Consultation on amendments to Sizewell C's electricity generation licence

Consumer Scotland has been invited by the Department for Energy Security and Net Zero to respond to the UK Government’s consultation on the proposed amendments to Sizewell C Limited’s (SZC’s) electricity generation licence.

Consumer Scotland is the statutory body for consumers in Scotland. Established by the Consumer Scotland Act 2020,[1] our Purpose is to improve outcomes for current and future consumers. We are independent of the Scottish Government and accountable to the Scottish Parliament. Our core funding is provided by the Scottish Government, but we also receive funding for research and advocacy activity in the electricity, gas, post, and water sectors via industry levies which are derived from consumers’ bills.

Our responsibilities relate to consumer advocacy. In our 2023-2027 Strategic Plan,[2] we have identified three cross-cutting consumer challenges, which guide our work during this period. They are:

• Affordability
• Climate change mitigation and adaption
• Consumers in vulnerable circumstances

Consumer Scotland welcomes the opportunity to contribute to this consultation. We are pleased to provide one part of the necessary input on the interests and protections on behalf of consumers.

This is the first response by Consumer Scotland on the UK Government’s proposals for the use of a Regulated Asset Base (RAB) model to support the financing of new-build nuclear power generation in Great Britain. Recognising the broad experience of economic regulation in the UK, Consumer Scotland acknowledges and shares the view of Ofgem that “RAB models can be an efficient way to finance large scale infrastructure projects such as water and electricity networks”.[3] Nevertheless, this will only be achieved if the incentive structure of the RAB model is designed and implemented effectively.

We recognise in full that the UK Government has made a clear commitment to proceed with this approach, subject to appropriate decision making processes under the terms of the Nuclear Energy (Financing) Act 2022.[4] Our comments are – in principle – neither in favour nor opposed to nuclear power, or to the use of a RAB model to support nuclear investment. Consumer Scotland has no statutory role in the decision making on nuclear projects in Great Britain. We note the Scottish Government is opposed in principle to new build nuclear power generation in Scotland “using current technologies”.[5]

To guide our response to this consultation, we have utilised our Consumer Principles. These are based on frameworks that have been developed over time by both UK and international consumer organisations. Reviewing policy against these principles enables the development of more consumer-focused policy and practice, and ultimately the delivery of better consumer outcomes.[6] The Consumer Principles are:

• Access – can people get the goods or services they need or want?
• Choice – is there any meaningful choice?
• Safety – are consumers adequately protected from risks of harm?
• Information – is it accessible, accurate, and useful?
• Fairness – are goods and services detrimental or inequitable to individuals or groups of consumers?
• Representation – do consumers have a meaningful role in shaping how goods and services are designed and provided?
• Redress – if things go wrong, is there an accessible and simple way to put them right?
• Sustainability – are consumers enabled to make sustainable choices?

Our response therefore focuses on the design, efficiency, and effectiveness of the economic regulation of SZC, as established through the proposed Generation Licence[7] – taking into account the statutory objectives in the legislation.[8] Our concerns relate to the risk allocation between taxpayers, investors, and consumers; and to ensuring that the protections for consumers are as robust as possible.

Dr. Simon Gill of The Energy Landscape provided expert advice on the development of this response.

On 6th November 2023, the UK Government published an open consultation on “Modifications to the Sizewell C Regulated Asset Base licence”.[9] On the same day, we received a formal letter of invitation to respond to the consultation from the Department for Energy Security and Net Zero. This included a copy of the Price Control Financial Model (PCFM), which gives effect to the proposed licence conditions. As requested in the letter, we have considered the consultation document in conjunction with the PCFM, the “draft electricity generation licence: special conditions for nuclear generator”,[10] and the “Guidance on our approach to the Economic Regulation of Sizewell C”,[11] published by Ofgem.

The consultation document sets out the scope of the consultation process and explains the particular role requested of Consumer Scotland. Overall, the consultation is part of the statutory process set out in the Nuclear Energy (Financing) Act 2022.[12] In particular, it seeks to fulfil the requirement on the Secretary of State to consult on the modifications to the Generation Licence of the designated nuclear generator (in this case, SZC), which in turn provide the framework to ensure value for money and an acceptable risk allocation between consumers, taxpayers, and investors.

The consultation sought views on the consumer and public interest from Citizens Advice for England and Wales and Consumer Scotland for Scotland. As outlined in the consultation document:

“the Secretary of State has decided not to consult with the general public. Instead, consumer groups will be consulted allowing expert input that will reflect the interests of the public. This decision was based on the highly technical nature of the modifications”[13]

Consumer Scotland would like to see the UK Government move beyond this “highly focussed”[14] approach. Notwithstanding the important contribution that Consumer Scotland and Citizens Advice can make, there is significant scope for engagement by and for consumers in this process. We acknowledge the UK Government has undertaken previous consultations on the RAB model, and that the parliamentary process leading to the Nuclear Energy (Financing) Act 2022 has provided opportunities for public comment. Moreover, we readily acknowledge the highly technical nature of the licence modifications. However, a sufficient consumer voice cannot be provided by our two organisations alone.

The importance of safeguards for consumer interests is important in all areas of economic regulation, but is especially important in the nuclear RAB model. This approach is substantively different to the Contracts for Difference (CfD) type approach employed for projects such as Hinkley Point C, and changes the allocation of risk between taxpayers, investors, and consumers. The CfD approach seeks to “price-in” future risks and provide a degree of protection that future consumers will not be required to fund cost overruns beyond those which have been priced-in. However, given the nature of nuclear investment risk, it is recognised that the level and complexity of assurance required by investors is such that a CfD type approach may not represent good value for consumers; alternatively, that investors may be dissuaded from investing in the project at all. The RAB model therefore shifts some of this investment risk onto future consumers by establishing a regulatory mechanism to require future consumers to fund a share of increased costs, which under the CfD model would have been entirely faced by investors. It is argued that this approach could reduce the overall cost to consumers (particularly through a lower cost of capital), and importantly provide sufficient reassurance to investors to enable them to invest.

