4 August 2016

“Market failure” and nuclear power

Edward D. Kee

Edward D. Kee

Edward D. Kee is CEO and principal consultant at Nuclear Economics Consulting Group in Washington, DC. He is an expert in nuclear economics, with a focus on the interaction between nuclear power...

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June 2016 was a bad month for the US nuclear power industry. In a single month, Exelon decided to retire its Clinton and Quad Cities nuclear plants; the Omaha Public Power District decided to retire Fort Calhoun; and PG&E decided not to pursue license renewal for Diablo Canyon.

The views expressed by former US Nuclear Regulatory Commission member Peter Bradford in a March 2013 Bulletin article, which described the situation facing the US nuclear power industry as grim, now seem restrained. Bradford predicted that “an abundance of natural gas, lower energy demand induced by the 2008 recession, increased energy-efficiency measures, nuclear’s rising cost estimates, and the accident at the Fukushima Daiichi Nuclear Power Station” would result in trouble for the US nuclear power industry. “Here’s what the US government must do to bring about a gradual phase-out of almost all US nuclear power plants: absolutely nothing,” Bradford wrote. He predicted that, without massive government assistance, new nuclear power projects would not be built and existing nuclear power plants would only operate until the end of their NRC licenses, meaning that the US nuclear fleet would largely be gone by the late 2050s. Since 2013, the factors listed in Bradford’s article have driven electricity market prices to low levels, resulting in the early retirement of operating units and stopping development of new nuclear power plants.

It isn’t just merchant nuclear power plants that are facing a bleak situation. (A merchant nuclear power plant operates in those states with a restructured electricity industry and a wholesale electricity market; about half of US nuclear power plants are merchant units, with the rest owned by regulated and government utilities.) The recent announcements include Fort Calhoun, which is owned by a traditional public power utility. Fort Calhoun’s early retirement shows that regulated and public power plants may also be at economic risk.

The owners of nuclear power plants make decisions based on the market value of commodity electricity and capacity—electricity is the power used (in megawatt-hours), while capacity is the ability to generate electricity (in megawatts). When electricity and capacity prices are low, as they are today, merchant nuclear power plants lose money; regulated or public power nuclear power plants increase rates for electricity users; and new nuclear power plant projects look unprofitable. When electricity prices are high, merchant plants are profitable; regulated or public power nuclear power plants decrease rates for electricity users; and new projects look more profitable.

Unfortunately, the US market approach does not compensate nuclear power for its substantial public benefits, which include environmental benefits (such as very low carbon emissions), electricity system benefits (such as fuel diversity, long-term cost stability, and the ability to dispatch electricity when it’s needed to meet peak demand), and economic benefits (for example, the positive impacts of providing jobs and paying taxes). To preserve these public benefits when markets do not, the government must step in.

Private gain, public loss. Market failure, an economic concept, is when the market (defined broadly) does not support activities that provide net public benefits. Net public benefits are when total benefits (public and private) are greater than total costs (public and private). Market failure is seen when companies decline to undertake activities or investments that result in private losses, even though these activities would have provided net public benefits.

Generic approaches to fix market failure include imposing costs on negative externalities (consequences that affect the public but are not reflected in the cost of electricity), providing compensation to support positive externalities, and government ownership of sectors likely to experience market failure. Resolving market failure is about increasing public good, so these approaches usually involve government action.

Carbon pricing is an example of imposing costs on a negative externality—the emission of greenhouse gases that are driving global warming. The United Kingdom’s financial incentives for new nuclear power are an example of providing compensation for positive externalities. Government ownership of nuclear power—as in France, China, South Korea, Russia, and the United Arab Emirates—is an example of a third approach to preventing market failure.

How to fix US market failure. At the Department of Energy Summit on Improving the Economics of America's Nuclear Power Plants held in May, key decision makers and stakeholders discussed ideas to help stop the early retirement of US nuclear power plants. The summit included a discussion of the Nuclear in the States Toolkit recently developed by the American Nuclear Society, a comprehensive list of policy options to prevent early retirement and to encourage the construction of new nuclear power plants.

Actions to remedy nuclear power market failure can be indirect or direct. Indirect actions, such as carbon pricing or changes to electricity market rules, might help nuclear power plants, but do not directly address the market failure problem. Electricity and capacity markets determine the revenue for merchant nuclear power plants and may determine the wholesale price of power for some regulated utilities. Electricity and capacity markets are working pretty well to achieve their design objectives—for example, providing reliable power and keeping prices low for consumers. Revisions to electricity spot market rules (currently under review at the Federal Energy Regulatory Commission) may result in higher electricity spot market prices in some markets. However, US electricity and capacity markets are not designed to preserve net public benefits from nuclear power, and these price formation changes are not likely to accomplish that. Nuclear power plants typically take up to a decade to develop and build, and can then operate for 60 years or more, which makes them long-term assets in a short-term world. In addition, the marginal cost of nuclear electricity—the cost of producing a small amount of additional electricity—is zero, which means that US nuclear power plants operate in 24/7 baseload mode. These limitations make nuclear power a poor fit with wholesale electricity markets, even if spot market pricing rules are adjusted.

