06 April 2011

Where's The "Fukushima Response Fund"?

A prominent feature of the U.S. government's response to the Deepwater Horizon / Macondo blowout disaster was the creation of the "Spill Response Fund", a $20 billion escrow account set up by BP to cover anticipated damage claims, clean-up and mitigation expenses, and other costs. Why has the Japanese government not negotiate a similar fund to cover claims arising from the Fukushima nuclear power plant disaster?

The establishment of this fund was a key political response of the Obama administration to show the nation that it was going to hold BP responsible for the damage the blowout would cause, including reimbursing the government for many of its costs. The fund was announced less than four weeks after the initial explosion at the Deepwater Horizon. The Government of Japan seems much less astute about the need to show that it is going to hold Tokyo Electric Power Company to account.

According to this Reuters story TEPCO is already in negotiations with the government on what share of damages the taxpayers will cover. TEPCO "said it must first assess the extent of damage before paying actual compensation. 'We are still in discussion as to what extent we will pay on our own and to what extent we will have assistance from the government,' TEPCO executive vice-president Takashi Fujimotohe told a news conference." As far as I know the government has not denied this. What a contrast with the U.S. response to Macondo.

[Update 19 April 2011 2320 GMT: This MSNBC story quotes Japanese Economy, Trade and Industry Minister Banri Kaieda: "While TEPCO will be primarily responsible for damages payments, the government may have to support the firm, we are considering taxation, the electricity charge and other measures to enable the government to shoulder some of the burden." Imagine if Obama had said that.]

[Update 9 May 2012 1400 GMT: BBC reports that Japanese government will effectively take over TEPCO, owning more than half its voting shares "in return for a one trillion yen ($12.5bn; £7.8bn) taxpayer bailout". Actually the cost to taxpayers and electricity ratepayers is much higher than that. And who says the Japanese government will be wiser managers of TEPCO than its own incompetent former management?]

Since the anticipated costs of the Fukushima disaster run to $40 billion or more (see estimates in this earlier post), and this amount may exceed TEPCO's resources of cash, credit and salable assets, the company and the government are in a difficult position.

How Would a "Nuclear Disaster Response Fund" Work?

One of the key features of the Deepwater Horizon Spill Response Fund was that BP didn't have to come up with the cash all at once. It was required to pay $3 billion into the fund in third quarter of 2010 and $2 billion in fourth quarter, followed by payments of $1.25 billion per quarter until it had set aside the full $20 billion. This means that as of now, one year after the disaster, it has only actually paid in about $7-8 billion. The fund is supposed to cover claims under "the claims process required under the Oil Pollution Act of 1990 . . . and certain other claims, including natural resource damages and state and local response costs." [Source BP press release]

At the time the fund was announced BP said it would post its U.S. assets as bond to assure that the fund contributions would be made. (Later this was modified to back the fund with BP's future U.S. production revenues.) This bond is perhaps moot, since it now looks like the fund will only have to cover about $10 billion in payouts (see this Bloomberg article), and that amount will have been deposited in the fund within a few months.

The Japanese government could make a similar deal with TEPCO. The size of the fund would have to be about $20 billion. (This would cover estimated damage claims and costs related to releases of radioactivity form the plant, and much of the cost of containment, clean-up and mothballing of the damaged facility.)

Since TEPCO is a much smaller company than BP (about one-fifth in terms of revenues) such a commitment would be much more difficult for it to meet. But TEPCO still has billions of dollars in annual cash flow from ongoing electricity sales even without the output of Fukushima Number One. This revenue stream could be pledged to guarantee the fund would be completed. Alternatively, the assets that generate this revenue stream are worth about $20 billion. They could be put up as collateral, and if necessary sold to generate the cash to complete the fund.

I don't know what remaining borrowing capacity TEPCO has, and its existing bondholders are already justifiably nervous. But the government could make guaranteed or otherwise subsidized loans to TEPCO to enable it to build the fund. This would be another way for the government to shift some of the costs of the disaster to taxpayers without obviously paying costs directly.

And of course as a regulated utility monopoly its rates are set in consultation with government regulators. Those regulators could raise rates to account for higher costs due to the disaster, essentially getting electricity consumers to subsidize some of the anticipated expenses. We have not heard about this yet, but I am sure it will be part of the government's response to rescue TEPCO.

