PUBLIC RISK, PRIVATE PROFIT RATEPAYER COST, UTILITY IMPRUDENCE ADVANCED COST RECOVERY FOR REACTOR CONSTRUCTION CREATES ANOTHER NUCLEAR FIASCO, NOT A RENAISSANCE Mark Cooper Senior Fellow for Economic Analysis, Institute for Energy and the Environment, Vermont Law School March 2013 TABLE OF CONTENTS EXECUTIVE SUMMARY v I. INTRODUCTION 1 A. ADVANCED RECOVERY CREATES RATEPAYER RISK AND 1 UTILITY IMPRUDENCE B. IMPRUDENCE AND THE “NUCLEAR RENAISSANCE” 2 C. WHY STUDY SOUTH CAROLINA 3 D. OUTLINE 4 II. THE RUSH TO BUILD REACTORS 6 A. THE COLLAPSE OF THE “NUCLEAR RENAISSANCE” 6 B. DÉJÀ VU ALL OVER AGAIN 11 C. THE INESCAPABLE ECONOMIC FAILURE OF NUCLEAR POWER 14 III. THE IMPACT OF ADVANCED COST RECOVERY ON THE CONSUMER 18 PROTECTION FUNDAMENTALS OF UTILITY REGULATION A. RECOVERY OF JUST, REASONABLE AND PRUDENTLY INCURRED COSTS 18 FOR USED AND USEFUL FACILITIES B. ADVANCED COST RECOVERY WEAKENS CONSUMER PROTECTION 19 C. THE IMPACT OF PERVERSE INCENTIVES ON UTILITY BEHAVIOR 22 D. CONCLUSION: CURRENT KNOWLEDGE AND PRUDENT DECISION-MAKING 25 IV. ECONOMIC CAUSES OF THE COLLAPSE OF THE 29 “NUCLEAR RENAISSANCE” A. NATURAL GAS PRICES 29 B. THE FULL RANGE OF ALTERNATIVES 30 C. COST TRENDS 33 D. EFFICIENCY AS A RESOURCE 37 E. SLOWING GROWTH OF DEMAND 39 F. THE IMPORTANCE OF FLEXIBLE SUPPLY 40 V. THE IMPACT OF CARBON AND SUNK COSTS 43 A. HOW THE ASSUMPTION OF A HEFTY CARBON COSTS MISLED 43 DECISION MAKERS B. MANDATES DIMINISH THE NEED FOR NEW NUCLEAR REACTORS 44 C. CARBON PRICE UNCERTAINTY AND CARBON COST SCENARIO ANALYSES 46 D. THE ECONOMICS OF THE SECOND NUCLEAR FIASCO 48 F. SUNK COSTS 50 VI. THE RATEPAYER HARM AND ECONOMICS OF THE LEVY REACTORS 52 A. UNDERMINING CONSUMER PROTECTION WITH ADVANCED COST RECOVERY 52 B. THE COLLAPSE OF “NUCLEAR RENAISSANCE” ECONOMICS 55 C. EXCESSIVE COSTS 59 D. CONCLUSION 61 APPENDIX A: NUCLEAR POWER: THE RENAISSANCE THAT WASN’T 64 APPENDIX B: DOCKET NO. 2012-203-E: TRANSCRIPT OF TESTIMONY 70 ii APPENDIX C: MARKET BARRIERS AND IMPERFECTIONS THAT MAKE 74 COMPLEMENTARY POLICIES VITALLY IMPORTANT IN THE INITIAL RESPONSE TO THE CHALLENGE OF CLIMATE CHANGE LIST OF FIGURES FIGURE II-1: CUMULATIVE NUCLEAR CAPACITY COMPLETED AND CANCELLED 12 FIGURE II-2: OVERNIGHT COST: U.S. ACTUAL AND “RENAISSANCE” ESTIMATES 13 FIGURE II-3: COMPLETED AND CANCELLED NUCLEAR CAPACITY COMPARED 13 TO FOSSIL CAPACITY: 1963-1996 FIGURE II-4: ESCALATING COST ESTIMATES IN THE COLLAPSE OF THE NUCLEAR 15 RENAISSANCE FIGURE II-5: THE REPEATED COLLAPSE OF NUCLEAR REACTOR CONSTRUCTION 16 FIGURE IV-1: NATURAL GAS PRICES AND PROJECTION HAVE PLUMMETED SINCE 2007 31 FIGURE IV-2: EXELON’S INCREASINGLY DIM VIEW OF NUCLEAR ECONOMICS AND 32 IMPROVING VIEW OF ALTERNATIVES FIGURE IV-3: PJM RESOURCE SUPPLY CURVES 34 FIGURE IV-4: NATIONAL AND REGIONAL ESTIMATES OF COST OF RESOURCE OPTIONS 35 FIGURE IV-5: KEY COST TRENDS FOR SOLAR POWER 36 FIGURE IV-6: CEC AND OTHER OVERNIGHT COST TRENDS 38 FIGURE IV-7: EVALUATIONS OF STATE PROGRAMS TO PROMOTE EFFICIENCY 39 & RENEWABLES FIGURE IV-8: DEMAND GROWTH HAD SLOWED DRAMATICALLY BY 2010 40 FIGURE IV-9: SUNK COSTS: TOTAL CAPITAL COSTS AND CONSTRUCTION PERIODS 41 FIGURE IV-10: GENERATION CAPACITY WITH VARIOUS RESERVE MARGIN 42 AND DEMAND ASSUMPTIONS FIGURE V-1: PROJECTED PEAK DEMAND WITH AGGRESSIVE DEMAND 45 REDUCTION MANDATES FIGURE V-2: GENERATION CAPACITY NEEDS, WITH EFFICIENCY AND 45 RENEWABLE