Energy and Climate Change CommitteeWritten evidence submitted by Martin Blaiklock (NUC 05)

1. Commentary

For the last 30 years I have worked as a project finance specialist across all sectors of international infrastructure and energy, including nuclear power. In general, I conclude that:

(a)Of all types of project, nuclear projects are the most complex to implement. Myriads of technical, safety, environmental and regulatory issues have to be satisfied for such projects to be acceptable. Furthermore, the management of the enrichment cycle, waste fuel and plant decommissioning are additional burdens to be overcome. Consequently, nuclear projects are the most difficult to finance.

(b)The nuclear sector is highly introspective. Notwithstanding efforts in recent years post-Cernobyl and Fukishima for there to be greater transparency and public understanding of nuclear issues, personnel working in the sector have for years been immune to outside comment and intervention.

This has resulted in the industry developing, without constraint, larger and larger reactor-types (eg 1,000–1,500MW EPR and AP1000 units), which are commercially and financially inflexible—and possibly, unfinanceable—whereas competition for Base Load generation has become standardised with conventional 300–500MW units at one fifth of the investment cost per installed MW. Economic and financial logic suggests that the nuclear sector should attempt to compete with alternative power sources, not develop technologies and unit sizes which are unaffordable; and

(c)The nuclear industry has for many years largely ignored the availability and cost (ie terms and conditions) of finance to support new-build projects. [NB. Interestingly, the NAO Brief attached to the Inquiry ducks this issue too!]

As a “project financier” I shall focus my comments to funding issues. I shall also try to be brief! [Apart from the characteristics mentioned above, the nuclear sector produces more paper/documents than any other I know!!]

2. UK Commercial and Financial Perspectives

(a)In the early 1980s a consortium comprising the CEGB, NNC, Babcock & Wilcox, GEC and a City merchant bank (in which I was an employee) attempted to create a “UK Inc” model for building a new family of NPPs** (PWRs) in the UK and to provide a platform for UK exports in this sector. In those days, the UK had the capacity and capability to build NPPs solely with UK resources.

[** NPP = Nuclear Power Plant; PWR = Pressurised Water Reactor.]

(b)The Government of the day declined to support such an initiative, and today, after subsequent Governments failed to implement a long-term Energy and/or Industry Policy, the UK in effect is unable to design and build such projects itself. Indeed, Government policy over intervening years has massacred the sector, and much UK nuclear expertise and industrial capacity has been lost.

(c)Following the privatisation of the REC’s (Regional Electricity Companies) in 1990–91 and the later creation of British Energy [“BE”] in 1996, any new-build power stations had to be private sector sponsored, funded either by existing private utilities using the strength of their corporate balance sheets to raise debt, or as IPPs (Independent Power Producers), stand-alone power plants funded in most cases with greater leverage (ie debt) secured by long-term offtake/sales contracts—a structure employed widely and successfully, internationally over the last 20 years.

(d)In the early 2000’s, the UK Government changed the system as to how generators sold their power into the market by the introduction of NETA (National Electricity Trading Arrangements). The intention was to provide more demand-side competition—which it did, and UK consumers have enjoyed lower electricity tariffs than their European counterparts ever since—but it also ultimately led to the final demise of the UK power generation equipment sector. Many power generators had their margins and cash-flows squeezed, and sector re-structurings took place with international power utilities picking up existing utilities cheaply. Hence, today we end up with a sector potentially short of Base Load capacity and largely owned by non-UK utilities (eg EdF, RWE, Eon, Iberdrola, Suez, Vattenfall, etc). SSEB and Centrica are the only UK utilities of any significant capitalisation.

(e)In due course, many of the independent IPPs also collapsed, as NETA outlawed the long-term contractual relationships upon which such projects relied to maintain financial feasibility. Investors, utilities and lenders, particularly from the USA, lost a significant amount (£5–7 billion?) on such projects, albeit lenders wrote off such losses against profits, which at that time were healthy. Nevertheless, such disasters deterred many power sector investors from considering the UK as an attractive country in which to invest.

(f)One important outcome of the above progression was that, following privatisation, power utility owners were entitled to buy the power plant equipment from wherever they wished. Not surprisingly, many of the non-UK-owned utilities, who in many cases fall under the influence of their national Governments, purchased plant from their own indigenous suppliers, eg Alsthom, Siemens, ABB, etc, which undermined the market for UK suppliers. Over time, the UK power plant supply base effectively disappeared (Rolls Royce apart). Similarly, the construction, project management and contracting components of such power plant projects went in many cases to non-UK companies, again leading to a fatal weakening of the sector.

