Role of the state in implementation of strategic investment projects: The SaHo Model for nuclear power

No single, consistent, and commonly accepted definition of energy security has been developed in the literature so far [Nyga-Łukaszewska, 2019]. Pursuant to the Polish Energy Law Act, energy security means meeting the current and future demand and needs of customers for fuels and energy in a technically and economically justified manner, while maintaining environmental protection requirements. It means the present and future guarantee of the security of raw material supplies on the one hand and the processes of production, transmission, and distribution of energy on the other. This view on the three dimensions of energy security (technical, economic, and environmental) is widespread in the literature [Szablewski and Martin 2011].

Energy security is recognized as one of the public goods that should be delivered by the state [Stiglitz, 2004]. There is a debate whether electricity itself can be considered a public good [Billewicz, 2016]. Undoubtedly, it is one of the scarce resources, with the price always above zero. Electricity is characterized by low price elasticity of demand. The EC emphasized that electricity is an essential basic commodity. Universal access to energy should be at the heart of Europe's energy policy and should be enshrined in the European Treaty. A Member State may establish certain public service obligations to supply electricity in order to eradicate energy poverty [European Economic and Social Committee, 2014].

Electricity itself should be clearly distinguished from the guarantee of its supply, which is the energy security discussed in the article. While electricity may be treated as a commodity, the guarantee of its supply at acceptable prices should be considered as public good and provided by the state to each recipient. In August 2015, because of heat and drought, there was a power deficit in the Polish power system, and “brownouts” were implemented. Economic entities willing to pay the market price for electricity

Setting the market price for electricity is a complex topic; it is not covered in this article; more on this can be found in Wojtkowska-Łodej [Michalski, Hawranek, 2014].

This situation is an example of the strong connection between energy security and the tragedy of the commons when resources (capacity in energy sector) are insufficient to meet all the needs. There are many possible solutions (e.g., rationing), but the only effective way (in the long run) is ensuring the proper conditions for investors to build new generating units, and even incurring a part of the capital expenditure by the state. The task of the state, however, is not the production and sale of electricity itself.

Investments in energy infrastructure are characterized by long periods of implementation (especially in the case of nuclear projects) and high construction and operating costs. However, these high expenditures are essential to meet current and future demands for electricity, resulting from its projected growth, as well as the need to replace operating units for zero- and low-emission ones. Nuclear power plants (NPPs) can produce huge amounts of energy, affecting the environment in the smallest possible way [NEEDS…, 2009]. Thus, nuclear power could be a good response to this growing demand projected and highlighted in the document “Energy Policy of Poland until 2040 (EPP2040)” [Monitor Polski, 2021, p. 264].

In Poland, no nuclear unit has been operated so far. In the social memory remains the case of the unfinished construction of the NPP “Żarnowiec”, started in 1984 [Jezierski, 2006] and stopped in 1990. Financial losses were evaluated as (at least) USD 2 billion [Melańczuk, 2019]. NPPs operate in 13 EU Member States and in other European countries, including Switzerland, Russia, Ukraine, and Belarus. Poland is a “desert island” on the nuclear map of Europe, importing cheap electricity from nuclear units operating in neighboring countries. It seems that a need to build the first NPP in Poland is justified due to not only energy security and economic, but also image-related, reasons.

Another dimension of energy security is continuity of electricity supply. In Poland, this is endangered due to aging power plants operating in the base load (mainly coal power plants [CPPs]). For the 2030s, numerous shutdowns of these plants are planned. NPPs work best as baseload units; therefore, replacement of CPPs with NPPs seems to be necessary and natural. This will help to both keep deliveries uninterrupted and avoid brownouts. Import of electricity cannot prevent emergencies because no one foreign system operator is able to guarantee future intervention delivery. Additionally, import of electricity does not lower the prices of electricity on the domestic market but leads to reduction in the production delivered by domestic producers. In effect, they lose a fraction of revenues in favor of the electricity importers [Mielczarski, 2020]. Lower revenues and lower profits mean smaller possibilities to finance subsequent projects in the energy sector. Hence, there is a need to create additional mechanisms encouraging entities to undertake new investments (e.g., capacity market) [Mielczarski, 2020]. Import of electricity may only increase energy security in some circumstances, and such a slight “technical” import is allowed in EPP2040. However, the basic assumption is that the Polish economy is self-sufficient. So, energy security requires, first of all, the creation of internal abilities to generate electricity.

