Playing the Odds on Plant Vogtle
OVERVIEW[i]
In this article, I provide a framework for an unbiased, probability-based model that can be used by the minority owners in Plant Vogtle to objectively arrive at the correct decision for continuing or canceling their participation in the project.
BACKGROUND
On or before September 30, the two minority owners of Plant Vogtle Units 3&4, Oglethorpe Power Corporation (OPC) and Municipal Electric Authority of Georgia (MEAG), will decide if they want to assume their portion of the recently announced $2.3 Billion cost overrun[ii] and continue participating in the project plagued by multiple delays and numerous cost overruns that have increased rates, impaired balance sheets, and strained borrowing capacities. They will decide if they want to ante-up and bet the house on flawless going-forward project execution at Vogtle.
I would advise them against that bet, and I’m in good company. This past February, the day after he left his position as Chairman of the GA Public Service Commission (PSC), Stan Wise was asked in a radio interview if GA Power would meet the revised project schedule that was hastily approved by the PSC last December. He replied, “I wouldn’t bet my house on it."
In only six months Stan Wise would be proven correct, along with the PSC staff and industry experts that voiced concerns about the project during December’s hearings for the Seventeenth Semi-Annual Vogtle Construction Monitoring (VCM). Many of these concerns focused on Southern Nuclear’s ability to assume the responsibility of the primary contractor and effectively manage, within their proposed budget revision, a cost-plus contract for continuing Vogtle after Georgia Power terminated its fixed price Engineering, Procurement, and Construction Agreement (EPC) with Westinghouse.[iii]
PLAYING THE ODDS
Given the hand that’s been dealt to the minority owners, how do they decide whether or not to continue on with Vogtle? The reluctance to cancel this project stems from the fact that so much has been expended to date. Regardless of how much they have vested, the minority owners need to acknowledge that Vogtle has fallen victim to the sunk cost fallacy and they need to objectively evaluate the costs and risks of their alternatives at the margin.
Only after the fact will perfect information be available to validate a choice to abandon Vogtle and pursue other options. But, if continuing on with the project and suffering additional cost overruns, it will be too late to protect ratepayer interests. An analogy is the decision making process for evacuating prior to a potential natural disaster. Once the information needed to verify that not evacuating will result in dire consequences, it is too late.
I believe that the decision on Vogtle can be boiled down to the joint probability of potential outcomes for the two drivers of absolute and comparative valuations for Vogtle.[iv]
The first driver is potential additional Vogtle cost overruns and how they would impact ratepayers. Below is a graph that tracks the numerous budget revisions to Vogtle over time as well as extrapolates two cost paths based upon these revisions to the currently expected project completion date.
The reason for the two cost path trajectories is to separate the periods used to estimate potential final costs between the one prior to, and the one after construction began on the project. These extrapolations result in a range of final project costs between $28.5 and $31.5 B. If these final project costs from the extrapolations are realized, OPC’s share would range from $8.55 to $9.45 B.
Recent public statements from OPC state that given the most recent final cost forecast of $25 B, its operating budget will increase by around 5.5%. Using the same benchmark comparisons, if the final project costs range between $28.5 and 31.5 B, OPC will require an increase in their operating budget between 8.5% and 15.5%, in addition to the already stated 5.5%. To protect ratepayer interests from further rate increases, there have to be assurances that the final costs won’t exceed $25 B. GA Power management enumerated a long list of issues that can cause further cost overruns in its filing for the 18th VCM.[v]
Vogtle proponents may criticize the accuracy of these extrapolations, but they aren’t required to be perfect in order to support the decision making process I outline below. Regardless, the graph clearly shows that the current expectation for completing the project for a total of $25 B is substantially below both trend lines for the project to date and therefore one may have a rational expectation that the chances of future overruns are greater than 50/50.
The second driver is future natural gas prices. GA Power has stubbornly clung to a very high natural gas price forecast like that used to support the original approval for Vogtle in 2009[vi], before our domestic Shale Revolution that drove prices down from $14.87 in June 2008 to $2.875 in June 2018. In my opinion, this is the primary reason for the large divergence between project valuations from PSC staff and industry experts versus that from GA Power, and a reason PSC Commissioner Echols admitted last December that Vogtle was an uneconomic option for ratepayers versus a natural gas-fired plant.
To support continuing on with Vogtle, it has to be a more economical option than a natural gas plant. That is, natural gas prices must return to their pre Shale Revolution era prices and possibly higher. Given that $15 per MMBtu was bantered about during the 17th VCM, I’ll refer to it as the $15 per MMBtu Case. The Table and the quote below is from GA Power’s 18th VCM Report and was used to defend its position that Vogtle is the most economical option for ratepayers.
A positive number means the Project is less costly than the gas-fired CC alternative.
