Thursday, March 11, 2010

Center for American Progress Distorts the Loan Guarantee Program

On Monday, CAP attempted to provide some facts about DOE’s loan guarantee program that needless to say completely distorted the picture. After spending a few days dissecting their analysis, NEI came out with a 13 page response that rebuts CAP and clarifies the facts. Below the rest of this post are just a few snippets from our response.

The Center for American Progress is openly and determinedly anti-nuclear and CAP’s recent paper reflects that anti-nuclear bias. Although it appears to be an objective discussion of credit subsidy fees, careful examination shows that the paper is built on mistakes and misstatements; unsubstantiated estimates of default probability and recovery rates; cost estimates of mysterious origin, lack of understanding about recent nuclear construction experience, and inaccurate descriptions of the DOE loan guarantee program requirements and project structures. An impartial observer could easily conclude that the Center for American Progress hopes to undermine the entire clean energy program, including support for wind, solar and other carbon-free technologies.

A few of CAP’s inaccurate and/or misleading statements are set forth below, accompanied by factual clarification:

Center for American Progress: “Building a nuclear reactor today will involve dealing with tremendous financial uncertainty.”

By the time construction starts; there is, in fact, a high degree of financial certainty – because the design is complete, quantities of commodities and materials are well-known and priced; EPC (engineering-procurement-construction) terms and conditions have been set; liquidated damages agreed to, and contingencies defined, etc.

Center for American Progress: “[T]here’s no way to predict what the final cost will be.”

Public filings and state public service commission analyses and orders in SCANA’s V.C. Summer or Southern Company’s Vogtle projects provide realistic examples of reactor costs. These projects have signed engineering-procurement-construction (EPC) contracts with significant fixed price portions to reduce risk. For the portions of the project that are subject to escalation, contingencies are built into the estimates to mitigate risk. In addition to the owner’s review, the respective state public service commissions have reviewed the contracts and risk-sharing mechanisms to ensure adequate protection for ratepayers.

The new nuclear power plants being reviewed by DOE’s Loan Guarantee Program Office are all under construction or in operation overseas. By the time the U.S. plants receive their combined licenses and close on loan guarantee financing, one design will be in the final year of construction and the others will be operational. The final costs will be informed by this additional data and will be reviewed as part of the financial closing for the loan guarantee.

Center for American Progress: “[T]he generic default rate is 50 percent.”

This assumption is not supported by any factual information or analysis, is unrealistic and irresponsible, and deserves to be ignored.

The assumption of 50% default probability is not credible because no company would pursue a project if credit assessment and due diligence showed a potential default rate of 50%. The companies building new nuclear power plants will have significant shareholder equity ($1 billion or more per project) at risk. The companies would forfeit this equity investment in the unlikely event of default on a guaranteed loan. No electric company could afford a loss of that size.

Center for American Progress: “These assumptions indicate that the credit subsidy fee on a nuclear loan guarantee should be at least 10 percent.”

Two items – probability of default and recovery rate in the event of default – drive the financial model used to calculate credit subsidy costs for federal loan guarantees. Since the Center for American Progress’ assumptions about default probability and recovery rate have no factual or analytical basis, and are not supported by historical data, it follows logically that CAP’s finding about subsidy cost is equally without merit or value. There is no credible basis for this number and it can be safely ignored.

NEI is not a party to the discussions between the Department of Energy and the companies seeking loan guarantees and cannot comment on the credit subsidy fees under discussion. For reference, however, the average fee for all government loan guarantee programs in the 2010 fiscal year is 0.2 percent of the loan amount. The federal government manages a loan guarantee portfolio of about $1.2 trillion. The government-wide average subsidy fee is low because many loan guarantee programs generate more fee revenue for the federal Treasury than they cost, as the DOE loan guarantee program for nuclear energy is expected to do.

Realistic estimates of default probability and recovery rate (i.e., in the 80-100% range) will produce credit subsidy costs approximating the range suggested by Energy Secretary Steven Chu on March 4, 2010, following his appearance before the Senate Energy and Water Development Appropriations Subcommittee. Asked about subsidy costs, Secretary Chu said: “It’s quite a small subsidy – 1 percent, plus or minus a half percent.”

There’s plenty more so please check out the rest.

1 comment:

perdajz said...

Nice job, NEI, with the credit risk. Default rate is moot if loss given default is very low or recovery rate is very high. As nuclear power plants will be coveted assets for decades time to come, I'd say recovery rate will be good, even in the unlikely event of a default.

By the way, credit risk bears some resemblance to NPP probabilistic risk analysis.