Geoff Rothwell is a fellow at

Stanford Universify’s Cenferfor Economic Policy Research. He wishes

to thank Jim Hewleft, ]im Lewis, Ed Kahn, Don Kern, Dan Nikodem and

Bob Wood for their helpful comments. Earlier versions of this article were

presented at the conferences “Nuclear

Decommissioning Trusts,” New York, N.Y., Nov. 18-19, 1996, organized by

International Business

Communications; and “Nuclear Power in the Competitive Era,”

Washington, D.C., Jan. 30-31, 1997,

organized by Infocast. This work has been done under contract to the

Department of Energy’s Energy

Information Administration.

Opinions expressed are those of the

author and do not necessary reflect positions of the Department of Energy

or the Energy Information Administration.

L August/September 1997

Continued Operation or Closure: The Net Present Value of Nuclear Power Plants

This article offers a simple method for calculating the net present value of continued operations at nuclear power plants based on economic analyses of Yankee Rowe and Trojan, plants that were closed in the early 1990s. Using assumptions made by the plant owners, the NPV of each was negative or nearly so, but those NPVs depend heavily on the assumed price of electricity and cost per kilowatt-hour.

GeoffYe S. Rofhwell

W ith the introduction of

competition into electric- ity generation, many utilities oper- ating nuclear power plants

(NPPs) are wondering whether

their plants will be profitable in a

deregulated environment. This ar-

ticle offers a simple method for

addressing this issue based on a synthesis of economic analyses of two single-unit NPPs closed in

the early 1990s.’ The Yankee Rowe and Trojan plants were

closed after their owners deter-

mined that the Net Present Value

(NW) of continued operations was negative or nearly negative.

The first section defines the NPV

for a generic NPI? The second and

third sections apply the analysis

to Yankee Rowe and Trojan. The

last section discusses the limita-

tions of the NW approach.

I. The Net Present Value of a Nuclear Power Plant

Modem finance theory assumes that firms are in the business of

J

41

maximizing value for their own-

ers. Under this assumption finan-

cial analysts would advise under-

taking projects that have a

positive NPV, where NPV is “the

difference between the dis- counted, or present, value of the

future income and the amount of

the initial investment.“’

Traditionally, regulated electric

utilities attempted to maximize

value subject to a rate-of-return

constraint. The implementation of

this objective led to inefficiencies

that regulators now are address- ing through the introduction of

competition into electricity gen-

eration. The deregulated gener-

ator maximizes value subject to

the discipline of the market. Analysis of power plant profitabil-

ity during the transition from a

regulated to a deregulated envi- ronment necessarily relies on a hy-

brid of assumptions appropriate

to the two regulatory environ-

ments.

U nder traditional regula-

tory economics, returns

to debt and equity are consid-

ered in a required revenues analysis. However, in a competi-

tive market, once a plant has

been built, continued operations

should not depend on initial, sunk investment. If the firm de-

cides to cease production, inves- tors are not guaranteed a return. Under traditional rate-of-return

regulation, investors in electric utilities were protected if the

power plant was prudently con-

structed. Changing the regula- tory environment exposes inves- tors in electricity generation to a

higher risk of losing revenues

fromunprofitableplants,hence

theproblemof”strandedassets.“”

I assume that electric utilities

that continue to sell electric power

in a competitive market will be

held legally responsible for debts incurred under regulation. (I will

not consider bankruptcy in this

analysis, although some utilities

could seriously consider this alter-

native under deregulation.) Simul-

taneously, I assume that equity is

sunk. Further, I assume that utili-

In a competitive mar- ket, once a plant has

been built, con timed operations should not

depend on initial, sunk investment.

ties owning NPPs will be held li-

able for the decommissioning

costs of their nuclear assets. The closure decision does not depend

on these liabilities: They must be

paid whether the plant operates

or is closed, so costs do not reflect either payments to debt, equity, or

the Nuclear Decommissioning

Trust Fund. Under these assump- tions,

where Rt = Revenues in each future period, t,

Ct = Costs in each future period, and

r = real discount rate.