[In this context, it is pertinent to make similarity with the current wind power sector, where the UK, I am told, has more wind than any other Western European country, yet we cannot build the turbines with UK-owned companies. Having been born and bred within walking distance of a C.A. Parson plant, where the World’s first steam turbines were built over 100 years ago, this is a tragedy for UK innovation and skills.]

(g)Meanwhile, notwithstanding many EU demands, etc, most of the mainland European power generation markets remained closed to non-national companies, which in turn led to the increased corporate power in those markets for a few large utilities, suppliers and contractors. The cost-of-entry into those markets for new players became prohibitive, whereas the UK represented an “open” market to investors, suppliers and contractors. Unfortunately for the UK, the EU Commission remained helpless, or unwilling, to enforce unbundling and the creation of an EU competitive power market.

(h)Overall, during the period 1985–2000 the UK lost the capability to build and complete major power plants, and that situation persists today.

When one also notes that the current Boards of Executive Directors—where the decisions on research, investment and procurement are taken for major projects—in EDF, RWE, Eon, Vattenfall, Iberdrola, ENEL, and Suez do not contain one UK national, not only has the UK lost its capability, but also decision-making influence over what is built where, when, by whom and with what equipment.

Furthermore, at least three out of these utilities are effectively owned and controlled by Governments, so it is indeed not surprising that they sponsor their own industries before the UK’s.

(i)Commercially, the UK is “up the creek without a paddle”. We/the Government are not in control of our future energy destiny!

(j)In the context of nuclear power, the advent of NETA led inevitably to the downfall of British Energy [“BE”]. Nuclear power represents Base Load capacity and is capital intensive and operationally inflexible. It needs long-term sales arrangements, which NETA outlawed, to sustain financial viability, In addition, reflecting the need for long-term sales contracts, the long-term fuel cycle contracts which BE had with BNFL became unviable as a consequence.

(k)BE collapsed, and the Government stepped in to restructure the finances at some cost to the public purse [Credit Suisse et al charged Government (£100 million plus to restructure £3 billion of British Energy loans and bonds (ref FT December 2003)]. BE shareholders received a pittance. In 2009, Government sold BE to state-owned EDF, consolidating their position in Europe’s nuclear market, cornering out competition.

(l)To rubber-stamp the demise of the UK nuclear sector, over the period 2005–09 Government sold off Westinghouse (the original designers of the PWR) and much of BNFL, representing the core of UK nuclear design and operational experience, to Toshiba et al. Later, Government awarded a £1 billion clean-up contract for Sellafield to a consortium led by French state-owned AREVA.

(m)Combined with the commercial demise as mentioned earlier, this reverse out of the nuclear sector by the UK Government could not have been more comprehensive. Our nation’s young engineers and scientists will have to look overseas most probably for future employment.

(n)Has this sell-off policy been “in the National Interest”, one might ask? Well, no other Western industrialised country has followed suit. Quite the opposite, in fact. We are, indeed, “up the creek without a paddle”!

3. Funding Structure

(a)Globally, all nuclear power plants built to date, bar two (see below), have been funded with equity and debt raised by:

(i)governments, or by government-owned power utilities (eg EDF); or

(ii)major private power utilities, sometimes quoted on a Stock Exchange, (eg Eon and RWE in Germany), where the nuclear new-build is one of a portfolio of power plant assets operated by the utility.

(b)The security for lenders to such projects has been direct and/or indirect government or corporate guarantees. Lenders evaluate the financial strength and creditworthiness of the borrower’s balance sheet or alternatively third party guarantees, and are not reliant on the specific cash-flows to be generated by the new-build for the repayment of the loans.

(c)To date, however, nuclear power projects have never been funded by debt secured on a “project financing” basis, ie against the future cash-flows of the project, as have many CCGT-type (“IPP”) power plants around the World.

