Can nuclear power be a safe investment?

Clifford German answers the questions potential investors need to ask about the British Energy flotation
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Q: On the reasonable assumption that the Government privatised the most profitable and easiest public sector companies to sell first, surely 15 years after the privatisation of Cable & Wireless, the final offering of British Energy has to be the absolute dregs? It produces high- cost electricity, poses a potential threat to population and the environment, and even without a disaster on the horizon the costs of decommissioning obsolete nuclear power stations will be horrendous.

A: Your assumptions are alarmist and out of date. The older and less efficient Magnox nuclear power stations and their decommissioning costs will be kept in the public sector. Only the eight most modern and efficient nuclear stations are included in British Energy. The oldest of these eight has at least a further 10 years of life before decommissioning costs are incurred, and the life expectancy of all eight could be extended by around five years to between 30 and 35 years..

Q: But are they reliable?

A: Dungeness B and Heysham 1 have both been operating below capacity because of repairs. These are now complete and the two stations have been operating back to schedule in the last two months. Hartlepool may need some welding work but it can probably be done while it it still working.

Q: But can they compete against thermal power stations, especially the new gas-fired stations using cheap fuel from the North Sea?

A: Nuclear power stations are designed to run continuously and provide the base-load for the electricity market, while gas-fired stations are much smaller and designed to operate during peak hours only. So there is room for both in the supply industry.

Q: But can nuclear be profitable, especially as the nuclear levy which conventional power producers have been obliged to pay to subsidise nuclear power is set to end next year?

A: The nuclear levy helped subsidise the old Magnox generators. British Energy's modern plants are competitive without it. The costs of running nuclear power stations are largely fixed. Once they are built the main charge is interest and depreciation on the capital. Even fuel costs are a relatively small slice. So as demand for electricity grows the operating costs of nuclear power stations could actually be cut as the stations work towards maximum efficiency.

Q: But how will British Energy cope in a free market for electricity? Isn't most of its output sold at "pool" prices which tend to be rock-bottom and are also most likely to fluctuate.

A: The output of the six nuclear power stations in England is sold into the pool, which takes all the surplus power not being sold direct to a consumer. Nuclear power is certainly vulnerable to a drop in the pool price, and that could happen if the other electricity generators, National Power and PowerGen, cut prices to maintain market share as new gas-fired capacity comes on stream. But British Energy can hedge its bets by signing direct sales contracts for future use with large industrial consumers. At worst the City thinks a drop in pool prices could slash the value of British Energy by up to a third.

Q: What about shut-downs for safety inspections?

A: All the English advanced gas-cooled reactors (AGR) except Dungeness B have been authorised to go three years between statutory shut-downs, and the Scottish stations have applied to do the same. Safety inspections are also much quicker than they used to be and could well be reduced further.

Q: What about the cost of reprocessing or disposing of spent fuel and de-commissioning the stations when they reach the end of their useful life?

A: The cost of reprocessing spent fuel is by far the biggest special cost, amounting to around a quarter of all costs. But British Energy has pegged its reprocessing costs until 2003-2005 by signing index-linked contracts with British Nuclear Fuels. Waste disposal is a smaller factor. British Energy is set to pay about pounds 300m towards the cost of a new repository operated by Nirex, which should be up and running by 2011. Waste disposal is likely to be cheaper in the long run than reprocessing.

Decommissioning costs on similar stations have tended to come in below the estimated costs. British Energy is due to set aside pounds 16m a year to cover likely costs and this is barely 3 per cent of estimated annual cash flow. These contributions will be reviewed every five years, however, and could increase if the safety regulator requires.

Q: What about fuel costs. What happens if for one reason or another Russia is no longer a net exporter?

A: Fuel costs are actually a small proportion of the total. Even if fuel costs double, total costs rise by just 7 per cent.

Q: Is there any scope for cutting operating costs?

A: The Government's advisers are assuming that pounds 40m could be saved by adminstrative efficiencies and staff cuts in the next three years.

Q: The regulators have played havoc with other utilities like British Gas. Is British Energy equally at risk?

A: In theory, no. British Energy's output in England is sold into the "pool", which is a free market in surplus power and is not subject to regulation. The industry regulator, Professor Stephen Littlechild, does reserve the right to intervene wherever he sees a need, and only this week he told Scottish Power and Scottish Hydro to cut prices and demand similar cuts in the price of power they buy from British Energy's two Scottish power stations. Scottish Nuclear provides about 55 per cent of Scotland's power needs but those contracts are firm until 2005, whatever the regulator says.

Q: What about investment spending. Is there a massive development programme to pay for?

A: No. Unlike the conventional generators there are no plans for new stations and investment costs will be less than pounds 100m a year.

Q: Is there any risk of the company embarking on a disastrous diversification programme like some other utilities?

A: It is certainly reasonable for it to diversify. Building or buying conventional power stations to balance its base load business is a distinct possibility. It could also invest abroad.

Q: Is British Energy in good financial shape?

A: Well the company has made a small pre-tax loss in recent years after juggling some substantial accounting factors, and the Government has imposed a debt burden of about pounds 700m on it. It is also expected to take a one- off asset write-down of around pounds 2bn in 1995-96. But the government's adviser, BZW, is predicting a pre-tax profit of about pounds 50m in 1996-97, with post-tax earnings building up from pounds 32m to over pounds 100m over the next three years. British Energy will also have a very strong cash flow, which would allow it to pay off its debt within two or three years.

Q: What sort of dividends can we expect?

A: British Energy has said it expects to pay dividends partly out of capital in early years, which has encouraged the City to expect dividends of around pounds 100m a year.

Q: What would that mean in terms of return on the shares?

A: That depends on the capital structure, the number of shares to be sold and the price the City tells the Government it might be willing to pay. These things will be revealed over the next few weeks. But remember Railtrack shares were sold last month yielding 7.4 per cent. That sale was successful but the Government cannot afford to price the shares too high and risk a flop. British Energy might also seem a riskier proposition than Railtrack, so the City is expecting a yield up to 8 per cent to guarantee a successful sale.

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