ANNEX ASupplementary provisions
ANNEX A CFD RATE OF RETURN Table 3 NNBG Financial Risk Assessment — estimated probability distribution of HPC's total outturn costs […] Source: TESLA4, page 12 Figure 2 UK historic forward prices and RP UK 1- and 2-Seasons Ahead Baseload Forward Prices and Simulated Reference Price Mid price (GBP/MWh) Source: Bloomberg ELUBS1, OECM, ELUBS2, OECM; UK REQ Delivery date 1 Season ahead Simulated reference price 2 Seasons ahead Difference if sold 2S ahead (compared to ref.p.) Gain if sold 2S ahead (compared to ref.p.) Table 4 Summary of approaches taken for analysing an appropriate rate of return, by KPMG (per cent) Approach Range of returns (project IRR; post-tax nominal) Comments Relative risk analysis 8,5-11 (project basis) Comparison of offshore wind and PPP/PFI returns during construction phase and also UK regulated utilities/nuclear operators during operations phase Benchmarking Analysis 6-13 (project basis) Comparison of UK regulated utility/PPP/IWPP/comparable nuclear projects Project Hurdle Rate analysis 10,5-14,5 Based on EdF WACC estimates plus premium observed in academic studies from a range of corporates Financing analysis 9-13 — construction 6-9,5 — operational Analysis of potential financing structures both during construction and during operations Assumed debt-financed structure with UK Guarantee 10,2 — Project IRR 12,8 — Levered Equity IRR Analysis of the Project Return and the Levered Equity Return (for the proposed UK guaranteed debt levels) and at the negotiated SP. The 10,2 % is due to the tax shield effect on project level cash flows and indicative IUK Guarantee pricing. Source: Notification, Table 5, based on KPMG Table 5 Commission sensitivity analysis — Model with changed annual cash flows in the construction phase […] Shaded cells denote construction cost capex — target IRR scenarios yielding a lower SP than 92,50 GBP/MWh. Based on NNBG Financial Model version 9.8. Table 6 Project scenarios, probabilities (confidence levels that outturn factors will be more favourable than assumptions) and key project metrics […] Notes: (1) Includes construction gain share benefit of GBP 0,8/MWh (real 2012) (2) Lump sum from SZC only released post COD2 and therefore does not form part of funding requirement (3) Opex adjustment only applied for first 15 yrs and after CFD period due to potential opex reopener protection. (4) Min DSCR excluding first period (5) EIRR committed real approximated as EIRR committed nominal minus long term CPI assumption (6) Lower level of Committed equity assumed in this version of the Financial Model will mean Committed Equity IRR is optimistic v current modelled results VERY LOW Very low likelihood of more favourable outcome than assumed LOW Low likelihood of more favourable outcome than assumed MODERATE Moderate likelihood of more favourable outcome than assumed HIGH High likelihood of more favourable outcome than assumed VERY HIGH Very high likelihood of more favourable outcome than assumed Table 7 Funding profile during construction and DSCR during operations […] Table 8 Combined capex, delay and other downside scenarios […] Table 9 Summary DDM results for a selection of scenarios Run Key Assumptions Capacity Market First Nuclear Deployment Grid carbon intensity 2030 Grid carbon intensity 2040 Grid carbon intensity 2049 1a BAU No 2037 232 188 96 1d BAU, High Fuel Prices No 2031 186 101 46 1e BAU, Low Fuel Prices No 2041 269 233 121 2a BAU + Nuclear CfD No 2023 158 88 37 3a Non-nuclear Low Carbon CfDs No 2037 164 135 61 3d Non-nuclear Low Carbon CfDs, High Fuel Prices No 2031 181 123 52 3e Non-nuclear