nuclear subsidies

Politicians don't like to admit that they have caved, and so try all sorts of wiggles to make it look otherwise.  But let's be clear:  even if you call it "Contracts for Difference" instead of "Contracts that Commit Taxpayers to Pay Prices Well Above Market for a Very Long Time" the essence of what you are doing doesn't change.  The policy is a long-term above-market price floor for new reactors.  Stated otherwise, the UK has jumped the shark, and, in a repeat of its historical approach (see p. 81) to the sector, will be subsidizing new nuclear in a big way for decades to come.

Nuclear industry: policy-enhanced investment offers the most favorable returns

Big projects mean big risks.  You might screw up construction, or markets could change so your product is worth less, or there is an accident somewhere in the world that sets all the annoying regulators atwitter forcing you to spend money you weren't expecting to have to spend just to prove you are safe (which of course everybody already knows you are).  Investors don't like this uncertainty, and using government as a special investment partner (i.e., pay money, bear risks, but don't have a stake in the profits) is a strategy that has proven quite successful for the nuclear industry over the years.  I've coined it "policy-enhanced investing (PEI)," and it normally offers better returns than the old-fashioned type.

The nuclear industry is nothing if not persistent.  Faced with an endemic inability to deliver market-competitive power, industry participants, its trade associations, and the politicians who support them, have used a three-pronged strategy for decades. Many of these attributes pop up in the UK justifications for the long-term price floors for new nuclear plants.

• Prong 1:  our cost overruns are other people's fault -- delays, litigation, regulation, all of which was unfair and uncessary, is what drove our costs up. 
• Prong 2:  we are the only, or the fastest, or the primary solution that works to deal with (depending on the time period) clean air, domestically-produced power, climate change.  Other fuels or strategies may claim they can solve these problems, but we are big, we are baseload, and we are really the only serious contender.  These themes have shown up in industry ad campaigns over the years, yet steer clear of the quite logical premise that solving the problem nuclear is supposedly best at solving is rather uncertain, with a variety of uncertain potential options each of which has varying estimates on costs, risks, scalability, and delivery times.  Accepting such a premise with respect to uncertainty of options would then argue one should just integrate the problem (carbon capture, emissions, etc.) in power prices, forcing nukes to prove in market competition that they were really the best solution to the issue at hand.  Getting hardwired subsidies is so much more attractive. 
• Prong 3:  government policy needs to support our sector in a big way, and doing so is some mix of:  in the interest of national security and retaining key manufacturing skills; needed to protect the climate; only temporary to overcome irrational investor fears of losing money (created mostly by prong 1 claims of problems being other people's fault), or to get us over the "first of a kind" engineering challenges that will soon be surpassed at which point we'll be really cheap; or merely in line with support the government has given to everybody else; or is not really support because we're not getting cash and we're not going to default, and if you are not giving us cash stuffed in an envelope it's not a subsidy.  No matter that many of these arguments conflict with each other: the industry will trot them out from the policy salad bar in any combination it thinks will work. 

Normal long-term contracts discount commitments; UK contracts pay more than market

Long-term contracts for power, or indeed for a range of items produced by large-scale, capital intensive industries aren't new.  Producers like these contracts because they need to ensure enough of their production will be purchased to cover most of the capital costs of their facility over the long period it will be operating.  These types of contracts can greatly reduce market risks prior to committing the capital.  But normally, a buyer entering into such a contract will get a discount on prices, often a substantial one, because they are willing to buy a large quantity for a long period of time.  Much can change in 20 or 30 years, so the purchaser does indeed take on quite a bit of risk that changes in their needs or the marketplace overall, will render the long-term purchase contract a financial albatross. 

Although the UK "Contracts for Difference" are long-term contracts, they differ rather dramatically from private market transactions.  Specifically, they are price floors, committing to long-term purchases at a premium rather than a discount -- the opposite of how private deals would normally run.  How can this be?  Simple:  the contracts are subsidies, not market transactions; and likely to be very large subsidies at that.

