New Dukovany: Czech ministry details why it will guarantee electricity purchase prices

At the beginning of last week, the government published a draft law on measures for the Czech Republic’s transition to low-carbon energy. After long resisting support for generation, the government is preparing to commit by law to support ČEZ through a guaranteed purchase price for electricity produced. The proposal also includes an explanatory memorandum that describes in detail (and often surprisingly, given previous statements) the government’s current position on the future of energy in the Czech Republic. 

For virtually the entire period of preparations for construction of a new unit at the Dukovany nuclear power plant, government representatives opposed guaranteed purchase prices for the future investor in the new nuclear unit. Only at the end of April, and relatively unexpectedly, the Minister of Industry and Trade announced that a new law was currently being prepared to establish a support scheme for electricity generation from the new nuclear source.

The situation has thus changed substantially for ČEZ: in addition to loan guarantees and the right to sell the project and receive compensation for construction costs (in the form of a so-called put option), it should also be assured a so-called realisation price, which it will receive for every MWh of electricity generated by the new nuclear source.

The law, and especially its explanatory memorandum, describes at considerable length the reasons why the state ultimately decided to introduce guaranteed electricity prices. The logical reason for the shift was apparently that, without guaranteed prices, the investor would probably once again abandon construction, as happened in the cancelled Temelín tender.

The government’s calculations are based on the assumption of a gradual decline in generation sources in the system. Czechia is expected to gradually shift from being a net electricity exporter to a net importer, with the main reason for the reversal in the balance being the gradual phase-out of coal-fired sources. However, despite measures planned by the European Union in the area of energy savings, the calculations envisage a gradual increase in electricity consumption from the current approximately 67 TWh to 77.5 TWh in 2040.

Why nuclear?

When selecting a source to meet increased electricity demand while replacing ageing coal-fired sources (and later Dukovany), the state considered five replacement options, using:

1. renewable energy sources,
2. natural gas-fired power plants,
3. increased electricity imports from abroad,
4. the development of storage and stronger demand-side participation, and
5. the development of nuclear power plants.

As might have been expected, the government does not consider either renewables or storage and demand-side participation to be sufficient replacements for retiring sources. Renewable sources do not have sufficiently suitable conditions here to provide the required capacity, and the Ministry of Industry and Trade (MPO) takes a similar view of energy storage, whose realistic potential in 2030 it estimates, in line with the National Action Plan for Smart Grids, at only 1000-1200 MW.

Similarly, according to the government, electricity imports from abroad do not have sufficient potential to ensure adequate and reliable capacity in the system. The calculations also indicate that sufficient cross-border transmission capacity would not be available. Nor can it be assumed that neighbouring countries will be electricity exporters, and this option was therefore logically rejected.

The government has long rejected basing Czech energy on natural gas, and the explanatory memorandum cites two main reasons why an energy system based on natural gas is not the preferred option. Above all, gas extraction in the Czech Republic is only marginal, meaning gas for electricity generation would have to be imported from abroad. This is at odds with the government’s goal of energy self-sufficiency. The government also refers to the National Security Audit, which identified a significant increase in natural gas imports, including for electricity generation, as one of the threats.

Finally, the MPO notes that, despite its lower emissions, natural gas remains an emissions-intensive fuel and is not suitable for achieving climate neutrality. Under the updated 2015 State Energy Policy, the government therefore still envisages a maximum 15% share of installed capacity in natural gas-fired power plants.

The government has therefore placed its bet on nuclear power. The MPO highlights nuclear sources primarily for their benefits in terms of energy self-sufficiency and zero emissions during electricity generation. It refers to the updated 2015 State Energy Policy and also to the National Security Audit, which warns against ending or not continuing electricity generation at Dukovany. In the section justifying the nuclear source, it is hard not to notice that it refers predominantly to documents prepared several years ago. The updated State Energy Policy in particular has been criticised for being outdated.

