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Nuclear Standoff - Nuclear Breach

Federal failure to fulfill spent-fuel obligations creates expensive risks.

Fortnightly Magazine - December 2009

simplifying assumption that the plant generates a uniform sequence of after-tax cash streams over its life. A simple NPV calculation of these three cases indicates the nuclear risk premium, including SNF uncertainty, decreases the actual purchase price by between 11 percent and 44 percent, with a midpoint of about 24 percent from what the plant would otherwise have been worth on a NPV basis. For an $80 million acquisition, these risk premiums imposed on the entire investment translate to a value diminution ranging from nearly $9 million to more than $32 million. The mid-point is $19.3 million or roughly 24 percent decrease on the $80 million spent. 

These results are scalable. For a $200 million acquisition under similar simplifying assumptions, a 20-percent IRR increases the value of the claim by between $22 million and $80.3 million with a midpoint of $48.3 million. A $400 million acquisition ranges from $88 million to $160.3 million with a midpoint of $96.3 million.

The SNF component of the nuclear risk premium can be inferred from these results using a variety of standard financial engineering methods. For some plants faced with an imminent shutdown, the SNF component accounts for risks in the range of 90 percent of the total.

 Again, these results are based on simplifying assumptions (i.e., uniform net after-tax cash streams), and might not reflect other aspects of the transaction structure (i.e., any commodities or assets with salvage value, or that can be sold easily in a liquid market). By comparison, in the Boston Edison case, Edison’s expert testified that the SNF premium was $38.7 million,  based on market experience that places SNF’s impact at Pilgrim in the range of 500 basis points to 750 basis points, depending on deal structure.

Clouding Nuclear’s Future

As claims made by NSP and Boston Edison in their court cases attest, risk has real costs. There are also consequential effects. Risk impacts the risk capital a company must set and cuts into liquidity. Unhedged and uninsured risks are borne by the available risk capital. If a loss is realized, thereby overwhelming the firm’s available liquidity and risk capital, the firm fails.

As seen with market and capacity factor risks, such risks typically are hedged to some degree using physical and financial instruments. Decommissioning trust funds ensure adequate monies are available after plant retirement, but the balance between risk and available risk capital impacts the value of a company’s securities. Rating agencies are taking a growing interest in the risk capital levels at energy firms. The balance between exposure level and available risk capital can be an important factor in the credit rating. In some cases, a company might find its rating agency imputing debt to cover potential risk exposures insufficiently hedged or unduly exposed to counterparty or systemic risk. 

These standards are impacting balance sheets at a difficult time for the industry. Over the past year or so, utility stock prices have declined generally. Kilowatt-hour deliveries are down as much as 8 percent with industrial sales often much worse. Some companies face significant pension shortfalls due to market declines.