An unsustainable buyer’s market for power

13 June 2011

Power project prices have been driven down by competition from the Far East, but with the global need for new capacity rising such low costs cannot continue

Key fact

As preferred bidder on the Qurayyah IPP, Acwa Power’s bid was 15.5 per cent lower than the next lowest bid

Source: MEED

During the economic boom of 2005-08, electricity demand soared in the GCC. Governments responded with a huge programme of capacity building. The surge in activity caused engineering, procurement and construction (EPC) prices to rise and drew new contractors into the market. At the same time, a limited pool of experienced international developers won contracts to build a series of independent water and power projects (IWPPs).

EPC price is a large component of the tariff, but you can’t get that kind of a tariff from the EPC price alone

Paddy Padmanathan, Acwa Power

Then the global financial crisis struck. For any deals that were struck, the pricing reflected the troubled times and the drying up of credit markets. Since then, demand forecasts have been revised down, resulting in far fewer projects on the drawing board. Eager to remain in play, developers are responding with increasingly attractive bids to build power projects. The continued competitiveness of South Korean EPC contractors and the entrance of Chinese companies is also encouraging lower pricing.

Qurayyah IPP bidders

In December 2009, Saudi Electricity Company (SEC) received five bids to build the Riyadh PP11 IPP. Japan’s Marubeni together with fellow Japanese company Kansai Electric Power Company and Saudi Masader Company for Power, Water & Gas offered the lowest bid of 7.7 hals a kilowatt hour (kWh) (2.05 US cents a KWh).

The issue [is] new entrants to the market. Those from China and South Korea are very important

London-based developer

The bid came in 28 per cent lower than the next cheapest bid, submitted by Belgium’s Suez Energy International with the local Al-Jomaih Group. The highest bid was entered by the UK’s International Power and Saudi Oger and Korea Electric Power Corporation, which made an offer of 12.99 hals a kWh.

Sec’s IPP Programme
Name of projectCapacity (MW)LocationCompletion Date
Rabigh1,200140km north of Jeddah. Under Construction.2013
Riyadh PP111,729Dhurumah, 125km west of Riyadh City. Under Construction.2013
Qurayyah IPP-11,800Eastern Province. Tendering Phase.2014
Qurayyah IPP-21,800Eastern Province. Planning Stage.2015
Dheba1,600North West, Red Sea Coast. Planning Stage.2017
IPP=Independent power project. Source: SEC

The tender immediately sparked rumours that Marubeni’s bid had omitted fuel costs due to the low price and the spread of bids. In the end, SEC opted for the group led by Suez, the second-lowest bid.

SEC then launched a tender for another IPP at Qurayyah having prequalified developers in December 2010. Bids were opened on 27 March and the consortium of Acwa with Mena Infrastructure Fund and Samsung C&T submitted the lowest bid of 7.417 hals a kWh.

Again, attention was drawn to the fact that Acwa’s bid came in 15.5 per cent under the next lowest bid, which was offered by Marubeni and South Korean companies Doosan and Hanwha. Their offer of 8.56 hals a kWh was close to the four other bids.

The lowest bid was 20 per cent cheaper than the highest. However, the lowest bidders on the Qurayyah tender have maintained that the offer was compliant and SEC selected the group as preferred bidder to build the project in June.

Qurrayah tariff speculation

This has led to speculation on how the Saudi developer was able to offer a bid that is so much lower than the others.

“I am surprised by the tariff bid by the lowest bidder on Qurrayah,” says one industry source. “Either they got an EPC price that allows them a good internal rate of return at the tariff – and they clearly did very well – or the EPC contractor decided to take a punt and offer a lower price in the hope that when it is signed, the price will be higher.”

Certainly, the use of a competitive South Korean EPC contractor has its benefits in terms of price. New entrants to the EPC market from Japan, followed by South Korea and most recently from China, have exerted downward pressure on the price EPC contractors are able to command.

Acwa’s president and chief executive officer Paddy Padmanathan says that this was not the only reason. “You need to pay attention to all of the different components of the bid,” he says. “Obviously, EPC price is a large component of the tariff, but you can’t get that kind of a tariff from the EPC price alone. We got a very competitive EPC price – clearly – but we also had the optimal technical evaluation and a very competitive total finance cost.

“This isn’t the first time that we have done this. For instance, with the Shuqaiq IWPP, there was a large difference in prices. Ours was the only bid using reverse osmosis – all of the other bidders submitted bids using multi-stage flash desalination bids.”

So why would firms intentionally price a bid below the market rate? “We have never adopted a market pricing strategy whereby we say that we can sell at a certain price and therefore we will,” says Padmanathan. “When you have a 20-year contract, anything can happen, 20 years is a long time. We want to be sure that if – for whatever reason – they start switching off power plants we have the lowest possible tariff so that ours is the last to be switched off. For us, it is simple business sense.”

Temporary power price trend

Although the trend in the short term is for lower prices, industry observers say it will only be temporary. Long term, demand for electricity is rising and new capacity needs to be built.

“I can believe it will remain a buyer’s market for a while, but if the Qurrayah price is right, I don’t believe it can stay like that for long,” says one regional developer. “The fact is Japan has a huge need for additional power, and that isn’t going to be nuclear. Plus, most of the GCC markets will continue to have high rates of growth.

“It is hard for me to believe that prices are going to continue to be driven down, because as a simple matter of supply and demand, the EPC contractors are not sufficiently desperate to push prices down.”

EPC prices clearly correlate with supply and demand factors. As new contractors enter the market, existing companies must respond with more competitive bids. The same is true of developers in terms of supply and demand in EPC providers – and developers competing with other developers. Furthermore, as financiers of large projects in need of significant leverage, developers are affected by the ups and downs in the global project finance market.

The political unrest in the Middle East and North Africa region might not have significantly diminished projected power demand in the affected countries, but the uprisings have caused several governments to abandon new power schemes, in particular private power projects.

The impact on sovereign credit ratings and perceived risk profiles has deterred some developers from working in the region. For instance, US developer AES Corporation decided not to bid on upcoming IPPs due to the unrest. AES was prequalified to bid on both the Qurayyah IPP in Saudi Arabia and the Sur IPP in Oman, but opted not to do so.

The unrest has also caused some governments to shelve IPPs due to anticipated higher costs associated with private sector projects as lenders price in the risk of signing long-term agreements in volatile countries.

Factors at play for power pricing

Looking further ahead, there are new developers keen to enter the market. “The issue isn’t so much the number of projects, as new entrants to the market” says a developer based in London. “I would say that those coming from China and South Korea are very important. I’m talking about developers, not EPC contractors here.”

Ultimately, there are many factors at play in the determination of pricing for both IPPs and EPC projects. The future for EPC contractors and developers will be conditioned by changes in supply and demand, along with the stability of the host countries and health of the financial sector. The fate of both are clearly inter-linked.

As for the Qurayyah IPP being the start of a trend for lower pricing, it is too early to tell. Already, SEC is keen to launch a tender for another IPP at Qurayyah by the end of 2011. It would happily see a repeat of Qurayyah 1. Whether it gets this or not will influence the direction developers see the market progressing.

Beyond Saudi Arabia, the picture is even less clear. While the Al-Dur IWPP in Bahrain got away with a highly competitive project cost of $2.13bn, a repeat performance following the uprisings would be highly unlikely. The project may have negotiated the aftermath of the global financial crisis, but the recent damage to investor confidence in the Bahraini market will prove much more problematic in the long term.

As for Egypt, the country’s first IPP at Dairut is on hold indefinitely as a result of the political upheaval. It may be some time before the volume of power projects recovers to the point that pricing trends can be analysed fully.


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