As soon as Rick Perry is confirmed as the new Secretary of Energy and finds out where his office is, he will be deluged with requests—for policy changes or new policies, requests to hire somebody’s friend, to have a meeting with every interest group in town, to make speeches at conventions, to testify before various House and Senate committees, and on and on. He will be very surprised at how many new good friends he has, people he may never even have met. Mostly he will get requests to spend money, the government’s money, really your money and my money. Everyone loves you when you spend money. It’s the easiest thing in the government to do. And everyone who asks for money will have a justification that’s not laughable as to why spending this particular amount of money on this particular worthy cause is in fact worthy. Nobody comes to you and says, “Please spend money on this, even though it’s really worthless, and benefits no one but me.”
Secretary Perry, don’t do it! Don’t do it especially if the amount of money is consequential, which in my definition is over a hundred million dollars. The late Senator Everett Dirksen of Illinois is said to have observed during a budget markup, “A hundred million here, a hundred million there, pretty soon you’re talking about real money.”
There are several potential candidates hanging about, project sponsors who will ask for money to bail out bad projects or bad policies. Here are suggestions to avoid the worst opportunities to waste government money.
Don’t bail out Kemper. This is a complicated project undertaken by Mississippi Power to demonstrate the wonders of “clean coal” technology. It was initiated in June of 2010 with an initial cost estimate of $2.2 billion. This was when President Obama had decided incisively that his energy strategy was “all of the above.” He had, perhaps, never heard of Nigel Lawson, the longest serving Chancellor of the Exchequer in UK history, who said, “To govern is to choose.”
In pursuit of this “strategy” Mississippi Power was given a $270 million grant from the Department of Energy and received $133 million in investment tax credits approved by the Internal Revenue Service. The plant is designed to generate 582 MW’s of power and was expected to be online in May of 2014. The most recent extension of the original schedule has brought the total cost to $7.1 billion. All the Mississippi Power web site says now about the schedule is “In Service: 2017,” three or more years late on a four year construction schedule. That’s hard to do. It should also be noted that a simple gas fired power plant of 582 MW would cost around $600 million dollars, not $2.2 billion. Or $7.1 billion.
The design and construction is being done by KBR, a major and well pedigreed international construction company formed in 1998 by the merger of M. W. Kellogg and Brown and Root. It is likely that they were chosen because the company has developed, according to their web site, a proprietary coal gasification technology. But there is no evidence that this technology has ever actually been built and operated at commercial scale. Except at Kemper, where it is not operating yet.
The drama has not been without consequences. Southern Company’s affiliate, Mississippi Power, owns the project, and its President was fired in 2013 for not keeping the project on schedule. Last year the SEC instigated an investigation of both Mississippi Power and the Southern Company, focusing on the Kemper project, with concerns that there was insufficient disclosure of Kemper status and risks to shareholders. Two weeks ago, lawyers representing Southern Company shareholders filed a class action lawsuit against the company, due to Kemper cost overruns. Last week Moody’s announced an investigation with the possibility of downgrading Mississippi Power’s rating to below investment grade.
Why has this project proven to be so difficult? It’s just a power plant with some fancy additional hardware, isn’t it?
The project is very elaborate. It consists of converting coal to gas by a complicated process in a large pressure vessel, burning the gas in a combined cycle power plant, then capturing the exhaust gas, separating the CO2 and piping it to an old oil field where it will be inserted into the void created by the oil which has been pumped out. Lots of engineered metal, lots of rotating equipment.
As noted above, the project is well past its projected start date and more than three times is original estimated cost. The unfortunate government contribution of about $450 million to the capital cost of this project is lost. More unfortunately, several congressmen have authored legislation which, if passed, would create a tax credit for this facility. This would benefit its owners, Mississippi Power and the Southern Company, and not really anyone else. The Southern Company is one of the nation’s largest electric conglomerates; it owns not only Mississippi Power, but also Georgia Power, Alabama Power and Gulf Power. It owns eight gas distribution businesses and even a telecom company. It has 44,000 MW of generation and 9 million customers. According to its web site, it prides itself on “inventing America’s energy future by developing the full portfolio of energy resources, including carbon-free nuclear, 21st century coal [sic], natural gas, renewables and energy efficiency.” So it is not a novice at the electric energy business. Why bail out a business of this size and competence?
Why is Kemper in trouble with such a distinguished sponsor and constructor? There are a number of things wrong with the project. First, turning coal into gas is not easy, nor is it simple. It has been done for a long time, with the result originally being “town gas.” The process was used to generate a heating and lighting fuel in the US from the 1850’s until replaced largely by oil and natural gas after WWI. The way it works is that coal is ground into a fine powder, injected into a large pressure vessel, and then oxygen, heat and steam are added. The carbon in the coal partially oxidizes into synthetic gas, or “syn gas” which isn’t really synthetic at all, it’s just carbon monoxide. But you also get carbon dioxide, hydrogen sulfide (a poisonous gas as well as evil smelling), water vapor and some molecular hydrogen. There may be other trace elements oxidized or not, depending on the chemical characteristics of the coal used. The unwanted by-products in the resulting mixture need to be cleaned up, and the CO2 removed by one of several “scrubbing” processes. More vessels, more pumps, more energy use, more chemicals. Making the coal into gas is a very inefficient process from an energy balance point of view, and CO as a gas is also low in energy content.
