Three ways to value nuclear power plants for buyers and sellers.
Appraisers don't make the market-they reflect it. But when the market speaks, appraisers listen. The appraiser must use judgment, experience, and common sense to correlate the final conclusion of value for a subject plant, basing the conclusion on market indicators.
The valuation of an operating nuclear plant assumes the transfer of ownership as of a particular date. The transfer price is based on the concept of a willing seller and a willing buyer, neither being forced to participate in the transfer and, also, both being reasonably knowledgeable of the relevant facts associated with the operations and the business. To determine the transfer price or value of the plant, three approaches to value are available to review: the sales comparison approach (based on the sales of similar plants), the income approach (based on projected cash flows), and the cost approach (based on the cost of construction).
In the sales comparison approach, transactions in the marketplace are used to derive a value for a nuclear plant based on the actions of buyers and sellers. Actual sales are analyzed and adjusted to the subject plant. Adjustments are made for: (a) size, that is, the generation capability of the generators; (b) production expenses, comparing the cost to produce electricity per kilowatt between the plants; (c) time, adjusting for the economics between the appraisal date and when the sale took place; (d) age, comparing the age (or remaining license life) and level of technology; and (e) location, adjusting for different economics between the subject and the sale; Several other adjustments can be made depending on the circumstances. Depending on the purpose of the valuation, any fuel inventories, intangible assets, power purchase agreement (PPA), transmission assets, or other assets must be removed from the transaction price to result in only the price of the tangible plant assets under review, as necessary.
The sales comparison approach is a powerful tool in a nuclear plant appraisal, because every nuclear plant uses a similar fuel source to generate electricity and is operated to maximize the production of electricity as a base-load plant. The difference between plants can easily be adjusted to the appraised plant by using the basic appraisal tools discussed in any valuation text.
Not So Risky Anymore
The market in sales of nuclear plants has been relatively dynamic. When plants first began to sell in 1999, they were considered risky investments. The first major transactions sold for between $0 and $72 per kilowatt of capacity, and several transactions that were announced never closed. However, by 2000, two plants sold for about $298/kW. In 2001, three additional plants sold for between $369 and $554/kW, and in 2002, two more plants sold for $257/kW and $477/kW. Two plant acquisitions were announced in late 2003 that are expected to close in 2004. These pending sales are at $343 and $582/kW. All of these sales prices reflect only the value of the tangible assets (net of nuclear fuel and intangible assets such as PPAs).
Ownership of a nuclear power plant involves risk. Thus, ownership of several nuclear plants can reduce this risk somewhat, as companies can use the expertise of their engineering staff to operate the plants more efficiently. One element of risk is the high operating cost of a plant during an outage, even one for scheduled maintenance. When a nuclear plant is not generating electricity, nuclear energy still is being consumed. This is because, unlike other types of plants that stop consuming fuel during an outage, a nuclear reaction cannot be stopped once it starts.
Catastrophic accident is also a risk incurred by owners of nuclear plants. Such an event could shut down a plant permanently, because the costs to rectify the problem, repair the damage, and pass the resulting scrutiny of the NRC likely would be prohibitive.
Additionally, nuclear plants are viewed unfavorably by some sectors of the public, and resulting social pressure could also force an operating plant to cease operation.
The Income Approach
The next indicator of value is based on future income realizations. The income approach is the tool most frequently used by buyers and sellers in the marketplace. The primary difficulty with the income approach is forecasting the future. Therefore, buyers and sellers use a matrix of income approaches to test their forecasts in as many different ways as possible, providing information regarding a range of values for use in negotiating sessions.
Items to be forecast in the income approach include electricity production, prices of electricity, energy costs (enriched uranium), operating expenses, future capital expenditures and sustaining capital requirements, additions to the decommissioning trust fund, and the capitalization or discount rate. Forecasts for prices of electricity are frequently available from various published sources, but the primary source for appraisers or consultants is the Energy Information Administration (EIA), part of the Department of Energy (DOE).
