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20/05/2015

Two easy steps to make the nuclear industry competitive

Thomas Talbot, a Sia Partners consultant, wrote an article published in this month's edition of Nuclear Connect. It tackles this question: "How can new nuclear reactors be built without state funding or vendors taking on more unbearable debt?"
 

More nuclear concrete is being poured than in the last 25 years. All poured with state backing and almost all poured in Asia. This is not surprising given the focus on climate change and the need for low carbon energy.

In the OECD however, it is difficult to find a government to fund new nuclear directly. Utilities and vendors are being forced to take on equity stakes funded by debt. This is placing an added burden on the industry, as evident from the recent difficulties at AREVA and Westinghouse. All of which means few reactors will be built in OECD countries even with closures of gas and coal plants and low carbon targets.

How can new nuclear reactors be built without state funding or vendors taking on more unbearable debt? Nuclear vendors must develop new designs attractive to private investors.

Nuclear is a capital intensive industry

Nuclear reactors are expensive. To build they are over three times as expensive as a gas plant and twice as expensive as a coal plant according to the EIA. The economics don't stack up as we've seen in Texas where several proposed projects are on hold. None of the nuclear concrete poured is for merchant reactors funded on the open market.

Safety has increased and capacity has increased, but designs stay the same. Capital costs have also increased. This is acceptable in the economic effervescence of a state run industry but not acceptable to an investor. The nuclear industry, raised with state backing, has had no need to adapt to capital markets.

The nuclear industry cannot rely on government funding, direct or otherwise to build new reactors. To survive and thrive the nuclear industry must develop more modular designs that are less expensive and can be financed one small unit at a time. This way the earlier units generate revenue to pay back the investment ready for further units.

New designs must adapt to the wider energy market. This will mean returns for investors, higher returns for vendors and more nuclear plants.

All thriving capital intensive industries adapt to stay attractive to capital markets

The nuclear industry is not the only capital intensive industry. Oil and gas projects can be as large as those in the nuclear industry but they are always funded by open capital markets.

In the oil and gas industry, where project finance started and matured, competition has caused constant adaption to stay attractive to investors. High oil prices led to predictions of the end of cheap oil and the infamous prediction of "peak oil": the end of fossil fuels. Instead the US oil and gas industry used the high prices to fund new production methods on the open capital markets. Methods that allowed US crude oil production to continue and surpass imports for the first time since 1992.

Now oil benchmarks have fallen in response to this increased production. Again there is adaption as US companies lower production costs to stay competitive with the Middle East. In this fashion the industry has produced good returns for investors and the procession of a profitable industry. By adapting to stay attractive to capital markets, the oil and gas industry has continued to thrive where otherwise it may have stagnated.

This is a guide for how the nuclear industry can adapt and thrive by attracting investors on open capital markets. If it adapts it will bring about a new generation of merchant nuclear plants. A suitably designed and financed new build nuclear plant is an ideal investment for energy sector investors.

The two easy steps to a competitive nuclear industry

Step 1: The nuclear industry must develop projects attractive to investors. Projects must spread capital investment and projects must generate revenue faster.

Current nuclear reactors need one large capital investment and decades to see a return. This is not acceptable to investors. Projects must reduce or stagger the capital investment and generate revenue faster. Modular designs do this by allowing small reactors to be financed and built one by one, with the earlier unit generating revenue for the next. So debt coverage can be tailored to the investors.

The finance for nuclear projects must be divided into smaller investments that will not swamp single investors. Different investors have different appetites. Infrastructure funds are happy to spend large amounts on single assets if the asset is judged to call for it. Others such as pension funds are less willing to take on large risks and are often limited to invest less than 10% of their fund at any one time.

Step 2: Risk must be reduced. Reduced risk gives more certainty and so more finance for nuclear projects.

With the exception of some replacements there will be no new reactors if they continue to be built over time and budget. This increases the investment and delays the return. The oil and gas sector which developed and matured the project finance industry also has cost overruns. Investors still invest there because they understand the risk there. The nuclear industry is an unknown.

Nuclear vendors and manufacturers should meet with investors at an early stage of project design. Questions about purpose and application of the project need to be agreed. Investors need reassurance about the reliability of the project. The capital plan must also be agreed to suit everyone. Vendors need the money to begin work and investors need to know they will get their return.

Investors need to realise there are opportunities for a reliable return. There is apprehension of the unknown and the nuclear industry is perceived as closed.
Governments who have shepherded the nuclear industry need to ease interactions between vendors and investors. Swings in government policy create risks. Clear and stable market legislation will ensure a liquid nuclear capital markets.

These steps will create new nuclear capital markets that fund a new generation of nuclear plants

The demand for investment in the energy industry is high. I advise investment firms looking for strong but reliable returns. There are investors who are cash rich and don't have to raise debt to fund their acquisitions. Individual investments in the order of billions of pounds are common for energy assets that guarantee a reliable return. Investors team up to invest in opportunities that are too large for them to fund themselves.

As more investors are attracted and liquidity increases in these new nuclear capital markets, initial investors will be able to sell their stakes into secondary markets. This will reduce their risk and the cost of capital for the nuclear vendor.

By working with energy sector investors, a new generation of nuclear power and decommissioning plants can be built to ensure good returns for vendors and investors and to help governments to meet low carbon power generation targets.

Sia Partners - Thomas Talbot

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