Exelon is the largest electricity supplier in the country. It also owns and operates the largest fleet of nuclear power plants, with a total of 17 operational reactors that have an average capacity factor well in excess of 90%. Last week, it reported a 26% increase in its 4th quarter profit figures compared to the same period last year with a reported profit of $707 million in 2008 compared to $562 million in 2007. It appears that its corporate strategy is working very well in these troubled times.
It might be a bit distressing for Exelon customers to learn that part of the strategy, however, is to profit from capacity constraints in its markets that result in higher prices, especially when the company purposefully decided, several years ago, to take action that would permanently remove 2200 MW of clean electrical supply from the Midwest power grid. Fortunately for ratepayers in the region, some decisions take longer than others to completely implement, so there is still an outside chance that Exelon’s move to restrain supplies (and increase prices and profitability) can be reversed.
In case you are confused, here is the situation. In the mid 1990s, ComEd, one of the predecessor companies for the entity now known as Exelon, was the largest owner of nuclear power plants in the country, but it did not have a very good reputation within the industry or even within its own territory. Through mismanagement and operator errors, its plants were often on the Nuclear Regulatory Commission watch list and they operated with relatively low capacity factors. Within the ComEd system, the station with the worst operating record, the most labor/management strife and the worst industry reputation was Zion, located about 40 miles outside of Chicago.
ComEd was also embroiled in a lawsuit with Westinghouse, the supplier that had built 8 reactors for ComEd, over the unexpectedly low service life provided by the steam generators in those reactor plants.
Steam generators are deceptively simple devices with few, if any moving parts, but they operate in a complex chemical environment and are subject to a number of physical stresses from pressure and temperature gradients. They are large, expensive components with thousands of thin walled tubes that separate pressurized reactor coolant from the steam used in the turbines. In many instances in the first and second generation plants, several tubes developed cracks or other types of leaks and had to be isolated. When too many tubes reached that condition, plant performance deteriorated and/or the steam generators needed to be replaced in a major refurbishment effort.
ComEd was not the only company that had trouble with their steam generators or the only one that sued the supplier when they did not last for the full 40 years of their initial design life. In fact, one of the contributing factors in the ending of the first Atomic Age was the amount of time spent in court by the leaders of the major supply companies. From what I can tell, many of them simply got tired of that aspect of the business and figured out that lending money or creating TV shows was easier and more profitable.
In the steam generator lawsuits, the suppliers were not always found to be at fault. During the 25 years between Zion’s construction and shut down, there are a lot of errors that operators could have made that would have caused problems with steam generator U-tubes.
In September 1996, Westinghouse announced that it and ComEd had reached a settlement on steam generators. That settlement was never made public.
Within months after the settlement, both reactors at Zion were shut down. Initially, the shutdowns were not announced as being permanent, but the company had to make a number of decisions about costs for refurbishment, efforts to improve the work force safety culture and actions needed to implement a long term company strategy in a time of rapidly changing conditions in the energy markets. Electricity deregulation was a hot topic, natural gas prices were less than $2 per million BTU, and there were many indications that obtaining nuclear plant operating license renewals would be exceedingly difficult if not impossible.
I remember those days in the industry quite well (we are talking about 1996-1998 here). I even stopped attending American Nuclear Society meetings; most of the exhibition floor and more than half of the paper topics involved D&D. (Decommissioning and Decontamination) I had no interest in talking to people about taking plants apart, I wanted to put them together.
For a lot of good reasons, ComEd decided that they would simply not restart Zion. To keep the annual costs at a minimum, the company gave up its operating license for the facility and converted it into a SAFESTOR license that covered the continued operation and monitoring of the used fuel that remained on site.
At least twice since 1998, the company has taken a look at what it would take to restart Zion. When PECO and Unicom (a later name for ComEd) merged, PECO brought a management team that had achieve excellent success in turning poorly performing plants around. Unicom had also taken action to improve its own performance including hiring Oliver Kingsley, a former US Navy submarine officer with a track record of commercial plant operating success. After the merger was completed, Corbin McNeill, the CEO of PECO, asked about Zion and its prospects for restart. He had been shopping around for nuclear plant acquisitions for PECO, so it is logical that he would consider an idle plant to be a potential asset.