Government: The market is failing and does not provide incentives to build new nuclear sources

The Ministry of Industry and Trade took an unusually critical view of the situation in the electricity market. According to the ministry, the electricity market displays failures on several levels. Besides the low carbon allowance price, which the document says is currently inadequate to ensure returns on nuclear units, there is also uncertainty over market developments, which are heavily influenced by political and regulatory decisions.

Regulatory conditions and decisions may also be applied differently in individual countries, meaning that although electricity prices are linked across borders, generation may face entirely different regulatory conditions in each country. Capacity mechanisms, already introduced in a number of European states but not in the Czech Republic, are one example.

“Investors do not bear the same responsibility for security of supply as the state and therefore have no reason to develop greener technologies with lower overall costs but a long investment payback period, and thus considerably higher risk,” the explanatory memorandum to the law on measures for the transition to low-carbon energy states.

All this logically leads investors to prefer projects with shorter payback periods and the lowest possible capital costs. The government acknowledges in the document that natural gas-fired sources currently require the lowest capital investment, followed by renewables and storage. At the other end of the spectrum is nuclear power, which is the most capital-intensive, although its generation operating costs are among the lowest.

That this is an entirely uncertain project for investors is also clear, in comparison with the construction completion timetable, from the assertion that any long-term energy price forecast (several decades in the case of completing a nuclear power plant) is currently impossible given its dependence on future regulatory and political developments.

The government also gives its opponents some credit in arguing that electricity prices can realistically be estimated only up to three years ahead, partly because electricity for more distant periods is virtually not traded on exchanges. This contrasts with estimates by the government commissioner for construction of the new source, according to whom market electricity prices in 20 years should be so high that electricity from the nuclear power plant will even be cheaper.

“Analysis of the electricity market situation showed that without state support, it is not possible to guarantee sufficient incentives for construction of capital-intensive low-carbon sources such as nuclear power plants,” the explanatory memorandum to the law on measures for the transition to low-carbon energy states.

Capacity mechanisms and regulated asset base are not suitable support models

It has long been clear that the Czech government has decided to develop nuclear power. However, for years politicians refused to commit to any financial support for construction – which is also why the project stood still for so long. Until last month, it was not entirely clear what form of support, if any, would be introduced. In the accompanying documents to the law, the MPO sets out five possible support options, with guaranteed purchase prices selected as the preferred option.

Leaving aside direct investment support and tax relief, which would either not be motivating or acceptable to the state, the options worth considering are support through capacity mechanisms, a regulated asset base and purchase prices. Although capacity mechanisms are used in the United Kingdom to support nuclear power plants, they involve only shorter-term contracts (for example, one-year contracts) supporting already-built plants.

If auctions were held for capacity contracts for new sources, combined-cycle gas sources would be highly likely to win due to their low capital costs. They are also inherently more suitable for providing reserve capacity. The MPO adds that capacity mechanisms do not allow funds to be returned to the state if the market price is higher and would result in excessively high investor profits.

The regulated asset base model, already used in a certain form for gas transmission and electricity transmission, can be considered relatively promising for nuclear power plant construction. Its purpose is to guarantee stable returns to investors managing key energy infrastructure; the revenues of infrastructure operators covered by the regulated asset base are then collected through a charge in the price of electricity or gas.

The United Kingdom is, for example, considering the regulated asset base model for construction of another nuclear power plant. While it chose a Contract for Difference for construction of Hinkley Point C, it is now considering a change.

This model would have several advantages for construction, notably that the investor’s activities would be financed through charges already during construction rather than only once the plant enters operation. Construction is planned for 7 years, but given comparable European projects, delays cannot be ruled out. A number of years may therefore pass between the investment and the first revenues, and the time factor will need to be reflected in the purchase price.

The MPO ultimately rejected the regulated asset base because it eliminates risk on the investor’s side and thus transfers it to the state, or rather to end electricity consumers. As a second reason, the MPO says that ČEZ would gain a significant market position when selling electricity from the new Dukovany, and such a support scheme might therefore not be approved by the European Commission.

