Nuclear loan guarantees and the “credit subsidy cost”
By Rod Adams
The elected representatives of the United States of America clearly intended to encourage nuclear energy development when they passed the Energy Policy Act of 2005. That act included a financing mechanism specifically aimed at correcting what Congress had determined was a market failure in providing reasonably priced financing for energy projects that reduce greenhouse gas production and reduce fossil fuel consumption. Despite this clear congressional intent, there was not a single loan guarantee awarded under section 1703 of title XVII of the act for more than four years after the act’s passage.
Finally, on February 16, 2010, 1653 days after President Bush signed the act that Congress had passed, President Obama announced that the Department of Energy had offered its first conditional loan guarantee to the Southern Company for its two-unit expansion of the Vogtle Nuclear Power Station. (Here is a professionally produced video explaining why Georgia Power is pursuing the project.)
The loan guarantee amount, $8.3 billion, represents 80 percent of the portion of the Vogtle project that Southern Company is purchasing; the overall project includes some owners that are not eligible for a loan guarantee under section 1703 of the Energy Policy Act because they are public organizations that have the ability to issue tax-exempt debt obligations. The DOE has made one conditional loan guarantee offer for a fuel enrichment facility, but no other section 1703 loan guarantee offers have been made in the seven months since February.
It is difficult to untangle the reasons why the U.S. government is moving so slowly on a commitment that Congress made to extend its full faith and credit in a carefully constructed program designed to provide reasonably priced financing for long-lived nuclear energy projects. Supported with links to more detailed sources, however, I will try to explain my own interpretation of events.
For a discussion of the background of the Energy Policy Act of 2005 and the implementation choices that have been made so far by the Executive Branch of the United States, I strongly recommend reading the statement of Michael D. Scott, managing director Miller Buckfire & Co., LLC, that was given before the United States Senate Committee on Energy and Natural Resources on September 23, 2010. Mr. Scott had a bird’s eye view of the implementation decisions in the early phases; here is how he described part of his background during his testimony:
I served for almost five years as a senior advisor at the Department of the Treasury where I was responsible for, among other things, federal credit policy, the evaluation, negotiation, and execution of federal loan guarantees and direct loans, as well as the management and oversight of the Federal Financing Bank. In my prior role at Treasury, I was one of the principal people who decided how and in what manner the large one-off federal credit programs (such as the Air Transportation Stabilization Board, the Rural Economic Development Loan and Grant Program in the 2002 Farm Bill, the Alaska Natural Gas Pipeline Loan Guarantee Program, and Title XVII of the Energy Policy Act of 2005) were executed during the September 2001 to July 2006 time period. This required me to be deeply involved with OMB [Office of Budget and Management] on Federal Credit Reform Act issues pertaining to the individual federal credit programs as well as the Federal Financing Bank.
To understand the nuclear energy industry’s particular concerns with the program, you can read the testimony that Marvin Fertel, president and chief executive officer of the Nuclear Energy Institute, gave at the same September 23 hearing.
My between-the-lines reading of the testimony provided by Scott and Fertel is that there are some number crunchers in the OMB who do not want the government to provide low cost financing for nuclear energy projects. Those number crunchers did not arrive with the change in administration; they have been involved in the process since 2005.
They have done what budgeteers sometimes do when they want to influence decisions—they created rules and used model inputs that caused sticker shock for people duly appointed to make financial decisions. (I am writing here with the perspective of someone who spent nine years fighting battles with those kinds of budgeteers in the Department of the Navy.) Though there have been some changes directed at the budgeteers as a result of some pointed investigations and discussions by several congressional committees in the past couple of years, the green eyeshade bureaucrats are still using model inputs that result in a higher than acceptable “credit subsidy cost” (CSC).
That term of art is not terribly familiar for most Americans. Even though the U.S. government has been offering loan guarantees for millions of people during the past seven decades, very few loan recipients have ever had to pay the CSC. It is normally paid by an appropriation that prevents Congress from ignoring the fact that a reasonably predictable portion of the people who obtain federally guaranteed loans will not pay them back.
