Our Nuclear Future - Financial Risk and Externalities II

Hanford Facility, Washington

In my last article on the nuclear issue, "Our Nuclear Future, Financial Risk and Externalities",

I discussed Rating Agency Capital Models in the context of nuclear risks such as those posed at Fukushima, Chernobyl and Three Mile Island.

The issue of managing the risks associated with both military and commercial nuclear applications is a vital one, that should interest all of us and speaks to the very concept of externalities and how to manage them in a global world.  In this article I focus on commercial applications.

The Fukushima disaster was impacted by inadequate safeguards.  The tsunami risk was not adequately taken into account in planning where to place the back up generators which could restore power in the event of an interruption of power.  The back up generators were placed at point too near the sea wall protection that left them exposed to the tidal wave action of the large tsunami that hit off Fukushima on March 11, 2011, when an 8.9 magnitude earthquake was experienced.

How do we deal with the risk management issues concerning the financing, construction and operation of nuclear plants, and with the issue of managing nuclear waste from both military and civilian applications?  These issues concern low probability, high risk events, issues that fall outside of the scope of normal everyday events.

The federal government offers nuclear power plants some degree of protection from liability.  These limits on liability, which exist in order to encourage the construction and operation of nuclear plants for power generation purposes, do not do as thorough a job of mitigating risk as they should.  This is because an external party, the federal government, is responsible for the oversight.  In the case of Fukushima, where plants are constructed and operated across national boundaries, the issues become more complex.

The Fukushima Daiichi nuclear power plant was constructed and operated in Japan, by Fukushima General Electric (GE), Boise, and Tokyo Electric Power Company (TEPCO).  The components of the nuclear plant were provided by contractors such as GE,which provided six GE nuclear reactors. Other contractors were also involved. Multi-national resources were employed.  Liability issues are very difficult to ascertain.  It is very probable that the loss of the ability of the generators to provide power after interruption in service due to the tsunami materially impacted the fate of the nuclear material in those reactors and magnified the effect of the event.

Management of these issues across national boundaries presents a serious issue.  How do you price for risk when governments put caps on liabilities?  It is easier for companies to price for risk when the risk is limited!  The incentive for commercial entities to manage risk is reduced when they do not have to absorb the risk of extreme events in either pricing of their products, mitigation of that risk, or the application of design elements to manage that risk. The risk is shifted to the governments.

When all else fails, due to the failure to put in place elements that will mitigate extreme risk, governments have to step in.  At this point, governments must ascertain their own issues of financial accountability and debate among themselves.  This issue is currently unfolding as nuclear radiation emerges from the Fukushima disaster and manifests itself in the ocean, carried by currents, and in the air, as was the case with the Chernobyl event.

Clearly, there must be a better match between potential liabilities and mitigation of risk.  The problem occurs when it becomes financially unfeasible for companies to price for the risk of very low probability, high risk externalities.  The government(s) must retain the capability to regulate.  History has shown that government regulation is difficult in the face of corporate profits.  This was shown in the history of seeking to regulate the ASARCO smelter.

Nuclear power plants do not arise ex nihilo. They must be financed, built, insured.  How do you finance nuclear power plants?  They can be built with government financing and the government can assume all the risk.  In a commercial enterprise, across national boundaries, private parties can finance nuclear power plants if they have sufficient funds and can insure the risk of loss, either by commercial carriers, government support or by self insuring.

There are many financial instruments that may be available to finance nuclear power plants.  In addition, nuclear power plants require real estate.   A component of a nuclear power plant can conceivably be moved from one site to another, yet the ground below stays, and is subject to the risk of contamination.

It is instructive to look back at the history of Nuclear Power Plant generation in the Northwest.  The situation with Washington Public Power Supply System Bonds is instructive (WPPSS).  An article from HistoryLink.org discusses this history of one of the largest bond defaults in history.  Five WPPSS power plants were envisioned, and WPPSS power plant 2, the Columbia Generating Station, survives.  The facility is now called Energy Northwest, and produces 12% of the power generated by the Bonneville Power Administration.

A great portion of the Northwest's power supply is generated by hydroelectric sources such as those operating along the Columbia River.

The discussion of financing nuclear power plants rests with a projection of bond default experience over time (default matrices), and how bond ratings emerge through Rating Agency models such as Standard and Poor's, Moody's and A.M. Best.

