The economic future of nuclear power in competitive markets

Most of the world’s electricity markets are now moving towards greater competition, driven in part by technology, and in part by experience that competitive markets are more self-sustaining. Increased competition has generally led to a downward tendency in the price of electricity generation when compared to prices received under more protected and monopolistic market structures.

This is true both in markets where demand is stagnant and where it is growing. Power companies increasingly need a commercial, profit-oriented approach to doing business if they are to survive and prosper. Freed from their traditional regulated and social monopoly status, they will focus on supply technologies that are low cost and low risk, and hence more profitable in a competitive market. Off-the-rack instead of tailor made plants and equipment will be the fashion, and rapid, high and secure returns more of a requirement. Even more, generators will need to make substantial cost reductions over the next few years. In general, nuclear power has the potential to be a competitive contender but realising that potential will require significant changes in the way the industry and its regulators do business.

Existing Plants

Nuclear power plants already built have generally fared well in restructured markets. The operating costs of nuclear power plants, including fuel costs, are usually lower than for most other major power generation alternatives, with the exception of hydroelectricity. Capital is largely depreciated and a plant with operating and maintenance costs (O&M) below market prices turns in a profit. In 1999, the most efficient plants saw costs of around US$ 0.011 per kWh. Moreover, the cost trend is still downward leading to optimistic anticipation that even lower operating costs are possible in the near future. Similar low and declining operating costs are experienced in other economies.

But while more than half the nuclear sites in the USA are considered competitive in changing markets, with two-thirds of the units producing power for under US$ 0.02 per kWh, yet others have costs of US$ 0.06–0.13 per kWh. In the United Kingdom, each of British Energy’s eight privatized nuclear stations sells power profitably at competitive market prices (an average of around US$ 0.03 per kWh), while the Magnox plants assigned to BNFL are still producing at about US$ 0.05 per kWh, or are being closed as uneconomic before the end of their design lifetime.

For nuclear plants, the ability to compete depends on cutting unit costs (especially operating and maintenance costs) without compromising safety, and on increasing plant availability. The importance of good management is emphasized for two reasons. First, a commercial and competitive management approach is new to many electricity and nuclear industry managers, and so bears mention. Second, good management can make a telling difference in the bottom line.

Almost all nuclear plants that are now competitive have made significant if not dramatic improvements over the past decade in their availability, and significant if not dramatic cost reductions. Well managed nuclear plants now enjoy a cost advantage over many other generators but as the average cost of all generation inches lower, operators of nuclear plants will have less of a cost advantage. As net cash flow margins converge under competition, nuclear operators will need to reduce their costs and increase their margins even further to survive.

In this regard, cost-effective safety regulation is crucial to the continued profitability of existing nuclear power plants. Maintaining high levels of safety is non-negotiable for nuclear plant operators, but the cost of safety compliance, along with other operating costs and on-going capital expenditures, will be a significant factor in management decisions about plant operations.

Spending more money on safety does not necessarily make a plant safer, just as cutting costs does not necessarily make a plant more unsafe. In the USA and the UK, there is a close correlation between nuclear power plants with high efficiencies and those with a high safety performance (see Figure 1). Those commercial plants with the best safety ratings also had the highest availability and the lowest operating cost.

Figure 1: Relationship between Unit Cost of Production of US Nuclear Plants and Regulatory Performance.

Unfinished Plants and Life Extensions

The aging of the world’s nuclear power park and the potential for lifetime extension are matters of considerable current interest that need to be evaluated objectively. Completion of unfinished nuclear power plants, or extending the life of a successful one, can be an economically attractive and practical alternative to building a new plant or to decommissioning an old one.

A decision on project completion, relicensing or life extension of an operating NPP is a comparison of only three elements: net present value (NPV) of the cost of completion versus the NPV of the anticipated future revenue stream from the completed project (generating revenue minus costs, discounted over the amortisation period for the plant), versus the cost of plant closure or stopping construction.

Project Completion

It is a trap to think of the current status of a project is a basis for deciding on its completion. A plant that is 90% complete does not necessarily have only 10% of its costs unpaid. The remaining investment cost could be less and very frequently is much more, perhaps even more than the anticipated revenues from the completed plant. The revenue side of the NPV equation is also independent of the per cent completion of the NPP, except in the timing of revenue receipts, which is also key to decisions on future investment.

