Hearings and Business Meetings
May 22, 2006
SD-366 Energy Committee Hearing Room 02:30 PM
The Honorable James Asselstine
Managing Director, Lehman Brothers, Inc.
TESTIMONY FOR THE RECORD
James K. Asselstine
Lehman Brothers, Inc.
United States Senate Committee on Energy and Natural Resources
Hearing on the nuclear power provisions contained in the Energy Policy Act of 2005
May 22, 2006
Mr. Chairman and members of the Committee, thank you for the opportunity to appear before you today.
My name is Jim Asselstine. I am a Managing Director at Lehman Brothers, where I am the senior fixed income research analyst responsible for covering the electric utility and power sector. In that capacity, I provide fixed income research coverage for more than 100 U.S. electric utility companies, power generators, and power projects. As a research analyst, I also work closely with the large institutional investors who have traditionally been a principal source of debt financing for the power industry.
I appreciate your invitation to testify at today’s hearing regarding the nuclear power provisions contained in the Energy Policy Act of 2005. My testimony will provide a financial community perspective on the current industry activities that may lead to applications to construct and operate new nuclear power plants, and the efforts by the federal government to implement the nuclear power provisions in the Energy Policy Act of 2005.
Mr. Chairman, I believe that you, the Ranking Minority Member, and the other members of this Committee deserve enormous credit for your efforts leading to the enactment of comprehensive energy legislation last year. Thanks to many of the initiatives and incentives in the Act, the industry is now embarking on a new construction cycle including investments to upgrade and expand transmission and distribution system reliability, to ensure environmental compliance for our large coal-fired generation fleet, and to add much-needed new baseload generating capacity. These new investments will require new sources of financing for the industry.
The Energy Policy Act contained four provisions that were intended to facilitate and encourage industry commitments to build and operate new nuclear power plants in this country. First, the Act included a 20-year extension of the Price-Anderson Act, which provides insurance protection to the public in the event of a nuclear reactor accident. With the previous expiration of the Price-Anderson Act, insurance coverage for the public remained in place for our existing 103 operating nuclear units, but that coverage would not have been available for new plants. The 20-year extension of the Price-Anderson Act corrected this problem. Second, the Act provided a production tax credit of 1.8 cents per kilowatt-hour for up to 6,000 megawatts of generating capacity from new nuclear power plants for the first eight years of operation. This production tax credit is subject to an annual cap of $125 million for each 1,000 megawatts of generating capacity. A similar production tax credit was provided, and has historically been available, for certain renewable energy resources. Third, the Act provided standby support or risk insurance for a new nuclear project’s sponsors and investors against the financial impacts, including financing costs, of delays beyond the industry’s control that may be caused by delays in the Nuclear Regulatory Commission’s licensing process or by litigation. This standby risk insurance for regulatory and litigation delays provides protection for the first six new nuclear units built. Up to $500 million in protection is provided for the first two new units, and 50 percent of the cost of delays up to $250 million, with a six-month deductible, is provided for units three through six. Finally, the Act provided for federal loans and loan guarantees for up to 80 percent of the project’s cost. These federal loan guarantees were made available to support the development of innovative energy technologies, including advanced nuclear power plants, that avoid or reduce certain air pollutants and greenhouse gas emissions.
Mr. Chairman, although we are still at an early stage in the process and no company has yet placed a firm order for a new nuclear unit, there is clear evidence from the level of activity within the industry over the past nine months that these provisions in the Energy Policy Act are having their intended effect of facilitating and encouraging new plant development. Three companies, Exelon, Dominion Resources, and Entergy, have filed applications with the Nuclear Regulatory Commission for early site permits (ESPs), and the NRC review process is now underway. Other companies have announced that they are planning or considering early site permit applications as well. Of the three new plant designs that appear to be of the greatest interest to the industry, one has received its design certification from the NRC, and the review processes for the remaining two are either underway or will begin within about a year. Finally, nine companies have announced that they are preparing a total of 11 applications for a combined license (COL) for as many as 19 new units, to be submitted to the NRC in 2007-2009. Taken together, the industry is investing more than $1.5 billion in the engineering, design, license preparation, and long-lead time procurement activities needed to support these applications. Over the past nine months, those of us in the financial community have become increasingly familiar with the level of activity and the seriousness of the industry’s efforts leading toward new plant commitments.