Low Carbon CfDs, Low Fuel Prices No 2041 182 120 66 3h Non-nuclear Low Carbon CfDs, more interconnection No 2037 160 133 59 4a Low Carbon CfDs No 2023 100 42 25 5a BAU Yes 2037 236 194 88 5d BAU, High Fuel Prices Yes 2032 194 111 52 5e BAU, Low Fuel Prices Yes 2041 272 235 126 7a Non-nuclear Low Carbon CfDs Yes 2046 104 49 33 7d Non-nuclear Low Carbon CfDs, High Fuel Prices Yes 2038 137 65 28 7e Non-nuclear Low Carbon CfDs, Low Fuel Prices Yes Not before 2049 113 51 44 7f Non-nuclear Low Carbon CfDs, High Nuclear Costs, Low RES and CCS costs Yes 2048 97 46 35 7g (only to 2030) Non-nuclear Low Carbon CfDs, more DSR, more EDR, more Interconnection Yes Not before 2030 104 N/A N/A 7h Non-nuclear Low Carbon CfDs, more interconnection Yes 2046 101 48 32 8a Low Carbon CfDs Yes 2023 104 50 31 8d Low Carbon CfDs, High Fuel Prices Yes 2023 99 48 30 8e Low Carbon CfDs, Low Fuel Prices Yes 2023 99 38 30 8f Low Carbon CfDs, High Nuclear costs, Low RES and CCS costs Yes 2023 102 45 28 8g (only to 2030) Low Carbon CfDs, more DSR, more EDR, more Interconnection Yes 2023 98 N/A N/A 8h Low Carbon CfDs, more Interconnection Yes 2023 100 53 32 Table 10 Benchmark infrastructure transactions Sponsor Antin Infrastructure Partners CDP Capital Brookfield Renewable Energy Partners Borealis, First State EDIF Fund Target Equity IRR 15 % 16 % 9 – 12 % 9 – 15 % Source: UK submission ‘ Answers to the Commission's questions received 16 September 2014 ’ based on Fund websites, Preqin, Press releases. Note: Fund target IRRs shown gross of fees and expenses. Exchange rates used: GBP EUR: 1: 1,26, GBP CAD: 1: 1,81. HPC post-tax nominal equity IRR used for comparison purposes. Borealis target IRR: 9 – 12 per cent, First State EDIF target IRR: 10 – 15 per cent. Table 11 Selected regulatory allowed returns calculations Electricity Transmission (Ofgem ( 1 ) ) Ofwat ( 2 ) — PR09 Ofwat — PR 14 (not finalised) ( 3 ) Note Period 2013-21 2010-15 2015-20 Real Levered cost of equity (post-tax) 7,00 per cent 7,10 per cent 5,65 per cent Cost of debt (pre-tax real) 2,92 per cent 3,60 per cent 2,75 per cent Notional gearing 60,0 per cent 57,5 per cent 62,5 per cent Vanilla WACC 4,55 per cent 5,10 per cent 3,85 per cent Inflation assumption 3,50 per cent 3,50 per cent 3,50 per cent Allowed Nominal Costs/Returns (geometric calc) Levered cost of equity 10,7 per cent 10,8 per cent 9,3 per cent Cost of debt (pre-tax) 6,5 per cent 7,2 per cent 6,3 per cent Vanilla WACC* 8,2 per cent 8,8 per cent 7,5 per cent Nominal (arithmetic calc) Levered cost of equity* 10,5 per cent 10,6 per cent 9,2 per cent Cost of debt (pre-tax)* 6,4 per cent 7,1 per cent 6,3 per cent Vanilla WACC 8,1 per cent 8,6 per cent 7,3 per cent https://www.ofgem.gov.uk/ofgem-publications/53602/4riiot1fpfinancedec12.pdf http://www.ofwat.gov.uk/pricereview/pr14/gud_tec20140127riskreward.pdf http://www.ofwat.gov.uk/pricereview/pr09phase3/det_pr09_finalfull.pdf Source: Presentation of EDF Energy to Commission officials of 15 July 2014, slide ‘ Comparison of HPC with UK regulated utilities ’. Table 12 Benchmark nuclear generation project Project Ontario Power Authority Technology Refurbishment of Bruce Power nuclear plant Gearing 20-40 per cent Real cost of debt (pre-tax) 6,20 per cent Nominal target equity IRR (post-tax) 13,7-18 per cent ( 12,8-17,1 per cent adjusted for current UK interest rate) Target project IRR 10,6-13,8 per cent ( 9,7-12,9 per cent adjusted for current UK interest rate) Investment horizon (asset life) 25 years Investment size 4bn CAD Level of Revenue certainty Fixed price CfD for remainder of plant life (25 years) Level of construction