Friday, February 11, 2011

USEC, on Fiscal Tightrope, Assesses Risks, Opportunities

What does DOE want in return for a loan guarantee?

This is my coverage, as published, by Fuel Cycle Week V10:N410 of 2/3/11; International Nuclear Associates, Washington, DC.

prudent investorFinancially challenged USEC (NYSE:USU) could succeed in building the new American Centrifuge Plant (ACP) by 2015, if all of the unresolved financial and technological issues break in their favor.

But many uncertainties remain in how risks and opportunities (or “catalysts” in Wall Street lingo) will play out— and now even more “what-ifs” have arisen that could hold down investor interest in the company.

So said Paul Clegg, a clean-energy analyst at Mizuho Securities USA in New York, who told FCW this week that it was “very probable that the multibillion project will be a commercial success.” Still, Clegg’s investment recommendation is “neutral,” and he pegs USEC’s share price at $6.00. The stock closed Jan 31 at $5.55 against a 52-week range of $3.90-$6.50, with market capitalization of $641 million. (Update 2/11/11 – the stock closed at $5.85)

The biggest challenge for USEC is access to the daunting amount of capital needed to build the new enrichment plant. The capital requirement dwarfs a recent commitment of $200 million by Toshiba and Babcock & Wilcox ($100 million each) for a 30% share in the firm. USEC has already spent $1.9 billion against a total projected cost of about $5 billion, making it necessary to raise $2.8 billion in a relatively short period of time, if the plant is to achieve its financial and production goals by 2013.

Holding Down Costs While Boosting Revenue

USEC is pinning its hopes on a $2 billion federal loan guarantee and a $600 million loan from the Japanese Export Credit Agency. Currently the company is negotiating the terms of the loan guarantee with the U.S. Department of Energy. Clegg estimates the cost of the credit risk premium “in the low single digits,” noting that a 2.5% charge, which would add about $50 million to the total project cost, is probably acceptable to USEC.

By contrast, DOE was reportedly discussing much higher credit fees with Constellation Energy for its Calvert Cliffs project last summer. On Oct. 9 Constellation quit the negotiations and the new-build project, alleging that DOE had demanded a “shockingly high” fee of 11.6%; DOE denied that the fee under discussion had been so high (FCW #397, Oct. 14).

DOE might also require that USEC thicken its book of contract commitments for enrichment services. On its website USEC claims to have a backlog of $3.1 billion in enrichment service contracts lined up. But industry experts have told FCW that those commitments likely have “walk-away” provisions if the plant is not built or is significantly delayed beyond 2013, the last year of the Megatons-to-Megawatts program, which has supplied USEC with down blended HEU from Russia at a steep discount.

The $600 million USEC is seeking from Japan is contingent on getting a $2 billion conditional loan guarantee from DOE, but the government decision doesn’t guarantee that investors will line up to provide USEC with the $2 billion.

The 2013 deadline is of course essential because it is the last year of the HEU deal. In anticipation of losing this key source of revenue, USEC recently announced that it was examining a proposal to re-enrich UF6 tails from DOE’s excess uranium inventory, currently stored in cylinders at its Paducah, Ken. gaseous diffusion plant. It would then sell the material into the market at a profit (FCW #408, Jan. 20).

But the potential contribution of these sales to the bottom line is speculative at best at this point. That’s why the other capital requirements for the ACP loom so large.

Paul Jacobson, vice president for communications at USEC, told FCW there are specific elements of DOE’s due diligence that USEC must meet in order to secure a favorable decision.

“We will need to demonstrate that sufficient capital is available to complete the project,” said Jacobson. “We have initiated discussions with Japanese export credit agencies regarding financing a portion of the cost of building the plant. However, we have no assurance that they will…provide the financing needed and on what terms.”

Not All Bad News

Mizuho’s Clegg estimates that the total cost will include $200 million in overruns, raising total spending, prior and future, to $5 billion. This would make the ACP the most expensive centrifuge project in U.S. history. No wonder he advises investors to take a careful look at USEC before buying in. Still, he believes that despite the cost, the plant can be a commercial success. By comparison, AREVA’s Eagle Rock Enrichment Plant in Idaho Falls, with its 3 million SWU capacity, is projected to cost half that amount.

