Sunday, October 10, 2010

Unanswered questions about Constellation

What really happened with Calvert Cliffs?

angry seaIn the middle of the night early Saturday Oct 9, long after the stock exchanges had closed, Constellation Energy Group (NYSE:CEG) issued an angry press release that it was walking away from the Calvert Cliffs III nuclear power plant. The utility said the reason was failure to come to terms with the government over the "risk premium" for a loan guarantee for 80% of the $7.2 billion reactor. The rest of the rhetoric sounded more like storm and fury on the Chesapeake Bay than the measured cadence once associates with the environment of a corporate boardroom.

Negotiations had dragged on for months with the government first demanding 12% or $864 million to insure a merchant project. Later the government climbed down from that high number to 5%, or $360 million, which was still way too high. Plus, the government added conditions that made the lower number look like less of a good deal.

By comparison, Southern, which is building two reactors in a regulated environment, reportedly paid less than 2% of the cost of its $8.3 billion loan guarantee. If the risk premium was 1.5%, then the cost of the risk premium was $125 million.

Why wasn't the White House paying attention?

rahm and obamaThe net effect of Constellation's action is that it handed a political hot potato to the Obama administration. Someone in the White House who should be paying attention to the future of the nuclear industry was asleep at the switch, or maybe was distracted by the departure of Rahm Emanuel, the president's chief of staff, who returned to Chicago to run for Mayor.

Meanwhile, the White House also lost the opportunity to help all democrats running for office in the small state of Maryland with an award of the loan guarantee and the 4,000 plus jobs that would be created by the reactor project. That includes the democratic candidate for governor who surely would have appreciated the help at a campaign rally attended by the president last week.

To make matters worse, the same week Constellation smacked OMB with a 2 x 4, the Department of Energy awarded a $1.06 billion loan guarantee to a wind farm in Oregon with none of the heavy handed conditions it sought to impose on the nuclear utility.

From where this blog sits, it looks like in an mid-term election year the Obama administration reverted to type in pursuit of green votes from the Clinton wing of the Democratic party.

What about the other nuclear utilities waiting for loan guarantees?

NRG is building the South Texas Project expansion with two new 1,350 MW ABWR reactors. The good news is the utility has financial support from the export bank in Japan. The reason is reactors are being supplied, and built, by Japanese firms. Also, Japanese nuclear utility TEPCO has indicated, well before the NRC license is in hand, that it will also take a stake in the NRG project.

In South Carolina, Scana says it doesn't need loan guarantees though it has applied for one and is on DOE's short list for award. Also, it has the prospect of new investors in the form of two of the South's biggest utilities.


Duke Energy and Progress have put their plans for a total of four new reactors in North Carolina on hold due to lower demand for electricity. Progress wants a 550 MW slice of the Scana project. It isn't enough electricity demand for a new reactor, but fits nicely as an investor profile into someone else's project.

Waiting in the wings is Luminant's expansion of the Comanche Peak plant with two huge Mitsubishi 1,700 MW APWR reactors to meet growth expectations in Texas. Like NRG, the project may benefit from export financing from the Japanese government.

What was OMB thinking?

Under the arcane federal laws that govern loan guarantees, OMB was mostly doing what it was required to do. The problem is no one at OMB has any direct experience with the nuclear industry or the financial models that make it work. In effect, you have the appearance of a case of nine blind analysts and an elephant.

Trying to make sense out of financing a nuclear reactor at OMB is like trying to repair one of today's high tech cars with a screwdriver and pair of pliers. You need an entirely different tool set and you need hands-on training and experience to do the job right. Did OMB have the right methods for calculating the risk premium?

From here it looks like not only was the agency stuck in bean counting mode, it was doing the work without the benefit of the expertise needed to get to closure on the deal.

Did Constellation have the right to act on its own?

Sarkozy 2nd nuclearProbably not. Electricite de France (EDF) owns 49% of the company and is a state-owned corporation. If EDF was just another stockholder group, lawyers might run up some fees with litigation, but now it's a diplomatic issue.

The reason is Areva, another French state-owned corporation, was slated to supply the reactor for Constellation. This is the flagship project for the entry of the two firms into the U.S. market.

Chopping down the flag pole in the U.S. is going to get a lot of people in Paris really mad. Note that EDF and Areva are still smarting from losing a $20 billion reactor deal in the UAE to South Korea. A major setback in the U.S. is not going to help matters.

U.S. Secretary of State Hillary Clinton may love the green voters her wing of the Democratic party brings to congressional races, but she's going to hate taking a call from her counterpart in France about Constellation's midnight press release.

Did Constellation really walk away?

The short answer is no. The utility did not withdraw its application with DOE. What it could be waiting for is an expected change over on the House side in Congress, and more republican votes in the Senate, which will swing the door open to $25 billion in new loan guarantees for new nuclear reactors along with better terms for merchant plants. It could be July 2011 before such a legislative measure hits the president's desk.

Until then we are going to see all sorts of sad laments about this move by a hot-headed CEO, who may have had political theater more on his mind than stockholder value. It isn’t the end of the nuclear renaissance in the U.S., but it is an ugly turn of events.

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Anonymous said...

The govt will cave & give them everything they want...

"sad laments about this move by a hot-headed CEO" ...that's rich.

Anonymous said...

It's sarcasm.

Meredith Angwin said...

I think CEOs have a right to a little theater.

Seriously, I see this as a tactical move and I expect they will be back at the negotiating table pretty soon.

Bryan Kelly said...

Steny Hoyer, please call your office.

Anonymous said...

Way too much analytical license by the author on this one Dan. You've swallowed the very bait that Constellation wanted you to. It is no coincidence that EdF is in Baltimore right now for the Unistar board meeting. An insider I know there says they very well knew in advance and that the whole event is posturing to get the administration off of the dime.

djysrv said...

Dear "insider",

You need to read the WHOLE blog post. The last sentence says, "a move by a hot-headed CEO, who may have had political theater more on his mind than stockholder value."

Get it, got it, good.

Joffan said...

I'm willing to swallow a little drama from Constellation. What's harder to take is the bone-headedness of the initial loan guarantee fee calculation at 11.6% of capital. That is beyond ridiculous. They'd probably have to take out a loan to pay the damned fee.

I can only assume that the OMB turned their accounting handles and out popped the number - and nobody at the DOE gave it a reality check.

As I have said elsewhere, I trust that the risk calculation has been adjusted specifically to exclude the risks posed by government action or inaction. Otherwise the loan guarantee fee is effectively charging for "insurance" against their own future misdeeds, which is commonly known as extortion.

Anonymous said...

There's something I don't understand. The post says that the OMB was "doing what it had to do" under laws that govern loan guarantees.

Can someone explain to me, then, how they were even allowed to grant a windfarm a loan with no fees at all. It's not that the default risk is zero (or even lower)....

I think I heard something about separate govt. appropriations (subsidies) being used to pay the loan guarantee fee (to satisfy OMB), but I'm still vauge on the details, at best. Whatever it is, is clearly outrageous.

Jim Hopf

djysrv said...

Jim, go back to Constellation's letter (see link in blog post) for their take on the risk premium calculations.