In today’s Independent newspaper (London, Monday 23 February) I argue that we may need to accept some new nuclear power stations. I put forward the view that the trench warfare between the pro-nuclear groups and those that support renewables means that progress towards ‘decarbonising’ electricity generation in the UK is too slow. We probably need to invest in many different types of non fossil-fuel generation as rapidly as we can if we are to meet the tough targets for UK emissions reduction so painfully won by groups such as Friends of the Earth. We no longer have the luxury of ruling out nuclear expansion.

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In this note, I want briefly to expand on this opinion. There are two parts to my argument – the medium term and the long term.

First, the medium term. It’s well known that a large fraction of the UK electricity generation capacity is scheduled to close between now and 2015. The Large Combustion Plant Directive (LCPD) obliges the coal-fired power stations that have not installed flue gas desulphurisation (FGD) equipment to close once they have worked for an additional 20,000 hours. (There are 8,760 hours in a year). In addition, the first and second generation nuclear plants are reaching the end of their working lives.

Over the last couple of years electricity demand has begun to fall slowly. December 2008 saw electricity transmission on the National Grid down almost 4% from the previous year. Some of this fall will be related to declining levels of economic activity and some to the historically high prices being charged. We cannot be completely certain but it also appears likely that some of the reduction is due to successful energy efficiency measures.

Nevertheless, even with stable or gradually falling demand, the UK needs more electricity generating capacity as the old plants are retired. The country needs new power stations both to meet existing needs and because we are likely to see the beginnings of large-scale use of electric cars within a decade. We may need eventually to add about 15% to our electricity production to cope with the needs of car batteries. In the past the government has said that we need 25 gigawatts of new capacity within twenty years, and I think that this number is still broadly correct. (25 GW is approximately a third of all current UK generating capacity.)

Where is this new capacity going to come from? Without nuclear, we are going to struggle to avoid relying on new fossil fuel plants. By 2020-25, we will probably have viable carbon capture technology so that new power stations then will not be major carbon emitters. This is ten to fifteen years away. The current problem is a slightly different one. At today’s fuel and carbon prices, the most profitable way to generate electricity in the UK is to burn coal (almost pure carbon) rather than natural gas (which is mostly hydrogen).

A year ago almost to the day, I walked round Didcot A Power Station, one of the largest and most polluting of the UK’s coal power stations. It had barely worked all winter. The price of coal was high, and emissions allowances were trading at above €25 a tonne. RWE, its owner, could make no money from producing electricity from coal. Gas-fired stations were operating instead. The world price of coal then collapsed and now stands at little more than a third of its peak price.

The chart below shows a sample of recent US prices (www.eia.doe.gov), where the price decline is slightly less apparent because much of the coal produced in the US isn’t open to the impact of rapidly declining international prices. Coal for UK power stations is, with most of the tonnage bought from Colombia, South Africa, and Australia.

Click to enlarge

Similarly, the price of European emissions permits has sunk precipitously, although there has been a slight rise in recent days back to around €9. Taken together, these two forces mean that power station operators are making a fortune from burning coal. But why does this matter if much of the capacity has to close anyway in the next few years as result of the LCPD?

The problem is that the generating stations don’t actually need to close. The press always reports this incorrectly. The LCPD obliges plants without FGD to close. But even as I write this, the analysts at the UK’s big six energy suppliers will be carefully calculating the cost of installing FGD on plants like Didcot. It’s very costly, but small compared to the profits they are now making from coal. In the next few months expect several of the UK coal-fired stations without FGD to announce that they will install this equipment before the 2015 deadline, instead of closing as expected. There’s still plenty of time.

The current economic slowdown has given us this gloomy combination – cheap coal, inexpensive CO2 permits, and relatively low wholesale electricity prices. The implications for the UK’s CO2 emissions are awful. If Didcot and other plants stay open, we are setting back the decarbonisation of electricity by a decade. Offshore wind, everybody’s favourite candidate for low-carbon generation, cannot possibly compete with coal-fired generation at today’s electricity and CO2 permit prices. Wind is subsided by the ROC system but even with these subsidies, the realised price is not enough to persuade banks to lend to the giant £1bn+ projects off the Kent coast and elsewhere.

So, to summarise, in the medium term, we need nuclear as fast as possible because otherwise we get more coal. Nobody concerned about climate change can regard the 8 GW of coal plants without FGD staying open with anything other than horror. I haven’t done the calculation carefully, but the effect of this might be to add 10% to UK emissions, compared to zero or low-carbon alternative ways of generating electricity.

