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Nuke giant Exelon's future: sustainable or stuck in the mud?

by Marci Jacobs
March 05, 2013


EXELON PIC

Energy Information Administration

The Energy Information Administration expects natural gas to continue displacing coal as a source of electrical power.

They’re more afraid of you than you are of them. And no, they’re not zoo animals. They’re nuclear power producers, and their future prospects teeter on whether we – the American public -- decide to view them as the future of “green” or the epitome of “unclean.”

Commonwealth Edison parent company Exelon Corp. is one such utility. Equipped with the largest nuclear fleet in North America, its long-term market position depends largely on whether energy consumers look to nuclear energy as a preferred, sustainable power source.

“Exelon both enjoys and is at risk of two very game-changing developments right now in the power market. On the one hand you have a strong move toward emissions controls,” said Travis Miller, analyst and director of utilities research for Morningstar. “On the other hand, concern about nuclear operations and even the viability of nuclear power would represent a substantial downside for Exelon.”

Efforts to stem greenhouse gases tend to reward nuclear power, which generates virtually zero carbon emissions. Global warming initiatives instead target the burning of fossil fuels like natural gas and, in particular, coal, which is considered one of the “dirtiest” of dirty energy sources.

But hydraulic fracturing in the U.S. has surfaced vast supplies of shale gas in recent years, making natural gas a cheap and attractive fuel source. And, given that it produces cleaner emissions than coal, it’s (managed to avoid the kind of environmental stigma coal plants suffer.) even been given the pass as being relatively sustainable.

“Power prices are typically correlated with natural gas prices,” Miller said. “And as natural gas prices have hovered at decades-low prices, power prices have come down substantially from the peaks they reached in 2008.”

Exelon spokesman Paul Elsberg explains the impact on the company. “Exelon, like the rest of the industry, faces the dual challenges of sustained low natural gas prices and a sluggish overall economic recovery,” he said.

Exelon was formed in 2000 by a merger between PECO Energy and Chicago-based Unicom Corp., creating a nuclear energy powerhouse with access to wholesale power distribution channels. Today, nuclear energy makes up the bulk of Exelon’s generating portfolio, with fossil fuels constituting a 22 percent greater portion over 2011’s portfolio share, due to last year’s merger with Constellation Energy Group Inc., a utility with a fossil fuel-heavy asset mix.

Analysts viewed the Constellation merger as an effort by Exelon to de-risk its energy asset mix.

“Exelon has one of the industry’s cleanest power generation portfolios,” Elsberg said, “with 55 percent nuclear, 28 percent natural gas and nearly 10 percent hydro, wind, solar and other clean generation.”

Prior to the merger, Exelon’s assets were 67 percent nuclear and 23 percent fossil fuel. But despite its recent portfolio diversification, waning wholesale power prices undercut Exelon’s sales in 2012. Though its merger with Constellation catapulted revenue to $6.28 billion from $4.36 billion, figures came in far below the consensus estimate of $8.26 billion, with earnings ringing in at $1.2 billion, a 53 percent decrease from $2.5 billion in 2011.

And, as Exelon Chief Executive Chris Crane said during a recent conference call with analysts, "We will not see the upside as soon as we had expected."

What’s more, Exelon announced it would be slashing its dividend payout by 40 percent in Q2 2013, something nearly unheard of in the utilities market, where regulations and inelastic demand have historically ensured generous dividends.

“We thought there would be a 40 percent chance the dividend would be cut,” RBC Leveraged Capital Analyst Shelby Tucker said. “We were not completely sure but we thought there was a large possibility.”

The 2008 recession softened demand for energy across all sectors, but particularly for nuclear power, which was in a position to benefit from a handful of legislative bills and new environmental policies prior to the financial downturn.

“Electricity is still below demand at the 2007 levels,” said Steve Kerekes, a spokesman with the Nuclear Energy Institute. “There’s got to be a great amount of concern about implementing legislation to reduce greenhouse gases.”

Earlier this month Exelon, which has 35,000 megawatts of current generation capacity, deferred its nuclear “uprate” program to increase power production across its plants to approximately 1,400-megawatts by 2017, which would have saved Exelon roughly half the cost of constructing a new reactor. Uprates are monitored by the U.S. Nuclear Regulatory Commission and allow plants to increase total output given safety precautions are met.

