A Wall Street Scram?

Issue 10 and Volume 112.

By David Wagman, Chief Editor

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Wall Street’s credit crisis raises interesting questions regarding the nuclear renaissance. Those questions sharpen in light of Constellation Energy’s financial straits, which sent it looking for a merger partner last month. Constellation, through its participation in UniStar, has been a proponent of new U.S. nuclear power plant development.

Many observers will watch to see whether the merger’s regulatory review distracts Constellation to the point that it delays or even derails UniStar’s push toward new build.

That said, Constellation’s decision to merge into Berkshire Hathaway via MidAmerican Energy could be something of a best-case scenario. The Warren Buffett-controlled Berkshire has a reputation for allowing the companies it owns to manage their own affairs. MidAmerican’s $4.7 billion offer for Constellation was a bargain, if for no other reason than it gains five nuclear operating units for roughly the cost of a single new unit.

Which brings me back to wondering: might the credit crisis disrupt the nuclear new-build movement by making it more difficult for developers to borrow money and leverage assets?

I asked John Hynes for his views. Hynes is a principal with Excidian and he (among other things) teaches a one-day course on utility finance fundamentals at POWER-GEN International. Hynes began with the reminder that building a nuclear power plant is a multi-year process. By the time the current nuclear license reviews pending with the Nuclear Regulatory Commission are complete the credit crisis likely will have run its course. Even so, issues related to risk, leverage and underwriting may affect how new-build finance is managed.

Certainly the credit crisis raises a number of risk issues. Hynes suggested considering how lenders might view a nuclear power plant project in today’s market.

If the company proposing the plant is a regulated utility allowed to recover, say, 50 percent of its costs upfront through regulated rates, then that project presents probably the lowest risk profile. An unregulated generator building a nuclear plant with a 30-year, legally binding purchased power agreement (PPA) presents a slightly higher risk depending on the language in the PPA, but still a low risk. The risk goes up if the builder is a regulated utility that must complete construction before it can put the plant into rate base and recover construction costs. And if the developer is an unregulated generator building a nuclear plant without a 30-year legally binding PPA, then it “probably cannot get a loan to finance this project, unless unique market circumstances exist,” Hynes said. Such unique circumstances might include a regional electricity market where prices are high and transmission access to other markets is limited. This might offset some risk associated with not having a 30-year PPA, Hynes said, as the market circumstances may indicate that prices are likely to remain high in that market for an extended period.

Given Hynes’ assessment it will be interesting to watch efforts by NRG Energy and Exelon Generation to build non-rate base nuclear power plants in Texas. At a GE Energy seminar more than a year ago, Thomas O’Neill, vice president of new plant development for Exelon Generation, listed five areas which he said must offer “bankable certainty” for such a merchant nuclear power plant to move forward: spent fuel disposal, regulatory stability, state support and public acceptance, passively safe and secure nuclear reactor design and favorable financial market conditions. The credit crisis would seem to make the “fifth leg of the stool” a bit wobbly, at least for the short term.

I also asked Hynes to assess the likelihood that credit requirements for nuclear new-build would tighten, potentially boosting the cost of borrowing. He said credit requirements need to be tightened in cases where third parties are inserted between the borrower and the lender. “This is where the burn is today,” Hynes said. It is also where the mortgage business may differ the most from the power industry. Whereas mortgages were repackaged and sold in such a way that it was difficult for the debt’s new owners to measure risk, power plant project debt is unlikely to be repackaged. Their risk is much more transparent to the buyer. Concrete, steel and labor costs will likely pose more difficult long-term issues, Hynes said.

Lastly, I asked Hynes to assess what the loss of an investment bank like Lehman Brothers might mean when it comes to assembling the capital necessary for a new nuclear plant. In the past, regulated utilities would form a special purpose entity to own the nuclear plant during construction. Hynes said that as long as 3 percent of the financing came from independent, outside investors, the utility could control construction, but did not have to show the asset or the liability on its balance sheet. This allowed utilities to spend billions of dollars on new asset construction without seeing their returns affected. Once construction was complete, the utility would buy out the 3 percent investors and open a rate case to put the asset into rates.

Investment bankers put these deals together, finding the 3 percent investors and charging a fee for doing so. They underwrote the issue of the utility’s debt and arranged bridge loans. Here is where the long-term financing costs will likely increase, Hynes said. With the recent collapses, consolidations and restructurings, these services will likely end up costing more.

Wall Street may not have pressed the equivalent of a nuclear control room’s “scram” button, but it triggered a crisis that must at least be labeled as an “unusual event.”