Many consultants forecast electricity prices on an hourly basis, based on computer models and supply and demand relationships. Past prices are frequently available on the Internet from the independent system operator Web sites. Electricity production and capacity factors can be forecast by reviewing past performance and the future budget for the plant. Operating expenses can be projected by reviewing operations over the last three to five years. Future capital expenditures are commonly budgeted by plant management for three-, five- or 10-year periods.
Beyond the budget, 2 to 3 percent of the replacement cost is necessary for sustaining capital, which keeps the plant in safe operating condition. It is especially important to review the decommission trust fund and also the decommissioning cost forecast. It is most common to develop a discounted cash flow, rather than just capitalizing one year. The industry typically is not stable enough to forecast a one-year normalized income stream. Participants in the market develop after-tax, debt-free cash flow streams that reflect the income level received by equity and debt holders. Depreciation also is calculated using modified accelerated cost recovery system or MACRS tables to reflect the buyer's new tax basis.
The discount rate to be applied to the after-tax, debt-free cash flow stream is developed utilizing a weighted average cost of capital (WACC). This method requires publicly traded guideline company stocks to be investigated to develop a typical capital structure (equity and debt weightings) and beta (volatility or systematic risk inherent in the industry). The capital asset pricing model, or the build-up method, is used to derive an equity investor's required return on an investment in the nuclear power industry. The equity return must be adjusted for risks inherent in the single plant under valuation and the additional risks of equity ownership, compared with a larger participant in the industry that most likely owns several nuclear plants and other power plants. Equity investment risk in the nuclear power industry is high because if the subject plant were to shut down, the uranium fuel still would continue to be consumed and the cost to start up again could be so high that it would prevent start up, especially if the shutdown were caused by a catastrophic accident. Additional risk factors of equity ownership must be considered. Because debt cost is also high due to the single-plant nature of the investment, higher risk industrial bonds (higher risk but not junk) are utilized. The WACC is then calculated on an after-tax basis and applied to the forecasted cash-flow stream.
The result of the income analysis is the value of the entire business enterprise associated with the operating plant. To determine the value of the tangible assets alone, a normal level of net working capital is deducted (based on the guideline company analysis); in addition, the intangible assets must be valued, then deducted. Intangible assets include, but are not limited to, the trained and assembled workforce and management team, operating manuals and procedures, PPAs, and software. The resulting income indicator of value for the tangible assets includes the real estate comprising land, buildings, and land improvements; and the personal property, both electrical generation equipment units and support assets.
The cost approach, the final approach to be investigated, requires a certain level of knowledge about the economics and technology of the industry. To apply the cost approach, the appraiser must calculate the current cost of a plant, and the reproduction cost (an exact replica) or the modern replacement cost. The difference is a form of functional obsolescence (loss of value from within the property) due to excess capital costs.
An increase in natural gas reserves has made combined-cycle gas turbine (CCGT) plants more economical. Using CCGT technologies results in decreased construction costs, lower operation and maintenance costs, higher capacity factors, low emissions, and a greater operating flexibility in a deregulated market. Currently, natural gas appears to be the fuel of choice for future electricity generation in the United States. The modern replacement for a nuclear plant most likely would be a CCGT plant. Based on EIA's Annual Energy Outlook 2004, the current cost for a nuclear plant would be about $1,928/kW of capacity, while a CCGT plant would cost only around $615/kW, a significant difference.
Physical deterioration is deducted based on wear and tear experienced by the property. At this point in the cost approach, economic obsolescence (a loss of value from an external economic force) is investigated. This investigation may include a study of industry margins, spark spreads (electricity price less the product of the heat rate and the price of fuel), supply/demand relationships, competition, and return on capital. Economic obsolescence also can be derived from actual market transactions.
