The argument over nuclear power rages on in many countries and, lately, between them. Meanwhile, researchers from the Energy Policy Research Group asked the ultimate question: Given a free choice between gas and nuclear, which will power producers choose?

"Merchant generators appear to lack incentives to diversify by constructing new nuclear power plants..."
--Conclusion of a detailed economic analysis comparing natural gas and nuclear power plants.

On its surface, the nuclear option appears worthy of keeping on the table. Proponents argue that it could be a hedge against volatile gas prices while diversifying the fuel supply, reducing costly greenhouse gas emissions, and providing electricity at more stable costs. The issues of public opposition and waste treatment appear to be the biggest barriers, potentially overcome by favorable policy.

If that's the case, then why is there only one nuclear plant under construction in Europe?

Looking below the surface

An International Energy Agency economist and three fellow researchers from Cambridge and MIT followed the argument a step farther. Power producers will eventually face an economic decision about what fuel to use in new power plants. In a deregulated energy market, where power producers are motivated by profit, it all comes down to money.

From an economic standpoint, nuclear has its advantages. Investing in nuclear is, in theory, a hedge against gas prices and carbon emission fees. But modeling the variables to test the theory would be a Herculean task.

Modeling the real economics of nuclear power

Would nuclear survive a true profitability test for power plant investment? What would the test look like? The IEA economist, Fabien Roques, and his colleagues devised the tests, created the models, and ran them 100,000 times using randomized inputs, for each of several scenarios. They reported their findings in the quarterly journal of the International Association for Energy Economics this month.

The economic models and results are described in detail in the 23-page article. The tests calculated the value to producers of having a choice of fuels -- termed the "option value" -- using net-present-value calculations and sophisticated forms of sensitivity analysis, combined with real-world factors such as the cost of high-risk capital and the correlation between gas and electricity prices.

Nuclear option of "little value"

The result of all the Cambridge number-crunching: Nuclear is less profitable and more financially risky than natural gas. Investors in power plants in a deregulated market will not choose nuclear based solely on profitability.

"The conclusion of our model is that there is little private value for a merchant generator in retaining the option to choose between nuclear and CCGT [gas] technologies in future in liberalized European electricity markets, which exhibit a strong correlation between electricity, gas and carbon prices. This result appears consistent with the observation that most new power plants built in liberalized electricity markets since the 1990s have been gas-fired power stations."

The authors cite several sources of investor bias against nuclear:

• Long payback periods
  
• High construction costs
  
• Risk of delay and cost overrun
  
• Greater downside risk of larger projects
  
• Regulatory creep during construction
  
• Fragmented ownership resulting from spreading risks and costs

Implications for the U.S.

These were the results of this model under the European Emissions Trading Scheme, where carbon emissions are levied a financial penalty per ton -- not in the United States, where carbon emissions are still free. Without the "carbon tax" factor, the case for nuclear would be even weaker.

Carbon emissions in Europe are priced on an open market, like stocks. The volatility of carbon prices adds to the risk and cost of using a typical combined-cycle gas turbine, but not enough to outweigh nuclear's financial disadvantage.

Making nuclear less financially risky

Long-term fixed-price contracts could encourage nuclear plant construction. The Finnish power company TVO is constructing a new nuclear power plant in which the capital costs have been financed by such agreements. The power purchasers are large industrial consumers -- mostly in the wood fiber industry -- and local utilities. They will receive their electricity at production cost for the 60-year life of the plant.

Consumers with equity in a nuclear generating company would be hedged to some degree against changing gas and carbon prices. As rising fossil fuel and carbon prices drive up the cost of (mostly fossil-fueled) power on the open market, the nuclear power producer and its shareholders would profit.

Lower cost of capital could also encourage producers to build nuclear plants. The cost of capital directly affects the profitability of a plant, regardless of fuel type. Capital costs are considerably higher for riskier nuclear projects, and a higher proportion of equity financing is required.

The U.S. Energy Policy Act of 2005 provides measures to lower the risk for lenders, thus potentially reducing the cost of capital. American taxpayers will cover cost overruns of up to two billion dollars on the first six nuclear plants built, and pay producers a production tax credit of 1.8 cents per kilowatt hour. The Nuclear 2010 Project is designed to remove regulatory barriers to nuclear construction through measures such as streamlining the licensing procedure and preventing lawsuits by opponents.

Same measures make renewables attractive

In reading the recommendations in the Energy Journal article, it occurred to me that the same measures that could make nuclear more attractive -- power contracts and cheaper capital particularly -- have the positive same effect if applied to renewable energy facilities, such as wind farms and large-scale solar arrays.

Long-term fixed price contracts provide an incentive for producers to build renewable energy facilities. Wind projects constructed in the U.S. almost all have power purchase agreements before breaking ground. Purchasers of power from other wind projects have high equity stakes or, in some cases, wholly own them.

Bonneville Power Administration, for example, agreed to purchase all of the power from the Klondike wind project for 20 years. Puget Sound Energy (PSE) owns the Hopkins Ridge Project, now operating, and the Wild Horse Wind Power Project, dedicated this summer and scheduled to be completed in December, 2006.

Lower cost of capital is also an incentive for constructing renewable energy projects. Renewable energy projects are approaching cost parity with conventional energy sources, and run the risk that gas prices (and carbon prices, in Europe) will fall.

The U.S. Congress has extended, for a short time, the Production Tax Credit (PTC) for wind energy producers. Uncertainty about the future of the wind PTC is a risk that drives up the cost of capital for new construction, and extending the PTC could make financing easier to secure.

Importance of public support

Taxpayers are footing the bill for wind and nuclear power PTCs. The public support for the wind PTC is strong -- not only because wind diversifies the fuel supply, but largely because of a general social sentiment favoring renewable energy.

When the first nuclear plants are sited and construction begins, we will find out whether fuel diversification is of sufficient value to overcome the tax dollar costs and public concerns.

Sources

"Nuclear power: a hedge against uncertain gas and carbon prices?" Fabien A. Roques, William J. Nuttall, David M. Newbery, Richard de Neufville and Stephen Connors, The Energy Journal (published by the International Association for Energy Economics) Vol.27 No.4 (Oct 2006): p1. (print edition)

The working paper on which the article is based is downloadable from the Energy Policy Resource Group (EPRG), whose research extends the Cambridge-MIT Electricity Project.