Clearly, the issue of using bonds to finance nuclear power plants is a critical one, in more than one way.  WPPSS financing has provided an example of the risk of building nuclear plants, financing them, and having companies such as insurers and banks assume the risk of financing them.

Financial institutions take risks when they purchase company bonds.  The construction and operational risks (there are separate bonds for construction and operation) are borne by those that purchase the bonds.  Riskier enterprises are assigned a risk premium that is reflected in the interest rate offered on the bond.  The riskier the enterprise, the higher the interest rate, and the longer it takes the enterprise to retire the bond.  This is basic economics.

Given the history of WPPSS, it is difficult to construct a model for financing nuclear power plant construction.  History has shown that even rating bonds for more ordinary applications, is fraught with risk.  The financial events of 2008 have demonstrated to us how the domino effects of  certain companies being taken down can bring a financial system to the brink.  It is clear that certain financial institutions were allowed fail, while others were bailed out by the government.  Insurer AIG, for example, was bailed out, while Washington Mutual was allowed to fail.  This is a very interesting aspect to investigate, since Chase was left purchasing and holding the assets that Washington Mutual had accumulated over time.

The 2008 financial collapse is another blog article, however it is instructional in how bond defaults can bring down a financial system. Suffice it to say that mortgage backed securities, collateralized mortgage obligations, credit default swaps (CDS's) and collateralized debt obligations (CDO's) played a large role in this collapse. These issues reflected the financial arbitrage reflected in Rating Agency and regulatory agency capital analysis of financial institutions.  The actions that the government took, in deciding which institutions to rescue and which institutions to allow to fail, helped determine the path that would be taken.

Rating Agencies played a large role in the events that unfolded.  I have discussed Rating Agencies in previous articles.

Clearly, nuclear financing issues present complexities beyond those presented by other issues financed by our market system.  There are limits to liability that impact the nuclear arena.  We are left, then, with a cooperative issue impacting the ways in which governmental regulatory agencies can interject themselves into the system and regulate in a manner to mitigate low probability high impact risk.

This takes us again back to the past, and the issues attendant in regulating ASARCO Smelter Emissions and the problems that this issue presented.

These are the issues we face in these times of global warming and climate change, as we consider the risks and benefits of financing nuclear power plants.  Alternative energy sources are discussed in my article "Global Warming and Climate Change - Polar Pioneer" .

We must consider the issues of regulatory government as it is juxtaposed with issues concerning market operations, in dealing with situations that involve low probability, high risk events.  It is clear that unfettered market operations may bring about market collapse through the interrelationships that exist within the structure of markets. It is also clear that government regulation that is not strong enough may not be able to counter the impact of market forces that overrun it, especially considering the profits that can be developed in certain markets.  Furthermore, it is clear that government forces may act in a manner contradictory to public interest by choosing winners and loser, perhaps steered by an array of  predefined values of certain groups.

Can we trust government?  We must have checks and balances.  Do we want government to only have one option, or to offer choices?  I'm in favor of choices, as choices facilitate change, which is needed. Market research has shown that people can tolerate only so many choices; this has been in areas such as bottled peaches, cereal, etc.  Would we ever want our choices in cereals and bottled peaches to govern our choices in power generation and other key areas?  No, however the analogy is instructive.

We need a government strong enough to regulate; the problem in regulation, however, has shown that it is difficult for regulatory agencies to keep up with the profits that can be made from activities under investigation.  This is certainly true in the financial arena where new instruments, especially those employing financial arbitrage, arise in order to present profit opportunities that defy regulation.

Constitutional issues such as due process and informed consent are bell weather issues in our financial and social system.  The Justice Department has a long storied history in regulating monopoly.  These are all important issues as we consider regulation of markets, intrusion of regulators/law enforcement into markets, and imposition of systems which defy Constitutional rights.

These issues all reflect ongoing issues of climate change and global warming and the effect of the environment on certain populations.

Our Constitutional rights are now under attack and must be defended, especially as regards issues of due process and informed consent.  I have made a thorough examination of the social processes existing in our society today and find material flaws in social systems.

