Energy and Climate Change CommitteeWritten evidence submitted by Sir Donald Miller (NUC 07)

1. In the Consultation paper on Electricity Market Reform the Government recognised the failure of the present electricity market to provide the required mix of generating plant with adequate margins of security and proposed to correct this by offering potential developers financial inducements in the form of Capacity or Premium payments. The Royal Academy of Engineering in a joint paper with the Institute of Engineering and Technology warned about the dangers of unintended consequences with this approach.

2. The draft Bill goes further, giving Government powers to require all suppliers to purchase shares of the energy output from plant constructed under Capacity Payments arrangements. The price for this energy is to be fixed by Government as a Contract for Differences of some 30 years duration. Producing robust and competitively priced long term contracts with so many variables potentially affecting the cost structure will be an immensely difficult if not impossible undertaking.

3. The plan presupposes that enough generators will be prepared to invest in high capital nuclear plant on which there will be no return for six years even though other competing generators confine their investment to heavily subsidised low business risk wind turbines with a pay back beginning after only two years. Investing in nuclear under these conditions would have implications for the share price of the investing company with the risk that there will be insufficient interest from private sector companies in providing this capacity at competitive prices.

4. There is no indication in the Bill or in the Ministers letter of 16 May to the Committee that these Problems have been recognised or how they will be dealt with. Clearly it is not in the consumers’ interest to see incentives for good performance weakened or to pay the inflated prices required under this system to induce developers to construct new nuclear plant. Developers will be aware these arrangements will put them in a strong negotiating position; EDF have recently increased the estimated cost of their new nuclear by 40%.

5. It is not clear that Government appreciate just how weak their (or their agents) negotiating position will be in agreeing Capacity Payments and Contracts for Differences with the difficulty this poses for safeguarding Consumers’ Interests. Government need the nuclear capacity but there is no necessity for any generator to provide it—only for suppliers to purchase the output if and when the plant is running and at whatever price Government agrees with the developer. This would mean even less competition than pre-privatisation when two Generating Boards vied in construction and operating performance.

6. In summary under these proposals the Government would:

(a)Determine how much nuclear we need.

(b)Have no certainty that developers will offer the required capacity at acceptable prices.

(c)Seek to substitute negotiated settlements instead of relying on market disciplines and competition to safeguard consumers’ interests.

(d)Take powers to compel all suppliers to purchase shares of the energy output at defined rates.

(e)Risk unintended consequences which cannot be foreseen, such as the effect it would have on the earning power of plant not constructed under the capacity payments regime

The proposals in the Bill will prove excessively complex to operate and the risk that the required outcomes will not be achieved is high. Other more straightforward approaches which do not involve Government in the commercial negotiations do not appear to have been adequately considered.

7. For example Government, while prepared to take powers to compel Suppliers to purchase shares in nuclear output under a specified CfD, have nor apparently considered taking powers to encourage developers to provide the required mix of generating plant without Government themselves getting involved in the pricing mechanisms. It is not clear why it should be more appropriate to require Companies to sign up-front long term contracts purchasing the output at prices over which they have no control rather than taking powers, using a mix of incentives and penalties, to induce the Companies to participate in the financing of the required generation, especially when the large Generators and Suppliers are effectively the same Companies. The large Generators could fulfil their obligations by taking a share in a construction project or, failing that, by participating in the funding of a new plant constructed by others. It is to be expected that faced with these alternatives, generators would prefer to be active partners in consortia undertaking the construction of new projects. In either case they would then be entitled to a share in the energy production at out-turn costs. No difficult (impossible?) price negotiations by Government would be required and normal market disciplines would safeguard consumers’ interest.

8. For the first of the new projects to be constructed in the UK it seems probable that some form of financial assurance will be required from Government. With this backing, since the large generators are also suppliers with established customer bases, their balance sheets should be sufficiently robust to allow non-recourse project financing using a mix of equity and debt, so limiting the liability of the parent companies to their equity investment stakes. It is noted that debt finance for new nuclear in the USA is to be backed by Government in the form of loan guarantees. Such assurances would result in better terms for borrowing (to the advantage of electricity consumers) and also provide safeguards against future policy changes which might impact on the profitability of the developments.

9. In the National interest the aim should be for the generators to form two nuclear groupings concentrating respectively on the Westinghouse and the Areva designs. This would afford a level of competition while restricting demands on engineering resources and fostering the build up of expertise in the design and construction teams. Equally vital, if the programme is to succeed, is to ensure continuity of energy policy and restrict design changes in successive projects.

10. As to construction of new nuclear to time and cost, concerns in this area should not be overdone. The UK’s follow-on AGRs nuclear plant had a creditable construction record (for example; those of which I have personal experience; Hunterston, although virtually a prototype, was less than a year late with cost overrun under 10% while Torness , although constructed after a long nuclear moratorium, came in on time and budget.). Both the Westinghouse and the Areva designs of PWR should on balance be easier to construct but success will depend on the forethought and care with which the projects are set up and manufacturing requirements addressed before the start on site. With Hunsterston most of the delay was due to the need to design and manufacture replacement core insulation after tests showed the initial design to be inadequate. For Torness (and its similar CEGB station Heysham) much care was taken in setting up the projects, for example. The SSEB jointly with CEGB carried out in-depth assessments of the various manufacturing areas and then, in advance of orders, financed the provision of the long lead time production facilities (gas circulators, graphite machining, and core insulation). This was successful and no delays occurred from late delivery of components to site. The importance of this pre-project work seems to have been recognised in respect of Rolls Royce for the nuclear submarines but strangely not in the case of Sheffield Forgemasters in respect of the civil programme.

11. To change course now to a more certain and effective approach for reforming the electricity market may be difficult but much less embarrassing to do so at this time before Government is forced to abandon their proposed system after all its complexities and high costs for consumers become apparent. To change now will also avoid further damaging delays in bringing much needed new nuclear stations into service.

June 2012

Prepared 1st March 2013