20 July 2017

The Hinkley Point fiasco doesn’t bode well for Brexit


Figures published this week suggest that households could end up paying eight times more for the Hinkley Point nuclear power station than was originally estimated four years ago. This should have come as no surprise. Last month, a devastating report by the National Audit Office (NAO) laid bare the full horror of this policy fiasco, for which the Treasury shoulders much of the blame.

Given that Chancellor Philip Hammond is now trying to take the de facto lead on Brexit, alarm bells should be ringing. The poor judgement that led the Government to rubber- stamp the disastrous Hinkley deal only last September is all but certain to lead to a bad Brexit deal.

Britain’s pro-nuclear policy was set out in a 2008 white paper, since when, as the NAO pointed out, the economic case for nuclear has deteriorated. Estimated construction costs have increased, while low-carbon alternatives have got cheaper (although the Government at last recognises that their intermittency means their costs are higher than they appear), and the price of fossil fuels has fallen. The Government agreed the key commercial terms of the Hinkley deal with EDF in 2013. But the significantly lower fossil fuel prices now expected over the life of the deal mean that the cost of top-up payments that consumers will be forced to make to subsidise the plant will rise from £6 billion to £30 billion.

On its way to striking this parlous deal, the Government crossed every one of its red lines bar one. The team negotiating the agreement had been told to fix the strike price – the guaranteed price France’s EDF will get – at no more than £85 per MWh. The strike price ended up at £92.50 per MWh (indexed to inflation).

To cap the levies used to subsidise low-carbon investment, the Coalition put in place a Levy Control Framework to protect consumers and businesses from ever-rising energy costs. By September 2016, the forecast top-up payments for Hinkley alone would bust the limit on the total set aside for new nuclear.

The Government’s “strategic case” for going forward with the Hinkley deal was to open up a pipeline of nuclear investment, hoping to build two new reactors every three years. But because there’s no money left in the Levy Control Framework, the Government’s new line is that the framework doesn’t matter any more. What now matters is the level of the strike price – and that hasn’t changed.

This is politically and economically dangerous. It means the Government is perfectly content to lock British consumers into high and rising electricity prices, and is happy to ignore the impact on competitiveness. While our competitors benefit from lower fossil fuel prices, British firms will, post Brexit, be burdened with some of the highest energy costs in the world.

But what is most revealing about the Government’s lack of concern over energy costs is its assessment of what would happen if Hinkley were delayed. On its central assumption for future fossil fuel prices, a three-year delay would actually save consumers £800 million. When delaying a project saves money, the project economics are screaming that you’d be better off cancelling the entire thing.

When Greg Clark’s business and energy department (BEIS) used lower fossil fuel prices than its central assumptions – a plausible view, given the impact of fracking on US output – and using gas-fired power stations to fill the gap, consumers would save £4 billion.

The Government has yet to cross one last red line: the paying of a hefty premium to keep the project off the Treasury’s balance sheet. Back in October, the Chancellor observed that “we are going to have to invest eye-wateringly large sums of money—perhaps £100 billion—just to ensure that the lights stay on”. As Chancellor, Mr Hammond is in a prime position to cut these costs. But because he’s not signing the cheques, he appears indifferent to the plight of consumers and businesses. Instead, he advises people to use less electricity.

According to the NAO’s analysis, businesses and households will end up paying substantially more for Hinkley Point through their electricity bills than they would do as taxpayers. If the Treasury had agreed to purchase the power station under an “engineer, procure and construct” turnkey deal, the strike price would have been £11.50-£52.00, rather than the £92.50 actually agreed.

Worse still, there remains a real risk of the deal collapsing and needing a Government bailout. As the NAO notes, any further deterioration of EDF’s financial position could “escalate to a discussion” about its ability to fund construction, as happened with a number of previous mega-projects.

The most damning aspect of the NAO report, though, was what it revealed about the role of the Treasury. Perhaps it is not entirely surprising that BEIS officials, having invested a huge amount of effort in a flailing project, were reluctant to see the writing on the wall. Indeed, the NAO slammed the department for its failure to manage the conflict of interest of a consultancy advising its on the reasonableness of EDF cost estimates when the consultancy’s parents were engaged by EDF.

The Treasury, however, has overall responsibility for the country’s economic performance and is meant to be immune from project capture. In January 2013, the Treasury expressed concern about the costs of Hinkley compared with the alternative of gas-fired power stations. By August 2016, the Treasury recognised that although the value for money case had worsened, it was worth proceeding with the deal “due to the strategic and political implications of withdrawing”.

In other words, the Treasury knew that on the economics, Hinkley was a lousy deal but felt that Britain was, in some way, morally committed to a bad deal (even though it hadn’t been signed).

This was a bad call. Britain does not stand taller in the world by feeling compelled to sign a bad deal. Potential investors in future deals will not be impressed by a counter-party that signs a deal that everyone knows is heading for disaster. When it comes to looking after their own interests, other countries are not as craven. According to the FT, $47.5bn high speed rail projects with China have been cancelled or discontinued, including the $12.7bn high speed line between Los Angeles and Las Vegas.

The Brexit negotiations are far more complex and more difficult than the Hinkley deal, in which the Government held all the high value cards. Strength and resolution are critical to any successful negotiation. Whatever one’s views on Brexit, the poor judgement displayed on Hinkley, particularly that of the Chancellor, suggests that Britain can’t but be heading for a bad Brexit deal. You have been warned.

Rupert Darwall is the author of 'The Age of Global Warming: A History' (Quartet, 2013)