Big risks and a dubious deal for taxpayers in the nuclear sell- off

INDUSTRY VIEW

As investors are deluged over the coming months with information to persuade them to buy into the pounds 2.6bn privatisation of British Energy this summer, a little historical perspective would not go amiss.

Reading the impressive financial forecasts this week by BZW, the Government's City advisers, it is hard to remember what a laughing stock the nuclear generating and construction industry has made of itself over much of the last three decades.

Look at the record of Dungeness B, one of the power stations investors are being asked to buy. Though admittedly the worst of the bunch, it has a claim to be the biggest industrial disaster in British history.

Important components of the reactor did not fit when they were brought on site, so the steel lining had to be rebuilt at huge expense. The contractor went bust, the whole sorry project took nearly 20 years to finish - six or seven years is the norm - and after the station started operating in 1983 weld problems kept output low for many years.

As recently as last year fresh problems with welds in the pipework forced a shutdown and lengthy repairs, making the company's boast a few months before that the rogue station had at last been tamed appear decidedly premature.

The other six nuclear power stations of the same gas-cooled generation have a mixed record. Astonishingly, this small batch of power stations was built to four different designs and, as a group, this has made them even more of a chronic burden on the power industry's technical resources over the years than if they had been all of a kind.

It was almost certainly the blunders of the advanced gas-cooled reactor programme, and not the environmental lobby or the scares resulting from foreign nuclear accidents, that nearly wiped out the British nuclear engineering industry. These AGR stations make up the bulk of what is being offered for sale.

History is bunk, the Department of Trade and Industry and its advisers might well say. How very unfair to raise problems that were long ago solved and rub them in the faces of the excellent engineers who are now running the plants up to record levels of output.

British Energy and its component parts, Nuclear Electric and Scottish Nuclear, have spent five hard years since the rest of the generating industry was privatised making their power stations more efficient and preparing them for sale.

Nuclear Electric has also built a pounds 2.8bn American-designed pressurised water reactor at Sizewell B in Suffolk on time and to cost. The industry is very different now.

This is certainly true. But the chequered history is worth repeating as a useful reminder that predictions by engineers about long-term nuclear performance ought to be taken with a large pinch of salt, especially when they are critical to the valuation of the company.

It so happens that one of the key assumptions in BZW's forecasts is that the performance of British Energy's power stations will continue rising - to a level that has never been seen before.

The brokers assume for their forecasts that nuclear station output as a percentage of maximum theoretical output over a year will rise from the most recent figure of 74.5 per cent to a load factor of 82.5 per cent.

The difference between an 80 per cent and an 85 per cent load factor - a mere 2.5 per cent either side of the base case - represents a pounds 700m variation in the valuation of the company. It would not take many more defective welds for the whole arithmetic to be shot to pieces.

This is, of course, a conventional enough problem, which investors face every time they put money into an engineering project. It has little to do with better-known fears about nuclear power, such as the long-term costs of decommissioning reactors over periods of up to 135 years, radiation scares or the threat of an accident.

Indeed BZW's achievement in its number-crunching is that it may have cleared away what a year or two ago appeared the biggest financial obstacle of all to a privatisation, the long-term cost of station decommissioning and waste treatment.

British Energy will have an unusual balance sheet, dominated by frighteningly huge provisions of pounds 14bn for its long-term liabilities.

For sophisticated investors the accounting magic of the discount rate has shrunk the cost of these risks - emotive political and environmental issues that they are - to quite acceptable proportions.

Even big changes in liabilities expected many years ahead - for example an unexpected doubling in British Energy's share of the cost of a new waste disposal facility - will have a relatively small present cost. The same applies to variations in decommissioning costs or the impact of tighter safety and environmental standards.

This arithmetic protects cash flow over the next decade and therefore the all-important ability to pay a high and rising stream of dividends, without which the City will not buy shares in a utility.

According to BZW, all the main financial risks for investors in fact arise from rather ordinary events. Early closure of Dungeness B because of technical or safety problems would, for example, knock pounds 500m off the pounds 2.4bn-pounds 2.8bn valuation put on the company.

The biggest threat of all, says BZW, would be from a collapse in the price at which electricity is traded in the pool. If it fell from 2.4p a kilowatt hour to 2p, pounds 750m would disappear from the valuation.

The risks are not all one way. If the electricity price rose to 2.7p there would be an pounds 850m boost to the value of British Energy, and there would be a bonus of pounds 700m if there were a five-year extension of the life of the AGRs.

Conventional though they are, the scale of the risks is likely to make British Energy hard to sell at a premium price, even assuming the Government agrees the big debt write-offs the company has demanded.

The company has yet to spell out its real objectives, other than managing the decline of an industry, now it has abandoned plans to build another nuclear station. And the lure for investors of efficiency gains is modest compared with earlier privatisations, because so much has been done to improve the company over the last five years.

In fact, if BZW's financial projections are right, they could make a good case for keeping British Energy in the public sector for the moment, rather than selling it cheaply in a hurry ahead of the election.

British Energy is expected to switch from being a high absorber of funds to generating a total of pounds 2bn of cash over the next five years - money which, if the company were kept in state hands, would count towards the public sector borrowing requirement. This makes a sale price of only pounds 2.6bn seem on the face of it a rather poor deal for the taxpayer.