Mr. Chairman, the process of planning, developing, licensing, building, and financing a new nuclear plant is likely to be very complex. From a financing perspective, investors will need confidence that a new nuclear plant can be built on a predictable schedule and for a predictable cost, that the cost will be competitive with that of other available baseload generating alternatives such as coal, and that they will be protected against the risk of licensing and litigation delays at least until the new NRC licensing process has demonstrated a track record of successful performance. Enactment of the provisions in the Energy Policy Act was the first critical step in meeting these financing requirements, but much of the detailed work remains ahead of us. It is therefore critically important for this Committee and other relevant committees of the Congress to continue to actively monitor and oversee the implementation of the provisions in the Energy Policy Act. To that end, I would offer a few comments on the implementation of the provisions in the Act to date.
With regard to the production tax credit, on May 1, 2006, the Internal Revenue Service issued a bulletin providing interim guidance on the eligibility and allocation of the production tax credit for new nuclear plants. Under the Service’s interim guidance, in order to qualify for the tax credit, a company must file an application for a combined license by the end of 2008. Allocations of the tax credits for the 6,000 megawatts would subsequently be made for the plants which commence construction by the start of 2014. The Service’s interim guidance seems to be sensible and practical, and consistent with the objectives of the statute. The guidance has the effect of encouraging the early filing of COL applications before 2009, but of allocating the available tax credits proportionately among all of the plants that begin construction by 2014. This should have the beneficial effect of encouraging a larger number of new applications, although the economic benefit on a per plant basis could be reduced if the total generating capacity of the eligible plants exceeds 6,000 megawatts. Issuing final regulations implementing this interim guidance will provide certainty and predictability for financing purposes. In addition, in order to maximize the availability of alternative financing sources, it would be helpful if the final IRS regulations permitted the transfer of the production tax credits to passive equity partners who may not be utilities or electric generating companies.
Concerning the standby support or delay risk insurance provision, the Department of Energy has done substantial work to develop its implementing regulations. The Department has conducted an open and collaborative process, starting with the publication of its Notice of Inquiry and a public workshop last year, and more recently, with the publication of its interim final rules. This is a complex rulemaking, and the current public comment period should provide an opportunity to ensure that the provisions in the rule are clear and workable. The risk of cost increases due to regulatory and litigation delay is a significant concern for investors, and the Department’s final regulations will likely be a critical ingredient in the ability to finance the initial new plants. One missing element in the Department’s implementing regulations is the methodology for determining the cost to the project sponsor of providing this delay risk insurance. This will be a component in calculating the overall project cost and in assessing the value and availability of the risk insurance protection.
With regard to the loan guarantee provision in the Act, the Department of Energy has not yet issued a Notice of Inquiry or proposed regulations designed to implement this provision. The availability of federal loan guarantees for up to 80 percent of a project’s cost, in conjunction with the production tax credit, offers the greatest potential to reduce the cost of the initial new nuclear plants to levels that are competitive with other baseload generating alternatives. In addition, for certain financing models for a new nuclear plant, such as ownership by an unregulated generating company or use of a single asset, non-recourse project finance structure, a federal loan guarantee may be required to provide the debt component of the financing. Further, as is the case with the standby risk insurance, the methodology for determining the cost of the loan guarantee to the project sponsor will be a factor in assessing the availability and value of the loan guarantee. For these reasons, the Department’s implementation of the loan guarantee provision is likely to be an important component in ensuring the availability of financing for the initial plants. Given the importance of the loan guarantee provision, the Department may wish to consider an open and collaborative process for the loan guarantee regulations similar to the one it used in developing the standby risk insurance regulations.
Finally, Mr. Chairman, I wanted to offer a few comments on the NRC licensing process. Although the standby delay risk insurance provisions are very helpful for the initial plants, it is clear that investor confidence needed to support the financing of a number of follow-on new nuclear units will depend upon the successful operation of the NRC licensing process in these early cases. Chairman Diaz and his colleagues on the Commission invited me to participate in a Commission meeting last fall with industry representatives to discuss the types and timing of new applications that may be submitted for NRC review. It was apparent from that meeting that the Commission could well face the need to review a sizable number of new applications of differing types – design certifications, early site permits, and combined licenses – concurrently. Moreover, the NRC has begun a major revision of its regulations, regulatory guides and standard review plans for new combined licenses at the same time that the industry is preparing its applications. The potential number of applications, the interaction of the various types of approvals, the potential for duplication of effort, and the need to coordinate the development of new regulations and regulatory guidance with the industry’s license application preparation work all pose substantial challenges. I am confident that the NRC can and will exercise its independent health and safety responsibilities. But if this process is to work smoothly and efficiently, we will need stability and continuity within the NRC, active management involvement by the Commission and the senior NRC staff, and close coordination between the NRC staff and the industry. The NRC will also need sufficient resources to conduct its reviews in an efficient and timely manner.
Mr. Chairman, again, thank you for the opportunity to testify today, and this completes my testimony.