Business & Money
The Exelon-PSEG Super Merger:
Experts debate the risks of a proposed acquisition that would increase the largest nuclear fleet in the country.
Even as many energy and financial experts are touting the so-called "synergies" of the proposed merger between Exelon and PSEG, some are growing concerned over one of the deal's chief selling points: the high concentration of nuclear power.
In fact, prior to the merger, Exelon's nuclear generation was equivalent to 37 percent of all nuclear generation in unregulated states from 2001-2003-and over this period nuclear generation accounted for 88 percent of the company's total power output. No company, in other words, offers as pure a play on the economic potential of nuclear generation in the United States as does Exelon, noted Sanford C. Bernstein & Co equity analyst Hugh Wynne, in a report.
The combined entity formed from Exelon and PSEG would have combined generation assets of 52,000 MW, including some 20,000 MW of low-cost nuclear capacity. On December 20, at a press conference announcing the deal, company executives noted several times how Exelon's top-quartile performance in the management of nuclear facilities would bring cost savings and performance advantages to PSEG's nuclear operation. The Exelon-PSEG group expects cost reductions to make up 85 percent of the anticipated savings from the merger, with increased output from PSEG's nuclear fleet accounting for another 15 percent. Moreover, an executive familiar with the deal says nuclear synergies makes up nearly one-third of the overall savings.
For PSEG, the merger could not have come at a better time, with the company's finances under scrutiny because of missteps in PSEG's generation operations. Standard and Poor's late last year had revised PSEG's outlook from stable to negative, citing "erratic performance at the nuclear fleet over the past few months," among other things. In fact, PSEG's 1,100-MW Hope Creek Nuclear plant had been off line since October 10, when a steam line failure and shutdown with complications prompted the Nuclear Regulatory Commission to send a team of investigators to the plant. At press time, PSEG was working to get the plant back online.
Meanwhile, despite those setbacks, Exelon has insisted that it can improve performance at PSEG's nuclear operations - so much so that Exelon already has begun to coordinate the nuclear fleets of the two companies, and to implement its proprietary methods for improved nuclear operation.
In fact, such confidence was on display by Christopher Crane, president and CNO at Exelon Nuclear, as he spoke glowingly of how every 1 percent increase in capacity factor for PSEG's nuclear fleet would generate additional pre-tax income of $12 million.
But critics question whether Exelon can really deliver as promised. They believe that Exelon's stellar performance operating nuclear plants cannot be continued indefinitely. They say the company's so-called top-quartile performance will prove more difficult to maintain as the company's nuclear fleet continues to age.
Furthermore, some analysts say that the nation's nuclear fleet already is exhibiting a great degree of unpredictability. Take, for example, how utilities in the last few years have had to spend hundreds of millions of dollars replacing reactor vessel heads due to corrosion. Or take First Energy, which had to shut down its 1,320-MW Perry nuclear station in Ohio on January 6 because of circumstances surrounding problems with two pumps. And in the last decade, Portland General Electric (PGE) had decommissioned its 1,130-MW Trojan nuclear plant, because the company deemed it too costly to replace some of its parts.
Similarly, many experts are discussing what would happen to Exelon if it were hit suddenly with hundreds of millions of dollars in nuclear repairs and overall O&M expense from multiple plants that suddenly needed to be taken off line or even decommissioned for economic reasons. As veteran Wall Street analyst Dan Scotto puts it, "How much concentration of nuclear do you want to put in one entity?"
Hanson Pickerl, managing director in Marsh's nuclear group, says, "As ownership of nuclear power plants continues to consolidate, there are economies of scale-especially for plants that have superior management of nuclear facilities, excellent procurement, and O&M. However, there are credible external economic scenarios, such as a terrorist threat or something else anywhere in the country that could ultimately force reactor owners to shut down their plants involuntarily. The financial reward comes from running the plant safely. The downside is exposure to a forced closure before the end of useful life."
Furthermore, Pickerl describes a possible scenario that anyone who owns significant nuclear capacity fears. If a generic or industry-wide issue forces widespread early and permanent closure of a substantial number of nuclear units in the U.S., the owners of those plants will face significant premature costs that they didn't anticipate. In this case, the more locations you own and the further away they are from scheduled decommissioning, the larger your exposure.
