Effect of Regulation on Nuclear Power Plant (NPP) Construction Risk Management

IAEA Technical Meeting on Risk Management in Nuclear Power Plant Construction

Vienna, 6-8 September 2016

Glenn R. George, PE, PhD

1

Key take-aways

Regulatory risk is a prime contributor to NPP construction cost overrun risk, which in turn affects the competitiveness and financeability of new nuclear power generation globally

This is especially the case in in newcomer countries, which tend to have less of a track record in nuclear regulation

Yet regulatory risk is amenable to analysis using many tools (e.g., probabilistic risk analysis) familiar to NPP designers and builders

It is possible to reduce both the probability of negative regulatory outcomes and their severity

NPP architect-engineer-constructors (and others) must think strategically about regulatory risk, drawing insights from game theory and information economics

Selecting the best tools to manage regulatory risk in a particular situation will tend to be very context-specific

Regulatory risk can and ought to be managed as actively as other sources of construction risk during NPP deployment

2

Motivation: Is NPP construction the only industry ever to experience negative learning-curve effects?

Answer: No! But what went on? The industry experienced round

after round of new and more stringent rules and regulations of various kinds during early NPP deployment

These “ratcheting standards” contributed to an average capital cost overrun of 207% for the first 75 NPPs built in the USA

This contributed to the cancellation of over 100 NPPs from 1974-1982 and over $17 billion in nuclear investments’ being written down from 1984-1993

But it was not due to ineptitude on the part of NPP constructors Managing regulatory risk would help control NPP construction

cost overrun risk, making nuclear power more competitive

Ove

rnig

ht C

apita

l Cos

t ($/

kWe)

US Nuclear Cost Projections vs. Realized Costs

Source: US DOE/ EIA-0485; NERA and Oliver Wyman Analysis

3

We consider any form of regulation with the potential to affect construction (and financing) of NPPs Siting and permitting (including construction permits and approvals) Nuclear safety regulations

National-level nuclear regulations governing design, operation, decontamination, and decommissioning of NPPs

Industry codes and standards

Other health and safety regulation (worker/occupational, public) Environmental regulation

Air and water emissions (including in accident scenarios) Carbon and other greenhouse gas emissions Spent fuel and waste disposal

Economic regulation Industry structure (regulated vs. liberalized; vertically integrated vs. not) Rates, tariffs, and subsidies (e.g., any “contract for differences,” as proposed

for the Hinkley Point C plant in the UK) Competition (antitrust) review EU state aid review

Not only must current regulations be considered, but potential future ones as well: especially challenging in

newcomer countries, which may lack a regulatory track record

4

What is regulatory risk?

Regulatory risk is the product of The likelihood of adverse outcomes during regulatory interactions, and The severity of those outcomes

Negative regulatory outcomes include Delay or denial of permits, licenses, and other required approvals Plant design or construction changes required by regulatory authorities Secondary effects, including construction delays and cost overruns

resulting from required changes in design or construction techniques

Regulatory risk is relevant to NPP designers and vendors NPP developers (future owners/operators) Lenders and financiers Architecture, Engineering, Construction contractors and

Engineering, Procurement, Construction (EPC) contractors Governments and agencies interested in fostering nuclear deployment

Regulatory risk is widespread in the construction industry, but is especially salient in the nuclear sector, where regulations are especially prescriptive and pervasive

5

Why should we care about regulatory risk in the context of NPP construction?

Regulatory risk is fully analogous to operating plant accident risk ( = probability of accident * consequences)

Regulatory risk is one element in overall project risk ( = probability that scope, cost, or schedule will exceed limits * consequences of such project management failures)

An adverse regulatory outcome can have devastating effect on NPP cost, scope, and schedule Impacts can be at least as large as other sources of construction risk (e.g.,

labor productivity, price and availability of key commodities) which are subject to intense analysis and scrutiny

Risks can be severe if the design is not finalized before construction begins

Regulatory risk is especially pronounced in nuclear newcomer countries Regulatory risk is amenable to being analyzed and managed, yet

Literature of regulatory risk, as distinct from broader area of project risk, is relatively sparse (e.g., in the Program Management Body of Knowledge)

Some owner/operators and builders may be insufficiently sensitive to the concept of regulatory risk management

Regulatory risk is a key contributor to construction cost

overrun risk, which in turn helps determine NPP financeability and profitability

6

Regulatory risk contributes to dispersion of projected Levelized Unit Energy Cost (LUEC) of NPPs versus alternatives

Nuclear LUECs exhibit a “fat” upper tail—reflecting upside risk in capital

cost

Projected LUEC Cumulative Distributions (Monte Carlo Simulation)

20

25

30

35

40

45

50

55

60

65

70

75

80

85

90

95

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

€/M

Wh

LUEC, €/MWh, IGCC LUEC, €/MWh, Coal LUEC, €/MWh, CCGT LUEC, €/MWh , NPP D LUEC, €/MWh, NPP A LUEC, €/MWh, NPP B LUEC, €/MWh, NPP C

Variance in construction cost contributes to the fat upper tail of NPP LUEC

All figures illustrative

7

What is regulatory risk management?

