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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Germany And France Finally Compromise On Nuclear

  • After a long period of disagreement, France and Germany finally reached a deal on electricity markets.
  • The Germans and French seized on a solution used in the UK for a quarter century to give the appearance of a functioning market: the contract for differences.
  • In an effort to find equilibrium between the European Union's two biggest members, ministers reached a consensus that governments "have the option" to implement CfD’s for established nuclear reactors.
Nuclear power plant

If you believe that nuclear power should play a role in the energy mix, pay attention to the nuclear deal fashioned this October between Germany and France.   

Here is the background, simplified. France depends heavily on nuclear power generated by state-owned EDF. Existing French nuclear plants will require major capital improvements and the plants under construction are enormously expensive. The French government wants to subsidize its nuclear program, but other European Union (EU) countries (especially Germany) objected, because state subsidies are not in the spirit of the EU’s energy markets. The market should determine prices, and should determine the appropriate means to supply the demand, the opponents argue. (Perhaps we should note that depending on the free market to sort it all out is a principal reason why Europe’s energy sector is in such a mess. The market, which sets day ahead prices does not look too far ahead and seems not to take into account such trivial matters as national security or climate change. Sorry for the editorial.)

Well, both the Chinese and the Americans have launched huge subsidy programs designed to produce more carbon-free energy and more electrified products. Europeans woke up to the likelihood that their unsubsidized firms would have to compete with heavily subsidized Chinese and American competitors. Furthermore, European firms looking at those American subsidies started talking about moving their facilities to the US, to qualify for the subsidies. So, what do pro-market states do when faced with subsidized competition? Do they let their local firms lose out to subsidized competitors and complain of the injustice of it all or institute their own set of subsidies? Well, you guessed that answer right. They subsidize. Related: China Continues String Of Discoveries With Giant New Gas Field

But why do these Euro nuclear plants require special consideration? Three reasons. First, because most nuclear operating costs are fixed, investors won’t put money into nukes unless they can collect a steady flow of income to cover these fixed capital costs. Investors do not want to depend on the variable income that a daily power market would produce. Second, nuclear plants may provide benefits to society beyond those paid for by the market, such as improved national security or reduced carbon emissions. Somebody has to pay for those benefits. But not in a way that makes the market look bad. Third, the risks of building a big nuclear plant are too great for any private enterprise to undertake. So the government has to step up to provide funds for the project. 

The Germans and French seized on a solution used in the UK for a quarter century to give the appearance of a functioning market: the contract for differences. It works like this. The power producer sets a strike price with the buyer (who has signed a multiyear year agreement to buy the electricity). When the market price the generator can collect exceeds the strike price, the generator has to refund the surplus to the buyer. When the market price falls below the strike price, the buyer has to give the difference to the generator. Now here is the key to the deal. The strike price does not result from market forces but rather from the revenue needed to cover the cost of building or maintaining a nuclear unit, which the buyers cannot evade unless the nuke stops operating. The state, in the end, sets the price, and determines the terms of what really is a long term fixed contract made with a buyer that has no choice but to buy. In other words, this is not a commercial transaction, because in free markets, buyers have a choice: to buy or not buy.

To us, this deal, if it gets approval from the EU, signals that the EU fully acknowledges that choosing nuclear power is a political decision. And that expanding nuclear power requires government actions and explicit government financial support. That clears the air. Now let's see what the policymakers do.

By Leonard Hyman and William Tilles for Oilprice.com

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