Presentations
I have been asked to substitute for Ashley Brown who was called to a meeting outside of the country. Ashley''s scheduled topic was "Nuclear Power in a Restructured Environment". I have a different background. I am not a lawyer nor have I been a regulator. Therefore I ask you to allow me to roam outside the topic Ashley set.
Specifically, I would like to address four questions:
First, how is the electricity industry likely to be restructured?
Second, can existing nuclear power plants compete in this new market?
Third, how will new federal air pollution initiatives affect nuclear''s competitiveness?
Fourth, what future uncertainties will nuclear power plant owners and operators confront?
Electricity Restructuring
While most states in the nation have discussed restructuring proposals, the rate of implementation is very uneven. Some states are trying to move to competition at both the wholesale and retail levels. But the retail part of the restructuring package is sputtering. This market is very thin, especially in the residential and small commercial sectors. Even California— which has progressed further towards a competitive system— is struggling to establish a workable market in these sectors.
Wholesale competition is easier to implement and the potential is more apparent. It has emerged in those areas of the country where electric rates have been higher than the national average, but it is advancing either at a much slower rate, or not at all, in states where rates are below the national average. This is understandable.
Proponents of wholesale competition go so far as to talk about the convergence of national electric rates. They foresee an electricity world in 2010 with a single national price. If you are a state with high prices, this scenario may sound like a good deal, but if you are one of the low rate states, such a scenario sounds much less attractive. Why should Kentucky want to lose the competitive advantage that below average electricity rates provide? Eventually market forces will drag most states into the competitive market. But there is no reason to expect that low-cost states will voluntarily accelerate their efforts to get there.
Federal legislation to whip the recalcitrant states into action is stalled. Proponents are frantically searching for ways to interject a sense of urgency into the debate. At the moment, they have not succeeded. Congressmen do not see this issue as worthy of cashing in their political chits.
The bottom line is that true wholesale electric markets will emerge at different times in different parts of the country. Further, these markets will be geographically limited, due to the inadequacies of the interstate transmission system. That is, the market discipline in the form of imported power is often not present due to the absence of sufficient transmission capacity. Therefore, some generators will possess an ability to manipulate local markets. Regulators will respond to these market power issues, but it will take time. Neither is it clear what specifically defines market power. Thus, it is not a foregone conclusion that every region that establishes a wholesale market will find that market truly competitive.
Role of Nuclear Power
In the simplest competitive model, all power sources must compete. For example, let us assume 20 gigawatts of power are offered for sale and the demand is only 15 gigawatts. The bids are ranked according to price, lowest bid first. The actual clearing price— the price that all generators will receive will be that bid by the producers of the last gigawatt sold— the 15th gigawatt. The other 5 gigawatts will have no buyers. Basically you will have an upward sloping supply curve. As more customers demand power the wholesale price rises.
Assume for a minute that a competitive power market emerges, the variable or operating costs of a nuclear plant must be below the marginal selling price for that hour or that plant will lose money. Unlike a gas fired plant, the nuclear facility cannot be turned on and off as market demand changes. For all intents and purposes, a nuclear plant might as well bid zero, since it must operate 24 hours per day. Its gross revenue flow will be dependent on the marginal plant not on the cost of its own operations. During periods of peak demand, the price will be considerably higher than at off-peak periods. The hope is that the nuclear plant will make enough money during the high demand periods to compensate for its loses in the low demand periods.
How many nuclear plants are likely to be able to meet this market test? Most of the studies I have seen make broad assumptions about the expected market clearing prices and then estimate the number of nuclear plants that will be competitive in any given year. For the most part, these assumptions are biased against nuclear plants, because they peg the wholesale clearing price to the costs of a modern gas combined-cycle plant. As I mentioned earlier, most markets will not operate so efficiently, nor will gas-fueled plants always determine the price, especially in the early years.
For the sake of argument though, lets say the markets do clear at the price of a new gas facility— around 3 cents a kilowatt hour. In 1996, 11 nuclear plants had annual production costs above this threshold and three others were within two mills. The national average production price for nuclear plants was 2.18 cents or almost thirty percent below the projected clearing price. Thus most nuclear plants in the country will be competitive.
