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January 21, 2000

Nuclear Energy Institute
Presentation to Wall Street Analysts

Joe F. Colvin
President and CEO
and
Ralph Beedle
Senior Vice President and Chief Nuclear Officer

January 21, 2000

Colvin: Good morning. I'm delighted you were able to join us this morning. It's a pleasure to see so many familiar faces at what has become an annual event for us at NEI.

When we did this the first time back in January 1998, only a dozen-or-so states had restructured and there was a lot of concern in many circles about the prospects for the U.S. nuclear energy industry.

I remember telling you all that competition was the best thing that had happened to this industry in a long, long time because it would focus political attention on the strategic importance of nuclear energy; because it would remove stranded costs as an issue and allow us to focus on operating economics going forward; and because it would serve as a powerful impetus for consolidation in the industry.

We still think all that's true. In fact, it's all coming true and we think the stars are aligned as favorably as they have been since the early days of nuclear energy in this nation.

We follow closely what the financial community writes and reports about the electric power industry and we see a consensus that this sector generally is undervalued by the market even though the fundamentals—earnings growth, cash flow and so forth—are strong.

As far as nuclear energy is concerned, we tend to agree. We think the fundamentals are very strong and we are convinced that we have not yet fully unlocked the value in our 103 reactors.

This morning, we want to update you on the fundamentals, and why those fundamentals support the conclusion that these plants are well-positioned for competition.

We want to suggest a number of additional ways in which we can, and will, unlock additional value from these plants—value which is currently hidden or not fully realized.

We will also show you what we're doing as an industry to manage or reduce the major business uncertainties facing us.

It all starts with the fundamentals, and the fundamentals are strong: cash flow, safety, performance, reliability, output are up; economic performance is solid; the business trends are moving in the right direction.

Just to remind you, 24 states have restructured their electric power industries. Sixteen of those states have operating nuclear power plants. That's 60 units out of a total 103, so we have a pretty good idea of how nuclear energy will be treated under restructuring. And most of the states that have not yet restructured are in the Southeast, and these states historically have acted responsibly in matters of electricity regulation.

We can see several common themes in all the state restructuring plans.

First, all the states have allowed the companies a reasonable opportunity to recover their stranded costs, including the capital invested in nuclear power plants, which accounted for approximately one-third of the electric industry's stranded cost exposure.

Second, all the states have recognized that nuclear plant decommissioning is a public health and safety imperative and have generally made explicit provision for continued collection of unfunded decommissioning costs in rates, generally through some form of "wires charge."

And finally, many states have created compelling incentives for divestiture of generating assets as a condition of stranded cost recovery. This is a major stimulus to the consolidation of nuclear plant ownership now underway.

Turning to nuclear plant performance, we estimate the industry's average capacity factor for the operating units in 1999 will be about 90 percent. For all plants, which includes the two D.C. Cook units that were shut down all year because of regulatory problems, we estimate the average will be about 86 percent.

In 1997, the year following the much-publicized problems at the Millstone plant, we had 10 units closed because of regulatory issues and a handful of others limping along with capacity factors in the 20 to 30 percent range.

With the elimination of the "watch list" and the dramatic improvement in the regulatory process and regulatory environment since then, we do not believe we will be subject to those kinds of crippling business risks again.

As you would expect from the capacity factor average, we saw a dramatic increase in output from the plants last year. And we estimate 1999 output of approximately 720 billion kilowatt-hours, likely the best year in our history. That's a record, and approximately 50 billion kilowatt-hours ahead of 1998, which is roughly equivalent to adding six to seven 1,000-megawatt nuclear reactors to the grid.

Or put another way: 50 billion incremental kilowatt-hours at a conservative 3 cents per kilowatt-hour represents an additional $1.5 billion of cash flow in the nuclear power sector. The marginal cost of producing those kilowatt-hours is very low.

Let's turn to competitive position. If you look at the three-year (1996-98) rolling average production costs for the U.S. plants divided into quartiles, you can see that the fourth quartile numbers are negatively skewed by the number of plants burdened with regulatory issues in 1996 and 1997. As we get more current data, you will see that fourth quartile approach the level of the third quartile, and you will see a narrowing of the spreads among each of the four quartiles.

Even so, you can see that we can continue to improve our economic performance to the level of the first quartile plants, which have O&M costs below a penny per kilowatt-hour.

One of the most obvious ways to improve is to boost output. You can see there's a five-percentage-point difference in average capacity factor between the plants in the third quartile and those in the first.

Production cost is a useful way to compare the relative performance of the nuclear plants. But it doesn't tell you the whole story about whether or not they're competitive.

