The Russia-Ukraine conflict has put nuclear power back in the spotlight in terms of energy security in Europe. In contrast, China has never wavered in its nuclear power ambition. The sector's growth is accelerating, with half of the reactors under construction having been approved in the past three years. S&P Global Ratings views nuclear power as important to China's decarbonization and self-sufficiency goals.

On April 20, 2022, the State Council approved six reactors for construction, applying Chinese Gen III technology. We project annual investments of more than Chinese renminbi (RMB) 100 billion up until 2025.

This comes at a time when more of China's electricity is traded in open energy markets, putting downward pressures on tariffs. However, returns for nuclear power will remain predictable, in our view. This and state support are necessary, in order to attract the needed capital.

In Asia outside of China, though, the nuclear power story is more mixed. Lack of social support, wavering political stances, affordability and cost efficiency are creating more uncertainty for nuclear power in Japan, Korea, and India.

China's Nuclear Capacity Could Expand 7% Annually Over 15 Years

China remains steadfast in its support of nuclear power. The 14th five-year plan (2021-2025) suggests 70 gigawatt (GW) of operational units by 2025. These soft targets could be roughly met, in our view, given China currently has operational units of 54GW with 22GW under-construction.

S&P Global Commodity Insights, a division of S&P Global, expects operational capacity will grow to 67GW by 2025, 105GW by 2030 and 145GW by 2035. That implies over 7% annual capacity growth for the next 15 years.

This growth will occur in the coastal provinces, where generators are already located. The state has put on hold inland development due to river pollution concerns and insufficient water resources. Coastal provinces can only locally resort to nuclear power or offshore wind for nongas-based decarbonization given resource constraints. The small contribution of offshore wind means the nuclear option becomes a major low-cost base-load solution in terms of decarbonization and energy security.

China's nuclear-energy policy balances longer-term technology advancement against more imminent imperatives for emission-cutting. We believe the country may reserve some sites for its Generation (Gen) IV reactors, which will provide better safety and environmental benefits from a closed fuel cycle (i.e., recycling of spent fuel). Meanwhile the Gen III reactors under construction come with long-run disposal burdens of high-radioactivity spent fuel. We expect Gen III technology to be productive at least through to the 2040s, allowing sufficient time to reap cost benefits and economies of scale.

Chart 1

China has the engineering and construction ability to handle the growth, in our view. Its engineering, project management and equipment providers (state-owned electrical equipment companies) have the required value chain and talent pool to accommodate the accelerated growth. Tech-trade conflicts further emphasize the importance of localization of inputs, which has reportedly improved to 85% for newer units. All the under construction or approved-for-construction units apply either Chinese (Hualong One, i.e. HPR1000; CAP1000) or Russian technology (VVER-1200).

See our Appendix for details on provinces' individual nuclear-power target.

Annual Capex For Nuclear Expansion: RMB100 Billion Or More

By our estimates, China will start approving construction of six to eight new reactors annually over the next few years. Most of these will be built by, China General Nuclear Power Corp. (CGNPC; A-/Stable/--), China National Nuclear Corp. (CNNC; unrated), and State Power Investment Corp. Ltd. (SPIC; A-/Stable/--). The central government has extended nuclear operating licenses to include China Huaneng Group Co. Ltd. (CHNG; A-/Stable/--), one of the "big-five" major power groups.

Chart 2

Chart 3

Capital is sufficient to meet high investment needs for nuclear power. The required capital spending (capex) of RMB100 billion-RMB120 billion annually through 2025 is equivalent to 6%-8% of the three entrenched incumbents' adjusted debt as end-2020. Actual capex could be less than our estimates, given that serial production brings economies of scale and engineering improvements. Nevertheless, we estimate the incumbents will still spend more over the current five-year investment period (2021-2025) than the previous one.

Regulatory Advantages For Nuclear Power

China's consistent support for nuclear power is vital to attracting capital into the sector. Nuclear power has priority on-grid dispatch with high utilization hours (about 7,700 hours annually, or 3x-6x that of intermittent wind/solar power). The on-grid tariff is the lower of RMB0.43 per kilowatt hour (kWh) and provincial coal-power base-tariff.

We believe regulatory settings and relatively low fuels costs will continue to provide a satisfactory profit margin for nuclear power. The decarbonization goal will act as an incentive for coastal governments to shield the sector from much disruption amid electricity market reforms in China.

Close to 40% of the country's electricity output is now priced on open markets. Nuclear power's discount has been insignificant, at about 4%-5% lower than the regulated tariff (assigned on a per-reactor basis) over the past two years. Pricing downside is also protected by power supply structures—given the majority of power demand is met by thermal power (mostly coal), which has a higher marginal generation cost. Nuclear power indirectly benefited from trading premium last year when coal prices peaked in 2021.

In addition, nuclear fuel is rather low-cost and stable. Fuel cost of RMB0.05 per kWh is 20%-30% of the generation cost (including depreciation and amortization, as compared with a fuel cost of 70%-80% for coal-power given the commodity upcycle. Nuclear fuel supply contracts are supported by long-term contracts with general immunity to spot markets, analogous to past liquefied natural gas (LNG) markets. China also stocks many years of uranium fuel and operators are expanding overseas mines.

