Localizing Nuclear Power Equipment Production Possible Impact of Latest NNSA Provisions

Monday, 15 June 2009 15:17

On May 4th, 2009, China’s National Nuclear Safety Administration (NNSA) officially posted new provisions on its web site to clarify the regulations governing the registration of nuclear industry safety equipment manufacturers in China. Although the new provisions simply relate to the application of inspection procedures and have still only been issued on a trial basis, they may well prompt some foreign companies to move faster towards localizing the manufacturing of their products in China.

To Localize Production or Lose Market Share – A Choice Must be Made
The localization of equipment manufacturing has long been a very hot topic in China’s nuclear power market. Attaining self-reliance is a goal strongly emphasized by the central government, and industry policy-makers consider the localization of equipment manufacturing to be a basis upon which China can achieve this goal. Manufactured under strict standards, nuclear power equipment is technology intensive and can therefore significantly promote technological development in the mechanical and electrical industries. Moreover, equipment produced in China is much more cost-effective.

According to the State Council’s “11th Five-Year Plan”, 70 percent (in value terms) of the equipment used in nuclear power plants must be localized by 2020. This target will very likely be raised to 80 or 85 percent by the “12th Five-Year Plan” to be issued next year.

Meanwhile, to achieve the current official target, the NDRC has been taking significant measures to support local manufacturers and promote the purchase of locally manufactured equipment by Chinese nuclear power generation companies. For equipment that Chinese manufacturers are still not in a position to provide today, the NDRC has been “encouraging” foreign companies to transfer technology or set up joint-ventures with Chinese partners to localize the production. In many instances, the “encouragement” has turned into a requirement integrated into bidding processes –for example, in its recent bid to provide safety-related 1E cables, Prysmian, a French cable manufacturer, was requested to localize its K1 cable production in Tianjin, where it has a joint-venture for manufacturing general-use cables. Given this practice, foreign bidders can expect to find themselves in an increasingly disadvantageous position if they do not localize the production of their nuclear power equipment.

As a consequence, a number of companies have begun to cooperate closely with local partners. KSB and Shanghai Electric set up a joint-venture to manufacture nuclear pumps and valves at the beginning of 2009, with Shanghai Electric holding a 55 percent share and KSB holding 45 percent. German diesel manufacturer, MTU, has also set up a joint-venture with Shanxi Diesel to manufacture 1E diesel generators for nuclear power plants.

Choosing to proceed with localization of production is not an easy decision. Many factors need to be considered, including: intellectual property rights protection, possible competition between the joint-venture and its parent company, constraints on investments in a currently challenging economic environment.

The Chinese government, however, clearly wants production localization to proceed faster. As a result, a domino effect comes into play, where the localization of production by a given supplier rapidly prompts other suppliers of the same equipment to follow suit in order to avoid losing market share. This domino effect is reinforced by the new regulations recently issued by the NNSA.

For Certification, Experience Matters
The NNSA initially issued two new regulations at the beginning of 2008, both requiring that nuclear safety-related equipment providers go through a registration process and be certified. One regulation, HAF604, targets companies which export equipment to China, while the other, HAF601, targets companies which design or manufacture equipment in China.

Both regulations require that the certification candidates have five years of experience at least in the considered field. This is not an issue for foreign companies undergoing the HAF604 registration process, as their factories outside China have usually been producing safety-related equipment on the global market for years. However, a problem arises if foreign companies set up a subsidiary company or joint-venture in China, as in principle the subsidiary companies or joint-ventures have to undergo HAF601 registration before they can take part in bids, but have only little or no experience given that they have been newly set-up –and therefore cannot be certified. This creates the following dilemma: with no certification, these companies are not allowed to provide equipment to Chinese nuclear power plants; this, in turn, prevents them from building up the experience required to obtain the certification in the first place. It quickly became clear that a solution needed to be found.

Exceptions With Limited Number of Certified Providers – First Entrants’ Advantage
By issuing the latest provisions on the application inspection procedure, the NNSA has finally provided a clear interpretation of the HAF601 registration process. These provisions clarify several cases under which the issues created by the five-year experience requirement can be practically dealt with. According to the new provisions, if there are less than three certified providers in China, new foreign-invested set-ups can be certified by referring to the experience of their parent companies.

