Hungarian Prime Minister Viktor Orbán and Russian President Vladimir Putin concluded an intergovernmental agreement on the construction of two new nuclear blocks at Paks, Hungary, on 14 January in Moscow. The first new block is to be commissioned in 2023; the second between 2028 and 2030. Moscow is also providing a sovereign credit line of up to EUR 10 billion, covering 80% of the construction costs. Details about the financing, the selection of a reactor type (between 1000 and 1200 MW capacity) and the conclusion of the related business and technical contracts between Rosatom and Hungarian companies are expected to emerge during the next few months.
Energy policy background
Hungary has four Soviet VVER-440 reactors at Paks, providing 37-43% of its electricity supply. These blocks were commissioned during the 1980s and, due to recent lifetime extensions supported by all political parties (the anti-nuclear LMP supported the decision only on condition that the share of renewables be raised), they are set to be decommissioned only between 2032 and 2037. Hungary is poor in conventional resources; some 17% of its electricity production comes from domestic lignite and peat, and approximately 8% comes from (other) renewables and waste. The rest is provided by natural gas, mostly imported from Russia, and electricity imports primarily from the EU and Ukraine. Due to high gas prices and low electricity prices on the market, imports have been rising steadily for the past few years, and in 2012 exceeded 20% of total demand. Most of the power plants are outdated; total installed capacity has been decreasing, and is expected to bottom out by 2025 at around 5000 MW. Significant investments in this sector must thus be made in the foreseeable future. But growth in electricity demand has been sluggish and close to stagnant during the past few years due to the economic crisis.
The focus of energy policy has been on natural gas, perceived as a relatively expensive and insecure source of energy. Accordingly, all governments since 1998 have prioritised lessening Hungary’s gas dependency on Russia (through Ukraine) and keeping domestic gas prices relatively low. The latter factor, coupled with high public indebtedness (above 80% of GDP), high budget deficits in the past and resistance from corporate interests, have constrained the expansion of renewables. The current market environment is hostile to both renewable energy and foreign capital.
Policy debates and public discussions on new nuclear blocks have been taking place since the mid-2000s, focusing on the need to replace the old plants in the 2030s, and in 2009 the parliament unanimously authorised the government to examine the possible construction of new blocks. Nonetheless, this legislation did not empower the Cabinet to make a final decision without parliamentary approval. It also set certain benchmarks and required several studies justifying any further measures.
Attitudes towards Russia were strongly polarised until 2010. The Gyurcsány social-liberal government’s pro-Russia policy was harshly criticised by the Fidesz party during the 2006-2009 period, especially when it came to the South Stream pipeline agreements. After his landslide electoral victory in 2010, however, Viktor Orbán moderated his staunchly anti-Russian rhetoric and embarked on a policy of ‘Eastern opening’ aimed at building bridges towards Russia, China and the Middle East. Still, the recent turnaround with this nuclear deal came as a surprise to many, and was poorly communicated to the domestic public and to external audiences alike.
The Orbán government underscored its pro-nuclear stance by outlining a nuclear-coal-renewables development path in the National Energy Strategy, adopted in 2011. This document envisages phasing out electricity imports and making Hungary a net electricity exporter (equal to 14% of domestic production) by 2030 – based on the reasoning that nuclear decommissioning in Germany and Switzerland will ensure the future profitability of such exports. Nevertheless, nuclear expansion is only one of the possible scenarios under the Strategy. Despite such statements and certain rumours, the deal came like a bolt of lightning out of the clear blue sky. Testifying before the parliament’s Economic Committee János Lázár, Minister of State for the Prime Minister's Office, hinted publicly about the impending agreement just three weeks before its signing. The government contends that it was legally empowered to strike the deal on the basis of the 1966 Soviet-Hungarian intergovernmental framework agreement on the first Paks blocks.
The government has also asserted that the agreement will provide a long-term guarantee for its low energy price policy for Hungarian households. The Cabinet decreased retail gas and electricity prices for the population by 20% during 2013, and is set to go further before the April 2014 elections. This policy has been perceived as a major success in terms of the government’s electoral campaign. According to opinion polls, support for Fidesz has risen by 7-8% since the “rezsicsökkentés” policy (state-imposed utility price cuts) was launched.
