Nuclear renaissance faces a big challenge

Globe and Mail: OXFORD ANALYTICA - January 12, 2009

SUBJECT: The outlook for nuclear power.

SIGNIFICANCE: Increases in the cost of borrowing and the availability of credit represent a major challenge for the nuclear industry.

ANALYSIS: A so-called nuclear renaissance has been under way for some years now. It has taken three broad forms, namely: the predominantly state-led and financed continuation of nuclear construction in countries with an existing industry, such as South Korea, China, India and Russia; renewed support for nuclear power in countries that have existing industries but that have not seen any newbuild in decades, the most notable in this regard being the United Kingdom and United States; and a host of potential newcomers to the nuclear market, the most substantial groups being emerging economies in Asia and the Middle East.

However, in practice, outside countries where nuclear is state-subsidized and driven by government-set targets, new nuclear is making little progress, despite increasingly supportive policy environments. Moreover, the financial crisis is having various impacts on the industry, the most critical of which is likely to be the increased cost of capital.

Nuclear finance. Increased borrowing costs are likely to more than outweigh the impact of the decline in basic commodity prices. Even if central bank rates have fallen, the cost of project finance has not. For project financiers working in energy, wind, solar or natural gas-fired plants, remain much safer investments than nuclear. Smaller-scale projects also suit the current conservatism in project lending.

On the other hand, governments, faced with recession, are committing themselves to a huge range of public spending initiatives, and promotion of so-called green jobs', which are undermining previous commitments not to engage in forms of state aid. A lack of bank lending is also pushing borrowers towards state banks, export-import banks and multilaterals. Both these trends could benefit nuclear, as governments become more amenable to providing the cheap finance that new nuclear requires. As such, the financial crisis may increase the chances of state support for new nuclear.

Construction costs. Materials costs are likely to fall, which would benefit overall construction costs and the amount of capital needed, serving to mitigate the upward spiral evident in recent cost estimates for nuclear newbuild. For example, a nuclear plant uses about three times more steel in its construction per mega-watt installed than a coal plant. However, the supply chain for nuclear plants will remain tight, both in terms of an aging work force and limited manufacturing capacity, with some severe bottlenecks in areas such as ultra heavy forgings and steam generation tubing.

Of the five new reactors being offered to western markets, only one Toshiba's Advanced Boiling Water Reactor has a track record of construction, while Areva's European Pressurized Water Reactor and Mitsubishi's Advanced Pressure Water Reactor are under construction. Westinghouse's AP1000 and GE-Hitachi's Economic Simplified Boiling Water Reactor both employ passive safety mechanisms that have not yet been incorporated in a nuclear plant anywhere, thus providing an additional layer of first-of-a-kind' technological risk, though they promise lower costs over the reactor's full life.

New demand outlook. Projections for increases in power demand are being revised in the light of an expected severe recession in the OECD and slower growth among developing countries. Power demand may contract in some OECD economies in 2009, and there is already evidence, for example, in Spain and the Netherlands, that this might indeed be the case.

In the OECD, the impact of lower energy prices should not affect new nuclear given little newbuild is expected to be commissioned before 2017 at the earliest. The long-term outlook remains one in which energy demand continues to grow. Among developing economies, the pace of power demand growth should negate the risk of insufficient demand upon completion.

However, nuclear plants are price takers in electricity markets, as they have to run at as near to full capacity as possible. This means that even when the wholesale price of electricity falls below their cost of production which is largely set by construction cost and financing terms they continue to produce at a loss. Should existing nuclear installations find themselves in this situation as economic activity slackens, it will again highlight a risk that has previously sent nuclear operators to the wall, and will dampen any enthusiasm for new investment in the industry.

Solid drivers. Nevertheless, the nuclear renaissance is based on solid foundations: Nuclear is a proven low-carbon technology. Concern over greenhouse gas emissions has been a major factor behind the revival of interest in nuclear. Although considerable concern remains about the long-term storage of radioactive waste, the gain in terms of low emissions has dampened environmental and public opposition to the industry.

Nuclear is seen as improving a country's security of supply, which may be attractive given the current gas crisis in Europe. It provides an alternative to traditional hydrocarbon imports, but it is usually still dependent on an externally-supplied fuel. For many countries, nuclear represents primarily a diversification of the energy mix, which reduces dependence on the hydrocarbon complex.

Nuclear delivers large-scale baseload power to national grids, making it attractive to countries with large expected increases in electricity demand, such as China and India. It also offers the possibility of developing a lucrative export industry, through the export of plants to countries without the capacity to build them.

As a result of these factors, the European Commission, International Energy Agency and governments in many parts of the world have accepted the need for nuclear power stations as an essential part of the policy mix capable of delivering a low carbon power-generating sector. Not least is the fact that as older nuclear units reach the end of their lives, there is a need to replace their generation capacity. Emissions targets being set by the EU and other countries fall particularly hard on the power sector and are already challenging. Phasing out a major low-carbon power source at the same time as trying to meet emissions targets appears to be illogical.

Eastern growth. Nevertheless, the main new nuclear building programs are taking place in China, Russian and India all countries where the government has mandated targets and is building new units through state-owned companies. In addition, South Korea and Japan, which are already heavily dependent on both nuclear power and imported fuels, have major construction programs. In South Korea, all of the country's nuclear reactors are owned by a subsidiary of the state-owned Korea Electric Power Corporation. By contrast, only two nuclear plants are under construction in Western Europe and none in the United States.

It would appear that the risks associated with new nuclear in liberalized, or liberalizing, markets are too high to attract capital at a price that makes new nuclear viable. Without additional state support, new nuclear will have to be built from existing utility revenue streams, which in some cases could damage credit ratings.

CONCLUSION: Meeting both emissions and supply security goals will be difficult, if not impossible, if an established low-carbon base-load technology like nuclear is ignored. However, newbuild does not look viable in current market conditions. State support is needed and may be more forthcoming from governments faced with recession.

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