Dinosaurs Got Massive & Then Died for Reasons

Why the AP1000 Is Dead and SMRs Are So Promising Here

Science suggests that competition for food, light, and resources led some dinosaurs, fauna, and even insects to reach enormous sizes. Bigger was better for hundreds of millions of years. Until it wasn’t.

The same kind of thing happened with nuclear power plant design. Thermal coal has always had a preditor - prey relationship with nuclear power. In the 1960s and 1970s, engineers grew nuclear power plants to enormous scales in order to compete with cheap coal. They failed. Powder River Basin Coal had killed nuclear power by about 1975. Yet, the massive-scaled power plant designs persisted into the AP1000.

Energy Project Finance

I used to work at one of the largest energy law firms in the world and got to work on all kinds of energy deals. New builds. Stock and asset sales. Mergers. Regulated and unregulated. Why does energy project finance matter? Without it, new projects are never built.

Massive-scale nuclear power plants suffer from the same financing problems as massive hydro or similar projects. Only governments can finance them. And governments are both terribly inefficient and fickle.

Everybody loves hydro power. Water is free. The electrical power is very high value—the best load-following resource in use today. Clean. Green. Renewable. Sustainable. The Poster Child for the Zero Carbon Energy Future. Except when it’s not.

The Muskrat Falls hydro-electric project sounds remarkably similar to what happened with the AP1000 projects in Georgia and South Carolina.

It’s been exactly 10 years since the government in Newfoundland and Labrador green-lit Muskrat Falls, a hydroelectricity project that plunged the province into financial and political turmoil.

The project is years overdue and its costs have ballooned to $13.4 billion, up from the estimated $7.4 billion, including financing costs, when it was sanctioned.

Muskrat Falls has eaten away at provincial budgets and resources. Its mounting costs prompted a $5.2-billion bailout last year from Ottawa. It flooded Indigenous lands and threatens to contaminate hunting grounds in Labrador. And a public inquiry that began in 2018 concluded the government failed its people in pushing it through.

The wounds continue to this day.

“It’s really a disgrace of some magnitude,” said Dennis Browne, a lawyer who was among a group formed in 2012 to oppose the project. He is also the province’s consumer advocate.

“We had everything going for us,” Browne said in an interview. “The government, with our oil revenues, were referring to this as our golden age. And then they took those oil revenues, and took our financial wherewithal, and put everything into Muskrat Falls. And it’s a failed project.”

Ten years later, Muskrat Falls has left ‘deep wounds’ in Newfoundland and Labrador

Understanding a bit about energy project finance helps explain why the AP1000-scale reactor is a dead letter but maybe only in the USA. And project finance is the main reason (even more important than new tech development) the SMR-scale is required for the USA to see new reactors. Pic: Natrium Site Prep, Kemmerer, WY.

Two of the three power reactors announced in the USA are on my grid (Natrium in WY to replace Naughton (a privately-owned merchant plant) and UAMPS-NuScale at INL). I also did legal work years ago for PacifiCorp, now owned by Berkshire. That’s where Natrium landed. I also worked at a bond law firm and did some project finance work for TVA, where the BWRX-300 project landed recently. Each utility is different and the deals are different. I will go through these financing scenarios below because they’re each quite different and they’re illustrative of the entire US market.

Universal Project Finance Issues

1. Defined Construction Costs & Schedule

Think of project finance like a complex construction loan that usually auto-converts to long-term finance (30 years). Foundational to a construction loan is a fixed construction cost and a fixed schedule. There’s a lot of risk around this topic. The larger the project, the more risk.

2. Defined Operating Costs + Defined Revenue

The project must be supported by a sold product and defined operating costs. The longer the construction schedule, the more risk in trying to secure firm product sales contracts and operating cost contracts (e.g., fuel). How much will coal or gas cost in 3 years is very different than how much uranium fuel will cost in 7-10 years. Similarly, how much will power be worth in 3 years is very different than how much will power be worth in 7-10 years. Yet the project must be supported by legally-enforceable contracts to secure necessary things like fuel and to sell at least enough power to pay the debt finance (30 years). Project finance usually results in the long-term sale of discounted power to show the lenders that their loan is covered. Contracts always carry financial penalties for breach or they would not be contracts. Project delays mean breached contracts to supply power and to buy fuel.

3. Regulatory Risk

Does the Project have all the licenses and permits required to operate? If not, what is the plan to get permits and licenses? Lacking key approvals adds immensely to the finance risks and often makes it a non-starter.

4. Technology Risk

What is the chance that the tech the project is using will fail? Is this off-the-shelf tech? How many other units exist? How do we know it’s going to work? Who is liable if the tech fails? How does the loan get repaid?

EPC Contractors & Performance Bonds

The primary way construction risks are managed is through EPC contracting. The EPC contractor bets the farm to deliver the entire project - Engineering, Procurement, and Construction - for a Fixed Cost on a Completion Date. Breach means the EPC contractor is liable for potentially enormous damages.

