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The Lazard People are Taking Over

Mark Nelson

Monday, February 21, 2022

Chris Keefer  0:00  

Warm Welcome back to Decouple. Today I'm joined by a returning guest, and some people refer to him as budding co host, Mark Nelson, whichever of those you are, Mark, we're delighted to have you back for an exciting episode on a bit of a dense topic, but we're gonna we're gonna keep it interesting. Mark, thanks for making the time. Sure, Chris, you've been on many times before mark, people know you quite well. We do self introductions from time to time. We don't need to do that anymore. I heard something interesting about you, though. And I want to see if it was true. And maybe you could flesh that out as a little bit of trivia that might keep the audience entertained. I heard you once once made up a list of foods ranked by energy density. And I'm wondering if there is a Mark Nelson diet program out there?


Mark Nelson  0:49  

Yes, so I've been poor. And when when you are extremely active, so I, you know, I was a growing boy and a runner. And I was a growing boy and a runner at different times that I was I've been a little bit cash poor. And it really matters to make sure that you know, when you're hungry and your body's lying to you, and you're or you're hungry, and your body isn't lying to you, and you actually haven't had enough to eat. And when the money's tight enough, you can't just leave that up to like, whether you feel whether your opinion is you're hungry. Screw opinions, you got to know Have I had enough calories today, especially considering if I'm going to go do running or walk around or something like that? So yeah, yeah, I have I don't know who you heard that from. But yeah, I have. And the key thing is to get a little fat. And sugar is typically the really, those two things together that cheap calories. Sugar is cheaper than fat, typically. But fat is more than two times the calories per gram. So going in that direction, you end up with a lot of vegetable fats and sugar. But if that's what keeps you alive, it keeps you alive. You know, what the same thing they might say and can do land. The furnace is hot enough anything will burn, Chris.


Chris Keefer  2:17  

Alright, we'll leave it there. We might get to publish something in the show notes. A little more specific. So Mark, you'd actually suggested this episode on our last, our last podcast. The title for this episode is the Lazard people are taking over. And I wanted to start with a little bit of a vignette from my angle why I'm interested in looking at the levelized cost of electricity. at COP, you and I were both there. One of my big highlights was it's kind of an ambush interview that I choreographed alongside brilliant Decouple filmmaker Jesse Freeston. Where we got Canada's Minister of Environment and Climate Change. Famously Anti-nuclear guy worked for Greenpeace for many years, at one point dangled off the CN Tower, which is was once the largest tower in the world. He repelled down there to raise awareness about climate change, etc. He's been a fierce opponent of nuclear energy, his whole his whole career pre ministerial. And so I, I took the moment to challenge him. And you mentioned that all four of the IPCC principle Decarbonization pathways call for an increase in nuclear energy and whether his, you know, Anti-nuclear commitments we're going to shade his judgment. It ended up going a little bit viral, it led to a lot of press in Canada. And most recently, it led to him having to acknowledge that there was a place for nuclear, but he had one important caveat. He said, If nuclear is able to carve out a place for itself in the market, which is very competitive, where the likes produced is made at very low cost. In many cases, we're talking about three cents per kilowatt hour. Well, it will be able to find a place.


Mark Nelson  3:57  

I think that's very reasonable, just that, like it was reasonable for Cinderella to be told she couldn't go to the ball until she'd finished her obligations, rightfully put on her and until she got a dress and a carriage. And, you know, I think it's very reasonable to expect people to pay their own way, don't you?


Chris Keefer  4:17  

Sure? Sure. But I'm we're talking about a framework I guess here and and my curiosity about LCV was was definitely perked by that wanting to know sort of where that that three cents per kilowatt hour is coming from because I certainly don't see that on on the bill. So it seemed like a good place to sort of tie in to take your suggestion and going a little deeper. Also, LC O E, and Lazard are two terms that have you know, become quite tied together intimately. I think Lazard is is a firm that produces maybe not the most reputable but the most famous of estimates. Let's just Let's just get super basic You know, LC we Lazard for dummies? Why don't you want to start off with helping us frame this and understand what is maybe a very basic, basic way of looking at things, but that that has a lot of impact in terms of the way we make our investment decisions and whether or not our minister hearing Canada will allow certain forms of electricity generation to be part of our mix.


Mark Nelson  5:24  

Sure, Chris? Well, let's start by saying that it is absolutely reputable. It may be constantly abused, it may be at the edge so abused, that it's like drugs company, making its painkillers and pushing it to doctors saying make sure you don't wrongly prescribe a ton of this drugs, but we'll pay you if you if you prescribe it like sort of like that. So it's highly reputable, but that's part of the issue I think we need to talk about so Lazard Lazard bank was founded by a pack of French brothers in the 1840s. In New Orleans, they had a dry goods store. And it was a time where if you got yourself hitched up to economic growth in the 1840s 1850s, you could do really well, if you ran your family well, and the brothers established offices for trading goods to service miners and the California gold rush and it's off to the races from there. They have offices all over the world and Lazard for most of its history is very famous for not being investors not being investment bankers. They are advice. They are a partnership. That gives advice. And that's what they do. They do not take, they do don't take or do not want ownership stakes that what they want is to be the ultimate source of good advice. If you just have to get extremely large decisions in business done correctly. So for example, they they were very famous in mergers and acquisitions practically invented m&a After a high up at Lazard got advice from a major American businessman that that would be a great thing to work on in the 80s or in the 1960s and 70s. So, Lazard is advice, not ownership, they are help with your judgment, they will not make the decision for you. They may take positions on boards because they will be intimately connected with the interests and and knowledgeable about the challenges of business entities that are formed with their advice. But they are there to give you great information and help you make judgment calls. They're not there to make it themselves.


