New nuclear build: Would the RAB financing model benefit from more alliance contracting?

In a previous article we summarised the key characteristics of a regulated asset base (RAB) financing model and compared these to those of a contract for difference (CfD) model.

In simple terms, a RAB model operates such that a government entity, acting as an economic regulator, grants a licence to a developer to charge a regulated price to the end-user customers of the intended infrastructure being constructed, thereby passing the cost of construction directly to the end-user customers. The intended consequence of this is that the overall cost of financing the project is reduced in a meaningful way and, as a result, the RAB model has been heralded as the answer to the challenge of how to generate financial investment for new nuclear build projects.  

The risk of delay and cost overrun

However, whilst the up-front capital costs might be lower if a RAB financing model is adopted, the use of the RAB model does not avoid the risk of construction delays and cost overruns that tend to occur in relation to major infrastructure projects. In fact, some critics might argue that, in the absence of a robust mechanism to contain costs and manage project delivery risks, the lower up-front cost of capital combined with the fact that the consumer will be picking up some of the cost during the construction phase will mean that there is the potential for these risks to be exacerbated – putting it bluntly, a developer might not be incentivised as much as it would otherwise be if it were responsible for all of the up-front capital costs, and contractors might not behave in a way that will save the consumer money to the detriment of their own profit.

So how might this risk be mitigated so that the RAB model can be used in a way that genuinely delivers value for money to consumers?

Would alliancing contracting help?

Well, one answer might be the 'alliance model' of contracting. Again, putting it simply, an alliance contracting model requires all interested parties to work together as part of an alliance based on a common set of goals where the parties get paid for delivering the project on-time and on-budget and are further rewarded for not being late or over budget.

Alliance contracting models are being used more and more. Outside of the nuclear sector alliance contract models have been used on projects such as Heathrow Terminal 5 and by organisations like Network Rail, but we have also started to see the nuclear sector adopting these models as well – most notably on the Hinkley Point C project through its MEH Alliance and Commissioning Alliance and, more recently, on Sizewell C through its Civil Works Alliance.

Traditionally, commercial contracting has often been an adversarial process, despite concerted efforts in recent years to introduce provisions which encourage more collaboration between the parties. It is frequently the case that each party tries to minimise its own risk by trying to account for every possible circumstance that could arise and allocating as much risk to the other parties as they can. This usually results in lengthy and complicated contracts, and often results in a contractor taking on risks that it might not be best placed to manage. In turn, this leads to the contractor either looking to price that (in some cases unlikely) risk into its contract sum – a process which often isn't all that scientific and which arguably does not result in value for money to the developer and end-consumer, or otherwise sets the contractor up to fail by asking it to deliver under a contract which isn't commercially viable for it. And then, if and when things then go wrong, the contract is used as a tool for pointing the finger and blaming the other party. Again, a costly and timely process.

The goal of the alliance contract model is to transform contracting into a more collaborative team effort. Instead of risks being owned by one party or another, under the alliance model the risks and benefits are shared by the developer and the contractor so that each party is incentivised to identify and mitigate risks as soon as possible. The parties are collectively incentivised to find the most appropriate solution in return for a share of the 'gain' and, if the project is delayed or exceeds the budget, the 'pain' is shared by both parties.

That all sounds lovely, but…

Sceptics often look at alliancing and question how any party is able to put its own commercial interests to one side and prioritise the interests of the project and the alliance. However, the key to overcoming this is that the two need to be aligned so that the priorities and interests of the alliance are the same as the interests of each party. To be effective, the pricing structure and incentivisation mechanism must therefore be set up in a way that rewards both parties for cooperation and teamwork and, equally, doesn’t unfairly prevent a party from being rewarded when it is doing the right thing even where the overall performance of the alliance might not be as intended.  

Of course, the alliance model is not perfect, and with the benefits also come some drawbacks when compared to traditional contracting. It can only be used effectively where all the parties completely buy into the ethos of the alliance and it naturally requires considerably more up-front planning and discussion. Alliance contracts are usually more complicated to draft and negotiate than traditional contracts because the reward and incentivisation mechanism must be very carefully considered and designed from the outset. Alliance contracts also have a significantly greater administrative burden due to their open-book nature.

Does RAB Model + Alliance Contracting = New Nuclear Build Success?

There is nothing new in the alliance contracting model and, on the whole, the potential benefits of alliance contracting suggest it is worthy of consideration for use on any major infrastructure project. However, in relation to the nuclear sector in particular, and in light of the potential shortfalls of the RAB financing model from a contracting perspective, there is clear potential for the alliance contracting model to help mitigate some of the risks that come with the adoption of a RAB financial model so that the UK's ambitious nuclear new build agenda can be delivered successfully and value for money can be achieved.

You can read more about the RAB model and alliancing models of contract here.