30 October 2013

Flabbergasted – The Hinkley Point Contract

This is copied from the website of  Liberum Capital, an independant investment bank

http://www.liberumcapital.com/pdf/ULkWtp00.pdf

 

Summary

Based on the disclosure so far this looks likely to be an outstanding deal for Edf

and its partners. On a leveraged basis we expect Edf to earn a Return on Equity

(ROE) well in excess of 20% and possibly as high as 35%. We forecast that cash

dividends of between £65bn to £80bn should be payable during the life of the Cfd.

Note that paying these dividends would still allow Edf to pay off all construction

debt within the term of the Cfd. When the station commissions in 2023 the strike

price will likely be above £121/MWh. For this to be competitive with fossil fuels,

the gas price will need to have increased by at least 130% from today’s levels.

Annual PBT should total c.£1bn (2013 money) pa at commissioning

(assuming 65% leverage) which compares to a total of £2.1bn EBIT reported

by the big six UK energy suppliers in 2012 for their generation businesses.

Once again, the UK government is taking a massive bet that fossil fuel prices

will be extremely high in the future. If that bet proves to be wrong then this

contract will look economically insane when HPC commissions. We are frankly

staggered that the UK government thinks it is appropriate to take such a bet and

under-write the economics of any power station that costs £5m per MW and

takes 9 years to build.

 

Introduction:

We have been a bit pre-occupied so have not had the opportunity to comment

on last weeks signing of the Heads of Terms agreement between Edf and the

UK government to build twin 1,600MW rectors at Hinkley Point. But having

considered the known terms of the deal, we are flabbergasted that the UK

government has committed future generations of consumers to the costs

that will flow from this deal. The full terms of the contract has not been released

so our modelling of the project necessarily contains a number of assumption

- which we will outline later. But the known facts are as follows:

Construction costs:

£8bn per reactor, or £5m per MW. As far as we can see this makes Hinkley

Point the most expensive power station in the world (excluding hydro

schemes) on a per MW basis. By way of contrast, for the cost of £16bn for

the 3,200MW to be built the UK could build 27,000MW ofnew CCGT gas

fired power stations solving the ‘energy crunch’ for a generation.

Construction period:

Edf has been given an astonishing 9 years to complete the construction.

This makes Hinkley Point both the most expensive power station in the world

and also the plant with the longest construction period.

Construction Risk:

The UK government are claiming that Edf are taking the construction risk.

But with an £8bn build cost, and a 9 year construction program, Edf have

built in so much fat into the project that a cost / time over-run should be

near impossible.

Strike Price:

Edf will receive £92.50 per MWh in 2012 prices. But with construction not due

to complete until 2023. Edf can expect an actual revenue of around

£121per MWh once the station opens

Strike Price indexing:

Perhaps the extraordinary feature of the deal is the 35 year inflation

indexing of the strike price. Nuclear stations have a very high revenue

to operating cost ratios. By granting full indexing of the revenue line

Edf are handed the opportunity to earn extra-ordinary returns as the

project matures.

Cdf length:

Has been set at 35 years. This means that the full economics of the

reactors will be recovered within the first 35 years when the stations

have an 60 year expected life span.

Rate of Return:

Edf have stated that they can expect to earn a 10% Project IRR. This suggests

10% IRR on an unlevered basis. Edf also suggest that they may seek 65%

non recourse financing which, on our numbers, suggests a 14.5% equity IRR