These figures jibe with those offered by Roger Gale, President of the Washington International Energy Group. Gale suggests that 17 facilities or 19,055 megawatts will be in trouble in a competitive market. These facilities tend to be those with poor capacity factors and high O&M costs.
There is one additional problem. Approximately 40% of the nation''s nuclear capacity will need to renew its operating licenses by 2015. Eleven licenses will expire by 2010 and another 25 in the ensuing five year period. Why is this a problem? Let us imagine a plant that has a production cost of 2.2 cents— the national average— and a license that expires within ten years or less. Perhaps, it suddenly faces a multi-million dollar backfitting order from the NRC or a major capital maintenance expense. It may decide that the remaining years of its license is insufficient time to amortize the capital cost of these improvements and still meet the market-clearing price. In such an instance, the owners will be tempted to retire the plant early rather than risk taking a financial loss. These retirements could add several units to our list of facilities in trouble.
Altogether, there is a possibility that as much as 20-25% of the nation''s nuclear capacity could close before 2010. Some people believe that the actual figure is closer to 40%.
While this number of retirements can happen, I doubt it will, but with one caveat. I assume that states will continue to allow nuclear investors to cover their uneconomic fixed cost through a charge on the wires. Such "stranded" payments have been accepted in most every jurisdiction that has opted for a competitive wholesale market.
The reasons I believe that the predictions of nuclear power''s demise are overestimated is that the pundits are ignoring or discounting the impact of new environmental initiatives.
Air Pollution Regulation
As ironic as this sounds, nuclear power may be saved by environmental regulation. As many of you know, the Environmental Protection Agency is in the midst of ratcheting down NOX emissions from midwest coal units. Pressure from the northeast states will force the agency to require stringent reductions in the five summer months. Operators of coal facilities in the Midwest will have three alternatives: 1. Switch to gas for at least the five months when ozone levels are highest; 2. Invest in selective catalytic recovery units, or 3. Retire.
In addition, these plants face round 2 of the SO2 reductions which will take effect in the year 2000; further ozone reductions in 2002-2003; and new submicron particle standards that are scheduled for implementation in 2004. It''s too early to get a clear reading on what exactly EPA will require from emission sources to meet the particle standard. However, an early candidate is a halving of the existing SO2 cap of 9 million tons.
All of these initiatives will add somewhere between 6-8 mills to the average cost of wholesale power from Midwest coal plants.
We at the Kennedy School are still in the process of analyzing this issue, but our early estimates suggest that the average production cost of a Midwest coal plant could go from 1.8 cents per kWh to 2.4 or higher. I am sure most of you have already reached the obvious conclusion that nuclear plants do not emit NOX, sulfur or particles. Therefore, these regulations will provide nuclear plants with a distinct competitive advantage.
My guess is that the advantage might be even greater, since the switch to gas will put some upward pressure on gas prices. For instance, the investment costs of the necessary expansion of the gas transmission system will push gas prices at the citygate higher, and these costs will be reflected in the production costs of gas-fired generators.
Nuclear plants with production costs above 3 cents per kWh will still face revenue losses, and some will still be retired early, but because of pending environmental regulations, the competitive marketplace may become more nuclear friendly than some of the recent studies suggest.
While conventional air pollution abatement will help, the big boost will come from carbon restrictions. I fully realize that this issue is controversial. There are experts telling us that the science is uncertain and that the cost of reducing carbon is prohibitively expensive. But the scientific evidence supporting the climate change theory is getting stronger every year and the skeptics are dwindling. There are still questions about how fast the planet will warm and the impact in one region as opposed to another, but few reputable scientists doubt that the problem is real. While the cost of controlling greenhouse gases is larger than what advocates imply, it is not anywhere near as high as certain coal company officials are claiming.
The world community is likely to get serious about doing something about the climate change problem some time in the next two decades. When they do, the planet will have to develop a strategy to cut its use of fossil fuels by about 35% before 2050. This will not be a small undertaking. At the moment, there are only two technologies that will allow us to reach such goals: renewable energy sources and nuclear power. At the moment, neither technology is in a position to fill this role. We will have to design and develop options in both areas that are different than the ones we have today.