Energy security is also a derivative of diversification of fuels and directions of deliveries. In the case of nuclear energy, these conditions can be reached easily. Uranium mines and plants manufacturing nuclear fuel are located in many countries on different continents [Uranium…, 2018…]. There is also the possibility of using unconventional uranium resources in Poland. Delivery of fuel assemblies does not require special infrastructure (which is necessary in the case of natural gas and coal), and nuclear fuel may be stored in large quantities for a long time. The prices for uranium on world markets are relatively stable, as is the share of the cost of the fuel in the total cost of electricity production [Appendix no. 5 in the PNPP]. All the circumstances assure the stability of costs of production and prices for consumers. Therefore, it is a key factor for enterprises (especially energy-intensive ones) and the whole economy. Moreover, nuclear energy is resistant to weather conditions, and this is particularly important in the context of development plans for solar and wind energy. It should be underlined that the possibilities for generating renewable energy are inadequate in relation to the forecasted demand for energy in Poland.

Thus, nuclear energy has many advantages in terms of energy security. Therefore, the share of nuclear energy in the energy mix is projected in the PNPP to reach 23% in 2045. The document also assumes NPPs operating at base load of the energy system in Poland.

Since the 1980s, infrastructure investments have been realized in the form of Project Finance. A new entity is established and appointed for the implementation of an investment project, with a separate mode of financing. Most of the equity is provided by the project manager or sponsor. The project company operates with high debt-to-equity ratio (60%). Many investment projects in the energy sector in the USA have been financed this way. In the UK, in the 1990s, the Private Finance Initiative was selected by the government to involve the private sector in the financing and management of infrastructural investments. Financing collected in the private sector reduced the need for public funding and transferred some risk to private entities [Brealey et al., 1999]. In the UK also, the Regulatory Asset Base (RAB) model is applied to finance infrastructural investments. It is based on the prices regulated by the government [RAB Model for Nuclear Projects, 2019]. The government can privatize a public utility that generates and distributes electricity, rather than grant a concession to a private company to generate power sold to the public utility. The project company can retain ownership of the project's assets based on an arrangement and agreement known as “build–own–operate” (BOO). Otherwise, ownership of the project's assets is transferred to the government at the end of the concession period. This is called “build–operate–transfer” project agreement (BOT). For example, ownership of privately financed toll roads and bridges is often transferred to the government [Brealey et al., 1999].

It is extremely important to address (in executive contracts) the different types of investment risks to the entities, which can best evaluate it, control it, and deal with it. Each business entity is exposed to basic types of risk, such as market, credit, operational, and legal risks [Kendall, 2000]. For the company operating in the energy industry, this list grows significantly. There are 24 types of risks mentioned in the literature, including those as specific as weather risk, capacity risk, and risk of terrorist attack [Michalski, 2012; Michalski et al., 2015]. Thought-out distribution of risk between the parties involved (investor, general contractor, and business partners) can reduce both the risk and the related costs. The success of the initial stages of the project will also reduce the risk and lower the cost of financing in subsequent phases. One technology vendor selected for several power units may additionally increase the credibility of the project, obtain economies of scale, especially in terms of construction and operating costs, and – as a result – reduce the financing costs as well. The participation of the State Treasury (ST) as the majority owner serves the same purpose.

An NPP does not emit greenhouse gases (GHGs); therefore, it does not need CO₂ emission allowances (EU Allowances [EUA]). The price of the allowances on the primary market of the European Energy Exchange has changed almost sevenfold during the past 5 years: from 6.94 EUR/EUA on the last auction in April 2016 to 48 EUR/EUA on the last auction in April 2021 [Handel emisjami CO₂… ]. The EC forecasts the price to be between 50 and 100 EUR/EUA in 2050. Accordingly, the expected strengthening of the upward trend in the coming years means a huge increase in production costs and electricity prices for customers in Poland because our energy sector is mainly based on coal and gas. NPPs are not only insensitive to changes in the EUA prices and in the context of EU climate and energy policy, they, in fact, enable achievement of climate neutrality.

