After blogging about Warren Buffett’s decision to purchase Constellation Energy Group, I received some comments from readers posing an interesting question. One reader interpreted the decision as a signal that Buffett, one of the world’s most savvy investors, supported the development of new nuclear power plants. Another one questioned that interpretation, pointing back to MidAmerica’s January 2008 decision to halt development of a new nuclear power plant in Idaho. That reader challenged me to provide evidence that Buffett has confirmed his support for a new reactor at Calvert Cliffs.
Here is a quote from a September 19, 2008 article written by Rebecca Smith for the Wall Street Journal titled Buffett Rescues Power Firm for $4.7 Billion:
Gregory Abel, chief executive of MidAmerican, said Berkshire is “very comfortable with and committed to Constellation’s current strategic plan” and intends “to allow Constellation Energy to operate autonomously” as it pursues its goals, including development of nuclear plants. Constellation’s current management is expected to remain.
Constellation owns roughly 9,000 megawatts of generating capacity, including nuclear reactors. It also is a partner with EDF in a nuclear-development company called UniStar Nuclear Energy LLC, which intends to build plants in the U.S. with technology developed by French-based Areva Inc., which is undergoing regulatory reviews at the Nuclear Regulatory Commission.
Constellation is not just in the planning stages of a single reactor at Calvert Cliffs, it is also past the earliest planning stages for at least one new plant to its Nine Mile Point station and is an active partner in the Unistar Nuclear plans at several other locations, including Amarillo, Texas.
A couple of years ago, I had the opportunity to listen to Matthew Wallace – Constellation Energy Group’s Vice Chairman and Chairman of Unistar Nuclear – speaking at an American Nuclear Society meeting. He described a the company’s strategic plan to build “a fleet” of Evolutionary Power Reactors (EPRs) with a configuration control scheme so that even the paint jobs would be identical. Nothing I have read in the past few months indicates any desire by the company leaders to vary from that long term vision. Their big hurdle in the past has been determining how to attract the required capital base to get the plants up and running.
Many anti-nuclear observers, like Tyson Slocum, who is apparently a devotee of Amory Lovins, continue to confuse initial costs with overall costs. They assert that no one will invest in the plants without substantial assistance from the government because of the high construction and component acquisition cost.
Those observers are either ignorant of how business decisions get made, or they purposely ignore the fact that initial costs are only a portion of an investment decision. Long-term investors like Warren Buffett understand that operating and maintenance costs over time are also important factors to consider, especially when the final product is electricity, a commodity with a vast and expanding customer base. Unlike many manufactured products, electricity is not a fad and not about to be replaced by a new and improved widget. In all developed countries, the group of people who would consider living for more than a few days at a time without predictable electricity can probably fit into a small room.
There is a challenge in attracting enormous quantities of capital for a production facility even with a relatively certain market. There is always a possibility in a large, complex project that it will encounter unplanned difficulties that stretch the construction time and delay revenue generation. There is even a more remote chance that the project will be cancelled before completion, causing all of the investment to become a dead loss. Many casual observers simply do not understand that recently announced nuclear project costs are driven by generous allowances for uncertainties and finance charges that represent 30-50% of the estimated final cost of the project.
There is also a chance that the market conditions can change – in both the US and the UK, the price of natural gas temporarily dipped low enough in the 1990s that gas plant operators could afford to drive down the price of electricity to the point where it made little sense to believe that a nuclear plant investment could pay off. After all, methane gas (aka “natural gas”) used to be just an oil well byproduct that was flared off as a dangerous waste material.
With Berkshire Hathaway as Constellation’s new owner, the access to capital question has been answered. Buffett has a long history of purchasing good companies with seasoned management teams and excellent products. He tells them to continue making good operating and planning decisions while thinking of him as their banker.
That model is a good fit here. When the new nuclear plants make long term sense, they will be built without worries about the vagaries of the financial markets and without concern that huge swings in interest rates will cause the dramatic cost increases associated with plants built during the first nuclear age. My analysis tells me that now is just the right time to get started, especially since many competitors will be unable to move due to lack of capital.
It would be good, however, for energy market investors to keep watching the competition – some of them have even deeper pockets than Buffett. His “world’s richest man” title does not include people with access to the wealth of nations like Saudi Arabia or Russia. It also does not include the leaders of companies that have been amassing capital at the rate of tens of billions of dollars per year during the recent period of high oil and gas prices.