate fully with the commission and the UK government as the investigation proceeds.