Nuclear plants are the electricpower industry's money machines. More may be on the way.
By Steven Brull
May 2001
Institutional Investor Magazine
Nuclear plants are the electricpower industry's money machines. More may be on the way.
On January 31, some 70 smartly dressed executives of electric utilities and representatives of nuclear power plant manufacturers, national laboratories and watchdog groups crammed into a narrow, windowless conference room at the Rockville, Maryland, headquarters of the Nuclear Regulatory Commission. It was supposed to be a briefing for a midlevel NRC bureaucrat - an event that would typically draw few onlookers - so the large turnout was unexpected. For several hours a dozen executives were sitting cross-legged on the floor, like so many middle-aged hippies.
As the crowded room grew stuffy, an executive of Exelon Corp., the nation's biggest operator of nuclear power plants, unveiled the first public details of plans for a new type of reactor that promises to be cheaper to build and safer and more economical to run than today's plants. "If our design-feasibility work is positive, we might submit a license application in 2002," says Corbin McNeill Jr., chairman and co-CEO of Exelon, which was born last year when Philadelphia-based PECO Energy Co. bought Chicago-based Unicom Corp.
A new nuke? A permit to construct a nuclear plant in the U.S. hasn't been issued since 1975. The U.S. industry was seen as all but dead after the Three Mile Island reactor near Harrisburg, Pennsylvania suffered a partial core meltdown in 1979, forcing the evacuation of 150,000 people. Then came the meltdown and explosion at Chernobyl in Ukraine in 1986. That calamity sent a miasma of radiation over the Soviet Union and parts of Eastern Europe. Thousands died.
But nuclear power is staging an unlikely comeback in the U.S. For the first time in a decade, nuclear energy has surpassed coal, natural gas and oil as the cheapest source of electricity. Sure, the spikes in oil and natural-gas prices are a big reason. But so is deregulation, which has allowed a handful of companies, Exelon and New Orleans-based Entergy Corp. among them, to profit very handsomely from buying up unwanted nuclear plants at throwaway prices, operating them with far greater efficiency than they were in the past and benefiting from the sky-high rates electric power commands these days.
Despite the general stock market meltdown, the stocks of these companies have shown impressive gains. Exelon stock surged 69 percent in the 12 months through the end of April, to $69 per share. Entergy's shares were up 63 percent, to about $41 per share.
The key to that stock performance, of course, is how little it now costs to generate nuclear energy. Nuclear power is the cost leader among nonrenewable forms of generation. "Nobody beats us except hydro," boasts McNeill, a 20-year Navy veteran who commanded nuclear attack submarines. In 1999, generating 1 kilowatt-hour of electricity from a nuclear plant cost 1.83 cents. That compared with 2.07 cents for coal, 3.18 cents for oil and 3.52 cents for gas. Hydroelectric power, at 0.67 cents, was the only major source of electricity that cost less to produce.
What McNeill does not say is that the low cost he brags about is only the direct cost of generating a kilowatt-hour of electricity from nuclear power. It does not include the heavy costs of licensing, construction, litigation and safety, which were borne by the utilities that originally built the nuclear plants in the 1970s and 1980s. Nor does the figure reflect the future expense of disposing of spent nuclear fuel. "The biggest problem with nuclear plants has been the sunk costs," says Carl Seligson, a senior adviser at New York City-based venture capital firm Prospect Street Ventures. "But if you could buy a Mercedes that cost $50,000 for $5,000 [with low mileage], you'd say you have a great automobile," he adds dryly.
It was those huge embedded costs that turned a technology that promised to be a plentiful and amazingly cheap source of electricity into an economic nightmare for U.S. utilities. Safety concerns and people's dismay over possibly having nuclear plants in their neighborhoods prompted endless, costly litigation. Even in the 1970s litigation ran the costs of nuclear plants up to $300 million to $500 million and extended the construction time to five years, on average. After the leak at Three Mile Island, increased community resistance and additional safety procedures ratcheted up costs to an average of $3 billion, and stretched construction time to 12 years. Most utilities have long since thrown in the towel on nuclear power.
