Nuclear Revival, the Sequel

This time could be different, but don’t forget we’ve been here before.

Nuclear energy is enjoying a revival in the U.S., driven by the exceptional performance records of the current fleet, high margins available to nuclear baseload plants and evolving regulatory preferences for power sources with low greenhouse gas emissions.

Some nuclear plant operators have certainly demonstrated they can profitably meet rising energy needs. In September 2001, the Nuclear Energy Institute reported an industry average net capacity factor of 93.7 percent. Current operating costs are under 2 cents per kWh. A typical nuclear operator sells forward to investment-grade counterparties some 90 percent of its capacity at more than $50/MWh. Anyway you do the math, that’s a money machine. There aren’t too many other generating options looking as good as that. Not surprisingly, everybody wants to get into the pool.

It looks like there’s plenty of room in that pool, too. The U.S. Energy Information Administration projects a 40 percent growth in electricity demand over the next 20 years or so.

Unfortunately, a successful operating experience is not a predictor for a successful nuclear construction program. In U.S. experience, constructing and licensing nuclear power plants has been marked by overruns, delays and volatile goverment energy and regulatory policies.

This time, most people are saying it will be different.

This time, U.S. officials point out, an applicant doesn’t have to pursue a construction permit and then an operating license. In the old system, intervenors would get “two bites” in their efforts to use the regulatory process to make a plant too expensive to complete. Today, it’s one-stop shopping with a combined construction and operating license (COL) before construction gets a green light.

This time, early applicants also get “no fault” insurance if license reviews by Nuclear Regulatory Commission (NRC) staff trigger construction delays. And, rather than relying on subjective quality assurance criteria and evolving plant design and construction standards, plant performance standards are supposed to be frozen in the ITACC process (inspections, tests, analysis, and acceptance criteria). No longer will reviewers have a free hand to reinterpret requirements. No longer will license hearings be forums for intervenors to sail in with speculative hypotheses or imaginative claims requiring an eleventh-hour redefinition of safety requirements.

In addition, production tax credits are now available for plants that submit their COL applications by December 31, 2008. And don’t forget the loan guarantees for greenhouse gas reduction technologies. Or the fact that nuclear plants can hold out the promise of securing non-recourse project financing backed by the government in lieu of the traditional mortgage bonds.

Vendors, too, are promising this time will be different. This time, they say, it won’t take a decade or more to design and build a nuke. Buyers get a standardized design, pre-approved by the NRC, and can count on construction techniques proven offshore to deliver in a few years rather than a decade or more.

With the promise of a nuclear money machine shimmering on the horizon just a few years away, with the government promising a commitment to nuclear power through financing, tax and regulatory policies, and with vendors promising to build it better, faster and cheaper, everybody in need of baseload capacity and constrained by greenhouse gas policies wants a piece.

Déjà vu or lessons learned?

Let’s not forget, however, we’ve been here before.

For many years, regulatory standards were volatile. When confronted by industry complaints of “moving goalposts” a generation ago, the Atomic Energy Commission and the NRC promised stability in design reviews by publishing standard review plans, regulatory guides and branch technical positions. Unfortunately, the development, revision and interpretation of these standards took years to stabilize.

Volatile federal energy policies bordered on cruel and unusual punishment. After encouraging utilities to invest in nukes with limited capacity for spent nuclear fuel pools, the government subsequently killed off reprocessing initiatives. With no place to send spent nuclear fuel and limited pool capacity, operators faced the prospect of premature shutdown. The Nuclear Waste Policy Act of 1982 promised to build a repository and have it ready to take the spent nuclear fuel in 1998. Today, the government continues to collect fees and the repository’s construction remains years away.

Nor is this the first time we’ve heard about vendors offering standardized designs. Many of the same vendors offered standard designs some 40 years ago.

Unfortunately for the industry, the fire at Browns Ferry in 1975 called attention to weaknesses in electrical standards. The dynamic and static loads on essential safety structures in a design basis accident constantly changed as accident analyses became more robust. Resolutions to other generic and unresolved safety issues were backfit on plants in the midst of construction. As a result, construction periods doubled and even tripled. The costs for many plants would grow three to five times above original estimates. The Three Mile Island accident in 1979 halted progress on the few plants still under construction and triggered several rounds of costly safety backfits that continued into the mid- to late 1980s.

Some argue that Three Mile Island also killed off the nuclear construction boom. But while this was a contributing factor on the death certificate, rising interest rates and slowing electricity demand growth provided more compelling reasons for companies to abandon or cancel nuclear plant orders.

Companies and ratepayers also experienced sticker shock when the bills came due. Many utilities took significant haircuts introducing their plants into the rate base. Companies with plants under construction faced staggering risk premiums to finance their completion, bankrupting a number of smaller companies. In 1983, the Washington Public Power System (WPPS) defaulted on $2.25 billion in municipal bonds associated with its nuclear construction program. The WPPS default remains the largest municipal default in U.S. history.