Chris Keefer  7:55  

And presumably people are are taking their judgment calls. And that's why I'll say we as as becoming something that's very important that's used a lot in terms of making these investment decisions around around energy. Certainly well


Mark Nelson  8:09  

they they certainly didn't invent the idea of levelized cost and probably go into some history here to to figure out where this comes from and a bit. The reason why Lazard became famous for that is because they made a public facing free advice product that became very prominent in the energy space and in the investment space. So this Lazard analysis that they did levelized cost of electricity was designed to show on an apparently even objective basis, how much it costs to get one megawatt hour of electricity from different electricity sources. And they don't have a dog in the race or horse in the race dog in the hunt, they are just there to advise and if they see prices go down costs go down for one type of energy source, it will be reflected in the levelized cost of electricity analysis. So I think we should take a moment to touch on what levelized cost is referring to what does it mean to say levelized? How do we how do we put energy sources with very different characteristics, different installation and construction times different lifespans, different ongoing operating costs, how do we level eyes? First of all, we have to say that levelized cost of electricity is an analysis that's in the category of discounted cash flows DCF discounted cash flow analysis, what is discounted cash flow, it means you look at just illustrate this. You look at each year of the building time and operation time and you look at the costs that are going to occur during each of those years. And then you take that cost, let's say in year six, your offshore wind farm is constructed. You ignore electricity sales that doesn't have anything to do with this analysis, the the volume, yes, the value No, you look at that time, six years out, your wind farm is now three years old. And your construction costs have gone to ideally zero, your maintenance costs may be this amount. And your fuel costs are of course, nothing. You may have some other small costs here and there. But you can take that six years out cash flow, negative cash flow in this case, because it's only the costs, and you discount that number six years out, in order to compare it against today's dollar today's investment decisions, that discount is done by applying a discount rate, let's say 1% 2% 4% 6% per year, it's an annualized rate. So that percentage is referring to an amount taken for the entire year. So six years out, if you were using a discount rate of 6%, for the entire project, you would need to multiply that number that many years out by one minus the discount rate to the power of the number of years, now I've done something very dangerous, and most people are just going to skip past that little moment. But let's just say we know this concept by a few other more common terms of the idea of interest rates, or the time value of money. In general, what these discount rates are trying to show what they're trying to express is the preference for money. Now, compared to the preference for getting money, the same amount, say in the future. In other words, if somebody offered you $100, today, and $100 in 10 years, which amount would you take, of course, you'd take 100 Because at minimum, you could put that 100 under your couch, and then your government wouldn't be able to freeze it to stop you from donating it to truckers. So I'm not trying to take not time that I'm just saying I'm just saying that expresses something about the importance of the value of money. So interest rates are not the same thing as the discount rate. But they are strongly connected topics, typically, especially in nation scale energy investments. Why is this because nation scale energy investments typically attract the attention of a nation of a state


and require the help or the planning permission or the investment direct investment, maybe from the nation itself. What appears to be happening with renewables, even nation scale renewables is that the cost the money preference value of money now versus money in the future, say from making money off of running your wind farm, that value of capital is as close as possible to the value of the interest rate set by the nation where the energy is being constructed. That is to say if the if the the Federal Interest Rate long term bond rate in the US is point 5%, or 1%, or 2%. People can argue that's the cost of money that we should use for the biggest most important are long lasting financial commitments that a society needs to make to build something like energy or to stop something like climate change. This brings me to a moment when when I want to just say as an engineer, or somebody coming from a science background, an irritation I have with economics that is hazy categories and non rigorous definitions, interest or or utility or even capital. These are things that are very hazy and little differences. Little differences in definitions used allow you to apparently match things that are not matchable that are not fungible, do not compare one thing to another. Let's come out of the abstractions for a moment. And let's use an example. Very recently, we saw something on Twitter, didn't we? A smart guy over in Britain Dr. Simon Evans of carbon brief made a tweet where he's responding to this slow moving catastrophe in Britain, where energy is now really expensive. Now, Britain has been investing heavily in cheap, cheap, cheap energy. But this winter energy is very expensive. So everyone's trying to blame some other party and figure out who's responsible. Dr. Simon Evans pointed out on Twitter, that solar is cheaper. Image solar in the UK and February, February of 22. Solar is cheaper, according to levelized cost of electricity than natural gas electricity. So and


Chris Keefer  15:43  

this is building new solar is cheaper, not the existing panels that are out there.


Mark Nelson  15:48  

Well, now you're just getting really specific. But yes, this is a number claiming to be about new solar doesn't mean you could actually land a project at that price, given the global supply chain issues and booming commodity prices. So, you know, is that really now? Or is that slightly delayed? Or is that really referring to a tiny number of solar projects that happened to get off the ground under pricing from before the commodity, price increases really started, it's not clear, but the he doesn't want you to go that far deep, you're just supposed to see that electricity from solar and February 2022, in Britain is cheaper than natural gas electricity, and February 2022. And on onwards in Britain. So now, the fact that solar in Britain has a capacity factor of you know, 678 9%, we're supposed to ignore this for one that is technically supposed to be included in the levelized cost of electricity from solar, it's supposed to be included in a very specific way, not the value of electricity, merely the quantity that is levelized cost of electricity is not about the value of the electricity has value moment,


Chris Keefer  17:12  

by value means the matching of supply and demand, not just the gross output.