Production cost is not a total "going-forward" cost because it doesn't include ongoing capital requirements, property taxes, administrative and general expenses and some other important items, like profit.

As a general rule of thumb, we must add between 0.5 and 0.8 cents per kilowatt-hour to production cost to get an approximate total cost, and as we consolidate, those add-on numbers should start coming down.

And as you can see, the first three quartiles are clearly competitive assuming markets clear at between 2.5 cents and 3.5 cents per kilowatt-hour, which is probably a little on the conservative side.

And, as I said earlier, when we see full-year 1999 data, I'm confident the fourth quartile will fall within that range, too.

One final thought on competitiveness. The chief executive of a generating company with nuclear assets must decide whether to continue to run the nuclear power plant or build new, replacement capacity, which, today, would be combined cycle gas.

We know the nuclear unit can run at 2 to 2.5 cents per kilowatt-hour. And we know the gas-fired plant has a total going-forward cost of 3 to 3.5 cents per kilowatt-hour, based on a capital cost of 400 to 450 dollars per kilowatt and a gas price of 2 dollars per million Btu.

That's not a difficult decision. I may need to build gas-fired generation to meet growth in electricity demand, but I won't build it to replace nuclear capacity.

We have been saying for the last three or four years that we expected to see significant consolidation in the U.S. nuclear energy sector. It was obvious that the power plant side of the business was ripe for consolidation. Ownership is (or was) highly fragmented: 76 companies own less than 1,000 megawatts of nuclear power production.

Consolidation of ownership and operating responsibility started in 1998 and accelerated dramatically last year. Three nuclear plant transactions—Pilgrim, Three Mile Island 1 and Clinton—closed. And a number of others—Vermont Yankee, Nine Mile Point, Indian Point 3, FitzPatrick, Millstone 2 and 3, Seabrook—are in the offing.

The consolidation involves more than outright plant sales. Companies that are minority owners are selling back their shares to majority owners, and companies are forming operating companies, such as the Nuclear Management Company in the upper Midwest, which will operate and perhaps eventually own the seven units now operated by four separate companies.

This consolidation is occurring throughout the industry—among suppliers of equipment, services and fuel. Witness the acquisition of Westinghouse's nuclear business by BNFL and Morrison-Knudsen, the merger of Framatome and Siemens, and more recently, BNFL's acquisition of ABB-Combustion Engineering's nuclear business.

We regard all this as a necessary and desirable step in the evolution of the nuclear business, a natural business response to competitive pressures and state restructuring. All of this positions nuclear energy well for the competitive market now developing, and will leave us with a safer, leaner, stronger industry because ownership and oper-ating responsibility will be concentrated in the hands of companies with nuclear energy as their core business.

So, the fundamentals are strong; cash flow is up; safety, performance, reliability, out-put are up; economic performance is solid; and the business trends, like consolidation, are moving in the right direction.

Competition clearly is good for the nuclear industry, but it is particularly beneficial with respect to license renewal. We believe a competitive market creates a powerful business incentive to extend the operating licenses of nuclear plants from 40 years to 60 years.

Companies have greater incentive to renew their nuclear plant licenses in a competitive market than in a regulated, cost-of-service market. In a regulated market, earn-ings are based on rate base. A 40-year-old nuclear plant is fully depreciated, and has minimal rate base value and, thus, limited earnings potential. In a competitive market, productive assets with little or no embedded capital have enormous earnings potential.

This explains the substantial interest in license renewal during the last 12 to 18 months. Five reactors have already filed and are undergoing Nuclear Regulatory Commission review. And another 21 reactors intend to seek license renewal over the next few years. We expect that virtually all U.S. nuclear plants will renew their licenses, partly because these plants have significant earnings potential and partly because it is dramatically less costly to renew the license of a nuclear plant than to build replacement capacity of any kind.

Let me turn now a brief summary of the ways in which we can unlock additional value in our nuclear assets. When we discuss the competitive position of our nuclear units, we tend to focus on the market clearing price of electricity in the day-ahead market and compare that price with the going forward cost of electricity from a nuclear power plant.

That's not the end of the story.

In fact, it is just the beginning of the story, and the first step in the value chain. We can add to that energy value in a number of ways.

First, and most obvious, we can add to that value by improving the performance of the nuclear plants in any number of ways, including uprates to boost the capacity, improving capacity factor through shorter refueling outages and other means, achieving fuel savings through higher fuel burnup, and reducing O&M costs through better management, improved efficiency, procurement improvements and other techniques.