For years after all of this, the financial community was more willing to invest in offshore economies with decades of default history before considering a nuclear plant in the U.S. Companies operating nuclear power plants often paid a premium for their financing. Companies without a nuclear portfolio often proudly announced their “nuclear-free” status in annual reports. After all, nuclear operators faced the risk of stranded investments, outage replacement power costs, inestimable liabilities storing spent nuclear fuel awaiting a federal repository, and the threat of premature shutdown from state or federal decisions.

New age promises

Throughout all the challenges, the nuclear plant operators soldiered on and got better at running plants. At the same time, NRC shifted focus from continuous improvement of plant designs to continuous improvement of plant operations. Today, nuclear plants are expected to run well above 90 percent, compared to the average operating rates of 50 percent to 60 percent in the 1970s.

The pressurized water and boiling water reactor designs of the 1960s are now a mature technology mastered by a mature nuclear operating industry and are less subject to “moving goalposts” for safety and operating standards. Along the way, the nuclear fleet consolidated through company mergers, acquisitions and industry exits. Today, there are 25 nuclear operators, when a decade ago there were 45.

The vendors also enjoy the benefits of a maturing technology. Advanced nuclear designs incorporate design features that improve upon the original “standard designs.” Most of these improvements target safety issues identified in NRC design reviews, generic safety issues and risk assessments of decades ago. For example, the pressurized water reactor was long known to be susceptible to the risk of a reactor accident and a sustained loss of all station electric power (a “station blackout”) that could in turn disable active safety systems and prevent the removal of decay heat. This accident sequence was declared an unresolved safety issue by the NRC in the mid-1970s and was the subject of a rulemaking in the mid-1980s. Westinghouse’s AP1000 employs passive safety systems and is not as susceptible to the station blackout accident. The AP1000 also promises to be cheaper to build.

The AP1000 received an NRC final design approval in 2004 and final certification in 2006. GE’s ESBWR is a competing passive reactor that promises to reduce capital costs by some 20 percent. Other advanced reactor designs are offered by UniStar (a joint venture between Areva and Constellation) and Mitsubishi.

Reasons for caution

Still, history tells us that preconstruction certification does not preclude problems. Just as the FAA often encounters technical issues after an aircraft is certified and flown for some time, it’s clear NRC will encounter similar issues with certified reactor designs. What’s unclear is the nature of problems that will arise. Time and experience will tell.

As for the need for nuclear power, the past teaches that future demand growth doesn’t always happen. Moody’s, for example, sees some parallels between the WPPS default and today: rising construction costs and the potential for demand reduction. The rating agency advises caution in nuclear plant planning and analysis.

Vendors would like to believe the vendors can duplicate the Japanese construction experience here at home. Certainly time-to-market delivery mitigates that risk.

But energy policies in countries where offshore construction experience has been a success are often premised on world views that aren’t always shared in the U.S. Not everyone wants a nuke (or a wind turbine for that matter) down the road. And “down the road” can mean 30 miles or more away.

As matters currently stand, operators like keeping their options open about adding to their nuclear fleets. The COL provides a licensee the option to build a nuclear plant. Exercising that option is another matter. The application will cost some $40-$80 million, which can be viewed as an option premium.

Presently, it’s not obvious the option is in the money. To actually build a plant will cost more than $5 billion. Investments of this scale are in the “bet the farm” category and exceed the market capitalization of most companies. WPPS bet the farm at a time when nuclear seemed like a “sure thing.”

The Nuclear Energy Institute observes that the energy loan guarantee program is “a critical factor in corporate decisions to proceed with new nuclear projects, and in facilitating construction financing and access to capital.” Such guarantees permit project-based financing, offer greater leveraging in capital structures, and promise potentially lower electricity costs.

In this light, it’s interesting that Entergy Corporation recently announced its intent to spin off its merchant nuclear fleet. The unregulated business runs six nuclear facilities in the Northeast and Midwest (three in New York state where there’s constant political pressure to shut plants down). Entergy’s merchant fleet generates a lot of cash and has little debt. In a “man-bites-dog” story, we’ve finally reached a point where analysts see Entergy’s commercial reactors as both a hedge for their regulated business (specifically, sovereign and risk) and a significant and reliable cash generator. Who knew?

Freed from the parent, Entergy’s nuclear business would be in a better position to take on debt than if it stayed married to Entergy’s regulated business.

And so we live in an era where nukes are money machines and natural hedges, but the risk of building one is difficult to quantify. We are fortunate to live in interesting times.


Stephen Maloney is a consultant with Towers Perrin. Maloney has more than 30 years of experience in energy asset valuation, trading risk management, and nuclear reactor economics, risk assessment and safety in North America and Europe. He has advised executive committees and due diligence teams concerning investment, mergers, acquisitions, and divestitures in the energy, chemical, financial services, and telecommunications industries.

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