December 5, 2009

By REBECCA SMITH
Wall Street Journal

Spooked by escalating costs, a city-owned utility in San Antonio is considering backing out of a venture with NRG Energy Inc. to build two next-generation nuclear reactors in Texas.

CPS Energy is expected to make a final decision next month, after it gets an updated cost estimate from Toshiba Corp., which will oversee construction of the two reactors. The project is one of the furthest along in a new crop of nuclear proposals, but it is proving unpopular with city officials.

The cost of the reactors, estimated at $10 billion to $12 billion before financing costs, is causing concern at a time when the utility is making big investments in renewable energy and pollution controls. Nuclear-reactor costs also look high right now against competing types of generation, such as gas-fired plants.

The San Antonio city council was poised to approve a $400 million bond issuance in late October, but held back when new numbers came to light that indicated the nuclear project could cost more than expected. Like most municipal utilities, CPS has an appointed board that reports to elected city officials, whose approval is needed for rate changes or bond issuances.

The political ruckus that ensued led to the Nov. 27 resignation of the utility’s interim general manager, Steve Bartley, and deputy general counsel, Robert Temple, who tendered his resignation, effective Dec. 15.

A utility spokeswoman said she expects the utility to decide by Jan. 15 whether to proceed with its investment in the South Texas Project, Units 3 and 4, where CPS already owns Units 1 and 2 with NRG Energy.

City officials say the cost estimate from Toshiba for the two-reactor project ballooned to $12.1 billion last summer from a preliminary estimate of $8.6 billion in 2007, catching them off guard. Utility documents show its board was working with a figure of $10 billion. NRG says that it is confident it will be able to get the cost below $10 billion, before about $3 billion in financing costs are added.

Even at $10 billion, the price might be “outside the affordability range for CPS,” said Steve Winn, president and chief executive of Nuclear Innovation North America LLC, the nuclear-development company 88%-owned by NRG and 12%-owned by Toshiba that would hold at least a 40% stake in the project.

Mr. Winn said his company is talking with investors who could replace CPS, if it decides not to proceed. CPS was expected to take a 20% to 40% interest that could cost it $2 billion to $4 billion, before financing costs were added.

Mr. Winn said NRG is working with Toshiba to reduce the cost. One problem is that the project involves $3 billion worth of equipment purchases from Japanese vendors, and a falling dollar and strengthening yen have pushed up those equipment costs.

Even if the final cost is about $10 billion, some city officials feel the project is too costly. “Based on the numbers I’ve seen, I don’t think it’s the right decision to proceed,” said Councilman Reed Williams. He said it made economic sense for CPS to build gas-fired plants or buy electricity from others.

Outside the nuclear arena, CPS plans to spend more than $5 billion on modernization efforts, including $871 million on energy-efficiency programs, $2.5 billion on renewable-energy projects and $2.1 billion on environmental upgrades to power plants. To finance the investments, it is proposing to raise rates through bill increases every other year for the next decade, totaling about 25%.

CPS’s skittishness about the cost of nuclear energy is understandable. The first two units at South Texas Project were supposed to cost less than $1 billion but ended up costing more than $5 billion. With that history seared into its memory, San Antonio officials have been sensitive to anything suggesting they could, again, get blindsided by escalating costs.

A change in leadership also appears to be having an effect, with San Antonio’s 35-year-old mayor, Julian Castro, who was elected in May, expressing reservations about the wisdom of a big nuclear investment. The city already has invested $300 million in the project.

NRG hopes to win permission to begin construction in 2012, and to put units into service in 2016 and 2017. “The project will go forward regardless of CPS’s decision,” said Mr. Winn, adding that he did not believe the matter would affect NRG’s ability to garner important federal loan guarantees for the project.

Write to Rebecca Smith at rebecca.smith(at)wsj.com