When compared with the well-established mechanisms for the protection of taxpayer and investor interests, the mechanisms for protection of consumer interests under a RAB model appear more limited. For example, the interests of taxpayers will be protected through the multi-layered internal processes of government, including the internal scrutiny in Departments; by the UK Treasury; and importantly, by the well-established process of Accounting Officer assessments. Likewise, the interests of SZC and its investors will be served by their advisers and due diligence processes. At present however, the consumer appears to be facing significantly greater risk, with limited assurance around governance, scrutiny, and visibility of decision making on their behalf.

We therefore strongly recommend that before making final decisions on the licence modifications, the UK Government broadens and deepens the range of contributions from consumers and from consumer organisations. Given the special characteristics of the nuclear RAB process, it should be the responsibility of the UK Government, the licensee, and the economic regulator to nurture an informed and technically literate engagement with this process.

In the immediate future, this engagement would be required to enable the Secretary of State to have due regard to the interests of current and future consumers when determining the final modifications to SZC’s Generation Licence, including in the setting of important regulatory parameters. More widely, the licence modifications and the economic regulation of SZC would benefit from greater engagement with consumer interests.

As an example, the regulatory Guidance issued by Ofgem[15] increases our confidence that Ofgem will discharge its duty to represent consumer interests. The Guidance highlights Ofgem’s statutory duties and typical regulatory processes – for example, referencing the RIIO-ED2 process used for setting the electricity distribution price control between 2019 and 2022.

Given that the Secretary of State, not Ofgem, is responsible for much of the regulatory process between now and the Final Investment Decision (FID), and throughout the pre-Post Construction Review (pre-PCR) phase of the project, we would like to see similar principles and processes laid out by the Secretary of State.

The consultation initiated on 6 November 2023 seeks input from consultees on the five areas set out below, but is not limited to these questions:

1. Do consultees consider that the licence modifications outlined within the consultation strike a reasonable balance between the need to support the financeability of the licensee and safeguarding consumer interests?
2. Do consultees consider that the incentives and penalties placed on the project through the modifications will support the efficient and timely delivery of the project, ensuring greater value for money for consumers?
3. Do consultees consider that the operational performance incentives included in the proposed modifications encourage the right behaviours?
4. Do the modifications set sufficiently clear expectations and boundaries for how the project company should operate in the market over time, and do the modifications contain sufficient flexibilities to account for future uncertainties in the energy market?
5. Do consultees think that the modifications provide Ofgem sufficient oversight in its capacity as economic regulator of the licensee?[16]

As far as possible our response takes into account the previous consultation processes on the nuclear RAB model, and in particular the Guidance published by Ofgem as noted above. It also acknowledges that the UK Government has given commitments that further information will be made available when the final licence modifications are published and the FID is made. This will include an assessment of value for money prepared by the UK Government.

Overall, our initial assessment is that the proposed licence modifications and related documentation do not provide sufficient institutional and regulatory safeguards on consumer interests.

In this response we have identified some suggested modifications to the draft licence and some high level principles that we would like the UK Government to consider to address some of our concerns.

However, it is beyond our remit as a consumer advocacy organisation to make specific counterproposals or to seek to draft suggested replacement text. Moreover, our concerns are not limited to these specific areas. The breadth of our concerns is also likely to require further modifications to the licence and in the procedures of decision making by the UK Government and Ofgem in particular.

Scotland specific considerations

Scotland forms part of the wider electricity system in Great Britain, and responsibilities for legislation and regulation of the sector are reserved to the UK Government and Ofgem. As such Scotland is treated in the same way as any other part of Great Britain. However, there are a number of characteristics of consumers in Scotland that are relevant to any assessment of the distributional impacts of introducing a RAB model for new-build nuclear power generation in Great Britain.

Typical energy consumption values, calculated by Ofgem, suggest that an average household in Great Britain uses 2,700 kWh of electricity and 11,500 kWh of gas.[17] In households that use electric heating, the majority of this gas use is transferred to electricity.[18] Average electricity use in homes with dual-rate metering (typical of those with storage heating) is 44% higher than in households with single-rate metering.[19]

Due in part to its climate, Scotland has a higher median level of domestic heat demand[20] despite dwellings which are, on average, more thermally efficient than a typical property in either England or Wales.[21]^,[22] The population of Scotland is also older,[23] and in less good health,[24] than the Great Britain average – both of which are markers of enhanced heating need.[25] Scotland also has a greater prevalence of traditional forms of electric heating than the Great Britain average.[26]

Taken together, these attributes mean that consumers in Scotland will, on average, use more electricity and will make a larger contribution to costs levied on bills on a per-unit basis than their equivalents elsewhere in Great Britain.

Under current market arrangements, electric heating users are considerably more likely to be fuel poor in Scotland compared to users of other heating fuels.[27] Additional levies on electricity bills would serve to increase detriment amongst an already financially vulnerable consumer group. Consumer Scotland’s energy tracker survey has repeatedly shown that electric heating users are more likely to report struggling to keep up with their energy bills when compared to other households – 37% of electric heating users reported struggling compared to a 30% average in the tracker’s autumn wave in 2023.[28]

The nuclear RAB model offers the prospect that by introducing an explicit risk sharing formula, and by allowing investors to start realising a return on their investment from day one, the return on capital required by investors in new-build nuclear power generation in Great Britain will be lower, and funding will be more likely. The UK Government has assessed that the nuclear RAB model will therefore make it more likely that a nuclear project will proceed, and that this lower return on capital will deliver savings for consumers (when compared to the funding model used to support Hinkley Point C).

Consumer Scotland acknowledge that a RAB type model could provide an efficient and effective way to take forward complex and risky infrastructure projects. There is potential to create a risk sharing framework that finds a “reasonable balance” between the interests of consumers, taxpayers, and investors. But a RAB type approach will only be successful if the design of the regulatory framework is sufficiently robust to match the scale and complexity of the project, and there is sufficient information to make that judgement.