risk Lower — refurbishment, not new build, cost overrun sharing Level of operating risk Lower — staff cost overrun sharing, fuel cost pass-through Level of financing risk Lower — smaller capital project, shorter period Contingent equity required Unknown Source: UK submission ‘ Answers to the Commission's questions received 16 September 2014 ’ based on publicly available documents (Bruce Power audit report — April 2007, p. 14.: Confirmed as a project rate of return in letter from CIBC World Markets Inc. to The Ministry of Energy, Ontario, 17 October 2005, http://www.rds.ontarioenergyboard.ca/webdrawer/webdrawer.dll/webdrawer/rec/67137/view/PWU_Exhibit_K11.3_fairness_opinion_bruce_20080613.pdf.PDF, Letter from CIBC World Markets Inc. to the Ministry of Energy, Ontario, 17 October 2005, http://www.rds.ontarioenergyboard.ca/webdrawer/webdrawer.dll/webdrawer/rec/67137/view/PWU_Exhibit_K11.3_fairness_opinion_bruce_20080613.pdf.PDF Bruce Power Fairness Opinion (CIBC World Markets Inc.) — October 2005, p. 5. Table 13 Benchmark Power Purchase Agreement (PPA) projects Technology CCGT PPA projects Gearing < 80 per cent Unknown Cost of debt Unknown Unknown Nominal target return on equity (post-tax) > 13 per cent Nominal target project return (post-tax) 9-15 per cent ( *1 ) Investment horizon (asset life) 25 years Various Investment size Various Various Degree of revenue certainty 20 year PPA PPA Level of construction risk compared to HPC Lower-EPC contract-based, well-known technology Unknown but likely lower Level of operating risk compared to HPC Lower Unknown Level of financing risk Lower shorter construction period Unknown but likely lower Contingent equity required Unknown Unknown References ( 4 ) ( 5 ) Source: UK submission, Table 2 — on Rate of Return, 10th September as well as (1) and (2) below. Table 14 Regulated Settlement Benchmarks: Allowed returns on regulated assets for UK energy and water utilities in recent regulatory price controls Regulator Ofwat Ofgem CC Ofgem CC CAA ORR Determination PR14 (not final) ( 6 ) WPD 14 ( 7 ) NIE 2014 Final ( 8 ) RIIO T1 2012 (NGET) ( 9 ) Bristol W 2010 ( 10 ) HAL 2014 Final ( 11 ) NR 2013 ( 12 ) Gearing 62,50 per cent 65 per cent 45 per cent 60 per cent 60 per cent 60 per cent 62,50 per cent Real cost of debt (pre-tax) 2,8 per cent 2,6 per cent 3,1 per cent 2,9 per cent 3,9 per cent 3,2 per cent 3,0 per cent Real cost of equity (post-tax) 5,7 per cent 6,4 per cent 5,0 per cent 7,0 per cent 6,6 per cent 6,8 per cent 6,5 per cent Real vanilla WACC 3,8 per cent 3,9 per cent 4,1 per cent 4,6 per cent 5,0 per cent 4,7 per cent 4,3 per cent Inflation 3,5 per cent 3,5 per cent 3,5 per cent 3,5 per cent 3,5 per cent 3,5 per cent 3,5 per cent Nominal cost of debt (pre-tax) 6,2 per cent 6,1 per cent 6,6 per cent 6,4 per cent 7,4 per cent 6,7 per cent 6,5 per cent Nominal cost of equity (post- tax) ( 13 ) 9,2 per cent 9,9 per cent 8,5 per cent 10,5 per cent 10,1 per cent 10,3 per cent 10,0 per cent Nominal vanilla WACC 7,3 per cent 7,4 per cent 7,6 per cent 8,1 per cent 8,5 per cent 8,2 per cent 7,8 per cent Analyst return on equity forecast ( ex ante ) c 14 per cent ( 14 ) Investment horizon ( 15 ) — Price control length 5 8 3 8 5 5 5 Investment Size: Regulatory Asset Value (RAV) ( 16 ) ( 17 ) ( 18 ) 70m — 11,7bn ( 19 ) (estimated 2014 — 15) values) 5,9bn (2014) ( 20 ) c GBP 950m (forecast across price control) ( 21 ) 2,2bn — 14,8bn (forecast RAV range of companies over price control) ( 22 ) 0,39bn (2013) ( 23 ) 14,9bn ( 24 ) 45bn (2013) ( 25 ) Degree of revenue protection More than HPC — see answer to question 2c — NNBG Submission on Rate