Appendix no. 5 to the PNPP presents the analyses performed using the Total Cost Methodology (TCM). The main overarching objective of the study is to minimize the total cost incurred by the economy and society for power generation, considering the indirect operating costs of the power sector, the energy mix, and energy security. The indirect operating costs of the system consist of side effects (emission of pollutants and system imbalancing) and external costs, which include system costs (power reserve, networks, and balancing), environmental costs (health and ecosystem), and macroeconomic costs (security, import–export balance, and employment). Therefore, TCM differs significantly from the investor's point of view. It allows the capture of the viewpoint of the state and the economy. The analyses indicate that nuclear energy is the cheapest source of energy when the full cost calculation (including investor, system, and environmental costs) is considered. Among the variants of the future energy mix examined, the scenarios involving nuclear power are characterized by the lowest energy generation costs. Nuclear energy has the greatest potential to reduce CO₂ emissions in the power generation sector. The lack of nuclear power in the energy mix means the highest external costs and their tendency to grow.

Nuclear power is characterized by the lowest average total cost among all energy sources if the weighted average cost of capital (WACC) is <6%. However, as the WACC increases, the average total cost increases the fastest. This shows how important it is to lower the WACC in nuclear projects and to prepare a precise financial and business model. A similar dependence occurs if the sensitivity of the total cost to the length of the investment period is examined: it grows the most for NPPs. The sensitivity of the total cost to changes in the amount of investment expenditures is also the highest.

NPPs have many features discouraging managers from investing. They are characterized by relatively high investment costs (Figure 1), high fixed operations and maintenance (O&M) costs, high investment risk (long construction period, complicated administrative procedures and licensing, risk of construction delays, and cost overruns), and long return on investment [Projected Costs…, 2020].

Figure 1

High investment risk is rooted also in social and political aversion to nuclear energy, caused by excessive phobia to the radiation and exaggeration of the effects of past accidents and incidents. Low public acceptance has forced decision makers and regulatory authorities to impose very restrictive safety standards on the nuclear industry. These standards increase the following:

predevelopment costs of the project, including site selection costs (Figure 2)

Figure 2

Financial institutions perceive NPPs as risky investments. In addition, these projects need a long time to get returns on the invested capital (typically 20–35 years). Together with a lack of long-term and credible national energy policy, it creates too much uncertainty for potential investors. This uncertainty manifests in high expected risk premium, which means high costs of capital: debt as well as equity.

Due to the high construction costs, moderate O&M costs, and long payback period, nuclear power investment projects need a stable and reliable stream of revenues. Today's electricity markets are based on marginal cost price signals and do not generate incentives for new investments, especially for units with high fixed costs. Renewable energy sources (RES) are exempted from these rules – they benefit from dedicated direct or indirect subsidies, or other forms of economic privileges against non-RES. Increasing the inflows of subsidized renewable electricity distorts market signals and even leads to negative electricity prices. Long-term price predictions are very uncertain. In these circumstances, any nonsubsidized project based on revenue from the electricity market is completely unprofitable.

There are many different methods used by governments to generate incentives for the construction of new power units or to keep running the existing ones on the electricity market. The most common are as follows:

Feed-in tarrifs (FiT)

All these methods can be divided into four types. The first six belong to Type 1, which basically ensures stable revenues guaranteed and regulated by the state. The next two methods form Type 2. Here, the electricity producer receives a fixed amount of extra revenues in addition to normal sales revenues (and capacity remuneration in CMs) or a tax exemption that effectively equals additional revenue (e.g., in PTC). Total revenues are as volatile as wholesale electricity prices but always sufficient to cover the fixed costs of the plants. Type 3 consists of the subsequent three methods. This is similar to Type 2, but the extra revenues are variable – either based on a dedicated market (e.g., green certificates, CES) or on periodic decisions made by the energy market regulator (e.g., ZEC). The last type is made of parafiscal taxes imposed on electricity generators who use highly GHG-emitting power units. It is intended to deteriorate the profitability of those units and to force the operators to close the plants. The tax rate is determined either by the government or by the dedicated market (e.g., EU ETS) with possible regulatory interventions (EC).

There are some business models operating outside of the electricity markets and enabling the sale of the electricity produced, as follows:

Exeltium

The Exeltium model is used in the Flamanville-3 nuclear project in France. It works as follows: a group of large electricity consumers sets up a company trading in a wholesale electricity market, which buys large volumes of electricity for their owners from Electricité de France's (EDF) existing nuclear plants with upfront payments [Sawicki and Horbaczewska, 2018]. This model has only been used in this project so far.