However, according to a March 2002 article from the Daily Herald titled Exelon has no plans to reopen Zion plant. the company determined that it would not make any preparations to restart the plant. That decision apparently made a local congressman happy:
Republican U.S. Rep. Mark Kirk of Highland Park, who has urged Exelon not to reopen the nuclear plant on the Lake Michigan shoreline, said Wednesday’s announcement was encouraging.
Homeland security and the fact that Lake Michigan is a drinking water source for millions were the primary reasons Kirk cited for not wanting the nuclear facility re-opened. The Zion plant is about 100 yards from Lake Michigan.
“I think the facility is safe and it is well designed and is well protected,” Kirk added.
Note: I would ordinarily provide a link to such an article, but I found it using a paid service called HighBeam Research. I have just started a free trial; so far I like what it has to offer in terms of comprehensive searches of a wide range of media outlets that often conceal their archives behind various subscription front doors.
That decision in 2002 probably made economic sense when comparing the cost of the effort to restart the plant to the cost of replacement fuel for gas fired generation. Over the next several years, however, natural gas costs continued to increase and economic conditions changed. TVA has recently demonstrated that a long shutdown nuclear plant can be refurbished at a reasonable cost and in a reasonable amount of time, especially compared to the cost of a new plant.
That is why it makes me and some other people curious about why Exelon is in such a hurry to turn over the SAFESTOR license for Zion to EnergySolutions so that the plant can be destroyed. There is apparently a fair amount of questioning going on in Northern Illinois, but so far Exelon’s response is that a restart is not an option.
I am not as surprised as some other people because I have learned from some very good teachers about the laws of supply and demand and how skilled businessmen view those laws as requiring active intervention, not passive market acceptance. Here is a quick example of one of my learning experiences. During a hiatus in my naval career, I served as the General Manager for a small manufacturing company. The owner was a true self-made man who parlayed a high school education, some good leadership skills, an eye for a bargain and some mechanical skills into a pretty nice career as an independent businessman.
Jim’s initial business involved purchasing used injection molding equipment at a steep discount, refurbishing it, and reselling it. He told me a story about how he sometimes had to work persuasively to prevent his sources from cutting up the machinery rather than selling it. Their concern was that Jim would sell it to a competitor who would be able to use the equipment to undercut the market. In some cases, the guys who sold Jim the used molding equipment were going against direct orders from management, but they just could not bear to throw something away that Jim was willing to pay thousands of dollars to buy. (New molding equipment can go for hundreds of thousands of dollars, especially the fancy stuff with modern control systems.)
When I dug into Exelon’s corporate history and current market position, I realized that its analysis of the economics of restarting Zion might have something to do with concerns about the effects of a new supply on the prices for electricity in their current markets. Since Exelon is operating a large number of plants already, just a 10% drop in sales price could overcome the benefits of selling a higher volume from the new supply. In the electricity business, a huge financial risk that is well known and understood by decision makers is “overcapacity”.
Just in case you think I might be way off base in my understanding of the economics of the situation, here is a direct quote from John Rowe’s preface to Exelon’s 2007 annual report:
- We have established our corporate structures and mobilized our legal and political teams to protect those market-based rates.
- Our marketing people are suspicious of fads and hardheaded about risks in volatile markets.
- Our plants will become more valuable in a future economy that is constrained both by carbon regulation and capacity limitations.
We are absolutely committed to the value of your investment with passion, with financial discipline and with our own personal commitment.
Now those are great and encouraging words for investors. As a businessman I have to respect that point of view, but I also think in this case it is important for the people who live in the area that could be served by Zion to understand that their interests are in competition with Exelon’s interests. For consumers, overcapacity is not a risk, it means that market competition can actually work because it forces high cost suppliers to shut their doors! Competitive markets can only work if there is enough supply to allow the superior performers to win. If the market is such that every supplier is needed to serve every customer, the result is that prices go up and service goes down.
Just think about how boring football would become if there were not dozens of want to be professionals for every one that actually makes it through the scouts, the tryouts, and the training camps.