The Nuclear Energy (Financing) Act 2022 (NEFA 2022), which came fully into force at the end of May 2022, introduces a new regulated asset base (RAB) funding model for new-build nuclear power projects in the UK.
What prompted the change in funding model?
There has been a long history of political support for nuclear power in the UK. However, this has been coupled with a desire to keep the cost of new nuclear power plants off the government balance sheet. Projects such as Hinkley Point C were funded under the ‘contracts for difference’ (CfD) model where developers bear all of the risk and are only entitled to receive the ‘strike price’ (i.e. a guaranteed price for electricity output) once power generation has begun. Investors were reluctant to commit without agreeing a high strike price which raised concerns about the costs for consumers and whether such projects delivered value for money. Even with a high strike price, it was difficult to attract sufficient investment in new-build nuclear given the risks associated with such projects, particularly in the early construction and development phases, and the difficulty of predicting and controlling the out-turn costs of such projects. Attempts to negotiate a lower strike price with investors were unsuccessful with planned projects such as Wylfa Newydd and Moorside ultimately being cancelled.
Given the importance of nuclear power in meeting net zero targets and achieving decarbonisation the government considered it vital to improve funding opportunities through introducing the RAB model.
How is the RAB funding model different from the CfD model
The RAB funding model takes a different approach than CfD. In order to attract more private investment from a wider range of sources, it provides for risk sharing between investors and consumers, with consumers contributing indirectly towards the construction cost of the nuclear project by paying a small amount through their bills. These initial contributions are intended to provide greater certainty for investors by allowing for a lower and more reliable rate of return in the early stages of a new-build nuclear project. The model also has financial implications for the government as construction is likely to appear on the government’s balance sheet – this change in policy further demonstrates political commitment to new nuclear projects.
The government anticipates that the new funding model will ultimately bring significant savings for nuclear projects as customers’ initial payments will lower the overall cost of financing. At the same time, RAB financing is expected to attract investors by giving them greater certainty of cashflow and a more predictable, stable return. The government has pointed to the use of a similar RAB funding model to finance the Thames Tideway Tunnel project (TTT) as evidence of its effectiveness, whilst recognising that new nuclear projects are significantly greater in scale and cost, and will face unique challenges that are different from those faced by TTT.
How does a company become eligible to benefit from the RAB funding model
To be eligible to benefit from the RAB funding model, a company must be a ‘nuclear company’ i.e. it must hold an electricity generation licence in respect of a nuclear energy generation project and it must be ‘designated’ by the Secretary of State to deliver that nuclear project.
There are two designation criteria that must be met 1. First, the Secretary of State must be of the opinion that the development of the nuclear project is sufficiently advanced to justify the designation (the ‘maturity’ test); and second, the Secretary of State must be of the opinion that designating the company in relation to the project is likely to result in value for money (the ‘value for money’ test).
The Secretary of State is obliged to publish a statement on the procedure for designation to assist potential applicants in understanding the assessment process given the subjectivity of the criteria 2. This requirement was met in April 2022 with the publication of the “Statement on procedure and criteria for designation” 3. The Statement explains how to meet the criteria, although leaves room for the Secretary of State to impose additional information requirements on a project-specific basis.
For the maturity test, the Statement provides that the Secretary of State’s assessment will focus on evaluating whether there is a credible strategy and plan for the design, construction, operation and ultimately decommissioning of the project. The assessment is, therefore, wide-ranging and will require the nuclear company to demonstrate that:
- there are sufficiently well-developed arrangements to securing an appropriate site for the nuclear power station, including having applied for a Nuclear Site Licence;
- adequate progress has been made in securing relevant regulatory approvals, licences, permits and consents, including well-developed plans for the project’s safety case; and
- there is an appropriate level of maturity in areas such as technical design, financing, programme management, governance, risk control, organisational development, cost estimates and supply chain contracting.
The value for money assessment is more focused and will be carried out in line with the Green Book, which sets out the government’s general approach to appraisal and evaluation, and involves considering monetised and non-monetised costs, as well as benefits to society as a whole. A key test will be to assess the difference between the costs of the electricity system if a project goes ahead as compared with the costs of the electricity system if alternative projects or generation technologies were built instead. The benefit of ensuring secure baseload power will also be an important non-monetary consideration. The RAB funding model will offer designated nuclear companies access to a predictable revenue stream for the construction and operational phases, meaning that designation can only be justified if it is likely to result in value for money. Although the designation process is intended to occur early in the nuclear plant construction process, it remains clear that a significant amount of upfront investment and effort will be required in order to achieve designation status.
Prior to making any designation, the Secretary of State will prepare and consult on draft reasons for the designation 4. The list of statutory consultees is broad and, as well as the nuclear company, includes Ofgem, the Office for Nuclear Regulation and the relevant environmental regulators according to the site of the project 5. The decision to designate may be made subject to the nuclear company meeting certain conditions. Given statements previously made by the government, it appears likely that future nuclear projects will include a condition allowing the Secretary of State to take a ‘special share’ in the company. The rights of the special share are likely to be limited to protecting national security interests, in order to complement the provisions of the National Security Investment Act 2021, and ensuring that significant stakes cannot be sold without the government’s knowledge or consent. Other conditions may concern, for instance, obtaining various relevant permits and licences, and the approval of the decommissioning programme.
Having decided to designate a nuclear company, the Secretary of State must publish a notice to that effect. The designation notice will include a description of the project, the reasons for the designation and details of any conditions that must be met (including the consequences of a failure to company with such conditions) 6.
