Executive Insight, Nuclear

Nuclear Friction: Challenging the Economic Rationale of State Support

“I doubt nuclear power will play a much larger role than it does now.”

– Al Gore

A number of states, such as Illinois and New York, have passed or are proposing legislation to support their nuclear power plants. The cost of government-engineered support ultimately is paid for by ratepayers via their utility bills, and therefore requires a proper justification for why such payments create benefits to justify above-market payments. Proponents justify their position in one of three ways: 1) economically embattled nuclear units are environmentally preferred and require a bridge of monetary support until they are competitive again; 2) keeping nuclear plants operational saves local communities and jobs; and 3) maintaining nuclear units online lowers electricity prices.  Supporting calculations upon which lawmakers depend, however, tend to be economically flawed.

Bridge Loan

While certain nuclear plants continue to be profitable, some nuclear units are facing economic challenges.  Although variable costs of production remain competitive, low capacity factors, ongoing fixed costs and mandated capital investments to ensure safety and meet decommissioning requirements can make retirement the economically rationale decision. Benefits of providing interim support, therefore, assumes that natural gas prices will increase and/or that a price for carbon or “clean energy” eventually will render the units economic again. Government support, under Ohio’s line of argument, simply provides a temporary bridge over currently low energy prices to ensure the nuclear plant is around when it can compete.  In Connecticut, which has one of the most profitable nuclear power plants in the fleet, legislation provides “price certainty” as a bridge over volatility.

The underlying premise requires scrutiny. First, although some of the older, poorly operating nuclear units may be financially stressed, there are many that have been and continue to be very profitable.  Legislated payments would go straight to equity holders, and make no contribution to the continued operation of the plant. Second, providing a financial bridge to a brighter future assumes that politicians have a better understanding of markets than the plant owners and lenders who will not support the nuclear units with additional cash investment. Lastly, in those instances where financial support is required, it is unclear why some of the most costly, inefficient units in the fleet should be subsidized at the expense of more cost-effective generators.

If the intent is to reward lower carbon emissions, then price carbon appropriately and let the market incorporate that price into production, while being agnostic as to the technology that achieves the goal.   

Saving Local Jobs

In some areas, the local nuclear power plant represents a significant portion of property tax revenues and provides jobs. Closure of those nuclear units, therefore, would financially strain the community.  Although the existence of local economic benefits is hard to deny, nuclear plant retirement could be replaced with new renewable resources and natural gas-fired units. Such build-out would create a new tax base and jobs in other communities, and possibly on the retired nuclear site. Failure to incorporate a proper representation of the alternative world into the equation results in a societally inefficient outcome that benefits a single community at the expense of multiple communities elsewhere.

The economic solution would allow the market to retire and build according to price signals. A transfer of resources to the impacted community, where the retiring nuclear plant, resides, could result in a mutually beneficial outcome where total gains to society are maximized and the allocation of benefits to individual communities cannot be improved. This pareto-optimal outcome should be the goal, not the protection of a single town.

Lower Prices

Under traditional economic theory, retirement of a large unit from the supply stack will increase prices, ceteris paribus. The world, however, does not hold everything equal.

Higher prices would encourage new entry by more cost-effective resources, causing prices to return to a long-run market equilibrium.  Artificially supporting an inefficient generating unit thwarts market pressures and can result in higher prices and a correction more painful than if the support had not been provided at all.

The Result: Unregulated Utilities

Politicians will continue to argue for their pet projects, informed by local interests and lobbyists. The economic underpinnings of any argument, however, should be carefully tested. Legislation being drafted in many states requires ratepayers to ensure greater than cost-of-service rates to competitive nuclear generators without the corresponding transparency of regulatory oversight.

Ratepayers are being asked to pay for competitively stranded assets again. And this time the money would go to unregulated generators.

About the author: Tanya Bodell is the Executive Director of Energyzt, a global collaboration of energy experts who create value for investors in energy through actionable insights. Visit www.energyzt.com. She can be reached at: [email protected] or 617-416-0651.