In the very special case of projects qualifying for loan guarantees under section 1703 of title XVII of the Energy Policy Act of 2005 (the section of the law that allows nuclear projects to qualify), the borrowers are responsible for paying this fee BEFORE they can receive any proceeds from a guaranteed loan. For anyone who has ever borrowed a large sum of money for a capital asset like a home or commercial building, think of the credit subsidy fee as a “closing cost” that is similar to “points” that a borrower pays up front to reduce the interest rate or to induce a lender to make a loan that they believe represents a higher-than-usual chance that the borrower will default. The closing cost total can make or break a deal.
Aside: The Energy Policy Act of 2005 did not target only nuclear projects, but it gives them “special” treatment. When sponsors of renewable energy projects that were also authorized to obtain loan guarantees by the act pointed out that they could not raise the required 20 percent equity, powerful sponsors turned what were initially sound loan conditions into sub-prime conditions by offering a 30 percent cash subsidy to “shovel ready” renewable projects. The equity sources of the highly publicized solar and wind projects that have been given loan guarantees get their money back (with a 50 percent kicker) within 60 days under current law. A section 1703 project that gets an American Recovery and Reinvestment Act section 1603 cash grant is essentially a “no money down” project with sponsors that can walk away and leave the key under the door mat if their project runs into financial trouble.
Renewable energy projects also qualify under section 1705 of the Energy Policy Act for an appropriation that pays their credit subsidy cost. Nuclear projects cannot qualify for either of those direct payments from the federal government, ostensibly because they are not “shovel ready.” I guess there is something less valuable about employing engineers, accountants, and document specialists in paper-ready nuclear projects. Of course, people who criticize nuclear energy projects as not being shovel ready apparently ignore just how many mechanical shovel operators are already working at the only project that has received a conditional loan guarantee. End Aside.
Even though the nuclear energy projects applying for section 1703 loan guarantees are intensely scrutinized for both technical merit and financial viability by technically qualified and hard nosed evaluators, the budget number crunchers are insisting on using a probability of default that is based on an average of experience from loans to small businesses, students, and homeowners. That assumed average default probability is much higher than the individually calculated probability would be if it was based on just the project specifics. These are sound nuclear technology deployment projects where there are not only strong companies with real money invested, but also participation by financially strong, politically friendly countries like France and Japan.
The other model input number that has a large effect in determining the credit subsidy fee is the expected value of the assets that can be acquired in the case of a loan default. To make the importance of this assumption understandable, think of it as the resale value that an automobile lender might assign when computing the financing charges and interest rate for a car. If the lender assigns a relatively high resale value, they will charge less for the loan because they know that they have a good chance of getting repaid when they sell a repossessed car that has a high value. (See discussion on page 12 of Scott’s testimony.)
The lower the assigned resale value, the more expensive the loan. Students and small businesses who borrow money often spend that money on items that either cannot be repossessed or have little resale value if they default; utilities and power generators will be buying assets where the traditional resale value of even incomplete projects usually ranges between 85-95 percent of the loan balance. Even the labor invested in activities like environmental impact assessments has recoverable value since the documentation reduces the effort required by any future purchaser.
The process of determining credit subsidy costs is shrouded by bureaucratic secrecy and by the reluctance of applicants to aggressively challenge the bureaucrats who think their job gives them the right to control billions of dollars and thousands of jobs. (The Constitution puts the power of the purse into congressional hands.) I have taken the time to delve into the matter, however, and read between the bureaucratic lines and watched a couple of hours of testimony.
My conclusion is that the current credit subsidy cost model outputs based on bureaucratically chosen inputs have been fees that are far too large to allow project applications to move forward. The Department of Energy has not offered any conditional loan guarantees because they do not want to be put into the embarrassing situation of having the companies refuse to accept them. In my opinion, the excessively high fees have been computed because at least some of the people who are selecting the model inputs do not like nuclear energy. They will do everything in their power to slow down nuclear power plant construction projects.
In the financial world, if you cannot move a project forward, you generally must decide to move backward. Standing still costs far too much money every day. Companies that have spent tens of millions of dollars to assemble and train qualified teams of engineers and license application specialists have not only stopped hiring, but have begun firing.
