Who will invest in new nuclear power plants in the UK? The Hitachi-Wylfa case.
The announcement that Hitachi will halt the nuclear mega project Wylfa plant in Wales came last week. Hitachi’s involvement in the power plant plans have cost Hitachi £2.14bn and the estimated total cost of the project is £12bn if it went ahead. The media presented Hitachi’s decision to withdraw as a surprise and a blow to the UK government energy strategy.
Is this however so surprising?
Let me answer this question by talking about the following three points:
How does Wylfa compare to Hinkley Point C – a nuclear power plant megaproject that has been a agreed a couple of years ago – in terms of the investors?
What kind of private sector party would be potentially interested in such investments?
What could be the way forward for the UK government when it comes to greenfield infrastructure finance?
First, the deal on Hinkley Point C was agreed in 2016 with estimated construction costs of around £20bn which are going to be paid by the investors – EDF and CGN. EDF is Electricite de France, a French electric utility company, largely state owned (85%). Its portfolio consists of about 60% nuclear power plants. It is trading on the stock market since 2005. CGN stays for China General Nuclear Power Group, a Chinese state-owned organisation which is investing predominantly in nuclear power plants. It is also the largest nuclear power constructor in the world. Both of those companies are largely state backed and have concentrated portfolios in nuclear energy. On the other side is Hitachi, largely diversified across eleven sectors including information and telecommunication, automotive systems, railway, etc. It has been set up as a private company and had its IPO back in 1949. So, to compare it with the above two investors in Hinkley Point C, Hitachi is not backed by the Japanese state therefore highly dependent on stock markets moods and is not specialised in nuclear power alone as above organisations. Hitachi’s shares are owned largely by institutional investors such as US mutual funds and pension funds (Oregon Public Employees Retirement Fund). The company also forms part of a large number of exchange traded funds (ETFs).
On the one hand, if the UK government wants to work together with firms (and not funds!) listed on the stock exchange and not explicitly or implicitly backed by a government, it would need to understand the infrastructure project exposure to the stock markets the incentive of listed companies to make infrastructure projects deliver required dividends for the shareholders, which is the ultimate goal of those companies. Hence, it is not that surprising that large listed companies would walk away if they do not feel that there would be a good deal for their shareholders. On the day of the announcement of Hitachi pulling out of Wylfa on 17th January 2019, the share opened at 13.65 and has since increased to 14.30 (26th January 2019). The few days before the announcement, the share traded around the 13.7 mark. So, we see that the markets have liked the announcement overall but there can also be other effects playing a role here. To be able to fully disentangle what has driven the share price up, one would need to conduct a more thorough analysis, such as an event study I did for REITs.
On the other hand, if the UK government does not want the stock market exposure and ETF exposure, then working with state-owned enterprises may be a way to go. However, this will expose UK nuclear power plants and energy supply to direct control from foreign states. One can say that the UK government should be concerned about the long-term involvement of French or Chinese states indirectly in UK energy provision as they are invested in Hinkley Point C. This remains to be seen.
To answer the second question, what other private sector investors would be interested in nuclear power plants in the UK, we need to look at what other financial vehicles are left. From the investor point of view, we need to understand that beyond the actual project costs, they are most concerned about political and regulatory risks in addition to the asset-specific risks and construction risks. From an institutional perspective point of view, what matters are the financial features of the asset. Nuclear power plants are large-scale greenfield projects, with very high upfront costs (£20bn) and a long construction phase (10 years) within the regulated infrastructure market. Who would potentially be interested to invest in it? Private equity funds have been an emerging player in infrastructure investment, mainly for renewable energy and focusing mostly on brownfield sites. Private equity funds are looking to deliver absolute two-digit returns in most cases. This is of course highly generalised, but based on current analysis of infrastructure funds, we observe this pattern. Moreover, PE funds mostly are interested in about 10-12 years investment horizon, building nuclear power plants would be too long for them. Another player are the large Canadian and Australian pension funds who have much more cash to invest over the long term and that may be one way to go. They are already heavily invested in infrastructure through different channels. UK public pension schemes could invest employees’ money into greenfield infrastructure as they are not expected to deliver the high returns that PE is targeting and can invest much more long term. What they will be looking is to make the project resistant to increases in inflation. So, inflation-linked products would be welcomed by them. UK pension funds have invested little percentage-wise in infrastructure so far as compared to Canada and Australia – so why not increase their share – it may be a win-win.
Finally, to answer the last question, the last option would be to do it in-house. This is a political decision – a fully government funded project. Given what has happened with other infrastructure assets (i.e. water companies), with social housing and public land, which were mostly privatised in the last 40 years, there seems to be no political incentive for a fully government funded project. Financially though, this is the cheapest option. If UK government bonds do not get significantly downgraded with Brexit coming, issuing public bonds is long-term cheap financing and also may be packaged under an ESG label – nuclear energy is environmentally friendly in terms of CO2 emissions.
So, why not?
Just some food for thought…