But now things have changed. These are very good times for those who still operate nuclear power plants. Even the reflexive public opposition to nuclear power seems to be waning as fears grow that California's energy crisis could spread. "The pendulum is well past the extreme position of 'no nukes anytime, anymore' and swinging back in the opposite direction," says Seligson. Public opinion is key, since the industry's prospects hinge as much on politics as on economics.
The deregulation that began in the early 1990s set the stage for independent power producers to buy existing plants on the cheap and run them more efficiently. These days operators run their plants at 90 percent of capacity, compared with 65 percent in the late 1980s, according to C. Randy Hutchinson, senior vice president for nuclear business development at Entergy subsidiary Entergy Nuclear. "That increase in output is equal to adding 23 1,000-megawatt nuclear plants to the nation's power grid," he told Congress in March. But deregulation is likely to pause for a time as lawmakers evaluate the mess in California, widely seen as the result of bungled deregulation.
Still, for the first time since the Arab oil embargoes of the '70s, the political winds are blowing in favor of nuclear power. Primed by the California shortages and rising natural-gas prices, 66 percent of 1,000 Americans polled in a March 2001 survey by Bisconti Research agreed that the U.S. should definitely build more nuclear plants. The survey was sponsored by the Nuclear Energy Institute, the industry's trade association. That's up from 51 percent in January this year and 42 percent in October 1999. "We're returning to the days when people are aware of energy," says Ann Bisconti, the polling firm's president. "And as energy comes back on the public agenda, people think about where it's coming from." Says Entergy president Donald Hintz, "I think we'll see a new nuclear plant built within the next five years."
The new administration is the most pro-nuclear in years. A chorus line of President George W. Bush's cabinet members talk up nuclear power as a way to meet growing demand for electricity without emitting greenhouse gases. "If you want to do something about carbon dioxide emissions, then you ought to build nuclear power plants," Vice President Dick Cheney said on MSNBC's "Hardball" in March. Energy Secretary Spencer Abraham paints a bleak picture of polluted skies, saying the U.S. would have to build 90 new plants a year to keep up with a demand for electricity that will grow 45 percent over the next 20 years. The cleanest thermal alternative to nuclear power, a gas-fired plant, is allowed to emit as much as 249 tons of air pollutants annually.
No matter what Hintz and McNeill say publicly, new nuclear plants will not be built for a long while - if ever. Public protests over plant sites and litigation over safety will not go away easily. The construction of new nuclear plants, moreover, depends crucially on a political decision to settle the industry's thorniest problem - what to do with spent fuel that remains hazardous for more than a quarter of a million years. "There will be no money to invest in a new plant until there's a guaranteed way of disposing of the fuel," says Mark Luftig, co-portfolio manager of the Strong American Utilities Fund. "The potential liabilities could be very high."
In 2000 the U.S.'s 103 operating nuclear power plants generated 754 billion kilowatt-hours of electricity - almost 20 percent of the nation's total and second only to coal-fired plants, which produce 51.4 percent. "Nukes are money machines when they run," says J. Michael Cavanaugh, an attorney with Holland and Knight, which represented the New York Power Authority when it sold two reactors to Entergy last year. At least they are if one strips away outlays for capital, regulatory hassles, decommissioning and insurance.
The emphasis, of course, is on that caveat, "when they run." When all-in costs are considered, nuclear power's economics are terrible. Consider the Shoreham Nuclear Power Station on New York's Long Island. When Long Island Lighting Co. first announced its intention to build the plant in 1965, it projected the construction cost at $65 million. By the late 1970s inept construction and federally mandated design changes had boosted that to $1 billion. Then came the Three Mile Island disaster, which prompted more design changes and a new requirement for an evacuation plan. Despite public protests and a declaration by the Suffolk County Legislature that Long Island's population could not be safely evacuated, Lilco completed the plant in 1984 and began low-power testing. But unable to demonstrate a workable evacuation plan, Lilco abandoned the Shoreham plant in 1989. Costs had ballooned to $5.5 billion, without a single kilowatt-hour of commercial electricity having been generated. New York's then-governor Mario Cuomo brokered a deal to permit Lilco to raise its electricity rates 4 to 5 percent annually through the end of the century to recover $4.1 billion of Shoreham's cost, while Lilco shareholders swallowed the rest.
