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The Future of Nuclear – SMRs?

Nuclear power is not an industry that experiences huge growth rates, and it is infinitely more difficult for investors to find a hidden gem in nuclear energy than it is in oil and gas. There just aren’t any mom and pop nuclear shops out there. Nevertheless, it is a global industry that does around $140 billion in annual business and thus it is important to get a status check on what is going on in the nuclear world from time to time.

A Renaissance Delayed

The “nuclear renaissance” was supposed to have kicked into high gear by now, as many predicted only a few short years ago. But the industry has hit a standstill in the western world, as a confluence of events conspired to kill off the renaissance before it got started.

First was the financial crisis, which depressed demand for electricity worldwide, and despite the economic recovery, power demand will not reach the trajectories that executives had previously anticipated. Then came the fracking revolution, which caused natural gas prices to plummet as a glut of new fuel came online. Utilities suddenly found it much cheaper to go with gas over nuclear power.

Meanwhile, the collapse of the cap-and-trade bill in 2009 in the U.S. Congress doomed carbon pricing for at least half a decade, perhaps longer. As a carbon-free fuel, the nuclear industry would have benefited enormously from restrictions or costs put on fossil fuels. Climate hawks are still trying to gain back the momentum they had in the months and years prior to 2009.

The nail in the coffin for the nuclear industry came on March 11, 2011 in the form of a massive tsunami. The meltdown of three of the six nuclear reactors at Fukushima Daiichi scared off any interest in nuclear power on the behalf of many governments across the globe.

A Nuclear Future

Still nuclear power has a lot going for it. It can provide truly massive baseload power. It has a tiny footprint in terms of land use with a power density of 338 megawatts per square meter. A Bloomberg article earlier this week noted that it would take 772 square miles of wind turbines to account for the equivalent amount of power coming out of just two reactors at Indian Point in Westchester County, New York.

Nuclear power will also not suffer from severe price fluctuations that natural gas power plants have to deal with. And over the long-term, which may be one of its biggest strengths, nuclear power does not produce greenhouse gas emissions. As more and more governments move to place limits on carbon pollution, nuclear will be there to pick up the slack.

But that doesn’t mean that utilities will simply build the massive gigawatt style nuclear plants of yore. Nuclear reactors of that size can cost over $8 billion a piece and take nearly a decade to complete. Utilities – and their shareholders and financiers – can’t and won’t wait that long to see a return. Moreover, demand for electricity in many countries is simply not growing that fast to justify such an outlay.

Scale Down to Scale Up

So, nuclear will need to be much more nimble.

That means new reactor designs, specifically smaller and cheaper ones.  Small modular reactors (SMRs) offer an interesting model for 21st century nuclear power. They offer several advantages over conventional large reactors. First, they can be added incrementally in doses of 50 or 100 megawatts, which could match up well to electricity demand that is growing slowly.

SMRs can be theoretically manufactured as if on assembly line, instead of on an ad-hoc, case-by-case basis at its final site. This could significantly reduce costs on a per-megawatt basis. They would also require significantly less money upfront, reducing risk, and thus, the cost of capital.

SMRs also offer potential benefits in terms of safety and security. They can be constructed underground, reducing their vulnerability to terrorist attacks or extreme weather events. Finally, SMRs could be constructed in remote areas that don’t have connections to commercial power lines – offering off-grid, decentralized power.

That is the idea anyway. But there are very big obstacles standing in the way. First, many critics doubt the hype. Without a single SMR constructed to date, much of the supposed advantages remain theoretical. Second, SMRs face the same problems as conventional nuclear power – cheap natural gas and flat demand.

But the huge potential of SMRs has caught the attention of policymakers at the highest levels. Under the Obama administration, the Department of Energy decided to offer $452 million in grants to the private sector – on the condition that recipients offer up an equivalent amount of money – in an effort to get a viable SMR design licensed and up and running by 2022. The Nuclear Regulatory Commission (NRC), which has setup its regulations based on large light-water reactor designs and is notoriously resistant to change, is working with DOE and the nuclear industry to kick start the design licensing process.

And progress has been disappointing, despite strong support from the Obama administration. The first recipient of DOE grant money, mPower, a division of Babcock & Wilcox (NYSE: BWC), is not doing too well. B&W and DOE spent a combined $400 million on mPower, but B&W decided to shelve the plans and lay off workers. B&W sees a weak power market for the foreseeable future, and doesn’t believe SMRs justify the risk.

The second recipient of DOE grant money was NuScale Power, a small company based in Portland, OR, and a subsidiary of Fluor Corporation (NYSE: FLR). NuScale is working on a 45-megawatt reactor that would eliminate a lot of the complicated engineering that goes into a large conventional reactor. As electricity demand rises, up to 11 additional SMRs could be added to a single site, totaling 540 megawatts of nuclear capacity, according to the company’s vision. NuScale hopes to submit a design to the NRC in 2015 for approval by 2018, putting on track for full commercialization within a decade.

All of this is not to say that big nuclear power plants are dead. China is in the midst of a massive buildout of nuclear power, and has plans to reach 58 gigawatts of installed capacity by 2020, quadrupling the size of its current fleet. Then, in the following ten years, China plans on tripling again to 150 gigawatts.

Such monumental plans for nuclear power have some companies in a great position to profit. In particular, Westinghouse remains a huge player in the global nuclear market. Westinghouse, a division of Toshiba (TYO: 6502), is the owner of the only generation III+ reactor design that is certified by the NRC, one that is the favorite for many new Chinese projects. There are currently four AP1000’s under construction in China, as well as two additional units that received a green light from Chinese regulators in February. The AP1000 is also the design of choice for the first nuclear reactors under construction in the United States in three decades.

Nevertheless, in the U.S., SMRs are more likely to win out over the long-run. “The future as we look at it for new nuclear, a decade-plus out, would be on efficient modular reactor designs,” said Christopher Crane, CEO of Exelon Corporation. Exelon (NYSE: EXC) just recently acquired Pepco, a utility that serves the mid-Atlantic region of the eastern seaboard. The combined company will be the largest utility in the U.S. in terms of customers served. But Exelon is also the largest holder of nuclear power plants in the country, and as of 2010, it generated 93 percent of its electricity from nuclear. If the executive of the largest nuclear power owner in the U.S. is looking at SMRs, investors should take note.

Indeed, despite the hiccups with mPower, there is still strong bipartisan support for nuclear power in the halls of Congress. Just look at the political firestorm that resulted from the Solyndra debacle compared to the non-news that was B&W’s decision to scale back its SMR plans. The White House’s FY1 budget proposal included a 30 percent increase in DOE’s SMR program. Strong political support for any energy source is hard to come by, and for nuclear power in general, and SMRs in particular, political support will be key in the years to come.

But it is no guarantee they will succeed. Investors should keep their eyes on this space because nuclear power is at a crossroads.

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