Mark Nelson  17:17  

Sure. So the price in an electricity market is if the electricity market is run correctly, or designed correctly, is hopefully supposed to match up the cost of generating electricity in some time period, one year, five year 10 year depending on how you set up the different parts of your electricity market and then stack the costs and rank the bids and all that it's supposed to line up to something like the generating costs if if it doesn't, and the price of electricity is routinely below the actual long term generating costs, which is what this situation has been in Britain for a really long time. Unfortunately, that's part of the crisis but maybe should wait for a What's the matter with old Blighty episode, then you get this mismatch where companies are apparently helping the public with really cheap energy, but really, they're bleeding to death, and they're not going to ever build any power plants anymore, even if a cliff is coming, where you just don't have enough power plants or you just don't have enough fuel for your power plants. Because money has not been passed on from the auctions from the Consumer Price backwards through the value chain enough to actually invest in new energy sources. Right. So in this case, was Simon Evans, we had solar, which barely works, and in the hours that solar is working in the winter, in Britain, if you added more solar, you would selectively decrease the value of solar in those specific hours without necessarily making solar more available, because that's a product of the sun hitting Britain in nearby countries if you have interconnections. Whereas what we really ought to do in interpreting the gas numbers is gas has been very expensive in Britain this winter. There's a number of reasons. Basically, there's more demand for it, then extra supply. And production has been declining in Britain, which means the gas needs to be transported from other lands. Gas is hard to transport and store. There's none. There's almost none stored in Britain because there's almost no storage facilities. All of that has made gas kind of expensive. In which case, why didn't people just not burn gas if Dr. Evans is claiming that the LCV levelized cost of electricity from solar is so cheap, and that and he would also show that levelized cost of wind is very cheap in Britain, then why don't people just use that electricity and not expensive gas electricity now you could counter Well, well, that's the problem. We don't have enough of the wind electricity yet. Okay. Okay, so if you had more wind electricity, the hours in which the wind makes electricity cheap, because there's a lot of wind are no longer the hours in which you'll pay almost any ultra high price to get the electricity that is no longer available from wind, which typically is the gas price. That is it's not that gas is expensive and burdensome, because that's just, you know, it's just terrible and we shouldn't have it. Therefore, it's that you need energy and electricity so badly that even extremely high gas prices, you just have to pay. The argument here is that no, no, no, design your system from scratch or go back and, and and make your system so that you, you need a lot less gas. But if you still need the gas power to keep the grid on, you have to pay pretty much any price for that volume of gas to keep your grid on. Which brings us to an interesting situation with levelized cost. France apparently has electricity prices and auctions that are not just extremely expensive. There are some of the highest prices in Europe. Right? So how can this be? Didn't we show that nuclear in France had relatively low levelized cost of electricity? Well, then we see that France has not had to increase electricity prices for its consumers. Because the amount of gas that you're using, the volume of gas that they're using is tiny. And the main supplier of electricity in the country, electricity to France is controlled by the government. And when the electricity price went up, it meant effectively that any electricity that EDF made from nuclear the price didn't go up because it didn't cost more to make nuclear electricity. The cost to EDF didn't go up. Therefore the price going up was just an artifact of market design and not really reflective of the fact that an immense amount of natural gas was being burned at high prices. That's true in Britain. It's not true in France.


Right? So all of this meant that EDF had extra earnings that could be expropriated by the state and return to Eds customers. That's what's going to happen this year. And it means that sure enough, although today, you could not choose nuclear because of its high LCV. That's what your Minister is talking about, it's somehow delivered the actual low price that's protecting French consumers, even though the market price seems to be going up as much or even more than Britain. Right, this is enough to pretty much kill any of your audience's attention. So we've got to figure out ways to make it a lot more exciting as fast as possible. Here's one way levelized cost of electricity is appropriate for comparing like versus like, if you have a bunch of wind and solar, that has an apparently low levelized cost of electricity. That doesn't tell you the value of that electricity, you can try to include it with another metric. But let me just say that in terms of like versus like, it's a bit like saying that the levelized cost of housing, of different housing systems can be used to decide which housing systems to build. On one hand, you have a tent, goes up really fast, maybe doesn't last as long. But it's housing if you just describe housing as a shelter, that's the effect of calling a kilowatt hour, a kilowatt hour, assuming it's fungibility and time, assuming that that fungibility and time is the same as a fungibility of value, that a kilowatt hours a kilowatt hour, then a tent is a roof. And as long as your housing definition is so weak, so unreadiness that a tent, for a family of four counts the same as housing as an apartment or a house for a family of four, then apparently, we should never build anything other than temporary shelters over a hole in the ground. Now, if you start to include other things like that housing has different characteristics that meets different needs, immediately, your housing compared on the basis of levelized cost must not be used to decide whether a tent or an apartment and if you say no, no, no, it's okay. We'll adjust it by area floor area. No, that's not that's still not quite I mean, at least we're getting somewhere but it just doesn't quite so we've added a unit floor area. This gets us probably about as close as we can to kilowatt hour in this case in this in this example. Now we can do this again. What if we define we want to decide what's the transportation system. So are we talking transatlantic transportation, crabbing across a big body of water? Are we describing a transportation system that has to work for a small town without growing population? Are we describing? Well, as long as we only look at passenger miles traveled, and we say our unit of analysis is dollars per passenger mile. Then you can see how we can get some pretty funny answers really quickly. Anyone can tell that the levelized cost of just teaching somebody to swim and letting them get cheap dollar per passenger miles swimming themselves across the ocean, it's going to be way cheaper than setting up a national airplane building company. Heck, let's just say Boeing already exists, it will still be cheaper than ordering a 737. And putting in passenger miles. If you're looking at say just startup costs, or if you don't take into account say the risk that you might drown or that you can't actually swim across the ocean, people will object that's a ridiculous thing. No one would be so stupid as to compare a swimming across the ocean with flying across the ocean. That's silly. But if you can make a metric dollar per passenger mile, Let's even say a strong swimmer that can put somebody on their back and start swimming now. There we go. Now you're a passenger, right. That's the effectively what's happening with the Lazard analysis on L Coe. And even though Lazar definitely knows the difference. The people who abused Lazard either do not know or do not care. Lazard puts disclaimers on their study saying hey, even though we know you're gonna abuse this addictive drug, don't abuse it. We're there we've done our due diligence we put our little notice on Don't abuse our study, and yet people do. Here's another one, bicycling versus car. Now this one's a little more interesting, because you might think that I'm really saying that.