Not surprisingly, when deregulation allowed utilities to divest their nuclear plants beginning in the mid-1990s, many were eager to unload their white elephants. To clear the way, regulators let operators sell the plants for whatever they'd fetch. Tens of billions of dollars in "stranded" costs - the difference between the plants' costs of construction and their market value - will be paid off by angry rate payers over a transition period lasting several years.
Still, there were so few bidders at first that buyers could pick up plants for less than the cost of the uranium fuel the plants stored. Among the first to take advantage of the dramatically lowered financial risk was AmerGen, a joint venture between Exelon and British Energy of Scotland. It bought the Clinton station in central Illinois in December 1999 from Illinois Power Co. for just $20 million. The Clinton plant, the second most expensive built in the U.S., was completed in 1987 at a cost of more than $4 billion, ten times the original estimate and 12 years late. Shareholders absorbed the loss. Exelon also bought the sister plant to the one that partly melted down at Three Mile Island, paying GPU $100 million: $23 million for the plant and $77 million for a five-year contract for the supply of nuclear fuel.
The nuclear fire sale has since ended. That became clear last August, when Richmond, Virginia-based Dominion Resources agreed to fork over $1.28 billion in cash to Northeast Utilities for the three-unit Millstone station in Waterford, Connecticut. That price valued 1 kilowatt of installed capacity at more than $600, about the same as natural-gas generators. "When a plant is constructed and operated properly, like Millstone, there's little or no risk with operating a nuclear plant from a safety standpoint," says Thomas Farrell II, chief executive officer of Dominion Energy, which acquires or develops additional sources of power generation for its corporate parent, Dominion Resources. Farrell declines to disclose the marginal costs of Dominion's plants, saying only that they're cheaper than all forms of generation except hydro.
The higher sale prices also reflect the new lease on life that nuclear plants are winning. In March of last year, the NRC approved the first license renewal for a commercial nuclear power plant. The move extends by 20 years the original 40-year license for two reactors at the Calvert Cliffs facility, 45 miles southeast of Washington, D.C., run by Constellation Energy Group's Constellation Nuclear. Dozens more extensions are pending.
Another factor in justifying higher prices for nuclear plants is the benefit of scale. The big plant operators run their bargain plants much more efficiently. Exelon operates 17 nuclear plants, which make up about 75 percent of the company's 22,500-megawatt generating capacity. That's almost double the number of plants of the next-largest producer, Entergy, which has nine. By streamlining operating procedures and adding capacity, outages have been reduced and refueling times shortened. Capacity utilization at Exelon's plants jumped to 93.8 percent in 2000, up almost 7 percentage points from the previous year and about 30 points higher than the industry average in the late 1980s. The upshot: Exelon's nuclear generating costs are just 2.1 cents per kilowatt-hour of electricity, including the reduced depreciation of its cut-rate plants, fuel and all other costs.
Safety also appears to improve with scale. If anything, the two go hand in hand. "My gut feeling is that consolidation should lead to safety gains," says David Lochbaum, nuclear safety engineer with the Union of Concerned Scientists, an organization long wary of nuclear risks. "A company with nuclear in its future would likely turn out better performance than a public utility stuck with one plant." Indeed, a June 1998 survey by the UCS of ten plants found that the lowest-cost producer in the survey, Dominion Resources, was also the safest.
Not surprisingly, betting heavily on nuclear power and paying so little for the plants it purchased has made Exelon highly profitable. In 2000 it earned $566 million on $7.5 billion in revenue, for a return on equity of 25.2 percent.
Entergy, which bought the first dumped plant - Boston Edison Co.'s Pilgrim station - and now has nine nuclear plants totaling 28 percent of its installed (or generating) capacity, has also done well. Last year it earned $679.3 million on $10 billion in revenue.
