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Nuclear subsidies: a gamble on the price of gas

Chapelcross, Scotland: decisions over our future sources of energy won’t wait until the cows come home. Magnox Sites Ltd

Providing power to the nation is no small task. It requires considerable forward planning, involves huge costs and considerable risks. More risk and cost, in fact, than most energy providers can stomach. So in order to make sure the lights stay on the government offers the firms subsidies to sweeten the deal.

But the idea of billion pound subsidies for a new crop of nuclear power stations in a time of austerity sounds outlandish. Is this a sensible use of the public’s money?

We should note that the government is not parting with any cash up front. This is a buy-now, pay-later deal. Money will only flow to the nuclear companies from our bills once they start generating electricity.

The first nuclear plant in the pipeline is Hinkley Point in Somerset, which has received planning consent. The government is currently negotiating a contract with the owner, energy company EDF, to agree a price they can charge when the plant comes online.

The contract terms will be long — perhaps up to 40 years — giving the company revenue certainty, and reducing their capital costs in the face of fluctuating market prices. Yet to be announced, this fixed price may be 70% higher (worth more than £1 billion per year) compared to today’s market prices. But as the plant will not be operational for at least ten years, the key question is what price power will be a decade from now.

That depends. If the price of gas stays where it is or falls, government will have locked consumers into an expensive energy source for 40 years. But if gas prices rise, electricity prices will also rise, and nuclear energy will subsidise us rather than the other way round. In which case, if the government fails to build new nuclear plants now it will have locked out consumers from a relatively cheap source of future power.

This is the nature of the commercial risks associated with nuclear, and why companies will not build new plants without some price assurance from government. By fixing a price, the government transfers that risk to the consumer. Depending on the terms of the contract agreed with EDF, the public may also share the risk of major cost overruns, and of dealing with nuclear waste.

Britain’s existing nuclear plants are also operated by EDF, which bought them from the government in 2009 for £12.5 billion in a deal that left the costs of cleaning up with the government. This is going to be expensive: the decommissioning of the huge nuclear reprocessing plant at Sellafield, Cumbria, is estimated at more than £67 billion, a bill that costs the government £2.3 billion per year through the annual budget of the Nuclear Decommissioning Authority. EDF pays nothing into this fund as the “polluter pays” principle says they should, so this represents a hefty subsidy. But the government would never have received such an attractive sale price if the taxpayer had not been left to pick up the tab.

Nuclear is not the only energy source that gets a subsidy. Fossil fuels receive a subsidy due to under-pricing of carbon emissions and other environmental impacts, valued globally at £1.2 trillion by the International Monetary Fund. In the UK, this subsidy is currently removed through the government’s “carbon price floor” – a tax levied per tonne of carbon dioxide emitted. Introduced to ensure fossil-fired sources of generation pay their way in environmental costs, the carbon price is supposed to help level the playing field for renewable and low-carbon energy. This raises prices compared to generators in Europe where carbon prices have crashed to rock bottom, incentives for carbon emitters to clean up their act disappear, and the effective subsidy awarded to polluters continues.

Renewable energy receives considerable subsidies through price guarantees fixed well above current market rates. Similar to those under negotiation for nuclear power, the justification is that new renewable technologies need time to mature and come down in cost before they can compete. In time low carbon technologies must stand on their own, however, or a subsidy-dependent energy sector will become inefficient, anti-competitive and lack innovation.

This presents the government with a difficult balancing act. Subsidies have to be high enough to attract investment, but low enough to avoid creating windfall profits. They need to be reliable enough to attract cheap sources of capital, but the government must keep control of when and how quickly they are phased out. Since technology costs and market prices (especially gas) are so uncertain, it is hard to predict in advance what route the government should take.

Striking the perfect balance given these conflicting conditions is clearly impossible, and mistakes will be made. Judged on purely commercial grounds, the nuclear decision is a large bet on the price of gas (not to mention nuclear safety). Judged against the more strategic aim of removing carbon from the electricity grid, it is a bet against the costs of other low-carbon power sources. And since it’s pretty clear that private companies are not brave enough to take this bet, it falls to the government to place bets on behalf of us all.

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