Rationale for exploring a narrative approach

Figure 26 introduces a third class of financial stakeholder: the tendering authority or electricity off-take agreement counterparty (labelled the ‘electricity off-taker’ in the figure). Clearly one approach to ensuring that all lenders and investors are satisfied with their share of project revenue streams (i.e. their returns) is to increase the value of the overall revenue stream by increasing the per kW·h payment terms in the electricity off-take agreement.

However, there may be some reluctance on the part of the tendering authority to allow the cost of electricity from a new NPP to be out of line with, for example, current or projected wholesale electricity costs in the market. In this sense, the challenge of reaching a point of equilibrium is a matter of reconciling three classes of financing stakeholders to a set of arrangements that specify electricity price, returns to lenders and returns to investors.

Reaching the point of equilibrium is based on a combination of, inter alia, in principle expectations (in terms of maximum exposure to financial liabilities, profitability targets, etc.) and a comprehensive and detailed analysis of the specifics of an investment. A broad economic analysis is subsequently needed in order to determine the ‘field of the possible’, which can bring together the different expectations and requirements from all the stakeholders involved in the preparation and the procurement of the investment proposal. Such analysis will be refined during a succession of phases and steps, each of which will move a succession of financing proposals closer to an eventual point of convergence in an acceptable set of returns, as will be outlined in Section 5.8.2.

5.8.2. Locating financing in the overall search for acceptable risk allocation

The process of allocating risk to the financing stakeholders, and achieving agreement on the returns that those stakeholders will receive, is essentially part of a broader process of allocating risk across all project stakeholders, including commercial stakeholders (such as EPC contractors), financing stakeholders (such as ECAs) and parties involved in guaranteeing the project’s revenue stream (for example, an electricity utility or set of electricity wholesalers). This process can be viewed from the perspective of the project developer concerned as a series of steps, as shown in Fig. 27.

As mentioned previously, the overall process of risk allocation is sequential and iterative, based on the various stages identified above and the developments of the commercial and contractual negotiation between the various stakeholders. Once the various contractual arrangements have been agreed and the project risks (including the financial risk) have subsequently been allocated and adequately mitigated, an ultimate assessment of the investment case is performed by the owner of the new NPP and its equity shareholders, before a final approval is given.

As noted already, the economic analysis of an investment opportunity for a nuclear new build is based on an exhaustive due diligence process (covering legal, regulatory, technical, economic and financial matters) that includes the definition of an investment base case; the preparation of (long term) financial projections to assess its resilience; and the testing of a broad range of costs and price variation scenarios in order to stress test it. Financial modelling is a tool to assist in that part of the decision making process. In fact, it is one of the key tools to be used by the future owner of a new NPP in order to develop a bankable investment proposal for its construction and financing; for an investment proposal to be bankable, it would need to demonstrate, inter alia, that it will generate sufficient cashflows in the future, benefit from an appropriate collateral and have a high probability of success (in its implementation and operation).

Long term financial projections will be developed by the owner of the new NPP very early on, and will then be updated on a regular basis, as and when the ownership and commercially related input changes and/or the technical, economic assumptions etc. vary. A financial model needs to be designed to that effect. The purpose of the financial model is, inter alia, to illustrate how project risks and risk allocation (inputs) will flow through the NPP’s cashflows and capital structure, and to generate a series of financial metrics that will allow key stakeholders (e.g. primarily equity investors and lenders) to assess the project risk profile, and more broadly the economic sense of the overall investment opportunity, notably in terms of both: (a) bankability (e.g. minimum investor and lender thresholds); and (b) capital recovery risk (e.g. ability to service debt and pay dividends across various project structures, and each structure’s ability to withstand downside risks).

When developed on a standalone basis, the financial model is typically designed on a cost recovery principle, meaning that the new NPP’s cost structure determines the revenue requirement (or cost recovery tariff or electricity price) in each calculation period. As the majority of the costs of an NPP are capital recovery related (e.g. equity and debt), the revenue requirement (e.g. a cost recovery tariff) is calculated by the financial model at a level that must satisfy the given risk parameters of the owner of the new NPP and the finance providers (in particular, the lenders).

In Step 1, the various project risks are priced individually, based on a preliminary in principle allocation to the relevant parties.

In Step 2, the combination of the various project risks leads to a specific risk profile for the new build project, upon which a first assessment of the project’s cost of capital can be undertaken by the owner of the future NPP.

In Step 3, now that the project has been assessed, its cost of capital can be tested against any relevant benchmark(s).

A typical interval of acceptability for cost of capital would be between the minimum cost of funding required for financing a business of a similar nature, including a premium for the project (based on a conservative ownership and contractual structure) and the maximum cost of funding that could be sustained by the project’s economics and would be acceptable to the market.

Step 4 is a detailed assessment; based on the outcome of the preliminary round of assessment of the project risks and the cost of capital, the owner and other stakeholders (e.g. suppliers, contractors) enter into more detailed discussions about various key parameters of the investment, including project and financing costs. Further to such negotiation, a revised allocation of the project risks is likely to lead to the revisiting of their pricing and hence of the cost of capital.

In Step 5, the project’s cost of capital, once re-assessed, can again be tested against any relevant benchmark(s), as outlined in Step 3 above; it should be noted that the outcome of Step 5 may lead to another series of iterations between the parties, before an equilibrium may eventually be found between risk allocation and the cost of capital.

FIG. 27. Allocating risk across all project stakeholders, from the perspective of the project developer.