Nuclear projects: how should they be structured?

28 October 2008

Recent years have seen a transformation both in the actual economics of nuclear power and also in the widening recognition that it occupies an increasingly important position in the energy marketplace.

The first task of the industry has been to convince potential investors that existing nuclear power plants are highly economic and a growing community now understands that this is indeed the case.

Power prices have risen sharply with the escalation of oil and gas prices, while well-run nuclear plants have stable and predictable operating costs that ensure excellent profitability for their owners in any type of electricity market. Indeed, current nuclear plants have been likened to cash machines – in Sweden, the government has noticed this and imposed a higher tax on their profits, while the German nuclear utilities are offering to share some of the benefits with renewable energy project development, in an attempt to overturn the phaseout obligations currently enshrined in law.

In most countries, the industry has succeeded in gradually building public support for nuclear power by demonstrating strong operating performance coupled with an excellent safety record. This is the basis on which policymakers have been able to point to nuclear energy as an important response to the imperatives of energy security and environmental protection, without the prospect of higher electricity prices.

While the cost of electricity from new nuclear plants should be competitive, the challenge of structuring projects correctly and ultimately financing them remains significant. A new World Nuclear Association (WNA) report, Structuring Nuclear Projects for Success, examines the somewhat unique characteristics of new nuclear power projects. They are capital intensive, with very long project schedules, and have significant fixed operating and maintenance costs but relatively low fuel costs. They exist in a rigorous regulatory environment where the regulator actively scrutinises the plant’s operations and has considerable authority that can impact on both unit construction and operations.

Although new nuclear power plants require large capital investment, they are hardly unique by the standards of the overall energy industry, where oil platforms and natural gas liquefaction facilities cost many billions of dollars. Projects of similar magnitude can be found in the building of new roads, bridges and other elements of infrastructure. New build risks in all these areas include costly delays due to problems with designs, equipment supply, project management, construction and commissioning. Many of the risk control and project management techniques developed for other projects are equally applicable to building nuclear power stations. Risks should always be allocated amongst the plant owner-operator, the engineering, procurement and construction (EPC) contractor, the plant vendor and financiers, according to who can best control or bear them.

Many electricity utilities are unfortunately very risk averse, some of them having suffered through projects that did not meet expectations in the past. Given the long period without any substantive new build nuclear projects, they are looking for ways to boost confidence that plants will be built to budget and on schedule, so that the promise of good economic performance will be realised. The new report describes the key risks involved with building new nuclear plants, shows how a good structure is essential for project success, and outlines how risks can be mitigated and allocated.

Structuring a nuclear new build project successfully requires a good understanding of the various risks associated with a project of this complexity and magnitude, then finding a contractual structure that allocates those risks amongst key stakeholders. Some are not so different to those pertaining to any power investment project. Others are clearly unique to nuclear, including those surrounding the management of radioactive waste and used fuel, and the liability for significant nuclear accidents. Although the list of risks is substantial – including regulatory, project delivery, operational and the electricity market – they can be mitigated through good management and planning. The remaining risks must be allocated to the appropriate stakeholder in the best position to manage them.

Construction schedules for nuclear projects are notably long. This can influence the allocation of cost inflation risk in relevant construction contracts. It can also impact on the negotiation of power purchase agreements if these are a requirement before construction commences.

In risk mitigation, government also has a very significant role in establishing and maintaining a sound framework for industry operation. Where regulatory and utility requirements can be harmonised worldwide, the cost of meeting them is reduced. The new regulatory approach exemplified in the USA and emerging in the UK moves all design, technical, regulatory and licensing issues to the front of the licensing process. Before construction begins and any significant capital spending occurs, safety and environmental issues can be fully addressed. The new licensing framework aims to assure potential investors that their investment in a new nuclear plant will not be jeopardised as long as construction adheres to the approved design and standards. Delays caused by public intervention in the past are now prevented by strictly defined timeframes for public hearings and consultations.

“Project structure must be appropriate to the relevant electricity market.”