This resulting gas, once removed from the vessel and cleaned, is ready to be burned in large gas turbines. But it is not a great fuel, as its energy content is about one fifth that of natural gas, (CH4, or methane) the fuel usually used in gas turbines. CO is 4368 btu/pound and methane is 23,875 btu/pound. Standard grades of coal run in the 10,000 to 12,000 btu’s per pound range. Even lignite, which Kemper plans to use, is a low-quality coal, hitting the scale at 6900. The Kemper plant at this point in the process will have gone to a great deal of trouble to produce an inferior gaseous fuel, one with only two thirds the heating value of the input lignite. Well, that’s impressive.
The syn gas, once burned, results in an exhaust of almost pure CO2. This exhaust is further purified, compressed, put in a pipeline and pumped sixty miles to be injected into a spent oil field reservoir. The gas presumably will now reside forever in the old oil field, and not go into the atmosphere to contribute to global warming. But wait, isn’t the purpose of an oil field to have lots of holes drilled into it so the oil can be extracted? Doesn’t an old oil field rather resemble a pin cushion? Sure, old wells are supposed to be shut down and some concrete poured into the casing, but this would hardly be a sensible person’s first choice for a place to sequester a gas forever. And let’s not even think about geologic conditions in the rock of the reservoir, and the risk of fissures, earthquakes, water erosion, etc. The subsurface doesn’t stand still, and even slight movements can create passages for the escape of this colorless, odorless gas. Good luck on monitoring that.
Everything about this is hard, some of it is new, and some of it is not only hard and new but a bad idea. The US government in 1980 created the Synthetic Fuels Corporation, whose mission was to support coal gasification. After doing a grand total of one project, Great Plains in Beulah, ND, the corporation was mercifully shut down in 1985. Just as hard cases make bad law, hard infrastructure projects make high costs. Southern Company cannot be said not to have understood what it was getting into, or what the risks were. Taxpayers should not bail out a bad project badly executed.
Don’t bail out Toshiba, Westinghouse, SCANA and Southern Company. Yes, here Southern is again, but this time the power plants in question are nuclear, not some coal to gas concoction.
Toshiba is building two nuclear plants of two units each in the US, using a new technology of nuclear reactor which has never been built before, the Westinghouse AP 1000 reactor. Does something about this start to sound familiar?
The first company, SCANA, is a holding company for three regulated utilities, and provides electric service in South Carolina and natural gas distribution in North and South Carolina and Georgia. It operates one nuclear plant, V. C. Summer Unit 1, and Toshiba is building two more units for it at the Summer site.
Toshiba’s other customer is the Southern Company. It is building units 3 and 4 at the existing Vogtle nuclear site. Southern operates six nuclear units in three sites already.
But as is traditional with nuclear construction in the US, things haven’t gone well. Constructing began in August of 2009 on both the new units in Georgia. The Vogtle units are three years behind schedule and $3 billion over budget.
One of these plants has received financial help from the government, sad to say. The new Vogtle units were given a $6.5 billion loan guarantee, from the Department of Energy, finalized in 2014. While this did not amount to a direct cash payment from the government, it did let the Southern Company borrow at a reduced rate based on the credit support for the US government. While this may sound like a clever way to finance such plants, the bad news is that the risk of default on loan guarantees, as calculated by the CBO, is greater than 50% for nuclear guarantees.
So how bad is the situation? In January, Toshiba announced that it would take a major write down on its nuclear construction business, perhaps as much as $6.1 billion. When this news was disclosed, Toshiba shares fell by sixteen percent by the end of the day. This was a $1.7 billion hit for a company with a market value of $11 billion. And on the 14th, when it had promised to release the audited financials, it did not, asking for a further delay. Toshiba did note that the anticipated number was now $6.3 billion, and the Chairman resigned, with apologies. And since the number really wasn’t final, who knows what will happen when the company issues its final numbers in mid-March. Wall Street analysts began speculating on a Toshiba bankruptcy.
Toshiba only got into this line of work when it acquired Westinghouse, which actually had the nuclear business, in October of 2006. The press release announcing the finalization of the acquisition stated: “Toshiba Completes Westinghouse Acquisition, Heralds the Dawn of a New Era for Nuclear Energy.” At the end of January of this year, dawn became dusk. Toshiba announced that it was exiting the nuclear construction business. Easy come, easy go? Not exactly. It still has to finish Summer and Vogtle, and it has taken on fixed price risk on the construction contracts at both of these plants. It is hard to see how this will end well for Toshiba, and perhaps for SCANA and Southern Company as well.
