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Babcock International – Onwards and Upwards By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

Confirmation from Energy Secretary, Greg Clarke yesterday of a mutually agreed intention by the Nuclear Decommissioning Authority (NDA) to terminate the management contract with Cavendish Fluor Partnership in which Babcock International has a 65% stake has clearly been taken for legal reason. The existing contract, covering decommissioning management of the UK’s twelve now redundant Magnox nuclear power plants together with two research sites and ‘Calder Hall’, the UK’s first nuclear power generation development plant opened by HM The Queen in 1956 and closed in 2003, will now end five years earlier than originally planned, in April 2019.

While the announcement yesterday may have surprised in relation to timing, it is important to realise that ending this contract five years early is in no way an expression of disappointment in respect of how the contract has been managed since it was awarded in September 2014. That fact was made abundantly clear in separate comments yesterday by the Department for Business, Energy & Industrial Strategy (BEIS) and from the NDA when both confirmed that that the Cavendish Fluor Nuclear partnership has and continues to be doing an excellent job of work.

The decision to cancel the existing contract in April 2019 emanates from ongoing and detailed contract consolidation review phase work during which process it became abundantly clear that work required to be done at the 12 decommissioned Magnox sites is materially different in volume terms from that which had been specified in the NDA’s original tender. In a complex process such as nuclear decommission is, it is wrong in my view to suggest that the original contract award was bungled by the Government. There is always a learning curve and in this case it is one that in my view has been handled very sensibly by all parties concerned.

My understanding is that knowledge of the required work to be done being materially different in volume terms placed the existing contract at high risk of legal challenge and, with the NDA having already gone through a similar process last year when a High Court judge had ruled against them in respect of the Magnox contract award, it appears that the NDA appeared to have little choice but to recommended early termination to the Energy Secretary.

Confirming that early “Terminating is no reflection on Cavendish Fluor Partnership as performance on the sites under its ownership has been strong” NDA CEO David Peattie said yesterday that “Making progress on the ground and keeping the sites safe and secure will remain the collective priorities”. In thanking Cavendish Fluor for its ongoing commitment as the partnership transitions to whatever future new arrangements ensue, Peattie also said that “excellent progress has clearly been made and that collectively the team has implemented a wide range of new initiatives and strategies that are delivering and will continue to deliver significant benefits to the Magnox decommissioning programme.

An important aside here is that it has been widely recognised by the NDA that if Cavendish Fluor partnership had continued to deliver to the end of Phase 2 then in excess of £2bn of savings would have been delivered to the UK taxpayers.

Separately, Babcock International CEO Archie Bethel said yesterday that: “I am pleased that the NDA has confirmed that Cavendish Fluor Partnership performance has been strong” adding that “We have developed a good working relationship with the NDA and look forward to working with them, not only to bring the [present ongoing] contract to an orderly end in two and a half years’ time but also on future projects, including the completion of the decommissioning of the Magnox power stations.”

For Babcock International the premature ending of the existing contract in April 2019 will result in the removal of around £800 million from the current £20 billion order book. In effect what this will do is to create an annual step down in revenue of around £100 million (approximately 2% of total Babcock International revenue) from FY2020/21 and beyond. That said, with UK infrastructure investment business increasing at a pace, it seems to me to be inconceivable that the company would not have effectively managed to have replace this in the normal course of business over a similar timeframe.

In addition, the company has confirmed that approximately £1 billion of ‘potential’ will now be removed from what is an estimated £11 billion bidding pipeline. This makes good sense but even so, given the number of newly identified opportunities coming forward onto the tracking pipeline, I rather doubt that the bidding pipeline will in reality end up being that much changed a year from now. Importantly, the ongoing decommissioning work being carried out at Dounreay by the separate ‘Cavendish Dounreay Partnership’ in which Babcock International has a 50% share, is unaffected by the NDA announcement yesterday.

Importantly, investors in Babcock International should note that early termination of the Cavendish Fluor contract in April 2019 is not expected to have any negative financial impacts over the next three years and as a consequence of this, the company does not expect to change any proposed financial guidance for the year to end 31st March and that will be given ahead of the full year results due in May this year.

While any decision that relates to ending a contract prematurely is disappointing, as I alluded earlier, this one was probably not that unexpected. Indeed, the decision to terminate early and reconsider the requirement and future contract award follows a lengthy consolidation period referenced in previous NDA reports that have been ongoing since the September 2014 contract award.

My understanding is that the ‘Consolidation’ period was a key principle of the contract and that this is standard procedure in major procurements of this nature and that this allows the CFP to be able to compare costed proposals in its tender with the actual progress achieved at each site, while beginning to progressively implement proposals contained within its tender.

What is clear to all concerned now is that the ‘Consolidation’ process has highlighted that the scope of work required at the 12 sites ‘is now materially different in volume to that which was initially specified’  and that as such, this places the [existing] contract at risk of a legal challenge

Clearly, given remarks made by NDA in respect of contract performance so far, Cavendish Fluor Partnership would appear in my view to well-placed to continue supporting the NDA in future in respect of whatever revised contract model that they deem appropriate in order to deliver continued decommissioning of the Magnox plants. In the meantime ahead of termination in two year time, the Cavendish Fluor partnership can be expected to continue maintaining the high standard of delivery in the current contract phase and that will hopefully place themselves in a strong position to continue this crucially important national work.

CHW (28th March 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue

 

 

 

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