Westinghouse bankruptcy epitomizes failures of electricity monopolies
Westinghouse Electric Co. LLC—the nuclear power company that traces its lineage to the original Westinghouse Electric Corp., founded in 1886—has been forced to declare Chapter 11 bankruptcy, largely the result of immense delays and cost overruns at two nuclear construction sites, Alvin Vogtle and V.C. Summer.
The bankruptcy places a potentially huge financial burden on electric ratepayers in South Carolina and Georgia and underscores the need for nuclear technologies to reduce cost overruns. But it would be a mistake to blame the current state of nuclear technology itself for Westinghouse’s failure. The mess really stems from the perverse incentives of the natural-monopoly model, which rewards utilities for building capital-intensive “mega-projects” irrespective of investment risk.
The story dates back to the late 2000s, when Southern Co. subsidiary Georgia Power Co. and SCANA Corp. subsidiary South Carolina Electric & Gas Co. received state regulatory approval for their shares to build two reactors each at the Vogtle and V.C. Summer sites, respectively. To their credit, the utilities entered into fixed-price contracts (with cost-escalator provisions) with Westinghouse to build the nuclear facilities by a guaranteed date. This helped to mitigate some of the ratepayer risk of cost overruns.
However, the Westinghouse bankruptcy diminishes these guarantees, causing legal disarray amid speculation of rate increases to recover costs of finding new contractors to finish the projects. Both utilities have filed interim agreements with Westinghouse to administer cost-to-complete assessments over a transition period.
The original sales pitch to approve the nuclear projects rested largely on hedging high natural-gas prices, federal carbon regulation, meeting customer demand growth and taking advantage of federal nuclear subsidies. Over the past decade, natural-gas prices tanked, federal carbon regulation (cap-and-trade) never materialized and demand weakened. Now, it appears the utilities may lose the cost advantages of federal nuclear subsidies. Terminating the Westinghouse contracts may force Southern to prepay the outstanding balance on the $8.3 billion loan guarantee provided by the Department of Energy. Billions in cost escalations would continue to spiral if the projects don’t start operations by the end of 2020, which would render them unqualified for the federal production tax credit for nuclear.
Many independent analysts project that delay beyond 2020 is a given. But as the interim assessment period trudges along, the utilities are telling their regulators a different story. Both downplay the remaining time and costs of completing the projects, while expressing their desire to push forward. Meanwhile, Morgan Stanley & Co. assert that abandoning the nuclear projects is the most likely outcome. If regulators elect to complete construction, Morgan Stanley predicts future delays for the projects and estimated additional cost overruns at $5.2 billion for SCANA and $3.3 billion for Southern. By comparison, building an efficient natural gas power plant would cost roughly $2 billion for an amount of capacity equivalent to each nuclear project.
A strong case can be made that the utilities don’t even need the plants’ full capacity. The Southeast has a surplus of regional capacity, meaning that third-party sources would be available at little cost. But because regulated utilities don’t have an incentive to buy from third parties, it leads to a well-documented bias to self-build.
State legislation championed by the utilities exacerbated the perverse incentives of the regulated monopoly model. Georgia and South Carolina passed laws in the 2000s enabling utilities to recover costs via rate hikes during construction, rather than waiting until completion. The laws lower finance costs, but shifts risk to ratepayers. The change also diminishes regulatory scrutiny of costs, thus dampening utilities’ cost-control incentives. The South Carolina Small Business Chamber of Commerce has criticized the unintended consequences, which include undermining utility incentives to avoid cost overruns and lacking transparency and a process for public input on construction contracts.
The Westinghouse bankruptcy makes one thing clear: when legislators and regulators socialize risks and costs, consumers suffer. The regulated-monopoly model creates moral hazard, epitomized by capital-intensive mega-projects in which companies insulated from investment risks lack incentives to guard against those risks. These nuclear projects are just new cases of a century-old problem.
By the late 1980s, monopoly utilities around the world faced high costs and unwanted assets. The subsequent political pressure led to electricity-industry reforms to change incentives, the locus of decisions and risk allocation. Some states liberalized their electric industries in the late 1990s and 2000s and, despite transition challenges, realized the benefits of competitive markets, as merchant suppliers internalized investment risk. In these states, the investment consequences of unexpected policy changes and drops in natural-gas prices and electricity demand have been borne by the private sector, which has repositioned itself to maximize value in a new investment climate. Meanwhile, regulated utilities have sat on power plants that no longer offer the most economical means of producing electricity in order to continue collecting a rate of return on their asset base. Worse, some have embarked on ill-advised investments on the backs of captive ratepayers.
States that failed to learn from the boondoggle projects of regulated monopolies have repeated them. Electric ratepayers will eat much of the cost, even if regulators elect to abandon the nuclear projects, as was the case with mega-projects decades ago. Perhaps the silver lining is that policymakers in regulated-monopoly states finally will learn the appropriate lesson and join the second wave of competitive-electricity reforms.
Federal policymakers should keep in mind that nuclear still provides a strong value proposition as a reliable, zero-emissions resource. However, any technology that takes a decade to build and carries huge capital demands creates an enormous investment risk. For nuclear, the best hope comes in the form of small modular reactors (SMRs). These reactors offer major safety and operational benefits with potential for much lower cost-overrun risk. NuScale Power announced the first SMR submission to the Nuclear Regulatory Commission in January. Easing the regulatory burdens on SMRs would reduce artificial barriers to entry. If SMRs become commercially viable, procurement decisions should come from competitive forces, not rent-seeking monopolies and their regulators.
Image by Martin Lisner
