TWiN 56 - Shumlin's Melt-down

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Entergy's Bold Move

I don't usually spend so much time on one story, but this one is unique, and it's the type of story that warrants a good deal of discussion. There is a financial development underway in the US nuclear industry that has yet to gain much attention, but could be one of the boldest and most innovative moves by any company to date. Entergy is planning to spin off ownership of more than half it's reactors into a new nuclear-only energy company. This will be the first free-market nuclear energy company in the United States.

Before I go into the details of this story, I need to make clear that all of the information I discuss on This Week in Nuclear is already in the public domain in one form or another. I don't do investigative reporting other than researching news that's already been reported. Hopefully I'm able to provide some insights, analysis, and context that listeners find informative and entertaining. Also, the opinions expressed here are mine and those of my occasional guests, and not the opinions of the companies that employ us. I've mentioned this before, but feel it's important to do so again now because this plan by Entergy's to spin off nuclear assets is still under way and involves publicly trades stocks. I don't want to give anyone the slightest impression that I'm discussing proprietary or insider information.

To understand the deal and the motivations behind it, it's helpful first to have an overall picture of Entergy's current business. Entergy is a big company, but in reality it is made up of two very different businesses:

• In the southern US, Entergy is a traditional regulated utility with power plants, transmission & distribution lines, and customers. If you live in many parts of LA, MS, AR, and TX then Entergy is the company that provides your electricity. This part of the business is called "regulated" because the rates the company charges for it's electricity is regulated by public service commissions and other government entities. The electricity markets in the territories Entergy serves in the south have not "deregulated" as they have in many parts of the USA. Five of Entergy's nuclear plants are in the regulated business; Waterford 3, ANO Units 1 and 2, Grand Gulf, and River Bend. Entergy also has a number of fossil generating plants in their regulated business. Profits for any regulated utility come from guaranteed rates of return on moneys invested and spent. It's a low-risk business model with a lower but secure rate of return for investors.
• The other part of Entergy's business is owning and operating six nuclear plants in "deregulated" markets in the northeast and midwest. These free-market nuclear plants sell their power to utilities and large customers, and they make their profits the way most other businesses do; profits are equal to revenues minus costs. The price these deregulated nuclear plants get for the energy they produce is based negotiated wholesale power contracts, and on the competitive market prices for electricity. Entergy's deregulated nuclear plants are Indian Point 2 and 3, Pilgrim, Vermont Yankee, James Fitzpatrick, and Palisades. The deregulated business also includes a contract that Entergy has with Nebraska Public Power District to manage the operation of the Cooper Nuclear Station, and a group that markets the power that the plants produce. This deregulated part of Entergy's business is very lucrative, and is fundamentally very different from the traditional utility business. From an investor and financial perspective, this part of their business could be viewed as having greater risk, with a greater potential return on investment. For example, according to Entergy's latest annual report, in 2007 the deregulated nuclear plants make up 21% of the company's assets while they generated 48% of the company's income on just 18% of their total revenues. So in round numbers, about one-fifth of the assets generated about one-half of the income.

So Entergy is in two very different businesses, one low risk, steady return, traditional utility, and the other a higher risk, higher potential return free-market energy generation company.

There is one additional factor affecting the decision to spin off the six deregulated nuclear units; Entergy's leadership believes those plants are worth more from an investment point of view than is being reflected in the current value of Entergy's stock. According to Wayne Leonard, Entergy's CEO, "..the full value of the business has not and is unlikely to be realized or recognized embedded in a regulated utility." In summary, they believe the new separate companies will have a total worth greater than the currently undivided company.

So here's Entergy's plan: after the spin off later this year there will be three companies instead of one.

• The six deregulated nuclear plants with about 5,000 MW of electricity generating capacity will be owned by a new nuclear energy company called Enexus. This company will be an investor owned, publicly traded company. While the terms of the split have not been announced, anyone who owns Entergy stock on the day of the spin-off will be granted shares in the new company.
• A new nuclear services company will be formed to operate all the nuclear plants owned by Enexus, plus all the nuclear plants owned by Entergy. This new nuclear operating and services company will be called Equagen. Equagen will be a 50/50 joint venture between Entergy and Enexus.
• What's left of the old Entergy, basically the traditional regulated utility will continue to be called Entergy.