The Japanese government does have some ways to minimize TEPCO's exposure and costs without actually taking on those costs itself. This Reuters story indicates the government may impose energy conservation measures to prevent the need for blackouts, which might otherwise be needed this summer when electricity demand in eastern Japan is expected to exceed supply by about 10% due to the loss of Fukushima Number One's generating capacity. This could effectively shield TEPCO from liability claims for harm business would have suffered due to such blackouts. This would reduce its potential liability by many billions of dollars without the government having to pay out anything.

Eventually TEPCO may have to be broken up and its remaining generating and distribution assets sold. Indeed this might be a fair result. It reaped profits for years operating in a certain way, and now that that mode of operation has resulted in huge losses it is only fair that the shareholders bear the burden. Their company is now worth next to nothing (market capitalization is down to about 10% of what it was before the recent events).

So here is a scenario:
  • The Japanese government and TEPCO agree to the establishment of a $20 billion fund to pay claims for economic losses associated with the Fukushima Number One incident, especially losses associated with release of radioactive material from the plant. The fund could also be used for environmental cleanup, acquisition of contaminated land, and other such costs.
  • TEPCO pledges its assets as collateral for completion of the fund. 
  • TEPCO makes an initial $3 billion contribution to the fund, and undertakes to contribute another $1.5 billion quarterly until the facility is fully funded.
  • The government guarantees special disaster loans to TEPCO, enabling it to make the contributions to the fund. (The government may already effectively be doing this, since major banks have continued to make loans to TEPCO. I doubt they would do so for a company with such an uncertain future unless they had assurance that the government would back the loans if needed.)
  • Electricity regulators increase rates to TEPCO customers to assure an adequate revenue stream to pay back the loans.
  • Optional: TEPCO is forced into bankruptcy and a reorganized "New TEPCO" emerges with significant government ownership (similar to the way the U.S. government took stakes in Chrysler and General Motors to support their bankruptcies and reorganization). "New TEPCO" leaves behind its major liabilities such as the damaged Fukushima Number One plant (perhaps in government hands) and eventually the government can sell its shares and re-privatize the company. Current bondholders take a haircut.  
  • Optional: Eventually the mothballed Fukushima Number One site is transferred to the Japanese government, together with any nearby contaminated land that has been acquired. The government is responsible for monitoring the site for some decades and then decommissioning it. Maybe TEPCO or its successors can be required to post a bond or create a fund to cover the eventual cost of decommissioning.
  • If the experience of the Spill Response Fund is a guide, the total of claims paid and remediation costs may be less than $20 billion. Any funds remaining can be used to pay down the loans made to create the fund.
  • In order for the government to get paid back for its loans, or to eventually sell its shares if it has become part-owner of "New TEPCO", the company will have to be allowed to rebuild and increase its revenues, through construction of new generating capacity and rate increases. Obviously the entire top management has to go, and better management practices must be adopted.
This approach essentially combines the "response fund" concept developed to reassure the public after the Macondo blowout, and aspects of the U.S. government's financing of the bankruptcies and reorganizations of Chrysler and General Motors.

05 April 2011

Fukushima vs. Deepwater Horizon

There are many parallels between the impacts of the nuclear power plant disaster at Fukushima Number One and the Deepwater Horizon oil spill disaster. But there are also significant differences based on
  • A nuclear facility on land compared to a hole in the bottom of the Gulf of Mexico
  • A monopoly supplier of electricity compared to a supplier of a oil, a fungible commodity
  • The much more substantial resources of BP compared to TEPCO, and its early assurance that it would cover all reasonable claims and costs.

The five million barrels of crude oil released from the Macondo blowout after the Deepwater Horizon rig failure disrupted fisheries and contaminated coastline, affecting many businesses. The radioactive contamination being released into coastal waters at Fukushima is causing economic losses to fisheries and other businesses in a similar fashion. How are the costs of these events similar, and how do they differ?

BP's Costs

BP, a "responsible party" for the Macondo blowout, early agreed with the U.S. government to establish a $20 billion "Spill Response Fund". So far BP has paid about $6 or $7 billion into that fund. The fund is intended to cover the liabilities of the responsible parties, and presumably BP will try to get the other responsible parties to contribute part of the fund or reimburse it for part of its contribution. Lawyers will be arguing about this for years.

Kenneth Feinberg was put in charge of managing the compensation payments from the fund. The fund is supposed to cover claims under "the claims process required under the Oil Pollution Act of 1990 . . . and certain other claims, including natural resource damages and state and local response costs." [Source BP press release]

According to this Bloomberg article, Feinberg estimates that only half of the $20 billion will be needed to cover such claims, and the rest will be returned to BP. So BP's cost for economic damages, some ecological damages and some cleanup will total around $10 billion.