(d)The only (two) exceptions that I am aware of are:

(i)EDF’s NPP Dunkerque, which supplies power to the local Pechiney aluminium smelter. The debt was secured against cash-flows supported by long-term alumina supply and aluminium sales contracts (albeit controlled by Pechiney, a French state-owned company at the time!). In effect, the underlying funding structure was viewed by financiers as a French Government liability; and

(ii)Finland’s 1,600MW NPP Olkiluoto-3, where the shareholders supported and committed to long-term dedicated sales contracts to secure debt funding. However, this project has yet to become operational.

Both these can be considered as “special cases”.

(e)With respect to a “project financing” alternative for the UK, creating such a funding structure and mechanism for the first time in this sector would be treading new ground and carries with it significant additional risks, which probably, in the event, will prove insurmountable.

(f)Typically “project financings” take twice as long to arrange as for conventionally-funded projects (ref & cf HM-Treasury’s PFI/PPP Review, PFI: Strengthening Long-Term Partnerships, March 2006). Hence, “project financing” is not “a quick fix”.

(g)Furthermore, for such “project financed” deals to be viable, they need to be underpinned by contractual arrangements. The Government has attempted to solve this issue via the CfD (Contracts for Difference) in the EMR (Electricity Market Reform) discussions, but the mechanism proposed is untried on the scale proposed, appears inordinately complex, and lacks the transparency the sector, investor and public requires. Furthermore, the credibility and creditworthiness of the CfD counterparty is far from certain.

(h)For a Government seeking quick results once the NPP approval decision has been taken, therefore, this funding route—“project financing”—is not the answer compared to conventional utility/corporate guarantees to secure debt.

(i)Hence, the new generation of UK nuclear power stations can really only be funded by existing major utilities who can secure the debt against their balance sheets.

4. Availability of Finance: Equity

(a)Typically, major power utilities comprise 50–60% long-term debt in their Balance Sheets. Hence, if they are to invest in a new NPP costing £5 billion, they need to commit £2–2.5 billion of shareholder equity and expect to raise £2.5–3 billion of debt.

(b)Secondly, such utility investors will not obtain any return on their investment for the four to five years that it takes to build such NPP’s. Many other investors, eg “private equity”, which comprises life insurance and pension fund investors, will shy away from such investments. They seek long-term low-risk investments, which infrastructure assets provide, but they also need income (ie dividends) to satisfy customers. Utilities, therefore, will to a large extent have to fund the equity for such projects out of their own corporate treasuries.

(c)Have these utilities got the financial strength to undertake such investments?

Over the last 1–2 years, many European power utilities including EDF, Suez, RWE, Eon, Iberdrola and ENEL have all seen their share prices fall by around 40%. This drop has been due to a number of factors:

(i)the economic climate in the Eurozone after the 2007 Financial Crisis;

(ii)the perception in the bond markets—the main source of debt for such utilities—as viewed through ratings by S&P, Fitch, etc, that the underlying cash-flows from utility operations are being squeezed; and

(iii)the need to de-leverage power utility Balance Sheets through asset sales to restore credit ratings: many such utilities embarked on ambitious international acquisitions in Latin America, Asia, etc, in the early 2000’s, funding such acquisitions with cheap debt.

Hence, not many European utilities are fit and ready to embark on major new project investments, particularly nuclear, in any country when investor returns will not be generated for some years.

More specifically:

(d)EDF (state-owned) has currently 58 operational NPP’s, of which many are coming to the end of their useful (licenced) life. Given the larger size of the EPR reactors to those previous built, a like-for-like re-build program would require around 42 units over the next 20–25 years. Assuming France decides to develop more renewable plants as alternatives**, this figure might drop to 25–30, ie one new-build committed each year for the next 20 years. Also, some existing NPP’s may have their licences extended to put off the day when they need to be replaced.

[** Renewables are not a direct alternative to nuclear; nuclear is Base Load.]

With a utility leverage of 55–60% and a construction period for each plant of 4–5 years, this program will require a commitment of £12–15 billion of EdF capital before any return is obtained for EdF shareholders/owners… and this is just to satisfy the needs of the French domestic power market.

Given the indebtedness of the French Government, etc, the ability of EDF to fund any NPP elsewhere, eg the UK, must be put into question. On the other hand, AREVA, the state-owned French nuclear power designer/contractor are desperate to have some additional projects to demonstrate their EPR model… but that does not provide equity.