Here's Edward Davey, Secretary of State for Energy and Climate Change, and MP for Kingston and Surbiton, doing the "No Subsidy Wiggle" in April 2012:

The  purpose of the Contracts for Differences which Fiona refers to in her article are to provide that greater price certainty in the period of transition towards a low carbon energy future, when investment requirements are so high. I want to make clear, just as Chris Huhne did, that this means that nuclear will not receive a higher price than comparable generation technologies whether they be renewables or indeed gas generation once its emissions have been abated by carbon capture and storage. There will be no public subsidy of nuclear generation.

Logic slip alert.  Davey's point that nuclear won't receive a higher price than comparable generation technologies is quite different from his concluding statement that there "will be no public subsidy of nuclear generation."  It may mean that nuclear subsidies won't be higher than subsidies to other power sources, or that offshore wind or other resources are also getting subsidized, but it certainly doesn't mean "there will be no public subsidy of nuclear generation."  Deep down, we all know that Davey knows this too. 

Current changes make the terms even worse for taxpayers

Recently, the no-subsidy "Contracts for Difference" seem to have gotten even worse for taxpayers.  Rather than a duration of 20 years as originally envisioned, the price floors are now being offered for 40 years.  And far from securing a discount for the project risk the public is bearing, the contracts will be at "more than double the market price for electricity, and higher than all but the most expensive government forecasts for the future."

Here's the promise of engineering miracles (noted in Prong 3) to bring the costs down:

Whitehall sources said they were confident that although the cost of the new reactor would be very high, that will start to fall with subsequent projects, and could fall as low as £55-56 a unit later in the programme.

Hasn't happened for the industry yet (see Exhibits 1 and 5, pages 4 and 14), not even in France, the poster child for industry-supportive nuclear policy.  And its unlikely to happen in the UK with a handful of subsidized reactors hardly comprising the type of production run for major economies of scale and learning to kick in.

Worried that perhaps the UK government doesn't have taxpayer interests at heart?  A Guardian article reveals that you should be:  a surprising number of nuclear industry staff are actually working for the government oversight agencies policing the sector.

A Freedom of Information request undertaken by the campaign group, NuclearSpin.org, showed at least 15 people working for the nuclear energy industry or its consultants have been seconded to areas responsible for policy or regulation, some being paid for by the taxpayer.

The government assures that they have adequate procedures in place to guard against conflicts of interest.  Still, anybody want to find which UK public policy schools think this type of arrangement is a good idea?

The gradually eroding red line on nuclear subsidies

Back to Edward Davey for a moment.  His piece in 2012 harkens back to an October 2010 statement by former Secretary of State for Energy and Climate Change Chris Huhne, noting that:

As Chris Huhne outlined in October 2010 this means that “there will be no levy, direct payment or market support for electricity supplied or capacity provided by a private sector new nuclear operator, unless similar support is also made available more widely to other types of generation.” [Emphasis added].

That is:  there may be a subsidy, but not a bigger one than renewables get.  But going back even further shows that the "Huhne Position," if we can call it that, is itself a subsidy capitulation.  Earlier history has been nicely summarized in a 2008 paper by Professor Steve Thomas, on the faculty at the University of Greenwich and a long-time analyst of the UK nuclear sector.  Here's an extract.

In May 2005, Tony Blair said 'Nuclear power is back on the agenda with a vengeance'[1]. His chief scientific adviser and other government spokespeople suggested that up to 20 new nuclear units would be needed. This was taken by many, internationally, as a signal that the UK was about to launch an aggressive new programme of nuclear power stations. However, in evidence to a Parliamentary Select Committee, the Energy Minister, Malcolm Wicks said[2]:

'It is not for government to say that we shall have X nuclear reactors and so on. Government will not be building nuclear reactors, will not say they want X number of nuclear reactors. I always thought myself that if at the moment one fifth of our electricity is from nuclear, if the market came forward with something to replicate that broadly in the future, from my own point of view it seems to me that would make a useful contribution to the mix. We are not going to do anything to facilitate that, nor this percentage nor that percentage.'

