Prospects for nuclear financing

Saturday, May 17, 2008

Silvia Pavoni reports on the potential and pitfalls of private finance for the UK´s new nuclear power station building programme.

Politicians are famous for announcing grand policy initiatives that have not been properly thought through and that then prove unworkable in practice. The UK government´s new nuclear power programme might be seen as one such ill thought out venture. It wants to build 10 new nuclear plants, replacing existing ones that are due to close, and proposes that the financing should be fulfilled entirely by the private sector. The first plant is planned to become operational by 2017 and the government hopes that the scheme will increase nuclear energy supply from the current 19% of national consumption.

The development of nuclear energy projects is famously lengthy and very expensive and so far there are few, if any, examples of it being done entirely by the private sector. To follow this through, the UK government should also decide what to do with its 39% stake in British Energy, one of the possible developers of the new nuclear programme.

"There will always [need to] be a fundamental involvement of either corporate or state recourse," says Mr Guillaume de Luze, deputy head of power project finance for the EMEA region at Société Générale. "Financing a nuclear station is impossible without state involvement."

The power of protest
To make matters more difficult, nuclear power projects are complex and often unpopular. Projects can generate a great deal of protest. As a result, many financiers do not want to discuss nuclear projects openly for fear of finding protesters outside their offices or even their homes. One senior manager at a leading bank refused to be named in this article, even in a discussion of the technical issues of nuclear power, simply because of the personal risks involved in an association with nuclear financing.

Some bankers decided not to speak at all: Royal Bank of Scotland and Barclays Capital, the biggest UK project financiers, declined to comment when approached about the topic.

Another banker, who is unwilling to be named, has similar misgivings, saying: "Because of the risk of having non-governmental organisations (NGOs) campaigning against these projects, I have doubts about the success of such programmes. Even if some banks are prepared to risk public slaughter, where are they going to find banks for the syndication?"

Protests about the most recent Slovakian nuclear development have been so strong that environmental agency Greenpeace has proudly announced its role in convincing ING Bank, one of the lenders to the Mochovce 3 and 4 project, to withdraw its support for the plan. ING confirmed the withdrawal, specifying that it had taken into consideration Greenpeace´s concerns, but declined to elaborate further on any specific reasons for its withdrawal.

A spokesman for the UK´s Department for Business Enterprise and Regulatory Reform insists that the UK government is confident in the programme´s success and says that nuclear power has been made a more attractive business proposition by the need for carbon emission-free energy sources. He also points out that ultimately it is up to the private sector to put a business case forward and if not, the public sector would not be investing taxpayers´ money in this field.

Repayment and risk
Many energy projects are financed purely on the ability of the project to generate repayments. This is true for traditional energy sources, such as gas plants, and in some instances also for energy generated by relatively new technology, such as offshore wind turbines. Yet, and not surprisingly, nuclear energy projects are so big and complex that the risks involved require some sort of recourse on the sponsoring company or government.

Only when permits, licences and authorisations are obtained (and this may take years: the most recently constructed UK nuclear power station, Sizewell B, took six years to secure planning permission) will the project enter its construction phase. This period, which is accompanied by construction risk, is crucial for any lender whose loan is expected to be repaid, at least partially, by the plant´s cash flow, because a nuclear plant takes much longer to build than a typical combined cycle gas turbine (CCGT). A CCGT takes about three years to construct; a nuclear plant takes about twice as long. The longer it takes, the more likely there are to be delays. And because of the size of the project - which could cost between EUR1bn and EUR6bn or more - any delay would be extremely costly.

Project financiers think long and hard before taking this type of construction risk on board. Liabilities would have to be determined and only contractors or investors with suitable financial muscle would be able to attract the right financial support from the banking industry.

The financial strength of the host country is also critical. Governments must pick up the pieces if things go wrong and they should also have the budget to seek proper advice on any nuclear programme. The amount of due diligence that needs to go into these projects is both highly technical and extraordinarily time-consuming, which pushes lenders´ costs even higher.

Other complex aspects of the nuclear plant lifecycle are waste management and the decommissioning process, which phases out the life of the facility. Government support is crucial here, too.

Insurance hurdles
Nuclear power´s high capital costs and low variable costs mean that the feasibility of a project depends on the cost of capital and the price of electricity. With no plans for the UK government to fund or subsidise its programme for new nuclear power stations, the insurance sector has been brought into the discussion to mitigate risk and therefore reduce the cost of capital.

The Lloyd´s insurance market seems to stand behind the UK plans. In an official statement, Lloyds said it expected to have "a significant involvement in the insurance programme". But it also pointed out that because new installations would not require nuclear insurance for another seven or 10 years, it was impossible to predict what insurance market conditions or capacity would be when the insurance was required. "A lack of confidence in the sector following bad publicity or an instance of poor risk management would be likely to affect the capacity offered by commercial insurers," said Dan Ash-Noble, senior property underwriter for the Catlin Syndicate at Lloyd´s, in the statement.

The insurance sector´s ability to reduce risk effectively without compromising the affordability of the project is also debatable. In a letter to the Financial Times in January, Steve Thomas, professor of energy policy at the University of Greenwich, said he was sceptical about the possibility that insurance companies would assess risk in a different way than lenders, and that the cost of covering risk through insurance would be cheaper than the one reflected in the high cost of capital.

