On 22 July 2019, the UK Government’s Department for Business, Energy & Industrial Strategy (BEIS) published, among others, its consultation on a Regulated Asset Base (RAB) model for nuclear power (the “Consultation”). The Consultation forms part of BEIS’ package of proposed measures to support the decarbonisation of the UK economy, which also includes consultations on CCUS business models, on reusing oil and gas assets in CCUS projects, on the Capacity Market carbon dioxide emissions limits and on facilitating energy efficiency in the electricity system.

BEIS considers that a RAB model, which would involve levying a regulated charge against energy consumers (via their suppliers) during both the construction and operational phases of a nuclear project, could reduce the cost of the low-carbon technology. The RAB model has historically been used in privatised monopoly industries (for example, the utilities networks and the rail sector). Recently it has been used for single-asset projects – notably the Thames Tideway Tunnel (TTT), but also (in a modified ‘cap and floor’ form) for the electricity interconnectors that will connect the GB electricity network to Belgium, Norway and France (among others). A similar model to the TTT RAB is proposed for new nuclear; however, the transfer of risk from developer to consumers and taxpayers, which is central to the RAB model’s ability to reduce costs, may be challenging as it could ultimately leave energy consumers paying the high capital expenditure of something that never gets built.

The need for new, dispatchable, low-carbon generation

If the UK is to meet its binding commitment to be emissions neutral by 2050, it needs a varied but low carbon energy mix. The Committee on Climate Change’s report limits the amount of intermittent renewable generation in its scenarios to 60% of the generation mix, leaving a significant shortfall for dispatchable, low-carbon power. Nuclear could provide low-carbon baseload generation on a large scale. Indeed, currently eight nuclear facilities provide around 20% of the UK’s power (but seven of these are due to come offline by 2030).

Whilst the Government has an existing subsidy model in place to incentivise investment – the Contract for Difference (CfD), as used for Hinkley Point C – there are perceived shortcomings of this model for both sides:

  • Energy consumers are committed to paying a guaranteed price (strike price) per MWh which appears to be poor value compared to alternative low-carbon generation; and
  • Investors must shoulder unlimited risk (including construction risk) with no revenue stream until a project starts generating electricity, which can be problematic considering the risk profiles, enormous capital expenditure and long construction phases that are associated with new nuclear projects.

The market has responded with a number of cancelled projects in the UK, which, perhaps, signals to some that the CfD model may not be fit to attract further investment and deliver new nuclear facilities. As an alternative to CfDs, the Consultation proposes a RAB model to support new nuclear in the UK.

How would a RAB model work?

The RAB model proposed has many similarities to the model used to support the TTT. It comprises twin support pillars: a Government Support Package (GSP) and an Economic Regulatory Regime (ERR).

Government Support Package

The GSP is aimed at addressing the low probability but high impact risks that currently sit with developers under the CfD model and drive up the cost of capital and overall project costs. The Consultation does not go into any detail about what this support may look like for certain risks (e.g. debt market disruption, insurance availability and political risks) save for in the case of wild costs overruns, for which a ‘Funding Cap’ is envisaged. Beyond this cap, either the Government may provide equity funding, the regulator (see below) could decide whether further funding could be provided under the RAB, or the Government may discontinue the project and provide a discontinuation payment. The final option gives rise to the possibility that energy consumers pay throughout the construction phase for a nuclear facility that is never completed, and which ultimately never benefits them.

Economic Regulatory Regime

The ERR sits at the core of the RAB model. In keeping with other RABs it would involve a regulator granting licences to nuclear projects that allow them to charge energy suppliers a regulated price (the Allowed Revenue) throughout the construction phase and part or all of the operating life of a nuclear power facility. The Allowed Revenue would be set by the regulator, and would be based on a series of building blocks, notably a return (at a weighted average cost of capital or “WACC”) on the approved costs of developing the project (the RAB), which will increase as construction progresses. The WACC may be determined by a competitive process (in whole or part) or be set administratively. In addition to the return on capital, certain other costs could be added to the Allowed Revenue, as set out below:

Source: the Consultation, p. 13

The key advantages of an ERR model are:

  1. Certain risks that would otherwise be priced into the project cost can be borne by or shared with energy consumers (via their suppliers); and
  2. During the construction phase, developers will receive a revenue stream commensurate to their capital expenditure, allowing them to service their financing costs and avoid compound interest, thus reducing project costs. Given the enormous capital expenditure in nuclear projects (£15-20bn), and the long construction phases, compound interest can represent a significant portion of project costs.

In accordance with the National Audit Office’s analysis on Hinkley Point C, BEIS considers that the GSP and ERR will significantly reduce the unit cost of electricity for new nuclear projects, compared to a CfD model. However, the transfer of risk to consumers (the necessary evil of RAB models which facilitates lower prices) may be politically unacceptable given nuclear projects’ risk profiles, which include heightened construction risks, performance risks and regulatory risks (not least in relation to decommissioning). The Consultation hopes that the rejuvenated supply chain and lessons learnt as a result Hinkley Point C will mitigate these risks.

What’s needed?

  • A regulator would need to be established or appointed to manage the consumer-project interface, with a regulatory framework established or applied for the regulator to operate within.The choice of regulator and regulatory framework requires careful thought: it must inspire confidence from investors while also standing as principal protector of consumer expenditure. Furthermore, the licensing function of the regulator, which would entail comprehensive diligence of prospective nuclear projects, demands deep industry understanding to ensure the unique risks of nuclear projects are fully identified and consumers protected from the possibility of paying for something that never generates electricity.
  • An intermediary body would need to be established or appointed to handle revenue flows from electricity suppliers to project companies.The Consultation points towards a model based on the Capacity Market design, rather than the model that applies to networks, who receive their RAB revenues via the System Operator.
  • State aid clearance (whether from the European Commission or, post-Brexit, the CMA) would likely be required for the GSP.
  • The terms of the GSP would need to be developed.
  • The detailed design of the ERR would need to be progressed, including the licence drafting. The Consultation leaves the detailed design of the ERR to be established on a project-by-project basis, which may deter investment. Further consultations may be held to refine the design of the model, and these are more likely to achieve an investable programme compared to leaving questions unanswered until licensing stage, when costs will have already been sunk.

The Consultation is open until Monday 14 October 2019.