As currently proposed, we have significant concerns that consumer interests will not be sufficiently protected – particularly in the setting of important regulatory parameters which will only be determined alongside the FID. Overall, our initial assessment is that as they stand today, the proposed licence modifications and related documentation do not provide sufficient institutional and regulatory safeguards on consumer interests.

The proposed licence modifications create a bespoke framework of economic regulation for SZC, including a project-specific framework for the allocation of risk between investors, taxpayers, and consumers. Through the licence, SZC will be provided with unique privileges as an electricity generator and substantial recourse to future consumers in the event of cost overruns, delays in the project timetable, lower performance, etc. This differs from other electricity generators (and from Hinkley Point C), where these categories of risk are faced by investors.

As published, the draft licence modifications provide important safeguards and a comprehensive set of special conditions. They appear to provide extensive safeguards to protect the interests of taxpayers and investors, which may make the FID more likely. But we are concerned that this will be achieved by shifting risk too far onto the shoulders of future consumers, with inadequate transparency and institutional safeguards of their interests.

Our view is that any RAB model which places a greater burden of risk onto future consumers should in turn include greater transparency, scrutiny, and institutional safeguards to protect consumer interests. Taken together, the draft licence modifications do not yet provide us with the necessary assurance that the interests of consumers will be sufficiently protected.

In particular, the initial regulatory parameters set by the Secretary of State will be the single most important component of the “reasonable balance” between the respective interests of consumers, taxpayers, and investors. The most important of these parameters will be set when the final licence modifications are published and the FID is made. Consumer Scotland is concerned that the pressures to set these parameters at a level which meets the interests of investors and taxpayers will be such to produce a questionable outcome for consumers.

It is imperative that the process and principles by which these parameters will be set is transparent. There are many examples of good regulatory practice, where decision makers set out principles and guidance on how decisions will be made and how decisions have been taken. The Guidance prepared by Ofgem alongside this consultation[29] is one such example.

We recommend that, through the licence conditions themselves and through separate publications, the Secretary of State lays out the specifics of how consumer interests will be considered and reported on, including a process of reporting how those principles impact on the setting of key regulatory parameters.

Introduction

Our response sets out our understanding of how the financial aspects of the regulatory framework will work in practice, including the implications for current and future consumers.

The RAB model significantly reduces risk for investors in the Sizewell C nuclear power station project, and for SZC as the developer / operator. It passes much of that risk to consumers and taxpayers:

• Risks associated with relatively likely contingencies, such as construction cost overruns and future electricity price variations, are passed to consumers
• Risks associated with low probability-high impact events, such as more extreme cost overruns or a significant future ‘change of law’ banning nuclear power, are passed to taxpayers through the Government Support Package that sits alongside the RAB framework

The UK Government has argued that this is necessary to realise the stated policy objective to enable further nuclear power developments to take place in Great Britain. Specifically, it has been stated that:

“it is clear that if any model is to attract private financing it will likely require:

• A variable £/MWh price allowing for the revenue stream to be adjusted by the Regulator as circumstances change
• An Allowed Revenue during construction to reduce the scale and cost of financing, increasing deliverability and reducing total cost to suppliers and consumers
• Some level of risk sharing between investors and consumers / taxpayers”[30]

The UK Government has determined that a CfD model is no longer suitable for new-build nuclear power generation facilities in Great Britain. It has argued that the financing costs (i.e. the cost of capital) required to entice investors would be very high, and/or that funding would be unavailable at the scale required. It has also highlighted that in the case of Hinkley Point C, which was developed on a CfD type approach (albeit without a competitive auction), the level of the strike price doubled between the start of negotiations in 2012 and the point at which the CfD contract was signed in 2016.

The UK Government has set out some of the similarities between the nuclear RAB model and the model utilised to develop the Thames Tideway Tunnel. Table 1 provides a summary of these different regulatory arrangements for risk sharing. Although there are similarities, Consumer Scotland notes that there are some important differences between the Thames Tideway Tunnel model and the nuclear RAB model being proposed.

The essence of the UK Government’s case for using this approach is that the special characteristics of nuclear investment make it unlikely that private investment will be secured under a CfD type approach. By way of comparison, under a CfD type model there is no regulatory mechanism to share the risk of cost overruns, and therefore no lower or higher cost thresholds to which investors are exposed. Consumers are therefore protected from cost overruns, and cost risks lie entirely with investors. However, in negotiating the CfD strike price, investors are likely to “price-in” some cost overruns and demand larger returns on their investment due to the significant risks they are taking on. While CfD type models therefore have considerable attractions in reducing risk to future consumers, this is achieved with an increase in the rate of return for investors.

From the information available Consumer Scotland does not have sufficient assurance that the modifications will ensure efficient and timely delivery, or value for money for consumers.

There is significant evidence from existing nuclear power generation plants and ongoing nuclear power generation construction projects that show the majority overrun in terms of cost and time – often significantly. Whilst Sizewell C is expected to benefit from the learning acquired during the planning, authorisation, and construction Hinkley Point C, Hinkley Point C was not the first European Pressurised Reactor (EPR) to begin construction; similar projects are underway in both Finland and France, and all three have faced significant cost and time overruns.

We are concerned that the CAPEX incentive scheme rewards SZC for moderate cost overruns (i.e. those below the level of the LRT), rather than aiming to penalise all cost overruns. We are also concerned that there could be a gap between the cap on SZC’s costs (i.e. the HRT) and the point at which cost overruns outweigh the benefit to consumers of using a RAB mechanism.

We are concerned that the penalties for delay will not be set sufficiently high. We note that for commercial projects, and for those supported by CfD, there is no revenue until commercial operations begin. This provides a very strong incentive on the developer to minimise delays. Under the draft RAB licence we understand that in the event of a delay, consumers will continue to pay a return on investment however that return will be reduced relative to the IWACC. It is important that a meaningful penalty is applied so that it is both fair to consumers and provides a sufficiently sharp incentive to deliver on time. We are also concerned that the licence does not place limits on continued additions to the RAB in the case of an extreme time-overrun beyond the longstop date.