Some experts see carbon pricing as a way to save nuclear power. Carbon pricing might improve nuclear power economics but probably not enough to save nuclear power, because it is unlikely to provide the sufficient and certain long-term revenue needed to support new or existing nuclear power projects.

Direct compensation to nuclear power plants is a more effective way to fix the market failure problem. For example, power contracts with regulated electric utilities can provide stable and sufficient revenue to nuclear power plants. One example is the 2013 extension to the power purchase agreement between an Alliant Energy subsidiary and the Duane Arnold nuclear power plant. The Iowa Utilities Board approved this extension based on “significant economic and non-economic benefits.”

Another way to compensate nuclear power plants directly is with state clean-energy mandates that would require regulated utilities that supply electricity to end-use customers to acquire a portion of their electricity from clean sources including nuclear power. Renewable energy mandates have been successful in providing incentives to wind and solar, but these intermittent energy sources alone are not likely to provide a means of moving away from fossil fuel electricity generation. The large size, dispatchable and reliable output, and high energy density of nuclear power make it an essential part of a carbon-free electricity sector.

Including nuclear in existing clean-energy mandates would provide some compensation to nuclear power plants for the environmental benefits they provide. New York state’s new Clean Energy Standard approved on August 1 includes a requirement that utilities pay nuclear power plants for Zero-Emission Credits based on the social cost of the carbon emissions avoided, and the New York Public Service Commission decision also discusses other benefits of nuclear power, including system reliability and fuel diversity.

In addition to power contracts and state mandates, federal clean-energy mandates or federal or state tax credits could be used to provide direct revenue to existing nuclear power plants to compensate them for public benefits.

“Plan A” for nuclear power. Government ownership of nuclear power might be an option for economically threatened plants; it would allow direct federal government responsibility for operating costs as a way to address market failure. A recent opinion piece in the Washington Post suggested that the US government buy coal-fired power plants to close them. New York attorney Stephen L. Kass presented this “Plan A” for coal plants as an alternative to the stalled Clean Power Plan—as an approach that would achieve the goals of the plan but would be faster, more certain, and more legally defensible. The cost of such a plan, including payment for seizing coal plants under eminent domain, would be justified by the net benefits for the climate. The US government should consider a “Plan A for nuclear power,” but with a twist—this Plan A would prevent the early retirement of nuclear power plants, instead of accelerating the closure of coal-fired power plants.

The cost of fixing market failure related to nuclear power will be seen in higher electricity rates, higher federal expenditures, lower federal tax income, or other ways. These costs can be justified by the same market failure arguments used to justify the cost of US federal tax credits for renewables, state renewable energy mandates, and even the European Union exemption for renewables from State Aid (a prohibition against government support for companies). Market failure arguments for renewables generally assume that the market may fail to invest in renewable energy assets despite the expected benefits of renewable energy to society (for example, no carbon emissions), making government action necessary to address this market failure. Similarly, the cost to keep nuclear power plants from retiring early is justified by the substantial public benefits from continued operation.

Lessons from the United Kingdom. The UK government has already demonstrated how to address nuclear power market failure. Starting in about 2002, British Energy, the owner of all UK nuclear power plants except the now-retired Magnox units, experienced financial problems as a merchant generator in the UK wholesale electricity market that started in 1990. British Energy's financial problems were mostly due to a drop in wholesale electricity market prices. To avoid the early retirement of British Energy nuclear power plants, the UK government re-nationalized British Energy in 2005.

The UK government also decided that new nuclear power capacity should be built, even though the UK electricity market and carbon pricing would not support new nuclear power investments. The government implemented the Electricity Market Reform program to create incentives for new nuclear power projects, starting with Hinkley Point C. Recent events have further delayed the Hinkley Point C project, but other new nuclear power projects are under development in the United Kingdom. In contrast, the US government has done little to save economically threatened operating nuclear power plants or to provide incentives for new nuclear power plants.

What next? If there is no action to resolve the market failure related to US nuclear power, more operating nuclear power plants will retire early and no new nuclear power plants will be built. Actions to provide direct compensation to nuclear power plants are the most certain way to resolve this market failure.

As Peter Bradford pointed out in 2013, only action by the federal government can save the US nuclear power industry. The problem is more urgent and important than he predicted. More nuclear units will retire early (threatened nuclear power plants include several Illinois units, Davis-Besse, Palisades, and Three Mile Island 1), and several new nuclear projects will not proceed despite NRC approval. The market failure represented by early retirements can only be avoided by government action, and the recent New York state Zero-Emission Credits decision is a good start.