But the days of easy acquisitions are over. A total of 14 plants have been sold since 1999, with only a handful - notably Vermont Yankee Nuclear Power Corp.'s plant in Vernon, Vermont, and North Atlantic Energy Service Corp.'s Seabrook plant in New Hampshire - still on the block. Analysts expect the roll-up to pause as companies evaluate California's botched deregulation experience and until energy and stock prices stabilize. Eventually, says Entergy's Hintz, consolidation will resume, and the number of nuclear plant operators is likely to fall from 46 today to five or six. They are likely to include Exelon, Entergy, Dominion Resources and Duke Power, a subsidiary of Charlotte, North Carolina-based Duke Energy Corp. "We've only seen the tip of the iceberg," Hintz says, of consolidation. "Generation is a commodity, and low cost is critical."
The regulators are making consolidation more attractive. "We've got a more stable regulatory environment," says Hintz. "Before, there was the sense that nuclear plants were always one inspection away from a regulatory shutdown. Yet many of the problems had little to do with safety. Now they're tougher on safety. But they're not forcing plants to spend so much time on nonsafety issues, such as administrative procedures."
Five utilities have been talking to the NRC about "prelicensing" sites for new reactors that could operate with greater efficiency and safety. Under the deregulation rules in place since 1992, public involvement in licensing new plants would take place early in the process, before construction begins. With safety and location issues addressed up front, a construction and operating permit would be issued. The goal of the utilities is to be able to build a new nuclear plant in 42 months at a cost of $1,000 per installed kilowatt or less and return the industry, at least partially, to the initial cost advantage that nuclear power plants were presumed to have over thermal plants like coal and gas.
The most vocal advocate of new licensing is Exelon, which is betting on an improved design called a pebble-bed modular reactor. Unlike a conventional reactor, a pebble-bed reactor uses uranium pebbles encased in graphite spheres about the size of tennis balls. Proponents say the reactor does not generate enough heat to melt down. It also uses helium, instead of water, as a coolant and energy-transfer medium. An earlier pebble-bed research reactor ran for 22 years in Germany, until 1987, and a small unit in China was fired up last December. Exelon has invested $7.5 million for a one-eighth share of an updated pebble-bed test reactor being built in South Africa by a British-German-South African consortium. The reactor could be completed as early as 2004.
The pebble-bed modular reactor could radically change nuclear economics. To avoid disrupting the market, modules of 125 megawatts each can be added in increments for about $150 million. By contrast, says Exelon's McNeill, new, large-scale conventional nuclear plants cost $2 billion to $4 billion and would pump out 1,600 megawatts of power when activated. What's more, each pebble-bed module can be built in 18 to 24 months.
New plants can be competitive only if natural-gas prices remain high. "If natural-gas prices fall to $3 [per 1 million BTU], then you can't build a competitive nuclear plant," says Hintz. Natural-gas prices this year have been hovering around $5 per 1 million BTU, but consensus forecasts see prices falling to less than $4 next year.
Nonetheless, Exelon is considering starting construction even before the data from the test reactor in South Africa is complete. "In the highest-risk scenario, we'll start construction early so that when the test results are done in 2005, we can get the NRC's okay and load the fuel into the reactors right away," says McNeill. "All the safety criticisms have been resolved - all except for the spent-fuel storage problem, which is on its way to resolution in the next year or two."
At least one longtime energy policy specialist is skeptical about new nuclear plants. S. David Freeman, until recently general manager of the Los Angeles Department of Water and Power, has kept the city out of California's crippling power mess thus far. He has now been appointed to head the state's task force on energy. "Investing in a new nuclear plant is a dream," Freeman scoffs. "It's consistent only with socialism - that is, with a government subsidy - not the free market. What we've found is that instead of being too cheap to meter, nuclear power isn't cheap enough to use."
Companies are unlikely to step forward until the government commits to building a permanent repository for spent fuel. Later this year or early next, the industry expects President Bush to decide to proceed with the plan to construct a repository in Yucca Mountain in Nevada. But it will be at least the end of the decade before the repository is completed. "It's a ways off before anybody will announce they're committed to building a new nuclear plant," says Prospect Street Ventures' Seligson. "Someone will have to have the guts to step up and say, 'This is what's right, let's do it.' " And to take the nuclear heat.