Social systems and the justice system as they currently exist need serious reforms to enforce the Constitutional rights that we hold so dear to us, as do imposed belief systems.

marilyndunstan.blogspot.com

Our Nuclear Future - Financial Risk and Externalities
Our Nuclear Future - Hanford and Spent Nuclear Fuel
Global Warming and Climate Change - "Polar Pioneer" and Arctic Drilling

Externalities

Chernobyl 25th anniversary 
Energy Choices and Risk
Global Warming and Climate Change-Polar Pioneer
Processing Risk and Uncertainty
Log in the Surf - 8.9 Japan Earthquake (9.0 updated)

History Link.org
Washington Public Power Supply System

Financial Rating Agencies and Risk - Liquidity

Iceberg, Weddell Sea, Antarctica

Updated 9/5/2015:
 

I took this photograph from the Icebreaker Kapitan Khlebnikov, as we transited the Weddell Sea from the Ice Shelf of Halley Bay to the Antarctic Peninsula.  Antarctica (map) is a land of beautiful desolation, and I was able to capture nature photographs depicting its stunning landscapes and the wildlife that inhabits it.  Many countries have stations in Antarctica and I was honored to be able to visit two of them, Neumeyer (German) and Halley Bay (United Kingdom).  

Icebergs have powerful symbolism, expressing concept in many different venues.  In the maritime sense, they represent hidden risk, as ten percent of the iceberg may be visible, the remaining ninety percent of the iceberg underwater.  The Titanic collided with an iceberg in the mid-Atlantic in 1912 and is an example of risk associated with transiting areas with icebergs.  These powerful metaphors or concepts can also be expressed in other venues, including the financial arena, where risk exists and may be hidden, subject to the impact of financial bifurcation points.  

Chaos theory discusses how financial risk, and bifurcation points can reflect hidden factors which sudden express what we term "Black Swan" risk events as typified by Mohamed A. El-Erian's work.

In the financial arena, these risks reside in financial rating models.  My June, 2015 article, Financial Rating Agencies and Risk, discusses Rating Agency models in the context of jet engines, which operate under a wide range of atmospheric conditions. Similarly, financial vehicles are tested under a wide range of scenarios, by various entities such as Rating Agencies and regulators in a wide variety of fields, including banking and insurance, under different legal constructs and governmental agencies.

As discussed in my article, Financial Rating Agencies and Risk, different Rating Agencies, such as Standard and Poor's and Moody's may reflect their analysis of risk in different ways.  General Electric (GE) is used as an example in my blog article. which discussed Standard and Poor's maintenance of GE's rating in the light of its decision to divest itself of real estate assets and exit its GE Capital Finance arm.  Moody's, however, downgraded GE on its decision, indicating GE was favoring equity investors over creditors.  These rating decisions reflect different decision processes by Rating Agencies, not explicit government agencies.  However these Rating Agencies have considerable impact over the manner in which financial decisions are reflected in the marketplace.

Clearly, there is hidden information which Rating Agencies, and governmental entities, are aware of.  When there is a relationship between Rating Agencies and financial entities, as in the payment of a fee in exchange for a rating service, there is an incentive for the Rating Agency to monitor the actions of the company, as money has changed hands, and participate in the decisions of the company involved.. At some point, however, the economic prospects of the company do not warrant the degree of risk assigned to it, and the Rating Agency may choose to exercise a number of financial tools in order to maintain its credibility in the financial marketplace as a reliable partner in assessing risk.

You see, the Rating Agency has two major clients; one, those purchasing its evaluations of companies, and another, two who pay for its services in order to exchange information, maintain a rating as to its financial soundness, and exchange information in order to do so.  Government agencies are a different entity involved, and they sit and cast a watchful eye over the ability of Rating Agencies to remain impartial; they are also concerned as to the ability that Rating Agencies have to move the markets, and, especially, their ability to impact major market moves that could mask efforts at financial or other types of terrorism.

This is where the increased complexity of emerging financial instruments presents a risk for regulators as they seek to keep up with new financial structures and derivatives such as special purpose vehicles, credit default swaps (CDS) and collateralized debt obligations (CDO's).  The Treasury, certainly, is interested in attack on the financial system.

A company does not exist in a vacuum; it exists within a financial structure of ever increasing complexity, reflecting not only national considerations, but a world economic milieu of globalization that impacts its decisions, as nations develop and industries expand, contract and relocate or adopt new methodologies such as outsourcing.  Externalities are always a consideration, and this this issue is discussed in my blog article of the same name.