Regulatory risk is amenable to being managed using generic tools and techniques commonly applied to other aspects of NPP design, development, licensing, and construction

These tools include Program Evaluation and Review Technique (PERT) and Critical Path

Method (CPM) approaches (for construction planning and execution) Probabilistic risk analysis (PRA)

PERT/CPM charts should explicitly account for regulatory interactions Including contingencies Reflecting not just the expected (mean) time to receive a required

regulatory approval, but the standard deviation around that mean (in terms of time) in addition to the probability of regulatory disapproval

PRA techniques applied to regulatory risk can reveal ways to Reduce the probability of negative outcomes Reduce the severity of negative outcomes

We further explore the PRA framework in the following 5 slides Regulatory risk should be conceptualized as one of

many discrete yet interrelated sources of risk which must be managed during NPP construction

8

Reducing the probability of negative outcomes

This is primarily a process of “risk identification” Understanding key sources of risk across the many forms of regulation

(health, safety, environmental, economic) governing NPP deployment Knowing what regulators care about, possibly in multiple jurisdictions, and

possibly where there is little history of regulatory interactions (as in newcomer countries)

Anticipating those issues in the design process and regulatory interactions

Plant designers and builders need to construct appropriate decision trees (or fault trees or equivalents) to analyze and plan activities, including Decision nodes, reflecting choices made by designers and operators (e.g.,

plant design parameters and licensing approach) Chance nodes, reflecting events which are, from the standpoint of the

designer or operator, probabilistic (e.g., whether competent regulatory authorities will or will not judge certain NPP features or construction approaches satisfactory)

Although every regulatory interaction is in some sense unique, it is possible to distil lessons-learned from one’s own experience or that of others

There may be a tendency among NPP developers and builders to underestimate

the likelihood of really bad regulatory outcomes

9

Decision tree (fault tree) analysis (slide 1 of 2)

As is the case with PRA, a dominant regulatory failure path can oftentimes be identified and minimized For example, a particular site permitting approach can, relative to other

factors, overwhelmingly increase the likelihood of failed regulatory outcome

Common-cause failures can be identified and, where possible, eliminated For example, one plant design feature or proposed construction technique

can increase the likelihood of regulatory failure at multiple points in the licensing process or in multiple jurisdictions

Sources of uncertainty regarding data and modeling assumptions can be targeted for reduction For example, additional discussions with a regulator can help reduce

uncertainty in the projected timing or estimated likelihood of success of a particular regulatory interaction

NPP developers and builders should conceptualize the probability

of adverse regulatory outcomes the way they think about, e.g., the likelihood of plant accidents or of commodity price spikes

10

Decision tree (fault tree) analysis (slide 2 of 2)

One can construct a regulatory decision tree, assigning a probability (p) to each regulatory outcome or scenario (designated S)

Each node can be considered a regulatory milestone, with probability p, which results in a new set of possible scenarios

S

S1

S2

S3

S4

S5

p1

p2

p

1-p

p3

p4

p5 Even highly negative—if unlikely—regulatory

outcomes must be included in the model

11

Reducing the severity of negative outcomes

Despite measures taken to reduce the likelihood of negative outcomes, they may still occur and the regulatory process must be planned and managed so as to ensure consequences are limited to a level that is acceptable for all stakeholders involved

Just as “defense-in-depth” of an NPP (from a nuclear safety perspective) relies heavily on maintaining containment by means of successive barriers, so too does regulatory defense-in-depth rely on multiple elements of sound program management to ensure that a negative regulatory outcome does not endanger the whole construction project

A key concept here is risk mitigation through hedging: securing against loss from a contingent outcome through compensating transactions on the other side of the event

Just as an individual can hedge one’s bets or hedge against losses in an investment portfolio, so can an NPP builder hedge its approaches to various regulatory interactions

Regulatory risk can and ought to be managed as actively as other sources of construction risk during NPP deployment

12

Regulatory hedging

Potentially problematic regulatory interactions should begin as early as possible, maintaining flexibility for subsequent corrective action If, for example, it is possible that a regulator could request, late in the licensing

process, lengthy component or system testing to confirm the adequacy of the design, then such testing could be undertaken sooner rather than later; no amount of wishful thinking or work avoidance can substitute for the opportunity to retain project flexibility and margin by front-loading the regulatory interaction

