JULY 30, 1998

I appreciate the opportunity to testify before the Subcommittee on Clean Air, Wetlands, Private Property and Nuclear Safety to offer the views of Fitch IBCA on the appropriate role for the Nuclear Regulatory Committee (NRC) in the evolving utility competitive environment. Fitch IBCA is the international credit rating agency that resulted from the December 1997 merger between the New York-based Fitch Investors Service and IBCA Limited of London. I will speak from the perspective of a member of the financial community as well as the former Chairman of the Michigan Public Service Commission. I should also note that I am not a nuclear engineering or nuclear physics expert, and in this regard I am representative of the large majority of investors and financial analysts who play some role in assessing the nuclear industry.

The NRC is at the center of investors' perceptions of the financial risks facing the U.S. nuclear industry. In evaluating utilities that operate nuclear plants, debt and equity investors study closely the processes and actions of the NRC. To the extent that these regulatory responsibilities are carried out in a consistent and predictable manner, investors find comfort with the outlook for both individual nuclear utilities and the nuclear industry as a whole.

It is difficult to envision a competitive electricity market without nuclear being a key element. Nuclear energy today accounts for about 20% of U.S. power supply. With state regulators generally providing utilities with almost total reimbursement for above-market generation costs, nuclear plants with their low variable costs are being counted on as a major source of low cost electricity for years to come. The balance that is ultimately struck by the NRC between its oversight responsibilities and the necessities of a free market will be crucial in determining whether these expectations are borne out.

In the past, it has been difficult for investors to predict with any certainty the actions of the NRC. As a former regulator, I can appreciate the pressures under which the NRC operates, attempting to follow statutory mandates that set strict adherence as the goal. Unfortunately, such a policy formulation creates a situation where there are so many standards and requirements that it is difficult for nuclear plant owners to know how to allocate resources, much less for a financial analyst to be able to make an assessment of overall risk.

Investors do not have a clear sense of the factors that the NRC uses to rate individual plants, modify Systematic Assessment of Licensee Performance (SALP) ratings, or place plants on the Watch List. This lack of certainty about the impetus for potential NRC actions has a negative impact on how investors evaluate nuclear companies, especially when one considers the severity of the resulting effects. For example, the posting of a plant to the Watch List is in itself likely to constrain a nuclear operator's financial resources and access to capital. Once the NRC takes that step, it typically leads to a lower stock price, reduced access to the equity market, weakening bond and commercial paper ratings, and higher cost of debt.

To compound the problem, investors perceive that once a plant is taken out of service for any reason, there is a tendency for the NRC staff to seek out additional flaws or issues, whether safety-related or not, for consideration and correction. The result is that an outage of any type holds out the potential for an indefinitely prolonged stoppage, with effects that utility investors most fear: unrecoverable purchase power costs, rate penalties, loss of rate base treatment, and potential fines or other expenditures to support required remedial steps.

As one utility CEO recently confided to me, "We need a new regulatory paradigm, because under the current system every nuclear plant in the country is ten minutes away from being offline for a year or two." And this from someone who praises NRC Chairman Shirley Jackson's leadership as "tough but fair, in a way that has made the nuclear industry stronger." Needless to say, debt and equity investors are keenly aware of the risk created when any major nuclear plant, regardless of past history, is potentially moments away from a loss of its operating license and a reduction in its market value of hundreds of millions of dollars.

What this means is that going forward the sensitivity of the NRC to the challenges facing nuclear utilities will be more important than ever before. In the past, utilities operated under a heavily-regulated cost of service-based system. To the extent that regulatory mandates placed additional costs on utility operations, in most cases those expenses were recoverable from ratepayers under cost-based tariffs.

Now, under the evolving competitive regime, all utilities will be called upon to react and deal with marketplace pressures. For nuclear utilities, this will be an especial challenge, because their need for greater flexibility will likely collide with the NRC's traditional highly prescriptive approach to regulating the sector. In the new environment, however, it is incumbent upon the NRC to differentiate between actions necessary for safety and those that have limited or no relationship to safety. The NRC must maintain vigilance over the former and allow flexibility with regard to the latter.

By moving to a risk-informed, performance-based regulatory approach, the NRC will be able to maintain its important safety oversight role, while allowing nuclear facilities to be viable players in the competitive system. During my tenure as a state regulator, the Michigan Public Service Commission (MPSC) distinguished itself by fashioning incentive-based plans in all regulated industries based on performance, service quality, and infrastructure improvement. By stepping away from the usual way of doing things, we permitted utilities to determine the best means to improve both operational and financial performance with benefits flowing through to consumers in the form of lower rates and a more efficient regulatory process. A similar approach at the NRC would seem justified to provide utilities operating nuclear plants with the ability and motivation to adopt innovative policies that could afford similar mutual benefits.

Investors and rating agencies will closely monitor the NRC as it goes through the first round of license renewals. With two applications for extension already filed by Baltimore Gas and Electric Co and Duke Power, the NRC has the opportunity to show that its promise of a fair, effective and efficient license renewal process will be a reality. If it succeeds in its goal, investors will be more willing to invest in existing nuclear facilities with the expectation that the plants will be able to operate safely and reliably beyond the end of their license period. If, however, the process for the first applicants bogs down, some plants might be shut down earlier than their currently licensed lives due to the unwillingness of investors to provide additional capital expenditures for a plant that may not be around long enough to provide a fair return.

A similar situation exists with the recent announcement by PECO Energy of their involvement in the proposed acquisition of GPU's Three Mile Island nuclear plant. The process the NRC utilizes and the regulatory rules imposed during consideration of this and other proposed transfers of nuclear facilities will have a major influence on the role nuclear will play in the competitive electricity market. An appreciation by the NRC and the Congress that the changing dynamic calls for reorientation of the NRC from a prescriptive enforcement body with regard to everything a nuclear owner does to one focussed more closely on true issues of safety will be an important step in ensuring a place for nuclear in the new competitive electricity framework.