All calculations are in real dol-

lars. (I use constant 1991 dollars in

the applications to Yankee Rowe

and Trojan.) Although several de-

flators are available, I use the Im- plicit Price Deflator’ for Gross Do--

mestic Product.5

A. Future Revenues from the

Sale of Electricity

Expected future revenues, I&,

are equal to the expected real

price per kWh in each future pe-

riod, PI, times the expected kilo- watt-hours sold, Q,. Of course,

during a transition from regula-

tion to competition, expected

prices will change. To simplify the

analysis, I assume that Pr is the

price of replacement power (for

example, the regional wholesale

price) in each period. (I ignore ca-

pacity charges,) So, under regula-

tion the price of a kWh is no more

than the cost of replacing it from purchases on the wholesale mar- ket. This price could be lower

than the price allowed by the regulator. Under deregulation, Pr

is the market price (for example, the annual average pool price un-

der that form of competition). This price could be higher than

marginal cost under long-term

contracts or contracts for differ-

ences.6 In practice, under both re-

gimes the price is usually as- sumed to be the long-run average cost of generating electricity with natural gas in a combined-cycle

combustion turbine.7

A lthough expected quanti-

ties sold could be less than demand, I assume that because of

the low marginal cost of generat-

42 The Electricity JotlrnaI

ing electricity with nuclear power,

all output that can be generated is

purchased. So,

Qr= Cf1xMWx T

where CFf is the expected capacity factor in

each future period,

MW is maximum dependable capacity in

megawatts, and

T is hours per year.

If there are no anticipated rerat-

ings of the NPP, MW and T are

constants, and forecasting Qt be- comes an exercise in predicting ca-

pacity factors as plants age.

T here is a debate in the em-

pirical literature regarding

the relationship between capacity

factor and plant age. This is be-

cause there are so few observa-

tions on NPPs over 20 years old

and because capacity factors have increased dramatically during the

1990s. Forecasts based on empiri- cal analyses of earlier data have been lower than industry experi-

ence. Therefore, a number of rea- sonable forecasting rules appear to yield good results. Possible

rules include (1) use the lifetime capacity factor and (2) use the av-

erage capacity factor since 1982 (assuming a regulatory regime

shift after the retrofits following the Three Mile Island Action Plan).’

B. Future Costs of Operation

There are three categories of cost, C, : (1) fuel, (2) operations and maintenance (O&M), and (3) capital additions.

Although fuel, Ft, is reported in

government documents as a cost

per kWh? accountants treat it as a

capital expense. Because nuclear

fuel requires more than one year

to process from the uranium mine through fuel fabrication and place-

ment in the reactor, and because

nuclear fuel releases its energy

over more than one fuel cycle,

fuel expenditures are considered

capital expenses in tax and regula-

tory accounts. But because nu-

Forecasting extraordi- nay Kt is afinction of NW type and age and can drive the deci- sion to close the plant, as with Yankee Rowe and Trojan.

clear energy is consumed only while the reactor is critical, it is

easy to associate fuel costs with kilowatt-hours produced. There-

fore, the fuel cost per kWh is sta-

ble over time and does not gener-

ally depend on the productivity

of the plant. So total fuel cost can be forecast as the product of the

cost per kWh and the total kilo-

watt-hours, Qf, where the fuel cost per kWh is either (1) the average

lifetime cost per kWh or (2) a trended cost, based on the imme- diate past.

O&M costs, OMt are annual ex-

penditures on labor and materi-

als.” They are expensed for tax

purposes and are treated as an- nual required revenues in regula-

tory accounts. Although econo-

mists generally consider expenses like labor to vary with output,

most of O&M costs at NPPs are fixed before the production year

begins. Although total O&M can

be stable over time, when produc-

tion is abnormally low (for exam-

ple, during a year with refueling outage), O&M / kWh is abnor-

mally high. Conversely, when pro-

duction is abnormally high (for

example, during a year without a

refueling outage), O&M/km is

abnormally low. Therefore, fore-

casting should focus on total OMf.

The third cost category, Capital

Additions (Kt,) includes annual

and extraordinary capital addi-

tions to repair or replace expen-

sive equipment. Although these

expenses are normally capitalized

and financed through debt or eq-

uity in the NPV calculation they should be subtracted from the

right-hand side because Kf would

not be incurred if the NPP was

closed. Alternatively, one could calculate the levelized annual pay- ments for each addition to total

capitalization and bring these pay-

ments to the present.

I simplify the analysis by ex- pensing Kr. Like O&M ex-

penses, annual K, per kWh de-

pend on the plant’s capacity factor, so forecasting annual K,

should focus on total annual capi-

tal additions per year. Forecasting extraordinary Kt is a function of

NPP type and age and can drive the decision to close the plant, as

with Yankee Rowe and Trojan, so

should be investigated with sensi-

AugtWGptember 1997 43

tivity analysis in the NPV calcula-

tion.

C. The Appropriate Discount

Rate

Endless debate surrounds the

appropriate discount rate in elec-

tricity economics. Although the absolute value of the NPV is influ-

enced by the discount rate, in the

Yankee Rowe and Trojan exam-

ples, discussed next, the discount

rate has little influence on

whether the NPV is positive or

negative. Generally, net income in

each future period is usually posi- tive. The primary exception to

this occurs in periods with large anticipated capital additions, for

example, a reactor vessel replace-

ment for Yankee Rowe or steam

generator replacement for Trojan.