Subsequently, after a challenge by Greenpeace, the High Court found in February 2007 that the government's consultation process on nuclear power was inadequate and had to be repeated. 'Mr Justice Sullivan said that the consultation exercise was "seriously flawed and that the process was manifestly inadequate and unfair" because insufficient information had been made available by the Government for consultees to make an "intelligent response".'[3]

The government's Green Paper on energy published in May 2007 therefore made no specific commitments on nuclear power. However, one of Gordon Brown's first statements as the Prime Minister in June 2007 seemed to pre-empt the consultation. He told Parliament on July 4 that[4]:

'...we have made the decision to continue with nuclear power, and ... the security of our energy supply is best safeguarded by building a new generation of nuclear power stations.'

A new consultation was announced in May 2007 and was closed to submissions in October 2007. In January 2008, the government announced the result of the consultation, which again favoured new nuclear construction. The new White Paper stated:

'Set against the challenges of climate change and security of supply, the evidence in support of new nuclear power stations is compelling.'[5]

The commitment not to provide subsidies was reiterated:

'It will be for energy companies to fund, develop and build new nuclear power stations in the UK, including meeting the full costs of decommissioning and their full share of waste management costs.'[6]

The utilities most likely to build nuclear plants, EDF and E.ON both supported the suggestion that subsidies would not be needed. Vincent de Rivaz, CEO of EDF Energy (UK) said: 'We have made it clear we are not asking for subsidies, all costs will be borne by us.'[7] While E.ON said in a press release: 'It also believes that there is no requirement for either government subsidies or for a guaranteed long-term cost of carbon to make new nuclear power stations economic.'[8]

Lessons from the UK experience

There are certainly some obvious take-aways from this. First, that concentrated industries with large potential gains from favorable policy shifts and large losses from the status quote will invest heavily in getting their positions heard and policies changed in their favor.  They will do this consistently over many years.  This creates significant challenges for taxpayers or less powerful competing industries, but nonetheless requires them to be both organized and equally vigilent.  Second, erosion of political positions (for example, from no subsidies to nuclear being diluted to no subsidies that are larger than what other forms of energy get) require immediate flagging and pushback.  A third lesson is that efforts to obtain energy- or technology-specific carveouts are routine in the world of subsidies.  Restructuring the policy wording to focus on the objective (e.g., lower carbon electricity) can make it much more difficult for politicians to claim their uncompetitive industry-specific subsidy programs are necessary in order to achieve the shared social goal.  Further, the reframing can force the nuclear industry to demonstrate it is the lowest cost way to achieve those social goals in competitive bidding, not just in white papers -- in the process saving public funds and forcing all potential subsidy recipients (not just nuclear) to be more competitive. 

Litigation on the Contracts for Difference as violations of EU rules on State Aid may soon be underway.

Notes to Steve Thomas extract:

[1] 'Blair to push for new wave of nuclear construction in UK' Nucleonics Week, 18 May 2006

[2] http://www.publications.parliament.uk/pa/cm200506/cmselect/cmtrdind/uc1123-vii/uc112302.htm

[3] Greenpeace (2007) 'Government's nuclear plans declared unlawful by High Court' Greenpeace Press Release, 15 February, 2007 http://www.greenpeace.org.uk/media/press-releases/governments-nuclear-plans-declared-unlawful-by-high-court

[4] http://www.publications.parliament.uk/pa/cm200607/cmhansrd/cm070704/debtext/70704-0003.htm#07070441001017

[5] Department for Business Enterprise and Regulatory Reform (2008) 'Meeting the Energy Challenge: A White Paper on Nuclear Power' Cm 7296, HMSO, p 8. http://www.berr.gov.uk/files/file43006.pdf

[6] Department for Business Enterprise and Regulatory Reform (2008) 'Meeting the Energy Challenge: A White Paper on Nuclear Power' Cm 7296, HMSO, p 10.

[7] Utility Week (2008) 'Going nuclear' February 1, 2008.

[8] E.ON (2008) 'E.ON welcomes new nuclear to UK mix' E.ON Press Release, January 10, 2008. http://pressreleases.eon-uk.com/blogs/eonukpressreleases/archive/2008/01/10/1165.aspx

Photo credit: Stock Exchange, dms1259, 22 March 2013.