This brings us back to the iceberg and the hidden factors. GE presents an interesting case study as we look to parse the actions of Standard and Poor's and Moody's in their rating of GE.  My blog article, Our Nuclear Future - Financial Risk and Externalities briefly discusses the issue of the six nuclear plants designed by GE, which were part of the Fukushima Daiichi Nuclear Site's design.  The interesting question is the use of ratings in conjunction with the use of chaos theory and bifurcation points to bring down the economy and financial system.

There are specific provisions (options) in financial agreements that allow a company to take action in the case of certain events such as ratings downgrades.  This puts a particular onus on Rating Agencies who have access to company information; it also presents a challenge to companies being rated as they seek to understand the processes which rating agencies use to rate their companies.

The interesting question in analyzing GE in the light of its departure from GE Capital, which finances GE engines, and from real estate, is its liquidity position and its exposure to risk from liquidity events in the light of the various risks that its operations faces.

Indeed, liquidity is an important consideration in analyzing a company's financial soundness.  An example where liquidity events have taken down companies is General American Insurance, where exposure to risk from institutional investors brought down the company.  General American had high exposure to funding agreements, which allowed policyholders to exercise a put option (withdraw funds without penalty) upon the adverse action of Rating Agencies. The construction of funding agreements involved mark to market issues and the use of put options in mutual funds (7 day put options).  Moody's downgraded General American's insurance financial strength rating from A3 to Ba1 on August 9, 1999.

The interesting question with the actions of Standard and Poor's and Moody's with regards to GE is the divestiture of the GE Capital financing arm and the Real Estate assets; both of these events seem to reflect a move to better match projected assets and liabilities by increasing liquidity, potentially in the light of anticipated liabilities.  These are the hidden, or unknown issues that confront regulators.

Why discuss GE?  With issues of climate change and global warming, jet engines, which operate under a wide range of atmospheric conditions utilize various fuels for combustion under a wide degree of parameters representing different aspects of aviation usages, including private, commercial and government use. My blog article on the Polar Pioneer discusses these issues in the light of exploration and drilling for petroleum products in the Arctic. The availability of fuel and the mode of combustion and types of engines employed will always be an important characteristic of any decision process as we analyze our future options.

Many people have contributed to the issues discussed in these blog articles and I express my appreciation to them and to their contributions.

Liquidity issues are important factors in assessing financial risk.  They represent one category of risk among others that can reflect bifurcation points which can impact the economy.  Organization structure is also important, as indicated by the Barings Bank issue where Nick Leeson was involved on both sides of the house, trading and operations.

Alamy.com - Risk Lightbox

marilyndunstan.blogspot.com:

Financial Rating Agencies and Risk 

Externalities

Polar Pioneer and Climate Change - "Polar Pioneer" and Arctic Drilling

Kapitan Khlebnikov (Icebreaker)

Wikipedia:

Titanic

Fukushima Daiichi Nuclear Site

Mohamed A. El-Erian

Maps:

Antarctica Map -One World - Nations Online

Rating Agencies:

Standard and Poor's

General American Insurance:

General American News - Mississippi Department of Insurance
Standard and Poor's- What May Cause Insurance Companies To Fail--And How ThisInfluences Our Criteria

GE:

GE - Fixed Income Investing

Our Nuclear Future - Financial Risk and Externalities

Hanford Site, Washington

In my blog article, Our Nuclear Future - Hanford and Spent Nuclear Fuel, I discussed energy issues, focusing on risks associated with nuclear power plants. and including the risks associated with spent nuclear fuel.

Risks associated with oil drilling are discussed in my article about the Polar Pioneer, 

Global Warming and Climate Change - "Polar Pioneer" and Arctic Drilling.  These risks increase as oil consumption and resources are impacted by peak oil considerations.

Nuclear power plants also pose financial risk.  I address this issue in my blog post,
Energy Choices and Risk.  This issue is a matter of continuing investigation as we look towards issues of financial risk management, and the costs  imposed on society and individuals as discussed in my blog article Externalties.

