Nuclear power got cool again....


Nuclear Energy's New Power Trip


30 April 2007

SOMETIME AFTER THREE MILE ISLAND and before Al Gore's movie on global warming, nuclear power got cool again.

It's not that anyone has figured out a brilliant way to store spent radioactive fuel. But the U.S. must maintain a reliable electricity network, and is stepping up pollution reduction to comply with new emissions standards. With North America's supply of clean-burning natural gas dwindling, turbines fueled by uranium -- which already produce 20% of the nation's power -- seem destined to play a bigger role in keeping the lights on, especially if regulators give the go-ahead for new U.S. nuclear plants; none have been ordered since 1978.

Fourteen companies have announced intentions to file license applications to build 34 reactors, notes Mitchell Singer, a spokesman for the Nuclear Energy Institute. The trade group estimates that the next reactor will be built by 2015. Given the political opposition that still exists to such plants in some areas, many Wall Street analysts view that estimate as at least two years too optimistic.

Whether new plants materialize depends, in part, on the industry's ability to convince the federal Nuclear Regulatory Commission that security can be made tight enough to thwart terrorists -- which nuclear proponents insist it already is at existing facilities. It also hinges on maintaining operational safety; another Three Mile Island could prove fatal to nuclear power's reborn hopes. And the growth of the industry is also linked, to some extent, on resolving the contentious, long-debated issue of where to permanently store atomic waste.

The dawn of a new U.S. nuclear-power age would be a boon for utilities, uranium miners and suppliers of nuclear reactors and related equipment and services. Making that a growing possibility are global-warning concerns and a rabid worldwide appetite for electricity.

A new U.S. nuclear-power age would be good for uranium miners, as well as operators and suppliers of reactors like those at this New Jersey facility.

Consider power-hungry Texas, where utility TXU (ticker: TXU) had planned to build a slew of coal-fired power plants to fend off brownouts. After private-equity firms Kohlberg, Kravis Roberts and Texas Pacific Group agreed to buy TXU, they wooed environmentalists by scrapping King Coal in favor of nuclear.

Abroad, China is supplementing its coal-power expansion with nuclear plants. General Electric (GE) hopes to sell reactors in India, where it built some in the late 1960s. And countries such as France, which already gets most of its electricity from atomic plants, will be adding more.

"There has been a positive shift in thinking about nuclear power with the climate-change debate [and] a better understanding that nuclear plants are the unsung workhorses of the American electric system's reliability and market-price stability," says Elise Zoli, a lawyer specializing in energy issues at Goodwin Procter, a Boston law firm.

Electricity demand is increasing at a 2% to 3% annual clip globally, but generation capacity isn't keeping pace. That raises the threat of outages everywhere.

Coal, America's most plentiful fuel, powers about half of U.S. electricity plants. But it produces carbon dioxide and other pollutants. Reducing CO2 is expensive, and schemes to bury it are in just the experimental stage.

If carbon-emission taxes replace the existing pollution-credit-trading system, the most-nuclear utilities benefit.

Nuclear plants cost three to six times as much to build as natural-gas-fired equivalents. But that disparity could decrease if utilities use the more compact reactor designs that have evolved since the last U.S. commercial nukes were built. Once they're online, however, nuclear plants are more efficient than fossil-fuel-powered facilities.

Producing a kilowatt hour of electricity costs, on average, 2.5 cents from coal and 8 cents from natural gas, says Bernard Picchi, an analyst at Wall Street Access, a New York research firm. In contrast, he says, producing a kilowatt hour at a nuclear plant costs about 1.7 cents. And uranium's operating-efficiency advantage over coal and gas should linger even if that fuel's cost doubles from its current spot price near $113 a pound.

Says Charles Gaffney, an energy and utilities analyst at Eaton Vance Management in Boston: "The low-cost nature of operating these plants, and the high-priced power environment we are in, will lead to margin expansion for the incumbent nuclear generators." (See table "Long Time Coming.")

While electric-utility stocks have climbed at three times the rate of the broader market in the past year, the upside could continue for three to five years for nuclear players in power-constrained markets.