The three other models are based on autoproduction. They are used for nuclear power only in Finland and the USA. In Finland, they are known as Mankala [Sawicki and Horbaczewska, 2019a, b]. However, from the legal point of view, they are not cooperatives but joint stock or limited liability companies, unlike in the USA, where they are essentially cooperatives [Sawicki, 2021]. The electricity generated in the co-op's power plants is directly sold to its owners, not to the market. In principle, the price equals the production costs, so these plants do not make profit. This is similar to the industrial power (autoproducer) model used in Poland, but here, the power plant is owned by one or more companies and the energy is consumed on site, with no long-distance transmission like in Mankala or in American co-ops. The energy clusters are made up of autoproducers and consumers of electricity located in a limited area. They have to self-balance, i.e., produce the same amount of energy as they consume. This is not the case in Mankala and in US cooperatives, which can consume more than produce and vice versa.

The models described above are used also to finance new nuclear investment projects. Of course, for every single project, local conditions have to be taken into account. For example, in the case of EU Member States, compliance with state aid rules and EC acceptance are necessary. So, from the European nuclear investor perspective, all these business models have advantages and disadvantages, as presented in Table 1.

Most of these models have been designed for specific local projects; hence, they may be difficult or even impossible to apply in other countries, or they may generate too much financial burden to the electricity consumers and taxpayers. A good example is the British version of CfD designed for Hinkley Point C NPP. The so-called strike price negotiated by the investor and the government is widely criticized as being too high [Hinkley Point…, 2017]. The revealed structure of costs (per megawatt hour) indicates that the nuclear risk premium stands at almost one-third of the strike price (GBP 36.0 out of GBP 92.5/MWh), while the nominal after-tax WACC is 9.2% [Nuclear Sector Deal…, 2020]. The CfD model allowed the cutting of capital costs only slightly [Discount rates…, 2011], and they still remain too high.

A significant drawback of the models mentioned above is the necessity to obtain acceptance from the EC for every nuclear project (state aid investigation). This generates additional risk for the project development phase and delays its implementation. From the end-user perspective, none of these models is able to noticeably decrease the cost of electricity, either because of high capital costs and/or because of additional costs to the process of electricity generation (e.g., generator's profit margin).

The name of the model is derived from the Authors’ surnames. Designing the model, the Authors analyzed a various business solutions used so far in nuclear projects across the world and applied their own expertise in the energy industry (including the nuclear sector), economy and finance, as well as knowledge of the legal and regulatory issues of Poland and the EU. As a result of their efforts, a comprehensive, consistent, and – at the same time – simple concept was created. The SaHo Model makes use of the elements of proven models, and it is possible to implement it in a short time because it is compatible with Polish and EU laws, regulations, and energy strategies, both existing and expected. The Authors focus on the Polish power sector, but the SaHo Model can be easily applied to finance nuclear investment projects in other EU countries as well as in the USA and Canada. The SaHo Model not only enables the building of an NPP efficiently and cheaply but also allows both enhancement of the competitiveness of the national industry and increase in public acceptance for nuclear power. Thus, it is not only a business model but also a concept for the functioning of the nuclear industry. It can be considered a breakthrough concept, changing the way of thinking about nuclear power and bringing it closer to citizens.

As mentioned before, the construction of an NPP requires high expenditure spread over a long investment period. For a private investor, it means a significant investment risk and high capital costs, usually putting into question the profitability of the project. At the same time, it is commonly known that the lowest-cost capital is usually available to the state (government). It is also the state that can best manage risks arising in the first stage of the investment (e.g., political risk, legal risk, and regulatory risk). State involvement reduces such risk and encourages private financial institutions to provide financing at the lowest possible interest rate. This lowers the WACC, which is a key parameter in the NPV method.

Therefore, the first step is to establish a Special Purpose Vehicle (SPV) or to take over an existing one (e.g., PGE EJ 1 in Poland). Its statutory objective is to build, own, and operate an NPP and sell the electricity produced to its owners.

And other products such as heat, hydrogen, and industrial radioisotopes, if available.