(e)Suez is another contender in the nuclear field and may, in the event, take up any slack in the French new-build program, which EDF cannot support. However, Suez, arguably commercially more dynamic than EDF—albeit there is a French Government “golden share” in its corporate make-up—has other international ambitions in gas/LNG and conventional power (via International Power, which it bought control of recently), which will take up much of any spare capital.

(f)RWE & Eon: both these utilities have been hit by the withdrawal of Germany from nuclear power and, indeed, from the UK nuclear new-build scene. This withdrawal has cost both utilities many €billion, and they will need to fund the conventional replacements for their NPPs closed down early. They are both also going through a program of asset sales due to ambitious acquisition programs earlier in the 2000’s. Their current financial standing, therefore, is not conducive to their being a serious player in the current UK nuclear initiative.

(g)Vattenfall (Sweden) is state-owned and operates 10 NPPs providing 40% of domestic Swedish demand. Many of these NPPs need to be replaced, which will keep Vattenfall’s capital tied up for some years. Their UK interest to date mainly lies in Renewables (wind), not nuclear.

(h)Iberdrola (Spain) and ENEL (Italy) operate NPPs in Spain and Slovakia respectively, but do not have the capacity to lead any new NPP initiative in the UK.

(i)Similarly, Centrica and SSEB are possibly participants in any new UK NPP initiative, but not as lead investors. They also are more interested in developing conventional and renewable energy resources with shorter term investor return horizons.

(j)Finally, there has also been some recent discussion as to the possibility of Sovereign Wealth Funds (“SWF”s), eg Abu Dhabi, China, etc investing in the sector. By their very nature, such funds have a political agenda and their presence will not negate the need to have in any UK consortium an experienced nuclear operator.

(k)Overall, therefore, not only is there a dearth of equity capital to fund a new UK NPP initiative, but the decision to proceed and the resources needed to implement such projects lies largely outside UK Government control.

The phrase: “we are up the creek without a paddle!” rings true!

5. Availability of Finance: Loans

(a)With respect to debt funding, prima facie each new NPP will require £3 billion of debt finance per plant. This is not an insignificant sum, and will require a large syndicate of banks to source, ie it will not be “a quick fix”. In addition, the project might not generate cash-flows for six to seven years, so interest will have to be capitalised. This will raise the actual debt outstanding at project completion to close to £4 billion Per NPP.

(b)Clearly, this increases the leverage or debt/equity ratio of the sponsoring utility, and lenders may insist that the equity proportion is increased due to the inherent risks of a long construction period. Additionally, without the support of firm off-take, or sales, agreements, lenders will not be comfortable with such a financing.

(c)Power projects, nuclear or conventional, have long project lives. Typically, the debt funding will have overall maturities (construction plus repayment period) of at least 12–20 years or so. NPPs require such maturities.

The introduction of Basel III regulations relating to the capital requirements of banks makes lending longer than 10 years expensive and not attractive. As 10 year loans are insufficient for NPPs, such loans would have to re-financed, at the latest, in Year 10, and to date there is no guaranteed mechanism that such re-financing can be achieved.

(d)Export credits are another long-term source of loans to supports NPPs, and under the Consensus there are special terms for such funding for NPPs. However, the UK is too rich to benefit from such credits.

6. Other Sources of Finance: Capital Markets

(a)Promoters of new UK nuclear power plants, eg utilities, may perceive that the capital or bond markets may be more receptive to NPP’s. After all, the long-term funds available in the bond markets are believed to be much greater than for long-term loans, and such bonds have been commonplace in US energy and infrastructure financings for years.

(b)Unfortunately, not so! Bond purchasers are more conservative than commercial lenders, and such funding is more cost effective for projects once completed, ie for re-financing existing operational utilities.

(c)Further, to rely on a bond financing, where there always remains uncertainty until the bond is issued and placed in the market, is a high risk strategy, viz the Channel Tunnel Rail Link financing debacle, which relied upon a bond issue subsequent to the outset of project implementation.

(d)The basic principle of project financing is that all funding—debt and equity—must be in place and committed before construction starts. This principle should be upheld at all times. Hence, a project with a long and complex construction schedule, such as a nuclear new-build, is unsuitable for bond financing, unless the re-financing of the initial loans with bonds on project completion can be guaranteed.

(e)This is the same problem that the UK Government/HM Treasury are grappling with over PFI/PPP, and so far no mechanism has been developed.