Maybe it all goes swimmingly from here on, although that’s not the way to bet. There are two especially ugly outcomes: Toshiba goes bankrupt, or Toshiba decides to just walk on the construction contracts, betting that the ensuing litigation will be less costly than finishing the plants with its own money. In either case, one can expect cries for help to go out from the two affected utilities, help from Uncle Sam. These cries should be resolutely ignored. The government is already on the hook for Vogtle, and that’s more than enough subsidy for this situation. And one final note: a $6.5 billion payment would make the government’s failed Solyndra investment look like chicken feed.
Don’t bail out Elon Musk. I have never met Elon Musk. He is held out to be a business genius, and investing in PayPal and then selling it before people realized that it was just a credit card substitute was pretty smart.
It is less clear that starting Tesla was smart, or that starting Solar City was smart. I don’t have an opinion yet about SpaceX, but I will say that he’s been active in a bunch of different business spaces which have no real relation to each other. But let’s focus on Tesla.
I like electric cars, and at one point convinced my company to invest in one, which subsequently failed and our investment went to zero. This could make me an expert or prove that I have no credibility here. I would buy an electric pickup truck tomorrow if the industry made one that was normal and not the size of an iceberg recently broken off Antarctica—Ford 150 Super Duty, we’re talking about you. As the race to upsize continues, US trucks will soon resemble Hummers with a small cargo space in back, but we digress.
Tesla has had an interesting history. The first car they made was a very rich person’s sport car, the Roadster, introduced in 2008 at a price of $100,000. Movie stars bought them, but only 2800 were produced and production stopped in 2012. There were several interesting innovations in the roadster, including the first use of a lithium ion battery in an electric vehicle, in a shape, called “form factor” in battery lingo, that was the same as that used in many lap top computers. This allowed for easier procurement of the battery. But the goal of the company was to make a mass market car, not a limited edition rich kid toy.
The second Tesla vehicle, the Model S, was introduced in 2012, with several remarkable characteristics and much well deserved fanfare. NHTSA gave it a 5.0 safety rating, its highest assessment. EPA rated its range at 285 miles, and it was also blazingly fast, the third fastest production car ever produced. It won buckets of awards, including car of the year for 2013 from both Automobile magazine and Motor Trend, and car of the century from Car and Driver in 2015.
It was still, however, quite expensive, retailing for between $95,000 and $105,000 in 2012. But Tesla sold all the cars it could make, frequently with a waiting period between ordering and delivery. But it has not become the leader in the field, that distinction falls to the Nissan Leaf which has sold more electric cars.
In 2010 Tesla received a $465 million loan from the Department of Energy, to allow it to build its Fremont manufacturing facility. It has also received government subsidies from selling “zero emission credits” to other car makers who are not able to make emission targets. The Energy Department loan was fully repaid in May of 2013, nine years ahead of its due date. Good for him.
There is a wide divergence of opinion about Tesla as a company. On the one hand, the stock market values the company at more than 43 billion dollars.
The negative view is based on fundamental analysis. At about $250 per share, Tesla as a company is “worth” $43.35 billion. But its cash flow is decidedly negative, its debt to equity ratio is high, its earnings are negative and its return on equity is negative. More troublesome, it has a history of missing production targets. We should admit that making cars is a difficult manufacturing feat. If it were not, there would be lots of successful car manufacturers in the US, rather than three. Nonetheless, Tesla made 50,931 vehicles in 2016 versus earlier forecasts of 80 to 90,000, which was to include both the Model S and the new mid-size Model X. No Model X cars were made in 2016 and production is now expected to begin in late February. It is interesting to note that if you multiply the $100k sales price by the units sold you get, obviously, $5 billion. Divide that by Tesla’s market cap and you get a ratio of 8 times revenues. Which is a conservative calculation, because some of the sales price goes to dealers, so the eight times number is really too low.
Ford has a market cap of $50.68 billion, and in 2015 manufactured 2.6 million cars. No matter how you calculate it, Ford is selling for less than 1 times gross revenue. It is hard to believe that in the long-term Tesla will keep its value at eight times that. One more comparison: The S&P sales to value ratio over the last ten years has ranged from 1.4 to 2.03. Never eight.
The market is not totally asleep. More than 25% of Tesla’s shares have been sold short, a number that one newsletter characterizes as “extraordinary.” And when one fourth of the people holding your shares believe, and make money only, when your shares go down, that’s a big number.
It would be nice to see Tesla succeed, in an industry where startups have been few and unsuccessful. Elon Musk has certainly brought interesting change to Detroit, and that is wonderful. But we’ve already given him $465 million of our money. If he gets in trouble raising capital, which is what could happen if Tesla fails to meet its production targets and his stock price declines dramatically, don’t bail him out. He’s had his turn at the Uncle Sam cashier window. And I don’t care if he is President Trump’s best friend.