The Outlook for Nuclear Energy In a Competitive Electricity Business

1776 I STREET N.W. SUITE 400 WASHINGTON, D.C. 20006 202.739.8000 The Outlook for Nuclear Energy In a Competitive Electricity Business Executive Summary: Nuclear Units Competitive, Profitable in Deregulated Electricity Markets Most U.S. nuclear power plants are well-positioned for competition. Measured by total going forward costs operating and maintenance (O&M) costs, fuel costs, ongoing capital requirements, taxes and general and administrative (G&A) expenses most nuclear units can compete in a deregulated, competitive electricity market. Many nuclear plants can improve their economic performance. Analysis shows a large spread between the nuclear plants with the highest costs and those with the lowest costs. The plants in the high-cost quartile spend twice as much on O&M and fuel as the plants in the low-cost quartile. The highercost units clearly have a significant opportunity to improve efficiency and reduce costs. U.S. Nuclear Power Plant Economic Performance: Consistent Improvement 3-Year Rolling Average Production Costs cents per kilowatt-hour 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 Economic performance of the U.S. nuclear fleet continues to improve. Three-year rolling average production costs are declining for all four quartiles. The improving trend is particularly dramatic for the fourth quartile. 1.47 1.43 1.33 1.72 1.69 1.58 Quartile 1 Quartile 2 Quartile 3 Quartile 4 2.04 2.04 1.84 1995-97 1996-98 1997-99 3.03 3.88 2.8

of 13 The positive outlook for U.S. nuclear power plants is in stark contrast to speculation several years ago when industry restructuring at the state level was just beginning and competitive markets were in their infancy that many nuclear units would not be economic and would be shut down prematurely. Since then, the performance of the nuclear units has improved dramatically; the cost of electricity from other sources has increased; and surplus generating capacity in most regions of the country has all but disappeared. Today, virtually all nuclear units are expected to operate to the end of their 40-year licenses, and most will renew their licenses for an additional 20 years. A generating company with nuclear power in its portfolio must decide whether to continue to operate its nuclear unit(s), or shut down its nuclear capacity and build new, replacement capacity. In today s market, that replacement capacity would be a gas-fired combined cycle power plant. A well-managed nuclear unit can produce electricity profitably at a total cost of 2.0-2.5 cents per kilowatt-hour. A new gas-fired plant would produce electricity at a total cost of 3.5-4.5 cents per kilowatt-hour, assuming a plant capital cost of $500-600 per kilowatt and gas prices of $3-4 per million Btu. The choice is clear: companies may build new gas-fired capacity to meet new growth in electricity demand, but they would not close an existing nuclear unit and replace it with a new gas-fired power plant. In addition to their value as reliable producers of low-cost bulk electricity, existing nuclear units have substantial additional value because of trends in the fossil fuel markets. The existing nuclear plants represent: $ per megawatt-hour $140 $120 $100 $80 $60 $40 $20 $0 Rising Gas Prices = Dramatic Impact on Electricity Cost $25 Existing Nuclear Power Plant $33 Gas at $2.50 $51 Gas at $5 $68 Gas at $7.50 $87 $122 Gas at $10 Gas at $15 Combined-cycle gas-fired power plant! A valuable hedge against volatility in the natural gas market. Natural gas prices to electric generators have doubled over the last 12 months, which has had a major impact on the cost of electricity

of 13 produced by gas-fired power plants. Nuclear units provide a high level of forward price stability, because their operating costs are predictable and stable. This price stability has value in volatile electricity markets.! Valuable protection against escalating environmental requirements and clean air constraints, which will drive up the cost of increasing electricity production from existing coal-, gas- or oil-fired capacity, or possibly preclude increasing output from existing fossil fuel-fired capacity or building new plants that burn fossil fuels.

of 13 Recent Trends in Economic Performance Of U.S. Nuclear Power Plants History The cost of operating and maintaining U.S. nuclear power plants rose steadily in the 1980s. After the 1979 accident at Three Mile Island, nuclear utilities invested heavily in equipment and manpower to meet new safety requirements, and to achieve the highest possible operating and safety standards. This investment paid substantial dividends in improved safety, reliability and output. The average capacity factor of U.S. nuclear plants rose from 57.6 percent in 1980 to 86.8 percent in 1999. Nuclear power plant operating and maintenance (O&M) costs increased, on average, by 7-8 percent a year above inflation through much of the 1980s. In 1986-1987, for the first time ever, the average production cost from nuclear plants exceeded that of coal-fired plants. (Production cost consists of O&M plus fuel.) Since then, nuclear plant O&M costs have leveled off and decreased. Recent Trends Nuclear plant operators pursued several initiatives to reduce O&M costs. U.S. Nuclear Industry Average Production Costs (in cents per kilowatt-hour: 1999 dollars) Except for 1997 and 1998, when a number of nuclear power plants experienced abnormally high costs because they operated only intermittently due to regulatory difficulties, production costs (fuel and O&M) have been declining steadily since the late 1980s. 3.5 3 2.5 2.23 2.5 2.7 3.1 3.19 3.11 2.98 3.04 2.9 2.79 2.63 2.57 2.48 2.36 2.25 2.18 2.1 2.04 2 1.83 1.5 1 0.5 0 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 Source: Utility Data Institute

