Iran's nuclear path - A justified mistake (part 3)

By Zam Armatay, 24 January, 2007

In the first part of this article I pointed out that the policy of continuing the current nuclear program by the Iranian government might be justified considering the geopolitical situation of Iran, while in the second part of the article I argued that it is not the right strategy concerning the national security of Iran. In this part of the article we'll have a look at the economy of the nuclear energy in general and the economic consequences of persuading the nuclear program for Iran.

The economics of nuclear energy

About 16% of the world's electricity supply comes from nuclear power, and global energy consumption is growing rapidly. The International Energy Agency projects a doubling of world electricity demand by 2030, creating the need for some 4,700 GWe of new generating capacity in the next quarter century. Hence it is conceivable that the demand for generating electricity by nuclear plants will increase in the future.
However the economics of nuclear power is highly controversial, and there is no universal agreed cost-benefit analysis of the nuclear power, simply because there are so many factors affecting the costs of constructing and operating nuclear power plants. For instance the building of new commercial nuclear power plants has ceased for years now in the U.S. and most of Western Europe, while as of 2006 new nuclear power plants are under construction in several Asian countries, as well as in Argentina, Russia, Finland, Bulgaria, Ukraine and Romania.
It is important to distinguish the key elements in the cost structure of a nuclear power plant and compare these with the costs of other modes of electricity generation. National and local circumstances and conditions are nevertheless crucial in these evaluations. Both the magnitude and the timing of costs are variable for different technologies and are very location-dependent.
With significant costs and revenues occurring at different times in the operating lives of all modes of electricity generation, a discount rate has to be chosen to bring (“levelize”) these to a common basis, in order to allow economic comparisons. This discount rate is sometimes set by a public authority as a target rate of return on capital, but in a liberalized market is effectively the rate of return required on the project by financial markets – in other words, the cost of capital (a weighted average of the interest rate on any loan capital and the required return on equity). The levelized cost of electricity (LCOE) is the price needed to cover both the operating and annualized capital costs of the plant and is used as a marker for economic viability.
There are several important determinants of the cost of electricity generated by a nuclear power plant. Some of these are intuitively clear whilst others are less obvious. The usual rule-of-thumb for nuclear power is that about two thirds of the generation cost is accounted for by fixed costs, that is, costs that will be incurred whether or not the plant is operated and the rest by running costs. The main fixed costs are the cost of paying interest on the loans and repaying the capital, but the decommissioning cost is also included. The main running cost is the cost of operation, maintenance and repair rather than fuel. However, as is shown below, there is a huge degree of variance in the assumptions made for these parameters from forecast to forecast, so the broad split should just be seen as indicative.
Recent studies show that capital costs including accrued interest account for around 60% of the levelized cost of electricity (LCOE) of a new nuclear plant. Fuel costs for new nuclear plants (including spent fuel management) account for only around 20% of the LCOE and is very competitive comparing to other fuels like gas and oil. Operations and maintenance (O&M) costs are very variable for nuclear plants, depending on factors such as plant size and age but on average account for 20% of the LCOE.
However, the assumption of low running costs was proved wrong in the late 1980s when a small number of US nuclear power plants were retired because the cost of operating them (excluding repaying the fixed costs) was found to be greater than cost of building and operating a replacement gas-fired plant.
It is also worth noting that British Energy, which was essentially given its eight nuclear power plants when it was created in 1996, came close to bankruptcy in 2002 because income from operation of the plants barely covered operating costs. This was in part due to high fuel costs, especially the cost of reprocessing spent fuel. Thus the operating cost may exceed substantially the generally agreed estimate of 20% of LCOE.
The importance of these very different cost schedules rises with the rate of interest levied. When interest rates are high, projects with high initial capital costs, such as nuclear, are disadvantaged in financial appraisals. Once capital-intensive power plants are completed, the capital costs and accrued interest must be recovered through a long operating life with fuel and O&M costs well below the prevailing electricity price. This has been the general experience with nuclear plants.

The economics of Iranian nuclear energy

As discussed above the overall cost of nuclear power plants depends in a great deal on national and local circumstances. Unfortunately there is yet no public cost-benefit analysis of the development of the various nuclear power plants in Iran.
In general the following costs may be considered:

1. The cost of constructing and operating nuclear power plants in general:
   
   • Construction costs (estimated around 60% of the overall cost)
   • Financing costs (depends on the interest rate and the relative cost of the capital. This is included in the construction cost, though may exceed substantially the estimated cost)
   • Operating costs (estimated around 20% of the overall cost, but may well exceed that)
   • Waste and decommissioning costs (relatively low)
2. The cost of nuclear fuel (estimated around 20% of the overall cost)
3. security costs including insurance and liability.