Three years of freedom of information act (FOIA) requests by the Southern Alliance for Clean Energy (SACE), along with a fair bit of litigation when FOIA docs came back mostly black with redactions, have met with some success.  SACE's efforts have unearthed a sizeable cache of documents related to the construction of two new nuclear reactors at Plant Vogtle in Georgia and the $8.33 billion conditional loan guarantee by the US Department of Energy that would finance a big chunk of the deal.  While the funding on offer is commonly referred to as a loan guarantee, it is actually a direct government loan:  the Federal Financing Bank, part of the US Treasury, is the source of the funds. 

Earth Track and Synapse Energy Economics teamed up to take a first look at the release documents.  Despite widespread redactions (many pages were still mostly black; critical data on key inputs underlying DOE's credit risk estimates were systematically blocked as well), there was nonetheless quite a bit there.  You can read the full study here, and other study-related documents such as the press release and conference, and links to key documents, can be accessed here.  Some key findings are below.

• Indications of involvement in the loan guarantee process and terms by political appointees. Top political appointees in the Departments of Energy, Labor, and Treasury were directly involved to make the deal a go.  The White House was also involved.  DOE staff were under pressure to expedite the deal as well.  An e-mail from December 2010 points to unspecified communication between the White House and the Nuclear Energy Institute over issues of concern. (In this and other cases, extensive redactions in the FOIA documents make the precise focus of the meetings and discussion unclear.)  An email from February 2010 notes that DOE did not “deal” with Shaw [the firm slated to do much of the reactor construction]; rather, “the [W]hite [H]ouse did.” Efforts for DOE to close out consultation, most likely on loan terms, was handled “at the political level” of the Department of the Treasury, according to another email. Emails from DOE staff indicate that Secretary Chu was involved in discussions with key Vogtle Project players over loans details as well. “MEAG’s CEO, Bob Johnston got a call on Friday from Secretary Chu and they discussed the progress that had been made with Southern and where we stood on our [the MEAG] term sheet negotiation,” read one email. These contacts and interventions were a potentially troubling blurring of financial risk review, political discussion, and potential modification of loan terms.
  
  We don't know how these contacts affected the terms of the deal.  However, the bigger the pile of money on the table, the more transparent the decision process should be, and the more completely financial analysis must be separated from political and policy goals in driving funding decisions.  These divisions were not properly respected, even though taxpayer support to Vogtle 3&4 is a big pile of money indeed:  by far the largest of DOE's Title XVII loan guarantee program, and much larger than funding through other venues such as venture capital investment in energy and export credit support via the Export Import Bank. 
• Credit subsidy payments appear too low to offer adequate protection to taxpayers in the event of a default. A key taxpayer protection under Title XVII is an up-front payment borrowers make to DOE to cover the expected risk of default.  Yet, it is clear that the most current estimates for these payments are unlikely to provide adequate protection for taxpayers.  Even the high estimate for Georgia Power ($52 million), for example, would add only about 1/8% to borrowing costs over the life of the loan. This increment, which is supposed to protect taxpayers from the risk of default on the first nuclear reactors built in the U.S. in 30 years, is likely less than the Federal Financing Bank (FFB) markup on the loan relative to the Department of the Treasury’s base cost of borrowing.  While the other investment partners were offered a conditional loan guarantee with substantially higher credit subsidy fees than Georgia Power, they were still not protective of taxpayers. Oglethorpe Power’s fee was 2.5-4.3% for a range of $70-132 million and MEAG’s fee was 5-11.1% for a range of $108-186 million.  The top end of this range is still lower than the average credit subsidy rate assumed on other Title XVII commitments, according to data from the US Government Accountability Office last year.
• Favorable repayment terms.  Taxpayer risk was also increased by loan repayment terms that allow Georgia Power to repay no principal at all on its multi-billion dollar loan until years 29 and 30 of the loan term.  Oglethorpe and MEAG do repay principal over the course of the loan, but assuming 40-year amortization period even though the loan term is only 30 years.  As a result, both will still owe substantial principal to DOE at the end of the loan term, requiring refinancing.  This structure increases the time over which the borrowers benefit from taxpayer subsidies on borrowing, and increases nonpayment risk to taxpayers should something on the project go wrong.
• Stale credit subsidy values. Over the past two years, there have been continuing changes to the loan terms, a deteriorating power market, and widespread changes in the prospects and operating procedures for nuclear power following the Fukushima accident.  All of these shifts would be expected to change the projected default risks of the Vogtle project.  Yet the DOE and OMB have both stated that there have been no subsequent adjustments to credit subsidy estimates to incorporate these market and deal shifts. 
• Over-reliance on external contractors for key risk evaluations. DOE appears not to have built sufficient analytic tools and staff expertise internally to properly assess credit risks and deal structure. 
• Inadequate control of credit subsidy assessment process. Credit subsidy values were issued to borrowers before the credit subsidy model was finalized, and there is some indication that Vogtle Project borrowers may have been given access to the analytic models DOE used to assess credit risks and subsidy rates.  

