Meltdown

t was hailed as the hallmark of government reinvention: The Clinton administration took the little known U.S. Enrichment Corporation (USEC), a wholly owned government corporation, and in 1997 flipped it to the private sector in hopes of saving taxpayers money and finding a more efficient way of doing business. The business model had been successful when Conrail was sold for $1.6 billion in 1987. Why then, privatization proponents argued, couldn't the same be done with USEC? After all, the federal government had little reason to be involved in the uranium enrichment business.

But the two privatizations have taken different paths. Conrail was fairly successful, restoring a viable freight rail system to the Northeast. Norfolk Southern Corp. and CSX Corp. bought and broke up Conrail in June 1999, ending its 23 years of monopoly. USEC's tenure has been far more tumultuous in a much shorter period. During the past two years, USEC's profits have fallen by a third, its stock price has dropped more than 70 percent, it plans to close down one of its two uranium enrichment plants and it has gone back to the government for financial aid. Three years after privatizing USEC, policy-makers are wondering what went wrong, while company officials are desperately trying to right the ship. Meanwhile, critics stand on the sidelines shouting, "We told you so."

USEC provides enriched uranium to fuel nuclear power plants. Since its customers are private sector companies, a government-to-business relationship did not make sense in the eyes of reinvention experts, who believed the exchange would be better handled in a business-to-business environment. Former Rep. Dan Schaefer, R-Colo., then-chairman of the House Commerce Subcommittee on Energy and Power, summed up the case for privatization during a February 1995 hearing: "This is a classic example of the federal government operating a business which would be run better-and more cost-efficiently-by the private sector."

But Schaefer was leery of making a mistake. "The task before this subcommittee is to ensure that American taxpayers receive a maximum return on their investment in the assets and technology of the corporation," he said. "Clearly, it is important that we ensure the long-term survivability of this new corporation in the private sector. It is crucial that the U.S. retain uranium enrichment capabilities, whether in the private or public sectors. I do not want to see the government forced back into this business because the USEC could not stand on its own two feet." Unfortunately, critics of privatization argue, that is exactly the situation now facing policy-makers. Since being sold in 1998, USEC has failed to set the financial markets on fire. It is doing just the opposite. The facts are indisputable:

• USEC's stock price dropped from a high of $14 per share at the initial public offering in July 1998 to $4.37as of Jan. 2, 2001.
• Profits fell more than $100 million, from $346.6 million in fiscal 1999 to $233.6 million in fiscal 2000.
• USEC's near dominance in global and domestic markets is threatened by an aggressive group of competitors.
• Its investment rating last summer was downgraded to junk-bond status.
• The company is shutting down its operations at one of its two production plants, forcing the Energy Department to pony up $630 million to keep the plant open.
• Company officials in 1999 asked Congress for $200 million to help pay the costs of a vital national security program USEC is charged with carrying out.
• A number of angry stockholders are suing the company claiming they bought into the IPO based on misleading information from USEC officials.
• A September 2000 report by the Nuclear Regulatory Commission suggests that USEC could be headed toward a complete meltdown by the end of the decade.
  

USEC's financial troubles have national security experts worried about the future. Thomas Neff, a physicist at the Massachusetts Institute of Technology, and one of the men credited with coming up with the idea for the U.S.-Russian "Megatons to Megawatts" deal, says it is unlikely that USEC can fulfill its national security role if its economic slide continues. Even high-ranking Russian officials have their doubts. "I have some concerns regarding the situation with the USEC company," Yevgeny Adamov, minister of nuclear energy for the Russian Federation, said during a July 24 speech to the U.S. Secretary of Energy Advisory Board. "Some time has passed since the USEC privatization, and we fear that the current status of the company can complicate further implementation of [the agreement]. On the one hand, we are worried that this economically ineffective company may be tempted to blame the agreement for its own losses. We do not understand why the agreement in this particular case shall compensate the USEC for its low economic efficiency."

If USEC cannot fulfill its obligation to buy Russian uranium, policy-makers will have to make a tough decision. They can find another company to act as executive agent or hand off the responsibility to the Energy Department. Doing the latter would cost taxpayers billions and require several members of Congress and former executive branch officials to admit that they erred in the first place. Or, policy-makers can decide to subsidize USEC. Indeed, Congress almost came to that point in the fall of 1999 when company officials asked Congress for $200 million to help pay for uranium purchases from Russia. USEC even threatened to withdraw as executive agent. Members of Congress and the Clinton administration were irate. According to a former Energy Department official, the administration started talking about the possibility of pulling the plug on USEC's role in the Russian deal. By December 1999, USEC retreated from its threat.