To the degree practicable, regulatory activities should be managed in parallel For example, licensing interactions can be undertaken in multiple jurisdictions at

once, increasing the likelihood (if the processes are independent) that delays or problems in one jurisdiction do not endanger successful completion of the regulatory review in the other

Design diversity is perhaps the most effective mechanism for mitigating the severity of adverse regulatory outcomes During the construction phase of an NPP, design diversity means maintaining

as long as possible the option of selecting any of the competing design elements or construction techniques, until that phase of construction begins

Defense-in-depth from the standpoint of regulatory risk management means reducing the severity of negative

outcomes (in project scope, cost, and schedule) by hedging one’s programmatic and technological bets

13

Strategic aspects of regulatory interactions

“Strategic aspects” in this context means those aspects of regulatory risk management which reflect One’s position relative to competitors (because regulators don’t make

decisions in a vacuum) Likelihood of success in future interactions (because regulation is a

“repeat-play game,” using the terminology of game theory): each side (regulator and regulated entity) learns from each and every iteration of the game

Because there are political and legal overtones to many regulatory interactions, regulatory strategy must be integrated with one’s overarching political/legal strategy to gain support for the NPP construction project

Information economics can provide significant insight into issues of regulatory risk management because regulatory interactions tend to be marked by Asymmetric information Asymmetric incentives

Regulatory strategy requires as much analysis, planning, and execution as corporate, financial, or technology strategy

14

Insights from game theory and information economics

A key strategic element in the regulatory process involves the revelation of information pertaining to the design or construction of an NPP For example, designers and builders whose NPP most exceeds regulatory

requirements have an incentive to reveal the most information, and regulators may draw the opposite inference from those who are less forthcoming

Knowledge of competing NPP designs and construction approaches is important For example, even where regulatory requirements prescribe an absolute

rather than a relative standard, NPP designers and builders should manage their regulatory interactions with an eye toward their position relative to competing designs, and emphasize their strengths

Learning from one regulatory interaction to another, over time and from one jurisdiction to the next, is another key strategic element If, for example, a design can be improved over time in a transparent way,

perhaps through increased margins or more extensive testing, then regulatory risk should decrease over time

NPP engineer-architect-constructors need to develop

a long-range strategic plan before they begin their regulatory interactions, not after

15

Selecting among competing risk-management tools

Reducing the likelihood of adverse regulatory outcomes is more easily accomplished in familiar jurisdictions, where regulatory hot buttons are well-known from long experience (this may be impossible in newcomer countries)

Reducing the consequences of negative outcomes tends to become less effective over time, as plant features and construction approaches are finalized and as the regulatory interaction proceeds toward its conclusion

Strategic considerations are most salient early in the regulatory process; as the process moves forward, and more information becomes available from all stakeholders, there is less scope for strategic interaction

Strategic approaches are likely to be most effective when there at least one other competing project going through the regulatory process, but not too many

A combination of tools and techniques—frequently and critically re-evaluated—is almost surely

the most effective way to reduce regulatory risk

16

Case studies

Olkiluoto NPP unit 3 (EPR, western Finland) Flamanville NPP unit 3 (EPR, Normandy, France) Plant Vogtle units 3 & 4 (2 x AP1000, Georgia, USA) Virgil C. Summer units 2 & 3 (2 x AP1000, South Carolina, USA) Ōma (ABWR, Aomori prefecture, Japan) Shimane unit 3 (ABWR, Shimane prefecture, Japan) Hinkley Point C (2 x EPR, Somerset, England)

In each instance, regulatory risk has been a major contributor to overall project risk

17

Conclusions and caveats

Managing NPP regulatory risk is among the most important elements in mitigating construction cost overrun risk

All the tools in one’s project management armamentarium—including techniques of PERT/CPM and PRA—must be brought to bear in a coordinated fashion

The regulatory process cannot be managed haphazardly, nor should the likelihood of negative outcomes be underestimated

This presentation is intended to offer an alternate lens through which to view the management of regulatory interactions

Nothing in this presentation should be taken as a suggestion that the regulatory process is something to be circumvented or subverted

On the contrary, managing regulatory risk increases the chances that regulatory interactions will be deliberate and transparent, thereby increasing the likelihood that NPP construction will proceed smoothly

The regulatory process should be viewed as

something to be actively and strategically managed rather than as a series of passive, one-off interactions

© Copyright 2016 National Economic Research Associates, Inc. All rights reserved.

Glenn R. George, PE, PhD Senior Vice President / Managing Director

NERA Economic Consulting

1255 23rd Street, NW, Suite 600

Washington, DC 20037 USA

glenn.george@nera.com

Tel. +1.215.620.0355