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Market Underestimates Nuclear’s ESG Benefits

Industry has a key role in improving utilities’ sustainability profiles.

Morningstar, 10/18/2017

By Travis Miller, Doug Marrow, and Luke Raftis

Nuclear power is at an inflection point in the United States, with a wide gap developing between antinuclear and pronuclear factions. This is a critical debate. The 99 nuclear units in the U.S. provide 20% of the nation’s electricity and meet essential reliability needs for major cities. Competition from cheap natural gas generation and renewable energy are pinching profits now, but we think a long-term perspective is important.

Contrary to many forecasts that show nuclear dying a slow death, we forecast that U.S. nuclear-generation capacity will remain mostly flat during the next two decades. In our fair value estimates and earnings forecasts, we assume nuclear generation contributes positive value for the 18 U.S. utilities we cover that own nuclear generation. We expect some plants to close, but on average, the U.S. nuclear fleet will remain economic, continue to operate cost-effectively, and keep its market share near 17% of U.S. electricity production.

We differ from the consensus because of three main views:

1 Our forecast for flat or growing U.S. nuclear capacity is more bullish than most forecasts. In particular, we disagree with the U.S. Energy Information Administration’s prediction that nuclear capacity will fall 11% by 2040. We think the U.S. could add as much as 5% net new nuclear capacity by 2040.

2 We think the market underestimates the returns for nuclear uprates. (The U.S. Nuclear Regulatory Commission restricts the maximum electricity output a nuclear plant can produce. Plants can request an “uprate” to exceed those levels.) Most market forecasts assume natural gas is the marginal generation source, but our calculations show nuclear uprates have similar economic returns and less long-term capital reinvestment risk.

3 Nuclear has a more favorable environmental, social, and governance, or ESG, profile than most other nonrenewable energy sources. Its low carbon-emissions profile and reliability make it a critical contributor to meeting state and federal environmental policy goals.

In this article, we will focus on the third point: The market underestimates the nuclear power industry’s positive ESG attributes. With the help of Sustainalytics, we will look at the environmental, social, and governance factors of nuclear operators.


Greenhouse Emissions
The electricity sector is the largest emitter of greenhouse gases, responsible for 29% of total U.S. carbon emissions, followed by the transportation (27%) and industrial (21%) sectors. Political pressure—particularly through the U.S. Environmental Protection Agency’s 2015 Clean Power Plan and the international Paris Agreement—is pushing utilities to continue reducing their carbon footprint. Nuclear and large-scale hydro are the only baseload generation sources that emit minimal greenhouse gas emissions, helping meet environmental requirements for carbon emissions reductions. Wind and solar are emissions-free, but to match nuclear as a firm baseload generation source, wind and solar require expensive battery backup or standby natural gas generation, which emits carbon dioxide.

Nuclear power in the United States generates an average of 16 grams of carbon dioxide equivalent per kilowatt-hour, according to the U.S. Department of Energy ( EXHIBIT 1 ). This output is comparable to that of renewable energy, on average. In fact, nuclear slightly outperforms solar and biopower on a lifecycle basis. Coal and petroleum are the highest carbon emitters. Natural gas has a significantly lower carbon-intensity profile than coal and oil but is still well above nuclear and renewable energy.

Most U.S. utilities are responding to long-term pressure from regulators and investors to cut emissions. Many of the largest utilities, including Duke Energy DUK and American Electric Power AEP, have made notable reductions. With new-build nuclear plants uneconomic, U.S. utilities have achieved the bulk of these reductions by tilting their generation mix toward renewable energy and gas. However, U.S. utilities still trail their European counterparts, such as Spain’s Iberdrola IBE:ES, Italy’s Enel ENEL:IT, and the United Kingdom’s SSE SSE:GB, in emissions performance.

U.S. utilities’ carbon emissions intensity varies dramatically. Carbon intensity is a function of generation mix. Utilities that are overweight nuclear and renewable energy have a lower carbon intensity, while utilities that are long on fossil generation—especially coal—have a higher carbon intensity (EXHIBIT 2).

The financial materiality of this differential depends to a large degree on uncertain U.S. environmental policies. But we think utilities with superior carbon-intensity profiles are best prepared to adapt to rising investor expectations for emissions performance and tightening carbon regulations, which we believe is a given in the United States in the long run.

Morningstar’s Carbon Emissions Outlook
Utilities have made significant progress in reducing carbon emissions. Carbon emissions from power generators are down 26% since their 2007 peak. We expect decarbonization to continue through 2030 even after considering the Trump administration’s decision to suspend the Obama administration’s Clean Power Plan and withdraw from the Paris Agreement.

