United States: Energy Valuation – The Overvaluation Of Nuclear And Fossil Fuel Generation

Last Updated: April 5 2018
Article by Mark Lansing

At one point, nuclear and coal generation facilities were the most valuable generation properties for property assessment purposes. At that time, coal accounted for over sixty percent of the electric generation in the United States. Both were supplanted by combined cycle gas turbines ("CCGTs"), which are less costly to construct and, with fracking, to operate. As a result of this paradigm change, nuclear and coal facility valuations declined significantly, to the point that many closed or, for nuclear facilities, states intervened with Zero-Emissions Credit (ZEC) to prop up their continued generation.1 However, the pendulum has kept swinging. New levelized cost of entry ("LCOE") for both solar and wind plants are shown to be lower than nuclear, coal or gas facilities. New bids for wind or solar generation in Colorado, Nevada, and Arizona were less than the variable cost to operate CCGTs. In Texas, the wind generation has not only reduced coal and nuclear generation, but also CCGTs.

Throughout the United States, pipeline expansion that would enable fracked gas to enter needed markets, such as the Northeast, or to be transported to LNG facilities for export, is increasingly under attack. Such concerted efforts, combined with ever expanding renewal portfolio standards ("RPS") (and, now, anticipated proliferation of energy storage facilities), should further decrease CCGT operations and make them more costly, driving their valuations down. To reach its RPS goals, the State of Massachusetts approved two plans that would transmit electricity generated by hydroelectric plants in Canada to Massachusetts, thereby reducing the need for CCGTs (and that of nuclear and coal). The continued reduction of fossil fuel generation should lead to continued declining property (personal or real) valuation of all non-renewable generation facilities.

As renewable energy drives down energy prices and energy storage complements renewable energy by providing "cheap" electricity when either renewable energy cannot operate or to supplement energy needs during peak loads, generation revenues should further decline. Lower revenues and higher costs (as availability of gas is restricted) should lower the valuation of non-renewable generation assets, including CCGTs.

A. The Marketplace for Generation Assets

When a market exists for property, the valuation should be the manner applied in the market. Whether a "market" exists is a question of fact. A "market" can be defined in two manners: (1) a market for the sale (both new and used) of the property (e.g., the sale of generation assets), or (2) a "market" with respect to the direct or intrinsic income generation of the real property (electricity prices, capacity prices, etc.). If no market exists, the property tends to be labeled "specialty property"; whereupon, the cost approach is normally applied.2

Today, numerous states have unbundled and deregulated wholesale electric generation assets. As a result, regional transmission organizations (e.g., PJM, MISO, ISO-NE, ERCOT, NYISO) developed, maturing the marketplace for the sale of electricity (and other energy commodities) and providing transparency in various commodity pricing (including electricity, capacity, ancillary services, etc.). The result has been the development of a market for electric generation plants; however, such markets are dependent upon the RTO or regulated nature in which the plant operates. This has led courts to find that comparing sales of generating assets outside those markets has not been viable.3

B. Valuation of Generation Assets

In valuing properties, most states agree that a recent sale of the subject property between a seller that was under no compulsion to sell and a buyer that was under no compulsion to buy is the best indicator of value. See footnote 2. For generation plants, that purchase price has been determined by the income approach (more specifically, the discounted cash flow ("DCF") methodology). See, e.g., footnote 3. Yet, the preferred valuation approach for property assessment purposes remains the cost approach. Both assessors and courts generally eschew the market place valuation by the income approach, finding it cumbersome. Unlike general commercial properties (where the income approach takes comparable market lease income, deducts market operating expenses (that tend to be stable and predictable) and, then, applies a capitalization rate applicable for the area or region in which the property is located), the income approach for a generation station involves the DCF methodology. That means annual projections of revenues attributable to tangible property, deductions for projected operating expenses and capital expenditures, and the application of a discount rate (taking into account an effective property tax rate) to present value the annual cash flow to the valuation date are necessary. With the increased presence of wind and solar, market electricity price projections are more complex but, generally, lower.4

Since the underlying issue is market value, and since the marketplace values electric generation plants by the DCF methodology, then generation plants for assessment purposes should be valued likewise for tax assessment purposes.