In these two examples, the capital

additions were anticipated for the

immediate future, so the choice of

discount rate did not influence

the NPV calculation. Because the

NPV formula discounts real net

100

90

80

70

60

50

40

30

20

10

0

Forecast

= Lifetime CF =72%

63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

Figure 1A: Yankee Rowe CF Forecast

70

56

01 65 '6k '66 '68 ‘7b '71 '74 '7b '78 ‘sb ‘s> ‘sh '86 'ab ‘96 ‘95 ‘94 ‘96 ‘98

I 'do

63 65 67 69 71 73 75 77 79 81 83 05 07 89 91 93 95 97 99

Figure 1 B: Yankee Rowe Cost Forecast (1991 Dollars)

income (to be distributed ulti-

mately to the debt and equity holders and government as

taxes), I use a real, pre-tax, weighted average cost of capital

(WACC, weighted by the percent

of debt or equity to total capitali-

zation) of 10 percent in the Yankee

Rowe and Trojan examples. Of

course, the application of the

NPV approach to another NPP

should consider a real WACC ap-

propriate to the specific case.

II. Applications

A. Yankee Rowe

Yankee Rowe was constructed

as a government-industry dem-

onstration project in Rowe, Mas-

sachusetts, with a Westinghouse

reactor and a Westinghouse 167

MW turbine-generator. The Yan-

kee Atomic Electric Company be- gan commercial operation in

July 1961, producing power for

its 11 electric utility owners, in- cluding New England Power,

Connecticut Light & Power, Bos- ton Edison, Central Maine

Power, and Public Service of New Hampshire. Its lifetime ca- pacity factor was 72 percent, one

of the highest in the industry It

had one lengthy outage in 1980

for Three Mile Island Action

Plan requirements. In 1991 its op-

erating license was to expire in

July 2000.

I n 1991 Yankee Atomic faced

the replacement of its reactor vessel at a minimum cost of $100

million. Figures lA-1D present a

NPV analysis based on informa- tion in a Federal Energy Regula- tory Commission rep0rt.l’ The

44 The Electricity Journal

forecast in Figure 1A assumes (1)

an annual capacity factor equal to

the lifetime cumulative capacity

factor through July 2000 and (2) reactor replacement in 1993 with a

CF in 1993 equal to the lowest ex-

perienced by Yankee Rowe. Fig-

ure 1B assumes that fuel costs re-

main steady at 10 mills per kWh

and O&M costs rise 2.5 percent

during the 1990s. (In the early 1990s most analysts believed that

O&M costs would continue to

rise, but in fact industry O&M ex- penses have stabilized in the

1990s; however, some believe that

if real O&M costs do not fall sig-

nificantly soon, many plants will

not be able to compete.) Figure

1C assumes (1) a rise of capital ad-

ditions to $23M in 1992 and to

$lOOM in 1993 with the replace-

ment of the reactor vessel and (2) constant capital additions of $5M

per year after 1993. Assuming a

price of 6 cents per kWh with a 0 percent annual price rise (under

traditional rate regulation),” the

NPV for Yankee Rowe was -

$134M. (See Figure 1D). How- ever, this calculation is sensitive to

the price and price growth as- sumptions; see Table 1. For most

prices and price growths consid-

125 , 1

100 I Forecasting Assumptions: Actual Forecast

(1) Constant after 1993 at $5M (2) Analysis in 1992 of $23M (3) Cost of replacement = $lOOM

3 75.

5 .- z

5 50.

25 -

63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

Figure 1C: Yankee Rowe Capital Additions (with Reactor Replacement)

20

Present Value of Net Revenues = -$134M

-80 4 \ i

+ With Reactor Replacement Cost of $1 OOM -100 -

-120 1992 1983 1994 1995 1996 1987 1998 1989 zobo

Figure 1 D: Yankee Rowe Net Present Value (10% Real WACC and 0% Price Growth)

ered, the NPV is negative. Based

on this the negative NPV, Yankee

Atomic closed Yankee Rowe in 1991.

Table 1: Sensitivity of Yankee Rowe Net Present Value to Price Assumptions

-2

Price -1

Growth 0 (Percent) 1

2

3

6

-162

-148

-134

-118

-102

-85

Price (cents per kWh)

6.5 7

-138 -113

-123 -97

-107 -80

-90 -62

-72 -43

-54 -23

7.5 8

-89 -64

-71 -45

-53 -26

-33 -5

-13 17

8 39

B. Trojan

Trojan was constructed north of Portland, Oregon, as a single unit

with a Westinghouse reactor, a

four-loop steam generator system,

and a 1,095 MW turbine-generator.