Those who build the first reactors of a new design (first of a kind, or FOAK) bear the burden of one-time risks and provide those who follow with valuable information and experience. To reward this benefit, the US government has introduced FOAK incentives that include loan guarantees, investment tax credits and insurance against regulatory delays. These may also be deemed appropriate in other parts of the world, but are not something that the industry can necessarily depend upon. Indeed, in the UK, the government has explicitly ruled out any such beneficial measures, to fit in with its ideological beliefs in ‘level playing fields’.

During the construction phase, the various risks can be covered by contractual arrangements among the utility, EPC contractor and vendors, and there is a range of possibilities. For example, in a turnkey project the EPC contractor can assume almost all risks of cost overruns and expect a higher price accordingly. This is an important point – those who take on risks expect some recompense for doing so – there are no ‘free lunches’ out there. Financial penalties and rewards are common for parts of the construction contract relating to timing and quality. Alternatively, utilities can assume greater risk of escalating costs in exchange for the prospect of a lower overall cost. Because nuclear plants are very expensive, risking company balance sheets, forming consortia to share risks will often be a good solution and this is to be the expected pattern in the USA.

Once a plant is running, the utility will control most of the risks – specifically, for safe operation, for achieving high capacity factors and for maintaining control of operation and maintenance costs. In controlling fuel and operational costs the utility can use long-term deals with suppliers and contract out key services such as plant outages.

The project structure must be appropriate to the relevant electricity market. For capital-intensive nuclear plants, spot and short-term electricity prices that reflect business cycles must be complemented by guaranteed long-term prices both on the wholesale and retail markets. A sole nuclear generator with no retail customers is particularly vulnerable to the risk of low prices – the past experience of British Energy proves this. Hence long-term baseload sales contracts are needed or the nuclear plant must be managed within a vertically integrated utility that has a diversified portfolio of generating sources and its own customer base.

In regulated electricity markets plant investment costs can be recaptured with greater assurance as they are simply passed on to retail customers. They are essentially monopolistic and cost of service determines the electricity rates. Lenders are secured by access to the assets and revenues of generating companies as well as by a strong degree of market assurance. Several potential new US plants fall into this category – indeed, most are sited in the south, where power markets are still largely regulated.

With an unregulated merchant generating plant there is open competition and no direct outlet for selling electricity. This liberalised market entails a significantly greater exposure to price risk, which must be mitigated by long-term power purchase agreements or support from a parent company. Projects here will require a less leveraged balance sheet - more equity and less debt – and also greater security for debt. The new South Texas plant in USA is in this category and is securing project financing.

World experience with electricity market liberalisation has generally tended to produce the kind of evolution that has occurred in Europe towards a small number of vertically integrated large utility groups, with a spread of generation facilities and regional supply outlets and some merchant plants. Such large groups use their large balance sheets to invest in generation projects with a good degree of security on the selling side. EDF’s new Flamanville reactor in France is in this category. Another possibility is some form of public private partnership, such as with Cernavoda 3&4 in Romania.

In the Finnish model for Olkiluoto 3, the equity is largely contributed by a consortium of local energy-intensive industries and utilities which will take the output of the plant at cost, amortising the debt portion from the market. If the plant operates well, owners will receive relatively cheap electricity over a long period, avoiding the risks of having to buy or sell power on the open market at uncertain prices.

Finally, emissions reduction policy frameworks will increase the cost of electricity from fossil fuels and thus should benefit nuclear investments and reduce market risks. At this point, there remains a risk as government policies related to carbon emissions are not assured into the long term and potential investors (such as those lining up in the UK) are seeking assurance on this point.

There are therefore no magic formulae for either structuring or financing nuclear power plants, but important principles that must be followed if projects are to be successful for all the stakeholders. The projects are very demanding to get right, but the rewards for society as a whole are potentially huge.

Author Info:

Steve Kidd is Director of Strategy & Research at the World Nuclear Association, where he has worked since 1995 (when it was the Uranium Institute). Any views expressed are not necessarily those of the World Nuclear Association and/or its members.

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