Considering the specific circumstances in Iran the above costs are a lot higher comparing to other countries such as Japan, China, Finland and so on. The construction of the underground nuclear sites constitute a lot higher cost than usually estimated for nuclear sites. Since the development of the nuclear sites are financed by the state, there is no credible evaluation of the financing

Booshehr nuclear plant

costs, but the delaying of the nuclear projects in Iran raises the financial costs substantially. For instance the 1000 megawatts nuclear powered electricity plant which is under construction in the city port of Booshehr on the Persian Gulf with the help of Russia should have been finished at a price tag of $600 million, has now costed Iran more than $800 millions and it is not certain that it would start working by this year, as promised by Russian companies.

The nuclear fuel is very cheap comparing to oil, gas and coal. However while the price of yellow cake, the ore for making uranium in the international market in 2006 is $40 per kilogram, experts have estimated that the cost of producing the same amount in Iran is at least double, partly because of the quality of uranium ore in Iran. This is one of the reasons why experts mean that the uranium enrichment program is not economically justifiable.

To the above costs we have to include the cost of security precautions against foreign attacks. Iran recently purchased 29 Tor-M1 missile systems for $1.4 bln (€1.06 bln) from Russia. The overall cost of securing the sites exceed far from that, and this is neither the first nor the last of the military contracts due to securing the nuclear program. Besides, the aggressive persuasion of uranium enrichment program has casted Iran in an arm race that will bring higher and higher costs. Of other costs one may include:

1. The economic costs of the sanctions posed by the UN Security Council resolution 1696 by 31. August 2006.
   
2. The effective cost of the uncertainty that the political isolation of Iran brings to the economy.

Clearly the aggressive persuasion of uranium enrichment is the main obstacle to reach an agreement with the West on the Iranian nuclear program. What is important to note here is that Iran may very well have a peaceful nuclear program, without the need to have a nuclear full fuel cycle capability. The uranium enrichment program due to obtaining the full fuel cycle capability is hardly justified from an economic point of view, particularly when considering the low nonvolatile cost of nuclear fuel in the international market. In fact the economic incentives proposed by EU-3 countries backed by US have been very generous from an economic point of view. The main incentives are:

1. To assist Iran with nuclear technology including "purchasing nuclear reactors". "provide a substantive package of research and development co-operation, including possible provision of light water research reactors, notably in the fields of radioisotope production, basic research and nuclear applications in medicine and agriculture."
2. "International guarantees of fuel supply", "access to the international economy, markets and capital, through practical support for full integration into international structures, including the WTO, and to create the framework for increased direct investment in Iran and trade with Iran."
3. Cooperation on various areas of economic development like "Energy Partnership", "Telecommunications Infrastructure", "High Technology Co-operation" and "Agriculture".

Although one may argue that it is advantageous in the long term for Iran to follow the strategic path of acquiring nuclear energy, it is quite disastrous regarding the current economic situation.

Current economic situation in Iran


The World Bank’s 2003 report about Iran noted, “Despite the growth in the 1990s, GDP per capita in 2000 is still 30 percent below what it was in the mid 1970s, compared with a near doubling for the rest of the world.” Iranians are galled to find that their country has slipped badly behind the Arabs on the south side of the Persian Gulf.
When Ahmadinejad came to power in 2005, the stock market plummeted, capital flight increased and real state market collapsed. To the rescue of Ahmadinjead and his new conservative government, oil and gas exports shot up from $23 billion in 2002-03 to $63.18 billion in 2006, driven entirely by higher prices. The oil exports have swelled government coffers allowing an explosion of off-budget spending that has sent economic growth shooting up to an average of 6.2 percent in 2006 (discounting for inflation) from 2002-03. Foreign exchange reserves have shot up to about $60 billion, more than twice the size of all foreign debt. While reported unemployment fell to an eight-year low of 10.3 percent last year, job creation remains insufficient to absorb the 700,000 young people entering the job market each year. The IMF forecasts that even if oil prices remain at their present high level, unemployment will steadily increase in years to come.