It began commercial operation in

May 1976 and produced power for Portland General Electric

(PGE), its majority owner, and for

the Bonneville Power Administra- tion and Pacific Power and Light, its minority owners. Its lifetime ca- pacity factor was 54 percent (low-

ered by system hydroelectric con- siderations), with lengthy outages

_

August/September 1997 45

100

80

60

40

/ Forecast

I

(1) 1992 CF = Cumulative (2) 1993 CF = 1991 CF (3) 1994-97 Gradual Rise (4) 1997-2010 CF = 64.3%

20 & Seismic Qualifications

Repairs 1993 Steam Generator Replacement

0

78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Figure 2A: Trojan CF Forecast

rise 4.3 percent in the early 1990s 250 ,

and 2.5 percent from then until T

I

2010.15 (Fuel prices were lower 200

than at Yankee Rowe because of

the scale economies in fabricat- 1 Total I I

ing fuel for Trojan and similar 150

c

NPPs. Also, O&M/kWh was E g ,::::-:::::;::::

lower at Trojan than at Yankee 5 100 Forecasting Assumptions:

(1) O&M grows

Rowe because of scale econo- 1992-1993: 4 3%

m 1994-2010: 2.5%

mies in staffing at NPPs.) Figure 50 (2) Fuel constant at 5 mills/kWh

2C assumes (1) a rise in capital ‘I additions to $24M per year in

1993 with a real rise of 1.6 per- 0 I

n d2 04’C&d8’lb I

cent thereafter and (2) a mini- 77 79 81 83 85 87 89 91 33 95 97 99 01 03 05 07 09

mum cost of replacing Trojan’s Figure 28: Trojan Variable Cost Forecast

steam generators of $145M in

in 1978 for seismic upgrades and

in 1991 for steam generator re-

pairs. Its operating license was to terminate in 2010.

In 1991, PGE faced the replace-

ment of Trojan’s steam gener-

ators by the mid-1990s. Figures

2A-2D present an NPV analysis

based on many assumptions.‘”

For example, Figure 2A assumes

that the annual capacity factor gradually rises to 64.3 percent

(the expected value14) after

steam generator replacement in

1993. Figure 2B assumes that fuel costs remain steady at 5

mills per kWh and O&M costs

1993. Assuming a price of 3 cents than 3 percent per year, the NPV

per kWh with a 3 percent annual falls dramatically Given the un-

price rise (under traditional rate certainties surrounding future

regulation), the NPV for Trojan electricity prices, PGE’s board of

was $lM. (See Figure 2D). directors closed Trojan in 1992.

n the early 199Os, as now, regu- 11 ated wholesale electricity III. Limitations of the NPV

prices were higher in New England Approach

than in the Pacific Northwest. How- The limitations of the NPV

ever, this calculation is sensitive to methodology have been dis-

the price and price growth assump- cussed elsewhere.16 In particular,

tions. (See Table 2). For prices less NPV analysis does not easily in-

than 3 cents or price growth less corporate non-quantifiable deci-

sion variables. For example, while

PGE was evaluating steam gener- ator replacement at Trojan, it was

facing the fifth vote of confidence

on nuclear power by Oregonians. Although the ballot measure that would have closed Trojan was de- feated in November 1992, it is

likely that the political climate in-

fluenced PGE’s decision regard-

ing continued operations at Trojan. Another limitation of simple

NPV analysis concerns the evalu-

46 The Electricity Iournal

Table 2: Sensitivity of Trojan Net Present Value to Price Assumptions

0

Price 1

Growth 2 (Percent) 3

4

5

-841 -611 -382 -153 n

-764 -516 -267 -19 230

-679 -410 -140 130 399

-585 -292 1 294 587

-481 -162 157 477 796

-365 -17 331 680 1028

2

Price (cents per kWh)

2.5 3 3.5 4

-

ation of risk. In the simple ap- proach presented here, the dis-

count rate includes a risk pre-

mium that reduces the present

value of net revenues.

I mplicitly, inside decision mak-

ers are assumed to evaluate

the riskiness of cash flows in the same way that outside financial

markets do. A more transparent

method embeds the NPV calcula-

tion in an uncertainty or certainty

equivalence analysis where dis-

counting is done with a risk-free rate. This leads to a probability

distribution for NPV and allows

decision makers to evaluate the tradeoff between cost and risk.17

Further, if one is willing to make assumptions about markets for

risky assets, the “real options” ap-

proach avoids the simplistic rule

of ceasing operations if the NPV

is negative.” These techniques

should aid electric utility execu-

tives and regulators to evaluate continued operation as uncer-

tainty increases under electricity

deregulation. n

Endnotes:

1. For a dynamic programming model of plant closures, see G.S. Rothwell and J. Rust, On the Optimnl Lifetime of Nuclear

Power Phnts, 15 J. BUS. AND ECON. STAT.