No, you can't compare because of course bicycling is not an answer, that even though a bike is cheaper, the car blah, blah, blah, well, but here's the thing. If you include the costs of using cars, let's say cars only to move a population around a city, you'll quickly find that the cost of cars is simply unaffordable. And if it appears to be affordable for the whole population, something else is probably missing from the analysis. So for example, if you care about climate change, and you don't have electric cars, yet, you might feel that it's important to put in the carbon for cars. Or how about this, you might think that if you have to spend a lot on roads, or you have to build are subsidized parking and storage for the car, once it arrives at its destination, should those costs be included or not? Well, that makes it a much more interesting or much more complicated problem, then yes. But then then let me say this about the levelized cost of electricity. If you cannot store electricity yet, but you think that's important, then you just can't use LCV. If you can start to store electricity, then you need to start including that as an analysis without separating it from the levelized cost of electricity. Now, sure enough, Lazard has an answer for the for you there, too. They handle snow a ce o 's levelized cost of storage, what you'll find is that if you have to add this only to the price of a wind and solar, you're almost immediately make the wind and solar quite expensive. And even then you're missing something else, which is if you're building storage, it makes your existing nuclear assets more valuable. It would also make future nuclear assets more valuable. But now we get back to a problem we discussed on a previous episode, which is once you've decided at the at the start of your journey down these really complicated, logical paths of what to build or what's good, what's bad, how to solve a missions, what direction should society be going? If you've decided as the first step on that path that nuclear is bad. You do not reexamine whether the things you're now justifying or saying you should spend money on actually work better for nuclear than they do for the path that you've decided to follow. The vast majority of grid storage in the world was built by in four nuclear reactor operators. It was it's just because nuclear was such a steady and predictable supply of energy that you could vary Easily justify, you know, on the basis of something like a levelized cost of energy from hydro pump storage, you'd be able to know that because society basically goes like this and its daily and nightly demand cycle for electricity, nuclear approximately goes this, it's flat, then you can add an energy storage to that where you dump, you fill and dump most of the usable capacity every single evening. But if you've decided that nuclear is bad, it becomes more difficult to justify the storage and you have to demand more funding outside of your renewables. It's to make the renewables work without necessarily needing to check whether that means that nuclear sneaks in the back and even if expensive, we'll come to that next, even if expensive, makes a lower total system cost. That brings us to your minister, I think. Okay, so he said that, come back to me, when nuclear is cheap now, first of all, no, he does not want you to come back to him when nuclear is cheap. He wants nothing like that. He


Unknown Speaker  31:09  

might he's open minded. He wouldn't


Mark Nelson  31:11  

look. The stepmother was not actually wanting Cinderella to go to the ball. That's the whole point of that analysis. If she did, she would get Cinderella a dress or have a servant do the duties that she's having Cinderella do just for a night, I'm sure the investment cost would be worth it to get a prince in the family. Right. The point is they that she doesn't want to succeed in attracting a prince to the family. With Cinderella. She wants it for her for Ugly daughters. Right. So let's just get that straight. He's not asking you to show how nuclear would be 30. Canadian dollars? Yeah, it's not even US dollars is Canadian dollars per megawatt hour, right? No. Yeah. Okay. Right. So nuclear. There was probably a point when I should have mentioned this earlier in the episode, but maybe we'll just put it put it down. Now. Cost is not the same thing as price. Price and cost are not the same thing as value. One person's cost is often by definition, another person's price. If you do the buying of somebody else's product at their price, then that is now your cost for at least that one thing doesn't mean it's the value to you. You might have underpaid or overpaid, depending on what you need to also purchase to satisfy your needs. Okay? But cost value and price are so frequently used interchangeably by even experts. I, I can't say energy experts without using a little scare quotes. Because most of the time they've started with very simple decisions earlier in the career. I don't like nuclear, I do like renewables. And then just because they've learned this rickety, rickety tower of flimsy little definitions all the way up to their wobbly point where they have to do an entire study to even know what they themselves are recommending. They they don't they? They can't they can't actually keep price COST AND VALUE straight in their heads when describing or looking at numbers.


Chris Keefer  33:24  

Well, no, we haven't. Haven't forbid they'd look at actual examples and see, despite these careful, I'll show because Chris, know the prices, the prices are matching up. And please


Mark Nelson  33:36  

do look at examples. They do look at examples. Let's take for example. Vogel Vogel nuclear plant in Georgia still waiting for our second episode. They look at that example. And they say see, we've looked at that example. And we're putting it in our levelized cost. Is that fair? Should you use a different number other than the cost of Vogel and in fact, let's talk about the cost of Vogel. So it's another case where cost and price are frequently almost intentionally confused by people. The price of Vogel to ratepayers is essentially set unless it collapses or Southern Company collapses. If Vogel is completed, the price is kept to ratepayers. So if you see in the news, Vogel more expensive, more expensive, more expensive. We're definitely going to have to go and look at our levelized cost of electricity from Bogle but that's not going to necessarily be that's not going to be the price that the public is paying. In fact, where is the where's the 1 billion per year of delay coming from to fund Vogel at the moment? It comes from the owners selling off chunks of their own assets to other companies that are going to operate them. I don't know just as well, better or worse doesn't matter. For this discussion. Southern is selling chunks of itself. to competitors to pay for the nuclear plant. That's not a great advertisement for nuclear to businesses. In this case, it should be an advertisement to the public for the value of the publicly regulated utilities. The utility didn't deliver what it said it could. It didn't deliver that what it said it would. And so it's having to sell off parts of itself. And if managers of those parts want to keep making money off of those things, they got to join the competitor that bought the system. Right. Well,


Chris Keefer  35:29  

I want to, I want to Vogel Sure, we want to, I want to step back for a little bit here. Because, you know, I think one of the critiques of lizards SEO is is that the cards are stacked against nuclear. You know, when referencing the cost for nuclear they're taking from that famous price plume, including only the examples of plants that have gotten highly overpriced, famous


Mark Nelson  35:51  

price, Flynn, let's clarify for your listeners that if you look at all the costs that you can gather up for the cost of nuclear in, let's say, recent years, recent is in the eye of the beholder is that last five years, 10 years 2040? Certainly as nuclear people, we'd like them to take really old times because then you include some really successful fleet builds, like the one we discussed in France, it's currently delivered, delivering wild value. Right. So you're saying that they're cherry picking?


