/ 19 February 2015

SA’s nuclear deal with Russia is far from done

The agreement as it stands will be binding for 20 years and indemnifies Russia against liability in the case of a nuclear accident.
The agreement as it stands will be binding for 20 years and indemnifies Russia against liability in the case of a nuclear accident.

Russia has emerged as an apparent frontrunner to participate in South Africa’s nuclear build, but selecting the technology is just the first of many challenges that could see a nuclear deal such as this come a cropper.

With the Russian economy in turmoil and the subsequent high cost of borrowing, its ability to raise the funding for its nuclear ambitions in many countries is being called into question – as is its ability to deliver on time.

For South Africa, it is even more of a mystery how the government will provide the loan guarantees that would be required, given that so many have been extended to ailing parastatals such as Eskom and SAA. The state may have hit its limit.

Regardless of which vendor is chosen, the guarantees and the government’s 50% localisation target for the project appear to be insurmountable obstacles, particularly given the challenges faced by the domestic construction industry.

The memorandum of understanding signed between Russia and South Africa last year is far more than a generic agreement, as the government had claimed it is. Rather, it lays the groundwork for government-to-government contracting, in terms that heavily favour Russia, the Mail & Guardian reported last week.

Not only will the agreement be binding for 20 years once in force, but the Russians will also be indemnified from any liability arising from nuclear accidents during the reactors’ life. Russia is also granted a host of regulatory concessions and favourable tax and other financial treatment. The designated competent authorities are South Africa’s department of energy and Russia’s Rosatom State Atomic Energy Corporation.

But unresolved issues could make the deal unworkable. An industry expert, who did not wish to be named, said: “My own view is I don’t think the guys driving it from the South African side have joined the dots. I don’t have huge confidence in the people running it and that they understand the issues.”

Despite the apparent commitment to forge ahead with Russian technology, the agreement defers a decision about funding.

The Russians are known to have offered South Africa a “build, own, operate” construction deal, according to which Russia would build and run the nuclear station, and sell the power to South Africa at an agreed price. This kind of vendor-assisted financing may be the only way South Africa could afford to go nuclear. But the bigger question now is: Can Russia?

First, sanctions have been imposed on Russia for its military intervention in the Ukraine. Then the oil price tumbled, severely hitting government revenues, which are heavily reliant on oil and gas taxes. Subsequently, the rouble has lost almost 50% of its value since the start of 2014, inflation has soared to 15%, and its sovereign credit rating was cut to sub-investment grade by one agency in January. And, in 2014 alone, $151-billion was taken out of the country.

Some nuclear economists and industry insiders believe this dire state of affairs could affect Russia’s nuclear ambitions, as new builds involve high upfront costs and are extremely sensitive to the cost of financing, which is mainly the interest rates at which the funding is secured.

Russia’s 10-year bond yield – the interest it pays on money it borrows in the market – shot up to 12% in February, which compares poorly with other emerging economies, such as South Africa, which has a bond yield of 7%.

“It was always extremely doubtful whether Russia could provide the finance for all the nuclear power projects it claimed to be close to winning well before the oil price collapse,” said Steve Thomas, a professor of energy policy at the University of Greenwich.

He said it was important to note that South Africa was also not the only country with Russian nuclear build in its sights – Iran, Belarus, Turkey, Bangladesh, India, Vietnam, Hungary, Finland and Jordan are some of the others on the list that would all need Russian finance for the projects to go through.

“Most of these markets are ones that almost any other vendor would leave running and screaming from,” Thomas said. The exception was China, which was increasingly competing for these markets and was in a better position to provide financing, although its technology was not as mature.

But Peter Attard Montalto, an emerging markets economist at Nomura, said the money would be provided by Rosatom’s financial arm, which has a huge cash pile, and local banks, and through government and quasi-government financing options.

“Certainly, their funding from local banks will dry up, but I wouldn’t say the overall current situation would impact their ability to fund programmes. Remember as well, they are basically providing funding for their own construction. It’s kind of circular. As such, it’s not one lump sum upfront.”

A Rosatom spokesperson said Russia’s credit rating would not influence the corporation’s plans for nuclear builds abroad.