In my blog article, Financial Rating Agencies and Risk, I discussed Rating Agency Capital models, using a conceptual model of jet engines as an analogy.  Fuel and energy are important components of growth and development, and the ability to test a jet engine for the proper mix of fuels that permit combustion under a wide range of situations provides a useful model to compare to the type of modeling required for financial stress testing.  In that article, I discussed General Electric (GE)'s Ratings in light of its decision to exit its GE Capital finance arm and divest itself of real estate assets.

The actions of Rating Agencies Standard and Poor's and Moody's are interesting in light of the issues concerning Fukushima and the use of six GE nuclear reactors in the Fukushima Power Plant.

marilyndunstan.blogspot.com
Our Nuclear Future - Hanford and Spent Nuclear Fuel
Global Warming and Climate Change - "Polar Pioneer" and Arctic Drilling

Externalities

Chernobyl 25th anniversary 
Energy Choices and Risk
Global Warming and Climate Change-Polar Pioneer
Processing Risk and Uncertainty
Log in the Surf - 8.9 Japan Earthquake (9.0 updated)

marilyndunstan.photoshelter.com


Wikipedia:
Peak Oil
Fukushima

Chernobyl 25th Anniversary

An aerial view of Chernobyl Nuclear Power Plant in April, 1986, with the red glow towards the center showing the heat from Unit #4. Source: epa.gov

The Chernobyl Disaster was a nuclear accident which occurred on April 26, 1986. It occurred in the Ukraine Republic (formerly part of the former USSR (Soviet Union)). Now the Chernobyl site is part of the country Ukraine. Today marks the 25th anniversary of the Chernobyl disaster.

It is particularly compelling to consider the impacts of Chernobyl today, twenty-fives years later, as we witness the unfolding of another nuclear disaster at Fukushima, Japan, following the 9.0 earthquake and tsunami on March 11, 2011. The two disasters arose from different circumstances and unfolded differently, however they share in common the impact of a low probability-high risk event.

They are set apart in both time and space, one occurring in vastness of the then-Soviet Union; the other set on the more densely populated island of Japan. The Chernobyl Disaster and the Fukushima disasters were both were graded as a 7 on the International Nuclear Event Scale. (Fukushima was raised from a 5 to a 7 on April 12, 2011, one month and a day following the earthquake and tsunami on March 11th).

How do we fathom such events as we seek to understand the risks of pursuing nuclear energy? How do we internalize these low probability-high risk events so that we carefully assess risks yet do not fall prey to unwarranted fears and suspicions? Do we hide our heads in the sands of improbability and ignore the potential of a very small yet very dangerous risk? Do we pour millions and billions of dollars to hedge against a risk that may never, in our lifetime occur? Do we even care about the impact of our decisions on those ancestors who may follow us many generations down the turnpike?

It is critical how we answer these questions, because our fate and the fate of our planet may hang in the balance. With the burgeoning population on this planet, the growing scarcity of resources, and the challenges presented by rising carbon dioxide levels, and other indications of planetary strain, we must find a way to make informed decisions that appropriately incorporate the low probability/high risk event in our search for and use of energy resources.

In my last blog posting, Emperor Penguin Energy-Risk Model - Part 2 , I discussed mathematical modeling, random variables and evolved a stochastic model of emperor penguin energy-risk behavior. I discussed some of the variables that may be considered in the emerging emperor penguin population, including mortality, morbidity and accident. I introduced the concept of a low probability event into the model (an eruption of an Antarctic volcano), and discussed the values of the stochastic process in informing results. The post was intended to discuss energy seeking behavior in a different (emperor penguin) population as an energy seeking risk example using stochastic modeling.

In my last post I stated “The objective of the stochastic processes is to help us inform our decision making process, to help us understand the impact of variables under a wide range of assumptions, conditions, and scenarios. Thus a stochastic process should inform us about the expectations of the model under a wide variety of conditions, including the impacts of low probability / high risk events.”

However, a stochastic process cannot inform without reasonable assumptions. Assumptions must be developed to allow the stochastic process to produce a credible range of results that will indeed be informative for the intended usages. There are many variables to consider, and assumptions to be made in analyzing risk. For a variety of reasons it may be difficult to obtain a robust set of assumptions that everyone agrees with for all potential uses.