Chris Keefer  36:19  

That's that's one allegation I've heard. I mean, maybe that's accurate. If we're looking at making investment decisions in the West, you know, things have not been going well with EPs and AP 1000s. But that's just one thing. I mean, another another element I've heard is that, you know, ALARA is lizard assumes a 30 year lifespan across the board. And we know that wind turbines, for instance, generally cap out at 20 years, and we've as discussed in previous episodes, we're seeing nuclear plants running well past 60 years. And that has big implications on the kind of numbers that are spat out and the kind of investment decisions that will be made. As a result, I'm just trying to get a sense of whether you believe that the folks at Lazard have a particular Anti-nuclear bias. Is this just coincidental that, that these these variables are being sort of played in in certain directions? Or is that all just accidental?


Mark Nelson  37:06  

I fundamentally believe that Lazar does not have any deep down institutional bias against nuclear, or at least not anything abnormal for financial world. I think Lazard truly does stand by it's good advice. And it's probably good advice to recommend that people don't invest in nuclear, if you're, if you're left if you're the company or the investor left holding the bag right now, that's a little bit of a challenge to us in the nuclear sector. But I think I can I think I can give you a little bit here. Chris. Lazard has no reason or call to be any more sophisticated on nuclear, certainly not in public, because who's asking? Well, in 2022, a lot of people asking, because there's a whole energy crisis that even to even in a world inundated with experts who are almost intentionally misunderstanding and energy in order to scream about the death of nuclear or the worthlessness of nuclear or conversely, in a world where an energy crisis is practically defined as exactly the times when all of your wind and solar isn't producing like that's almost by definition. Now in a high penetration, wind and solar environment, your crisis, and your decision making needs to be based around specifically when the things that are supposedly cheap, aren't producing, and you need an entire energy system, even if that's one with an immense number of batteries that you pluck out of the levelized cost of storage. Many times the price of the energy itself, right is the cost of storage over the life of the battery on a levelized cost basis. Well, now, in a world where almost nobody is looking for nuclear, there's not a reason for Lazar to take a more sophisticated look certainly not in public. In a world where we are now looking at nuclear 2022 there's clearly an error in the LCP somewhere there's something people smell that something's not quite right, a tent isn't quite the same as a as a five over one multifamily apartment block like it's something isn't feeling right. And people are just knowing that these big cheap energy projects are both not making energy cheap, but also they're they're not making much profit, people are looking for something new. You can expect Lazard is probably starting more sophisticated work privately for specific clients, in which case, if they're putting it in a public product, you'll know after they've given their advice to private clients. Now, are they going to misunderstand the full implications of things like the use of a discount rate in a society that's not growing much anymore or growing very unevenly? Yeah, they'll probably get that wrong, but that's a little bit more in like accounting philosophy or which direction the world is. Going at the type the level of person that was art whose job it is to know whether the music is stopping or starting. That's not the person who's digging down with how an electricity grid works, or how storage works or the trade off and value between putting storage near where the energy is needed for users versus where it's needed by suppliers from wind farms, like that's, that's below the line, shall we say, of the type of person high enough at Lazard? Who's there to smell whether growth is turning on or off? Does that make sense? So there's kind of disconnect, which we can we can expand on that just to say, in general, elite Americans have almost zero contact with physical production, either in or at a factory or or have knowing anything about like what electricity is or isn't or what's an engine, how does an engine work or anything like that there's a there's a genuine lack of practical knowledge. And the thing about practical knowledge is it can build up a bunch of really good intuitions that say, an engineer has who's complaining about LCP on Twitter, that an expert with a PhD who's obviously making a fool of themselves saying that you can compare the LCR we have a new solar system in February of 2022, against the energy costs to provide power in February in Britain and 20. Like, the engineer may be really correct without the right words, but Dr. Simon Evans is the one who has the era of the ministers. So is, you know, one's elite. And one's just a, you know, an engineer yapping on Twitter when they come home from their day job of securing the basis of society.


Chris Keefer  41:47  

Can see what side you're on here? A little bit arbitrary? A little


Mark Nelson  41:49  

bit? A little bit. But I think there's an interesting question here about this growth rate and discount rate. What does it mean? And I saw I saw another energy thinker post about this a few years, maybe about a year ago, I think it was one of the big Texas energy Twitter guys, maybe Dr. Josh rose or something like that. Anyway, he said, what's the he made a joke about what's the levelized cost of the this bridge? And it was like a 800 year old bridge still in beautiful working condition for Modern uses. Right? So what's the how do you? How do you use discount rates on that


Chris Keefer  42:26  

worthless? There's, it's completely worthless now?


