13 January 2017

The delayed government review into tidal lagoons was published by former Coalition Energy Minister Charles Hendry yesterday. Graham Atkins says it hasn’t presented a convincing case for investment yet.

Tidal lagoons have become more prominent since Tidal Lagoon Power received planning permission for a Swansea Bay site in 2015, and a media campaign focused on the wider economic benefits of the lagoon including job-creation in manufacturing and potential sports and tourism opportunities. Initially predicted to cost £0.9bn, the Swansea Bay project’s capital costs are now estimated at £1.3bn.

But on the basis of this week’s review, the Government hasn’t presented a wholly convincing case for investment in tidal lagoons.

Wider economic benefits have often been cited by political proponents as reasons for advancing with the scheme. Wider benefits to the community are of course important, but they should not be used to mask the real issue at stake: whether or not the proposal represents good value for consumers.

The claim that Swansea Bay will cost ‘30p per household for the next 30 years […] less than a pint of milk’ at best overly-simplifies, and at worst obfuscates, comparisons between different options. The Government’s own analysis of cost per household – tucked away in the final appendix of the report – suggests that similar-scale nuclear and offshore wind projects would cost less on this 30-year-per-household basis.

Four reasons why we don’t know if tidal lagoons are cost-effective

It is difficult to establish whether tidal lagoons are good value both in terms of the ‘strike price’– the government-guaranteed price the taxpayer agrees to buy the electricity – and cost per MwH compared to other low-carbon energy options. Here are four reasons why:

1. Given that energy prices are subject to volatility, the tidal lagoon poses significantly more risk to the taxpayer than Hinkley Point C. This risk is not factored into the comparisons. The most optimistic strike price of £89.60 in the Government review – which is lower than the £92.50 strike price for Hinkley – must be considered in the context of the varying contract lengths. For Hinkley, the strike price is guaranteed over a 35-year contract. The most recent proposal for Swansea Bay was 90 years.

2. The review’s comparison of lifetime costs with other low-carbon options forecasts that lagoons will be less expensive than offshore wind and nuclear over their total project lifetime. However, this depends on highly optimistic cost reductions in proposed future lagoons at Bridgwater and Cardiff Bay. Again, this posies an additional risk to the taxpayer.

3. The review also argues that tidal lagoons provide greater energy security because, unlike solar and wind, tides are reliable and constant. A similar claim about consistent power generation was made for Hinkley, although one particular issue in the Government’s Hinkley value-for-money (VFM) case was the refusal to provide a monetary estimate for the impact of reliable power generation, despite the availability of tools which can do this. Like Hinkley, the review did not attempt to do this, for reasons which are unclear.

4. The review dedicates two chapters to the wider economic benefits in creating a supply chain and export opportunities. These opportunities have been subject to extensive media attention but there are numerous alternative investments which the Government might use to spur job-creation in coastal regions. Although not explicitly within the report remit, any claims about wider benefits require comparison to the wider benefits of other low-carbon projects to demonstrate they are an effective use of Government funds – which the review did not cover.

We’ve previously argued that transparent decision making is important to judge whether governments’ decision making is sound. The three-page Hinkley VFM assessment did not meet the transparency standards one would expect for a major investment decision. But the tidal review stacks up well. It publishes major modelling assumptions, allowing the public to scrutinise the assumptions and analysis, though it is questionable that the review relied on data provided by the project’s developer.

Like solar, wind and nuclear, tidal lagoons provide a source of energy that would help the UK lower its carbon outputs and meet its emission targets. So, it’s right for the Government to consider it as wide a range of options as possible to meet the ‘energy trilemma’ of security, decarbonisation, and affordability. But we need a more detailed assessment focused explicitly on the consumer costs of tidal energy, and comparing the wider benefits of different projects on a fair basis, before we proceed with tidal lagoons.

Comments

I have not yet read the full report but I hope the French experience with the Barrage de la Rance has been looked at. This has now been in operation for many years. Many snags and problems were encountered initially. Their website says they are running at 500GW at 20 centimes per KWH.

The pint of milk thing is especially annoying. It's unclear what the 30p actually refers to, but is probably meant to be the subsidy cost above market rate -i.e. what Swansea adds to bills. It amounts to £8.1m per year for 27.1 million households. Given the annual output is 570GWh per year, that's an extra cost of £14/MWh (not much).

Is that really the subsidy level required? It seems very low for a project of this size. It relies on three gigantic assumptions not surfaced in Hendry's soundbite and barely transparent in the his report: (1) the cost of capital; (2) the time allowed for financing the project; (3) baseline unsubsidised costs - and the milk equivalent is highly sensitive to these.

1. Cost of capital
A recent study* put the typical UK weighted average cost of capital (for onshore wind) at 6.5% (with lowest in Europe being Germany at 3.5%). The Swansea tidal lagoon electricity output is 570 GWh/year and the CapEx £1.3 billion. Using a rough cash flow estimate, just financing the CapEx alone over 30 years at this typical 6.5% rate would need a strike price of £175/MWh with operation and maintenance on top. If cost of capital was 3.5%, the strike price = £124/MWh and if 10% the strike price = £242/MWh for CapEx only. This shows how sensitive the power price is to cost of capital, and that under any plausible assumptions it is far higher than other renewable or nuclear projects.

2. Financing period
The precise wording of Hendry's 30p claim is slippery in the BBC link... "If you look at the cost spread out over the entire lifetime - 120 years for the project - it comes out at about 30p per household for the next 30 years. That's less than a pint of milk". So this suggests recovering the whole cost over 120 years at market rates with an added boost over the first thirty years. The trouble is that it is very rare for any project to be financed in total over more than 30 years. In reality, they will need to build and pay for the project in 30 years and that will need to be reflected in any CFD.

3. Baseline price
The milk money amounts to £8.1m/year or £14/MWh for the project output. This is modest in relation to the annualised capital costs at any plausible cost of capital above. Given the current day ahead wholesale price is in the range £40-60/MWh and even the nuclear CFD is £92.5/MWh it is hard to see how the extra £14/MWh would be sufficient to brige the gap to the strike prices require to fund the capital cost. Even allowing the 120 year financing, and the £14/MWh subsidy for 30 years, it would still require a £136/MWh underlying average price for 120 years just to finance the capital.

The framing around the cost of a pint of milk is absurd and patronising. It is almost certainly a huge underestimate - but whatever it is, it is contingent on some major assumptions to which it is highly sensitive and without which it is meaningless. These basic VfM calculations, not jobs, export potential etc, should be at the core of any policy-making on tidal lagoons. Until the basic VfM pitch is clear there should be no further movement on it.

* http://www.ecofys.com/en/press/mapping-the-cost-of-capital-for-renewable...

Graham says that "Wider benefits to the community are of course important, but they should not be used to mask the real issue at stake: whether or not the proposal represents good value for consumers". But is the real issue simply that of VFM? Surely there is increasing attention to the wider benefits (and dis-benefits, such as environmental impact) in investment decisions such as this one.

The idea of looking more broadly than the economic case when public sector organisations are procuring goods and services was captured in the Public Services (Social Value) Act of 2012. This requires public authorities ‘to have regard to economic, social and environmental well-being in connection with public services contracts’. The legislation does not define ‘well-being’ but official guidance encourages commissioners of public service contracts to meet the wider social, economic and environmental needs of the community, as well as the best price. Does this re-frame the debate?