The unorthodox model of risk pricing behind the UK EMR #6: it gets better

Earlier this week, the UK government submitted draft legislation on its Electricity Market Reform (EMR).  In a series of blog posts from last July, I critiqued the central premise underlying this insurance proposal. The touted benefits overlook the cost of risk passed along to UK taxpayers or ratepayers. They are based on a fanciful imagination of the costs of nuclear new builds, how risk factors into investment decisions, and the ease with which the relevant risks can be transferred at the stroke of a pen. Of course, so long as the government’s scheme remains an abstract plan, this critique remains a theoretical one. It will only be once an actual price insurance contract is laid on the table in order to finance an actual nuclear new build that the faults in the government’s scheme will reveal themselves in specifics. The new draft legislation includes a little more information, but not much. However, I did enjoy the footnote to a curious calculation, which reads: “The following simplifying assumptions have been made: that required debt returns are fixed as long as minimum cover ratios are met, and that equity investors’ hurdle rates do not vary with gearing/variability of prospective equity returns.” (emphasis added) That’s exactly the type of simplifying assumption one needs to make sense of the plan.

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