Left Outside

How to guarantee your shiny new nuclear power plant is over budget

September 2012 - EPR reactor construction site - Flamanville, France © EDF, Morin Alexis

September 2012 – EPR reactor construction site – Flamanville, France © EDF, Morin Alexis

First of all, nuclear power is a safe and clean energy source. However, building nuclear power stations is really, really hard and they are often delivered over budget and behind schedule. You’d think, since we’re on the verge of building a new one at Hinkley Point, we’d be doing everything we can to make sure it’s done right. Right? Wrong. To incentivise its construction the government and EDF are doing everything they can to destroy any incentive of building to time and budget.

To understand energy investment in the UK today you need to understand the government’s energy market reform. Trust me I’ll keep it short and use bright colours.

The government doesn’t want to, and legally cannot, willy-nilly subsidise energy investment in the UK. One because they’re Tories and they don’t want any spending on balance sheet because they’ve fetishised the UK’s debt and two because EU state aid rules mean they’re just not allowed to subsidise private energy producers. In the next few years lots and lots of power stations are going to be retired because they’re old and nobody wants to replace them without a subsidy. We are at an impasse that leads to an energy crisis. Can an impasse lead somewhere? Yes. Shut up.

The solution is an elaborate system of contacts, payments, counterparties, bargaining, auctions and horseplay that we know as Electricity Market Reform. The system is really simple. You sign a contract agreeing to produce electricity and the government guarantees you for a set number of years a certain price per Megawatt hour. If the market price is below that contracted price consumers receive a surcharge on their bill, if the market price is above it they get a bonus. How often do you get the bonus? Shut up.

EMR

Eventually the contracts will be auctioned which should mean that payments to consumers occur roughly as much as payments from them. But to begin with the contracts will be negotiated. Because we’re in such a poor state generation wise we’re getting blackmailed by the French.

Taken from here.

Taken from here.

EDF want to build a nuclear power station using a reactor developed by Areva called the EPR. In order to build it is reported that EDF are to receive £93-96 per Megawatt hour. This is more than double the current market price of electricity. To justify the investment EDF claim to need an ex-ante internal return of around 10%. Their problem isn’t that a nuclear power plant is an unproductive investment, they produce a phenomenal amount of electricity. It’s the construction.

Olkiluoto, the first EPR to be built will be 200% over budget and six years late when complete. Flamanville, the second EPR will be about 150% over budget and 4 years late. Linear projects are a fool’s game, but fuck it, at this rate Hinkley Point C will be two years late and double the cost expected. Since the UK is desperate for new, low-carbon generation EDF know they have us over a barrel and a likely cost overrun on their hands. Hence why we’ll be paying them double the market price for electricity.

It doesn’t end there though. If you thought the incentives were bad enough as I’ve describe, it gets worse. To prevent massive windfall profits the government are going to insert a clause into the agreement which will allow for excess profits to be clawed back. Mull that one over.

If EDF build over budget they’ll make a modest profit because they’ve been guaranteed a high energy price.

If EDF build to budget they’ll make a modest profit because government will confiscate the payments consumers pay to EDF because they’ve been guaranteed a high energy price.

As well as being an arsebackwards roundabout way of getting you and me to subsidise the building of power stations it completely eviscerates any financial incentive for EDF to run the project to budget and to schedule. I’ve a soft spot for giant infrastructure projects, complicated engineering and carbon free electricity, but we are running this project like we want it to fail and to cost everyone a lot of money to get there.

Filed under: Economics, Politics, The Media, , , , , , ,

The art of taxing carbon without taxing carbon

Before I talk about how the coalition have screwed up, I’ll talk about how the energy industry seems to be moving in the right direction. Despite there being limited progress in pricing carbon or achieving a low carbon economy. People in the energy industry seem to be acting as though there has been. I put this down to expectations.

The more and more closely with people in the energy sector, the more and more I begin to see expectations determining people’s behaviour. Every UK energy company has a smart metering team (that is mandated by law), but they are also dedicated to working out how to get people to use less energy (which isn’t).

Likewise, BP has invested in renewable energy research (although of course it hasn’t abandoned its profitable fossil fuel business). Other energy companies have made a move to low carbon generation and to reducing their customers’ energy consumption. The language executives use has even shifted. Find a speech from an energy company exec that doesn’t mention reducing emissions, you might be surprised how hard it is.

These actions won’t show up in policy discussions because the policies haven’t been implemented yet. So pessimism is to be expected. But when you look at what people are moving towards, it begins to look as though the expectations of more expensive carbon and cheaper renewables is affecting people’s behaviour. In an industry with such a long planning horizon I suppose this is to be expected, but I was surprised.

I suppose this is another of my hobby horses. Economics isn’t about choice. It is about expectations and contracts. Expecting higher prices, even if today’s prices are low, will impact your decisions. I think we can see some of this in the energy sector. I don’t want to be Panglossian, we are still probably screwed by climate change, but probably less screwed than people assume.

Filed under: Economics, , , ,

When NGDP is Depressed, Employment is Depressed

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