Removing USEC from the Megatons-to-Megawatts agreement presents challenges to domestic energy supply too. Nearly 50 percent of USEC's annuals sales of low enriched uranium come from Russia. Without that supply, many of USEC's customers could be forced to turn to foreign uranium producers. USEC's threat to withdraw as executive agent also raises questions about the government's ability to find a new executive agent. A December General Accounting Office report, "Nuclear Nonproliferation: Implications of the U.S. Purchase of Russian Highly Enriched Uranium" (GAO-01-148) criticizes the Clinton administration for not adequately monitoring USEC activities, a job given to the Enrichment Oversight Committee. President Clinton created the committee by executive order in 1998 and staffed it with top officials from the National Security Council and the Energy and State departments. GAO found that the committee has failed to fulfill all of its legislative responsibilities. Most importantly, the committee is required to develop a plan for replacing USEC should the company no longer be able to carry out its national security obligations.

"However, the committee had no procedures when USEC considered resigning as executive agent in 1999 and continues to lack a contingency plan, should USEC need to be replaced in the future," GAO found. "Furthermore, the committee is only beginning to conduct the required analysis of the impact of the agreement on the domestic nuclear fuel industry."

USEC's story shows what can go wrong when public and private sector interests intersect. In turning a national security program over to the private sector, policy-makers put USEC's fiduciary obligations in direct competition with its role as an agent of the federal government, says Ronald Moe, a specialist in government organization and management at the Congressional Research Service. Speaking on condition of anonymity, a USEC official puts some of the blame for the company's financial instability on Congress and the Clinton administration.

When privatization legislation was moving through Congress in 1997, lawmakers saddled USEC with restrictions that would hamper nearly any private sector company. For instance, the legislation prohibited USEC from laying off more than 500 workers in the first two fiscal years of operation. The company also had to keep its two aging production plants open through Jan. 1, 2005. Those plants happen to be located in states that were considered up for grabs in the 2000 presidential elections-Kentucky and Ohio. Further, there is a three-year prohibition on the sale of more than 10 percent of the voting stock to a single entity.

These restrictions left USEC vulnerable to fierce global competition, plummeting prices and overcapacity. "Even before privatization, the U.S. government uranium enrichment enterprise faced increasing global competition," says Charles Yulish, USEC vice president for corporate communications. "Until the 1970s, the U.S. government had 100 percent of the world market. When it could no longer meet growing worldwide demand, other nations developed their own commercial enrichment operations. The U.S. faced three new rivals [Uranco, a British-Dutch consortium; Eurodif S.A., which is controlled by the French government; and Russia's Tenex] that were increasingly selling aggressively in the global market-including the United States. Those competitors have the advantage of newer enrichment technology and we believe they have been violating trade laws requiring fair pricing. They have been dumping uranium to gain market share in the United States, materially damaging the U.S. enrichment industry."

Additionally, oversupply in the market has depressed prices. USEC has seen prices drop from more than $100 for a unit of its product in 1998 to about $80 for a unit now. Yet production costs have not come down. Critics charge that USEC is partially responsible for the oversupply. The company in the late 1990s started selling off a portion of its reserves, which had been transferred from the Energy Department during privatization. Nonetheless, the statutory restrictions make it impossible for the company to respond to a changing marketplace, USEC officials argue.

Path to Privatization

It should come as no surprise that USEC is at the center of a debate over how, when and whether the federal government should engage in privatization. Despite support from Democrats and Republicans, USEC has found itself mired in conflict at every step along the path to privatization. Uranium enrichment privatization traces its roots as far back as the Nixon administration. In November 1969, President Nixon asked the Atomic Energy Commission to operate its uranium enrichment facilities as a separate organization "in a manner which approaches more closely a commercial enterprise." Nixon's goal was to eventually sell the operations to the private sector, according to a Nov. 10, 1969, White House press release.

