Abu Dhabi’s move this month to reform power and water tariffs is one of the most sweeping policy changes in the GCC’s recent history, illustrating the increasing burden subsidies are having on government finances and utilities. What makes the reforms more groundbreaking, and far more reaching than what has come before, is that the new tariffs target nationals for the first time.

The hoped-for drop in consumption that will follow should not only reduce the financial burden on government accounts, but should also help alleviate the capacity crunch the emirate is facing, with demand for water in particular moving dangerously close to supply levels.

Reduced tariffs

Under the new tariff structure, the cost of water for expatriates will soar by 170 per cent from January 2015, from AED2.2 (60 cents) a thousand litres to AED5.95 for up to 700 litres a day for an apartment and 5,000 litres a day in a villa, with cost-reflective tariffs to be introduced for higher usage. Emiratis, who currently pay nothing for their water supply, will pay AED1.7 a thousand litres for usage of up to 700 litres a day in an apartment and 7,000 litres a day in a villa, and AED1.89 a thousand litres for consumption higher than this.

The cost of electricity for expatriates, meanwhile, will rise by 40 per cent from 15 fils a kilowatt hour (kWh) to 21 fils a kWh for usage of up to 20 kWh a day in apartments and 200 kwh in villas. The current rate of 5 fils a kWh will remain flat for local residents who consume up to 30 kWh a day in an apartment and up to 400 kWh a day in a villa.

Subsidies have been a long-standing burden on the GCC’s utility sector, with government expenditure rocketing in recent years due to rampant population and industrial growth. Free or low-cost utilities are perceived as a right by most GCC nationals, who see them as one of the ways governments share their oil wealth with citizens. But this encourages wasteful use, with per capita consumption of power and water among the highest in the world in the six member states.

Although the need for reform has long been accepted by governments, the politically and socially sensitive nature of utility tariffs, particularly since the Arab Uprisings in early 2011, has until now hindered any action.

“The new higher tariffs have been universally welcomed in the industry,” says Saad Alani, an independent regional water consultant. “Domestic power generation and water consumption take a huge amount of money out of national budgets, and it is increasing at a frightening rate.”

The tariff reforms will deliver a major boost to government coffers at a time when oil prices are falling. Brent crude reached a four-year low this month, although it still remains above the UAE’s current budget breakeven oil price of $70 a barrel. The Washington-based IMF estimates that subsidies and transfers currently cost the Abu Dhabi government about $13bn a year, or 20 per cent of its budget.

Just as important to Abu Dhabi will be a reduction in consumption of electricity and water, which will relieve the pressure on power generation and desalination plants already operating at close to full capacity.

Forecast shortage

While no demand forecasting data has been published for the emirate’s utility sector this year, the most recently available figures suggest Abu Dhabi faces a shortfall of water next year unless new capacity comes online or consumption is reduced.

Abu Dhabi Water & Electricity Company (Adwec) estimated in its 2012/13 forecast that by 2015, peak demand for water would reach 934 million imperial gallons a day (MIGD), with the emirate’s total water production capacity recorded at 916 MIGD in 2013. While it is possible that consumption growth has been slower than expected, it is clear demand is edging dangerously close to the supply level.

The problem has been caused by delays with the Mirfa independent water and power project (IWPP), for which the final project agreements were only signed this year. The scheme, which will deliver 52.5 MIGD of desalination capacity, had originally been scheduled to come online in 2015, but after several delays and false starts in the procurement process, it will be completed in 2016 at the earliest, with many in the industry even citing this as an ambitious target. Until the Mirfa project is finished, the only new water capacity to be delivered will be the 30 MIGD expansion of the Fujairah F1 facility, due in the second quarter next year.

Abu Dhabi is also facing a potential shortfall of electricity within this period. While the commissioning of the 5.6GW Baraka nuclear complex from 2017 will secure the emirate’s mid-to-long term power needs, delays to the Mirfa scheme mean there is a near-term risk of a shortage.

Abu Dhabi had total installed generation capacity of 13,899MW in 2013, which was comfortably able to cover the peak load of 11,243MW recorded during the year. However, Adwec, in its 2012/13 forecast, estimates that demand will jump to 14,864MW in 2015 and 16,009MW in 2016. While the 1,647MW of new capacity from the Shuweihat 3 IWPP is set for commissioning in the coming months, a potential shortfall could arise in 2016, until Mirfa delivers its 1,600MW of capacity.

There is a precedent in the UAE for raising utility prices and this succeeded in putting a brake on consumption growth in Dubai.

Dubai Electricity & Water Authority (Dewa) introduced cost-reflective utility tariffs for expatriates (who account for 90 per cent of the emirate’s population) in 2011. This contributed to a deceleration in consumption growth, with the compound annual growth rate for peak electricity demand dropping to 3.6 per cent in 2009-13, from 10.4 per cent in 2004-08. The recession will have also played its part in this, but certainly higher bills would have made people reconsider their usage.

Higher tariffs have reduced consumption growth elsewhere in the region. After electricity prices were raised in 2012, per capita power consumption in Jordan fell by 0.3 per cent, following growth of 3 per cent for the previous two years.

“People waste water because it is heavily subsidised; they’re not paying for it. In other countries, people look at their bills because they are paying for it,” says Alani.

The drop in consumption resulted in Dubai establishing comfortable reserve margins for both power and water, and while the emirate is moving forward with plans for solar and coal-fired power schemes, there is no requirement for additional desalination capacity in the foreseeable future. It is estimated the introduction of cost-reflective tariffs has saved Dubai close to $2bn in investment in new capacity that would have been required had usage rates remained the same.

The demographic make-up of the emirate of Abu Dhabi is different to Dubai, with Emiratis accounting for more than 20 per cent of the population. This means that while Dewa was able to leave subsidies for nationals untouched, the Regulation and Supervision Bureau (RSB), the regulator for the utility sector in Abu Dhabi, had to take the plunge.

“We can expect a slowing down of demand growth, which will result in savings in future sector capacity and hence investment,” says RSB spokesperson Rashed al-Rashdi.

The challenge Abu Dhabi faces with its tariff reform programme will be getting people to pay. When the northern UAE emirate of Ajman launched the Gulf’s first direct-billing wastewater network in 2008, the authorities had numerous problems trying to get Emiratis to pay for services, and the scheme was almost abandoned before commissioning.

Tough enforcement

Although still heavily subsidised, Kuwait has also had major difficulties in trying to get payment for utilities in recent years. Tough enforcement will be key to getting the hoped for outcomes. In the case of Kuwait, this has involved disconnections, while in Ajman companies were threatened with non-renewal of trade licences and residents faced having power supplies cut off.

An awareness campaign of the environmental benefits of using power and water more efficiently would help compliance, along with a clear communication that prices are still subsidised for the lowest consumers.

The RSB estimates that in 2014 the cost for supplying water and electricity to residential customers (including production, transmission, distribution) is AED10.62 a unit of water (1,000 litres) and 32.6 fils per unit of electricity (1 kWh).

Abu Dhabi’s decision to reform tariffs is a bold step that will bring numerous benefits in the long run. With all GCC countries facing similar pressures, it is surely time for other states to follow.