But what about the cost of nuclear power? This blog has had several articles in the last year that look at the price of the new Finnish reactor, now several years and several million euros over budget (see here and here). I can see no reason to believe that nuclear construction in the UK will not be dogged by similar problems as in Finland. The next generation of nuclear power stations (principally the Areva EPR) are likely to cost over £4bn and possibly as much as £5bn for 1600 MW plants. Although construction processes may improve and regulatory costs decline, the EPR will probably deliver electricity at over 7p per kilowatt hour, twice what it costs to produce coal-fired electricity today. This means, as some of the big six electricity companies seem to be telling government already, that nuclear will need guaranteed pricing. EDF told me that nuclear power will cost 4.2 to 4.5p per kilowatt hour but the other companies were quietly very much less optimistic. If today’s prices persist EDF may possibly build nuclear power stations without financial guarantees; the other potential operators simply will not.

Therefore I am afraid that not only will we need to encourage nuclear power but we will also need to give the operators guaranteed prices for their nuclear output, and at levels well above today’s standard wholesale prices. By the way, we’ve got into this mess simply because we didn’t invest heavily enough in onshore wind, tidal or wave power in the last two decades. The various virulently anti-wind bodies, such as the Council for the Protection of Rural England, should be ashamed of themselves. But it’s too late to do anything about it now.

Second, the longer-term need for nuclear. David MacKay’s book Sustainable Energy – Without the Hot Air has many telling illustrations. One of them is an Ordnance Survey map on which Sizewell nuclear power station is shown. Sizewell generates 3% of the UK’s electricity in an area of a few hundred hectares. To generate as much power with wind would require about 2,500 very large turbines. (All the wind turbines currently working in the UK deliver less electricity than Sizewell.) 2,500 turbines will use about 40,000 hectares of good hilltop land or about 0.2% of the UK. Personally, I would rather have the turbines than Sizewell, but I’m aware this opinion is not shared by the majority of the UK population.

Professor MacKay uses this comparison to point out how much land area is used by renewables and how many turbines and other devices we need to replicate the output of one large power station. The implication of his clear and rigorous analysis is that we will struggle to cover our energy needs (not just electricity of course) from renewables. To get to the Climate Change Committee’s target of no more than 20% of today’s emissions by 2050, we may need to accept nuclear. (In my book Ten Technologies to Save the Planet I try to show how it is possible to cope without nuclear, but I readily accept that the target is tough to achieve.)

Mark Lynas makes an analogous and wider point. He says that renewable technologies will generally have a much greater impact on ecosystems than nuclear energy. What is better, he says: vast biomass plantations with minimal biodiversity or a single nuclear plant? Hundreds of thousands of wind turbines or twenty nukes? In his view, the increasing pressures on the world’s ecology from human activities make it difficult to conclude that nuclear is the wrong answer. He’s not just talking about climate change, but the other main global boundaries of limited water supply, species loss, the abuse of the phosphorus cycle, and other problems.

I’m not quite sure I entirely agree with Mark Lynas, but I do think that the public debate needs to move beyond the ritualised and stale statements of both the pro- and anti-nuclear groups. Nuclear is costly, the new EPR technology is untried, and waste disposal and the proliferation of weapons grade fissile material remain serious issues. But we are making so little progress with other technologies that I reluctantly conclude that we also need to sponsor nuclear power in the UK.

Community-owned wind farms are a rarity in the UK, despite their popularity in other parts of northern Europe. So should we welcome an opportunity for individual investors to invest in a newly built wind project in northern Scotland? Yes and no. The prospectus promises reasonable returns. But the protections to investors are limited and the information about the mechanism by which shareholders get their returns is sadly lacking. Even enthusiasts for individual investments in wind power need to be very cautious about investing in the Great Glen Energy Co-operative.

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Buy a share in a conventional company and you normally acquire a right to participate directly in its success or failure. The Great Glen Energy Co-operative is different. It is raising up to £1.8m so that it can buy what it calls a ‘Royalty Instrument’. The Great Glen prospectus says that this Instrument gives the company the right to some of the profits from a big new wind farm, owned by an unrelated third party, Millenium, a wholly-owned subsidiary of Falck Renewables. This is a financial contract that gives the holder payments dependent on the performance of the third party. In effect this is a ‘derivative’ arrangement.

There’s nothing necessarily wrong with this scheme. If a reasonable share of the profits of the wind farm flow to Great Glen and its shareholders, no one will complain. But the Great Glen prospectus is very unusual. It states that the company is trying to raise £1.8m but it never actually says what rights the Instrument is buying with this money. You would expect that the prospectus might say that the £1.8m buys, for example, a 3% share in the profits of the Falck wind farm. But the prospectus makes no such statement. It does contain a simple financial table that provides an illustration of the returns to members, but provides very little detail on how these projected returns are calculated. At one point the prospectus implies that the backers of the Great Glen Co-op do not even know the price which Falck believes it will obtain for the electricity from the wind farm. Frankly, anyone putting money into the Great Glen Co-op is investing on trust.