Exelon originally viewed the uprate program as a profitable investment and part of a long-term sustainable energy strategy. But today, nuclear operators like Exelon are backing away from uprates, given that input costs for competing fossil fuel companies continue to fall and nuclear input costs remain fixed.

“What we’re seeing is an interesting development in the power market,” Miller said. “Natural gas prices and coal prices are making it more difficult for nuclear operators to justify investing more capital in their nuclear plants.”

Though Exelon has pushed back its uprate program, officials say it does not currently have plans to close plants.

"Nothing that we see today would drive us to do that unless we see further degradation," Crane told analysts in a conference call following Exelon’s Q4 2012 earnings report.

The country is boosting its reliance on natural gas not because it’s afraid of nuclear power, but because fossil fuels are currently cheap. Even so, natural gas is not an unlimited resource and is not without its own environmental drawbacks. As a result, nuclear power generators have the opportunity to convince regulators and the public that nuclear power is a sustainable and safe long-term energy source.

Should wholesale power prices escalate or if regulators tighten emissions standards or enact carbon controls, Exelon is positioned first in line to capitalize on a shift in preference to nuclear power, given is nuclear market dominance, producing 22 percent of the U.S.’s nuclear energy.

Exelon’s diverse portfolio and strong clean energy position are core strengths and major sources of competitive advantage, Elsberg said, as well as its scale and scope across the energy industry.

“To the extent global warming initiatives result in less fossil fuel power generation, Exelon wins,” Miller said. “Exelon is the big winner in the industry if gas prices rise and if emissions regulations tighten on fossil fuel generation.”

That is, if costly regulations don’t become a stranglehold on industry growth.

Following the 2011 Fukushima disaster, the Nuclear Regulatory Commission created a variety of plant recommendations and orders focused on emergency preparedness, from improvements in flooding barriers to adoption of enhanced equipment to monitor spent fuel pools.

“There will be costs. There already have been costs associated with enhancements following Fukushima,” NRS spokeswoman Viktoria Mitlyng said. “What we’re looking at is events and scenarios that you cannot predict – so not only the worst possible scenario, but the worst possible scenario you cannot even think of.”

These upgrades have imposed significant costs for the U.S.’s 103 working nuclear reactors, 17 of which Exelon operates. The company may spend $350 million over the next five years on Fukushima upgrades, according to Jack Thayer, Exelon’s chief financial officer. And that figure doesn’t include filtered vents, which would add $15 million to $20 million at each of Exelon’s 11 affected reactors.

Though Kerekes points out that the enhancements U.S. nuclear plants have made post-Fukushima “are not out of bounds of what we’d normally do,” questions arose last month regarding Exelon’s ability to adequately decommission, or in other words dismantle and decontaminate, its plants at the end of their lifespan.

Public sentiment toward nuclear energy suggests that Exelon’s future may nevertheless be bright. A September 2012 poll sponsored by industry trade group the Nuclear Energy Institute release this month found that public support for nuclear-generated electricity in the U.S. is returning to pre-Fukushima levels, with 65 percent of Americans currently in favor, approaching 71 percent before the disaster.

And favorable public sentiment may translate to political support for carbon-free electricity, of which nuclear energy currently supply 63 percent in the U.S.

In New York Stock Exchange trading Tuesday, Exelon shares -- which have been under pressure in recent months -- closed up 10 cents at $31.44. At that price, the utility has a price-to-earnings ratio of 22.14; that's higher than the S&P 500 Index's P/E ratio of 17.24.

Kerekes explains: “If indeed there’s going to be a serious effort to reduce greenhouse emissions and other pollutants in the energy sector, nuclear energy is going to have a huge role there.”

That’s the future Exelon’s planning for.

“We have taken disciplined steps to protect our long-term value…and to position ourselves to capture the upside when power markets recover,” Elsberg said. “With continued emphasis on operational excellence and financial discipline – areas of our business over which we have control - we are optimistic about our long-term value prospects and confident we will succeed.”

Until then, Exelon straddles a fine, fine line -- with a whole lot to gain, a whole lot to lose, and a whole lot of cheap gas to dilute market prices in the meantime.