It wasn't until 1992 that Congress finally took up the privatization question as part of the Energy Policy Act. The law turned USEC into a government corporation and set the wheels in motion for an outright sale. As a government corporation, USEC was required to act like a business. It had to make a profit and was no longer supported by tax dollars. In fact, it had to pay dividends to the U.S. Treasury, which it did to the tune of $30 million in 1993, $55 million in 1994 and $120 million in both 1995 and 1996. The 1992 law also required USEC's board of directors, all presidential appointees at the time, to develop a privatization plan and submit it to Congress and the President. As USEC was studying privatization, the Clinton administration in 1993 struck the historic deal with Russia to buy 500 metric tons of uranium. The 20-year deal was worth $12 billion. The privatization plan was finished in 1995. It called for a dual track, recommending that the board simultaneously pursue a negotiated sale and a stock offering. Doing so would meet one of the main criteria of the energy policy law: ensure that the government got the best possible price. Many high-profile bidders were rumored to be interested in purchasing USEC, including Westinghouse, Lockheed Martin and General Atomics. The plan called for a sale or public offering to be completed by March 1996. After several delays, it was determined that selling stock would maximize returns. In 1996, Congress passed the USEC Privatization Act and in July 1998, the Treasury Department authorized the sale of 100 million shares of stock, netting $1.9 billion.

A Question of Ethics

How the board reached its decision is at the center of the USEC controversy. Minutes of all the board meetings were kept confidential until after privatization. They were not made public until 1999 after labor unions sued to gain access. The unions feared that privatization would threaten jobs since company officials, beholden to stockholders, would look for ways to cut costs. In a strange twist, one of the unions that sued-and today stands as a chief critic of privatization-was once a proponent of the idea. The Paper, Allied Industrial, Chemical & Energy Workers Union, in 1996 teamed with Pleiades Group, a New York-based consortium headed by former Commerce Secretary Robert Mosbacher, to buy USEC from the government. Union officials claim Pleiades had a far more viable privatization plan. Only when it became clear that an IPO was the favored route, however, did the unions mount an aggressive campaign to halt privatization.

Rep. Ted Strickland, D-Ohio, says that shroud of secrecy allowed company insiders to exert considerable influence on the sales process in order to win an IPO, which was in their self-interest. If another company had acquired USEC, it could have put its own people in charge. USEC officials were better off under the IPO scenario, says Richard Miller, a policy analyst for OCAW. Not only could the USEC board stay in power, but members could benefit financially. That's just what happened. William Timbers, president and chief executive officer, for instance, made $325,000 as head of USEC when it was a government corporation. His annual salary jumped to $600,000 as head of the private company. In 1999, he received a $600,000 bonus and stock options valued at more than $1 million.

"I have always had a suspicion that there were people who were motivated by self-enrichment," says Strickland, whose congressional district includes USEC's Ohio plant. "Do conflict-of-interest rules mean anything to someone like [Timbers], whose salary was $325,000 from a public entity, and after being involved in the process, goes up to $2 million or so? What can be more of a conflict of interest than that?" he asks.

Federal ethics standards bar government employees from participating in decisions that affect their personal finances, but William Rainer, USEC's chairman at the time, granted Timbers a waiver so he could take part in the debate over how to take the corporation private. USEC officials declined to comment on salary increases after the IPO.

According to a former Clinton administration official, a determining factor in conducting an IPO was a pledge by USEC executives to continue work on a laser-based uranium enrichment technology known as Atomic Vapor Laser Isotope Separation (AVLIS). The Energy Department had spent nearly $2 billion testing the technology. At the time of privatization, USEC officials said AVLIS would improve efficiencies at the Ohio and Kentucky production plants, and reduce energy costs as well. At a June 3, 1998 board meeting, Timbers said, "every day that privatization is delayed is a delay of deployment of AVLIS." He assured the board that AVLIS would be in the company's future despite the fact that competitors discounted the technology, saying it was not commercially viable. USEC killed AVLIS shortly after privatization. The move stunned administration officials. Former Energy Secretary William Richardson, writing USEC officials in late 1999, said he was "surprised that this [suspension] decision would take place so soon after privatization. . . . I understood that USEC considered AVLIS as an asset for its future viability."