The table of projected returns shows shareholders in Great Glen achieving an average yearly return of 10% on their money over the 25-year life of the wind farm. The prospectus further states that the parent company, Falck Renewables, guarantees a minimum return of 6.5% per annum, even if the wind farm itself is unable to pay its obligations under the Royalty Instrument. Based on today’s wholesale power prices, I calculate that the returns to Falck from this investment are about 27%, vastly greater than the returns offered to Great Glen investors.

I have asked Great Glen and its backers for details of what the Royalty Instrument is buying and how the projections in the prospectus are calculated. I have been told that all the terms of the Instrument are confidential. Shareholders and potential investors are not entitled to know any of its contents. This means that even simple questions about the risks and returns to Great Glen shareholders cannot be answered. Here’s a list of entirely reasonable queries which potential investors in Great Glen will never know the answer to:

• a) What share of the profits of the Falck wind farm is Great Glen entitled to?
• b) What assumption is made about the sale price of the electricity generated from the site?
• c) What happens to shareholder’s returns if the price of electricity falls from today’s historically high levels?
• d) What would be the impact of a fall or a rise in the price of Renewable Obligation Certificates, the second principal source of revenue from a wind farm?
• e) Is the return to Great Glen ‘geared’ in any way to the performance of the wind farm? If, for example, Falck decided to raise a substantial amount of debt secured on the wind farm’s revenues, would this affect the flow of cash to Great Glen?

These are crucially important questions, vital to an understanding of the likely financial performance of Great Glen. Great Glen’s backers, Energy4All, told me that one of the reasons was that the Royalty Instrument contained intellectual property that Falck wanted to keep secret. Energy4All also says that Falck insisted that the full wind speed projections for the wind farm site were confidential, although the average projected wind speed is contained in the prospectus. So outsiders cannot even check that the projected electricity generation figures for the site are reasonable.

These are serious issues, particularly since the Great Glen investment opportunity is targeted at ordinary people living close to the wind farm and not professional investors. But perhaps more important, I am concerned that the prospectus is misleading in the way it describes the investment. The prospectus implies that the offer enables investors to own a stake in the wind farm. For example, it states that:

• a) ‘Great Glen Energy Co-op was established in 2008 for the specific purpose of owning a stake in a wind farm being constructed in the hills north of Invergarry in the Great Glen, Scotland’.
• b) ‘Falck wished to offer a degree of local public involvement in the Project and approached Energy4All at the beginning of 2003 to explore the idea of offering partial ownership of the Wind Farm to local people’.
• c) ‘The Royalty Instrument provides Great Glen Energy Co-op with the right [...] to purchase a stake in the Wind Farm’.
• d) ‘The Royalty Instrument Agreement provides for a[n] interest in the Wind Farm [...]’.
• e) ‘Falck approached Energy4All at the beginning of 2003 to explore the idea of offering partial ownership of their Wind Farms in the North of Scotland’.
• f) ‘Community ownership of part of a wind farm is good from a social and environmental perspective’.

It seems to me that actually the Royalty Instrument does not give the Great Glen investors a stake in the wind farm. Rather, it provides for Great Glen to have certain rights over a portion the cash flow from the operation. This is very different from owning a share in the business itself. Falck remains in total control of the wind farm. In particular, as far as one can tell, it can sell the wind farm at any time and simply repay the money invested by Great Glen. It also appears to be able to raise debt secured on the wind farm without restriction, and the bankers involved could refuse to allow further payments to the Co-op. (Falck has however guaranteed the minimum return of 6.5% if this happened.)

These are very unusual terms for people who have a ‘stake’ in a business. I think it would be much more accurate to say that the Great Glen shareholders are, in effect, unsecured creditors of the wind farm company, ranking behind banks and other financiers. This would be acceptable if fully explained to shareholders and if Great Glen shared in the upside if the wind farm did well. But the upside appears to be limited: although Great Glen appears to benefit if electricity prices rise (though we don’t know this for sure), shareholders will not benefit if the wind farm is sold at a profit.

This is an attractive deal for Falck. The Great Glen investment gives it the prospect of cheap financing (the guarantee of 6.5% is far less than it would pay for unsecured debt in today’s capital markets) and it appears to have unrestricted rights to sell the wind farm or to load it with debt at any debt, much like a householder might remortgage a house. (I may be exaggerating the poor quality of the protection afforded to Great Glen, but the lack of detail in the prospectus makes it impossible to tell.)

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Energy4All has responded to these criticism by saying, inter alia, that I am wrong to focus on Falck and Great Glen. Falck is the only significant wind farm developer in the UK willing to grant any participation to community interests. It is therefore unfair to comment unfavourably on their arrangements with Great Glen. I hesitate to say this because of the admiration I have for Energy4All, but I think that this is the wrong attitude. Although the Great Glen arrangement may have been the best one Energy4All could obtain from Falck, this does not make it necessarily a good deal or one that is robust enough to present to private individuals.

