If pension funds could buy electricity bonds based on the future stream of electricity generation at fixed prices, then in thirty years elderly Europeans would not have to worry about lighting their homes and watching television.
In 30 years, more elderly Europeans than ever will be lighting their homes and watching television. Buying electricity for them today at a low fixed price is a simple mechanism to alleviate the coming demographic problem.
The British government’s recent energy review sets the scene. The complex economics of nuclear power hinge on the capital intensity of the project. A megawatt of capacity will cost about £2,000 ($3,640) to build: considerably less than the updated cost of Britain’s last nuclear power station at Sizewell but substantially more than the contract price for Europe’s only new nuclear station, due for completion in Finland in 2009.
A banking case would amortise that £2,000 over 25 years at a cost of capital of 10 per cent, implying capital costs of 3p to 4p per kwh of electricity produced. This figure is above the total costs of conventional power generation. So nuclear stations are not going to be built without explicit or covert assistance from the British government, which cannot otherwise meet its climate change commitments, and the French government, which is anxious to promote technology in which France is now world leader.
Yet there is another way of looking at it. The British government can borrow money today for the 40-year life of a new nuclear power station at a real rate of return of 1 per cent. On that basis, the capital cost of nuclear electricity is less than a penny a unit. It is then attractive, not just to build new nuclear plant to replace old, but to expand its share of generation capacity. Which calculation is right? The cost of capital to the private sector is much higher for several reasons, mostly to do with the associated risks. Nuclear power is politically sensitive; it is seen as – and perhaps is – dangerous; and problems of waste and decommissioning are not adequately resolved. While these are primarily problems for government, any realistic private sector operator knows he will be caught in the flak.
The other main source of uncertainty is that any generator is exposed to volatile wholesale electricity prices. These are sensitive to the costs of oil and gas and may be sensitive to any action taken to reduce greenhouse gases. This uncertainty is an artifice of the way the electricity market operates. If there was an active market in
long-term future prices for electricity, the risk could be completely hedged.
Why is such hedging not possible? In part, it is: the Finnish project is backed by long-term contracts from Finland’s paper-making industry. But the people who most need protection against future inflation are potential retirees, and the pension funds that invest on their behalf. They can make forward contracts in the general retail prices index, and their anxiety to do so has driven long-term indexed bond yields to these very low levels. But pension funds pay pensions in cash, not electricity: even though it is electricity we will want to use our pensions to buy. For the ultimate beneficiaries, futures in electricity prices are every bit as attractive as futures in a basket of commodities: perhaps more so.
One solution might be to issue bonds to retail investors that pay in electricity rather than interest. But this idea is too clever by half, and the benefits would be lost in complexity, commissions and inevitable misselling. The simplest answer is for the government itself to manage the swap. The coupon on nuclear bonds would be linked to the retail price index and would be exchanged for electricity prices – the currency of revenues from the sale of nuclear-generated electricity. The proceeds – which would be positive if electricity prices were high and negative if low – could then be used to stabilise the retail price of electricity through subsidy or tax.
The outcome would be greater certainty of electricity prices, more secure retirement funding and prospects of significant action on climate change. All this in a public- private partnership that takes away from the British government responsibility for what it has proved so bad at – determining energy priorities and building power stations – while leaving with it responsibility for one thing the British government has always done cheaply and well – borrowing money.