Even applying the cost approach, the starting point is the replacement facility, which is the lowest LCOE generation facility. Thus, whether applying the reproduction cost new or the replacement cost new approaches, the legitimate starting point is the replacement facility having the least capital cost, same utility, and that produces the same output (which eliminates the need for or quantifies excess construction obsolescence). The assessor must account for all three forms of depreciation—physical, functional and economic (not just physical).5 Functional and economic obsolescence necessarily consider the market forces and their implications on value, thereby inherently addressing and incorporating the market's volatility (in particular, for determining economic obsolescence). In contemplating functional or economic obsolescence of CCGTs, the valuation must take into account the lower cost to operate renewables (as demonstrated by recent bids for solar and wind facilities), and the political forces seeking to reduce the carbon footprint, wherever found. Thus, not only are coal and nuclear facilities less valuable, but also, CCGTs.

That is, the paradigm change continues. CCGTs are being supplanted by (or plants proposed to supplant them with) renewable generation. As noted, the LCOE and bids for renewable generation are lower than CCGTs, which should further reduce electric prices, and continue or increase the surplus of electric generation in the marketplace. Thus, generation and capacity revenues decline further (in particular, peak load revenue). Like the impact on coal and nuclear when they were supplanted by CCGTs, the valuation of CCGTs should likewise decline. For example, sales of CCGT plants in Texas, following the wind farm construction and its generation being made available in eastern Texas, were at purchase prices lower than when the same plants were purchased prior to that wind generation. Yet, assessments for the CCGT generation assets, generally, have remained the same. As such, fossil fuel and nuclear generation property remain over-assessed.

As the underlying issue is market value, and the marketplace values electric generation by the income approach, then, the valuation of electric generation plants for tax assessment purposes should be likewise. However, the correct application of the cost approach should result in similar valuations, provided all forms of obsolescence are accounted for. Yet, normally, both functional and economic obsolescence are not considered. As a result, the market forces and their implications on the value of the fossil fuel and nuclear generation station are often missed. Similarly, payment in lieu of taxes or assessment agreements entered into ten or more years ago, are likely "reverse" Agreements (meaning the payments or assessments overstate what they should be under present market paradigms). Accordingly, owners of legacy fossil fuel and nuclear generation assets should carefully examine whether taxing authorities are overvaluing such assets.


1 ZECs are designed to compensate nuclear power units for production of zero carbon electricity, providing, a supplement to nuclear plant energy market revenues. The value of the ZEC is quantified based on the social cost of carbon and energy market prices, and it will vary: as market prices decrease, the ZEC value increases, and vice versa. New York, Illinois and Ohio have instituted ZEC programs. The New York ZEC program was challenged in Coalition for Competitive Electricity et al. v. Zibelman et al., case number 1:16-cv-08164, where the United States District Court for the Southern District approved the program. This decision is on appeal to the United States Circuit Court of Appeals for the Second Circuit (case number 17-2654), which has heard oral arguments.

2 Babcock, Appraisal Principles and Procedures (Washington, D.C.: American Society of Appraisers, 1980), p. 139; The Appraisal of Real Estate, 9th ed. (Chicago: American Institute of Real Estate Appraisers, 1987), pp. 16–20; The Dictionary of Real Estate Appraisal (Chicago: American Institute of Real Estate Appraisers,1984).

3 Orange & Rockland Utilities, Inc. v. Town of Haverstraw, 2006 NY Slip Op 51564(U) (Sup. Ct. West. Co. 2006) (J. Dickerson).

4 As natural gas prices declined and remained low, CCGTs were more competitive and cheaper to operate. Natural gas plant generation (mainly combined cycle gas turbines) supplanted coal generation due to sustained lower electricity prices in the wholesale marketplace (CCGTs produce electricity more efficiently and less costly than coal plants). The combination of lower electric prices with a general surplus of electric generation in the major deregulated markets (e.g., NYISO, PJM, ISO-NE, MISO and ERCOT), caused the value of nuclear and coal plants to decline.

5 Unfortunately the cost approach has often been applied to avoid the full impact of depreciation from all causes. Thus, for example, starting an appraisal with the cost to reproduce or replace a coal or nuclear facility, when no new coal or nuclear stations are being built, purposely inflates the valuation conclusion.

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Mark Lansing
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