of 13 More comprehensive planning and innovative management techniques have reduced the time that nuclear power plants are out of service for refueling. In 1990, the average duration for a refueling outage at U.S. nuclear power plants was 101 days. Since then, that figure has dropped steadily. In 1999, the average outage was 41.5 days, and the top performers are recording refueling outages of 25 days or less. This and other improvements have resulted in substantial increases in the amount of electricity produced by the plants.! In 1990, 56 nuclear units had capacity factors above 70 percent; 31 units operated above 80 percent.! In 1999, 98 of 103 units had capacity factors above 70 percent; 90 units operated above 80 percent. Thanks to improved management practices, higher reliability and output, and shorter refueling outages, the average production cost (O&M plus fuel) of electricity from U.S. nuclear power plants has declined since the mid- 1980s a 45 percent decrease since 1987, when average nuclear production costs peaked at 3.19 cents per kilowatt-hour. In 1999, average nuclear plant production costs reported to the Federal Energy Regulatory Commission were U.S. Nuclear Power Plant Average Capacity Factors 1980-1999 Note: The decline in industry average capacity factor in 1997 was a temporary phenomenon, and reflected plant outages caused by regulatory issues. In 1997, 10 plants were shut down all year due to regulatory problems. Four plants had capacity factors less than 30 percent in 1997 as a result of being shut down for most of the year due to regulatory issues. 90 85 Capacity Factor (%) 80 75 70 65 60 Operating Plants (88.5 % in 1999) All Plants (86.8 % in 1999) 55 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 Year

of 13 1.83 cents/kwh, lower than average coal-fired production costs (2.07 cents/kwh) for the first time since 1987. Nuclear plant operators are also reducing capital spending. Capital requirements at operating nuclear plants have dropped dramatically from $60-$70 per kilowatt per year in the mid-1980s to $20-$30 per kilowatt in the early 1990s. Most nuclear units are projecting incremental capital requirements of approximately $10-$15 per kilowatt going forward. Opportunities for Improvement In Economic Performance Many nuclear plants should be able to improve their economic performance even further. Analysis shows a large spread between the nuclear power plants with the highest costs and those with the lowest costs. The nuclear plants in the lowcost quartile had an average production cost (O&M plus fuel) of 1.33 cents per kilowatt-hour in the 1997-99 period. The plants in the high-cost quartile had an average production cost of 2.8 cents/kwh more than twice as high. The plants in the second and third quartiles had average production costs of 1.58 cents/kwh and 1.84 cents/kwh, respectively. (The units with the lowest O&M costs tend to be among the most efficient units, with high capacity factors and superior performance ratings from the Nuclear Regulatory Commission and the industry.) U.S. Nuclear Plant Production Costs, Capacity Factors (3-Year 1997-1999 Rolling Averages) Quartile Production Cost Average Capacity Factor 1st 1.33 cents/kwh 91.4 percent 2nd 1.58 cents/kwh 87.9 percent 3rd 1.84 cents/kwh 82.3 percent 4th 2.8 cents/kwh 74.6 percent While there is still room for the lower-cost plants to improve, there is a significant opportunity for the higher-cost units to improve efficiency and reduce costs dramatically. For the plants in the third and

of 13 fourth quartiles and, to an extent, those in the second quartile the obvious challenge is finding ways to improve economic performance to the level achieved by the plants in the first quartile. Although the larger plants simply because they can produce more electricity are generally better-positioned for competition, analysis shows that smaller plants can also operate safely and reliably at low cost. Consolidation As competition develops and industry restructuring unfolds, electric power companies across the country are making strategic business decisions. Some companies are divesting power generation assets and focusing on transmission and distribution. Some are divesting generation in their traditional service territory, but buying generation elsewhere. All companies are evaluating the economics of their power plants, including future capital needs, to determine whether those plants can survive in a competitive market. This new business approach is also at work in the nuclear energy sector. Some companies are divesting nuclear assets. Others are buying. The transition to greater competition in electricity generation is leading to formation of new corporate entities, such as large nuclear operating companies. By focusing resources solely on nuclear power operations, such restructurings will enhance nuclear power plant reliability, safety performance and, in parallel, economic performance.

