Doug Brown Goes Nuclear

To view this article in digital magazine format, click here.

Energy giant Exelon’s CIO delves into the niche domain of nuclear decommission trusts (NDTs)—and the complex portfolios that result from the need to restore these sites to their original state one day in the future.

“I'll caveat—there are a lot of caveats here—and say that I had absolutely no idea what a nuclear decommissioning trust was four years ago. At the time, Exelon was changing the way we managed our assets, and so I was hired and given a crash course in these things. Essentially, it’s money set aside to some day take down all the nuclear plants in America and restore the sites to what they were before the facilities were there. Exelon has 11 plants, with 21 nuclear units, that will need to be decommissioned and most of them will last until 2030 or 2040—so we have about $8 billion set aside in 42 trusts to some day decommission all those physical assets. Storage of the spent fuel is still up in the air—Yucca Mountain in Nevada was the chosen site, but politics got in the way—but we basically need the capital to restore those sites to what they once were. That may sound simple, but this is a complex business. What makes it difficult is that all the trusts are taxable, unlike a pension. It’s quite cumbersome structurally, as each nuclear unit has two investment trusts at two different tax rates—thus the 42 trusts. From an investment point of view, on the surface it appears to be almost the perfect investment vehicle—long-dated, very little liquidity constraints to speak of, with little paid out before decommissioning begins. The industry, in fact, has had a fairly basic investment approach. They began with the ‘Black Lung’ rules, with a lot of munis and T-bills, but that was liberalized in the mid-1990s. Since then, the assets have largely been in tax-advantaged equity and fixed income—yet we’ve introduced alternative assets to this investment platform, building up our private equity and real-estate holdings, and introducing better hedges. There is no reason why not to, really. This is just a big institutional pocket of capital, but they’ve historically never looked like institutional portfolios. It’s all costs you’ll incur 30 years from now, so inflation is the biggest risk to the whole process. Despite the move into alternatives, we definitely have a liability-based approach for both our pension and NDT pools. The difference is that interest-rate risk is huge in the pension liability, and it can drive P&L consequences and massive contribution volatility. That’s why the majority of corporate plans have taken, to some degree, a liability-driven investment approach. You don’t have that in the NDT—there is no drop in interest rates that would cause contributions. They are well-funded. The severe interest-rate component is not present in an NDT. I don’t know if there is a close investment cousin. Endowments and foundations have to pay out a certain amount every year, with liquidity needs ongoing, as do pension funds. I think of NDTs as a huge, bullet-payment way out in the future. In 2044, for example, we’ll start to decommission a site—and it’s a long process—but the money would be drawn down quickly, over a seven- to ten-year period. The big thing is to be tax-efficient; it’s extremely important to be tax-efficient. The one word associated with NDT is complexity. It’s a complex structure, a complex tax situation, with a complex number of methods to determine the funded status—everything about them is complex. We’ve tried to set aside all the noise, if you will. We’ve set aside the fact that the structure is hard, the taxes are complicated—we can deal with that. So we take a step back and ask about the best way to invest this portfolio and meet the obligations. When you set it all aside, it’s not too dissimilar from what other liability-focused investors are trying."