Introduction

Time and cost overruns will both lead to significant consumer detriment: cost overruns will lead to consumers paying more than expected through levies on their bills, while time overruns will leave consumers facing higher than expected electricity prices and without the benefit of a major component of the low-carbon electricity system. It is therefore critical that an appropriate incentive framework is put in place for the pre-PCR of Sizewell C. The framework must ensure clear motivation for SZC and its investors to manage costs and minimise delays. This is particularly important because, whilst construction risks are complex and large, SZC is the only organisation able to control and mitigate most of those risks.

There is the potential for significant cost overruns in relation to the construction of Sizewell C. This is clear from the recent global history of constructing new nuclear power stations and specifically projects related to the EPR design on which Sizewell C is based.

Cost efficient delivery

Reviews suggest the cost overruns for nuclear power stations have reached more than 100% of the initial estimates for a number of projects in the recent past.^[51]

The cost estimate for Hinkley Point C, which has a very similar design to that expected to be used at Sizewell C, has risen from £16 billion in 2012, to £18 billion in 2016 (at the point of signing the CfD contract),^[52] to between £25 billion and £26 billion in 2022, and to between £31 billion and £34 billion in 2024^[53] (all in 2015 values). Recent projects using the same design in Finland and France have experienced cost overruns of three- and four-times initial estimates, respectively.^[54]

The argument for RAB funding is predicated on the assumption that consumer savings due to reduced financing costs will offset even significant cost overruns. Analysis by the National Audit Office suggests that a reduction in the cost of capital from 9% to 6% could offset a cost overrun in the range 75% - 100% of the initial estimate.^[55]

The HRT represents the upper limit on cost overruns that can be incurred without submission and approval by the Secretary of State of an “Increased Allowed Revenue” (IAR) application. The HRT plays a number of important roles. Firstly it places a limit on expenditure that can be added to the RAB under the licence; therefore it is an upper bound on consumer costs. Secondly, it provides a limit on investors’ commitments – investment at FID stage involves a commitment to spend only up to the HRT. Thirdly it allows the Secretary of State a number of options for continuing the project:

• by encouraging investors to continue funding the project but without additional spend being added to the RAB, in order to realise the value of their investment to that point; or
• by allowing further capital spend from investors to be added to the RAB (subject to investors submitting an IAR application); or
• by funding further work via Government (i.e. taxpayer) spending, funded from the Government Support Package

The consultation describes the HRT as a limit that is “at a significantly remote scenario above the licensee’s view of an extreme outturn cost.”

Consumer Scotland is concerned that setting a high HRT could mean that if construction costs do overrun to this level, the benefit to consumers of using a RAB mechanism to keep down the cost of capital could be outweighed by the costs faced by consumers from high cost overruns.

This point is illustrated in Figure 1: Relationship between cost estimates, RAB and regulatory thresholds

The operational performance framework laid out in the licence will not be implemented for more than a decade. For this reason, whilst the licence lays out the framework and sets some parameters to initial values, decisions on many of the regulatory parameters are deferred until the PCR and subsequent five-yearly periodic reviews. Consumer Scotland feels that this approach and framework is appropriate given that Ofgem intends to apply a rigorous regulatory process to determining the value of parameters and retains the right – if required – to adapt the framework.

In carrying out this role, we would expect Ofgem to apply its wider regulatory principles, narratives, and statutory duties to ensure that determinations are made in a clear, evidenced, and transparent way, following the best practice it currently uses in its network regulation.

We are concerned that the market performance incentives, whilst potentially sufficient to incentivise efficient trading of the output from SZC alone, could be insufficient when considering the impact on a wider trading portfolio. For this reason we recommend that the licence includes a formal requirement to ringfence trading of SZC’s output from trading of the output of other assets owned by EDF or other investors.

Operational incentive mechanisms and periodic review

It is reasonable for consumers to expect the highest standards of operational performance throughout the lifetime of Sizewell C in return for the substantial investment they are making in the project. In terms of performance, the license includes frameworks to incentivise availability and through-life capacity. It also chooses to apply an incentive to reduce TOTEX (total expenditure), rather than apply separate CAPEX and OPEX incentives.

These frameworks are linked to determinations that Ofgem will make at the PCR and subsequent periodic reviews. During these reviews Ofgem will set new values for regulatory parameters including the real WACC, target unit capacity factors (UCF) and TOTEX sharing factors. The full details of the parameters that will be set in the PCR are listed in Special Condition 43, and for the periodic reviews in Special Condition 58.

Ofgem has issued draft Guidance explaining how they will approach the regulation of SZC.^[58] This includes references to its existing legislative framework, consultation policy, and good practice taken from its network regulation.

Consumer Scotland agrees that the broad framework for operational performance incentives can protect consumers, and that it is appropriate to defer decisions on key operational phase parameters until the operational phase itself.

We expect Ofgem to take a similar approach to determining the PCR and periodic reviews as it does for its current network price regulation. This includes setting out a clear process with draft and final determinations, and opportunities for a wide range of stakeholders – including consumer representatives – to engage, comment, and provide evidence to assist Ofgem in its decision making.

Whilst the framework appears appropriate, we would note that representing the consumer effectively in an area as technically complex as nuclear power is challenging. We are concerned that it may be difficult for consumer groups to challenge justifications made by SZC for underperformance and which may affect the determination of future price control periods. During the operational phase, there is no Independent Technical Adviser (ITA), and we suggest that the UK Government consider carefully how it will ensure sufficient technical understanding and resource is available to consumer representatives.

The risk of market power within the electricity market

Sizewell C is expected to be operated by EDF Ltd., who are also expected to partially own and operate Hinkley Point C along with a growing fleet of wind farms, solar farms, and short duration electricity storage projects in Great Britain. EDF is also a large electricity supplier in Great Britain.