We think utilities can achieve at least a 31% drop in carbon emissions from 2005 levels by 2025, primarily based on our forecast for state-level renewable portfolio standards, underconstruction gas generation capacity, and changes in nuclear generation. Through 2025, we expect utilities to reduce their carbon emissions by 119 million metric tons, from 1,797 million metric tons in 2016. Most of this reduction comes from much higher natural gas and renewable energy generation offsetting a steep drop in coal generation. Our forecasts assume nuclear generation grows slightly as uprates and new-build capacity offset planned and possible retirements. Achieving these carbon emissions reductions would put the U.S. power sector ahead of schedule to meet the Clean Power Plan’s targeted 32% reduction from 2005 levels (EXHIBIT 3).

Waste Management: Avoiding Pitfalls
Waste management is a crucial concern for all power generators, but it is particularly important for nuclear operators because of the long-term health and environmental impacts associated with radioactive waste. Ultimately, we view waste management as an unfavorable ESG issue for nuclear power. Radioactive waste and other hazardous waste produced at nuclear sites are subject to strict regulation. Violations can result in penalties or even the loss of operating licenses.

The Department of Energy is responsible for developing a long-term storage solution for high-level nuclear waste, but those efforts have met social and political roadblocks. In the meantime, utilities remain responsible for managing lower-level radioactive waste as well as storing spent nuclear fuel, which can remain hazardous for well over 10,000 years. While nuclear power plants have safely stored nuclear waste on site since their inception, the industry and the U.S. government have failed to come up with a viable long-term solution for spent nuclear fuel. This is critical, given the long decay period and limited on-site storage space.

Nuclear leaves a relatively small footprint of waste volume at 4.4 grams per kilowatt-hour, but this alone does not represent the high level of nuclear waste management risk. About 11% of nuclear waste is radioactive, making nuclear the only generation source with solid waste that has both radioactive and hazardous components. Coal produces much higher waste volume, but the EPA recently ruled coal combustion residual was nonhazardous despite its heavy metal content, which includes fly ash, bottom ash, boiler slag, and flue gas desulfurization gypsum. Upstream and downstream fossil fuel generation processes also produce much higher waste volume but none of it is considered radioactive or hazardous.

For nuclear generators, radioactive waste is classified as low-, intermediate-, and high-level risk. Low-level and intermediate-level waste accounts for approximately 98% of radioactive waste from a nuclear plant and consists of items such as protective shoe covers and clothing, reactor water treatment residue, and tools and equipment that have become contaminated with radioactive material. Low-level waste is typically stored on site until large quantities are gathered for disposal at one of four low-level waste facilities in the United States. Low-level waste poses little public safety hazard.

However, high-level and some intermediate-level radioactive waste poses a material public safety risk if mishandled. High-level radioactive waste is the byproduct of the reaction inside nuclear reactors and comes in two forms: spent nuclear fuel and waste materials remaining after spent fuel is processed. All U.S. nuclear power plants store recent spent fuel rods in water storage pools about 40 feet deep. These pools cool the spent nuclear rods and serve as an additional shield from radiation. The storage container is several feet thick, often with steel liners. Typically, after five to 10 years the spent fuel rods are moved to on-site dry cask storage, where the spent rod is surrounded by inert gas inside a steel cylinder cask.

Nuclear facilities have safely stored nuclear waste on site since the late 1970s. However, the only way for highly radioactive waste to become harmless is through decay, which can take hundreds of thousands of years for high-level wastes. As nuclear waste builds and remains radioactive, nuclear plants will find it challenging to continue storing and managing the waste. Thus, a long-term nuclear waste management solution is needed. The technology to store nuclear waste long-term is available and being tested in Finland. The underground spent nuclear repository Onkalo is 450 meters deep and set for completion in 2023.

Progress on a long-term high-level waste storage facility in the U.S. has been highly politicized with little progress since the 1982 Nuclear Waste Policy Act. In 1987, the U.S. government identified Yucca Mountain, at the southern tip of Nevada, as the permanent underground storage site. It was scheduled to open in 1998. After many years of stalled negotiations, the Obama administration mothballed the project in 2011. The Trump administration included $120 million of funding in its proposed budget, but we remain skeptical that a long-term storage facility will be completed anytime soon. If the Trump administration’s budget is passed, Nevada has filed 218 contentions against the Department of Energy’s application for the storage site that must be remediated. This could cost as much as $2 billion. Until the U.S. develops a long-term waste storage solution, we will consider nuclear waste a negative ESG factor.