BP also incurred substantial costs to contain and plug the blowout, and to carry out various cleanup activities during the spill. It took a $32.2 billion pretax charge against its second quarter 2010 earnings reported 27 July 2010. The charge was "to reflect the impact of the Gulf of Mexico oil spill, including costs to date of $2.9 billion for the response and a charge of $29.3 billion for future costs, including the funding of the $20 billion escrow fund." [Source BP press release]

Thus BP spent about $3 billion on the immediate response and plugging the blowout, and anticipated another $9.3 billion in future costs that would not be covered by the Spill Response Fund. These future costs will probably include various fines and penalties, damage claims (for instance from the families of the men killed), litigation costs and so on.

The U.S. Oil Pollution Act of 1990 created the Oil Spill Liability Trust Fund, funded by an five-cent-per-barrel tax on domestically produced and imported oil. (Thus the cost is borne by oil consumers.) The fund is allowed to grow to a maximum of $2.7 billion. The fund can pay for certain oil spill cleanup costs and damages, but only up to a limit of $1 billion per incident. Responsible parties are supposed to reimburse the fund, and presumably part of the $20 billion Spill Response Fund will go toward such reimbursements. According to this GAO analysis, because of the way the Liability Trust Fund was structured it may not be able to pay out, nor recover from the Spill Response Fund, more than $1 billion for this incident. Government expenditures beyond that will have to be recovered from the responsible parties by other means.

Summary of Macondo Blowout Costs

Response and containment$3-4 billion
Economic claims and state and local response costs (from Spill Response Fund)$10 billion
Fines, penalties, other damage claims and other anticipated costs$9 billion
Uncompensated economic losses and other damage borne by the public, corporations and individuals, and unreimbursed government costsunknown, but probably billions of dollars
Estimated totalAbout $25 billion

[Update 2012-08-01: According to this piece in The Guardian, BP's costs are now estimated at around $38 billion. "The $38bn already includes $14bn in costs to restore 4,375 miles of shoreline and $8.8bn in compensation payments, although it has been reduced by $4bn following settlements with partners in the ill-fated Macondo well."]

Compare these costs with the estimate of the costs of the Fukushima disaster.
  • The response costs are similar.
  • The nuclear accident has substantial clean-up and mothballing costs at the reactor--about $10-15 billion--that weren't seen at Macondo.
  • The environmental clean-up and remediation costs may be similar--several billion dollars.
  • The liability for economic loss and other compensation to individuals and businesses hurt by the event may be similar--around $10 billion.
  • The liability for harm to businesses caused by the blackouts resulting form the loss of generating capacity at Fukushima is potentially substantial--a rough guess is $10 billion.
Thus many of the costs of the two events are rather similar. The differences are related to the complexity of decontamination and mothballing a ruined nuclear plant and the economic damaged caused by blacking out utility customers.

1. Tokyo Electric Power Company, the owners of Fukushima Number One, is exposed to the huge costs of cleaning up radioactive contamination of the facility and entombing the damaged reactors, even after the initial response is over and the reactor are stabilized and cooled down. These are costs inherent in risks associated with nuclear power generation, and quite different from the clean-up costs of other kinds of industrial accidents.
2. Electricity is a monopoly, while oil is a fungible commodity. BP didn't need to disappoint any customers. The Macondo Prospect well hadn't started to produce yet, so there are no direct lost sales. And any contractual supply obligations BP had could be met by oil from other sources.

But TEPCO dominated electricity supply in Japan's eastern grid area (power can't be transferred from the western to the eastern grid areas in any substantial quantities). The loss of generating capacity due to the earthquake and tsunami has meant significant shortages and rolling blackouts. Eventually most of that capacity will come back on line. And customers may not have recourse for lost business due to blackouts that were due only to those "acts of God". If there was ever a force majeure, that was it.

However if customers suffer blackouts, and consequent harm to their businesses, just because of the failure at Fukujima Number One, which is arguably due to design and operational failures on the part of TEPCO, some liability may exist. This could be minimized if electricity users in eastern Japan can conserve a little. Less than 10% conservation would make such blackouts due just to the loss of Fukushima Number One capacity unnecessary. The Japanese government will have to get involved in encouraging such conservation, and thus saving TEPCO (or the taxpayers) many billions of dollars.

The effect of these costs and liabilities is vastly different between BP and TEPCO, mainly because BP is five times large. BP had the financial strength to take a $3.7 billion loss in 2010, sell some assets to cover the costs of the Macondo disaster, and continue as a going concern. TEPCO will require the Japanese government and taxpayers to accept a substantial share of its liabilities if it is to emerge as a going concern.

