Among the goals often posited for federal energy policy are to enhance energy security by diminishing the nation's reliance on foreign oil, to meet a growing demand for electricity, and to reduce greenhouse gas emissions by encouraging investment in clean energy production and technologies. To help further such objectives, the Energy Policy Act of 2005 (Public Law 109-58) established incentives to encourage private investment in innovative technologies, including advanced nuclear energy facilities. Much of the support for such investment is provided under title XVII of that legislation, which offers federal loan guarantees for the construction of nuclear power plants and other types of "alternative" energy facilities.
Administered by the Department of Energy (DOE), the loan guarantee program encourages private investment in nuclear energy by lowering the cost of borrowing and possibly increasing the availability of credit for project sponsors—usually an individual utility, a consortium of utilities, or a merchant power producer. In exchange for providing a loan guarantee, DOE is authorized to charge sponsors a fee that is meant to recover the guarantee's estimated budgetary cost.
However, budgetary cost estimates—which are calculated as required under the Federal Credit Reform Act of 1990 (FCRA)—are not a comprehensive measure of the cost to taxpayers of those guarantee commitments. Specifically, FCRA estimates do not recognize that the government's assumption of financial risk has costs for taxpayers that exceed the average amount of losses that would be expected from defaults; those additional costs arise because a borrower is most likely to default on a loan and fail to make the promised payments of principal and interest during times of economic stress, when the losses are especially painful for taxpayers. Consequently, the estimated budgetary cost of a guarantee is generally lower than its estimated "fair-value" cost, which approximates the market price that a private guarantor would charge for an obligation with similar risk and expected returns.
Because budgetary cost estimates are not a comprehensive measure of the taxpayer resources committed, and because of concerns about the accuracy of the methods and assumptions that DOE uses to forecast default rates and recovery values, some commentators have suggested that federal loan guarantees for the construction of nuclear power plants are being systematically underpriced, whereas others believe they are being overpriced.
For this study, the Congressional Budget Office (CBO) reviewed the many factors that can influence the cost to the government of guaranteeing loans for the construction of advanced nuclear facilities; developed a model to estimate guarantee costs for a representative loan using both FCRA-based and fair-value methodologies; performed a sensitivity analysis of those estimated costs to changes in assumptions about key drivers of cost; and explored the challenges inherent in attempting to charge borrowers the full cost of a loan guarantee. CBO's findings are as follows:
Using a single recovery rate tends to increase the variability of estimated guarantee costs relative to their true values, which increases the government's exposure to a phenomenon known as adverse selection. Adverse selection occurs when borrowers are better able than the government to assess the value of a guarantee offer and take advantage of their superior information at the government's expense. For nuclear construction loans, borrowers will tend to turn down a guarantee if they believe the fee set by DOE is too high but go forward if they consider it fair or underpriced, which increases the likelihood that DOE's portfolio will include more projects for which the subsidy fee has been underestimated than overestimated.
CBO relied on a credit-ratings-based approach to evaluate the probability of default rather than on the historical experience of the nuclear industry, for which not enough data exist to draw quantitative inferences. However, historical experience suggests that investing in nuclear generating capacity engenders considerable risk. One study found that of the 117 privately owned plants in the United States that were started in the 1960s and 1970s and for which data were available, 48 were canceled, and almost all of them experienced significant cost overruns. As a consequence, most of the utilities that undertook nuclear projects suffered ratings downgrades—sometimes several downgrades—during the construction phase.
However, bondholders experienced losses from defaults in only a few instances. Losses for the most part were borne by the projects' equity holders, the regions' electricity ratepayers, and the government. Supporters of nuclear power argue that newer plant designs and changes in the regulatory environment make nuclear investments less risky now, but recent experience abroad suggests that cost overruns and delays are still common phenomena, and concerns remain about an uncertain regulatory environment and changes in demand for electricity.
Finally, although the federal budget is intended to account for the costs of federal activities, it does not account for the benefits of such activities. As is the case with other types of federal spending, loan guarantees for the construction of nuclear plants might increase well-being by supporting activities that are valuable to society but that are unlikely to be economically viable without governmental support. In assessing the value of the program, such benefits must be weighed against the costs of those activities. However, an analysis of the benefits of loan guarantees for nuclear construction is beyond the scope of this study.