Technology risks are much more difficult to manage - usually impossible without government intervention. The entity who backs a new technology is always entitled to huge premiums because doing so enriches the technology owner more than developing the tech in the first place. For nuclear reactors especially, the financing of a First of a Kind (FOAK) is extremely dicey but also rewarding for a tech developer.

Westinghouse (Toshiba) & the AP1000

Toshiba bought Westinghouse just months after the NRC licensed the AP1000 (final design cert in March 2006). This was not a coincidence. The passive safety of the AP1000 was and still is industry-leading. From what I can gather, technology risk was too high for the FOAK so Westinghouse/Toshiba took the highly unusual risk for a tech developer to step into the EPC role for Vogtle III and IV. To do so, Westinghouse and Toshiba literally put their entire balance sheets on the line. The AP1000 cost overruns were due to lack of construction management, not to failure of the technology. In fact the AP1000 technology has reached nth of a kind (NOAK) status and many nations with government-backed finance are pursuing it, so much so that Cameco just paid nearly $3B more for Westinghouse than Toshiba paid in 2006.

In the USA, the federal government is reluctant to be seen competing with private electrical generation businesses. But the truth is that the New Deal-era hydro electric and TVA projects have resulted in the federal government being the largest single power generator in the USA. Still, Congress prefers a low profile, though TVA is a strange kind of entity. More on TVA later.

Scenario #1 - UAMPS Municipal Public Power - NuScale

This project was first so I’ll start here. I know UAMPS fairly well. I’ve done deals involving them on different things (e.g., CHP). UAMPS is a western US municipal public power consortium. Non-profit. Most munis came out of rural electrification and many of UAMPS’ members indeed came out of that federal program.

Municipal power is 100% financed by municipal bond finance. Muni bond investors are the most risk-averse investors on planet earth. My former partner represented the largest muni bond-funded power project ever closed as of that time. It was a beast to get financed. I did quite a bit of work under the structures he set up to get the whole deal financed (and refinanced later). He created some ingenious solutions to de-risk it. Genius fuel supply arrangements. Brilliant. Impressive. It was all to de-risk the bond offering.

Muni bond offerings depend highly on legal opinions by bond counsel. There is enormous liability associated with bond opinions. The opinions need to be backed by malpractice insurance. The liability often exceeds the fee—sometimes by orders of magnitude.

Bond counsel therefore conduct excruciating due diligence to document the basis for their legal opinions. Primary opinion areas include legality of entities, powers, duties, authorities; regulatory risks; legality of financial instruments; and so forth.

There are many topics bond counsel exclude from opinions, notably construction and technology risks. Attorneys have no way to evaluate these risks.

I don’t know too many details about UAMPS’ deal with NuScale Power. But I know enough to say that I’m still surprised that UAMPS got enough backing to digest a FOAK nuclear reactor that itself is based on a startup company. That being said, the DOE has provided enormous financial support, including providing the operating facility land and millions expended to date for permitting and licensing. There must enough confidence in the viability of a future muni bond offering to move forward. When and if the Offering Statement comes out, I’m planning to take a look through it.

It is notable that Fluor, a large contractor, has taken a large stake in NuScale. This makes sense but NuScale, being a startup, has a long way to go to prove viability. It needs to create a new supply chain from scratch. This is in contrast to GEH. This is not investment advice.

For its part, UAMPS has created CFPP LLC as the operating entity. The Project will sell electricity generated by the Project to its sole member, UAMPS. There are PPAs in place for the power and members have already paid out quite a bit of capital to get the project to this point. In short, there will be a highly subsidized muni bond to finance the first VOYAGR. What UAMPS gets in return for enriching NuScale remains to be seen. Ontario Power Generation (also muni power in anada), by contrast, got lots of concessions for taking on the FOAK BWRX-300.

All of that being said, the small and flexible scale of the first Voygr project is the only reason it’s financeable under a municipal project finance scenario. Even though the AP1000 is NOAK, there is not a municipal power group in the USA that would EVER try to finance one. Too much risk. Too long to build. Too much cost to float for too long before the first revenue. Too much risk to get PPAs or any other contracts. It’s just too big to finance.

Scenario #2 - PacifiCorp - Natrium

GEH and TerraPower won the DOE’s ARDP fast reactor bid and settled on replacing the Naughton coal plant in Kemmerrer, WY. I happened to drive through there last year. My son-in-law bagged a monster elk this year near Kemmerrer. Don’t go there in the winter unless you’re prepared.

PacifiCorp is a private company now controlled by one of Warren Buffett’s energy companies. I was involved with PacifiCorp back when it was owned by Scottish Power. Naughton is a merchant plant. Natrium will be a merchant plant. It will be outside of the rate base. Its ownership will be 100% at risk capital. Public disclosure of the terms of the deals is limited to the SEC filings of the various publicly-traded companies.