All told, the documents released do not generate confidence that decisions have been made in a systematic, objective, and independent way; or that the more than $8 billion that taxpayers are putting at risk is being adequately protected.  Press coverage of our study has been fairly broad, and in a number of the stories Southern Company officials have noted that the project is not dependent on federal loan guarantees to continue. 

DOE ought to take Southern up on this statement.  Having Vogtle 3 and 4 move forward without Title XVII loan guarantees would certainly be a good outcome for taxpayers, as we bear much of the risk of default but share none of the upside if the project is successful.  However, I think that self-financing the deal would actually be better for the long-term viability of the nuclear industry as well.  True:  eliminating subsidized Title XVII loans will still leave many other props to the project in place:  advance nuclear surcharges on Georgia Power customers -- Georgia's form of CWIP; long-term take-or-pay power purchase agreements that remain in force even if the plant is never completed; more than $2 billion in tax-advantaged Build America Bonds; and access to existing nuclear subsidies in the form of production tax credits, socialized nuclear waste management, tax favored nuclear decommissioning trusts, and liability caps on accidents.  But demonstrating they can tap into private capital markets for the rest would help establish a more replicable financing model going forward.  

Energy Fair, based in the UK, has just launched a case before the European Commission challenging a range of subsidies to nuclear power in the UK.  Among other issues, the complaint attacks artificially low caps on operator liabilities for accidents and waste disposal.  They estimate that the accident liability cap alone, were it removed, would increase the price of nuclear-generated electricity by a minimum of 14 euro-cents per kWh.  This would be enough to make the resource uncompetitive with alternatives. These policies are clearly subsidies, not only in the UK, but in most countries of the world.  It will be interesting to watch how the EC rules on the issue. 

The action is being overseen by lawyer Dorte Fouquet, who a few years ago brought another case before the EC regarding illegal state aid through subsidized credit support to nuclear projects.  The EC ruled against her at that time, under the incorrect assumption that nuclear projects were not incrementally riskier than other types of projects, and therefore didn't need to carry a higher interest rate.  On the liability side, nuclear insurance is clearly not like insuring an automobile or an ice cream shop.  An appropriate nuclear liability policy needs much higher limits than what is currently required anywhere in the world.  Further, the cost of coverage will, by definition, be higher per unit of coverage than for lower risk activities.  Here's hoping the EC doesn't apply its flawed logic from the credit side onto the liability portions of the new case.

The Energy Fair complaint also views the introduction of a carbon price floor as a windfall subsidy to existing nuclear reactors.  I diverge a bit with them on this issue.  Clearly, absent the elimination of other subsidies to nuclear, if you simply start charging for carbon the policy shift will be distortionary to energy markets, in favor of nuclear.  However, it is also true that relatively lower (though not zero as the industry likes to claim) carbon emissions from nuclear is a benefit of the nuclear fuel cycle relative to conventional fossil fuels.  Logically, this advantage should be reflected in relative prices in a carbon-constrained power market.  But stripping the many other subsidies the nuclear industry unfairly gets must be part of the picture; and once you do, it is unlikely that new reactors would be cost-competitive even with the benefit of its lower ghg emissions.

Energy Fair Website - Energy Fair Summary of Complaint