THE UK Government is set on using a Regulatory Asset Base (RAB) model to fund nuclear projects south of the Border. This will directly result in Scots paying more on their energy bills. Here, former Scottish Office chief statistician Jim Cuthbert explains what an RAB model is, and the problems behind it.

What is a RAB scheme?

RAB funding is a method of funding capital expenditure in regulated, privatised utilities. First, the regulator must approve the amount of expenditure needed. This amount is added to the total – the regulatory asset base. The regulator (here, energy watchdog Ofgem) then works out an amount which is charged to the consumer each year over the life of the relevant asset to cover the cost of the capital expenditure.

Where has RAB been used before?

The RAB approach was introduced in the UK following the great wave of Margaret Thatcher’s (pictured) privatisations. It was first used in the water industry in England.

It has subsequently been extended to cover capital expenditure in most of the UK’s regulated utilities, including the national grid, rail, and airports.

What are the problems with RAB?

In practice, regulators of RAB schemes have often been unduly generous in estimating the actual cost of debt. Equity owners have tended to game the system by working on a higher ratio of debt-to-equity than assumed by the regulator. There is a strong suspicion that capital projects are often gold-plated to inflate the RAB base.

This all has the effect of forcing consumers to foot higher bills, while equity owners pocket the resulting gain as a windfall profit. The most extreme examples of these features have probably been in the privatised water industry.

Why is RAB potentially problematic?

There are two main reasons. First, the construction phase of nuclear projects is extremely long. Further, nuclear construction is notoriously beset by technical difficulties. Midway through a nuclear construction project, it will be extremely difficult for the regulator to resist pressure for the RAB base to be inflated to overcome any technical problems or uncertainties.

Secondly, the operating life of nuclear projects is again very long, with the UK Government’s current working assumption being about 60 years. This means that any surplus which is built into the stream of future RAB payments will be available to be capitalised over this long period – which will greatly increase the potential windfall profits to be extracted by the original equity investors.

How much will nuclear RAB add to people’s bills?

Whatever estimates the government may have come up with, the actual answer is that nobody knows: because nobody knows how much the RAB base for any given nuclear project will be inflated during its lengthy and complex construction phase. The scope for such inflation will be immense, as will the incentive on the equity owners.

What could be done to improve nuclear RAB?

There could be limits on the extent to which projects can be loaded with debt, and there could be arrangements to ensure any windfall profits arising under RAB can be fairly shared with consumers. It would also be helpful if the government published the criteria for securing these aims in advance of any new contracts being signed.