But Clegg also noted that cash flow from contract commitments during the first ten years of operation would boost investor confidence. If DOE were to grant the loan guarantee, funding from investors could be in hand to remobilize construction activity by yearend.

Clegg agreed with industry estimates that total domestic demand for enriched uranium by 2013 will be about 13.5 million SWU. This would exceed projected U.S. production capacity of 12 million SWU by 2014.

The Russian uranium enrichment firm Tenex could easily take up the slack—and could compete successfully for contracts to supply SWU for the small number of initial cores to new U.S. reactors now slated for construction, Clegg told FCW. At this point there are only four. Southern Co. is planning to install two AP1000 reactors at the Vogtle site near Augusta, Georgia, while South Carolina Electric and Gas Co. is moving forward on two more at the Summer plant in South Carolina, which it plans to build regardless of whether it gets a DOE loan guarantee (FCW #398, Oct. 21).

But USEC has some things going for it. One is Toshiba’s potential involvement, which is contingent on DOE awarding a loan guarantee. Toshiba would take a long-term equity position in USEC specifically to ensure it has fuel for the cores of those Westinghouse reactors.

Reactors falling by the wayside

The tight economy has led utilities to shelve or delay their plans for six other AP1000s. Florida Power & Light has pushed back the construction of two more AP1000s at least a decade. TVA also mothballed its license applications for two AP1000s at the Bellefonte plant at Scottsboro, Ala., instead electing to complete a partially built unit there.

Units planned in North Carolina, South Carolina, and Florida, by Duke Energy and Progress Energy, had also gone by the boards, but a proposed merger of the two companies may produce a combined rate base large enough to revive one or more of these projects. Toshiba has also signed a contract with NRG to build two GEHitachi ABWRs at the South Texas Project. By press time NRG had not responded to an FCW inquiry about where the cores would come from.

Another item that could draw investment is the ACP technology itself. USEC’s centrifuges stand 40 feet tall and can produce 350 SWU per year 50 SWU per year. By comparison, other gas centrifuges are seven to ten feet tall and annually produce about 45 SWU.

Although the technology could be extremely productive, each bank of centrifuges requires a great deal of capital to assemble, so that once they begin generating revenue, it takes longer to pay off the upfront costs, compared to conventional centrifuges. That means USEC will need longer to add new increments of centrifuges in the early stages of plant operations.

In short, USEC executives will have a lot of challenges—and opportunities— in managing several discontinuous vectors in their business plan. If they succeed, the ACP will be the first American owned uranium enrichment plant, with American technology, even if it also turns out to be the most expensive one ever built.

How Much More Contract Volume Does USEC Need?

Paul Clegg, a clean-energy analyst with Mizujo Securities, told FCW that the Department of Energy could ask USEC to line up more contracts than the $3.1 billion’s worth it claims on the company website. But how much is enough?

Clegg did not offer a number, but a look at USEC’s capital resources and likely requirements yields some clues. Assuming USEC gets the DOE loan guarantee and thereby gains access to $600 million from the Japanese Export Bank, that is about $2.6 billion. Clegg estimates that the project will have a $200 million in cost overruns associated with building a new enrichment plant with first-of-a-kind 40-foot high centrifuge. It would presumably seek other investment to cover those costs.

This means the volume of new contracts over a hypothetical ten year payback period must generate enough revenue to pay off riskier—and therefore higher interest—loans from the Japanese bank and the new investors. The reason these are higher risk is that their investment is not covered by the loan guarantee.

Assuming that it paid off the loans over ten years at an interest rate of 6%, USEC would need to gain about $106 million annually in new profits after production expenses, to cover these loan payments.* If business is good, USEC might be able to negotiate an early payoff.

This estimate is pure speculation, because USEC’s margins are unknown, and the new centrifuge technology has no track record of commercial performance.

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*Ten years at 6% yields annual payments of $106.5 million, an aggregate of $1.065 billion. With $800 million borrowed, the loan cost comes to $206.5 million.

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