In 2022 EDF had an 18%^[59] market share in the electricity generation market as well as a 14% share of the domestic electricity supply market. Although all of EDF’s existing nuclear stations are currently expected to close by the early 2030s, from the late 2030s the combination of Hinkley Point C and Sizewell C could be as much as 14%^[60] of current annual electricity demand. There has also been a recent suggestion from EDF that they could look to extend the lifetime of their existing nuclear fleet.^[61]

The inclusion of a large RAB funded power station in EDF’s trading portfolio has the potential to influence the way that portfolio is traded in the wholesale electricity and wider energy markets.

The draft license includes a market price adjustment which delivers an incentive to trade power efficiently. The sharing factor for this mechanism will be initially set at the point of the FID and will be reviewed by Ofgem during the PCR and at subsequent periodic reviews.

This mechanism should provide sufficient incentive on SZC to achieve and, if possible, exceed the baseload market reference price (BMRP) – assuming that trading is optimised for SZC alone. However, there is a risk that, if traded as part of a wider portfolio, losses from underachieving the BMRP at SZC are offset by greater gains elsewhere in the portfolio.

Revenue streams for CfD renewables provide an example of a situation where complex interactions within a portfolio could lead to a misalignment of incentives. During periods of low market price it makes a significant difference to the revenue of CfD generators if the price is just below or just above zero. Since CfD allocation round 4 (AR4), no CfD difference payments are made to generators if the market reference price is less than zero. The operation of SZC, particularly in combination with onsite flexibility options such as hydrogen electrolysers and short duration electricity storage, could have the potential to influence the market price in a way that would have significant impact on revenues for EDF’s renewable fleet and outweigh any gains or losses from the SZC market price incentive.

Ofgem have existing powers to guard against wholesale market manipulation. However, the regulatory burden of proving instances of manipulation is high. For this reason, it could be of benefit to consumers – and helpful to Ofgem – to provide further protection beyond existing powers.

One approach to managing these risks is to ringfence the trading of power generation at SZC within EDF, or to require that an independent entity is put in place to trade the output from SZC. This would provide consumers with confidence that market power was not exercised and ensure that the incentives on SZC operate as designed, without interaction with wider “portfolio” effects.

We recommend:

Recommendation 3.1: The UK Government should consider carefully how it will ensure sufficient technical expertise and resource is available to consumer representatives.

Recommendation 3.2: The trading of SZCs energy market activity should be ringfenced. Ringfencing could be within EDF’s wider trading functions with a requirement to report on how independence is achieved, or by requiring the trading function to be delivered by an independent third party.

Over the coming decade there will be significant changes in the structure of the energy system and associated markets. Whilst the operation of nuclear power stations provides a useful baseload supply of electricity in today’s system, the value of doing so in a high-renewable, low-carbon electricity system in future could be much lower. As such, there is likely to be value in SZC being incentivised to be as flexible as possible in terms of its ability to generate electricity, its co-optimisation with other forms of flexibility such as short duration electricity storage, and its exploration of non-electricity energy markets.

Ofgem’s Guidance document[62] highlights the potential for the electricity market structure to change, and that the licence may need to be adapted to reflect those changes. As an example, the Guidance notes that the definition of the market reference price may need to change, or even that the concept of using a reference price at all may need to be replaced by an alternative approach.

Whilst the Guidance appears to be aware of the potential for changes to the electricity market, Consumer Scotland are concerned that the licence and Guidance give insufficient attention to the potential for non-electricity energy outputs to become a significant part of SZC’s revenue. This could be driven by reduced need for baseload electricity generation and/or the growing opportunities and scale of markets for low carbon hydrogen and/or heat. Consumer Scotland recommend that greater consideration is given to ensuring the licence is sufficiently flexible to deal with non-electricity revenue streams.

The value of flexibility

Nuclear power stations derive their revenue almost exclusively from the sale of electricity within the wholesale market. Traditionally they have operated as baseload, with a flat generation profile as close to maximum output as is technically feasible. There is some optimisation associated with the timing of maintenance and other outages, although this flexibility is somewhat limited by the regulatory requirements imposed by the Office of Nuclear Regulation (ONR) and in order to manage nuclear safety issues and carry out regular inspections.

The need for baseload electricity generation is reducing and it is expected that by the 2030s there will be significant periods of the year during which there is an excess of renewable generation available over and above that which can be used to meet demand, charge storage, or export over interconnectors. For example, a recent analytical illustration of a summer day in 2035 shows up to 19 GW of renewable generation required to turn off whilst baseload generation – nuclear in the example used in the illustration – must continue to operate.[63] National Grid ESO’s most recent Future Energy Scenarios suggest renewable curtailment purely due to an excess of renewables and baseload generation of between 38 TWh and 67 TWh in 2040 for net-zero compliant scenarios.[64]

During periods of excess supply from renewables the need for, and value of, baseload electricity will be minimal and potentially negative.

There are a number of options for how Sizewell C as a project can deliver flexibility:

a)the stations could be development alongside flexible technologies such as batteries and hydrogen electrolysis which are then operated to adjust the export of power from SZC to the grid.

b)flexibility in the project’s operational business model.

c)the design of the power station itself.

Interaction between the electricity market and wider energy market

By the time operations begin at Sizewell C there are likely to be alternative revenue streams available to electricity generators. For example, SZC’s generation could be used to produce heat and/or hydrogen rather than being exported to the grid.

The size of these alternative markets could be large, and there is the potential that, at least in some scenarios, a significant fraction of SZC’s revenue comes from non-electricity sources. For example, in National Grid ESO’s 2023 Future Energy Scenarios, hydrogen electrolysis capacity rises to 42 GW in the System Transformation scenario in 2040. This scenario includes production of 12 TWh of hydrogen specifically from nuclear-connected electrolysers in 2030, from a total hydrogen supply of 269 TWh.

The draft license does acknowledge the potential for multiple revenue streams, for example defining “Supplemental Revenue” as well as “Actual [electricity] market revenue”. However, the structure of the operational phase license conditions focuses primarily on the sale of electricity. For example, the “market price incentive mechanism” provides an adjustment relating to the difference between the actual electricity revenue compared with the expected electricity revenue.