MANDATES FIGURE V-3: ESTIMATES OF THE COST OF CARBON IN THE U.S. CAP AND TRADE DEBATE 46 FIGURE V-4: THE CARBON PRICE-RESOURCE DECISION MATRIX: THE 2008 NET COST 47 FIGURE V-5: THE CARBON PRICE-RESOURCE DECISION MATRIX: WITH CURRENT 48 CONDITIONS AND CORRECTIONS OF ANALYTIC FLAWS FIGURE V-6: LEVELIZED ANNUAL ECONOMIC “TO GO” COSTS AND SUNK COSTS 51 FIGURE VI-1: LEVY KEY COST DRIVERS: PROJECTED OVERNIGHT CONSTRUCTION 57 COST: 2008 – 2012 AND NATURAL GAS PRICES FIGURE VI-2: DECLINES IN PROJECTED PEAK DEMAND SINCE THE NEED 58 FILING EXCEED LEVY CAPACITY FIGURE VI-3: EXCESSIVE COST OF LEVY COMPARED TO NATURAL GAS 59 (CUMULATIVE PRESENT VALUE OF REVENUE REQUIREMENT, CPVRR) iii FIGURE VI-4: IMPACT OF A LOW DISCOUNT RATE ON THE NUCLEAR-GAS 60 COMPARATIVE ECONOMIC ANALYSIS LIST OF TABLES TABLE II-1: FACTORS THAT UNDERMINED THE “NUCLEAR RENAISSANCE” 7 TABLE III-1: THE IOWA UTILITY BOARD ANALYSIS OF THE PROBLEMS WITH 20 ADVANCED COST RECOVERY TABLE III-2: ALLOCATION OF COST OVERRUNS 25 TABLE III-3: THREATS TO RATEPAYERS FROM ADVANCED COST RECOVERY 26 TABLE V-1: ANNUAL LEVELIZED COST COMPARISON: NUCLEAR AND GAS 49 iv EXECUTIVE SUMMARY In recent weeks, much attention has focused on the woes of the nuclear industry in Florida and the increasing number of delays and cost overruns associated with the Vogtle project in Georgia. This fragmented focus on nuclear power may create the impression that the industry’s challenges vary widely and are localized to specific reactor sites. They are not. This paper presents an economic analysis of the new nuclear reactors being built in the South East United States, specifically South Carolina and Florida, where advanced cost recovery statutes to subsidize nuclear reactor construction have been enacted. It shows that industry-wide problems have undermined the economics of two of the three projects – the Summer reactor project in South Carolina and the Levy reactor project in Florida. South Carolina is used as the focal point of the analysis for two reasons. The advanced cost recovery statute under which the nuclear project is being developed is South Carolina is typical of the few such statutes that have been enacted in recent years, primarily in the Southeastern U.S., but with expression of interest surfacing in state legislatures as far flung from the Deep South as Utah, Iowa, and Missouri. The South Carolina utility’s projected construction costs are substantially below other estimates for new reactor construction; yet, the economics of the project are abysmal from the ratepayer point of view. The economic harm that nuclear reactor construction imposes on ratepayers can be summarized as follows: Given the facts on the ground today, the utilities that rushed to sign engineering, production, and construction (EPC) contracts to build new nuclear reactor will impose billions of dollars of excessive costs on their ratepayers. The exact amount will vary depending on the assumptions made about the construction costs, the discount rate (cost of capital), the projected cost of gas, and the cost and availability of other alternatives. The best estimate of the excess costs that will be borne by South Carolina ratepayers and the South Carolina economy is in the range of $10 billion. With future cost overruns and adjusting for the discount rate, the Levy reactors in Florida would