One curious note: Shutting down a construction project is potentially expensive, as most construction contracts have cancellation costs or penalties if a project is terminated. Completing the project at a loss may be cheaper than closing down the project. In these cases, it makes economic sense to complete the project.

Lifetime Extension

There are several major benefits to lifetime extensions over the building of new plants. One assumes that operating costs are already low or else extension would not be considered. The plant’s decommissioning fund obligations should also be fully satisfied, further reducing operating costs. Investment costs for lifetime extension, while not trivial, are likely to be only a fraction of the cost of a new plant. Life extension can also be attractive for environmental reasons in regions where compliance with air pollution standards or commitments to greenhouse gas emissions reductions argue against increased use of fossil-fuel fired generation. Such plants usually carry little debt, being largely amortized by the time of renewal, and already have a revenue stream attached to assure repayment of any financial obligations incurred for the relicensing or life extension. A lifetime or license extension can also result in the effective addition of new capacity.

Safety Upgrade

Safety upgrades may be required for a number of reasons and may or may not result in increased efficiency or may, in fact, carry efficiency penalties. Owners faced with safety upgrades could face investments they cannot expect to amortize over the extended life of the plant. Moreover, plants with insufficient cash flow simply cannot finance needed upgrades, no matter how closely these might be linked to safety concerns. If continued regulatory approval for the operation of the plant hinges on the upgrade, the cost of such investments needs to be weighed both against expected revenues and against the cost of closing the plant.

New Plants

New NPPs can cost 2–4 times more to build than fossil-fueled plants. Investment in a nuclear plant would require well over twenty years to repay. Competitive capital markets would require a higher return on investment to justify these longer-term risks.

Generating costs have fallen from US$0.043 per kWh in 1995 to US$0.03 per kWh by 1998. The average is now around US$0.02 and likely to fall further. This decline in generating costs did not just result from competition, but also from low fuel prices and from significant improvements in efficiency in the use of coal and gas. The thermal efficiency of gas use has risen to well over fifty percent with promises of further improvements. Low cost and high efficiency will therefore be essential characteristics of any plants to be built in the future, and non-nuclear technologies are developing rapidly in this direction.

Since investors in new generating plants have no sunk costs and are free to choose at the outset the fuel, technology, site, plant design, financing operations and risk allocation that suits them best, they will tend to opt for the highest-return, least-risk alternative. Unless the nuclear industry takes dramatic action to reduce capital costs and financial risks for new nuclear plants, nuclear power could well be priced out of the market, even where it offers other significant advantages.

Figure 2: Average electricity generation cost structure for nuclear, coal-fired and natural gas combined cycle plants, 10% discount rate and 25 year planning horizon. Source: Adapted from OECD, 1998.

Capital Costs and Risks

High capital costs are the largest single barrier to financing and building new nuclear plants, accounting for some 70% of total generating costs of new nuclear plant (see Figure 2). Under current estimates these capital costs would need to be reduced by some 35%-50% before new nuclear plants can compete with new coal and gas fired generating technologies. Certainly such reductions are possible, but would require a number of measures, including reactor designs that are tailored to market needs at competitive prices and that reduce the cost of enhanced safety, and reducing the uncertainties associated with regulation and with post-operational liabilities.

New nuclear plants are sometimes divided into evolutionary and innovative designs. Evolutionary designs can be defined as those not requiring a prototype for development and are generally understood to include incremental improvements on existing designs or technologies. Innovative designs, defined as those which may require a prototype for demonstration, offer perhaps a greater potential for competitive advances, primarily because they can be designed explicitly for current and future market conditions. Yet with the exception of the development of the Pebble Bed Modular Reactor (PBMR) in South Africa, and the Advanced Light Water Reactor (ALWR) in the USA, no advanced reactor development has identified as its primary goal a commercially competitive reactor that will meet and beat prevailing market prices, with increased efficiency, profitability and performance, as well as enhanced safety. The development of most advanced reactor designs, prompted by the TMI accident, focus on enhanced safety, but with a cost premium.

