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Project Financa for Nuclear Power

Hallengren, Erik (2008)
Department of Law
Abstract
As energy demand soars to new levels in heavily industrialised European countries, difficult decisions have to be made on how to ensure sufficient future energy capacity. The decision of the EU to put nuclear energy back on the agenda as a means of solving this issue must be seen against the backdrop of the debate over climate change and the outspoken policy to substantially reduce greenhouse gas emissions. Furthermore, the struggle to ensure energy security is an influential factor to be considered. It is in this context that the plans for a new privately financed nuclear build in the UK should be seen. The thesis maintains focus on how such a financing could be structured in the United Kingdom. The reason for choosing the UK as a base... (More)
As energy demand soars to new levels in heavily industrialised European countries, difficult decisions have to be made on how to ensure sufficient future energy capacity. The decision of the EU to put nuclear energy back on the agenda as a means of solving this issue must be seen against the backdrop of the debate over climate change and the outspoken policy to substantially reduce greenhouse gas emissions. Furthermore, the struggle to ensure energy security is an influential factor to be considered. It is in this context that the plans for a new privately financed nuclear build in the UK should be seen. The thesis maintains focus on how such a financing could be structured in the United Kingdom. The reason for choosing the UK as a base for the study is the present situation in the country, with a growing demand for increased power supply and the need to replace the ageing nuclear plants that the country relies on today. Furthermore, the UK Government has an outspoken political ambition to pave the way for privately financed nuclear power plant construction, which makes a project finance solution especially interesting. The UK Government Energy Review opens the door to new nuclear build as it lays the political foundation necessary for financiers to contemplate providing debt for nuclear plant construction. Further, the Energy Review makes clear that it will be for the private sector to finance the new build. The aim of the thesis is to analyse the reasons for, and consequences of, using a project finance model to finance the build of a nuclear plant in the United Kingdom. A certain focus is maintained on the management of the risks associated with such a project. A project financing involves several parties, such as banks, sponsors, contractors, operators, suppliers, purchasers and a project company - all with their own interests and objectives. Since the recourse from the lenders to the participating companies is limited, project finance allows participating companies to use a highly leveraged finance structure with minimum exposure to the risks associated with raising debt. A review of the economics of nuclear generation and the effects of the deregulation of the power market in the UK shows that the capital costs associated with constructing a nuclear power plant are substantial. This might become an impediment to financing the construction of a nuclear plant. The essence of project finance is the identification of key risks and the apportionment of those risks among the project parties. As a general rule, a particular risk should be assumed by the party best able to foresee, manage, control, spread, mitigate, or hedge against it. Importantly, risks should not simply be assigned without further consideration to the project company. The analysis is limited to risks that raise specific legal and financial issues for a nuclear plant project finance scheme, namely political and regulatory risk, completion risk, and market risk. Political and regulatory risk can be reduced by several measures. Government can take steps to combine the construction and operating licenses into one single license. Another Government alternative would be to improve the process for regulatory decision-making. The foremost private initiative would be to structure a Power Purchase Agreement. However, it is highly uncertain whether this would be possible in the deregulated power market of the UK. As a last resort, the sponsors, who will likely be experienced nuclear operators, might take on the risk. Completion risk is likely to be a key risk in a project financed nuclear power plant build. An effective manoeuvre made by lenders to mitigate the risk of delayed completion can be to include a claim for liquidated damages in the contractual framework. Lenders will want to see performance and defects liability bonds from institutions with acceptable credit ratings in place before issuing any debt to the project company. Furthermore, lenders will probably require that an engineer contracted by them be entitled to inspect the construction works, receive reports and attend tests throughout the construction period. If unable to achieve these objectives, lenders are likely to demand completion support from the sponsors. Market risk is easy to identify but not as easy to manage, owing to the fact that mitigation efforts to a large extent depend on third party relations. Due to the deregulation of the UK energy market, the passing on of risks to consumers is hardly possible. An effective way of mitigating market risk is to enter into offtake agreements with third party purchasers of the project product or a sponsor. However, such agreements are not very likely, due to risk of price fluctuation and sponsor balance sheet protection. If the preconditions for successfully negotiating