7. Project Size

(a)Twenty years ago the standard size nuclear plant was 660MW. Since then, the market has been dominated by 350MW unit CCGT’s, etc, which are more flexible, affordable, less complex to build, and easier to finance than NPPs.

(b)For inexplicable reasons, possibly due to an industry which at times has tended to bury itself in its own problems, unaware of how power markets now operate, the nuclear industry has directed its efforts towards bigger (ie 1,600MW) and less flexible and financeable units.

(c)If the nuclear industry could offer developers and utilities a power unit comparable in size to an “off the shelf” 350MW CCGT, many financing difficulties as described above would diminish significantly.

(d)Smaller projects would attract more investors and lenders, and the sector become more competitive, with a concomitant impact on prices. The future of the sector would look much brighter!

8. Concluding Remarks

(a)The conclusion arrived at is that funding new UK nuclear power plants exclusively through private sector capital and initiative will be a difficult task and, possibly, insurmountable. We are entering new territory, so to speak.

(b)Government support will be needed not only to facilitate a planning process which allows private capital to be made available at reasonable cost, but also to cover those risks which cannot be valued (e/g/nuclear catastrophe).

(c)As it stands today, the main nuclear option for the UK to replace existing base load capacity comprises the construction of (at least) one EPR by EDF, supported by a group of international investors. In other words, this option is based upon:

the decision to proceed or not being dependent on a foreign Government, which already is highly indebted;

a commercially (today) unproven reactor design;

a project design for which fixed cost estimates cannot be given;

an unproven CfD mechanism to support lenders and investors;

a timetable which will take at least five years before we know whether this option is successful or not; and

minimal UK industrial and construction participation.

Overall, this option, to me, seems high risk and makes only limited contribution to the nation’s industrial base. Hence, it is of little value to the national interest. Strategically, it is also putting “all the UK’s (nuclear) eggs into one basket”.

(d)Is there an alternative, one might ask? Is there a “ Plan B”? [Probably, not!!]

(e)I would like to suggest that a lower risk and more certain way forward for the UK to replace existing Base Load nuclear capacity would be to:

Implement a short-medium term program of CCGT’s—hopefully, using UK-built gas turbines—which could be spread around the UK to ease the current imbalances in the UK Grid system, complemented by a program of renewable energy and energy efficiency projects, when viable. In fact, currently I am informed that Centrica has around 3GW of CCGT capacity mothballed in the UK. This represents two EdF-sized EPRs in capacity terms. At little cost, such CCGT’s could be brought back into service as an interim measure; and

Use some of the £1 billion monies awarded to Rolls-Royce recently to develop the next generation of NPP’s for the propulsion of the UK’s nuclear deterrent program to develop small NPP’s for electricity power generation.

It is interesting to note that the Russians are building six x 30MW NPP’s on barges for use in distant parts of Russia and the USA is also developing such smaller units. It makes both economic and financial sense, although there will be some competitive cost disadvantages due to the loss in economies of scale compared to EPRs and AP-1000s.

(f)In the long-term such a “Plan B” might benefit UK industry much more, be lower risk, and so be more in the National Interest.

I have worked in the field of energy and infrastructure project financing both in the UK and overseas since 1973. My nuclear activities have included:

undertaking an assignment for the market impact of heavy water reactors for BNFL in the early 1970’s;

employment by Kleinwort Benson 1974–1985, where assignments covered: (a) the development of the original financial structure for UrencoKleinworts was Financial Adviser to the multinational Urenco consortium—(b) the financing of CANDU power stations in Canada, and (c) a major initiative for building a program of PWR’s in the UK and for export in the early 1980’s;

employment with EBRD, 1991–95, where I was Director, Power & Energy Utilities and grappled with the issues of the nuclear legacy in Central Europe, eg NPP Mochovce & NPP Bohunice (Slovakia), NPP Ignalina (Lithuania); NPP Temelin (Czech Rep); etc (I have even been inside a reactor core!!); and

working on schemes for the replacement power plants for NPP Ignalina (Lithuania: 2001) and nuclear units in N Korea (2005).

Since 1995, I have operated as an independent consultant in energy and infrastructure financing, following closely developments in the nuclear field as they arise.

I also have undertaken more than 70 three to four day Courses on “Energy & Infrastructure Project Finance” for Governments and banks over the last three to four years, including three on “Financing Nuclear Power”.

July 2012

Prepared 1st March 2013