Saturday, November 12, 2011

Is deregulation really the problem for new nuclear?

John Rowe, CEO of Exelon Energy (operator of one of the largest nuclear fleets in the U.S.), is not exactly shy with his thoughts on the economics of new nuclear.

In an August meeting of the American Nuclear Society Utility Working Conference, Rowe gave a hard-edged presentation titled, "My Last Nuclear Speech" in which he laid out his position that nuclear "is a business, not a religion," and predicted that lower natural gas prices would persist for the next 10-20 years, making investment in new nuclear energy uneconomic. To be clear, Rowe is not an anti-nuke (at least not by ideology); it would be an awfully hard fence to straddle were he, given that Exelon's portfolio consists of 93% nuclear.

Rowe, like Vizzini, believes new nuclear plants in merchant
utility markets are "inconceivable."
Depending on your point of view (and perhaps, your political leanings), Rowe is either a hard-nosed energy economics realist or simply a rent-seeking opportunist hoping to cash in on the rush to natural gas. (In truth, there's probably merit to both cases, given Rowe's penchant for lobbying both the government and industry for outcomes such as a carbon tax and increased natural gas consumption which would increase the value of his current fleet.)

Recently, Rowe raised new hackles in criticizing the Calvert Cliffs expansion project in Maryland, describing the move to build a third nuclear unit in a deregulated electricity market as "almost inconceivable." The basis of his incredulity? Low natural gas prices coupled with a competitive market for electricity. (Unlike states with regulated utilities, where a public utilities board sets electricity prices, prices deregulated markets are controlled by the lowest-bidding providers on the spot market.) Rowe remarked,
"At today's [natural] gas prices, a new nuclear power plant is out of the money by a factor of two," Rowe said, echoing one of the main points of his speech. "It's not 20%, it's not something where you can go sharpen the pencil and play. It's economically wrong. Gas trumps it," he said
Fellow nuclear blogger Rod Adams took this as an indication of Rowe's hypocrisy, asking why he isn't immediately "selling off its existing nuclear plants and investing the proceeds in additional gas-fired generation." But this is a facile understanding of the situation - Rowe's position is not that the existing fleet is uneconomic - quite the opposite. A nuclear plant whose capital costs are already paid for can outbid natural gas - even "cheap" natural gas - every time, namely because the fuel costs of an established nuclear plant are incredibly low. For example, the EIA predicts the operation costs of a new nuclear plant entering service in 2016 to comprise roughly 10% of total electricity cost, compared to around 70% for natural gas. (All of this is roughly consistent with current estimates for electricity costs).

So where is the problem? Capital costs - especially the cost of money (i.e., the premium paid to investors to borrow money to finance new nuclear builds). These costs, by the above estimate, make up 80% of nuclear electricity costs. In other words, most of the cost for nuclear is up-front. Hence, the paradox of nuclear: expensive to build but incredibly cheap to operate, especially once the unit is paid for. Thus the reason CEOs like Rowe are loathe to part with their existing nuclear fleet to gamble on new gas capacity - established nuclear is a sure economic winner, even in deregulated ("merchant") utility markets.

Given this, why does Rowe seem to think nuclear is so "inconceivable" in a deregulated market compared to gas? Namely because of the same reasons it's hard to build nuclear in the first place - costs are front-loaded, and in a merchant market there's no guarantee of the rate of return. (Regulated markets, on the other hand, can both generally guarantee a price for electricity as well as allow for construction work in progress [CWIP] financing, allowing the utility to collect some of the financing costs up-front, thus saving ratepayers millions of dollars in the future by lowering the total amount financed). Natural gas doesn't face this handicap, although it faces a different gamble, in that future energy prices are heavily tied to the future costs of gas. (Given the low fuel cost of nuclear, on the other hand, even a doubling in the price of uranium would only produce a small uptick in the price of power - about 7%, less than a penny per kWh).