Innovative financing
Projects of this complexity and size do not lend themselves to just one form of financing. Perhaps the UK government should look to Finland, the first country in Europe to have built a new reactor after a 20-year period, which has come up with some interesting ideas on how to finance it. Electricity producer Teollisuuden Voima Oy (TVO)´s new nuclear development, Olkiluoto 3, involves a mix of financing facilities, parts of which are typical of the Finnish energy market. "In the current environment, we do not consider it feasible to finance a new nuclear power plant as a non-recourse project financing," says Jean-Francois Tapprest, head of energy industry group at Nordea, one of the project´s mandated lead arrangers. "However, we believe that it can be entirely financed by the private sector, and the TVO model can be replicated elsewhere."
This should be good news for the UK.
Although TVO is not entirely a private sector company, the risk of financing it, as Mr Tapprest points out, is perceived as a Finnish industry risk. TVO is a limited company owned by the main industrial and power companies in the country, one of which, Fortum, is 51% owned by the government. TVO sells electricity to its owners at cost; they, in turn, are severally liable to cover the plant´s fixed costs. These include the capital costs and a fixed portion of operation and maintenance costs. The variable operating and maintenance costs, including fuel, are passed through to the shareholders according to the amount of electricity that they off-take, making the project more palatable to financiers. This is the `Mankala structure´, named after the first Finnish power company that used this co-operative structure.

France´s Areva and Germany´s Siemens form the consortium that will supply the nuclear power plant unit as a turnkey delivery. The consortium has the total responsibility for the plant equipment, buildings, licensing and performance, and for the time schedule.

The project´s initial investment-cost was EUR3bn, 25% of which was borne by shareholders in the form of equity (20%) and a loan (5%). The remainder was provided through a debt package, signed at the end of 2003, which included a EUR1.95bn syndicated revolving credit facility, arranged by BayernLB, BNP Paribas, Handelsbanken, JPMorgan and Nordea, and EUR550m worth of bilateral loan commitments. In March 2004, a EUR587m facility guaranteed by French export credit agency Coface was arranged, replacing part of the original revolving credit facility, while in June 2005, the rest of the original revolving credit facility and some bilateral loan commitments were refinanced.

Cementing the principles of the Mankala structure into the financing agreements was key. "Properly structured, such consortium or co-operative models can achieve significant benefits, especially for nuclear projects, given their long lead-time, the long life of the plant and the stable cost of the electricity that is produced," says Mr Tapprest.

Not everything has gone smoothly, however. While it has been praised for its creative structure, the project has been heavily criticised for its delays and cost overruns: it has a two-year delay and is reportedly 60% over budget.

Part of Olkiluoto 3´s initial success is also due to strong government support - which ought to speed up the approval and licensing process - and wide public acceptance, despite some disruption activities by Greenpeace.

"We do our job and the NGOs do theirs," says Lauri Piekkari, vice-president and treasurer of TVO. "But I don´t think that protesters´ activity has hindered the development of the project. I also think that there is a good level of public acceptance in Finland."

Mr Tapprest believes that existing successful plants have also made a big difference. "We have four operating nuclear plants in the country and have had no problems with them, which has helped to reinforce the community´s approval," he says.

European developments
In Europe, other governments are launching new plants, including new EU members that are required to replace their Chernobyl-era nuclear reactors. One of them is Bulgaria, which wants to build two new reactors on the Danube River, near to the city of Belene. BNP Paribas has indirectly taken part in the financing. The bank has granted a EUR250m corporate loan to NEK, Bulgaria´s national electricity company, which will be used to finance part of the plant´s construction.

Areva and Siemens, which are developing Olkiluoto 3, may also be involved. Given their expertise that is not surprising. What has raised some concerns and complications is the involvement of a third partner, Atomstroyexport, which is part of the Russian government.

At a press conference in January, the then Russian president Vladimir Putin said that Russia was keen to provide financing to the facility. The loan would amount to EUR3.8bn and some fear that it is part of a broader strategy to keep Bulgaria within Russia´s political and economic orbit.

Whatever the motivation, Russia´s involvement has reportedly upset locals and triggered fear about Bulgaria´s growing dependence on Moscow. In the UK, one of the key arguments in support of nuclear energy is that it would reduce electricity dependence on what are regarded as unreliable sources, including Russia.

Other programmes
On the other side of the Atlantic, the US government is also relaunching its nuclear programme but it seems to be willing to take a larger role than the UK government. A banking source says that although the US programme is not yet finalised, the US administration is providing a degree of state support. "My understanding is that the Department of Energy is prepared to provide a form of guarantee to the benefit of financiers on the performance of the loan," says the banker. "And my understanding is that it is a very strong financial support."

Asia is becoming increasingly involved in nuclear energy too: India is building six reactors, China is building five and Korea is building three. Not surprisingly, government leadership and support in those three countries is conspicuous.

Which financing model is best suited for the UK market is debatable. No doubt discussions have and will continue to take place behind closed doors. But along with resolving the excruciatingly complex technical issues, a formula for public acceptance of nuclear energy will have to be found. The fact that so few financiers are willing to talk openly about the issue suggests that such a solution is a long way from being reached.

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