Had the project been canceled instead, Southern Company's shareholders, rather than its ratepayers, could have potentially been on the hook for billions of dollars of unrecoverable losses.
That's a key reason why SO's stock rallied moderately on the news. A short-term hit to the firm's financial health appears to have been avoided, and its dividend safety outlook remains unchanged.
But there's more to the agreement reached this week that could have implications for Southern Company's longer-term outlook.
As a refresher, the nuclear project has four owners with the following stakes:
- Southern Company's subsidiary Georgia Power: 45.7%
- Oglethorpe Power: 30%
- Municipal Electric Authority of Georgia (MEAG): 22.7%
- Dalton: 1.6%
In August, Southern Company announced another $2.3 billion cost increase was expected to finish the project, triggering a clause in its ownership agreement that required at least 90% of ownership to vote to continue the project, or else it would technically be canceled.
On Monday, Southern Company, MEAG, and Dalton all voted to move forward. However, Oglethorpe Power's 30% vote was needed to hit the 90% threshold to continue construction.
Oglethorpe agreed to move forward on Monday, but the firm demanded that Southern Company be on the hook for any future cost increases above the latest budget estimate:
"Since commencement of work on Vogtle 3 and 4 over a decade ago, the project’s partners have faced an ongoing series of cost increases. The latest, as Southern Company now projects, is an additional $2.3 billion since December 2017. Collectively, the overruns have expanded Oglethorpe’s share of the project’s budget from an initial estimate of $4.2 billion to approximately $7.25 billion.
With four years remaining on the construction schedule, Oglethorpe sought to protect electric cooperatives, and their rural energy consumers, and hold Southern Company accountable for its newly revised budget and let their owners be responsible for any additional amounts beyond this level."
This set off a flurry of negotiations between the co-owners. Again, if a deal could not be reached, the project would be canceled with billions of dollars of losses on the line. The U.S. Department of Energy even said it would likely require the more than $5 billion of 25-year loans it provided for the project to be quickly repaid if the project did not move forward. The stakes were high.
An agreement was finally reached late Wednesday afternoon. You can read Southern Company's entire statement on the new deal's terms here.
The main takeaways are summarized below, starting with the firm's obligations if the project's overall price tag unexpectedly heads higher. That was arguably the biggest point of contention and posed the greatest risk to the firm's dividend if the project encountered future challenges:
- Southern Company will be on the hook for a higher proportion of any additional costs incurred beyond the latest budget estimate. Specifically, Southern Company must pay 55.7% ($80 million more) of cost overruns between $800 million to $1.6 billion and 65.7% (a further $100 million) of cost overruns between $1.6 billion and $2.1 billion.
- If the latest budget is exceeded by more than $2.1 billion, the other Vogtle owners could sell a portion of their interest to Southern Company in exchange for Southern Company's agreement to pay 100% of their remaining share of costs in excess of the $2.1 billion overage. Southern Company would also have the option of cancelling the project instead.
In other words, Southern Company appears to have greater cost protection than what Oglethorpe Power initially demanded. Its share of additional project costs up to $2.1 billion appear reasonable and unlikely to jeopardize the dividend in such a scenario.
Furthermore, the ownership agreement was modified to give Southern Company significantly more control over the project's continuation regardless of what happens:
- If construction cost estimates increase again, it would no longer require a vote by the co-owners to continue the project. Additionally, Southern Company may cancel the project at any time in its sole discretion.
Simply put, Southern Company is even more in control of its own destiny now. And while the company is now somewhat more on the hook for any additional cost overruns, the utility will also disproportionately benefit if progress on the nuclear power plant exceeds expectations:
- If the project comes in under budget and is delivered on time (November 2021 for Plant Vogtle Unit 3 or November 2022 for Unit 4), Southern Company will receive a higher (60.7%) proportion of the cost savings.
This seems particularly important for co-owner MEAG, which is locked in heated litigation with Jacksonville Electric Authority (JEA) over their 20-year power purchase agreement. JEA wants to scrap the agreement it signed in 2008 in light of all the cost overruns significantly increasing their power costs.
To mitigate this risk and help ensure that the project can continue, here's an addition the Vogtle co-owners made to their agreement:
- If MEAG is unable to make its payments due to the conduct of JEA, Southern Company will purchase from MEAG (at a discount) the rights to PTCs attributable to MEAG's JEA-related share of Plant Vogtle Units 3 and 4. Southern Company would also assume MEAG's right to vote.
Overall, the agreement Southern Company reached with its co-owners appears to be very fair and provides the troubled project with greater visibility. The risk of the project being canceled, which had the potential to force shareholders to shoulder billions of dollars of losses, has diminished over the short to medium term.
However, the stakes are still high. If nothing else, the last decade has shown just how complex and costly it is to construct a new nuclear power plant. The two nuclear reactor units under construction are not expected to come on-line until November 2021 and November 2022, and Southern Company still expects to spend more than $4 billion to get the project to completion.
That's a lot of time for additional technical challenges to emerge which could leave Southern Company's shareholders on the hook for additional losses or even force the firm to ultimately cancel the project if unexpected issues are bad enough. In that case, however unlikely it may be, the utility's dividend safety would need to reevaluated. For now, Southern Company's payout appears to remain on solid ground.
With that said, until more construction progress is made over the next few years, these issues seem likely to continue weighing on investors' confidence and thus Southern Company's stock performance. Income investors still need to have a lot of patience to hold this stock, but hopefully Southern Company can return to being a much less exciting regulated utility investment sooner than later.