Price Pressure on Input Capital Costs

We all know about the high cost of building nuclear power plants.  However, the operating costs are so low that the total cost of power out of a new nuclear power plant is just about competitive in the US electricity market.  According to the World Nuclear Association, as of 2013 October 1[1], there are 100 operable nuclear reactors in the United States and 3 under construction, equivalent to just 3% of the existing fleet.   In overseas markets, where the cost of competitive fuels are much higher, the total cost balance seems to be swinging in favor of nuclear power.  Outside the United States, there are 332 operable nuclear reactors and 67 under construction, or 20% of the existing fleet.

In light of some of these and other statistics, a cynical friend has suggested that the high construction costs are only tolerated because of the low nuclear fuel costs.  He suggested that as we see other fuels become more competitive with the cost of nuclear fuel, we will see price pressure put on the manufacturers of nuclear plants and of their component parts.  For those working in the electric industry, this is almost heresy.  The electric industry and their suppliers have a cost of doing business, a cost that is then recovered in the prices charged to their customers.  A lower price would mean a loss to the manufacturer, a loss they cannot afford.  Thus, the conventional wisdom is that there is little, if any, ability for competition to force prices lower, especially for the prices of capital equipment such as a nuclear power plant.  At least that is the conventional wisdom.

However, the electric industry has always had some competition.  Even small isolated utilities with two or more generators have competition in that the generators have to compete against each other to produce electricity at the least total cost.  This is the ancient concept of joint optimization.  The internal competition carried over with the formation of power pools and now with independent system operators.

The competition was not just an internal optimization but was also external.  Utilities buy and sell electricity with their neighbors on a competitive basis.  Most investor owned utilities are interconnected with two or more other utilities, with the interconnected utilities always attempting to sell electricity to their neighbors, which requires the selling utility to be cheaper than the price being offered by other utilities.  These prices would often be quoted for large blocks of power[2], and until recently didn’t have the finesse that has been attributed to power pools and independent system operators.  But the external transactions are still forms of competition.

So the concept of competition is not foreign to electric utilities, competition in the construction of nuclear power plants just hasn’t been in the forefront of the minds of utility executives, perhaps because of the small number of power plants that have been built.

Another friend, perhaps also a cynic, claims that drilling rig operators set their prices to extract much of the consumer surplus out of gas and oil fields.  He claims that the charge for drilling wells is greatly influenced by the expected profitability of the well.  Quoted prices are always low enough so that the field owner can expect to earn a return of his investment in about five years but are high enough so that the field owner can’t expect a return of his investment in less than three years.  My gas and oil friend’s claim is essentially the same as my cynical nuclear friend, that the construction costs go up and down based on the investment level needed for the facility to be profitable, whether it is a nuclear plant or a well expected to produce oil or natural gas.

This cynicism suggests that the United States should defer committing to new nuclear plants until the overseas rush as died down.  The nuclear industry has some limits on the ability to build new power plants.  The high price of fuel in overseas locations has made these locations to be more tolerant of high capital costs, more tolerant than in the United States, explaining some of the disparity mentioned above between the 3% growth in the United States versus the 20% growth overseas.  As the overseas nuclear building boom declines, maybe the cost of new nuclear power plants will decline, making them once again very competitive in the United States.



[1] http://www.world-nuclear.org/info/Facts-and-Figures/World-Nuclear-Power-Reactors-and-Uranium-Requirements/#.Uk2PQ1vD_IU

[2] “Electricity Is Too Chunky:  The Midwest power prices were neither too high nor too low.  They were too imprecise,” Public Utilities Fortnightly, 1998 September 1.