Global financial meltdown – what impact on nuclear?

4 February 2009

With the headlines since last summer dominated by the world financial situation and its implications for economic growth, jobs and individual prosperity, it is worthwhile assessing the probable implications for the nuclear sector. The general gut reaction by commentators has been that the impact will be adverse. At the point where the industry needs to achieve firm plant orders in order to add substance to the talk of nuclear renaissance, some have gone so far as declaring that tighter credit conditions and slower economic growth could be fatal, destroying many nuclear projects at an early stage. There are, however, different ways of looking at what has happened, which may lead to a more positive conclusion.

So far as the impact of the “credit crunch” on the real economy is concerned, to the extent that economic growth will slow, this must have an impact on electricity demand. But while rapidly growing power demand is clearly a favourable factor for new nuclear investment, much of the requirement in the developed nations at least is for replacement and not incremental generating capacity - the United Kingdom being an obvious case in point. Nuclear is now responsible for only 15% of total world power generation, so there remains plenty of room for expansion even if demand is not expanding rapidly. It is also likely that developing countries will return to rapid electricity demand growth at some point in the near future, as their economic development heavily depends on it. If nuclear remains a sound investment for economic, environmental and security of supply reasons, slower economic and electricity demand growth is likely to have only a comparatively minor impact.

While the environmental and security of supply motivations for “going nuclear” should remain as strong as ever, it is reasonable to consider that the basic economics may not now look so attractive. To the extent that falling fossil fuel prices can be attributed to the new financial situation rather than a cyclical downturn (yet this seems equally credible as an explanation), this must have an impact on the relative economics of investing in nuclear as opposed to a gas or coal-fired generating units. In markets such as the United States where the economics are very tight (coal is a formidable competitor to nuclear in many areas), this makes it even more important that nuclear achieves some form of carbon credit, either by carbon taxes or through a viable emissions trading regime. Potential investors are seeking a greater deal of certainty, as much as the level of advantage nuclear should receive.

At the heart of the “credit crunch” must be consideration of what is happening in the banking system, in particular the ability of electric utilities to borrow the money needed to build new nuclear plants. Banks will likely now be more risk averse and will also more careful in their procedures for assessing risk. A nuclear power station is a very capital-intensive way of generating electricity and, on its past record, is economically somewhat risky. So it is clear that unless ways can be found to insulate the financiers from this risk, the impact on nuclear investment could potentially be severe. Yet although the supply of finance has suddenly tightened, its cost has not necessarily risen. Short term interest rates have fallen sharply and once money eases up again, both equity and loan finance will be looking for good projects. This is important for nuclear plants as their economics are very sensitive to the effective interest or discount rate.

The key, as always, is the need to structure the projects in such a way that allocates the various risks in an equitable way amongst the interested parties. Then even if a risk premium is attached to nuclear, lower interest rates are favourable for financing projects with heavy capital expenditure and long time horizons. Recent governmental attempts to counter the impact of the anticipated economic slump have concentrated on infrastructure investment, which is itself good for nuclear. Also the popular reaction against “short termism” and “making fast bucks” in the financial world may prompt a return to more traditional, stable forms of investment, once funding is loosened up again. Investors such as pension and insurance funds may now prefer moving towards physical assets with more predictable returns above some of the now unfashionable sophisticated financial instruments. Indeed in the current environment, governmental measures to “kick start” nuclear, such as the loan guarantee and construction delay insurance schemes in the USA, will take on increased importance. This is particularly the case in areas with competitive power markets, where project costs (and effectively the risks) cannot be passed onto electricity customers through power prices.

One likely beneficial effect of more difficult project financing and the weaker overall demand outlook across the whole economy is a reduction in cost pressures. Many projects outside nuclear will now fall by the wayside and the inflation experienced in recent years in the capital cost of equipment should abate and even go into reverse. The supply chain tensions that have been mentioned as a possible barrier to new nuclear build may turn out to be much less than some observers have feared as other industries, notably oil and gas, slow down and place less pressure on resources. Mining cost inflation has been a particular issue in the uranium sector, as all mining sectors experienced a simultaneous boom, led by rapidly-rising Chinese demand for basic commodities, but the froth has now rapidly disappeared from this sector. Share prices have been decimated (even for leading mining companies such as BHP Billiton and Rio Tinto) but obtaining qualified staff and the necessary equipment at reasonable cost should now be a lot easier.