Designation is time limited and will cease to have effect at the end of five years (or such date as has been specified in any subsequent notice which has been consulted on and issued by the Secretary of State) or upon entry by the company into a revenue collection contract 7. The Secretary of State also has the power to revoke a company’s designation in certain specified circumstances including where the nuclear company ceases to hold the necessary electricity generation licence 8.
What happens following designation
The next key step in the process is for the Secretary of State to modify the terms and conditions of the generation licence held by the nuclear company through amending and inserting new conditions and making modifications to the existing licence terms.
When exercising this power the Secretary of State is obliged to consider a range of matters including the Secretary of State’s duties under the Climate Change Act 2008 relating to carbon targets and budgets and the interests of existing and future consumers of electricity, including ensuring security of supply and predictability of costs. Importantly, from the perspective of investors, the Secretary of State is specifically required to have regard to:
- costs, expenditure or liabilities of any description that the nuclear company may reasonably be expected to incur in carrying out its activities;
- the need to secure that the nuclear company is able to finance its activities; and
- the need to secure that the nuclear company has appropriate incentives in relation to the carrying out of its activities.
A non-exhaustive list of possible licence modifications to be made for designated nuclear companies is set out in NEFA 2022 which the Secretary of State may include in the licence as deemed appropriate 9. The list includes provisions:
- about the allowed revenue the nuclear company may receive and how it is calculated;
- listing permitted and prohibited activities;
- detailing how any permitted activities shall be carried out;
- requiring the nuclear company to provide information to Ofgem and to assist Ofgem in carrying out its functions;
- governing the circumstances in which a licence may be revoked; and
- enabling the nuclear company to appeal a licence modification decision to the Competition and Markets Authority.
Importantly, as the Statement notes, the licences will provide the details on how the construction risk and associated development costs will be shared.
- licences will include details on the ‘base cost forecast’, representing a robust estimate of the total expenditure required to complete the project. With the exception of certain specified, excluded items, all expenditure up to the base cost forecast will be added to the RAB, and investors will be able to earn a return on it. This is a standard approach for RAB-based funding models.
- licences will also include the ‘financing cap’. Any cost over runs between the base cost forecast and the financing cap will be assessed by Ofgem – if they are accepted, they will be considered to fall within the RAB, and therefore investors would earn a return on them. Above the financing cap, costs are expected to be covered through a government support package, which will presumably be the subject of negotiation for each project. The financing cap is intended to be set at the level at which there is only a remote risk of construction costs reaching it, in order to provide protection against remote but high impact events.
- investors must finance the construction of the project up to the financing cap.
Modifications to a nuclear company’s licence will come into effect only at the point of the designated nuclear company entering into a revenue collection contract with a revenue collection counterparty.
Accordingly, the exact licence conditions will have a critical role in determining whether nuclear projects will ultimately be attractive for investors. In particular, the estimates and contingencies must be robust and take account of the complexity and duration of nuclear projects, in order to provide investors with confidence that a satisfactory level of return for the investment is achievable.
How will the nuclear company be regulated
Once the amended licence is in place and the company has entered into a revenue collection contract, it will be subject to economic regulation by Ofgem in accordance with the terms and conditions of its modified licence. In performing this role, Ofgem must apply its existing statutory duties, including its principal objective of protecting the interests of current and future electricity consumers.
Importantly, Ofgem will also set the allowed revenue for the nuclear company in accordance with the modified licence. This will be charged during both the construction and operational period, with charges increasing over the construction period in line with the cumulative project spend.
To enable the developers to collect the allowed revenue, the Secretary of State is required to put in place regulations which implement the mechanics of the RAB model revenue stream. A consultation on the revenue regulations was issued on 14 June 2021 10. As set out in the diagram below, the allowed revenue will be funded by electricity suppliers (in proportion to each supplier’s market share) who will recover the cost from their customers. The revenue collection counterparty (Low Carbon Contracts Company Ltd) will collect payment from suppliers and pass it to the nuclear company.
As observed in other industries, we expect that the calculation of the allowed revenue will be complex, and is likely to be contentious given the number of judgments that will have to be made on the various parameters. The calculation will have to account for a number of elements, including return on capital and the weighted average cost of capital, as well as depreciation, incentives, penalties and various other operating costs. In setting the allowed revenue, Ofgem will need to strike the right balance, having regard to its statutory duties, of promoting consumers’ interests while allowing investors a reasonable rate of return.
If the modified terms and conditions of the licence give the company the right to do so, it may bring an appeal to the Competition and Markets Authority against any decision made by Ofgem. Such an appeal would follow the same process as for other generation licences, as set out in the Electricity Act 1989.
The NEFA 2022 also introduces a special administration regime, in order to protect consumers in the event of the nuclear company becoming insolvent. It shares similarities with the special administration regime under the Energy Act 2004. The Secretary of State (or Ofgem, with Secretary of State’s permission) has the power to apply to the court for the appointment of a special administrator, with the goal of ensuring that the nuclear company begins, or continues, to produce power, until the company can be rescued as a going concern or its assets can be transferred.
In order to ensure that the NEFA 2022 achieves its objective of attracting private capital to reduce overall costs to consumers, the framework needs to be flexible, take account of long construction periods, and allow reasonable returns to investors. It must also recognise the varied risks involved in the construction of new energy projects, and account for them throughout the project lifetime. The recent consultation on revenue regulations offers investors a further opportunity to influence the underlying funding arrangements.
Nuclear energy is one of the ‘sensitive sectors’ under the National Security Investment Act 2021. If the relevant triggers are met, the investment in nuclear energy project may require national security clearance. For further information on the UK’s foreign investment regime please refer to our previous publication:
The UK’s new NSI regime: What do you need to know?