Government commentators have emphasised the beneficial terms provided by Russia for the construction. Although these are still to be finalised, Moscow would provide a maximum EUR 10 billion credit line for 30 years with no payments due until 2023. The interest rate is reportedly below 5% – less than what Hungary currently pays on the bond market. The agreement also includes a 20-year Russian guarantee to take back depleted fuel cells. János Lázár characterised the agreement as the “deal of the century”, and Hungarian-Russian relations as a “marriage of convenience, which the partners are increasingly enjoying as well”.
Large-scale Russian financing was an essential factor. The disclosed terms seem to be relatively good – close to standard Russian initial offers. Still, in view of the unique nature of every nuclear deal, the government’s superlatives about the agreement can be called into question. Other Rosatom deals have better terms, for example: the two blocks at Phước Dinh cost around USD 10.5 billion, while Belarus received Russian financing at under 4%. A final assessment of the deal’s financial aspects can only be made if negotiations are concluded and further details are disclosed.
Referring to offsets in gas imports, the project was characterised as one that would decrease Hungary’s energy dependency. Mihály Varga, the Minister of National Economy, has underscored that Budapest would purchase only technology – not energy – from Russia. Furthermore, he expects that the blocks’ construction will create 10,000 new jobs and add 1% of additional GDP growth, as well as a guaranteed 40% Hungarian share of subcontracts. János Lázár has made scant references to “German mediation” during the negotiations and seemed to suggest that the deal was supported by German business. No evidence for this has been provided, however.
Almost all of the opposition parties condemned the deal, although for different reasons. The green LMP was at the forefront, emphasising that Orbán was increasing Hungary’s dependency on Russia. The Socialist Party (MSZP) criticised the secrecy and undemocratic nature of the agreement and, together with centrist Together 2014-Dialogue for Hungary (Együtt 2014-PM), raised the prospect of a potential referendum on the issue. Only the pro-Russian radical right-wing Jobbik party remained silent. It seems very likely that the seriously fragmented democratic opposition might find a single crossover issue as a basis for cooperation just three months ahead of the April elections. In any case, the issue is set to remain high on the agenda even after the elections (schedule for 6 April 2014).
Despite government assurances, the deal raises many doubts regarding conformity to EU rules. The framework is basically one from the 1970s: no tendering for the selection of Rosatom, the entire loan will be added to the public debt, and its repayment will come fully from the state budget – not from state company MVM or from a tax on electricity consumption. DG Energy has already begun to examine the agreement from the public procurement point of view, and many other aspects are relevant as well (e.g. nuclear security). Moreover, the agreement must comply with EU state aid procedures. Finally, since the deal will add another 12-15% to the national debt by the end of the 2020s, it will have a significant impact on public finances. Consequently, it will not escape the attention of the DG for Economic and Financial Affairs. Hungary was just released from excessive deficit procedures in June 2013. These and other legal factors may even derail the entire project. It would be a bit of surprise if such a business model were to undergo Brussels’ scrutiny without serious objections being raised.
Economic assessment and risks
Any assessment can only be preliminary, since the deal has not yet been finalised and disclosed. Despite its voluntarism and the incumbent risks involved, however, the project cannot be deemed unequivocally unreasonable: it offers a certain chance of profitability coupled with significant economic risks. Three major aspects warrant consideration. First, as is the case with all nuclear projects, management risks will have to be handled. Hungary’s record is relatively poor with respect to both regulation and management. The construction will have to be managed over the course of successive governments in an environment of significant corruption. The government failed to secure critical public and political support at the outset, and it is unlikely that public attitudes will become more positive amid the scandals which can be expected during construction. Problems with EU-conformity further decrease the likelihood of smooth implementation.