In explaining the decision, Timbers told the House Commerce Oversight and Investigations Subcommittee last April that the rate of return on investments in AVLIS failed to make it commercially viable. Stopping work on AVLIS left USEC with no immediate plans to update technology at its aging Ohio and Kentucky facilities. Shutting down AVLIS also set off warning lights at the Nuclear Regulatory Commission, which is charged with certifying USEC's operations.

"We figured there were going to be some difficulties," says Robert Pierson, division director of fuel cycle, safety and safeguards at NRC. "We could see that the stock was declining in value. We could see they were having trouble paying dividends. As early as [summer 1999], we started monitoring them. Clearly, one should understand that if the flagship technology is canceled, it could have a detrimental effect on the long-term status of the company." During the past year, the company has invested in a new laser technology still years away from being tested in a real-world environment.

Tough Decisions

Having fallen on hard times, USEC officials are now faced with making some tough economic decisions. In June 1999, the board of directors authorized a buy-back of 10 million shares of stock through June 2001. Last February, the board expanded that by 20 million shares through the same period. A chain reaction of negative news followed the buyback expansion. Wall Street analysts downgraded the company's stock to junk-bond status. Once that happened, the NRC was required by law to launch a full-scale investigation into USEC's finances. Copies of the final report, kept confidential, were delivered to members of Congress and national security advisers in September. The report, obtained by Government Executive, shows that unless drastic steps are taken, USEC's costs will continue to rise and cash flow will continue to fall. The company could reach total meltdown within five years. Slipping to junk-bond status also triggered a provision in the 1996 privatization law allowing USEC to close one of its production plants before 2005. The company plans to shut down operations at the Ohio plant by June. Doing so will cut USEC's fixed production costs by $55 million in 2002.

"Given our Russian purchases, slackened worldwide demand and other factors, including very aggressive sales and dumping by our competitors, our two enrichment plants are operating at only about 25 percent of capacity," says USEC's Yulish. "Faced with those factors, in order to better compete, we made the tough decision in June to consolidate all of our production at our enrichment plant in Kentucky and cease enrichment at our Ohio plant in June 2001."

During the presidential campaign, the Clinton administration said it would ante up $630 million to keep the Ohio plant open and save 1,200 union jobs. The money is in a trust fund left over from USEC's public offering. Its intended purpose is to pay for expenses associated with privatization; a former Clinton administration official says those expenses include the plant closure.

But Rep. Thomas Bliley, R-Va., former chairman of the House Commerce Committee, thought otherwise. Last October, he wrote to Richardson questioning the legality of the move. During the presidential election campaign, George W. Bush said he, too, wanted to keep the Ohio plant operational. The plant will be kept on what is called "cold standby," meaning it could be brought up to full operation without a major ramp-up. It could also be reengineered to accommodate a new laser-enrichment technology the Energy Department is testing.

Watch the Money

While acknowledging that USEC has not met its shareholders' expectations, former Clinton administration and USEC officials refuse to say they were wrong. They point out that USEC still is in business and still is carrying out its role as executive agent of the deal with Russia. They note that USEC recently renegotiated the deal to ensure that prices for its uranium ebb and flow with market conditions. (The original contract locked USEC into a nonnegotiable premium price.) Additionally, USEC reported in December that it was ahead of schedule in implementing the 20-year deal to buy the enriched Russian uranium.

"As Deep Throat said, 'To understand this you have to keep your eye on the money.' While this is a national security undertaking, the simple fact remains that someone has to pay Russia for this material," says Yulish. "The government did not opt to use $8 billion of taxpayer money. They opted instead to go the commercial route and to have an executive agent buy the enriched uranium and sell it to utility customers to fuel their nuclear power plants. USEC has been proud to be the executive agent of the "Megatons to Megawatts" program since its inception nearly seven years ago, even though the market price declines for enriched uranium have made it unprofitable for the past few years."

A former Treasury Department official adds that the true measure of the success of the privatization is whether USEC is fulfilling its obligation as executive agent of the deal with Russia, not how it is performing on Wall Street. Still, MIT physicist Neff points out that in July, the three-year restriction on any single entity buying more than 10 percent of USEC voting shares expires. "When that happens, someone can come in and buy shares and liquidate the company. Do we really want the [Russian deal] tied up in liquidation?" says Neff. "They will be liquidated if nobody acts. That's a dangerous proposition. The U.S. should not let it get to that point."