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Finance & Investment Analysis Nuclear spring Investor view Nigel Robinson Some heavyweight analysts think EDF will do very well out of Hinkley Point C, says Megan Darby. "There is much talk about the lights going out, yet power companies are closing power stations and postponing investment in new plants." W T hen Liberum Capital analyst Peter Atherton gave his reaction to the Hinkley deal last week, you couldn't accuse him of understatement. "Flabbergasted" was his one-word summary. The new nuclear deal was "economically insane" on the government's part. EDF Energy and its partners had got an "outstanding deal". On a leveraged basis, he forecast a return on equity "well in excess of 20 per cent and possibly as high as 35 per cent". Investors could expect dividends of between £65 billion and £80 billion during the 35-year lifetime of the contract, he said. Atherton likes big numbers. One tweeter with a sharp memory pointed out that in May 2012 he confidently predicted EDF would demand a £166/MWh "strike price". Even if you accept Atherton's latest estimate that the £92.50/MWh agreed will rise with inflation to £121/MWh by the time Hinkley is commissioned, there is quite a disparity. Allowing for a certain "ahem" exuberance of expression, his conclusion nonetheless reflects a general consensus that EDF Energy has done well for itself. It was seized on by Green MP Caroline Lucas, who told The Guardian: "When City analysts tell you a contract is 'economically insane', it's time to admit that you might have got it wrong." However, she is not known to be a fan of Atherton's implied alternative: gas. For the £16 billion price tag of Hinkley, you could build 27GW of gas plant – "solving the 'energy crunch' for a generation", he claimed, not commenting on what that would mean for the UK's carbon budget. The Department of Energy and Climate Change (Decc) maintains that nuclear will be "competitive" with gas-fired power in the 2020s. With the nuclear price locked in there will be no real competition, of course. It is a carefully chosen phrase that promises nothing. Decc assumes gas prices will continue to rise, as will the carbon price, boosting the relative value of low carbon generation. Analysts say they could just as easily stabilise or even fall. here is so much discussion in the media right now about the lights going out in this country over the next two to three years that it almost starts to be believable. Yet power companies are closing existing power stations and postponing investment in new generating capacity due to low power prices and the lack of so called "scarcity premium" (the difference or margin between the power price and the cost of fuel, indicating that the market needs more capacity to be delivered). How have we got into this position, and what can we do about it? Back in the Blair-Brown days, the grand vision was for clean and self-reliant energy based on 10GW of new nuclear and at least 40GW of offshore wind. However, this ignored the cost. At today's prices to build out this entire nuclear and offshore wind fleet would roughly be £170 billion. Plus, inflexible nuclear was never a good fit with intermittent wind. But no alternative capacity is coming through because of the significant level of uncertainty in the power market "This over prices, strucuncertainty ture and returns has caused on capital. It is this uncertainty utilities that has caused to shelve utilities to shelve investment investment plans, plans" and institutional investors such as our pension funds to largely stay away from direct investment in the sector. Investors understand, manage and price risk: they direct their investments to areas where they can quantify such risks. In this sense, the FIT CfD mechanism, together with capacity payments, will and should play a big role in providing institutional investors a much greater degree of confidence to provide both debt and equity to the electricity generation sector. And positive investment signals in renewables should flow through to conventional generation under EMR. Power generation is a capital intensive business. In a low and falling wholesale power price environment, the cost of capital plays an even larger part in generating adequate returns on investment, but for capital to be attracted, we need the clarity and certainty derived from a long-term stable support mechanism. The time for tinkering is over. Nigel Robinson, head of power, Investec Power and Infrastructure Finance UTILITY WEEK | 8th - 14th November 2013 | 21