a guaranteed offtake agreement are not present, the lenders will likely be the ones taking on the market risk. Although the very core of project finance is the matter of mitigating and allocating risks, there are limits to the risks that can be dealt with in a satisfying manner. The vast risks associated with the financing of a nuclear power station are not easily dealt with. In spite of the highly advanced legal tools available for risk management, the parties to a project financing might not be able to mitigate or allocate the most dismaying risks and at the same time retain a healthy financial outlook for the project. Risk mitigation is complex and time-consuming, and thus associated with significant costs. Even if most risks could be hedged effectively, the greatest obstacle of all - the immense capital costs - remains to be dealt with. Although excellent for reducing and spreading risk, the project finance approach is not renowned for decreasing costs. Due to the complexity and the time-consuming character of project finance schemes, as well as the many risks associated with project finance, the costs are often higher than other comparable means of financing. Thus, the ability of market leading nuclear operators with sufficiently strong balance sheets, such as EDF, Areva and E.ON, to balance the risk of energy prices on the rest of their portfolios gives them a substantial advantage over companies looking to employ a project finance model. The experienced operators will be able to offer the same project standards but at lower costs and without the many legal complexities associated with project finance schemes. Should any of these companies be willing to do so, one can conclude that the first new plant built in the UK will most likely not be project financed, due to the costs, risks and timeconsumption of the complex model. Rather, the plant is more likely to be financed via a full recourse syndicate bank loan with security taken over the assets on the balance sheet of a single company. The implications of such an approach is not reviewed in this thesis, however. All aspects of the project finance approach should not be fully out ruled, however. Indeed, some elements of a project finance solution could prove quite useful to the companies financing the build with their own assets as it could allow them to move these costs off the balance sheet once construction is complete and the plant is in business. This could be achieved by re-financing the plant on the bond market through the use of a special purpose company. Obvious advantages of such an approach would be that it gives the company a strong market position as it can then offer the procuring authority to insert the freed capital into a new plant and thus compete for the construction of more plants with a substantially lower cost prospect. Furthermore, a bond market re-financing will probably be cost competitive when compared to re-financing by means of debt provided by way of a syndicated bank loan. (Less)
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author
Hallengren, Erik
supervisor
organization
year
type
H3 - Professional qualifications (4 Years - )
subject
keywords
Kredit- och säkerhetsrätt, Bankrätt
language
English
id
1558063
date added to LUP
2010-03-08 15:55:21
date last changed
2010-03-08 15:55:21
@misc{1558063,
  abstract     = {As energy demand soars to new levels in heavily industrialised European countries, difficult decisions have to be made on how to ensure sufficient future energy capacity. The decision of the EU to put nuclear energy back on the agenda as a means of solving this issue must be seen against the backdrop of the debate over climate change and the outspoken policy to substantially reduce greenhouse gas emissions. Furthermore, the struggle to ensure energy security is an influential factor to be considered. It is in this context that the plans for a new privately financed nuclear build in the UK should be seen. The thesis maintains focus on how such a financing could be structured in the United Kingdom. The reason for choosing the UK as a base for the study is the present situation in the country, with a growing demand for increased power supply and the need to replace the ageing nuclear plants that the country relies on today. Furthermore, the UK Government has an outspoken political ambition to pave the way for privately financed nuclear power plant construction, which makes a project finance solution especially interesting. The UK Government Energy Review opens the door to new nuclear build as it lays the political foundation necessary for financiers to contemplate providing debt for nuclear plant construction. Further, the Energy Review makes clear that it will be for the private sector to finance the new build. The aim of the thesis is to analyse the reasons for, and consequences of, using a project finance model to finance the build of a nuclear plant in the United Kingdom. A certain focus is maintained on the management of the risks associated with such a project. A project financing involves several parties, such as banks, sponsors, contractors, operators, suppliers, purchasers and a project company - all with their own interests and objectives. Since the recourse from the lenders to the participating companies is limited, project finance allows participating companies to use a highly leveraged finance structure with minimum exposure to the risks associated with raising debt. A review of the economics of nuclear generation and the effects of the deregulation of the power market in the UK shows that the capital costs associated with constructing a nuclear power plant are substantial. This might become an impediment