“We may eventually see the financial be beneficial to nuclear”

It can also be argued that the financial crisis has come rather earlier than the key point of financing need for new reactors, especially in the USA. Although potential investors are already procuring long-leadtime major components such as large forgings and are investing significant sums of money in licensing, the real financing need should only come in a few years time when firm decisions have been made to proceed with projects. By this time, the financial markets should have adapted and settled down once again and projects which make good economic sense and are well-structured should still be able to attract financing. In normal circumstances, the world economic system throws up a wall of money available for lending. Banks only make money by engaging in lending (banking is fundamentally a simple business – borrowing money at one rate of interest and lending at a higher rate), so there should always be competition be involved with those projects that make good economic sense.

The particular status of the nuclear project investor becomes even more important at this time. Whether it is in the public or private sector, the size of its market capitalization and the strength of its balance sheet become more crucial. Looking at the Chinese, Russia and Indian programmes, all are essentially financed or guaranteed by state backing and are unlikely to be adversely affected by the financial crisis. Such state-backed projects require a lower rate of return than those with private investors, but the big European utilities like EDF, RWE, and E.ON are generally in a better position than their US counterparts like Exelon, Entergy and Duke in market capitalization and balance sheet strength. The position is also relatively favourable in Japan, which experienced a significant financial bubble and subsequent meltdown in the 1990s – the utility plans for new nuclear build are unlikely to be affected now.

Within the nuclear fuel sector, the credit crisis had an immediate impact as many of the financial players who had bought uranium decided to liquidate their holdings, contributing to the price falling sharply since last summer. It was, however, arguably only a matter of time before they baled out of the market – things just happened a little sooner than they would have otherwise. Market fundamentals have remained essentially unchanged. The same can be said about the sharp decline in the share prices of junior uranium companies. It was going to happen anyway and just needed the spur, which tighter credit conditions provided. Mining finance is clearly now a lot tighter, but the demand prospects and declining secondary supply situation in uranium remain, making it one of the more attractive sectors to invest in. Political interference and regulatory delays remain as issues as always, but nothing much has fundamentally changed. Although postponements to projects such as Midwest in Canada and Dominion in South Africa have been blamed, partly at least, on financing difficulties, this has had more to do with rising project costs and the falling uranium price.

Thinking more expansively, we may eventually see the financial crisis as one of the events prompting more fundamental changes in society, likely to be beneficial to nuclear. Some commentators have claimed that people will now become more selfish and care less for the environment and the common good. This is unlikely – even more disillusionment with private markets and the political process, which has allowed them to run unfettered and uncontrolled, is likely to become reinforced. There is a suggestion that people are content to see more public planning and control – no doubt making use of private markets where they can assist, but not allowing them to “rule the roost”. Malcolm Grimston, amongst others, has pointed out that nuclear was rather out of kilter with the main societal trends in the 1980s and 1990s of individualism, pushing for rights rather than fulfilling obligations and privatising key industries. Perhaps the tide has now turned?

We know that nuclear needs firm government support – without some degree of state energy planning and intervention, it is likely to flounder. Many people are now looking somewhat enviously at the French economic model with central planning focusing on key areas of the economy and their big companies, notably in the power sector with EDF and Areva. Although this strategy is particularly French in character, fitting in with established social, political and cultural norms, there are clearly some lessons to be learned elsewhere. The United Kingdom could turn out to be a good test case for an active energy policy but with private companies expected to take the lead, notably in nuclear.

The USA is also very interesting. The final nail in the coffin of the Bush Administration was the inept way it handled the financial crisis, arguably a major reason for the stunning success of Obama and the Democrats. Whether this is good or bad for nuclear remains to be seen. The appointment of key officials in the energy and environment portfolios who take a less emotional, more objective and scientific approach may appear a favourable development, yet they have plenty of bedfellows whose nuclear scepticism is well-entrenched. As in the UK, it will be private utilities that must lead the way, but they will probably require a better-funded loan guarantee scheme and detailed action on carbon emissions before committing to invest.

Author Info:

Steve Kidd is Director of Strategy & Research at the World Nuclear Association, where he has worked since 1995 (when it was the Uranium Institute). Any views expressed are not necessarily those of the World Nuclear Association and/or its members

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