Proposal for a Revolving Endowment Fund to Assist the Introduction of Nuclear Power Technology in a Deregulated Electrical Market

John H. Walsh
Energy Advisor

This note was tabled for discussion purposes at the Annual General Meeting of the Canadian Association for the Club of Rome of June 5, 2001.

This paper considers the problem of introducing new nuclear capacity in a deregulated electrical industry environment given the rise of rapidly-constructed low first-cost combined-cycle generation facilities based upon gas turbines fuelled with natural gas. It begins with a consideration of some characteristics of the electrical network that may not have been fully realized by those who implemented the policy of deregulation. A Revolving Endowment Fund is then proposed which would be replenished over time by the recovery of the extra investment required to overcome the first-cost problem after the reactors enter service. This procedure is applicable to any technology with low operating costs and a long life span such as possibly solar collector panels. A deregulated electrical power scheme has the important advantage of providing a path for the introduction of the `green' generation technologies whose energy some purchasers may well prefer though more costly than power generated by conventional means. It is even possible nuclear power would benefit by personal choices made the same way if a difficult and obvious problem with carbon dioxide materializes. Deregulation of power generation in effect allows such choices to be made.

There are three characteristics of the electrical network important when such systems are to be deregulated. First, there are only very limited means available to store electrical energy and consequently effectively no inventories exist to smooth short-term supply/demand imbalances. Second, the network is a classic example of a command-and- control system in that there has to be centralized management of its operation on a second-by-second basis. Third, the most expensive electricity is the energy one does not have. Electricity is also unique in that it may not be improved as such: electricity is electricity and this will be true any time in the future. The analogy may be to the comparison of methanol with gasoline: the composition of methanol as a chemical compound is fixed whereas that of gasoline may be varied to suite circumstances.

It is possible to off-set the lack of means to store power to some degree by such techniques as, for example, in the hydroelectric branch of the industry, by releasing water only during periods of peak demand with the object of selling this energy at higher prices and then replacing it with purchases during periods of low demand at lower prices. However, such practices are only feasible in a few cases.

Deregulation regimes generally depend upon the response of independent power producers to market forces to install new capacity. This procedure has in effect removed the responsibility of planning for the longer-term from the network system operators. In this situation, the choice of shorter-term options is encouraged in the industry because the market will select the technology for generation that appears cheapest at the time. (One other recent consequence of short-termism has been the marked reduction in the commitment to longer-term research and development by the electric power industry. In a truly competitive market, no single player can engage in expensive activities of this kind in the longer-term if his competitors do not.) Finally, an independent power producer operating gas-fired combined-cycle plants can outbid most other consumers of natural gas because this cost may almost always be recovered in the much higher price for power obtaining during periods of electrical crisis. Because the electrical system is prone to price `spiking,' this characteristic behaviour will spread to the natural gas market as the reliance on natural gas for generation increases.

For these reasons, there is a need for a stabilizing technology whose costs, once built and operating, are not greatly affected by prevailing economic conditions. The object is to dampen price spikes and to prevent them from spreading to other sectors of the economy. Hydroelectric generation plays this role in much of Canada as does nuclear generation in Ontario. This paper was prepared to illuminate this question.

In recent years, particularly in the U.S., it is becoming evident that the life of existing nuclear reactors will be extended well beyond what was originally expected. Nuclear facilities are becoming a long-lived technology in much the way that hydroelectric installations are now. That this life extension is advantageous may be seen in the recently reported actual costs of the roster of 103 active reactors in the U.S. For the group in the top quartile, operating (non-capital) costs for the last three years were found to be a remarkably low 1.5 cents (US)/kWH, and, for the industry as a whole, the operating costs averaged 1.8 cents (US)/kWH. In Canada, the then President of Atomic Energy of Canada placed CANDU operating costs at 2.2 cents (Can)/kWH three years ago. (R. Morden, in discussion at the 19th Canadian Energy Forum, Niagara-on-the-Lake, Ontario 21/23 September 1997.) Even lower costs are characteristic of long-lived hydroelectric power installations. There are many aging hydroelectric installations around the world including one at the Chaudière Falls in Ottawa that is now some eighty years old.

It is the fundamental contention of this note that the combination of long-life and low continuing cost (operating plus maintenance) of these technologies are not adequately taken into account when a project is contemplated because of the failure of discounting calculations to value long-range income streams adequately. This is the main difficulty that has impeded investment in new nuclear facilities. In this situation there is every incentive to continue to operate a reactor that has already been built but little to build it in the first place. In Canada, some shut-down reactors in Ontario are to be returned to service because, even after taking into account the additional costs of the new start-up, the results are still favourable compared to other choices.

For the near-term future, the main competitive alternative to nuclear power in most regions for base load operation is combined-cycle facilities based upon gas turbines fuelled with natural gas. Given a unit investment of about $600/kWH for such units as compared with $2000/kWH for nuclear installations, a 15% total return to capital, and prevailing natural gas and uranium prices, the endowment required for nuclear generation to be equivalent in present value terms is of the order $700/kWH (or $700 million for a typical one gigawatt reactor). Once the reactor is operating, however, it is quite possible some $70-100 million could be returned to the proposed fund each year without diminishing competitive advantage greatly. A period of a little over a decade would thus be needed to replenish the Fund for each endowment given prevailing rates of interest. This `tax' for the return of funds might be of the order of one cent/kWH. Even with this amount added, the marginal cost may still be below other options. If not, the amortization time would have to be lengthened. The income stream returning to the Revolving Fund would then support the building of another reactor.

The Revolving Endowment Fund might be financed in its initial phase by a proposal by the well-known energy expert, Philip K. Verleger Jr., who has criticized the new U.S. National Energy Policy Plan for its lack of boldness (New York Times, 20 May 2001). He calls for more rapid deregulation of the U.S. electrical system accompanied by an excess profits tax to discourage independent power producers from engaging in practices that lead to excessive price spiking. In an American context, the proceeds of such a tax could be a possible source of starting capital for the Revolving Endowment Fund. There is also the possibility of novel financial instruments being developed for this purpose in the private sector.

In France, in a non-deregulated market, the high nuclear penetration (about 78% of total generation) was supported by direct investment derived from public funds. The benefits over time accrue directly to the consuming public presumably in lower electrical costs than otherwise. This practice has the advantage of simplicity but does not necessarily encourage efficiency. In the procedure recommended here, there would be competition for access to the Revolving Endowment Fund. Other things being equal, the successful bidder would be the one who required the least investment from the Fund per unit of energy produced. Such an approach encourages efficiency not only in the physical aspects of the construction of the project but in the financial arrangements as well.

The justification of some measure of public support for such a fund comes from a consideration of the `free-rider' problem. If there are in fact economic and environmental benefits arising from deregulation of the electrical system, then there is merit in supporting a measure that is aimed at overcoming its main disadvantages. The benefits accrue to everybody and so there is public interest in assuring its success.

A Revolving Endowment Fund is applicable to any technology with low operating cost and long service life. It is possible solar panels and some other renewable technologies could be introduced more rapidly with the aid of such measures. Without some way of overcoming the first cost problem, such as the proposed Fund, it is difficult to see the future for nuclear power and some renewable technologies in an era of deregulation of the electrical system. Without nuclear and other means of generation, there will be a crisis in the North American natural gas system at some time in the future whose consequences should not be minimized.

June 2001
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