Are investors wary of new nuclear builds? 

Bank report says prospects are going south, but consultant says the real game is managing risk

A new report by Citigroup on the prospects for equity investors in the nuclear energy industry casts doubt on prospects for profits.  While the report is focused on Europe, its authors claim their findings have equal weight in the U.S.  Citing it in the July 2010 issue of the EEnergy Informer, published by Fereidoon P. Sioshansi, Ph.D., a utility consultant, he writes Citigroup's report "New Nuclear – the Economics and Politics" says that for every step forward there is another that takes a step back. 

Separately, a group of analysts at consulting firm Arthur D. Little say the financing isn't so much the problem as managing the risk with the key emphasis on "management." In a June 2010 report titled "Nuclear New Build Unveiled," the firm reports realistic schedules, and managers who understand the complexities of building new nuclear reactors, are the essential elements of managing risk. The report's authors say that failure mode will follow not paying attention to these issues.

Citigroup's dour doubts

Citigroup's analysis argues that rising costs for new nuclear reactors in Europe, coming in at €3,000/kW ($3,754 (05 Jul 10) pegs a new 1,600 MW Areva EPR at over $6 billion. The report assumes these costs relate to a reactor for which construction breaks ground in 2013 and enters revenue service six years later.  Without a carbon tax or other government regulatory constraints, utilities will thumb their noses at the global warming crisis and build coal or natural gas fired power plants which will take far less money and time to build and turn a profit.  [See comparative chart on carbon pricing cross-posted at the Energy Policy blog.]

Another startling finding by Citigroup is that a carbon tax would have to be pegged at €80 per metric ton. The current European Union price is woefully short at €15/tonne. The bank adds that the lack of a credible, regulated international market for carbon trading "dents prospects for a nuclear revival."

Sioshansi says the high cost of nuclear reactors will make them easier to build if financed by state owned corporations.  He notes that authoritarian countries, like China, are the most aggressive builders of new nuclear plants because a single state-owned enterprise does all the heavy lifting.

By comparison, in the U.S. the private sector "is expected to assume the risks investing significant sums to build new reactors."  He looks at the market capitalization of the major utilities, and notes that just a few of them are up to it.  Only a few of them, he writes, are capable of putting $10-14 billion in play for a single power station.

In an aside, Sioshansi observes that oil giants like Exxon and Chevron have market capitalization in the range of $150-300 billion and could easily take on the financing of new nuclear reactors.  Unfortunately, most of their product – crude oil – winds up as refined distillates in the highly profitable transportation sector as fuel for cars, trucks, trains, ships, and airplanes.

Except for a brief foray into the nuclear reactor field in the 1970s, oil companies have stayed away from nuclear utilities.  Instead, they have promoted the development of new natural gas plants with their significantly faster time to market.

Management makes the difference

Utilities can overcome financing obstacles, and manage the risk of building a $10-14 billion nuclear power station, if they will be realistic about the challenges they face and the measures they take to deal with technological risk.  Arthur D. Little (ADL) developed a comprehensive database of factors affecting new nuclear builds globally including technology, licensing, financing, and procurement. Additionally, the firm's analysts interviewed executives at nuclear utilities to understand what keeps them awake at night.

In its findings, Arthur D. Little writes that risks can become uncontrolled, causing schedule delays and rising costs, when firms don't make an upfront assessment of what could go wrong.  ADL identified six ways a new nuclear build can go south.

• Starting construction before the design is done
• Insufficient recognition of regulatory requirements in design drawings
• Inadequate coordination of project schedules with key suppliers
• Failure to flow down strategic issues into operational plans
• No commitment to follow through on risk mitigation measures
• Assignment of unqualified project leaders to first-of-a-kind new builds

The director of the ADL study, Matthias von Bechtolsheim, said in a press statement that failure will result when mangers "underestimate interdependencies among project activities."

"All evidence suggests that the management challenges of new nuclear builds should not be underestimated."

Now this seems pretty obvious, but the failures and cost overruns of the 70s and 80s can be tied to these issues.  Another aspect of risk is the time it takes to get approval for and build a plant. Political issues rise which are outside the control of even the most prudent EPC contractor.

Perhaps mirroring ADL's report, MarketWatch reported June 29 that German nuclear utility RWE AG was downgraded by banker Morgan Stanley. The bank said the utility's risk profile had risen sharply because of the unresolved policy issues of reactor life extension and plans for new taxes on profits from its plants.

While these developments are largely outside of the utility's control, they illustrate how the capriciousness of elected officials can create risks that hold the potential to derail projects with timelines measured in decades rather than the two-to-four year election cycle.

Utility stocks advance despite bankers' cautions

Despite a gloomy outlook presents by Citigroup, CNBC reported June 24 that key nuclear utilities were top performers in the S&P 500 in the past 30 days. Barclays Capital wrote that dividends from regulated utilities are improving," and the report said yields are expected to increase over time.

Among the nuclear utilities cited in the CNBC report, Southern, Exelon, and Dominion have dividend yields of 5% which beats U.S. Treasury bonds at 3%. Barclays wrote that regulated utilities will "outperform the S&P 500." The reason, the report said, is that even if the economy goes into a double dip recession, "power is the one thing we can't live without besides food."

How about that?

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