Energy Choices and Risk

Japan’s March 11, 2011 Tohoku 9.0 earthquake, ensuing tsunami and nuclear incident at Fukushima Daiichi Nuclear Plant have reminded us all that nuclear plants are subject to risk. This should be no surprise, as all sources of energy are subject to some degree of risk. In fact, just about everything in life has some degree of risk attached to it. However, nuclear plants, with their added radioactivity risk, present a considerable challenge in managing the lower probability, higher impact events.

We face global, environmental challenges in managing climate change issues. These climate change issues affect both micro-climates and have a planet-wide impact. In order to meet these considerable challenges, nuclear energy must be a part of the solution along with other energy options. We must seek to understand and mitigate risks facing nuclear plants as we go forward to solve the larger planet-wide problem which affects us all.

It has been almost 25 years since the April 26, 1986 nuclear incident at Chernobyl, in the Ukraine. That incident was ranked at “7” on the International Event Scale. The Three Mile Island Accident, beginning on March 28, 1979 ranked as a “5”. That incident, occurring exactly 32 years ago, took place at the Three Mile Island Plant in Middletown, Pennsylvania. The Fukushima Nuclear Accidents have so far been ranked as high as a “5”, and the situation has not yet been resolved .

In the midst of the efforts to bring the Fukushima Reactors under control, there have been calls to reexamine the safety of nuclear power plants. The International Atomic Energy Agency (IAEA) called for a meeting before the summer to discuss an assessment of the Fukushima accident, lessons to be learned, strengthened safety measures and strengthened responses to future incidents.

As the Japanese workers worked on the reactor, rating agencies Moody’s Japan K.K. and Standard and Poors downgraded Tokyo Electric Power Company (Tepco’s) long term debt. Moody’s indicated that it saw risk in GE’s nuclear business, although it did not downgrade GE, which contributes 1% of GE’s annual $100 billion revenue. GE was the designer of the Fukushima nuclear power plants., and the supplier of reactors 1,2 and 6.

At the same time, ongoing issues regarding the storage of the nation’s nuclear waste are unfolding. This waste includes waste from commercial nuclear plants and military/defense waste products. The waste is stored in a variety of locations, ranging from storage on site to storage at the Hanford Site, in Washington State, where two-thirds of the nation’s high-level radioactive waste is stored. The storage issues are complex, involving the removal of the nation’s only designated nuclear waste repository from consideration, and related litigation by states (Washington and South Carolina) and regulators (National Association of Regulatory Utility Commissioners).

We should develop an energy strategy that optimizes the risk profiles of the various types of power generation (including nuclear). This strategy should be science-based, above politics, in the interest of the nation (and world) as a whole, reflecting our responsibilities to the environment both in theory and in practice, and appropriately reflecting risks in pricing decisions.

Processing Risk and Uncertainty

Koi Surfacing, Japanese Gardens, Washington Park Arboreteum, Seattle, Washington

In my last blog posting I discussed the question of how we integrate our feelings, our sensations, perceptions with scales we use to measure risk. My discussion centered around the Japan 9.0 Earthquake and the moment magnitude scale used to measure it.

In fact, the earthquake was originally judged to be an 8.9 by the United States Geological Survey (USGS) and subsequently upgraded to 9.0 by the USGS. The moment magnitude scale, being logarithmic, meant that this reassessment implied a 41% more intense earthquake than the original 8.9. This reflects logarithmic scales in action.

As the disaster unfolded, the world could see the Japanese heroically struggling with a trifecta of horrors -- the initial earthquake itself, the tsunami that followed, and the accident at the Fukushima I Nuclear Power Plant (Fukushima Daiichi) in Fukushima, Japan.

News coverage of the Japan disaster was continuous in the media. However, with military intervention in Libya by a group of nations including the Canada, France, Italty, United Kingdom and the United States, the coverage of the Japan disaster on television has diminished.

How do we respond when events are at the forefront of the news? How do we respond when they are forced by circumstance to share the spotlight with other compelling, competing issues or even tucked away out of sight? How do we respond with our feelings towards others in their disaster, or triumph, and how do we translate those feelings into our own forward seeking risk assessments?

Indeed, there are compelling issues on the horizon, decisions to be made, and the evolving situation in Japan is certain to be a part of the equation in attempting to balance risks in managing our future with respect to energy, focus and other issues.


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