A more flexible incentive would be one that compared actual and expected energy market revenue (which includes both electricity revenue and supplemental revenue) and would incentivize SZC to find any way to outperform the market reference price, but not just in ways that relate to trading electrical energy.

An alternative approach could be to continue to focus on electricity market revenues in terms of the core licence, reflecting the fact that difference payments are levied on electricity consumers (rather than consumers of hydrogen or heat), but to introduce an incentive mechanism which shares the revenue from non-electricity energy markets between SZC and electricity consumers.

The need for a pre-operational review

The points above highlight some of the significant uncertainties over the future electricity market and wider energy markets. This is crystallised in the current UK Government review of electricity market arrangements (REMA), which has the potential to significantly change the way electrical energy is traded in Great Britain. Options under consideration through REMA include a move towards locational prices, centrally dispatched wholesale markets, and loss of firm access rights for generators. This would significantly change the market structure in which SZC will operate.

Ofgem have noted the potential for major reform of the market and its impact on SZC’s licence. For example, they highlight that should the BMPR become unfit for purpose, they anticipate considering whether to amend the calculation of the BMPR, replace it with a different reference price, or replace the concept of a reference price with a different methodology.[65]

Ofgem goes on to say that the review of the reference price methodology will happen as part of the PCR. However, this is only due to take place three years after commercial operations begin. Whilst part of the period between the start of commercial operations and the PCR will be taken up with commissioning, there is significant potential for consumer value to be lost if the licence does not match the structure of the energy market during that period.

There are a range of other changes to the structure electricity and wider energy markets which could require alterations to the licence frameworks. The most obvious example is the potential, discussed above, for SZC to derive a significant fraction of its revenue from non-electricity energy markets.

In order to avoid a three year period where the licence does not fit with the prevailing energy market structure, we recommend that consideration is given to adding a “pre-operational” review, with the scope to adjust the licence to better align with the prevailing electricity market design and wider options for using SZC’s output.

We recommend:

Recommendation 4.1: The licence should be adjusted to better incentivise flexibility. It is important that this is introduced ahead of the FID to ensure that the incentive can affect the design of the project – including, for example, the addition and integration of on-site flexibility with the nuclear station itself.

Recommendation 4.2: The licence should ensure that there is a clear and fair incentive on SZC to maximise revenue in all available energy markets, including non-electricity energy markets.

Recommendation 4.3: A pre-operational licence review should be introduced ahead of the COD, with the scope to adjust the licence to reflect the prevailing energy market structures – including relevant non-electricity energy markets.

We support the significant role for Ofgem to regulate SCZ during the operational phase of the project and strongly welcome the Guidance published by Ofgem alongside this consultation.[66] A role for an independent economic regulator remains a vital safeguard to provide assurance to existing and future consumers in the utility sector across the UK. Ofgem’s expertise and statutory duties, especially their principal objective to protect the interests of current and future electricity consumers, put them in a strong position to take on this role.

We are however concerned that the role of Ofgem is circumscribed, and largely applicable only to the operational phase of the project. We would expect the independent economic regulator to play a larger role – as is the case with the RAB model used for the Thames Tideway Tunnel, which the UK Government has suggested is a relevant comparator. We think the circumscribed role for Ofgem in the initial phases of the project is not consistent with independent economic regulation of a RAB model.

The final licence modifications should include a much greater scrutiny role for Ofgem to enable them to have sufficient oversight over the whole lifecycle of the project. This would include providing some form of independent assessment of the setting of regulatory parameters and substantially greater role during the pre-PCR phase.

This enhancement of the role of Ofgem to provide sufficient scrutiny would require greater attention to the governance of, and transparency of the work of, the ITA. We recommend changes to the governance of the ITA, and mechanisms for greater transparency of decision making.

Introduction

There is and will be significant consumer and citizen interest in the development of the nuclear RAB model. The recourse to future consumers to help manage the risks of the project brings with it a greater need for transparency and visibility of decision making and the costs to consumers. This should be overseen by an independent economic regulator, and we support a significant role for Ofgem.

There are several people and entities whose role it is to represent consumer (and taxpayer) interests in the RAB process. These are:

• The Secretary of State for Energy, who is responsible for negotiating the support package which will deliver the investment needed. This includes both the RAB framework and the Government Support Package. In this role the Secretary of State will set the license conditions which form the basis of the current consultation.
• The Secretary of State for Energy will set a number of key parameters which will significantly affect the share of risk and reward between SZC and consumers. Several of these parameters are yet to be set, including the LRT, HRT, and the IWACC which sets the return on investment allowed throughout the pre-PCR phase.
• The Secretary of State for Energy is also responsible for deciding any applications for any IAR application which would enable SZC to log spending above the HRT to the RAB.
• Ofgem will be the economic regulator: working within their remit to represent the needs of consumers Ofgem will apply the license conditions, determine allowed revenues, and set the RWACC for the operational phase.
• The Independent Technical Adviser is a group of experts whose role is to provide independent scrutiny of SZC’s costs and make recommendations to Ofgem as to what costs should be logged to the RAB each year.
• The Low Carbon Contracts Company will be the Revenue Collection Counterparty; this is the organisation that holds the contract with SZC for the payment or recovery of difference payments. It will also calculate and collect levies from supply companies to fund the difference payments. It has a role in calculating difference payments based on forecasts of future electricity market prices and information provided to it by Ofgem, however its function is largely administrative.

Concerns about the circumscribed role for independent regulation

139. In the draft modifications, the setting of initial regulatory parameters is entirely for the Secretary of State. We think that Ofgem should play a key role in the decision making process on the regulatory parameters and the UK Government’s endorsement of the project, and that this should be clearly set out in the licence. We are concerned that the Guidance published by Ofgem,^[67] and its response to the UK Government’s consultation on the designation of SZC, confirm that Ofgem have “no formal role” in the assessment of value for money and no role to provide independent verification of the UK Government’s modelling. Ofgem’s response to the consultation on the designation of SZC made clear that:

“For the purposes of project designation and noting that we have no formal role in assessing whether the Sizewell C nuclear project presents value for money for consumers, Ofgem has not undertaken any assurance relating to BEIS’s modelling or analysis, nor otherwise sought to independently verify on behalf of BEIS whether project designation is likely to result in value for money for consumers.”[68]

We think Ofgem should have these roles, and that the role of Ofgem should be set out clearly in the licence modifications.