of 13 Evaluating the Competitive Position of Nuclear Plants Operating Economics Few exercises are as complex as evaluating the competitive position of a nuclear power plant (or, indeed, any power plant), and making judgments about whether a given plant is economic or not. Any such assessment, however, should proceed from certain basic facts: Existing power plants, including nuclear units, will compete solely on the basis of operating economics, which do not include sunk capital costs. As the electric power industry is restructured, recovery of invested capital is handled separately, usually through some form of separate transition charge. Production costs (O&M plus fuel) do not represent the complete cost of electricity produced by a nuclear power plant, and are thus not a definitive indicator of its ability to compete. A nuclear plant must be able to compete on the basis of total cost production cost plus ongoing capital requirements plus general and administrative (G&A) expenses. (G&A expenses typically include property taxes.) A number of nuclear power plants built in the 1980s cost considerably more than originally estimated a product of oil supply and price disruptions in the Most U.S. Nuclear Units Well-Positioned for Competition 1997-99 Rolling Average Production Cost (cents/kwh) Most U.S. nuclear units will be easily competitive on a total cost basis assuming markets clear between 2.5 cents per kwh and 3.5 cents/kwh. The units in the second, third and fourth quartile can continue to improve their economic performance to the level of the first quartile. 0.5-0.8 cents/kwh for capital additions, A&G, property tax, etc. 4 Likely price range in competitive market 3 2 1 0 2.8 1.58 1.84 1.33 Quartile 1 Quartile 2 Quartile 3 Quartile 4 Production Cost = O&M + fuel + waste fee + decommissioning Data source: EUCG

of 13 1970s, which led to double-digit inflation, slower economic growth and reduced growth in electricity demand. In addition, after the accident at Three Mile Island in 1979, nuclear plants were swamped by new regulatory requirements, and forced to undergo extensive redesign to incorporate lessons learned from the accident. These design changes for plants still under construction, coupled with licensing delays, resulted in long, drawn-out construction schedules. On average, it took 10.5 years during the 1980s to build a nuclear power plant in the United States and get it into operation. (By contrast, it takes four to five years to build a nuclear power plant in France, Japan and other industrialized countries.) To make matters worse, many of these plants were being built at a time of double-digit inflation, when interest rates on borrowed money were very high. As the electric power industry is restructured, these and other categories of stranded costs are being recovered in whole or in part through special transition charges. The stranded costs associated with nuclear power plants will not affect the cost of electricity produced by those plants. Other Factors Cost is not, however, the sole determinant of whether a nuclear unit will be able to compete. Other factors can have a significant effect on the market value of a nuclear power plant, including:! whether there is surplus generating capacity in a region and, if there is, how long that surplus is expected to last;! clean air constraints that will drive up the cost of increasing electricity production from existing coal-, gas- or oil-fired capacity, or possibly preclude increasing output from existing fossil fuel-fired capacity or building new plants that burn fossil fuels;! transmission constraints into the region, which may limit the amount of power that can be imported and thus increase the value of in-region generation; and! whether the nuclear unit provides essential ancillary services and is important to maintaining the stability and reliability of the transmission system.

of 13 Natural Gas Price Volatility, Clean Air Compliance: Added Value for Nuclear Generation In addition to their value as reliable producers of low-cost bulk electricity, existing nuclear units have substantial additional value because of trends in the fossil fuel markets. The existing nuclear plants represent:! A valuable hedge against volatility in the natural gas market. Natural gas prices to electric generators have doubled over the last 12 months, which has had a major impact on the cost of electricity produced by gas-fired power plants. Nuclear units provide a high level of forward price stability, because their operating costs are predictable and stable. In volatile electricity markets, this price stability has value to buyers.! Valuable protection against escalating environmental requirements and clean air constraints, which will drive up the cost of increasing electricity production from existing coal-, gas- or oil-fired capacity, or possibly preclude increasing output from existing fossil fuel-fired capacity or building new plants that burn fossil fuels. Natural Gas Prices After several years of low wellhead prices (in the $2.25-2.50 per million Btu range), U.S. natural gas prices started to increase rapidly early in 2000. The rapid escalation in gas prices was largely caused by gas demand (particularly in the electric $ per million Btu $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 Natural Gas Prices to Electric Generators 1999 and 2000 Natural gas prices to electric power plants increased dramatically in all regions of the country during 2000. Prices roughly doubled in most major consuming areas except California, where gas prices to electric generators almost tripled. $2.31 $2.30 Source: Natural Gas Week $2.33 $2.32 $2.72 $2.61 1999 Average 2000 Average $6.20 $4.23 $4.32 CA TX LA Midwest S.E. N.E. $4.42 $4.66 $4.96 generation sector) beginning to outstrip supply. Several years of low wellhead gas prices had depressed domestic exploration and production for natural gas.