In the short term, any administration concerned about climate change will not want to see large scale retirements of existing nuclear power plants. They may not be willing to push for new facilities, but they will not want to lose the savings in carbon emissions inherent in the 100 gigawatts of nuclear capacity we now have.
If, five to ten years from now, the US imposes either a cap on carbon emissions or a carbon tax, the cost of coal and oil-fired electricity generating will rise. But so too will the cost of gas fired generation plants. Market clearing prices may easily break the 3-cent per kWh barrier and begin to move to 3.5 and 4-cent levels.
Before you get your hopes up, I would not count on any meaningful US program before 2008-2012. But unless significant scientific evidence to the contrary emerges, some type of carbon reduction program will be implemented within this time frame.
UNCERTAINTIES
There are a number of people who are claiming that nuclear power cannot compete in the new competitive marketplace. I have given you some arguments as to why this marketplace may be more nuclear-friendly than these experts claim. However, there are some big uncertainties looming in the future. I would like to conclude my remarks by touching on three.
- As I mentioned earlier, the operating license of approximately 40 nuclear facilities will expire before 2015. Many of these plants will face tough decisions about whether or not to invest in capital improvements. Thus the 2015 target is misleading. The "retire or invest" decisions will come in the next eight years, not in the next fifteen. The Nuclear Regulatory Administration will have to establish a clear policy on relicensing as soon as feasible— otherwise plant owners facing new capital expenses will opt to close rather than bet the store on the possibility that a favorable relicensing policy will one day emerge from the NRC. The closer to the end date on their licenses, the less the owners will be willing to live with potentially costly uncertainty.
The NRC has two applications for relicensing— one for Duke Power''s Oconee plant and one from Baltimore and Electric for its Calvert Cliffs Plant. How the agency handled these applications will have a significant bearing on the number of nuclear power plants that will retire before 2010. - The nuclear waste problem seems to defy resolution. Last spring, I went to a briefing in which federal officials walked the audience through the steps that would have to be taken to obtain final approval for the Yucca Mountain facility. I came away from that discussion convinced that there was no way that this facility could survive such a process. I hope I am proven wrong. But I do not expect to be.
This leaves the federal government in the position of either endorsing the concept of interim storage and thereby killing off Yucca Mountain or proceeding with Yucca with a probability of success around 20 percent. I suspect that in the end the US will have to accept the interim option.
The US is not alone. Most countries with nuclear power are struggling with these same issues, and most will have to opt for some type of interim arrangement. The waste problem is a serious one and the public is demanding resolution. Further, nuclear power as a primary energy source cannot advance in the industrialized countries unless there is a resolution of the waste issue. - Nuclear safety will remain a major concern. NRC officials have already expressed the worry that nuclear plants might cut corners in order to compete in the market. Regardless of whether or not this concern is misplaced, it exists and I suspect it will become louder in a competitive marketplace.
The public''s concern will make nuclear power extremely vulnerable to the political fallout from a nuclear accident anywhere in the world. If another Chernobyl occurs in Bulgaria or Taiwan, US nuclear plants will not escape the tidal wave of negative reactions.
To make matters worse, I believe that the industry is equally vulnerable to the public fury that will follow if and when a terrorist state or organization explodes a nuclear device. The world is more vulnerable to this threat today than it was ten years ago. The US nuclear industry should be leading the vanguard against proliferation, should be in favor of purchasing Soviet weapon-grade nuclear materials and should insist on a strong international regime to enforce safety standards. These are not other people''s problems, because if something goes wrong, your industry will bear the brunt of the impact.
I realize that I have skimmed over a lot of material in a short time. But I think the nuclear industry is at a crossroads. It is evolving from a world where it was protected. Where it was the domain of risk adverse managers and super-cautious regulators. The world of the new century will be one in which creativity, imagination and the willingness to explore new ground will be required. Admittedly, the journey will be fraught with peril, but it will also possess the possibility of breaking out of the morass that has been strangling this industry for two decades. The question is whether you are prepared to go down this new path— with all its uncertainties and risks— or stay on the path with which you are familiar and comfortable. I would strongly urge you to consider the first.