Financing for the deal is fairly complicated, but in a nutshell Enexus will borrow $4.5 billion to buy the six nuclear plants from Entergy. That's a lot of money, but when you consider what it would cost to build 5,000 MW of base load generation capacity it is a great price. Those six nuclear plants are probably worth two or three times that amount. From what I can tell, Enexus will pay Entergy $4 B for the plants. I'm not sure where the other $500 million will go, but presumably it will be used for initial operating costs. Entergy will use the $4 B it receives in the deal to pay off $1.5 B in debt and, and $2.5 B will be used to buy back stock. In theory, Entergy's stock price should drop on day one of the spin-off, then should increase later as the company uses that $4 B in cash to reduce debt and buy back stock.

So is this a good idea? Well, I guess that depends on whether or not you believe that a 100% nuclear generating company in the Northeast USA is a good business idea. If you use recent financial performance as a measure, the new company will have assets worth about $10 B (or more), debts of about $4.5 B, and annual revenues of about $2 B. Remember those plants generated about one-half of Entergy's earnings last year (about $500 Million), so theoretically in the future they should be able to generate about $500 million in profits on $2 Billion in revenues. If the price of electricity goes up, then they stand to make more. If any kind of carbon legislation gets passed, then you could expect the market price of electricity to go up, and these plants would benefit.

On the down side, if you believe there is any risk that license renewals for Pilgrim, Vermont Yankee, or Indian Point will not get approved, then Enexus's assets would be worth considerably less.

From my opinion, I think it's a great idea. You've heard me talk before about how difficult it is for new power plants of any type to be built in the northeast, and I believe that the price of electricity will continue to go up as fuel prices rise for oil, gas, and coal. I think some kind of carbon tax or cap and trade program is inevitable, and that will provide advantages to nuclear plants that emit zero greenhouse gasses or other forms of air pollution. I also believe that while the political battles over license renewals will be hard fought, in the end all the plants who seek license renewals will be granted them. In my opinion the risk is pretty low. But PLEASE don't take this as financial advice! If you have any interest in investing in any of the companies I've mentioned, please talk to a financial professional.

Vermont State Senate Leader Peter Shumlin's Poor Behavior Forces Governor to Apologize

Vermont's Governor Jim Douglas was doing damage control this week after State Senator Peter Shumlin publicly insulted business leader John O'Kane. O'Kane is a representative for IBM, one of the state's largest employers. In essence, Peter Shumlin called O'Kane a liar during a press conference called by business leaders who oppose Shumlin's latest legislative attack on Vermont Yankee.

For years Shumlin has been at the center of opposition to Vermont Yankee. This latest proposal would force Vermont Yankee to make $400 million in additional payments into the decommissioning trust fund that they say is under-funded. The plant's contention is that there is plenty in the account to cover the eventual cost of decommissioning when interest earning is factored in. Business leaders, including John O'Kane voiced their opinion that the legislation is unnecessary and that there are many financial means other than cash deposits into the fund that would provide added assurance to the state. The business leaders are concerned that the legislation would result in rate increases and higher costs for businesses and the people of Vermont.

During the press conference O'Kane made the analogy of a 30 year mortgage in which the bank suddenly demanded full repayment of the loan. Here's a transcript:

O'Kane "Money has time value, and you're changing the time.

Shumlin: "We are not asking for the money. You're lying about that. We are not asking for the money. The bill says..."

O'Kane: "Peter, that's it. You just called me a liar."

Shumlin: "I said you're not telling the truth about that, John."

After Shumlin's freak-out, Vermont Governor Jim Douglas called IBM to apologize for Peter Shumlin's inappropriate comments and his behavior "disgraceful."

Under Shumlin's leadership the state legislature has proposed a long series of laws to extort moneys from Vermont's nuclear plant, including:

• $28 Million for a "clean energy fund" to promote wind, solar, and methane projects,
• $7.8 Million to clean up algae in Lake Champlaign (BTW, the plant is not even located on the lake).
• $2.1 Million to subsidize low-income home heating
• An "excess revenues" tax that would only apply to the plant.
• A tax on stored fuel rods.

Fortunately most of these bills were defeated and never became law, but that does not slow him down. Shumlin has another piece of anti-nuclear legislation going though the process now; a bill that would require Vermont Yankee to undergo a costly and subjective "comprehensive vertical audit and reliability assessment."

All this to oppose a plant that keeps Vermont's carbon footprint the lowest in the nation, and the electricity rates at about one-half of what is paid in surrounding states.