We're conducting an industry survey on reactor uprates and upgrades. We don't have all the data in yet, but it suggests that we've added approximately 1,000 megawatts of capacity over the last 10 to 12 years through uprates. There is at least that much more yet to be gained. Remember, too, that these uprates are low-cost undertakings, $15 million to-$20 million for another 10 percent to 20 percent of output from a plant. I am not aware of any other technology that can deliver additional output at such modest cost.

We can also add to the value of the nuclear assets by leveraging the unique characteristics of these plants—among them the ability to provide a high degree of price stability. In competitive markets like California, we are seeing large electricity users willing to pay a premium above the average market clearing price to lock in an assured source of electricity supply at a known price. This protects them against the damaging effects of price volatility in the day-ahead electricity market.

We are aware of transactions in the bilateral contract market in California in which large users were prepared to pay a premium of $5 to $8 per megawatt-hour above the day-ahead market clearing price to protect themselves against upside price risk.

Nuclear plants also have additional value, which typically is not yet recognized, in pro-viding ancillary services, such as voltage support, and they should be compensated for those services. Nuclear plants also play a key role in maintaining the reliability of the grid, and this service has value in an unbundled market. As we continue to liberalize the market, these ancillary services will become even more important.

Many of our nuclear power plants also have significant additional site value. In many cases, sites that host single units were originally scheduled for two, and sites that hold two units were originally planned for four. That means the sites have switchyards, access to the grid, spare cooling capacity, and, in some cases, room to expand to build additional generation.

In fact, there are some attractive synergies. Imagine a situation where a nuclear plant operator builds gas-fired peaking capacity on its nuclear plant site. This company cov-ers its nuclear costs by committing a portion of its nuclear output through forward sales in the bilateral contract market, generates additional revenue by moving its remaining nuclear output in the day-ahead market, then generates yet more revenue by selling, say, 10-minute spinning reserve capacity or other peaking capability in the day-ahead market where prices for these services can be quite astronomical.

The next building block in the value-added chain is the clean air compliance value as-sociated with emission-free reactors. We have completed a number of analyses over the last year to satisfy ourselves that this compliance value exists, even though nuclear plants do not, at present, derive economic recognition for that value. Specifically, we evaluated the role of nuclear power plants in reducing the compliance obligation imposed on coal-fired power in reducing sulfur dioxide (SO2) emissions under Phase 1 of the Clean Air Act. We also analyzed the compliance value of nuclear power in reducing compliance costs for nitrogen oxide (NOx) emissions, using New York state as a case study.

Each year, nuclear plants avoid approximately 5.1 million tons of SO2 emissions, 2.4 million tons of NOx emissions, and 150 million tons of carbon emissions. This corresponds to 42 percent of SO2 emissions, 33 percent of NOx emissions, and 26 percent of carbon emissions from electric utilities. These avoided emissions alleviate the compliance obligation and associated costs for affected fossil-fueled power plants. Emission-free nuclear power permits emitting generation to avoid or minimize capital outlays for compliance with federal and state emission requirements.

Let me give you just a couple of examples. Most of the states east of the Mississippi are operating under statewide budgets for NOx emissions. Thirty percent of the New York state NOx budget would be needed if nuclear plant generation were replaced by natural gas combined cycle generation, which complied with new source review (NSR) require-ments. Thus, the existing fossil power plants would have only 70 percent of the allo-cated NOx allowances available for compliance, meaning that there would be greater emission reduction requirements imposed on each plant. And greater reduction re-quirements generally mean higher compliance costs. In Illinois, replacing the nuclear units would consume 47 percent of the state NOx budget; Pennsylvania, 41 percent.

These environmental services provide substantial benefit to the electric supply system and support regional economic growth—essentially by providing offsets to pollution that allow industrial growth and expansion. We are working toward the day when this environmental service is recognized, appropriately valued, and benefits nuclear plants and the shareholders of the companies that own them. We are working particularly hard to ensure that we capture this value as it applies to reducing carbon dioxide emissions.

And finally, we see potential additional value in the unique capabilities and management tools and techniques required to maintain and operate a world-class nuclear operation.

Successful operation of a nuclear facility requires a substantial investment in informa-tion technology, meticulous record-keeping, maintaining configuration control and design and engineering drawings, personnel records, training, tracking the pedigree of spare parts and equipment, scheduling of maintenance activities, and supply chain management.

These tools and techniques have value, witness the decision last May by Sears to retain Carolina Power & Light to provide maintenance management services for all 845 Sears full-line stores around the country. This will include processing maintenance work orders, scheduling equipment maintenance, tracking and ordering parts, maintaining warranties, and ensuring compliance with safety, environmental and other workplace regulations.