New nuclear plants also have high financial risks that are not necessarily unique to nuclear power. Uncertainties, risks and liabilities are economically significant because they carry a cost, sometimes high, that can be reduced or managed more or less. They in fact have tipped the balance in some of the recent decisions to shut down operating plants in the U.S. before their operating licenses have expired. Therefore, reducing financial uncertainties will be just as important as reducing nominal costs.

Cost-Effective Safety

Improving the cost-effectiveness of safety-related investments can contribute to the financeability of new plants. While the share of safety costs as a percent of total costs for a new NPP cannot be determined with any precision, some estimates range up to 40-60%.

There are a number of approaches being explored to reduce the costs of enhanced safety in new reactor designs, many of which include making a standard of no significant off-site consequences even under worst-case accident scenarios (instead of specifying a number of individual performance requirements and regulations).

The safety risks associated with current nuclear plants have already been reduced to very low levels, while the financial risks associated with building new nuclear power plants are large and growing. Some sense of economic proportion needs to be defined.

This question of diminishing returns is not unique to nuclear safety, but in fact governs most environmental and health protection standards. It must be unequivocally stated that the level of safety-related expenditures is not a measure of a plant’s safety level. What has to be accomplished is to reduce safety costs while not compromising safety.

Managing Liabilities for Decommissioning and Waste Disposal

Post-operational liabilities, namely the costs and risks associated with NPP decommissioning and waste and spent fuel disposal, are perhaps, after capital costs, the second most important impediment to financing new nuclear plants. The engineering plans and cost estimates for decommissioning and waste disposal have been thoroughly researched and are regularly updated. Nonetheless, present cost estimates will surely differ from the costs ultimately incurred, because the circumstances on which these costs are predicated will surely change. What will matter in the end is not so much the precision of relevant engineering cost estimates, but how a company is prepared to deal with unanticipated change.

Most of the nuclear industry is not well equipped to deal with the uncertainties that surround their post-operation activities. As a result, significant economic costs and inefficiencies are likely to be incurred by the industry and by society, and the financial risks associated with these post-closing operations can grow rapidly unchecked. The focus should be on prudence rather than foresight, and on the possible financial provisions for uncertainties in post-closing costs for nuclear power plants. The choice of how expensive and how efficient decommissioning and waste disposal will be is largely political.

Nuclear Power and Public Policy

Nuclear power does offer clear advantages when it comes to public policy considerations about energy supply security and diversification, health and environmental protection (external costs) including significant greenhouse gas mitigation benefits.

Supply Security: Because of nuclear power’s low-volume fuel requirements per unit of electricity, nuclear power offers a definite level of energy security, which may be especially important in countries with high degree of energy import dependence.

External costs:Nuclear power generates minimal air pollution, making it an attractive alternative to mitigate the adverse health and environmental impacts caused by particulates, acid rain precursors or greenhouse gas (GHG) emissions. The ability to offset external cost advantages against the higher capital costs of nuclear power will depend on the willingness of environmental regulators to force the internalisation of the externalities associated with fossil fuel combustion.

Reduction of Greenhouse Gas Emissions: In the short-to-medium term, there is no economic alternative to nuclear power as a GHG mitigation option for baseload electricity generation.

Note that each of these "benefits" of nuclear power is defined by government policy, and so their importance will vary as policies change. Where governments still choose technologies, nuclear might be chosen to satisfy any number of public policy objectives.

Closing

So what is the economic future of nuclear power? Existing plants, where efficient, can be expected to thrive. Few new plants are being built and fewer can be expected unless the nuclear industry initiates clear and strong measures to change dramatically, and policy makers are ready to drastically change its regulatory context. Key to such changes will be a strong focus on cost-effective safety, on liabilities management and on innovative and competitive nuclear technologies. Finally, policy makers will have to address the question of waste disposal, and be willing to let the industry demonstrate the availability of appropriate and sufficient technology to manage nuclear waste. Such a demonstration is essential to establishing informed public perceptions about the safety of nuclear waste disposal as an industrial process.

The contents of this paper reflect the views of the authors and not the views of the International Atomic Energy Agency (IAEA) or its Member States.