Nuclear power and carbon trading

A key signal of just how important carbon trading is for nuclear power was buried away in a technical annex of the July 2006 report, The Energy Challenge –Energy Review Report 2006. The annex graphically compared the cost ranges of different forms of electricity generation under various carbon price scenarios. With no carbon price included (in other words where the carbon price is EUR0 per tonne) the two cheapest forms of electricity production are the latest generation of pulverised fuel advanced supercritical (PF-ASC) coal-fired plants fitted with flue gas desulphurisation (FGD), and also combined-cycle gas turbine (CCGT) gas-fired plants, with nuclear in third place. If the carbon price rises to EUR25 per tonne (similar to trading prices today) then nuclear power becomes the cheapest form of electricity generation, followed closely by PF-ASC/FGD coal-fired plants then CCGT gas-fired plants. If the carbon price rises even higher to EUR36 per tonne, similar to its early peaks under Phase I of the ETS, then nuclear becomes even more cost-competitive compared with coal and gas. Overall, the economics of nuclear power critically depend on assumptions made about future carbon and gas prices, set against nuclear generation costs.

But not everybody agrees with the advantages of carbon trading. The importance of carbon trading for nuclear power is not lost on green groups such as the Amsterdam-based World Information Service on Energy (WISE), which has complained that “the carbon market artificially created by the ETS is a brilliantly concealed way to make taxpayers foot the bill for the revival of the nuclear industry” (Nuclear Monitor, No. 665, 28th January 2008). WISE makes a reasonable point although the criticism is slightly unfair because carbon pricing simply forces fossil fuel generators to pay for their carbon pollution, whereas they had previously avoided these costs in the past. In economic terms, carbon pollution is an externality which the ETS successfully forces energy businesses to internalise by factoring pollution costs back into the total market price of electricity generation.

There is however a major catch. Although carbon trading is regarded by many as the economic saviour of the nuclear industry, it has a serious downside for nuclear utility investors: what if the costs of decarbonising the world economy turn out to be cheap? The result would be an overall fall in the price of carbon permits, arising from excess of permit supply because fewer businesses would need them, damaging the economic case for investment in nuclear power. Nuclear power would not be needed if carbon emissions could be prevented cheaply. This is a real risk for nuclear investors because a similar market event actually happened in the 1990s with the world’s first emissions trading market, developed by the Environmental Protection Agency (EPA) to control sulphur dioxide emissions from power stations in the United States. High levels of atmospheric sulphur emissions were a problem in the US because they caused acid rain, damaging plants and trees and acidifying lakes, killing their aquatic ecosystems. After negotiations with power producers to retrofit emissions scrubbers had stalled, the EPA decided to set up a permit-based auction for the right to emit sulphur dioxide. In fact the design of the European carbon emissions trading scheme was partially modelled on the EPA sulphur emissions trading system. Power producers argued that the cost of fitting FGD would be prohibitively expensive, leading to market expectations of high permit prices. Even the EPA estimated that the cost of reducing sulphur emissions by one tonne would probably be in the range from $250 to $700 and might be as high as $1,500 per tonne. But when the EPA conducted the auction in 1993 very few polluters made high bids. Pollution abatement proved cheap to install and by 1996 sulphur permit prices had fallen to $70 per tonne. Getting rid of sulphur dioxide emissions was so cheap that few American businesses were willing to pay much for the right to keep producing it.

This American experience offers an important warning signal for nuclear investors gambling on sustained high carbon prices to make nuclear power economic. If a cost-effective transformational technology emerges in the future for limiting carbon pollution, then the economic case for nuclear investment will be seriously undermined because any resulting depression in the carbon price will automatically lead to a fall in electricity prices. Remember that the Energy Review Report 2006clearly showed that the latest designs of coal-fired and gas-fired generation are cheaper than nuclear generation as the carbon price drops towards r0 per tonne. What’s more, the capital investment in new nuclear plants will already have been paid for up front by investors, effectively locking them in for decades. Investors stand to lose serious money if the wholesale power price falls below the cost of nuclear generation as it did in Britain in 2002. The bottom line is that if a magic bullet carbon abatement technology is developed sometime in the future, crashing the carbon trading price, then new nuclear plants would most likely become unsaleable stranded assets needing a government takeover again.