That said, profitability could be lower than in the past. We estimate the approved Gen III tariffs are just 7% higher than Gen II reactors, even though the investment cost of Huarong One is 15%-20% higher for the new technology.

Credit Quality Can Withstand The Coming Investment Cycle

High capex won't materially weaken the financial standing of CGNPC and CNNC. These companies are entering the expansion phase after reaping profits from an expanded operational fleet, half of which became operational in the 13th five-year period (2015-2020) (see chart 5).

We expect leverage to be stable at around 10x despite heavy investment over the next few years. Debt for CGNPC and CNNC has grown 10%-14% over 2015-2020. Yet leverage (debt to EBITDA) stayed below previous peaks of 12x as EBITDA kept pace.

A favorable funding profile is critical to large upfront investments like nuclear. In general, it takes five to six years before a project is up and running, and nine years for first-of-its-kind French (European pressurized reactor) and US. Gen III technology (AP1000) in China. The International Energy Agency, in a 2019 report, estimates that if a nuclear facility's weighted cost of capital rises above 7%, capital charges would make up more than half of generation cost.

Long-dated cost-effective project loans from state-owned banks fund the majority of investments for China's nuclear sector. Government commitment to project completion means cost-overrun is taken care of without much hassle. Interest coverage is manageable. For example, CGNPC's funds from operations (FFO) to cash interest dipped to 1.8x during 2013-2014 when the company had six reactors running and 18 under construction. If excluding interest during construction that's capitalized, the ratio would have been around 3.5x.

Chart 4

Equity funding can also partly help with leverage. For example, CGN Power Co. Ltd, the listed nuclear power subsidiary of CGNPC, raised RMB12.3 billion equity in 2019 through a domestic IPO. Wind/solar's equity funding were impaired by subsidy delay woes until recently. In comparison, coal power's low, volatile profitability and environmental concerns hurt its market access.

Decommissioning Liabilities, Nuclear Waste Are Manageable

Decommissioning is not yet a major issue for China's reactors because of the young age (9 years on average). Qinshan Unit 1, operational since 1991 with a planned life 30 years, has been extended for another 20 years till 2041. We also expect Daya Bay unit 1 and 2, three years younger than Qinshan, to obtain extensions. As such, asset retirement obligations remain a small portion of our adjusted debt, unlike for European peers.

Radioactive waste management has been handled carefully. Under China's policy, an operator must contribute to a fuel treatment and disposal fund starting from the sixth year of the nuclear power plant's operation. Still, until centrally stored underground, the fuel has to be stored on site.

A Different Story For Other Asian Countries

We think Asian countries are broadly in favor of nuclear power. China and India's governments want to increase nuclear power's share in the power mix. Authorities in Japan and Korea want to restore nuclear power on decarbonization and energy security grounds. However, social backlash and political differences have led to uncertainty elsewhere in the region.

Political and social concerns led Japan and Korea to turn to LNG as an intermediate solution to decarbonization. S&P Commodity Insights estimates that nuclear will have only a 9% share of Japan's power mix by 2030. This is higher than the current 6% due to slow restarts following the Fukushima nuclear disaster in 2021; however it's lower than the government's goal to restore up to 20%-22% from 6% today.

For Korea, the country's flip-flopping stance towards nuclear power has weighed on the industry despite its proprietary Gen III technology. Nuclear power requires at least one decade of planning and execution, yet presidential terms only last five years. This poses much policy uncertainty. The current president aims to keep the share of nuclear at above 30% by restarting construction and life-extension by 2030. This is a U-turn from his predecessor.

Chart 5

While we view Japan's utilities as having a high likelihood of extraordinary government support, any delays in restarting reactors could weigh on ratings. Korea Electric Power Corp. (AA/Stable/A-1+), the state-owned vertically integrated national utility, has an almost certain likelihood of support from the government. However, the group's stand-alone credit profile is weakening because it has not been able to fully pass through higher fuel inputs.

India also plans to expand nuclear power, albeit from a smaller base. Technological problems, cost escalations, huge upfront investments have made nuclear power a less attractive option than cheaper solar and wind power. Last year the government reduced its nuclear power capacity goals to 22.5GW by 2031 compared with an initial target of 60GW by 2032 set 12 years before. The Russia-Ukraine conflict could further slow the newer under-construction project that adopt Russian technology.

Digital design: Evy Cheung

Appendix

Table 1

Related Research

• China Ramps Up Nuclear Investments In Push For Decarbonization, published by S&P Global Commodities Insight, April 22, 2022
• Kepco's Operations To Stay Tough In 2022, March 3, 2022
• Korea Hydro & Nuclear Power Co. Ltd., Jan. 27, 2022
• China General Nuclear Power Corp., Dec. 23, 2021
• Nuclear In Europe: Lessons Learned And Ways Ahead, Dec. 16, 2021
• KEPCO And Power Generation Subsidiary Ratings Affirmed; SACPs Lowered On Weakening Financial Metrics; Outlook Stable, Oct. 28, 2021
• Tokyo Electric Power Co. Holdings Inc., Apr. 27, 2021
• The Energy Transition: Nuclear Dead And Alive, Nov. 11, 2019
• The Energy Transition: Different Nuclear Energy Policies, Diverging Global Credit Trends, Nov. 11, 2019