of Return, 10 September Degree of construction risk Less than HPC. See detailed discussion recitals 124 – 131 — NNBG Submission on Rate of Return, 10 September Degree of operating risk Less than HPC. See detailed discussion recitals 132 – 135 — NNBG Submission on Rate of Return, 10 September Degree of financing risk Less than HPC. See detailed discussion paragraphs 136 – 139 — NNBG Submission on Rate of Return, 10 September Other risks Less than HPC. See detailed discussion on difference in fundamental business models; diversification of assets; and technology risks in recitals 113 – 122 — NNBG Submission on Rate of Return, 10 September Contingent equity required None Source: based on UK submission ‘ SA.34974 Hinkley Point C State aid case — Answers to the Commission's questions received 16 September 2014 ’. Table 15 Cost of capital estimates for companies belonging to industry group ‘Utility (general)’ in the European Union (per cent) Company Name Country Cost of equity in USD Pre-tax cost of debt in USD After-tax cost of debt in USD Cost of capital in USD E.ON SE (DB:EOAN) Germany 8,25 4,04 3,19 5,78 RWE AG (DB:RWE) Germany 7,95 4,54 3,59 5,54 Centrica plc (LSE:CNA) UK 6,99 4,44 3,11 6,04 Veolia Environnement S.A. (ENXTPA:VIE) France 11,62 5,44 4,30 6,46 National Grid plc (LSE:NG.) UK 9,37 4,44 3,11 6,33 Suez Environnement Company SA (ENXTPA:SEV) France 9,97 4,94 3,90 6,38 A2A SpA. (BIT:A2A) Italy 13,72 7,44 5,88 8,68 Hera SpA. (BIT:HER) Italy 12,65 5,94 4,69 7,94 MVV Energie AG (XTRA:MVV1) Germany 8,31 4,04 3,19 5,70 ACEA SpA. (BIT:ACE) Italy 12,15 6,44 5,09 7,68 Iren SpA (BIT:IRE) Italy 13,85 7,94 6,27 8,80 Mainova AG (DB:MNV6) Germany 6,96 5,54 4,38 6,30 Gelsenwasser AG (DB:WWG) Germany 6,09 5,54 4,38 6,08 Telecom Plus plc (LSE:TEP) UK 6,45 4,94 3,46 6,44 Compagnie Parisienne de Chauffage Urbain (ENXTPA:CHAU) France 7,73 4,94 3,90 6,33 Zespól Elektrocieplowni Wroclawskich KOGENERACJA Spólka Akcyjna (WSE:KGN) Poland 7,44 5,39 4,26 6,94 Fintel Energia Group SpA (BIT:FTL) Italy 9,88 8,94 7,06 9,02 REN — Redes Energéticas Nacionais, SGPS, S.A. (ENXTLS:RENE) Portugal 19,97 7,64 6,04 10,05 GDF SUEZ S.A. (ENXTPA:GSZ) France 8,70 4,44 3,51 5,74 Burgenland Holding Aktiengesellschaft (WBAG:BHD) Austria 6,08 5,54 4,38 6,08 Source: http://www.stern.nyu.edu/~adamodar/pc/datasets/Eurocompfirm.xls (retrieved on 14 June 2014). (The presented WACCs are nominal (in USD terms, using USD risk free rate = 3,04 per cent) & post-tax. For the various definitions used by Damodaran, see: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/variable.htm). ( 1 ) Final Proposals for National Grid Electricity Distribution and National Grid Gas ( 2 ) Ofwat Future water and sewerage charges 2010-2015: Final determinations ( 3 ) Ofwat: Setting price controls for 2015-20 — risk and reward guidance ( 4 ) In tenders for Independent Water and Power Producer (IWPP) contracts in Abu Dhabi, which include a 20 year fixed-price water/power purchase agreement with inflation indexation, ‘ the nominal internal rate of return (IRR) on equity is required to be not less than 13 per cent ’. These projects will typically involve construction of technically — mature CCGT capacity under a lump sum, date-certain turnkey EPC contract, with provisions to compensate investors for any delays and deviations from the terms of the contract. See Independent water and power producers, Abu Dhabi Regulation & Supervision Bureau, http://rsb.gov.ae/assets/documents/231/infoiwpp.pdf. (Source: UK submission) ( 5 ) http://www.gdfsuez.com/wp-content/uploads/2012/07/GDF-SUEZ-at-a-glance-060712-final.pdf Slide 8 ( *1 ) While the