Another executive speaking on the condition of anonymity adds, "Once those plants are shut down you would no longer have an income-producing asset. You now have a liability on your hands."
Decommissioning: The Multi-Billion-Dollar Unknown
Craig Nesbitt, communications officer for Exelon Nuclear, isn't worried about whether his company will have enough funds for decommissioning. Most utilities, he points out, are allowed by the PUC to collect in rates monies that will go to a special external decommissioning fund.
But as Nesbitt explains, the process can prove troublesome to manage.
"The whole notion is that by the time the plant reaches decommissioning, adequate funds exist to decommission the plant," he says. However, he adds, "there are a lot of other factors that go into this."
"Most plants cannot be decommissioned until the fuel is removed, and the fuel cannot be removed until Yucca Mountain or some other central repository is open. So they just sit there. Some plants sit there in their entirety. Some plants are partially dismantled. Decommissioning is returning the site to its green-field state."
Most of Exelon's plants likely will receive a license extension to 60 years, so the funds accumulated over 40 years will accrue interest, according to Nesbitt.
"They are portfolio investments and are going to continue to grow and be bigger than anyone expected. So you are not only extending the time that these investments are growing, you are also cutting the cost of the actual decommissioning because of the learning curve."
Nesbitt says there will be no change in the company's management of its nuclear fleet-whether it consists of 17 units before the merger or 20 units after. "We have gotten pretty good at managing a fleet of nuclear plants. So, what we are doing is adding these three units to that fleet. We have a management model that is published and proven," he says.
Decommissioning costs that end up being more than planned do come out of the company's funds, Nesbitt admits. "But the odds are that it will come to less," he says, optimistically.
According to several analyses by insurers, a typical estimate for the cost of decommissioning a single nuclear unit runs in the range of about $400 million (in 2003 dollars). But these estimates are highly variable, so much so that insurers and utilities have recently worked on an insurance product to take on some of the unforeseen costs from decommissioning.
Marsh's Pickerl says several insurance initiatives are looking at the ability to take 20 to 25 percent more of the risk that the decommissioning funds would otherwise not be able to assume. "It's whatever the projected future cost of the decommissioning liability would be plus an additional 25 percent above that," he says. This is particularly helpful, he says, as it's difficult to predict future environmental or nuclear wastetransportation regulations that could substantially change the cost of decommissioning. Uncertainties regarding labor force composition and decommissioning technology also add measurable risk to the process.
Naturally, Pickerl believes the industry initiative to pool funds to meet the decommissioning requirements is more financially efficient than the external sinking-fund method used today.
According to Exelon's third-quarter filings, the company had $4.9 billion set aside in an external fund for decommissioning. But the amount that Exelon has been setting aside in the last few years for decommissioning is wholly inadequate, according to the General Accounting Office (GAO).
Cited in Exelon's 2004 Annual Report was a 2003 GAO study on the Nuclear Regulatory Commission's need for more effective analyses to ensure adequate funds to decommission nuclear power plants in the United States. As it has in the past, the GAO concluded that accumulated and future proposed funding was inadequate to achieve NRC funding levels at a number of U.S. nuclear plants, including several that Exelon owns.
Nevertheless, in its 2004 Annual Report, the company insists all is well: "In spite of any temporary shortfall in NRC funding levels, [Exelon] currently believes that the amounts in nuclear decommissioning trust funds and future collections from ratepayers, together with earnings thereon, will provide adequate funding to decommission its nuclear facilities in accordance with regulatory requirements."
Furthermore, one industry advisor puts Exelon's larger scale in perspective. Thomas J. Flaherty, senior vice president at Booz Allen Hamilton, who assisted the companies in the deal, says the merger by no means come close to creating diseconomies of scale.
In fact, he says, by European and Asian standards the company that will emerge from the merger of Exelon and PSEG will still be moderately sized on a global stage. While the new Exelon will boast a 50,000+ MW portfolio, that is still half the size of the 100,000+ MW portfolio of Electricite de France (EDF), which owns all of the nuclear in that country.
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