While the energy sector's attention was focused on Entergy's (ETR) decision to retire its Vermont Yankee Nuclear Power Station 20 years early, Southern (SO) was quietly maneuvering to change the financial terms for its new Vogtle Electric Generating Plants. Both moves signal growing challenges for the nation's utilities to build, own and operate commercial nuclear power plants.
Entergy's decision to retire and dismantle Vermont Yankee came about for one simple reason: Vermont Yankee's cost structure was uneconomic and uncompetitive. Entergy had to change the cost structure or hope for changes in the power market. Seeing no possibility for improvement in either, the company decided to protect its shareholders and shutter the plant.
As Entergy struggled to keep its Vermont Yankee station alive, Southern has been struggling to construct new units at Vogtle. Southern is the lead owner in a multi-owner project, whose costs have been creeping up and schedules have been creeping out.
Until now, Southern's shareholders have been protected by Georgia's Public Service Commission. As a matter of law, Southern's construction costs are passed through the commission and on to the state's consumers. Under this scheme, the state of Georgia allows Southern to pass its nuclear construction costs on to consumers as Vogtle is built and before construction is completed.
The concept is called CWIP, and it means construction work in progress. CWIP allows regulated utilities to earn returns on unfinished construction assets.
Lobbying organizations such as the Nuclear Energy Institute have advocated using CWIP rules for years. Their argument is that CWIP lowers the utility's cost of nuclear construction. Lower construction costs benefit regulated consumers via lower energy costs.
The Nuclear Energy Institute is right. Without CWIP, utilities and their financiers were forced into a risk position. Without CWIP, the utility accumulates growing interest costs with no offsetting revenue for as long as it takes to complete construction. As time progresses, the financial burden becomes heavier and financial risks increase.
Here is the interesting part. Utilities generally do not expense construction interest. They capitalize it. At the end of construction, interest charges for the entire construction period are collected, summed and distributed into the plant's capital accounts. As a result, the utilities' crippling interest expenses become assets, and regulated consumers end up paying the utility a return on assets for years to come.
Technically, CWIP does lower capital costs. Consumers do win. So do utilities. If the construction is completed, the NEI is right, and all parties benefit from CWIP.
It is not a surprise that before starting construction on its new nuclear units, Southern convinced their utility commission to allow CWIP. It was not alone. Before retreating from their nuclear construction projects, Duke Energy (DUK) and NextEra Energy (NEE) convinced the state of Florida to do the same.
Today, Southern is passing its nuclear construction costs on to consumers as costs are incurred. However, there are caveats. A big one is that any cost passed on must be within the budget pre-approved by the state.
However, if construction is not finished, the consumer is left holding the bag, and the utility rides off into the sunset. This is what just happened when Duke canceled its nuclear construction planned for Florida's Levy County after its estimated date of completion had stretched into 2024 and a revised cost estimate grew past $20 billion. According to Bloomberg BusinessWeek, Duke's exit from nuclear construction leaves utility customers in Florida "with a tab of more than $1 billion -- most of it already paid to Duke -- for unbuilt plants that may never produce a single kilowatt of energy."
One month after Duke pulled the plug in Florida, Georgia's regulators are rethinking their strategy. It appears the state of Georgia is developing serious concerns over Vogtle's nuclear construction costs. As such, they want to find ways to cap their exposure to the potential of an out-of-control project. Their plan is to modify the terms of their CWIP agreement with Southern
According to the Associated Press, the commission has a proposed deal with Southern, whereby Southern would withdraw its request to increase its CWIP budget. Instead, the commission's approval to raise Southern's construction budget would be delayed until one of Vogtle's new reactors comes online.
If Georgia's commission approves the deal, Southern will keep CWIP for budgeted construction costs and forfeit incremental CWIP for all cost overruns. It still may be able to pass some of those overruns on to consumers later.
From an investor's point of view, Georgia's deal represents a workable compromise. Southern's shareholders' exposure to financial risks remains limited to the utility's share of incremental costs, which is slightly less than 46%.
While the regulatory language may sound complicated, Southern's shareholders should not be concerned, at least not for now. Any leaps in Vogtle's construction costs, should they occur, are years away.