UK's submission quotes 9-15 per cent post-tax nominal rates of returns from the source given in (2), the Commission notes that this seems to ignore the ‘ regulated and concession ’ projects mentioned in that source. The Commission understands from (2) that the regulated and concession activities of GDF-Suez are indicated to realise around 5-13 per cent post-tax nominal project returns, with the most likely range being below 10 per cent. ( 6 ) http://www.ofwat.gov.uk/pricereview/pr14/gud_tec20140127riskreward.pdf ( 7 ) https://www.ofgem.gov.uk/ofgem-publications/86375/fast-trackdecisionletter.pdf ( 8 ) https://assets.digital.cabinet-office.gov.uk/media/535a5768ed915d0fdb000003/NIE_Final_determination.pdf. The Commission notes that while Table 13.10 of the quoted document provides a ‘low’ and a ‘high’ estimate for the reported financial indicators, the UK's submission seems to be based on the ‘high’ estimates alone. ( 9 ) https://www.ofgem.gov.uk/publications-and-updates/riio-t1-final-proposals-national-grid-electricity-transmission-and-national-grid-gas-–-overview ( 10 ) Source was not provided in the submission. ( 11 ) http://www.caa.co.uk/docs/33/CAP%201140.pdf ( 12 ) http://orr.gov.uk/data/assets/pdf_file/0011/452/pr13-final-determination.pdf ( 13 ) Nominal values are calculated using an arithmetic approach. A geometric approach would add 0,1 per cent-0,2 per cent to nominal cost of equity and nominal vanilla WACC estimates. ( 14 ) Credit Suisse: National Grid — No longer a growth/value play, cut to Neutral, 29 May 2014; Credit Suisse: SSE — Referendum risk to be addressed, 15 August 2014; Macquarie: National Grid — Quality costs, but better opportunities elsewhere, 24 March 2014. ( 15 ) The submission interpreted the length of the investment horizon as the length of a price control period. However, the submission notes that the asset lives of the investments undertaken by regulated companies often span multiple price control periods, having ‘useful lives’ of up to 60 years. ( 16 ) The value ascribed by the regulator to the capital employed in the licensee's business. ( 17 ) Where source RAV values are stated in historical price terms, they have been converted to current prices using the ONS RPI index (unless otherwise stated). ( 18 ) We note that regulated companies' investment expenditure is in diverse, multiple projects that typically form only a small proportion of its RAV. ( 19 ) http://ofwat.gov.uk/regulating/prs_web_rcvupdates ( 20 ) http://www.westernpower.co.uk/docs/About-us/financial-information/2014/Annual-reports-and-financial-statements/Financial-performance-for-website-Mar-14.aspx ( 21 ) http://www.uregni.gov.uk/uploads/publications/RP5_Main_Paper_22-10-12_FINAL.pdf (page 100). ( 22 ) This is Ofgem's forecast for RAV at the end of the price control period. Note that at the start of the price control period SHETL is estimated to have a RAV of 0,7bn (which is forecast to increase to 3,6 bn by 2020-21): https://www.ofgem.gov.uk/ofgem-publications/53747/sptshetlfpsupport.pdf (pages 36 and 37) and https://www.ofgem.gov.uk/ofgem-publications/53602/4riiot1fpfinancedec12.pdf (pages 8 and 9). ( 23 ) http://www.bristolwater.co.uk/wp/wp-content/uploads/2013/04/Annual-Report-2013.pdf (page 27). ( 24 ) http://www.heathrowairport.com/static/HeathrowAboutUs/Downloads/PDF/Development_of_Regulatory_Asset_Base_30-Jun-2014.pdf ( 25 ) http://www.networkrail.co.uk/browse%20documents/regulatory%20documents/regulatory%20compliance%20and%20reporting/regulatory%20accounts/nril%20regulatory%20financial%20statements%20for%20the%20year%20ended%2031%20march%202013.pdf (page 331).