Sustainalytics shows that some U.S. utilities are better prepared than others to manage environmental risks associated with hazardous waste treatment and disposal for their entire generation fleets, including nuclear (EXHIBIT 4). Sustainalytics scores waste management on three pillars: hazardous waste management, environmental management system, and environmental policy. All scores are out of 100 possible points. Xcel Energy XEL is best positioned with a score of 83 from Sustainalytics. Xcel Energy’s 1,594 MW of nuclear capacity accounts for only 12% of its generation mix and only 2% of total U.S. nuclear capacity, limiting its risk relative to other nuclear operators. However, the company is well ahead of its peers with respect to waste management and is well positioned to manage existing risk.

Other top performers in Sustainalytics’ waste management rankings include Entergy ETR, PG&E PCG, and Exelon EXC. Exelon and Entergy are the two largest nuclear owners in the United States. PG&E recently announced plans to exit the nuclear business by closing its Diablo Canyon plant in California starting in 2024.

At the other end of the spectrum, Sustainalytics’ analysis reveals a dearth of relevant environmental programs at Great Plains Energy GXP, Westar Energy WR, and FirstEnergy FE. These firms also have below-average nuclear capacity compared with the U.S. utilities industry. But their exposure, constituting 17%, 16%, and 24% of their generation mix, respectively, is far from trivial. Great Plains and Westar jointly own the Wolf Creek nuclear plant in Kansas and plan to merge in the first half of 2018.


Is Radiation Exposure From Nuclear Power Safe?
Nuclear power checks many of the boxes for positive social stewardship. Nuclear power plants employ several hundred professionals in high-paying jobs, often in small- and midsize towns. Exelon recently estimated that its smallest plant, located in Clinton, Ill. (population 7,000), generated $713 million for the state economy and paid $22 million in state and local taxes in 2014. Most of Exelon’s other plants produced more than double those numbers.

Nuclear safety, however, is a key social concern. New York Gov. Andrew Cuomo cited safety in his opposition to the Indian Point nuclear plant not far from New York City. Nuclear disasters have been dramatized repeatedly, notably in the 1979 movie “The China Syndrome” and the television series “The Simpsons.”

However, we think nuclear power safety is misunderstood. A variety of different measures suggest that nuclear generation is the safest source of baseload power generation in the U.S. We estimate U.S. nuclear plants have been generating power for a cumulative 28 million hours, or almost 3,200 years, since the first unit went into service in 1957. In that time, there has been only one accident in the U.S. with relatively minor radiation leakage and no fatalities. There have been other minor radiation leak incidents but none serious.

Americans on average are exposed to about 620 millirems of radiation per year split evenly between naturally occurring and human-made sources. Naturally occurring radiation sources include bodily functions, airborne radon, soil, rock, and certain foods. Human-made sources include diagnostic medical equipment (x-ray, CT scans), nuclear medicine procedures, building and road construction materials, fuels, and electronics.

Radiation levels from normally operating nuclear plants are a small fraction of normal human radiation exposure and pose no safety risks. Studies show:

> Eating a banana causes more radiation exposure than one year living within 50 miles of a nuclear plant.
> Living adjacent to a nuclear plant would result in less radiation than living in a stone house.
> Living near a coal plant exposes a person to three times as much radiation as living near a nuclear plant.
> The U.S. NRC requires nuclear plants to limit the annual external radiation exposure to the public to 100 millirems, less than 20% of Americans’ baseline radiation exposure.

Nuclear plant workers are exposed to about 400 millirems of additional radiation each year. Nuclear plant employees cannot be exposed to more than 5,000 millirems per year based on NRC guidelines.

Nuclear Accidents Rare
Nuclear radiation leaks are rare and typically within a normal range of base radiation exposure. The three worst nuclear power accidents worldwide—Three Mile Island (U.S.); Fukushima Daiichi (Japan); and Chernobyl (Ukraine)— resulted in varying levels of radiation exposure.

The only major U.S. nuclear safety breach occurred at the Three Mile Island nuclear plant in Middletown, Pa., on March 28, 1979. A combination of human error, design deficiencies, and component failures caused the accident. During the accident, residents within a five-mile radius of the nuclear plant were evacuated. Estimates show nearby residents received an average radiation dose of 8 millirem, or about the same as taking a round-trip flight from New York to Los Angeles. Even the most exposed people experienced only about half the radiation as a head CT scan.