The document does not elaborate on the significant market position, but in the case of ČEZ’s generation portfolio it would represent only a partial increase in installed capacity, including in the context of the expected gradual reduction of ČEZ’s installed capacity in coal units and the closure of older Dukovany units. The regulated asset base is a frequently used model in energy, and could therefore be acceptable to the European Commission as part of the notification process.

Electricity purchase scheme wins – a state company will buy and sell the power

Support in the form of purchasing electricity at a so-called realisation price was therefore selected as the most suitable option. It is to be set under a contract between ČEZ and the state. The draft of this contract must be submitted to the investor no later than two years after authorisation for construction of the nuclear source is granted.

Authorisation is a type of permit under the Energy Act and is a necessary prerequisite for construction of a power plant; it should generally be obtained at the very beginning of the process leading to construction of a new plant. The Energy Act even indirectly assumes that it should be obtained before an application for a zoning decision is filed (which, under the plan, should be issued as early as during 2021, although this deadline is highly ambitious). It is therefore highly likely that negotiations on the contract and realisation price will begin in the coming years (note: the purchase contract is to be proposed within two years, but no date by which it must be concluded is specified).

The main point of the contract is to be the realisation price at which the state will purchase electricity generated by the new nuclear unit. Under the draft law, this price is to reflect economically justified costs of ensuring electricity generation from the nuclear source, including a reasonable profit and costs associated with decommissioning the nuclear unit.

“The realisation price must reflect economically justified costs of carrying out construction of the low-carbon generating plant, including the costs of equity and debt capital, costs related to operation of the facility and electricity generation, as well as the need to create a reserve for the future decommissioning of the source and a reasonable profit for the investor,” the explanatory memorandum to the law on measures for the transition to low-carbon energy states.

Although the law does not state this explicitly, the accompanying materials naturally note that the calculation of the realisation price will take inflation into account. The realisation price is handled similarly in the case of Hinkley Point C. For Hinkley Point C, it is £92.50/MWh at 2012 prices and just over £100/MWh at 2017 prices (and approximately 103 EUR/MWh at current prices).

At first glance, the proposed Czech model may appear identical to the contract for difference concluded for Hinkley Point C. From ČEZ’s perspective, the result would be similar – it would receive a guaranteed price for electricity generated – but under the Hinkley Point model, the market price is calculated from a mix of prices for individual contracts on the exchange. The plant operator therefore has an opportunity to increase its profits slightly further through a successful exchange trading strategy.

Under guaranteed prices, this is different: ČEZ will receive the guaranteed price regardless of how the electricity is sold on the exchange. The electricity is to be sold by a company 100% owned by the state. Any difference between the exchange-traded price and the guaranteed price will then be paid by end consumers through their bills, thereby also transferring to end consumers the consequences of any poor exchange trading by the state company responsible for selling the electricity.

Purchase prices show the government is serious

By guaranteeing purchase prices for electricity generation, the government has genuinely shown that it is serious about completing the project (or at least continuing preparations). Without guarantees, it is difficult to imagine that current efforts would not end as the previous Temelín nuclear power plant tender did. Indeed, the accompanying materials to the law make it entirely clear that guarantees are essential for construction.

The draft law only establishes a framework intended to lead to the conclusion of a purchase contract. Only on the basis of this contract will it be clear to what extent construction will be worthwhile for end consumers. The contract will undoubtedly be subject to lengthy negotiations, and it can already be assumed that the biggest battle will be over setting the electricity realisation price and penalties for failing to commission the new unit by the specified deadline.

However, the documents supporting the law also show that any future investment of this scale is highly risky, and the state is assuming these risks to some extent. Yet the state is relying on materials whose currency had already been questioned several years ago. A project with such a duration and such impacts would undoubtedly deserve decisions based on up-to-date documents.

However, this law remains only a proposal; if the process proceeds smoothly, it should take effect as early as 1 January 2021