Thus, even though once the cost of the facility is paid-off nuclear can under-bid even historically low natural gas prices, the difficulty lies in recovering the cost of the investment. As a result, some nuclear advocates (such as Adams) point to this as a fundamental flaw in energy market liberalization, pointing out that deregulated markets drive a race for short-term profits over long-term planning. (Rod even goes so far as to characterize Rowe as a ruthless energy market villain counterpart to Mister Potter from It's a Wonderful Life).

[Note: My colleague Alan reminds me that the capital cost itself is irrelevant to the bidding itself; i.e., the bid is controlled by the marginal cost of production (e.g., fuel cost). Hence, even new nuclear can under-bid low-priced natural gas in the spot market. The issue is not the capacity for new nuclear to under-bid then, per se, but rather to do so while garnering a return capable of also paying back the existing capital costs.]

But is it really deregulated energy markets that are the problem for nuclear? Rod points to √Člectricit√© de France (who owns a 49% stake in the Calvert Cliffs project) as evidence of Rowe's shortsightedness. Yet there is a fundamental difference overlooked in this analysis between the two companies - the total market equity of Exelon is $13.16 billion, while that of EDF is €36.9 billion ($50.1 billion USD). In other words, EDF is over three times the size of Exelon; while the cost of one new nuclear unit (at around $4 billion) might very well be a case of "betting the farm" for Exelon (despite being one of the larger U.S. utilities), it is a much more easily handled investment for a giant like EDF.

There is often a caveat made to investors wishing to bet against obvious irrationality in the market - "Markets can stay irrational longer than you can stay solvent." Here it would seem the same caveat applies to perhaps resolve our seeming contradiction. The problem is not necessarily that deregulated electricity markets hinder long-term planning, but that lack of sufficient capitalization (i.e., access to capital) makes it much more difficult for smaller utilities to engage in long-term economic planning than much larger firms like EDF.

Further, this again seems like a place where small modular reactors may yet tip the balance. Given that the business case for nuclear is driven by long-term stability in costs but hampered by high up-front investment costs, SMRs may well be able to provide for an opportunity for forward-looking utilities to compete even in deregulated markets. Given that the up-front investment is smaller for SMRs while the overall economics are largely unchanged, SMRs may offer the capacity for such utilities to incrementally enter merchant markets to compete with gas even at record-low prices, namely by allowing a smaller up-front investment to be recovered over the same time period.

Likewise, given the "modular" part of SMRs, utilities can more easily scale up their energy investments with nuclear, avoiding the economic catastrophe that befell many nuclear unit investors in the 1980's when energy demand unexpectedly plateaued. (Such a recent slowdown in growth of energy demand has likewise been a chief element in slower investment in new nuclear units domestically.)

Thus, a Chinese proverb seems appropriate here: "It is better to light a candle than to curse the darkness." Deregulated energy markets and historically low natural gas prices may by their nature provide a challenge to new nuclear - but certainly not an insurmountable one. The key to success for new nuclear will be in its ability to adapt, both through new technologies like SMRs which allow for more scaleable development in competitive energy markets and perhaps through innovative partnerships between utilities which allow for more efficient financing of large builds without the "bet the farm" risk presented to less capitalized firms.

Thus the new rule for new nuclear: adapt or die. The alternative is to simply curse the darkness.


  1. SMRs, hm? - in which case, you may not like Rod's arguments, but you can love what he's actually working at... B&W's mPower.

    And yes, I also think SMRs can make a big difference, provided they are not regulated to death.

    And that regulation, incidentally, is one reason I think investors don't like nuclear build very much, because it represents the incredible barriers that various branches of government can fling - unexpectedly - in front of such a project.

  2. @Joffan - that's the thing; even though I disagree with Rod's arguments on this issue, I'm still both a regular reader of his blog (which I rather enjoy) and more importantly, hugely supportive of the work he's doing with B&W / mPower, which I think has the potential to change the dynamics of the nuclear market.

    I agree regulation has been a huge issue, but I'm curious to see how the new process bears out with design standardization. It is my sincere hope that this makes the process more orderly and predictable (and less open to interruption) as builds begin to proceed.