The certification requirements for 100 percent foreign-invested companies and joint-ventures are slightly different:
- For a 100 percent foreign-invested company to be certified, its parent company will need to show at least five years of experience producing the equipment, and to demonstrate that the relevant technology has been fully transferred to the Chinese company, with all key manufacturing processes carried out in China.
- In the case of joint-ventures, the foreign investor will have to demonstrate that it has at least five years of experience manufacturing the equipment, and the Chinese investor at least five years of experience providing similar or related equipment. The two partners will need to have concluded a long-term technology transfer contract, and the joint-venture’s Chinese staff must master the transferred technology.

The provisions are quite strict when it comes to the technology transfer requirement, and some companies may need time to consider how to meet this condition. However, the provisions have also lightened the experience requirement for new foreign-invested set-ups, the prerequisite being that fewer than three providers of the same equipment have been certified. It is therefore in a company’s best interest to quickly set up a factory in China and rapidly become one of the three foremost providers of a certain type of equipment, so that it can much more easily obtain certification. The faster a company enters the market, the greater its competitive advantage in seeking certification.

Options for Latecomers
Considering the implications of the new provisions, one would naturally wonder how one goes about obtaining certification if more than three providers have already been certified. The answer is not stated clearly in either the HAF601 regulation or the newly issued application inspection procedure, but it can be reasoned out.

Several solutions are possible. One approach is to invest in a local company that already has more than five years of experience or been certified, so that the new joint-venture can apply for a certificate based on the Chinese partner’s experience or update the original certificate if technology is transferred. However, the foreign companies may need compromise more than they would want to when negotiating with the Chinese company as they have to rely on Chinese partner’s references to obtain certification.

If a foreign company wants 100 percent control of the new set-up and does not want to rely on a local company, there is another option. The new set-up can first manufacture products that are similar to safety-related products, then apply for a certificate to produce safety-related products after five years. But this is only a theoretical solution, as few companies would likely be willing to wait for as long as five years, and bear the significant risk of seeing many competitors enter the market during that time.

Overall, neither of the two approaches is attractive –so perhaps a foreign company’s best choice after all is to move fast and work towards establishing itself as one of the market’s first entrants.

Regulatory Revision Still Possible – Waiting Could Be an Acceptable Option
From the time we first went through the new regulations, we have wondered why the number of certified suppliers would have been set at three. In the booming Chinese nuclear power market, three certified providers for each category of equipment would hardly seem to be enough. We expressed our concern to the NNSA, and one NNSA expert conceded that the latest regulations may contain some unreasonable items and that revisions may be warranted, as problems with the HAF601 regulation and related provisions have become increasingly obvious through implementation. This may be one of those times where it could pay off to just wait and see.

In our view, it is very likely that the limit to fewer than three certified suppliers in one given product category will be revised. First, as stated previously, three certified providers would probably not be enough given the size of the market –especially for those products that are heavily used in NPPs, such as pumps, valves, pipes and cables. Another factor could be that while some Chinese companies have been certified to provide certain types of equipment, their product quality may still be inferior to that of leading manufacturers overseas. Should those leading international providers wish to localize their products and be willing to transfer their technology to Chinese companies tomorrow, why would the NNSA keep them away?
It appears that the NNSA may have no choice but to rethink the regulations at some point in the future. Possibly, this would result in raising the number of certified suppliers from three to five, or even ten. Regulatory revisions could also include distinguishing between foreign-invested and local companies when applying the limited number of certified providers rule –so that if there are already a number of certified local companies providing one type of equipment, the limitation on the number of certified local providers does not apply to foreign companies wishing to obtain certification, unless the set maximum number of foreign-invested enterprises have already been awarded HAF601 certificates.

For sure, early entrants would find themselves at an advantage with regards to certification. However, latecomers may find opportunities with the possible revision of regulations, and there is therefore still time for foreign companies to consider their long-term strategy in China’s nuclear power market. That being said, whether the regulations maintain the limitation to three certified providers or not, the requirement for foreign companies to transfer technology should remain unchanged, and this raises many questions –On the protection of intellectual property going forward, extracting the maximum benefit from know-how, and the definition of a “win-win strategy” that can ensure market share in China without harming the core competence of the parent company in other markets. If those questions are answered, obtaining certification should not be a big obstacle. While there may be a number of technical issues at hand, solutions should be quite easily attained by relying on internal efforts and/or external expertise.

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