“The weighted average expected value of the relative savings for completion of the Project as compared to the gas-fired CC alternative is $1.3 billion based upon the results provided in Table 4.1.”[vii]
Given the analysis I’ve reviewed, GA Power’s Natural Gas Price Forecasts are indicated to be much higher than those from industry experts. GA Power does not publically report its forecast, forecast methodology, or weighted average valuation methodology used to create Table 4.1 above.
I personally think that there will be more cost overruns at Vogtle and that the $15 per MMBtu Case will never be realized.[viii] But that doesn’t necessarily matter in deciding whether or not to cancel the project.
Avoiding rate increases above those recently announced requires that Vogtle doesn’t exceed the recently revised budget of $25 B. Assuring that Vogtle at $25 B is in the most economical option, requires that the $15 per MMBtu Case is realized.
Therefore, for continuing on with Vogtle turning out to be in the best interest of ratepayers it requires that:
- Final project costs won’t exceed $25 B, AND the $15 per MMBtu Case is realized.
For canceling Vogtle to turn out to be in the best interest of ratepayers it requires that:
- Final project costs won’t exceed $25 B, AND the $15 per MMBtu Case is not realized.
- Final project costs will exceed $25 B, AND the $15 per MMBtu Case is not realized.
- Final project costs will exceed $25 B, AND the $15 per MMBtu Case is realized.
CONCLUSION
Assigning an equal probability, or 50/50 chance, to each of the possible, uncorrelated outcomes for project costs and natural gas prices, results in a 25% chance that continuing on with Vogtle will turn out to be in the best interest of ratepayers, and a 75% chance that canceling Vogtle will turn out to be in the best interest of ratepayers.
Biasing probabilities for one’s expectations changes the results. For example, assigning a 65% probability to further cost overruns at Vogtle and a 30% probability that the $15 per MMBtu Case is realized, results in a 10% chance that continuing on with Vogtle will turn out to be in the best interest of ratepayers, and a 90% chance that canceling Voglte will turn out to be in the best interest of ratepayers.
If the minority owners can negotiate a price cap on the shared project costs to be $25 B, and they assign a 30% probability that the $15 per MMBtu Case is realized, then there is a 30% chance that continuing on with Vogtle will turn out to be in the best interest of ratepayers, and a 70% chance that canceling Voglte will turn out to be in the best interest of ratepayers.
Additionally, if considering renewables in the alternative generation mix for Voglte, the potential impact of the $15 per MMBtu Case natural gas will be less and the expected probabilities can be adjusted to reflect this as well as for potentially hedging gas price exposures.
To me the answer is obvious. Given unbiased, or rationally biased expectation based upon the project’s history and the natural gas market post the Shale Revolution, Vogtle should be canceled.
OPC and MEAG don’t have to agree with my analysis, but they should heed Stan Wise.
Don’t bet your house on Plant Vogtle.
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Joseph Pokalsky, Managing Director of Prosumers Energy, has more than 25 years of experience in the energy and utility sector. He helped found Southern Company Energy Trading and Marketing; provided services for resource planning, production costing, and power procurement for a group of EMCs in the Oglethorpe System that opted not to participate in the Vogtle project; and was a Director specializing in Risk Management for PwC’s Energy and Utility Practice.
He is a Chartered Financial Analyst (CFA) and received a Masters in Finance as well as in City and Regional Planning from the University of Pennsylvania.
[i] This article is a slightly edited, extraction of a section from a more encompassing post of mine regarding Vogtle published today here at MasterResource
[ii] The cost overrun announced in early August equates to $1 MM per megawatt of generation capacity and the overrun by itself will pay for the much less risky development of equivalent capacity in a natural gas-fired plant.
[iii] There were other concerns expressed, including whether the revised budget itself was in ratepayer interests, and if there was actually a need for the Vogtle capacity. More details of the circumstances surrounding and concerns expressed at the 17th VCM Proceedings can be found here.
[iv] This comparison is very simplistic and ignores other alternative capacity options such as renewables, but it’s the comparison used by GA Power to support completing Vogtle in section “4. An updated comparison of the economics of the certified project to other capacity options” in its Semi-annual Vogtle Construction Monitoring Reports and it doesn’t invalidate the decision-making process outlined here.
[v] Eighteenth Semi-annual Vogtle Construction Monitoring Report, February 28, 2018, Docket No. 29849, p.7
[vi] GA Power has also stubbornly clung to a same vintage load forecast that according to expert testimony at the 17th VCM overestimated its capacity requirements in 2016 by 5 times their share in the new Vogtle units.
[vii] Eighteenth Semi-annual Vogtle Construction Monitoring Report, February 28, 2018, Docket No. 29849, Table 4.1, p. 34.
[viii] Additionally, if pursuing a gas plant option, OPC Member EMCs and Municipalities can hedge their gas price exposure. Renewables won’t require a fuel price hedge.