It was really for these unstated reasons that the government’s May 2007 Meeting the Energy Challenge –A White Paper on Energy promised greater certainty for investors through action to underpin the price of carbon if the EU ETS failed to deliver a sufficiently high carbon price by Phase III in 2013 –the critical date when energy utility investors would need to commit their capital financing for building a new generation of nuclear reactors in Britain. With their five-year construction period, new reactors would need to start coming online from 2018 onwards to replace nuclear capacity lost from closure of Britain’s AGR nuclear power station fleet by 2023. The option of state intervention to maintain the price of carbon is highly controversial. After all, if the carbon market functions properly there would be no need to artificially prop up the trading price. The carbon price itself signals whether nuclear is really needed. A high price would signal that nuclear is necessary, while a low price would signal that it is not. At a carbon price of EUR22 per tonne (£17 per tonne) –the price as of early April 2008 –new nuclear stations ought to be the cheapest form of electricity generation, slightly better than gas and coal.

At present, the advanced technology most likely to disrupt the carbon market is carbon capture and storage (CCS). Clayton Christenson explains in his 1997 book, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail, that disruptive technologies can radically change established market structures very quickly. CCS is a disruptive technology under development by the oil and gas industries, and clean coal industries, who have the most to gain from making CCS work and the most to lose if it does not. The basic idea is that carbon emissions from heavy industry can be trapped and stored underground, most likely by dumping them in the same spent oil fields where the carbon originated. CCS applied to a modern conventional fossil fuel power plant could reduce carbon dioxide emissions to the atmosphere by approximately 90 per cent compared to a plant without CCS. But capturing and compressing carbon dioxide consumes energy increasing the fuel needs of a plant with CCS fitted. As a result CCS would increase the cost of energy produced from a new power plant fitted with CCS, and would also incur disposal charges for dumping the emissions in a suitable geological storage location.

Innovation efforts are not just limited to end of pipe carbon trapping solutions. Sir Richard Branson’s Virgin Group launched its Earth Challenge competition in February 2007, offering a $25 million prize for anyone who can come up with a system for removing greenhouse gases directly from the atmosphere.

In practice, less spectacular but gradual improvements in better energy efficiency of the Wurlitzer-to-iPod variety are likely to threaten long-term price stability in the carbon trading market. For example, in September 2007, New Labour’s Environment Secretary of State Hilary Benn announced joint plans with British retailers to phase out high energy tungsten light bulbs by 2011. Greenpeace has estimated that if every light bulb in a UK home was replaced with an energy efficient bulb, Britain could save 3.5 per cent of its total electricity demand, roughly equivalent to the output of two modern Sizewell B nuclear power stations (Energy Security in a Cold Winter, Greenpeace Brief, November 2005).

There is one remaining potential market trap for unwary nuclear energy investors: climate scientists might have got their sums wrong. Global warming has become the great environmental worry of our day. Yet in the 1960s and 1970s the environmental movement was more concerned that future generations of society would suffer a ‘nuclear winter’, similar to that thought to have killed the dinosaurs, where the prehistoric atmosphere cooled rather than warmed. Despite the present physical evidence for global warming it is possible that the scientific community might in future decide that man-made carbon dioxide emissions are not responsible for climate change. Or that the rate of global temperate increase turns out to be much slower than forecasted by present-day computer models. Climate sceptics point out that predictions of global temperature rises strongly depend on assumptions made about the sensitivity of the Earth’s positive feedback loops to carbon dioxide. The feedback loops act as gears, amplifying the climatic effect of carbon dioxide resident in the atmosphere. The gearing factor is around 60 to 80 per cent. Because the most recently observed temperature rises have actually been lower than computer predictions –2008 is expected to be cooler than previous years for example –the gearing multiplier effect from atmospheric carbon dioxide might turn out to be less than expected. The US website www.climate-skeptic.com suggests that carbon dioxide pollution is more nuisance than catastrophe. If the Earth does prove to be resilient to carbon dioxide levels, or if global warming continues but is found not to be caused by industrial carbon emissions, then the price of carbon permits would fall as investment in carbon pollution prevention would no longer be needed. There is clearly a risk to nuclear energy investors that new scientific knowledge about the origins and causes of global warming might result in a revaluation by the markets of the carbon trading price, rendering nuclear power stations uneconomic. It is precisely for this reason that some nuclear lobbyists remain privately cautious about promoting nuclear energy based solely on its low-carbon environmental credentials. Backing the climate change horse might backfire on nuclear investors unless the government guarantees a minimum price for carbon.