TEPCO is already in negotiations with the government. According to this Reuters story, "'We are still in discussion as to what extent we will pay on our own and to what extent we will have assistance from the government,' TEPCO executive vice-president Takashi Fujimotohe told a news conference." So far TEPCO has only made about $2 million in token payments to towns evacuated around the plant.

Less than four weeks after the Deepwater Horizon explosion BP and the U.S. government had already agreed on the $20 trust for the Spill Response Fund. [Source BP press release] The Japanese government doesn't appear to operate in the same way at all.

04 April 2011

Is Nuclear Power Too Risky?

Are some energy investments so unpredictable and potentially unprofitable that governments should promise to cover the downside risk for private companies involved? The nuclear power generation industry seems to think so.

Many energy investments carry significant risks of expensive disaster. Examples:
  • The Buffalo Creek Flood (Pittston Coal Company dam failure) of 1972 cost 125 lives and destroyed hundreds of homes.
  • The Piper Alpha disaster in the North Sea in 1988 cost 167 lives.
  • The Three Mile Island accident of 1979 cost the plant's owners, General Public Utilities and Metropolitan Edison, more than a billion dollars in containment and clean-up costs, legal settlements and other costs, as well as loss of electricity sales from the destroyed reactor, which had only been on line for 13 months, and from the other reactor at the site which was shut down until 1985.
  • Two hundred thirty-four people died in the Chuandongbei natural gas field explosion in China in 2003 (see NYT article).
  • In 2006 12 coal miners were killed in the Sago mine disaster in the U.S.
  • Twenty-nine coal miners were killed at the Upper Big Branch disaster in the U.S. in 2010.
  • The Deepwater Horizon disaster and resulting Macondo blowout cost the lives of 11 rig workers and cost BP roughly $10 billion.
  • The ongoing nuclear power plant disaster at Fukushima Number One will probably cost around $50 billion, of which its owner will only be able to cover about half. (See this post.)

Existing Subsidies

In the United States the nuclear power industry is protected from much of the liability that would be associated with a disaster like that at Fukushima by the Price-Anderson Nuclear Industries Indemnity Act of 1957 and related legislation. Under the act, the industry is only required to have $375 million of liability insurance per plant. Industry liability from a nuclear incident is limited to $12.6 billion (from a fund generated by industry payments of $111.9 million per reactor, to be made in the event of an incident with liability exceeding insurance coverage). Beyond that the Federal government picks up the tab.

The offshore oil drilling industry receives similar limitation of liability through the Oil Spill Liability Trust Fund. A tax of eight cents per barrel of oil produced in or imported into the USA has built up a fund of some $1.6 billion. In return companies have their liability for damages limited to $75 million, paid from the fund. The fund also pays for some government operation on an annual basis. Costs beyond $75 million, or the resources of the fund, would be paid by the taxpayer. (Of course the eight cent tax is passed on to oil consumers.)

Because of the very large capital costs of nuclear power generating plants, the industry lobbies for and receives substantial loan guarantees, reduced rate loans, tax breaks and other subsidies. But similar subsidies are available to several other sectors of the energy industry, and to other industries. Likewise the favorable monopoly rates of many electric utilities enable them to pass on many costs and expenses to their ratepayers. This is not unique to the nuclear power generation industry.

The nuclear power industry claims it can only expand if it receives various government subsidies and guarantees.
"They cannot be built without government guarantees ... shifting risk from investors and lenders to taxpayers."--Peter Bradford, adjunct professor at Vermont Law School [Source Reuters article]

"We believe many new nuclear construction projects will have difficulty accessing the capital markets during construction and initial operation without the support of a federal government loan guarantee."--2007 letter from investment baking firms to Department of Energy [Source Christian Science Monitor article]

Distorted Investment Decisions

These subsidies, guarantees and liability limitations distort investment decisions. If someone else (the taxpayer) is going to cover some or all of the cost of default, accident, liability, cleanup, waste management or other potential expenses, that makes even a potentially risky investment look like an acceptable deal to private enterprise.

Of course the problem is even worse where nuclear power generation capacity is being built and operated by the government itself. There the taxpayers bear all the risk, and the detailed analysis of risk and reward that private enterprise uses to decide whether to allocate resources to a particular enterprise is skipped altogether.

Nuclear power generation will never be as safe as it can be unless the private firms that stand to profit from it accept all of the costs and liability associated with problems at their facilities.

Further reading:

List of accidents and disasters in this Wikipedia article.

Prominent energy accidents of the past 100 years listed in this article.