The government’s 35-year subsidy for the construction of Hinkley Point C nuclear power station is a high-stakes gamble. We would be better off taking Poland’s alternative approach and adopting a system of reverse auctions
My wife and I have a weekly contest to try and predict eight home wins from any division in the football league. Because we have been together for a few years now, these childish games take on an intensity and competiveness far beyond the actual contest. If at the end of the season I win at this, my summer is worth living. If I lose it won’t be.
It is, of course, almost impossible to predict eight wins because you are trying to determine the future in a world of uncertainty and random events. If sport were predictable it would be not interesting, which is why nobody cares about this season’s Formula One anymore.
However, despite the obvious truth that you cannot predict the future with any degree of certainty, this week’s announcement of the £16bn investment in nuclear power at Hinkley Point C is evidence that the Department of Energy and Climate Change (DECC) still believes they can.
My man-on-the-streets understanding of their thinking is as follows: the UK needs to generate 15% of its electricity from renewable sources by 2020. We are currently at about 5%, somewhere slightly south of the rest of Europe. In footballing terms, we would be Crystal Palace and Germany would be Arsenal. In order to encourage us to catch up, DECC is subsidising the construction of Hinkley Point C with a guaranteed £92.50 per megawatt hour of electricity for 35 years.
This is about double the conventionally generated price and gives their, no doubt, grateful French and Chinese backers a nice 10% return. It also means that the uncertainty and risk of investing in nuclear has been taken away and, following DECCs theory, the investors will want to build lots more.
What it also means is that like my wife Emma and me, DECC is trying to pick winners in the global renewables technology league. DECC clearly think that more nuclear is just what we need to get to the 15% target and hence they will pull investment through by dangling suitably large carrots. They have also picked the winners for wind, solar and tidal, so these each get different-sized carrots according to DECC’s view of how much cajoling the respective industry needs to invest.
This approach is repeated throughout Europe, so we have a veritable grocer’s shop window of subsidy carrots each varying by technology and trying to entice the nervous impala-like investment community to take a nibble.
The trouble with this approach is, of course, that technology prices and other competing subsidy regimes move around a lot. Furthermore, the nice people in DECC are somewhat removed from the actual reality of putting projects together on the ground.
The combination of these factors makes the future very uncertain and we are almost constantly in a position where either the technology-related carrot is too large in relation to the risk, so people make a lot of money at the taxpayer’s expense, or it is too small and shrivelled and nobody invests.
This is the Goldilocks and the Three Bears world of trying to set subsidies. They cannot be too big or too small, but the technology ingredients keep changing and the global financial market keeps turning up, then turning down, the cooker.
DEEC clearly thinks that a £92.50 per megawatt hour carrot for nuclear is the third bowl of porridge in all of this – just right to make a nuclear plant – and EDF and their Chinese backers seem to be saying ‘oh well, go on then that will do’. Whether in five or ten years’ time this will still be the case is anybody’s guess.
Now, although I said that dangling hopefully right-sized carrots of subsidies is a European-wide phenomenon, there are a couple of countries that are trying to take a more innovative approach. Poland, for example, has just shut down its grocery store and is moving to a system of reverse auctions that are technology agnostic.
Basically, the Polish Government is saying it needs to install a certain amount of renewable generating capacity each year in order to meet the 2020 target. It doesn’t know which ‘winning’ technology to back or the subsidy required, so it relies on a free market to determine this.
There are periodic auctions where projects developers bid down the price at which they want to sell their renewable energy into the grid. For each auction there is a set number of megawatt hours of power that the Polish Government wants to see built and they pick then lowest bids until they reach this capacity.
Once you win the auction, you have the contractual obligation to build a plant and you get your bid rate per megawatt hour guaranteed for the next 20 years.
It’s not rocket science really, but the great advantage of this system is that the market is picking the technology winners and the size of the carrot they need. The role of the government is limited to running the auction and awarding the contracts. This is the sort of administration thing that governments are good at and markets bad. What they are not doing is the things that markets are very good at, such as choosing viable technologies, prices and required rates of return.
So, nine weeks into a long season, I am slightly ahead in the ‘eight homes’ game although Manchester United’s unexpected draw at home cost me. What I don’t know is where I will be at the end of the season. In the same vein, DECC knows it is committed to buying nuclear generated electricity from Hinkley Point C at about twice the current market rate, but what it doesn’t know is whether this will be a good or a bad thing in 35 years’ time.
Because of the uncertainty surrounding renewable technology and investor sentiment, the Polish civil servants have decided that this Mystic Meg stuff is not for them and they are focused instead on creating unfettered markets, not picking and rewarding winners.
I don’t know which approach will work in the long run when it comes to getting capacity built. But, in terms of which one will give value for money to the taxpayer, my money is on the Poles.
Michael Ware is corporate finance partner at BDO. @michaelware13