Second, the Hungarian Cabinet appears to expect high electricity and carbon prices on the European market by the second half of the 2020s. Indeed, during the 2020s a relatively large portion of Europe’s baseload capacity is set to be decommissioned. The current low electricity prices constitute a disincentive to investments in power generation, further exacerbating the situation. Carbon prices may increase due to the logic of the EU Emissions Trading Scheme, but at issue is not rising price trends per se, but rather their scale. In this regard, the Cabinet has not provided any economic analysis quantifying the interrelation between the cost of electricity generated by the new blocks and its anticipated European benchmark price during the 2020s.
Third, interest rates may have a huge impact on the project’s profitability. In this regard, the interest-rate formula for the Russian loan will be of particular importance. Given the vulnerability of the Hungarian economy, its high sovereign risk and credit default swaps, capital could become extremely expensive for the national economy. The country’s sovereign credit rating is in junk status at all the three major rating agencies, and it weathered the financial crisis only thanks to EUR 20 billion in IMF/EU support. Hungary is taking out this loan in an environment of low interest rates when central banks all over the globe are providing monetary stimulus to their economies. Nevertheless, it is certain that this situation will change soon, and a turn in global finances could sharply degrade the project’s financial outlook.
Given the abruptness and slightly surreal nature of the agreement, speculation has emerged as to the underlying motivations behind the deal. The visit’s timing seems bizarre, occurring just three months ahead of elections and at a time when Viktor Orbán appeared to be enjoying overwhelming support and when his basic campaign strategy could have been merely to avoid making mistakes. Both the Russian and Hungarian governments denied the existence of a quid pro quo “package-deal”, i.e. an interrelation between the nuclear project and gas or other issues. The credibility of this assertion was slightly undermined by Viktor Orbán himself, however, who during the visit promised full implementation of the bilateral intergovernmental agreement on the South Stream gas pipeline. This latter agreement is in breach of EU law, and just a few weeks ago the European Commission requested that Hungary, among other participating countries, renegotiate or cancel it.
Many experts believe that Hungary has received or will receive concessions on gas pricing, or will be able to conclude a new long-term gas contract on more favourable terms. The current long-term contract expires in 2015. State company MVM purchased E.ON’s Hungarian gas wholesale subsidiary in autumn 2013, paving the way for the government to negotiate directly with Gazprom. Alexey Miller, Gazprom’s CEO, met with Viktor Orbán unexpectedly in mid-December in Budapest, just a few weeks before the nuclear deal was announced. A third round of gas and electricity price cuts for households was set just a week after Orbán’s Moscow visit. All these coincidences tempt many to speculate about a possible connection between the two issues.
Another area of speculation concerns the finality of nuclear investments. Even if the government says that the new plants are going to replace the old ones, the construction timeline suggests a different scenario. According to current deadlines, the old and new reactors would operate in parallel for approximately five years (between 2028 and 2032). This presupposes large investments in training for the necessary personnel and in transmission capacity, most of which would go idle through the gradual decommissioning of the old plants (between 2032 and 2037). The only economically reasonable way to utilise this transmission capacity and skilled workforce is to build another two blocks. This would mean another similar nuclear deal in the next 4-8 years. Still, no public indication has been made by the government about any move of this type.
The nuclear deal has serious deficiencies in all possible regards. Most of the legal, economic and political risks have been neglected. The government failed to do the necessary preliminary studies, prepared the agreement in secrecy, and would like to secure parliamentary approval based on shaky legal arguments and in an undemocratic manner. Even if it may yield some short-term benefits, the new Cabinet will have a politically and economically toxic project to grapple with after the upcoming elections.
Hungary already has the fifth-highest share of nuclear production globally in its total electricity generation, and with these additions it might overtake France for the highest share by 2030. Such a high level of baseload generation poses significant challenges for network balancing in a situation where flexibility is increasingly becoming one of the key merits of any electricity system in Europe. A resource-poor country with shaky economic fundaments would make major investments in order to become an energy exporter, and subsidies provided by Hungarian taxpayers would be redistributed among foreign consumers. Around 55-65% of the country’s electricity production would be based on Russian technology, operating at a single location (Paks). This is a project with an obscure past and a murky future.
The author András Deák is Associate Fellow at the Hungarian Institute of International Affairs and Board Member of Energiaklub Climate Policy Institute.