Ofgem should also have sufficient oversight of the pre-PCR of the project, in its role as an independent economic regulator. This is essential to provide assurance to consumers that the project is on track and that the regulatory thresholds are being effective during the pre-PCR to drive the right behaviours. Given the very significant risks that future consumers are being asked to take, we think it only right that consumers can look to a suitable role for independent regulatory oversight of the pre-PCR phase of the project.

We note the important role for Ofwat in the case of the Thames Tideway Tunnel. The UK Government has made clear that:

“in developing a potential nuclear RAB model, the Government has taken the model used for Thames Tideway Tunnel (TTT), as a starting point, whilst recognising that new nuclear projects are significantly greater in scale and cost, and face unique challenges, which are different from, and would not have been relevant to TTT”.[69]

Our view is that independent economic regulation of the pre-PCR is a fundamental requirement of a RAB model. We are concerned that the nuclear RAB model appears to limit the role of regulation too far in this phase, and instead relies almost wholly on the incentive mechanisms to ensure cost-effective construction.

There is not the provision in the licence modifications for a price control review before the PCR, which may well be 15 years after the project is initiated. Moreover, the Guidance published by Ofgem sets out its expectation that it will not make changes to the licence. It states that:

“Conditions we do not expect to change include the capacity targets, the Initial Weighted Average Cost of Capital (IWACC), the principles by which the nuclear licensee will be able to recover allowed revenue, the principles of the incentive mechanisms, and the protection against market movements in the cost of debt. There are also no Periodic Reviews prior to the PCR”.^[70]

In effect, the risk-sharing mechanisms are set out in the licence modifications, with very limited scope for change to allow for appropriate scrutiny. We understand that these commitments to provide clarity and to limit the extent of regulatory intervention are likely to provide assurance to investors. But we are concerned that the licence modifications, and the scope for Ofgem to scrutinise their implementation, shifts the balance too far.

As an illustrative example, in the event that the project is subject to a substantial cost overrun, the licence modifications provide a secure mechanism for SZC to add further costs to the overall RAB and recoup these costs from consumers. So, if the capital costs of the project are £10 billion over the LRT, consumers will be liable to fund £5 billion of these costs. The draft licence modification does not include any additional mechanism for scrutiny and review of these costs, or assessment of whether they reflect unavoidable circumstances or managerial effectiveness.

In the event of such cost overruns, we would expect significant consumer and parliamentary interest in understanding the causes and explanations of the outturn. It does not seem credible that future Ministers would be able to rely on the licence modifications to argue that there is no role for the UK Government or Ofgem to scrutinise such an outcome. We therefore think it is in the interest of consumers – and indeed of taxpayers and investors – to consider how the operation of the licence would work under scrutiny in the future. This suggests further clarification of the role of Ofgem and the ITA.

In the draft licence, there is a clearly stated mechanism for the calculation and verification of the “allowable costs” incurred by SZC which can added in the calculation of the RAB. This is the key parameter against which the ultimate costs to consumers will be based. This number will be calculated and monitored by Ofgem, based on estimates provided to them by SZC and the ITA. The governance of this flow of information is set out in the licence.

We think this flow of information can and should be enhanced. At present, the formulaic mechanism to calculate the RAB is based on information provided by SZC and verified by the ITA. The consultation document describes this process as follows:

“The logging regime is designed to be mechanistic and operates so that all capital spend is logged to the RAB (i.e. “allowable” capital spend) with only a limited category of specific types of cost which are excluded”.^[71]

Moreover, in their Guidance document, Ofgem indicate that:

“We expect to ordinarily accept the ITA’s recommendations during the pre-PCR phase. This includes their recommendation on the achievement of the commercial operations date as prescribed in the economic licence, and their recommendations on determining allowable and excluded expenditure during the pre-PCR phase”.^[72]

Overall, the formulaic and mechanistic approach to the calculation of the RAB leaves limited scope for regulatory scrutiny and oversight of the construction costs of the project. In the event that the RAB exceeds the LRT, we would expect some provision for review, including greater scrutiny and visibility of the performance of SZC.

Concerns about the governance of the Independent Technical Adviser

The licence modifications also establish a critical role for the ITA.

The current proposal is for the group of advisers to be appointed by SZC under the terms of its license, subject to approval by Ofgem and the Secretary of State. The group will need to work closely with SZC but will have a formal duty of care to Ofgem and the Secretary of State as well as to SZC and will also have a duty of candour to the ONR and the Environment Agency.

For the RAB framework to be implemented successfully from the perspective of consumers (and taxpayers), it is imperative that Ofgem and the Secretary of State have access to high quality technical knowledge and informed opinion on material produced by SZC. The ITA can provide that.

However, we are concerned that the ITA is constituted as a body set up by and managed by SZC. Although the license highlights that the ITA will have a “duty of care” to the Secretary of State and Ofgem (and a duty of candour to the ONR and the Environment Agency) it would appear that an advisory body directly responsible to either Ofgem or the Secretary of State would support more informed decision making by both.

Visibility and Transparency

The licence modifications make clear that there will be significant information flow between SZC, the ITA, and Ofgem. This is of course essential. We also think there is a need for the licence modifications to prescribe a greater degree of transparency than has been the case.

We note that the legislation includes provision for the Secretary of State to not disclose material, the disclosure or publication of which the Secretary of State considers:

a)would be likely to prejudice the commercial interests of any person, or

b)would be contrary to the interests of national security.

We acknowledge the need to avoid the release of sensitive information. However, given the role that future consumers are being asked to play, we think this bar should be set at a high level. We therefore think that a licence modification that places and obligation on SZC to publish an Information Schedule, which requires it to release information on the project, would avoid future controversy and public concerns over disclosure.