Mark Nelson  42:30  

Well, so that brings us to a few interesting corrections, we could start to talk about, you know, we've denied your listeners the cost price value of Vogel and we should probably do that at least. So you have a segment to refer to. But on that bridge, that bridge, if you build a bridge, should you build it with really good rocks on really good foundations? And should you build it to last 20 years, if you can no such thing, or 100 or 1000 years? What does it mean for the value? If you use something like a discount rate were the apparent value of the bridge? In today's terms? 30 years from now, is zero, mathematically zero, then you've come out with a sort of time paradox, where 30 years from now, you can bet that you'd really love to have the bridge. But if you 30 years prior, calculated it to have a value of 30, you have an apparent disagreement. Where does this come from? One possibility is this here's one solution. Well, if the world is really progressing, and wealth is growing a lot, why don't you wait until we have excellent bridge building technology with the highest quality quarried stones taken from either further away that will last even longer once you build it? 30 years hence. So there's one one possibility the world is changing, growing so much that it's hubris not to apply a discount rate, because we'll be better at what we do in 30 years, we'll have better stone will build a better medieval bridge? Well, I can tell you that for most of me, for most of human history, there was not an assumption that things automatically grow get bigger, much wealthier. And in fact, for some societies, while that wealth and growth was happening, there was maybe maybe didn't feel that way. I certainly think we're in that time where although GDP numbers are still kind of going up for a large portion of society, life is not really changing much for the better in in rich countries, certainly at the edge of the development wave in the world if there is such a thing, remarkable progress and very short periods of time can happen. I talked to a young man in from Sierra Leone, a young engineer who was getting into nuclear and he told me he came from the village and that his drive, and he came from a village in a time when Sierra Leone was just emerging from an awful Civil War, right? Wars devastate are just completely devastating to your infrastructure to your the health of your population. People who can flee, do flee just terrible, right? So he's seen the worst of the worst he's seen. He comes from a Sierra Leone, grew up in Sierra Leone at the bottom of human development index, and is and is seen Sierra Leone get wealthy, really fast, not wealthy, like it's wealthy today, no, not at all. But he has an engineering degree. And he's going into nuclear so that his kids never see the world that he grew up in. Without electricity. Yeah. So in, in that case, discount rate may have a different meaning in Sierra Leone, than it does in America. In fact, here's where I really, really worry about a sort of circular problem with discount rate.


If your growth is disrupted, let's say you mess up on the energy transition, and it doesn't work out like it's supposed to. And all the experts kind of mess it up that I mean, they don't mess it up that it might be possible, but they don't quite deliver. And there's a big shortage between the power that we need and the amount we have. And then there's a Texas but it's broader, only, we don't get lucky and the grid does collapse, like that sort of thing, then you're maybe not going to have growth. And it may be that the value of $100 today is radically, radically higher in even in hindsight, then, okay, so what what does this mean, if you don't have even growth, if incomes are not rate rising for a bunch of the population, it means that that marginal value, the extra value of a little bit of money may be the same for them, but not for the folks whose incomes and wealth has grown? Well, what we've seen too, in modern times, is that you can have a lot of income growth in some segments of society without the ability to build or even maintain basic infrastructure. Now, if you're the one for whom the wealth is up, you can choose and pick and choose your time and place to make sure you always have some infrastructure, maybe it's private insurance, infrastructure, like transportation, like the car from the middle class or the airplane for the for the elite, right, you are going to experience a different logic around investment and around future growth, then somebody who is part of the say, the large amount of people in our time in our generation, Chris, who do not see their horizons expanding much either because they can't afford a house like their parents could, or university education is vastly more expensive and dollar value with much less career advancement out the door, that sort of thing, right. In this case, if your energy investments, as steered by LCR, we actively degrade your physical wealth, the physical wealth of society, your grid, the ability to manage it, the cost of providing service from it, then you may actually deliver a world of no growth or low growth or Degrowth. That invalidates that use of a discount factor that so disadvantages something ultra long lived like nuclear in the first place. I can guarantee you that the builders of the medieval bridge didn't have all COE didn't use it. Very quick history for people of discounted cash flow as a way of working in terms of lending science like lending and mathematics. The person who has wealth of some kind has money or some kind of power to make somebody else's dreams come true with a loan or some kind of grant of physical capital or land. So the lending mathematics has been around since 2000 BC, like since since the near Middle East developed such things Yeah, so Babylonians would have had it.


Rome would have had it anybody whose wealth depended on loaning existing capital that they had knows about knew about interest or how to charge it, how to calculate it, how to think about it from very early on. The use of that discounted cash flow outside of finance, though, had to wait until much later in the 1500s or 1600s. people first started thinking about it in ways that would sort of start to become something like what we call the science of science of economics. Economists and engineers then grew up together along finally with this class of person, they accountant, where they started applying discounted cash flows to evaluate physical projects like railroads, for example. Yeah, or power plants where you could see from the existing power plants that some power plants were really good and can make you money. But then you'd see that to have a bigger power plant that made cheaper power would take each even more money and take a longer time to build. How do you justify how do you evaluate whether you should or shouldn't discounted cash flow is one way to determine for yourself whether a project seems worth it, and then to sell decision makers on it. So decision makers were very slow to come to discounted cash flow. And in fact, in the 50s, and 60s, big electricity, utilities in the US still, we're not really using discounted cash flow, they kind of do use rules of thumb, or you know, just judgment so to speak, they didn't turn it all into year by year accounting, cash flows, make some assumptions, add it all up and choose that way. They just knew that you build power plants, if you build them, right, and they are bigger than the last one and more modern than they make cheaper electricity service as a whole for everyone. And sure enough, electricity got cheaper from approximately 1900 to approximately 2000. And now it's going the other way. Right? So whatever that method was, somehow it worked. Now maybe we can say that it got cheaper all the way to 2000. Because increasing accounting and financial discipline invaded the ranks of the decision makers, and people start stopped building wasteful power plants. Or maybe what so called wasteful power plants is waste as defined by people taking an atomizing view of an individual plant decision and decision to invest without looking at the total cost of the full service of electricity to a large population. You can tell by my tone of voice that is where I land on this. Let's talk about Vogel really quick, shall we? Sure. Okay, so Vogel currently is costing about $16,000 per kilowatt capacity. That is the cost appears to be about 33 $34 billion. Now, again, as we said earlier, the cost to ratepayers is kept as long as the project doesn't collapse, in which case,


Chris Keefer  52:04  

just for context, that compares to wait and see the Barakaat build out in the UAE, like, you know, a state of the art project that's going really well. So six weeks, he