The biggest incumbent is Exelon (EXC), whose assets are concentrated in Illinois and Pennsylvania. Roughly 66% of its generation capacity comes from atomic power. However, its near-term prospects have been muddied by threats of rate freezes in its home state of Illinois, owing to allegations of manipulation in a power auction. Entergy (ETR) is the second-largest owner of nuclear generation in the U.S. Other players Eaton Vance likes are Dominion Resources (D) and Constellation Energy (CEG).

Table: Long Time ComingRoughly a third of Constellation's electricity is uranium-fueled, much of at plants in Maryland and New York. Jefferies & Co. recently raised its 12-month price target on the stock by more than 20%, to 105, on the assumption that natural-gas prices will hold near $8 per million British thermal units.

Even though nuclear accounts for just 5% of its power output, NRG Energy (NRG) has strong prospects, too. An unregulated merchant seller of power, it operates in several electricity-hungry markets, including the Northeast and Texas, where it and some partners own two nuclear reactors and could add two more on the same sites.

"If you have the right access, land, water, transmission grid, expertise in running efficiently, as NRG does, those are strong selling points to state commissions," says Eaton Vance's Gaffney. "The best way to solve high retail-electricity prices is to develop lower-cost sources." Because many Texas power plants are gas-fired, "you become the low-cost provider with a nuclear plant."

NRG shares have moved up in the past year, making its current-year price-earnings multiple near 20 look a bit high. But analysts are increasingly looking at cash flow in the sector, since private-equity buyers are interested in paying higher prices for nuclear assets, and the stocks are trading at a discount to asset value.

Using enterprise value (stock-market value, plus net debt) divided by earnings before interest, taxes, depreciation and amortization, NRG is trading at 10.6 times, in line with peers, despite its unregulated upside. That's one reason bulls think the stock could rise roughly 25% over the next two years.

Constrained supply is helping to boost uranium prices. (The first uranium futures contracts will be offered by Nymex May 6.) One factor: Russia has said it won't extend its agreement with the U.S. to share thousands of tons of recycled uranium from dismantled nuclear weapons beyond 2013. Roughly half of the uranium used in U.S. power plants over the past decade has come from Russian bomb-grade uranium, says Picchi, obscuring the "fact that uranium-mine production has failed to keep pace with reactor demand for years."

Where will new supply come from? Australia has the largest reserves, although it is second to Canada in production, followed by Kazakhstan, according to the World Nuclear Association trade group.

A flood in one of North America's largest new uranium mines, Cigar Lake in Canada, controlled by Cameco (CCJ), will delay production. That's provided a chance for investors: While stocks in small, speculative uranium-mining concerns have shot to the moon, Cameco, given its woes, merely has trailed the Standard & Poor's 500's 14% rise over the past 12 months.

The Bottom Line

Electric-utility stocks have climbed at three times the rate of the S&P the past year -- and gains should continue for three to five years for nuclear players in power-constrained markets.General Electric expects double-digit growth from its nuclear-services business as more U.S. utilities get approval to extend their licenses and boost their capacity. Says Andrew White, GE's CEO of nuclear energy: "The economics of nuclear energy now, because of fossil-fuel prices, means that power generators on the fence about upgrades or life extensions of nuclear plants want to do things faster." GE gets about 33% of its infrastructure profits from its energy units, and nuclear is a small piece it doesn't break out. But one or two reactor orders would goose earnings. NRG and its partners chose GE reactors for their proposed Texas plants.

Another company that could benefit is Fluor (FLR), a global engineering and project-management outfit that provided engineering or construction services for 20 nuclear units between 1970 and 1993 -- and is an expert on cleaning up nuclear waste. This year, Fluor formed an operation to address potential new U.S. nuclear-power business.

Fluor shares, like those of Chicago Bridge & Iron (CBI), which also provides services to nuclear-energy companies, are near all-time highs. But earnings estimates for both could prove conservative for 2008, given the strength in energy prices.

In sum, the outlook for the nuclear-energy industry in the U.S. is clouded by political issues that seem to be abating. If those issues don't fade away, the plants that exist today will remain an important part of the power grid, and are likely to be upgraded. And if new plants are allowed to be built, the nuclear-power industry's growth surge should be electric.