Nuke Owners Are Playing Chicken

 | Aug 02, 2013 | 5:00 PM EDT
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This is an historic week. The long awaited collective awakening in the nuclear power industry arrived with a series of stunning announcements. The theme in common was similar: We want out. Nevertheless, investors should be careful. Large generators are playing a giant game of chicken.

Exelon (EXC) had two announcements. Their French partner, state-owned Electricité de France announced they want to exit from U.S. nuclear power industry. Through their joint venture with Exelon, EDF owns 49.9% of five nuclear power plants: Maryland's two nuclear units at Calvert Cliffs, New York's R. E. Ginna plant and Nine Mile Point. Plant licenses are being transferred from their joint venture company, Constellation Energy Nuclear Group to Exelon Generation. EDF's equity position will transition later.

EDF's move may be good news for Exelon. With most of their nuclear power assets under one umbrella, Exelon can achieve economies of scale and reduce operational expenses. In addition, Exelon is in a better position to hedge generating assets in forward contracts with the market and with large energy consumers.

Exelon also announced its intention to keep Clinton Nuclear Power Station in the company's nuclear fleet. Clinton is located 23 miles south of Bloomington, Ill. At 1,043-megawatts, Clinton is a relatively new plant and has a healthy operating history.

By most industry accounts, Clinton is technically a solid asset with a bright future. The problem is that Clinton is a merchant plant which is operating from the wrong location. Because of chronic transmission line constraints, Clinton's power cannot get to market. As a result, the market price of power at the generating leads is below production costs.

Nevertheless, if Exelon's management team has the right long-term strategy, its nuclear fleet could become very profitable. They are gambling that so many plants will exit the market that energy and capacity prices will return to healthy levels. If their gamble is wrong, Exelon could face enormous challenges.

Entergy (ETR) is in a similar position. Behind Exelon, Entergy is the owner of the nation's second largest fleet of nuclear power plants. Five of their facilities are merchant plants located in Michigan, New York, Massachusetts and Vermont. They have a below-average capacity factor of 82% and a much higher-than-average production cost of $29.16 per megawatt-hour. For the first half of 2013, production costs are increasing in the face of decreasing market prices (currently averaging at $46.40 per megawatt-hour). Entergy expects its average production costs will decrease enough to reach the annual cost of $27.54. They also expect market prices for power to increase enough to reach an annual price of $51.95 per megawatt-hour.

Entergy's expectations are aggressive. If they miss, these five nuclear units could be in trouble. This may explain Entergy's unexpected announcement.

According to Reuters, Entergy's CEO is "mulling the future of its wholesale nuclear operation" and he plans to cut 800 jobs. This statement is an early warning that Entergy's merchant fleet is in trouble.

If Entergy decides to retire Palisades, Indian Point, Pilgrim and Vermont Yankee, there could be substantial impacts on the company's enterprise value. Entergy cannot sell these units. There is almost no market value for these assets as few qualified investors would be willing to buy them. In all likelihood, they will be retired and written off.

Entergy's second quarter financials illustrates the problem. Its wholesale operations, which include the nuclear units, booked a $16.264 million loss for operating income. They were saved by interest income and income tax refunds.

To pile on Entergy's financial challenges, its fleet is under intense political pressure by New York state and the Vermont. Both states are aggressively seeking to shut down three of Entergy's five nuclear plants. The remaining two units have weak pro formas and they could retire early.

It is difficult to see any upside for Entergy's nuclear units. They may get lucky and see improvements in the markets. If not, investors should expect to see massive retirements.

Finally, Duke Energy (DUK) dropped the last bomb, pulling out of its plans to build two new nuclear units in Florida. Duke will continue with licensing, but cancelled the engineering, procurement and construction contracts with Westinghouse and Chicago Bridge & Iron Company (CBI).

Duke's decision is not a surprise. The decision will have minimal impact on its financials.

Generators like Exelon want their competitors to exit the market leaving them with higher prices.  They know coal will be exiting the market for sure. They would love it if more capacity would join in on the exit parade. As a result, many of these announcements could be a giant head fake.

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