Ahmadinezhad’s policy is based on producing everything at home and creating barriers to trade. He has no use for globalization. His government has been discouraging foreign investors, for instance, refusing to allow Renault to use the billion-dollar facility it built in Iran to build an inexpensive car for the Asian market. The recent Iranian boom has been based almost entirely on profligate government spending which cannot last forever. Despite the flood of oil money, government policies are such that the IMF warns the budget will fall back into deficit again within two years even if oil prices remain sky-high.
The Iranian government relies on oil revenue to fund 75 percent of its expenditures, according to Karafarin Bank. Perhaps the most damaging for the Iranian economy is the energy subsidies, which are estimated by the Iranian government at $13 billion a year. The low gasoline price results in a massive loss of government revenue; just the cost of distributing the fuel after it leaves the refinery gate is more than what the customer pays. This, put together with the fact that more than 40% of the 350,000 barrels of gasoline sold daily is imported from abroad, shows the lack of any sound energy plans in the country. Few steps would help the Iranian economy more than forcing a reduction in gasoline consumption. Technocrats have long urged that the Iranian government ration gasoline, with only a limited amount sold at the controlled price and the rest at a market price. The IMF and World Bank have spent years documenting in great detail the pernicious economic and health impact of the excessive gasoline consumption. The IMF 2005 Article IV Consultation has strong language about the negative impact of the energy subsidies, which is also a major theme in the World Bank report Converting Oil Wealth to Development.

The latest objection to Ahmadinezhad's economic policy comes from fifty Iranian economists, who published an open letter to the president in June 2006, warning about the direction of the Iranian economy. Ahmadinejad's government "has been adopting an expansive monetary policy against the state macro policies... This, combined with political instability, international threats, and decreasing interest rates can wake up the sleeping inflation beast." (Officials put the inflation at between 12 to 15 per cent, but economists say it is closer to 25-30 per cent). The letter described the effects as being evident in "deteriorating foreign and domestic investment... escape of human and financial sources from the country and the consequent falling rate of economic growth."

Farshad Momeni, a prominent Iranian economist, warned that Ahmadinezhad’s economic policy follows that of Mohammad Reza Shah in the 1970s. During that time, the price of oil rose sharply and despite expert opinion, Shah personally interfered and injected the oil income into the national economy in order to accelerate the movement toward “the great civilization.”
Momeni warns that using the current oil income without wise economic planning will have terrible consequences and that a decline in oil prices would be disastrous for the national economy. After all, that was the experience after both the 1973-74 and 1980-81 price increases: within four years, the oil market got soft.

Iranian business community is nervous that international pressure on the economy could have a major impact on business confidence. “The [Tehran] stock market has shown to be hypersensitive to political issues (such as the course of the nuclear enrichment negotiations), as well as domestic economic policy uncertainties, ” writes the state-owned Karafarin Bank in its Survey of the Iranian Economy for October-December 2005.
In 2005, the stock market index fell 26 percent. At the same time, the banking system was hit by a crisis from dishonored promissory notes, primarily by big firms unable to pay their debts.

A March 2006 IMF report on Iran says "[T]he possibility of a prolonged period of 'wait and see' on the part of the private sector could adversely affect the economic outlook." Foreign direct investment, which was $500 million in 2004, has also since dropped significantly because of political uncertainties, according to the United Nations Conference on Trade and Development.

The two largest Swiss banks (UBS and Credit Swiss) and a large British bank (HSBC) decided recently that Iran was not an attractive place to do business, so they stopped taking new business. The impact that this is having was well described by the state-owned Karafarin Bank in its Survey of the Iranian Economy for October-December 2005:
“Most probably, the fear of imposition of sanctions by the UN against Iran, in connection with the nuclear enrichment issue, has reduced the reliability of Iranian banks as international trading partners. In other words, despite [an] important balance of payments surplus, Iranian banks have been facing difficulties dealing with their otherwise cooperative correspondents. This may prove to be for the banks and the country as a whole, one of the most important obstacles to hurdle in the months to come.”

Conclusion

Mr. Sa’id Leylaz, a leading economist, said recently that “the future of the nation has never been so dark, both politically and economically”. Well, I cannot agree more. And this is simply because the Iranian government are continuing the nuclear program at a very high price and at a very high risk to the country's security.

It is arguable that Iran may need nuclear energy in future, considering that Iran has the second largest gas reserves and fourth largest oil reserves in the world. The current economic situation does not justify such huge investments on the nuclear program either economically or politically, at the expense of much more urgent needs of the country like creating jobs, controlling the inflation, health, education, political stability, securing foreign investments, investment and redevelopment of the oil and gas industry and so on.

The option of stopping the nuclear program completely may not be very attractive now because of the huge investments that already have been made, but it is not too late to stop the uranium enrichment program. With that, Iranians obtain too little at a too high price.
What Iran needs at the moment is first of all political stability both inside the country and in the region in order to avoid a catastrophic confrontation with US and Israel, normalizing the relationship with the neighboring Arab countries and the European countries, and to create a suitable environment for investment, avoiding capital flight and attracting national and foreign investments.