Given energy markets’ newfound volatility and the range of exposures that global energy firms must deal with, the reactive, reporting-oriented nature of transaction management practices is in need...
Managing Risk: Prudence Reviews and Nuclear Projects
How to avoid the billions of dollars in costs that were disallowed during the last round of construction.
With nuclear energy again being viewed as part of the solution for the United States’ energy needs, a number of companies are starting the early permitting and licensing process. However, no nuclear facility will be constructed if capital markets don’t believe that a plant can be built within established budget targets. Meeting budget targets means the industry must address project-management issues and the risk of end-of-project disallowances for any company or regulator to be able to move forward with new construction.
Prudence Reviews and the Resultant Disallowances
A prudence review is a retrospective analysis of the decision-making process and the activities performed during the licensing, construction, and start-up phases of nuclear power-plant construction. It uses specific evaluative criteria to determine whether construction-related decisions were reasonably made and the activities prudently performed.
When these activities or decisions are found to be imprudent, the adverse impact, if any, is evaluated and quantified in financial terms. This financial quantification exercise forms the basis for identifying expenditures that may be disallowed from inclusion in the rate base upon completion of the prudence review.
If some expenditures are disallowed, the shareholders of the utility—not the customers—pay the cost of activities and decisions found not to have been reasonable to the extent that a third party ( e.g., a construction company, architect/engineering firm or another similar entity) is not found responsible and liable.
The cost and difficulty of a traditionally conducted prudence review is substantial because of the effort required to analyze activities inadequately documented when performed years earlier. For various reasons, utilities historically have not comprehensively or effectively documented the decisions and activities regarding nuclear power projects during construction.
The cost of traditional prudence reviews pales in comparison to some of the amounts disallowed in the last round of construction. For example, PG&E sought to recover $5.5 billion in expenditures for building its Diablo Canyon nuclear power plant. The California Public Utilities Commission allowed only $1.1 billion of these expenditures to be included in the rate base, a disallowance of $4.4 billion. PG&E prepared to litigate the decision before a settlement was reached that amounted to a $2 billion disallowance.
Similarly, San Onofre, South Texas Project, Byron, Braidwood, and Davis Besse are all examples of nuclear power plants where construction activities were subject to prudence reviews, and various amounts were disallowed by state regulatory commissions.
Changing Technologies, Risks & Tools
Since the last nuclear power plants came on line in the United States a few decades ago, nuclear power-plant construction has evolved in terms of new reactor technologies, regulatory requirements, project management, and accounting advances. These programmatic and technological changes have given birth to new risks, thereby adding complexity to future prudence reviews. Consequently, evaluation criteria need to be modified to match the new reality.
For example, the use of sophisticated, automated project management tools such as Primavera will be expected to monitor and control