Then, in the period between the establishment of the project company and connection to the grid, the initial investor gradually sells its shares to electricity consumers – let us call them final investors (Figure 3). The sale of shares may be organized in the form of tenders, auctions, or bilaterally negotiated contracts. Finally, at the time of grid connection (i.e., the end of construction and start of operation), the initial investor should possess no shares. Here, the SaHo Model starts to function in a similar way as the Polish industrial power (autoproducer), the American public power and co-ops, the Finnish Mankala, or even a German renewable co-op model. Electricity is produced only to satisfy the needs of the owners (shareholders). The offtake is the right and the duty of the shareholders. The offtake is proportional to their share in the ownership and based on the cost-price formula since a profit is not an objective of the company. The statutory goal of the company is to produce and sell energy to its shareholders at the lowest possible price covering the total production costs.

Figure 3

The shareholders may be electricity consumers of various types:

Manufacturing industry (various sectors)

The shares can be bought by the final investor from the initial investor at any time between SPV establishment and connection to the grid (see Figure 4). The later a final investor buys them, the higher is the price because the investment risk and the time needed to complete the project are reduced. On the other hand, the certainty of project completion is increasing. No wonder that the share price will increase along with the implementation of subsequent stages of the investment. But the price still should be attractive to potential investors. The reasons for this approach and assumptions are the following: 1)

Project development is effective owing to a reliable state initial investor.

Figure 4

Acquiring an electricity offtake at production cost in the completed NPP will undoubtedly be a good investment opportunity for electricity consumers, even if they use the NPV method for economic evaluation of the investments.

A significant advantage of the SaHo Model is the strong commitment of the state in the initial stages of the investment project. The state is able to collect the necessary financing at a low interest rate as well as manage the most challenging kinds of risk specific to the initial phases of the project. The distinguishing feature is gradual reduction of state involvement at subsequent stages of the investment.

Another advantage is the compliance with Polish and EU laws and policies, both current and expected ones. It has many features of the European industrial power model and energy cooperatives, which are very perspective in the context of EU energy and climate policy.

According to the Polish Commercial Companies Law, a company is obliged to realize its objective determined by the shareholders. In the case of an NPP company operating within the framework of the SaHo Model (the SaHo-NPP), the objective is not making profit but the production of energy (primarily electricity) and its delivery

Not including transmission and distribution.

The cost of electricity production in the SaHo-NPP would be approximatley USD 20/MWh (total operation cost or operating expense [OPEX]).

The Authors assumed OPEX for Generation III NPPs with 1,100 MWe capacity in USA, according to data from the NEA-OECD [Projected Costs of Generating Electricity, 2020]. For depreciated Generation II NPPs in Europe, these costs are mostly at EUR 12–30 per MWh.

In the Authors’ opinion, assuming the political determination for nuclear power development and an active state participation in the early stages, the SaHo Model has no defects. It meets all the criteria of a perfect (nuclear) business model, listed above in this article:

Ad. 1. The SaHo Model is based on Polish and EU laws, regulations, and long-term strategies.

Here comes the question of whether the electricity consumers, primarily industrial companies, will be interested in buying shares of the SaHo-NPP? But do they have a cheaper option of electricity supply? In the case of companies operating in the EU economic environment, there are no viable alternatives. The cheapest one could be probably a mix of own RES and capacity market based on gas units. But the total cost of this solution is way above the total cost of electricity possible to be obtained from the SaHo-NPP for the reasons mentioned in this chapter. Certainly, before the implementation of this model, the government should carry out consultations with end-user organizations (e.g., national industrial associations) to make sure that the benefits of the SaHo Model are well understood and there is a real interest among them to buy SaHo-NPP shares.

Therefore, the SaHo Model is beneficial to all stakeholders of the nuclear power program: the government, capital providers, electricity consumers, and the society in general. Among the benefits for the government are the following: successful implementation of a nuclear power program, building a decarbonized baseload capacity to the power system, providing the national economy with cheap and stable electricity (increasing energy security), GDP increase, and reduction of inflation and unemployment, thus, resulting in an increase of social wealth. This facilitates the dynamic development of the national economy and an increase of its competitiveness on international markets. Electricity consumers have 24/7 weather-independent access to cheap electricity. Low electricity costs for industrial plants lead to (at least partially) low manufacturing costs.