Taken together, we believe these building blocks of additional value represent significant potential for nuclear power plants, and we know our member companies are already planning ways to unlock this value and move it to the bottom line.

Beedle: Today, the nuclear power industry faces two major business uncertainties—the regulatory process and used fuel management. We've been able to manage both areas with sufficient success that neither represents an appreciable business risk to operating our plants safely and economically.

Let me start with the truly dramatic progress made over the last 18 months in working with the Nuclear Regulatory Commission to achieve fundamental, revolutionary reform of the regulatory process. There has been a remarkable improvement in the regulatory environment and, at the same time, the NRC remains a credible, effective regulator, which is absolutely essential.

As you would expect, our goal is to drive unpredictability out of the regulatory system, to develop a high degree of certainty about what is expected at our plants, and to reduce the business risk associated with the regulatory process.

We've worked with NRC to develop a new process to monitor and evaluate nuclear plant performance and all stakeholders have sufficient confidence in that process that the NRC has eliminated the "watch list" of plants requiring additional regulatory over-sight. That alone was a huge step toward greater certainty, greater objectivity and greater integrity in the regulatory process.

We've also achieved notable success in working with the NRC to create a more disciplined and businesslike process for processing license transfers and license renewals. License transfers have become fairly routine. For example, it took the NRC just four months to approve the transfer of Clinton's operating license from Illinois Power to AmerGen Energy.

We have a high degree of confidence that companies will be able to implement business decisions and reposition their nuclear assets within a credible, effective regulatory process.

I must tell you that none of this would be happening if it wasn't justified by the improvements in nuclear power plant performance. This is a mature industry with sufficient operating experience to warrant a critical reexamination and overhaul of regulations and requirements that were put in place over the past 30 years, regulations imposed in a piecemeal, incremental fashion where one set of requirements was simply layered on top of another.

What we've learned over the years is that, in some cases, we are focusing resources on areas of the nuclear plants with little or no safety significance. We're now in a position to reduce that regulatory burden without compromising safety in any way. In fact, we will enhance safety because we place management attention on those areas that have greatest safety significance. We're also finding a few areas which the risk assessment tools tell us have greater safety significance than we thought.

We find the NRC open to working with all stakeholders. One of the more interesting features of the new plant assessment process is that the approach enjoys the unqualified support of the NRC management, the industry and the intervenors, like the Union of Concerned Scientists. All regard it as a quantum step forward toward a more objective, understandable and transparent system.

I should add that none of this would have happened as quickly as it has happened without a keen level of interest from the NRC oversight committees in Congress, and we expect that oversight interest will continue.

The most dramatic change involves the new assessment process for our nuclear power plants. We know this is a top-of-mind issue for the financial community because this replaces the SALP (Systematic Assessment of Licensee Performance) process, which you and others used as a barometer to track plant performance, and the "watch list," which constituted a huge business risk because assignment to this list represented such a crippling drag on earnings for the companies affected.

The new assessment process is really a three-part program, involving a new system to monitor plant performance using a set of 19-quantitative performance indicators as well as a revised inspection program and a new approach to enforcement.

All of the parties involved believe the new assessment process is a marked improve-ment from the old system. It replaces subjective criteria with objective performance indicators, it establishes clear, quantitative thresholds separating acceptable performance from unacceptable performance, and it discards lagging indicators like SALP and the "watch list" and replaces them with real-time indicators of plant performance.

The new assessment process was field-tested last year at nine plants. All agreed that the new system achieved most of its goals and, with some refinements, is ready for in-dustrywide implementation in April.

I said earlier that the new assessment process is more transparent. For the pilot plants, and for all the plants when the program is rolled out industrywide, you will be able to log on to the NRC's web site and read the performance record of any nuclear plant in the country. The performance indicator results will fall into one of four color-coded bands—green, white, yellow or red. Where the indicators fall will determine the regulatory response.

In the revised inspection program, the areas for inspection are selected based on safety significance and other factors. Like the performance indicators, the inspections results will be coded green, white, yellow or red. As long as indicators and inspection results are in the green band, NRC will maintain only routine interactions with the licensee and conduct a baseline inspection program.

To the extent plant performance and inspection findings fall in the white or yellow bands, the level of NRC involvement will increase. In the unlikely event that performance and inspection results degrade into the red band, that would indicate an unacceptable reduction in safety margin and the plant would not be permitted to operate.

Management of used nuclear fuel represents the second major business uncertainty facing the nuclear industry, and, as with the regulatory process, we don't believe this uncertainty represents a threat to the competitive position of our plants—with just one or two unique exceptions.