We also think it vital that the ITA or Ofgem are under a licence requirement to release an assessment of the final RAB during the pre-PCR phase. This will enable consumers to understand the likely outcomes ahead of time.

We recommend:

Recommendation 5.1: We strongly support a role for independent economic regulation and recommend that Ofgem’s role be enhanced. This should include playing a role in the assessment and independent verification of the decisions at the point of the FID. Importantly, it should also include provision for closer monitoring and scrutiny of the pre-PCR phase, especially in the event that the regulatory thresholds are met or are likely to be met.

Recommendation 5.2: The ITA should be appointed by and directly responsible to Ofgem rather than SZC. This would require redrafting of Special Condition 8.

Recommendation 5.3: The ITA, or Ofgem, should on an annual basis provide their assessment of the likely outturn RAB. This estimate should be made publicly available. More generally, SZC should be subject to a duty of transparency in the licence to provide information to consumers on the development and operation of the project.

[1] Consumer Scotland Act 2020

[2] Consumer Scotland (2023) Strategic Plan 2023-2027

[3] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C, p5

[4] Nuclear Energy (Financing) Act 2022

[5] Scottish Government (2023) Nuclear energy

[6] Citizens Advice Scotland (2018) Leading by Example: A principled journey through regulation

[7] UK Government (2023) Draft electricity generation licence: special conditions for nuclear generator (redacted)

[8] Nuclear Energy (Financing) Act 2022

[9] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence

[10] UK Government (2023) Draft electricity generation licence: special conditions for nuclear generator (redacted)

[11] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[12] Nuclear Energy (Financing) Act 2022

[13] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence, p10

[14] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence, p9

[15] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[16] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence, p32

[17] Ofgem (2023) Average gas and electricity usage: Information on average gas and electricity usage and how it is calculated

[18] UK Government (2023) Energy consumption in the UK 2023: Primary energy consumption data tables, table P6

[19] Ofgem (2023) Decision on revised Typical Domestic Consumption Values for gas and electricity and Economy 7 consumption split

[20] UK Government (2023) National Energy Efficiency Data-Framework (NEED): consumption data tables 2023

[21] Scottish Government (2023) Scottish House Condition Survey: 2021 Key Findings, p40

[22] ONS (2022) Energy efficiency of housing in England and Wales: 2022

[23] ONS (2022) Population estimates for the UK, England, Wales, Scotland and Northern Ireland: mid-2021

[24] ONS (2022) Health state life expectancies, UK: 2018 to 2020

[25] The Fuel Poverty (Enhanced Heating) (Scotland) Regulations 2020

[26] Ofgem (2015) Insights paper on households with electric and other non-gas heating

[27]Scottish Government (2023) Scottish House Condition Survey: 2021 Key Findings, ch3

[28]Consumer Scotland (2023) Energy Tracker: Insights from latest survey, Autumn 2023

[29] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[30] UK Government (2023) Government Response to the consultation on a RAB model for new nuclear projects, p19

[31] UK Government (2021) Regulated Asset Base model for new nuclear: impact assessment

[32] UK Government (2022) Designation of NNB Generation Company (SZC) Limited

[33] Newbury, D (2013) The cost of finance and the cost of carbon: a case study of Britain’s only PWR

[34] Helm, D (2009) Utility regulation, the RAB and the cost of capital

[35] Helm, D (2017) Cost of Energy Review, p116-118

[36] UK Government (2021) Regulated Asset Base model for new nuclear: impact assessment

[37] UK Government (2022) Sizewell C: Accounting officer assessment 2022

[38] UK Government (2023) Electricity generation costs 2023

[39] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence, p23

[40] See for example: Newbury, D “Strengths and weaknesses of the British market model” Chapter 6 in “Handbook of Electricity Markets”, 2021. http://tinyurl.com/vzx9hfb6

[41] 231106 Consultation Document.pdf page 24

[42] Ofgem (2016) Ofgem’s regulatory stances

[43] Ofgem (2019) Ofgem strategic narrative: 2019-2023

[44] Ofwat Our Principles of Economic Regulation

[45]Ofwat (2019) Time to act, together: Ofwat’s strategy

[46] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[47] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence, p23

[48] EDF (2024) Press release: Hinkley Point C Update

[49] Citizens Advice (2019) Response to BEIS consultation on whether it should move to a Regulated Asset Base (RAB) model to finance new nuclear power stations

[50] UK Government (2021) Regulated Asset Base model for new nuclear: impact assessment

[51] Citizens Advice (2019) Response to BEIS consultation on whether it should move to a Regulated Asset Base (RAB) model to finance new nuclear power stations, p4

[52] National Audit Office (2017) Hinkley Point C

[53] EDF (2024) Press release: Hinkley Point C Update

[54] Citizens Advice (2019) Response to BEIS consultation on whether it should move to a Regulated Asset Base (RAB) model to finance new nuclear power stations, p4

[55] National Audit Office (2017) Hinkley Point C

[56] Electricity Act 1989

[57] Ofgem (2023) The Enforcement Guidelines

[58] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[59] Ofgem (2023) Wholesale market indicators – Wholesale electricity generation market shares by company in 2022 (GB)

[60] Ofgem (2024) Retail market indicators – Electricity supply market shares by company: domestic (GB)

[61] BBC News EDF Energy aims to extend life of UK nuclear plants, 9 January 2024

[62] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[63] National Grid ESO (2022) Bridging the Gap: A day in the life of 2035, Second Edition, slide 25

[64] Today, almost all curtailment is due to network constraints rather than an excess of renewables across Great Britain. Network-based curtailment in 2020 was 2.3 TWh

[65] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C, p16

[66] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[67] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C

[68] UK Government (2022) Designation of NNB Generation Company (SZC) Limited: draft reasons, p3

[69] UK Government (2022) Nuclear RAB model: Statement on procedure and criteria for designation, p7

[70] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C, p11

[71] UK Government (2023) Modifications to the Sizewell C Regulated Asset Base licence, p22

[72] Ofgem (2023) Guidance on our approach to the Economic Regulation of Sizewell C, p11