Mark Nelson  52:15  

knows something, we know something about the price to the UAE, of baraka from the Koreans, which isn't the same thing as knowing that the Koreans are making money off of it. That would be the cost of Korea providing a reactor at that cost. And none of that is saying, what is the value of the project either, strictly speaking to the cost of total cost of electricity service in the country, in which case, I'm sure the value is really good, really high at this point when they should be selling their gas at World record prices rather than burning themselves. Right. So the value of that electricity is going to be really high. Yeah. But yeah, leaving all that aside, the the going, the thing that people know about the contract is 20 billion USD in $2,012, for four by 1400 megawatts, that's about 5600 megawatts, 5.6 gigawatts at 20 billion. Let's inflate it a bit to say in 20 $22, since that's what I'm effectively sort of using for pricing Bogel, you get something like what 25 billion for 5.6 gigawatts compared to Vogels 34 35 billion for 2.2 gigawatts. Okay, now, are we going to be able to upgrade the 2.2 gigawatts to a bit bigger yet, eventually. But for now, that is our cost of capacity. It's not the levelized cost of electricity, that, remember, has to take into account the cash flows negative, not positive, only the negative cash flows in each year of operating the nuclear plant. So that's the fuel. So it's the security staff, it's the maintenance, it's all the NRC checks, it's saving for the decommissioning funds, that sort of thing. Right. So when we look at the levelized, cost of electricity for Vogel, we have to make some assumptions like how much are all those costs gotta be just a decent rule of thumb, a new modern, efficient American nuclear plant should in the long run cost about $25 USD 2022, all in annual cost, as long as is producing at 9394 95% capacity factor. If your capacity factor drops, that cost goes up quite a bit, because almost all of those are fixed costs. Even if you're down for maintenance, you don't get to save on fuel or security staff or right taxes, depending on how your plant is taxed by your state and your community and your and the government. Right. So with Vogel with a assuming $25 all in costs. And assuming again 93 94% capacity factor, then we have to choose the discount rate. And that that discount rate, along with the number of years we take into account in this analysis become really critical factors. What do I mean by that? Well, if your discount rate is very small that is you drop the assumption that you have to match private lending rates, and you can just take it on state balance sheet and state interest or the let's say the country decides is so important that the thing these projects get financed that the cost of money is near zero, and that that becomes the discount rate you use, like 1% 0.5% 1.5%. Even with this extremely high cost to build the plant, if you have a low discount rate, and a long time horizon, those two things work together to make this really competitive. Can you get down to the $30 Canadian per kilowatt hour? No, but I also we just spent, what, 15 minutes now, deconstructing the problem that he was comparing it to what appeared to be a cheap cost of new solar in Ontario, when the power shortages, when they come, they're gonna come in the winter at night, not in the daytime, in the summer, for God's sake. Right. So leaving aside that 30, you're not going to get there, even with an ultra low discount rate for the Vogel project, and a, you know, good operation and a long time horizon, you won't quite get 30 but you can get can mess up the numbers until you get like 4045 $50 a megawatt hour. Now, if your discount rate is up at 456 percent. Now things start to get really painful. Even if your time horizon is 7080 90 100 years, 100 years is absolutely a sensible thing to bet on the coming life of Vogel. Okay, now we have to see if there's quirks about the AP 1000 design that make it not last that long. So one of the many reasons I don't like innovation very much in nuclear, because once you build the damn things, clearly, there was no advantage for simplicity in the AP 1000 versus earlier PW Rs, it just there wasn't any wasn't any advantage there for simplicity. So whatever they whatever changes they made, need to be taken as a risk that the plant won't last as long for whatever reason, as the previous complicated junky generation, two stalwart designs that were built for to answer a previous question of yours, like under 1,000,000,020 $22. All in, you know, for a gigawatt yet,


you're never gonna, you're never going to achieve that no matter what discount rate you use for these new Vogel plants, unfortunately, but, but even if you assume a one, two, or even 3% discount rate and a long enough time horizon, you start to see the plant looking a little more reasonable 60 $70 A megawatt hour over that really long time horizon. Over the long run, we're all dead, as famous economist once said, but over the long run, the rate payer keeps having to own the results of however their electricity system is run and operated, the rate payer will do very well, in the long run in Georgia, from a decision that by today's lights should never have been undertaken, if you knew it was going to cost that much. Now I see a lot of people online, misusing the cost versus price versus value to to imply that you shouldn't continue Vogel like you should stop now. Right. Now, that's just absolutely preposterous. And it just that those are the people that are truly in the tank for nuclear Lazard wouldn't advise not completing the plan. And as long as Southern has chunks of company left to sell, then they're going to do it because in the opinion of Southern and this is correct, they would never recover as an entity from an abandonment of a nuclear plant the entities involved in the abandonment of the South Carolina project. They're toast, right? Do we know