In an industry where there still exists a lot of concern about attracting sufficient numbers of well-trained people, good people are getting reassigned or laid off. The companies are taking this action because they have recognized that the market failure that Congress tried hard to correct more than five years ago still exists today. The retrenchment decisions being made today will have long-range implications; people who see others getting laid off after investing many years into difficult education programs will be reluctant to take that path themselves.
I can offer a personal testimony here. One of the affected projects, Calvert Cliffs Unit 3, in Maryland, is being developed a pleasant hour’s drive to the south of my Annapolis home. The main office for Unistar, the coalition company developing the project, is in Baltimore, less than a 40-minute commute to the north. When I made the decision to retire from the Navy and seek employment with the commercial nuclear power industry, the companies involved in the project were hiring a lot of people. As a local resident and as a former Navy nuke, I had a reasonably good chance of landing one of the jobs, so I worked my network and was pleased with the outlook when I first made the retirement decision.
A commissioned officer has to give the Navy between nine and 12 months notice before retiring. During the period between September 2009, when I submitted my request to retire from active duty, and September 2010, when the Navy agreed I could stop working, the interest being given to my employment application dropped to zero. All of the companies involved in the stalled project instituted hiring freezes and then began shrinking the teams dedicated to the project. I have heard similar stories from people associated with South Texas-3 and -4.
My personal job hunt had a favorable result; I landed a good job working on the B&W mPower™ small modular reactor project. That result was made possible by my flexibility in accepting a relocation to Lynchburg, Va., rather than remaining in Annapolis, where I have lived for the past 11 years. That relocation decision might have been more difficult at a different stage in my life; I seriously considered forgoing any involvement in the nuclear energy industry and building my second career in a more reliable industry in the Annapolis/Baltimore/Washington DC area.
The Energy Policy Act of 2005 loan guarantee program offers some useful lessons to nuclear energy advocates. The first is that it should be clear that there there are friends who support the technology and want to see it succeed for a number of very good reasons. If that was not true, there would not have been a loan guarantee program created in the first place. The second lesson worth learning is that there are plenty of well-placed people with excellent educational backgrounds that do not want nuclear energy to succeed. They will do all they can to handicap its success. The opposition seems to care little about the negative impacts that their actions have on the people who dedicate their lives to learning as much as possible about the details of nuclear power plant design and operation.
The third lesson that I take away from the experience is that depending on coalitions among advocates of other energy sources is a risky strategy. Even though the Energy Policy Act 1703 program includes a number of energy sources that share some similar challenges in explaining the execution hurdles erected by Executive Branch employees, the other energy source sponsors left nuclear energy to its own devices when they worked to convince Congress to pay for their credit subsidy fee under section 1705 and when they convinced Congress to pay their equity funders off within just 60 days of loan closing under section 1603 of the ARRA. Nuclear energy was purposely left outside of those programs. The natural friends of nuclear energy are not its competitors in the energy business; they are the customers who will benefit when new nuclear energy facilities begin producing increasing quantities of low cost, clean energy.
The final lesson that I have learned is to stop being fearful of the accusations that I am a focused nuclear energy advocate. (Note: There are aggressive, usually anonymous commenters on the Web who use the derogatory term of “nuclear shill” for anyone who argues for nuclear energy. I have decided to own that accusation and be proud of it, even though I am not a paid advocate.)
If you fundamentally believe, as I do, that nuclear energy is the best choice for investing our next energy dollar, get out there and tell the world. Here is how I express it to others: If you want to pour money into a temporary job-creating hole, support unreliable renewable energy projects that rarely affect the fossil fuel market. There is a reason why oil and gas companies pay a lot of money to advertise their interest in solar and wind energy projects – neither one is a threat to their main business.
If you want to invest in abundant, reliable, clean energy that reduces fossil fuel combustion, provides sufficient return on that investment to support additional future investments, and helps to create lifetime careers, buy as many nuclear plants as possible.
Rod Adams is a pro-nuclear advocate with extensive small nuclear plant operating experience. Adams is a former engineer officer, USS Von Steuben. He is founder of Adams Atomic Engines, Inc., and host and producer of The Atomic Show Podcast. Adams has been an ANS member since 2005.