have a similar level of impact. Other states implementing an advanced cost recovery statute today would likely face even larger excessive costs. Time is of the essence in conducting prudence review of these massive construction projects since the statutes guarantee cost recovery and costs mount quickly. Although the estimated costs for reactors in the Southeast are in the range of $60-$70 billion today, less than $6 billion has been spent to date. The excessive costs of completing the reactors far exceed the sunk costs at present, which means they should be cancelled. However, as more and more is spent, under the perverse logic and incentives of advanced cost recovery those sunk costs become a burden that ratepayers will have to shoulder for decades. v The facts on the ground that have created this economic fiasco for ratepayers include: Nuclear cost overruns, Declining natural gas prices, The falling cost of other alternatives like wind and solar, Slowing demand growth; and Climate change policy that is emphasizing targeted incentives and performance standards for low carbon resources, rather than hefty carbon costs. The critically important role of advanced cost recovery (sometimes called “construction work in progress” or CWIP) in creating the new nuclear fiasco is demonstrated by the behavior of utilities. All of the projects for which EPC contracts have been signed involve guaranteed advanced cost recovery. Three-quarters of the states where advanced cost recovery quickly saw an EPC contract signed. Not one of the projects proposed in a state without advanced costs recovery has moved to the EPC phase. In other words, although projects in non-advanced cost recovery states constituted three quarters of the total projects proposed, all of the projects under an EPC contract are in advanced cost recovery states. While the economic case against nuclear reactor construction was strong in 2008 when these EPC contracts were signed and the construction approved, a dramatic change in material conditions was evident by 2009-2010 and the reactors should have been cancelled. The primary reason that the reactor projects were proposed and allowed to continue far past any remote chance they would be economically justifiable is the fact that advance cost recovery for nuclear reactors shifts the risk of construction from stockholders to ratepayers. Utilities had a huge incentive to construct reactors that would dramatically expand their rate base with full, guaranteed return on investment and virtually no risk to stockholders. Guaranteed advanced cost recovery undermined the ability of public utility commission to protect ratepayers from excessive costs because it undercut the two most important principles of consumer protection in utility ratemaking – the requirements that facilities be used and useful before costs are recovered from ratepayers and that only just, reasonable and prudent costs be recovered. With neither stockholder risk nor utility commission oversight disciplining utility management behavior, imprudent decisions, including continuing expenditures on projects that are clearly uneconomic, are a virtual certainty. Advance cost recovery destroys the consumer protection that lies at the heart of utility regulation, as a 2012 analysis prepared by the staff of the Iowa Utilities Board concluded.