The next deduction is another form of functional, or operating, obsolescence caused by changes in technology. New or different technology frequently results in better control systems that increase yield, and reduced labor and energy requirements, which generally make the modern replacement plant more valuable. In a nuclear plant, operating obsolescence is calculated by comparing its operations with a CCGT plant. Nuclear plant capacity factors are lower than that of a CCGT by 5 or 10 percent, because of the longer period required for fuel replacements and maintenance. A lower capacity factor results in a lower level of electricity produced and, hence, lower revenues. Operating expenses in a nuclear plant are also higher, resulting in lower earnings.
The advantage of a nuclear plant is fuel cost. The cost of uranium is around $0.50 per million Btu (MMBtu), while the cost of natural gas, the fuel for a CCGT, is around $4.00 to $5.00/MMBtu. This is a major advantage for a nuclear plant, resulting in a form of operating obsolescence that is negative. This mathematically increases the cost indicator of value. When the appraised plant's performance is compared with the performance of the modern replacement plant, the penalty, which in the case of a nuclear plant is negative, is present-valued over the remaining life of the plant. The present value of the penalty is the adjustment in the cost approach for operating obsolescence.
The last deduction is a form of both functional and economic obsolescence that is sometimes termed a necessary capital expenditure. Such a capital expense is required by a government agency primarily for environmental reasons-in the case of a nuclear plant, it is primarily the additional contributions to the decommissioning trust fund. Additional costs could come from cooling-water environmental concerns related to fish and other water life. Again, based on the capital budget, the present value of these capital costs is deducted.
These deductions are made, and the value of the land is added after deducting any known and budgeted clean-up costs from the land value as if clean. In the case of a nuclear plant, this cost typically is zero. Nuclear plants normally do not have any environmental soil or water problems. The result is the cost indicator of value.
Correlation
The value indicated by the sales comparison approach can be a very strong indicator of value because it directly reflects the actions of buyers and sellers in the market. Using even one, two, or three sales gives the appraiser a range of value into which the subject property value should fall. Even in a market where few sales are available, the appraiser cannot ignore the market. The sold plants do not have to be exactly the same as the subject, as they will be adjusted; however, they should be as similar as possible.
The income approach, as mentioned above, is the method buyers and sellers rely upon to make a decision. Buyers and sellers make the market, and appraisers only reflect that market. Participants in the market develop several income approaches in preparation for negotiating a price, because they cannot forecast the future with any degree of certainty. Now, appraisers use the results of buyers and sellers in the sales comparison approach and try to mimic them by developing an income indicator of value based on projections and an industry-based discount rate.
Application of the income approach can be very volatile based on very minor changes in the forecast. Although the income approach is a useful valuation tool, it should be supported by either the cost or sales comparison approach to value.
The cost approach is especially useful for unique property where sales do not exist and an income approach is not possible. This approach develops the current cost of the property being valued, less all forms of depreciation and obsolescence, plus land value. One problem, however, is that the appraiser must be knowledgeable of the industry's economics and technology. Preparing a complete and detailed cost indicator of value is very time consuming, but it produces the most subject-specific detail of any of the three indicators of value.
The most supportable appraisal, a complete appraisal, uses all three indicators of value. In a perfect world, they all support the same value conclusion, or at least a narrow range. All three indicators reflect the market. The market is defined by buyers and sellers: the market for electricity, fuel costs, operating expenses, the current cost of equity and debt, and the market for current construction costs, new technology, and industry economics.
Nuclear plants have not been constructed in the United States for many years, but the current administration supports the construction of new plants. Nuclear plants are environmentally friendly; they do not pollute the air, the water, or the soil. Once the federal government opens the Yucca Mountain long-term used fuel storage facility, the problem of "what to do with spent fuel" finally will be solved. At present, operating plants in need of additional storage are building dry storage facilities to temporarily store used fuel. These large concrete facilities are expensive and contribute little or no value to an operating plant. The federal government, not the nuclear plants, is responsible for long-term fuel storage.
In 2003, the DOE worked to understand the business risks associated with the design, development, and operation of new nuclear plants. The United States Senate plans to reauthorize the Price-Anderson Act, which limits the liability insurance coverage for plant owners.
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