In 2011, a 9.0 magnitude earthquake struck offshore Japan, creating a 15-meter high tsunami that hit Tokyo Electric Power Co.’s Fukushima Daiichi plant units 1–4. The nuclear reactors and containment structures held up well. However, 12 of the plant’s 13 backup power generators failed, causing operators to lose the ability to maintain proper reactor cooling and water circulation. More than 100,000 people were evacuated from the surrounding area. To date, no deaths have been directly attributed to Fukushima. Estimates for the average radiation dose for individuals within the 20-kilometer evacuation area were 20 millirems, or about 3% of normal annual radiation exposure. The highest measured radiation dose among Fukushima workers was well below radiation poisoning levels but still above the annual dose with links to increased cancer risk.

The most damaging nuclear accident occurred in Chernobyl, Ukraine, in 1986. It is the only documented commercial nuclear power accident to cause radiation-exposure fatalities. A flawed reactor design that only Eastern Bloc countries used at the time and significant human error caused the disaster. Two operators died immediately from the disaster and 28 others died from radiation exposure in the following months. Among the most exposed, 134 people received between 80,000 millirems and 1.6 million millirems. The average radiation dose to the roughly 115,000 individuals evacuated from Chernobyl was about 3,100 millirems, or about five times the normal annual dose. There has been a significant increase in incidence of certain cancers among residents who had the greatest exposure. The World Health Organization estimates the number of cancer deaths related to Chernobyl were about 4,000.


Operational Governance
We think the nuclear industry gets high marks for its governance framework. It is the most regulated industry in the United States. Federal oversight through the Nuclear Regulatory Commission, or NRC, is key, but nuclear plants also are subject to numerous regional, state, and local regulations. This creates a strong governance structure in the industry and an impressive safety record. Additionally, the oversight process is steadily improving. Regulators and plant owners strengthened operational requirements after the Fukushima nuclear accident in 2011. In addition, nuclear plants are highly secured and have not had a material security breach in recent years.

The NRC routinely visits nuclear facilities to assess compliance with regulations and corrective actions, if ordered. The NRC uses enforcement actions to ensure plants are operating safely and in line with current regulations. If the NRC identifies a violation, it assigns a severity level or a risk color code. Risk color codes range from red (highest risk) to green (little risk). Of the 86 enforcement actions the NRC has issued since 2013, there have been only five yellow violations and no red violations. After Fukushima, the international nuclear generation community implemented additional measures to protect plants from a similar incident.

Operational Incident Analysis
While the U.S. nuclear industry is highly regulated, operational incidents, including violations of safety standards, small-scale leaks, and chemical releases, happen occasionally. Sustainalytics’ incident analysis for the 20 U.S. utilities with nuclear exposure in our coverage universe showed 56 low-risk Category 1 and 2 incidents but no Category 3, 4, or 5 incidents during the last three years.

Entergy has the second-worst record for incidents when adjusting for its sizable nuclear fleet. Entergy’s 8,759 MW nuclear fleet accounts for 10% of total U.S. nuclear capacity, but it is responsible for 23 incidents, or 41% of the national total. Scana SCG has the worst record as a function of the size of its fleet. Scana owns just 67% of one nuclear reactor but has been involved in three incidents during the past three years. By contrast, Exelon, which owns 21,585 MW of nuclear generating capacity, has experienced only six incidents, or 0.3 per gigawatt, and has proved itself to be one of the safest nuclear operators in the world.

Incidents can be the result of many factors, including facility age, but significant gaps in performance can also indicate differences in operational strategy and point to potential weaknesses in management.

In our opinion, Exelon’s low number of nuclearrelated incidents is in part due to strong nuclear fleet governance. Exelon’s board of directors has a generation oversight subcommittee that is responsible for the safe and reliable operation of all its generating facilities. The committee comprises CEO and president Chris Crane, who previously was Exelon’s chief nuclear officer and chief operating officer, and five independent board members who have significant industry expertise.

Entergy, the second-largest nuclear owner, has a board of directors with vast industry experience, but it has no committee dedicated to the oversight of its nuclear generation fleet. This governance difference might partly explain Exelon’s superior performance.

ESG Premium
We think nuclear power has a more favorable ESG profile than most other nonrenewable energy sources. Its low carbon-emissions profile and reliability make it a critical contributor to meeting state and federal environmental policy goals. It also is the safest baseload energy source for employees and the public on several measures, including minimal radiation risk.

We think that top-tier nuclear operators should earn premium valuations for their positive ESG characteristics and that sustainability will help ensure that nuclear remains a primary energy source in the United States for decades.

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