to financing the construction of a nuclear plant. The essence of project finance is the identification of key risks and the apportionment of those risks among the project parties. As a general rule, a particular risk should be assumed by the party best able to foresee, manage, control, spread, mitigate, or hedge against it. Importantly, risks should not simply be assigned without further consideration to the project company. The analysis is limited to risks that raise specific legal and financial issues for a nuclear plant project finance scheme, namely political and regulatory risk, completion risk, and market risk. Political and regulatory risk can be reduced by several measures. Government can take steps to combine the construction and operating licenses into one single license. Another Government alternative would be to improve the process for regulatory decision-making. The foremost private initiative would be to structure a Power Purchase Agreement. However, it is highly uncertain whether this would be possible in the deregulated power market of the UK. As a last resort, the sponsors, who will likely be experienced nuclear operators, might take on the risk. Completion risk is likely to be a key risk in a project financed nuclear power plant build. An effective manoeuvre made by lenders to mitigate the risk of delayed completion can be to include a claim for liquidated damages in the contractual framework. Lenders will want to see performance and defects liability bonds from institutions with acceptable credit ratings in place before issuing any debt to the project company. Furthermore, lenders will probably require that an engineer contracted by them be entitled to inspect the construction works, receive reports and attend tests throughout the construction period. If unable to achieve these objectives, lenders are likely to demand completion support from the sponsors. Market risk is easy to identify but not as easy to manage, owing to the fact that mitigation efforts to a large extent depend on third party relations. Due to the deregulation of the UK energy market, the passing on of risks to consumers is hardly possible. An effective way of mitigating market risk is to enter into offtake agreements with third party purchasers of the project product or a sponsor. However, such agreements are not very likely, due to risk of price fluctuation and sponsor balance sheet protection. If the preconditions for successfully negotiating a guaranteed offtake agreement are not present, the lenders will likely be the ones taking on the market risk. Although the very core of project finance is the matter of mitigating and allocating risks, there are limits to the risks that can be dealt with in a satisfying manner. The vast risks associated with the financing of a nuclear power station are not easily dealt with. In spite of the highly advanced legal tools available for risk management, the parties to a project financing might not be able to mitigate or allocate the most dismaying risks and at the same time retain a healthy financial outlook for the project. Risk mitigation is complex and time-consuming, and thus associated with significant costs. Even if most risks could be hedged effectively, the greatest obstacle of all - the immense capital costs - remains to be dealt with. Although excellent for reducing and spreading risk, the project finance approach is not renowned for decreasing costs. Due to the complexity and the time-consuming character of project finance schemes, as well as the many risks associated with project finance, the costs are often higher than other comparable means of financing. Thus, the ability of market leading nuclear operators with sufficiently strong balance sheets, such as EDF, Areva and E.ON, to balance the risk of energy prices on the rest of their portfolios gives them a substantial advantage over companies looking to employ a project finance model. The experienced operators will be able to offer the same project standards but at lower costs and without the many legal complexities associated with project finance schemes. Should any of these companies be willing to do so, one can conclude that the first new plant built in the UK will most likely not be project financed, due to the costs, risks and timeconsumption of the complex model. Rather, the plant is more likely to be financed via a full recourse syndicate bank loan with security taken over the assets on the balance sheet of a single company. The implications of such an approach is not reviewed in this thesis, however. All aspects of the project finance approach should not be fully out ruled, however. Indeed, some elements of a project finance solution could prove quite useful to the companies financing the build with their own assets as it could allow them to move these costs off the balance sheet once construction is complete and the plant is in business. This could be achieved by re-financing the plant on the bond market through the use of a special purpose company. Obvious advantages of such an approach would be that it gives the company a strong market position as it can then offer the procuring authority to insert the freed capital into a new plant and thus compete for the construction of more plants with a substantially lower cost prospect. Furthermore, a bond market re-financing will probably be cost competitive when compared to re-financing by means of debt provided by way of a syndicated bank loan.},
  author       = {Hallengren, Erik},
  keyword      = {Kredit- och säkerhetsrätt,Bankrätt},
  language     = {eng},
  note         = {Student Paper},
  title        = {Project Financa for Nuclear Power},
  year         = {2008},
}