of 13 Gas prices to electric generators have increased substantially. The Energy Information Administration now projects the average cost of gas for power generation this year will be $3.99 per million Btu, a significant increase from the $2.57-per-million-Btu average in 1999. Prices to electric generators are up significantly in all regions of the country. Significant Volatility During 2000 In Natural Gas Prices to Electric Generators ($ per million Btu) $30.00 $25.00 $23.92 $20.00 $15.00 $10.00 $5.00 $2.61 $2.62 $2.68 $2.65 $3.06 $3.80 $3.73 $3.59 $3.66 $3.63 $4.06 $3.87 $5.26 $4.50 $4.54 $4.58 $4.90 $4.77 $5.72 $5.14 $5.18 $5.29 $5.56 $5.55 $9.93 $5.15 $5.57 $5.48 $5.73 $5.90 $8.26 $8.49 $9.69 $8.63 $10.80 $0.00 1Q 2000 2Q 2000 3Q 2000 Oct-00 Nov-00 Dec-00 CA TX LA Midwest S.E. N.E. Source: Natural Gas Week Drilling for gas has increased sharply in response to higher prices: the number of rigs drilling for gas in the United States has risen to over 800, 45-50 percent higher than a year ago. Even so, it will take 12-18 months to bring new supplies to market, and consensus forecasts indicate that higher natural gas prices will persist through 2001. Even if and when gas prices moderate, most analysts expect the price volatility to continue, and believe that natural gas will behave like all commodities (including electricity): (1) higher gas prices will prompt more drilling and more production; (2) production will outrun demand, forcing prices down again, although probably not down to previous lows; (3) lower prices will drive up demand until demand outruns supply; and (4) the cycle will repeat. The sharp increase in gas prices this year has a significant impact on the cost of electricity produced by gas-fired power plants because these plants are

of 13 Rising Gas Prices = Dramatic Impact on Electricity Cost The cost of electricity in dollars per megawatt-hour from an existing nuclear power plant compared to the cost of electricity from a gas-fired power plant at different gas prices. $ per megawatt-hour $140 $120 $100 $80 $60 $40 $20 $25 $33 $51 $68 $87 $122 $0 Existing Nuclear Power Plant Gas at $2.50 Gas at $5 Gas at $7.50 Gas at $10 Gas at $15 Combined-cycle gas-fired power plant Gas-fired electricity costs are representative of new gas-fired combined-cycle capacity: $600 per kilowatt capital cost; heat rate of 7,000 Btu per kilowatt-hour; 24-month construction time; 85 percent capacity factor; 60/40 debt/equity ratio on financing; 9 percent interest rate on debt portion of financing; 20-year debt term; 15 percent internal rate of return. extremely sensitive to changes in fuel price. Approximately two-thirds of the cost of electricity from a new combined-cycle gas plant is fuel cost. Clean Air Compliance Power plants burning fossil fuels, particularly coal-fired plants, are subject to heavy and increasing regulatory and enforcement burdens under a Clean Air Act that has become steadily more complex and intrusive over the past 25 years. The cumulative impact of increasingly restrictive clean air requirements will be costly both in terms of additional investment in equipment and increased operating costs and will almost certainly increase the relative attractiveness of non-emitting sources like nuclear energy. The cost of air pollution control is already high, and likely to get higher. From 1987 through 1994, electric utilities spending for clean air compliance doubled, increasing from $3 billion to $6 billion in 1994 (constant 1993 dollars). This represents a real annual growth rate of 10 percent over that period an extraordinarily high rate of real, sustained growth compared to other economic indicators.

of 13 Looking to the future, one analysis 1 shows that U.S. power companies clean air compliance costs will increase from $6.6 billion in 1995 to $11.4 billion in 2000. In fact, since the year 2000 marks the start of Phase II of the 1990 Clean Air Act s acid rain program, it is likely that air pollution costs in the early years of the 21 st century will increase more rapidly than in the 1995-2000 period. Another recent analysis projects the cost of meeting new EPA air quality initiatives at $21.8 billion over the next 10-15 years. 2 At the very least, existing and emerging clean air requirements will tend to drive up the cost of coal-, gas- and oil-fired generation, possibly by a significant amount, and thus make existing nuclear power plants more competitive. 1 Costs Incurred by the Electric Utility Industry due to Federal Air Pollution Control Requirements, by Management Information Systems, Inc. for the Edison Electric Institute, July 1996. 2 At What Cost? Federal Environmental Regulations in a Competitive Marketplace; analysis by Resource Data International for the Edison Electric Institute, June 1998.