Many people, including some in the industry, have developed a somewhat jaundiced view of this program. But I must tell you that although we're not satisfied with program implementation by the Department of Energy over the last several years, much of the news is good and we still believe the DOE program can achieve the desired result.

Many people talk of our waste management "problem." We don't have a waste management problem. What we have is one of the best examples in any industry of an ef-fective cradle-to-grave waste management system. We can account for, and have carefully controlled, every gram of used fuel produced by this industry since its inception. Let's not forget also that we have the most advanced nuclear fuel management program in the world. No other nation is even close to the site characterization we have underway at Yucca Mountain.

The scientific work at Yucca Mountain is going well. The DOE's viability assessment report, published at the end of 1998, and the draft environmental impact statement issued in 1999 show unequivocally that we have a very solid technical basis for proceeding to develop a repository at Yucca Mountain.

Yes, we have frustrations—mostly with the government's failure to meet its obligation and start moving fuel as required by law beginning in January 1998. But the industry is coping well with that delay, and taking actions to recover the money caused by that delay.

Companies have built 14 on-site storage facilities and another 16 are planned in the near-term. Licensing of these facilities is generally routine and non-controversial, and the additional cost of on-site storage will not place any nuclear unit at competitive risk.

The bottom-line: Used fuel management is a major public policy issue that must be re-solved, but it is not a major business risk. As with the regulatory process, our goal is to manage the uncertainty in this area to minimize the business risk to operation of the plants. We have a four-pronged program to achieve that goal.

We must obviously make sure that companies retain the ability to build additional on-site storage capacity when needed, and we are working with the NRC to streamline further the process for certifying storage casks.

As far as the Yucca Mountain program is concerned, we are approaching a window of opportunity to make further progress there. Later this year, the Department of Energy is scheduled to issue for public comment its site recommendation report on the suitability of Yucca Mountain as a geologic repository. That, in turn, will lead to a site recommendation decision by the President sometime in late 2001, and then to submittal of a license application to NRC in 2002-2003.

We also know we can count on continued congressional oversight of this program, which will encourage the Executive Branch to hold to its schedule. The industry has for several years pursued legislative initiatives to correct deficiencies in this program. We will continue to pursue these initiatives: To authorize early receipt of spent fuel at Yucca Mountain, to assure adequate funding for the program, to ensure a safe, rational radiation standard for licensing and design purposes and to protect the Nuclear Waste Fund.

In addition, the industry continues to press forward with development of two private storage facilities for used nuclear fuel—the Private Fuel Storage venture in Utah and the Owl Creek project in Wyoming. Both continue to look promising.

And individual companies will be pursuing their legal rights, through the U.S. Court of Federal Claims and in private negotiations with DOE, to recover damages from the government's failure to begin moving used fuel on January 31, 1998. Recovery of damages likely will include reimbursement for any costs incurred to build additional on-site storage.

Colvin: As I said at the beginning, the fundamentals for out industry are very strong. Costs are coming down and can come down further. Virtually all nuclear power plants are—or can be—competitive, and performance is outstanding and getting better. The consolidation we've been anticipating for the last three or four years has moved into high gear, and we know there is substantial untapped value in these plants.

Nuclear power plants have unique advantages compared to other sources of generation. Unlike gas-fired power plants, which are extremely sensitive to fuel price changes, nuclear plants are relatively insensitive to fluctuations in fuel price. In addition, they are immune to escalating environmental requirements, which can have a dramatic impact on the cost of fossil-fired generation.

Looking ahead, we expect the year 2000 will see complete implementation of the NRC's new assessment process, continued progress at Yucca Mountain leading to a site rec-ommendation, continued consolidation of ownership and operating responsibility, and additional license renewals for nuclear plants.

Equally important, we expect continued, even growing, support from policymakers and the political establishment for two reasons: We see growing concerns over reliability of electricity supply as electricity demand grows significantly faster than expected. And we see a growing recognition that the large, baseload nuclear units are indispensable in assuring the stability of the grid and reliability of the supply system. And second, we see growing recognition of the dominant role of nuclear energy in preserving air quality and reducing emissions, particularly emissions of greenhouse gases.

The government recently published the results of voluntary reductions in carbon emissions in 1998 under a program authorized by the 1992 Energy Policy Act. U.S. industry across the board reduced carbon dioxide emissions by 212 million tons in 1998, and improvements in nuclear power plant performance—just the improvements, mind you—accounted for almost one-half of that amount—100 million tons.

 


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