Project finance of Natrium is quite flexible. They can set it up however they want. Typically, equity wants to leverage large projects if they can get good rates, but I suspect debt markets will be skeptical of a truly new technology like Natrium. There’s too much risk without significant loan guarantees. which the DOE is offering. Based on those guarantees, I suspect that PacifiCorp will use every borrowed dollar they can get.

A primary financing mechanism for the first Natrium reactor will be equity. No doubt Warren Buffett will be able to extract value from GEH and TerraPower for bankrolling the FOAK as is always the case for promising new tech. Strategic capital is always cheaper for a project than dumb capital. The fact that TerraPower raised $750MM from private investors is very promising.

But imagine if Natrium were 3x larger in scale. The FOAK would cost $12B and take an unknown number of years to build, all before anybody could prove it would work. That is the AP1000 in a nutshell. Would Warren Buffett be willing to bankroll that level of investment? Congress? DOE? GEH? No, of course not.

Recently I attended a presentation by PacifiCorp on the Natrium project. I asked about the regulatory status and learned of an interesting nuance. The Natrium reactors will indeed be financed and constructed as merchant plants. All the risk will be on TerraPower and GEH. Project cost overruns and delays will not impact me as a ratepayer. However, after the reactors are online, the agreement is for PacifiCorp to buy them based on a valuation of their electrical generation relative to the going PSC-approved rates and will thereby get the reactors into the rate base. But the cost will be based on power rates, not on actual construction costs. For its part, TerraPower will take a haircut on the first several reactors. But TerraPower will also achieve full commercialization of its technology. This plan avoids the kind of disaster that Ga Power digested with the AP-1000, where the whole construction project was in the rate base from day one.

Scenario #3 - TVA - BWRX-300

TVA is a strange kind of entity. It’s a “federal” corporation. Not an agency. Not a board. Not a commission. Not a department. It has federal backing. Board members are nominated by the President and confirmed by Congress. TVA is extremely well managed and primarily relies on bonding authority to raise capital. In this sense, it’s quite similar to municipal finance, though sometimes Congress provides direct financing.

It is highly noteworthy that TVA selected the BWRX-300 for its long-planned and site-licensed Clinch River project. The selection was timed to follow on the heels of OPG so TVA will not be bankrolling the FOAK but will be an early tech adopter. To me, that means that it’s likely TVA will be able to get a good bond subscription for the project finance, especially with DOE loan guarantees to reduce the risk. This will help the nascent US rector construction market keep pace with OPG. The rest of the US market - municipal, private merchant, and integrated public utility will be watching closely. TVA is a market powerhouse. And again, it is the small scale of the BWRX-300 that makes this all possible. TVA has no appetite for another Watts Bar 2 experience. From a project finance point of view, the lack of new tech in the BWRX-300 design is a good thing! And its small scale make its financing feasible.

Scenario #4 - Integrated Utilities - Summer

As explained in my public utility article, the name of the public utility business is to hang as much infrastructure inside the rate base as possible. Only the PSC stands in the way of infinite infrastructure. PSCs are interesting and each one is different. They tend to be risk averse and conservative. A PSC would hardly ever allow new technology risk to be foisted on ratepayers. Georgia ratepayers are still fuming about Vogtle 3 and 4. With the bankruptcy, there was not enough money to cover their risks and losses. After Vogtle, PSCs will be even more averse to technology risk and the risk of oversize projects.

The basic financing model of integrated projects is 50% equity and 50% debt, usually in the form of bonds sold by the private utility company. These bonds usually have extremely low rates because of the low risk. The equity risk of investor utilities is a different proposition than, say, merchant projects.

The Summer follow-on project for the AP1000 spelled the ultimate demise for Westinghouse, which had entered EPC arrangements for Vogtle 3 and 4 as well as Summer in SC. The Summer project would have been seen as lower risk because it followed the FOAK Vogtle 3. Summer was an integrated deal. The utilities put up lots of cash and issued bonds. Westinghouse’s bankruptcy resulted in huge costs for ratepayers for a reactor they will never see. Based on Vogtle and Summer, I can’t see any possibility for a PSC to approve any new AP1000-scale reactors, maybe ever. There will not be an EPC contractor big enough and crazy enough to “bet the farm” on a new AP1000. This is driven 100% by construction risk, not tech risk.

It is equally clear, however, that the smaller scale of SMRs will help avoid risks such that it should not take long for EPC contractors to back and PSCs to approve reactors like the BWRX-300, Natrium, and others that achieve NOAK status. PSCs will unlikely be backing FOAK reactors.

Europe, etc.

Very little of this applies outside the USA, where government-owned power generation is almost universal. This is why we will see AP1000 reactors—improved designs from the base—deployed around the world. These all involve direct government finance of the projects. I can see from many European and other contacts on Twitter that there is a lot of confusion about project finance issues in the USA. I hope this analysis proves helpful.