This is the first of what will hopefully be a series of posts looking at specific aspects of The American Power Act (APA) proposed by Senators John Kerry and Joe Lieberman.
This one deals with the nuclear “loan guarantee retention fee” (section 1102), as an item I’d flagged an needing additional information in my initial review of the Bill’s summary.
More resolution on other nuclear subsidies from detailed bill language
Before delving in to that specific item, the detailed APA brought a few other nuclear-related subsidies into greater focus than could be discerned from the summary alone. Clearly, Kerry and Lieberman have some broader strategy behind their strong desire to shift more and more of the investment risk for an ever larger number of new reactors from investors to taxpayers. Maybe it is pure politics (MA has MIT, a strong backer of nuclear; CT is the headquarters of General Electric); maybe it is some downpayment on a future climate deal; maybe they really do believe that nuclear power should be the anointed winner of the post-carbon energy world, without even having to compete.
Whatever it is, however, the risk-reward balance is worrying (with taxpayers on the hook for so much of the investment risk, K-L don’t even give us any of the upside), as are the potential impacts on inter-fuel competition.
- Nuclear delay insurance subsidy expansion is larger than was evident in the summary. This is because the fixed number of contracts role to new facilities if no claims made. Rather than "just" tripling the face value of the policies from $2 billion to $6 billion, and eligible reactors from 4 to 12, K-L also took allows all 12 available policies to be reused and reassigned to new projects if claims are not made on the inital plant. This change greatly increases the likelihood of the government incurring losses under the program; and practically means that coverage will be available to any reactor that wants it during the period of delay insurance operation.
- Near-current deduction of investment tax credits by counting them as “progress payments.” The bill summary made it clear that K-L thought production tax credits for new nukes weren’t enough, and that they wanted investment tax credits as well. ITCs in general dramatically shift performance risks from plant owners to taxpayers relative to production tax credits (which can’t be earned until a plant is actually producing). The progress payments allow more rapid deductions on partially complete investments.
- Increased nuclear production tax credits (section 1124) – national cap is increased by 33%, from 6,000 MW to 8,000 MW.
A detailed look at nuclear loan guarantee retention fees
Including a retention fee is a de facto admission by K-L that federal loan guarantees for nukes will be among the cheapest money in the project. I don't see this admission as a bad thing. Quite to the contrary: in any 12-step program, recognition is step 1. Only by acknowledging the enormous value of the guarantees can K-L or others in Congress more directly assess their impact on the competitive dynamics of the energy industry.
For too long, the entire focus on the loan guarantees has been on whether or not they will default, not on the enormous distortions they will cause in energy investment patterns even if they don’t. Look at the industry’s own cost models (which do not predict default and bankruptcy) and the loan guarantees top the list for most valuable “incentives”. NEI also holds the guarantees at the top of their long and growing wish list of support. This subsidy is what I refer to as the intermediation value of government loan guarantees – basically, the difference between what a true market transaction would price the risk at and the US Treasury’s cost of borrowing.
Loan guarantees generate subsidies even without default in two main ways. First, they reduce the cost of debt substantially. The higher the market risk of your project, the larger the cost savings from replacing “debt investor” with “taxpayer” as your funding source. Second, because title 17 of the Energy Policy Act now allows 100% of the debt to be federally guaranteed (up to 80% of the total project cost), nuclear investors get to use far more debt than any true merchant structure would have ever allowed. Debt is cheaper than equity, so the weighted average cost of capital on the new reactor goes down further.
This creates some uncomfortable facts for K-L, however. The first is that less risky projects – even if they also get federal guarantees – will end up relatively worse off vis-à-vis nuclear than without the guarantees. If these other projects are also less politically powerful, they may end up far worse off – an unfortunate outcome if they also happen to be quicker, more scalable, less expensive, and lower risk to the taxpayer-investors than a new reactor. The second issue is that if the feds are the cheapest source of funding, there’s no reason for the nuclear borrowers to pay it off any sooner than they have to (potentially 30 years out).
The retention fee attempts to deal with this second issue. It partially calls industry's bluff that they need financing only during the construction phase -- though even with the retention fee, low cost credit lasts well into the plant's operating life -- and possibly for the full duration of the loan.
Retention fee mechanics
Assuming a 4 year construction period (admittedly ambitious), you have the following schedule of retention fees (longer construction times would delay the year in which the retention fee kicks in) that escalate the cost of borrowing over time:
- Years 1-4: no retention fee due to construction period
- Years 5-9: no retention fee due to 5 year grace period
- Year 10: 0.5% fee added to whatever base rate the borrower is paying
- Year 11: 1.0% fee added (escalating 0.5%/year through year 14)
- Year 12: 1.5% fee added
- Year 13: 2.0% fee added
- Year 14: 2.5% fee added
- Year 15: Rate jumps to 5.0% above original note interest rate; this occurs no more than 10 years after operations begin, and stays there until the normal expiration of the note.
Will the retention fee accelerate repayment of government guaranteed debt?
For the borrower to want to pay off the federal debt earlier, the cost of that funding must rise higher than alternative sources of debt. This is possible – if, for example, the reactor comes in on-time and below budget, and interest rates stay low, the jump to a 5% retention fee might trigger refinancing in year 15 instead of year 30.
But there are also many scenarios where the refinancing is unlikely:
- Default. The risk of default is highest during the construction phase. With no fee until at least year 9, the majority of defaults will kick in prior to any impact from the retention fee.
- Financial stress. If the reactor is under financial stress due to construction delays, cost over-runs, or an expectation that break-even power rates will not be achievable when the plant goes live, there will likely be no capacity to repay any of the debt lines early. If there is, the government debtor is likely to be more easily lobbyed for relaxed repayment terms than is a bank. This would especially be true in a situation of systematic financial stress across the nuclear sector, as would occur following a reactor accident somewhere in the world; or from structural changes in electricity markets that alter the economic benefits of large scale, centralized power generation.
- Federal credit is still cheaper. Even with the retention fee premium at 5%, it is quite possible that the alternative sources of credit will be more expensive. This outcome could arise in two situations. If the market situation is not great for nuclear, industry promises about take-out financing once the plant is built may not materialize inexpensively. Second, replacing the Federal Financing Bank with a private lender, even if the initial interest rate seems lower, could well be far more expensive if the 80% debt structure of the project needs to be ramped down to 40 or 50% to meet private lender debt covenants.
There are also a variety of unknowns in how the sketchy language on the retention fees would be deployed. These include:
- Impact on existing $18.5 billion nuclear pool. Though K-L want to amend the title 17 statutory language, it seems unlikely that they could retroactively institute this fee on guarantee applicants for the first $18.5 billion. What is unknown is whether there would be any restrictions in modifying the terms of a program to which $122 billion in applications have already been submitted under the old rules.
- Retention fees versus credit subsidy and administrative fees. While it is rational to assume that retention fees are in addition to, rather than in partial lieu of, credit subsidy and administrative fees, this is not explicit in the proposed language. In the high stakes world of nuclear lobbying, nothing should be taken as a given.
- Cash cow for DOE? Under title 17, the interest and principal goes directly back to Treasury. Fees, on the other hand, appear to go to Treasury but remain available to DOE for subsequent use. This is a very interesting potential wrinkle. Consider that were this this interpretation is correct, the retention fees would create a return of up to $5 billion per year (5% of $100 billion in total authorizations) that would flow to DOE rather than to the general taxpayer. If we further assume that DOE pools the money to support additional guarantees, this might create a revolving-fund like structure similar to what the CEDA legislation would have done, without the need to pass CEDA. Any lawyers out there who can evaluate whether this type of an outcome would be possible?