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The United States Enrichment Corporation, which for now has a national monopoly on the enrichment of uranium for nuclear power reactors, is at risk of turning into the Impoverishment Corporation for its shareholders.
USEC is the trust fund baby of the American nuclear industry. It was born in 1998, inheriting leases on the ageing and power-hungry plants that the government had built to separate out the radioactive fraction of uranium that can be used for nuclear reactors or weapons.
It also inherited contracts with the utility industry, a stockpile of uranium, and the economic benefits of an agreement with Russia that allowed the company to sell diluted Russian bomb material. Off the balance sheet, it inherited political influence, partly completed designs for new equipment, and the conviction on the part of the government that the country needed what Europeans would call a “national champion” in uranium separation.
In the tradition of overindulged rich children, it has proceeded to squander this patrimony like a playboy at St Tropez. However, Darwin’s laws may well catch up with USEC, which, to maintain its position, is effectively betting the entire company on a set of defence contractors’ ability to deliver a complex, little-tested technology on a tight schedule and within budget. The odds could be better.
“The utilities hate USEC. The Russians hate USEC. The DOE [Department of Energy] hates USEC,” says a west coast investor. Much of the investing public, however, has rather liked USEC. It has a market capitalisation of just about $1bn, based on a price/earnings ratio of 17. This is based on the notion of a headline in USEC’s annual report – “Pure Play in Nuclear Power = USEC”.
To begin with, the uranium stockpile that, effectively, constituted one of its trust funds is nearly gone. “They’re down to seeds and stems there,” as that west coast investor puts it. So some of those earnings are really a monetisation of inventory.
The economics of the legacy gaseous diffusion plants, about as energy efficient as a 1970 Cadillac limousine, were further hit by the Hurricane Katrina-related increases in electricity costs, along with a long-anticipated 50 per cent increase in base electricity costs that hit this year.
Finally, and, perhaps, most ominously, the Russians who supply about half the “separative work units” that comprise USEC’s enrichment service are increasingly annoyed that USEC refuses to adjust its purchase price to reflect current market prices for SWUs.
While the company will not reveal the terms for the Russian contract, one of its bond dealers estimates USEC pays the Russians about $90 per SWU, while the world market price is between $120 and $125 per SWU. That, apparently, represents better than $100m in extra profit for USEC. “Its margins are about 2 per cent on [the production from the gaseous diffusion plant] and 20 per cent on the Russian contract,” says another analyst.
Last month, Sergei Kiriyenko, the former Russian prime minister who is head of Rosatom, the federal nuclear energy agency, went to Washington to see about ending USEC’s effective monopoly on sales of Russian low enriched uranium. The alternative to sales through USEC is assuming the burden of a 112 per cent tariff, which is in place to prevent the “dumping”, or, to consumers of power, low cost sale, of uranium. According to Russians, Mr Kiriyenko was given a lecture on the sanctity of contracts; USEC’s Russian contract to be the executive agent runs until 2013.
The Russian suspension agreement that underpins the economics of the Russian contract was struck in 1992 between the Russian Federation and the US government. Russia can terminate that agreement on 60 days’ notice. When Russia made the agreement, it was broke and demoralised. Now, it has a substantial current account surplus and foreign exchange reserves, the desire to export nuclear reactors with attached fuel contracts, and a prospective uranium shortage.
“They [the Russians] have not expressed to us a desire to renegotiate the contract,” says John Welch, the president and chief executive of USEC. “They would certainly like to have more access [to the US market] and sell directly to the utilities. [But] the industrial base of the country is going through a transition, investing billions of dollars, and now is not the time to open the market.”
But one Russian diplomat with responsibility for the nuclear fuel trade says: “We want to change the conditions of the suspension agreement and open the gates more widely for the export of Russian uranium. The US utilities very much support the Russian attitude.” While Russia wants to keep a political deal with the US on uranium, “we want to change the conditions of the contract [so as to be] closer to the real conditions of the nuclear market.”
Keeping the profitable Russian contract in place is key to the financing of USEC’s American centrifuge plant, which the company estimates will cost $1.7bn, excluding capitalised interest. Wisely, the company’s disclosures say: “We will continue to refine total cost estimates . . . ”
The main contractors for the plant are Boeing, ATK (the munitions maker), Honeywell, and Fluor.
A nuclear engineer for the electric utilities says: “We in the industry need the production from the plant. We want them to be successful.” He and his colleagues are concerned, however, that: “The bigger the centrifuge, the harder it is to build. This is a really big one.
“If it was my money, I wouldn’t give it to them unless I knew it had been working for a couple of years at least . . . if you had 1,000 [centrifuges] operating for three or four years, then you would have the operating data you would need to be comfortable.”
Again, the industry people want USEC to succeed. But, as the engineer says, “I don’t see why the stock is trading where it is today.” And USEC needs to make another successful stock offering this year, both to meet the terms imposed by its lenders, and to start the financing of the new plant.
I wouldn’t buy it. The $150m or so of outstanding bonds are a better value. They pay about 7 per cent, and are only 30-month paper.
USEC won’t be allowed to collapse but let them bet the company with someone else’s money.