195 (1997).

2. R.A. BREALEY AND S.C. MYERS, PRINCI-

PLES OF CORPORATE FINANCE (McGraw- Hill, 1996).

160

40

Actual Forecast

Assume: (1) Rise to $24M in 1993 (2) Replacement in 1993 (3) Min Cost = $145M (4) 1993-2010: 1.6% growth

3. This article does not calculate the value of stranded assets of closed NPPs. This would involve a calcula- tion of the present value of debt and equity.

4. ENERGY INFO. ADMIN., AN ANALYSIS OF

NUCLEAR POWER PLANT OPERATING

COSTS: A 1995 UPDATE (SR/OIAF/95-01, 1995).

5. COUNCIL OF ECONOMIC ADVISERS, ECO-

NOMIC REPORT OF THE PRESIDENT 279 (1995).

6. S. Thomas, The Development of Com-

petition, in THE BRITISH ELECTRICITY EX-

PERIMENT 82 (J. Surrey, London, ed., Earthscan Publications, 1996).

7. See, e.g., I.. BAXTER AND E. HIRST, ESTI-

MATING POTENTIAL STRANDED COMMIT-

I

I -

0” ,,,,, ,,,,/ , ,I ,,,,, r ,,,,,,,

72 78 80 8b 84 86 88 9b 92 94 96 98 00 02 04 06 d8 li 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

Figure 2C: Trojan Capital Additions (with Steam Generator Replacement)

50

Present Value of Net Revenues = 1 M

f Steam Generator Replacement Min Cost of $145M

-250 1 19b2 / 19b4 , 19b6 , 1988 , 2000 / , 2002 , ’ 20b4 20b6 ’ 2ob8 ’ 2oi(

1993 1995 1997 1999 2001 2003 2005 2007 2009

Figure 2D: Trojan Net Present Value (10 Percent Real WACC and 3 Percent Price Growth)

August/September 1997 47

MENTS FOR U.S. INVESTOR-OWNED ELEC-

TRIC UTILITIES (Oak Ridge Natl. Lab.,

ORNL/CON-406,1995).

8. One analysis found that the capac-

ity factor is best fit to the inverse of age. This specification allows for the estimation of an upper limit on the ca- pacity factor. See G.S. Rothwell, Fore- casting Nuclear Power Plant Generation under Electric Utility De- regulation (Center for Econ. Pal. Res., Stanford Univ., 1997) (prelim. rept.).

9. See, e.g., ENERGY INFO. ADMIN., ELEC-

TRIC PLANT COST AND POWER PRODUCTION

EXPENSES 1991 (DOE/EIA-0455,1993).

10. Expenses reported as O&M costs vary between data sources. EIA re- ports tend to understate O&M costs; see EIA, sr~prn note 4, at 4. Proprietary

financial or tax reports could include other cost categories, such as nuclear insurance premiums and NRC regula- tory fees.

11. Federal Energy Reg. Comm’n, Yan- kee Atomic Energy Co. (June 15,1994) (Opinion No. 390).

12. A price of 6 cents was used to cali- brate the NPV here with that found in FERC, id. Lower prices decrease the NPV further.

13. The assumptions are reviewed in E.A. Bowers, The Trojan Shutdown De- cision (Oct. 7-9, 1992) (presented to Nuclear Nonoperating Owners’ Group, Fall 1992 Conference, Minnea- polis, Minn.).

14. Id.

15. Id.

16. See G.S. Rothwell, Economic As- sumptions for Evaluating Reactor-Re- lated Options for Managing Plutonium (March 18-20, 1996) (pro- ceedings of International Conference on Military Conversion and Science of the Utilization and Disposal of Excess Fissile Weapons Materials, Como, It- aly, (UNESCO Venice Office).

17. Bowers, sqra note 13. Using the same software and similar assump- tions as Bowers, NPV was found to be most sensitive to assumptions regard- ing electricity price and the plant’s cost per kWh.

18. See A.K. DIXIT, AK. AND R.S. PINDYCK,

INVESTMENT UNDER UNCERTAINTY ch. 7 (Princeton Univ. Press, 1994).

Extrinsic events-chance-may determine fhefufe of many plants.

48 The Electricity Journal