Chris Keefer  59:21  

do we know what the discount rate is for local approximate,


Mark Nelson  59:26  

we said that discount rate and cost of capital are similar and they kind of seem to go together and you should probably put your discount rate up near the cost of capital if you're having to pay that cost of capital. But that means you're going to have an immense divergence between the value of the project you know, to the to the state to the country, the value is going to be very different than the awful a negative decision, you would have to take with a high cost of capital at your start. So those are two different things the discount rate and cost of capital, the cost capital for Vogel seems to be something like something like four to 6%, it's a little bit hard to figure out, I worked with our dear friend, Simon Holmes A court a while back to try to figure out what that cost of capital actually is, at the point that Southern is selling off chunks of itself to sell fun the plant. That's bad if you're Southern, and you want to be a bigger company, rather than a smaller nuclear focused company, but I mean, no skin, the customers back at this point, well, what this what that means is they're not borrowing that money, they're just chopping off chunks of, you know, a big wheel of cheese and selling it off to customers, right. So that you may have to do a separate check in with Southern to see was your cost of just selling bits of your company was that better than borrowing and current interest rates, or maybe no one will loan for this project anymore, but you stop. So I have to keep going. What that means for us, if we're looking at the weighted average cost of capital, the whack W ACC, then the the weighted average cost of capital is, you know, kept down a bit by punitive high interest loans not being needed to fund this project. Because the customers are chaat are the the customers of the plant I mean, are protected more or less, and the company's building and owning the plant or just having to pay for it themselves? So four to four to six now is that the interest rate you would get on an equivalent project day? Well, depends on whether anyone thought you'd learned your lesson depends on whether the state stepped in certainly in the UK size, we'll see is going to go ahead if the UK backs it with its full faith and credit or gives gives the project at least some really secure ability to know that if it does complete, if it does get built, it will it will be compensated well. So that brings us to an interesting point about offshore wind, by the way, the value I kept saying value value value, we didn't get to value Hospers value. Yeah. So at the moment, we're looking at the first if we take a for say, let's say a four or 5% discount rate for Vogel 34 $35 billion to build it to units at 1.1 gigawatts. And putting all that together, we get a cost of electricity for the first 3035 years of something like $120 per megawatt hour. That puts us right in the center line of what companies are claiming they need to build, similarly scaled, but much less predictable offshore wind in the US. Now, not offshore wind in Georgia, because the winds are just garbage down in the Gulf Coast. No, I mean, offshore wind in the really windy places, is supposed to cost about the same as an absolutely catastrophic, nuclear industry destroying project and Vogel makes you think a little. But that's not the same as value, the value of that Vogel electricity, if you looked at the total system costs the alternative to buy coal or gas produced out of state and burn it in your plants, which you have to build and maintain, or the renewables which are cool, I guess, just like a tent keeps you sheltered from the rain. When you look at the value of Vogel, you're going to see that it is probably this is just me guessing here, it's going to be something like 40 to $60 a megawatt hour, that's not the same as what the price what they'd be able to get on an auction necessarily, if there was an auction system for electricity in Georgia, which thank God there isn't my opinion.


But that it means that the cost that the consumer is paying which is I believe something like 70 to $75 a megawatt hour for Vogel the rest above that being paid by the losses that investors in southern and and the mothership is paying, right. So the value of Vogel is really close to the cost of Vogel for consumers as far as I can tell. Now, that's a little bit rough and I don't have the figures and maybe we need to do a whole study on it. But that's pretty close. For the offshore wind Absolutely. In no way shape or form is can this possibly be true? First of all, at costs of offshore wind subsidies that are currently going in the UK companies are losing a shirt like they are they are not making money on offshore wind in the UK. At best we can say that offshore wind in the UK appears to be lost leaders, not just the not just the owners, but the contractors who are having are on the hook for delivering services they promised like securing the anchors, the foundations offshore or the cables into the that have to be built to bring the power on onto land. So that Wind, the value of the electricity is probably going to be quite low. And we'll see how this happens. Because if the wind pops up suddenly during a long period where gas is super hyper expensive, and there's not too much wind, so it doesn't saturate that market. During that time when gas is expensive and solar isn't around, then you'll have some periods of pretty high value for the wind. But the only way that wind is going to be high value electricity is if the entire system is ridiculously expensive. And people are going to make all the tweets showing how it's the gas making the system expensive. That's going to be the price for electricity that will provide a value to the investors high enough that they won't be just devastated by the low value of the project, regardless of the of the levelized cost apparently being below nuclear.


Chris Keefer  1:05:51  

And I guess the problem we're wrestling with is that you're you're talking about nuclear having this high value, especially once it's built and it's paid for itself. But these plants are still closing down for economic reasons because of deregulation, because the way that the electricity markets are structured,


Mark Nelson  1:06:05  

careful, they were closing down until 2022. The decision to close a plant like Palisades was taken by a company Entergy that just as a company policy was just going to trash all their plants or sell them and they're just kind of slow moving. And I like I that's only one nation on planet Earth. There is no other nation on planet Earth where this has been a particular issue. Now in some places like Sweden, low wholesale prices have been combined with the government specifically taxing the nuclear plant to death, and then saying, Well, we have to tax it to death to fund cheap renewables that aren't cheap and to make the price. Right. So that's a different thing. That's a specific government policy decision to make the nuclear plants just bleed them to death. Right. So that's different. Only in the US was there the need to close. So existing nuclear plants, the going forward costs, the levelized cost of extending nuclear plants goes anywhere from like, you know, 510 $15 a megawatt hour in some extreme cases where everything has been done, they're only being forced to close because they've got haters, too, you know? Well, let me say that, that levelized cost of scratch that the levelized cost of electricity of letting Indian Point nuclear plant continue operation was probably going to be something like 30 $35 a megawatt hour because the big critical decisions had already been made and investments had been made to upgrade it just like Diablo the levelized cost of electricity going forward to Diablo since they've already spent what 800 million or whatever to upgrade the plant for interminable life, well, then the cost of electricity going for is quite low. That's another thing where the experts themselves take months or even years of paying attention to the discourse to even get straight in their thick skulls. Whether they're talking about the going forward cost of existing plants, or the or the cost to build new right fortunately on energy Twitter, most people hate nuclear gotten that through their the school as I just said, they see that ongoing nuclear plants are a different thing than new build nuclear plants.


Chris Keefer  1:08:22  

Lizard right does that as well. And are there charts? Yeah, yeah. Yeah.


Mark Nelson  1:08:26  

And Lazard is going to be sophisticated about all that. That doesn't mean they knew that it was even an issue or that should they should pay attention until it was smacking him in the face, or at least in their public charts. They wouldn't necessarily known but yeah, at least they they recognized that part is good.


Chris Keefer  1:08:40  

Yeah. Mark, I think we should wrap it up there. We're a little over an hour. I'm hanging on to the roller coaster here. But I think things are slightly more clear to me. We may need to clarify. But thanks for taking the time to come on.


Mark Nelson  1:08:54  

Yeah, thank you for having me, Chris.



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