“The structure of our funding sources is protected from the direct impact of such decisions made by Western rating agencies. For example, many projects abroad are financed through government credit in the form of state loans. It was implemented, for example, in Bangladesh and Vietnam.”

The spokesperson said another financing option was “bringing in resources of the national wealth fund”, as was the case with one Finnish nuclear power plant in which Rosatom owns shares.

But, as reported by Bloomberg in December, Russia’s finance minister warned the country would burn through its wealth fund reserves in three years if the government didn’t change its budget structure.

Rosatom said it had been resilient in hard times and its book of foreign orders had grown steadily, despite the economic turmoil of 2014, and its 10-year portfolio of export orders had gone up from $72.7-billion to $100.3-billion.

The unnamed industry expert, however, expressed concern that Russia might commit itself to a further agreement but not honour it. He said other nations that had signed nuclear deals with Russia, such as Vietnam, India and Turkey, had all experienced delays.

In Vietnam, the start of construction had been pushed back from 2014 to 2016 to ensure “the highest safety and efficiency standards”, according to its prime minister. In Turkey, which had chosen the build, own, operate model that South Africa is said to favour, there had been many delays. According to a Reuters report, the most recent delay had been caused by the Turkish authorities, which had asked Rosatom to review and resubmit a key environmental report. They said the previous two had not met their criteria.

But there are a wide range of domestic issues that stand in the way of the government’s nuclear ambitions. For one, most of the vendor-funding models will require government guarantees, but South Africa has hit the ceiling of what can be considered prudent and could scare off investors if it issues further guarantees, much less for something as large as a nuclear build, which is estimated could cost R1-trillion.

Leon Louw, the director of the Free Market Foundation, said South Africa would probably have to underwrite the deal. “But can we do it? What will it mean for our credit ratings? Will it reduce us to junk?” he asked.

The government has said the project should be about 50% localised, but the domestic industry faces challenges in achieving this. “It’s not going to happen,” the expert said.

At a nuclear forum, which took place in in February 2013, Yves Guenon, the managing director of Areva Africa, said that only 10% of local companies audited by the French nuclear entity would have qualified for a nuclear build at that time.

There is concern that this percentage could be even lower if the construction firms that colluded to win tenders, particularly for infrastructure for the 2010 World Cup, have been deregistered from the Construction Industry Development Board.

In 2013, the board announced it would investigate whether those companies who colluded should be deregistered. This would, in effect, bar them from getting government tenders. The firms involved are some of the largest in the country. The board was unable to provide an update on its investigation this week.

Louw said the deregistration of these firms could be problematic for the nuclear build. “I foresee a really big problem and an almost insurmountable problem,” he said. “If those companies are excluded, we will not be left with the capacity in South Africa to build a nuclear power station or another Kusile or Medupi for that matter … the situation is best left alone.”

However, in 2014, Business Day reported that Trade and Industry Minister Rob Davies told MPs that a group of companies were acquiring the international qualifications needed to work on a nuclear build.

The construction industry’s share prices have been driven down partly because of the threat of deregistration, and the sector’s cumulative market capitalisation is currently less than R60-billion, raising the question whether it would be able to afford the performance guarantees that would be required.

The industry expert said: “If a pair of reactors were R150-billion for 3GW or so, and let’s say you localise to 40%, that’s R60-billion. And the bonds and the performance guarantees you have to put up [as a construction company] amount to 30% or 40% of that, so you will end up having to put down at least R20-billion in performance guarantees. Your shareholders are not going to allow you to bet the whole farm …

“Five years ago, the industry was very keen on this, but companies are diversifying out of this space, which they don’t trust anymore,” they said.

Louw said there was another option. “If government wants to be the buyer, it should call for tenders. Let nuclear providers, coal and gas providers bid and offer competitive prices,” he said.

  • Clarification

In a previous version of this article it was stated that: Yves Guenon, the managing director of Areva Africa, the French nuclear entity, said previously that only 10% of South African engineering companies would qualify for a nuclear build.

The writer has further clarified this statement to read as follows: At a nuclear forum, which took place in in February 2013, Yves Guenon, the managing director of Areva Africa, said that only 10% of local companies audited by the French nuclear entity would have qualified for a nuclear build at that time.