Shell backed out of its commitment to provide the financing for one third of the world’s largest offshore wind farm off the Kent coast. The London Array, expected to cost about £2bn, now needs to find a new investor. What about tapping the public? The project has reasonable economics, and private individuals could benefit from 40% tax relief by putting shareholdings into pension plans. Perhaps as importantly, such a move would raise understanding of renewable energy generation among the wider community.

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The London Array is a proposed wind farm, located over 12 miles off the Kent coast in south-eastern England. Up to 340 large turbines will produce up to one gigawatt in strong winds. Actual production, taking into account periods of low winds, will average about 400 megawatts, equating to about 1% of total UK electricity needs. This is by far the largest offshore wind farm in the world.

The project has now finally succeeded in obtaining most of the consents and planning permissions necessary to build the farm and bring its electricity onshore to link to the high-voltage backbone of the grid. The remaining backers, E.ON and DONG Energy of Denmark, still face huge hurdles. Few manufacturers make turbines that can survive offshore conditions. Only a small number of vessels are available worldwide to construct the foundations of the turbines.

Nevertheless, the project should have acceptable financial returns. Much can go wrong, but a simple model shows that dividends should meet the requirements of most individual investors.

First, let’s examine the financial characteristics of the wind farm:

1. Shell was due to put down one third of the money. The costs of this project have escalated substantially, but I assume that Shell’s withdrawal has left a hole of about £700m, including payments to the remaining consortium members for their efforts so far. Wind farms can be partly financed by debt – perhaps in a ratio of £300m debt to £400m shareholders’ investment in this case.
2. If the debt costs 7%, then servicing will be about £21m per year.
3. We cannot know accurately what the annual maintenance charges will be. A small onshore wind farm has operating and maintenance costs of about 15-20% of revenue. Expressed as a percentage of revenue, it seems unlikely that this huge project will have higher costs.
4. Projected electricity generation is about 3,200 gigawatt hours. At typical electricity prices of about £45-50 per megawatt hour, the output from the entire project will be worth about £150m a year.
5. This is less important than the money generated from Renewable Obligation Certificates. New rules mean that the farm will attract 1.5 ROCs per megawatt hour. At current ROC prices of about £50, the value of the output of the London Array will be approximately £240m.

We should be clear: neither the electricity price, nor the ROC value, is guaranteed. The price of ROCs is entirely dependent how much renewable energy is produced expressed as a fraction of the government’s target which rises over the years. The London Array is so large a project that its arrival will affect this ratio and this will push down the price. Nevertheless, forecasts of renewable generation still strongly suggest that the future price of ROCs will continue to be buoyant. In other words, there is little likelihood that the percentage of all electricity derived from renewable sources is never likely to rise fast enough, even with the Array, to cause a crash in the price of ROCs.

If private investors bought a one-third share in the project, the outline finances would look approximately like this for the first year of full operation. I have not included fund raising costs:

† This is not a cash cost, but can be used to generate a sinking fund that repays the debt and then the full investment after 25 years, with interest.

There are many questionable assumptions in this illustrative calculation; but it shows that to a private investor the returns may be acceptable. The income would be more attractive if the individual’s shares were placed in a pension fund. Such an investment would allow the higher-rate taxpayer to reclaim 40% of the cost of his or her investment, raising the effective return to 17.5%.

What does this mean for a 40-year-old investor putting money into the London Array for 28 years (a three-year construction period plus a twenty-five-year operating life) as part of pension planning? My very rough calculations suggest that an investment of £10,000 wrapped into a pension fund that accumulates all the payments from the Array would multiply the investment over 15 times after tax relief. I make the assumption that ROC and electricity prices stay constant and that the cash accumulating in the pension fund only earns 5% return. For the boffins reading this article, this is a real internal rate of return of well over 10% a year.

From the individual investor’s point of view, these figures ought to be reasonably attractive. There are substantial risks, such as cost overruns during construction and falling ROC prices, particularly during the latter half of the project life. But they are partly matched by the possibility of the Array realising higher electricity prices, and ROC prices rising over the next few years. An investment will also act as a hedge for the individual investor against rising retail electricity prices.

This quick look at the economics of the London Array shows why Shell backed out. The returns don’t match what it can hope to achieve getting oil out of the Alberta tar sands or in onshore wind projects in the US. Nevertheless, it also demonstrates that, properly packaged, the Array should be able to attract money from individual investors.

* The idea of using private investors’ money to plug the gap left by Shell was proposed by Phil England, climate change journalist. I am very grateful for permission to write about his idea.