The Iraqi Electricity Ministry’s decision to relaunch its independent power project (IPP) programme in December is an important step towards resolving the country’s electricity shortage, but many are still wary of the risks involved in developing long-term projects in an unstable territory.

The ministry received expressions of interest from 17 companies in January for the first publicly tendered IPP since the collapse of the previous programme in 2011. It addresses difficulties the country is facing in rebuilding its infrastructure in the face of lower oil prices and the ongoing struggles with the jihadist group Islamic State in Iraq and Syria (Isis).

Insufficient funding

“There is urgent demand for more power, but the government does not have the money to pay for all that is required,” says a source close to the IPP programme. “We are talking about billions of dollars. And with falling oil revenues and increased expenditure on military to combat Isis, the ministry hopes the immediate financial burden can be reduced. So from this viewpoint, it is a logical step to try and restart the IPP programme.”

It is unlikely we would go into Iraq any time soon; I wouldn’t say never, but it’s highly unlikely

Project financier at a major GCC bank

While the Electricity Ministry’s motives for restarting the programme are easily understood, those within the utilities sector are sceptical of whether developers and financiers will be willing to take on the risk to deliver schemes on long-tenor contracts and loans.

The IPP programme has been designed to play a part in reducing the supply shortfall for electricity, which is having a major impact on quality of life for Iraqis and also hampering the country’s industrial growth. As a result of years of underinvestment and conflict, the installed capacity of 11,025MW in 2013 fell far below the 16,574MW peak power demand recorded during the year.

Power shortages

Many areas of the country continue to receive less than eight hours a day of electricity, and, despite the award of engineering, procurement and construction (EPC) contracts to install more than 13,000MW between 2008 and 2013, there is little sign the electricity problem will be resolved any time soon.

The financial implications of the power issues are clear: it is estimated the cost of power shortages to the economy is about $40bn a year. “Not only are the power shortages preventing new industries and businesses from growing, but the government and individuals are forced to turn to more expensive forms of temporary generation,” says an international contractor who has been involved in executing power projects in the country in the past seven years.

The first proposed, publicly tendered IPP, the Al-Samawa plant, is a different proposition to the majority of IPPs and independent water and power projects (IWPPs) that have been executed in the Middle East over the past two decades. The facility will use turbines from GE, which were purchased as part of the ministry’s mega-deal with the US manufacturer and Germany’s Siemens in 2009 to provide equipment for fast-track power projects. As part of the IPP, bidders will be required to purchase the turbines.

In order to increase interest and make the project more attractive to potential developers and investors, the ministry is prepared to provide financing for the turbines at a low interest rate if required. While the ministry’s efforts to make the scheme more attractive to investors should be welcomed, the risks of entering the developer market in Iraq will provide the main stalling block to the Al-Samawa project reaching fruition.

Developing power projects under the public-private partnership (PPP) model carries considerable economic, political and security risks for all parties involved, and Iraq currently offers problems on all three of these fronts.

The location of the proposed first IPP, in the southern part of the country, about halfway between Baghdad and Basra, means security concerns are not an immediate problem. The conflicts with Isis are currently all in the northern part of Iraq, and international companies have been developing oil fields in the relatively stable Basra area since the overthrow of former president Saddam Hussein in 2003.

Economic challenge

While there will be significantly greater security costs for building and operating plants in southern Iraq in comparison with the rest of the region, it is the economic and political risks that are the main challenges.

“It takes us 25 years to get our full returns on building a power plant, so we are taking a 25-year [chance] on the government, and [its] ability… to stand against a promise made 20 years ago by a previous government,” says Lucas Hautvast, president and CEO of GDF Suez Energy South Asia, Middle East and Africa, the largest developer of utility schemes in the region. “This is often the much bigger risk.”

Hautvast’s concerns are shared by the project finance sector, whose support is a crucial part of any successful IPP or IWPP. “Iraq is still a big risk,” says Naoki Tamaki, chief representative in Dubai for Japan Bank for International Cooperation (Jbic), Japan’s export credit agency (ECA). “We have been contacted by some Japanese companies about projects in Iraq, and we are not closing our door for Iraqi transactions, but for project finance it will need to take some time.”

Sovereign guarantees

Tamaki says Baghdad will need to ensure it can offer sovereign guarantees on foreign investments in the country, particularly as the first IPP planned has a contract duration of 17.5 years.

“A sovereign guarantee is the minimum requirement,” he says. “But even if you have a sovereign guarantee, the question will be: who will be the sovereign? At this moment, there is a central government, but the country is effectively divided and you may end up with three countries. So the risk still remains high.”

Tamaki’s concerns are shared by the commercial lending sector. “It is unlikely we would go into Iraq any time soon; I wouldn’t say never, but it’s highly unlikely,” says a project financier at one of the GCC’s major banks. “In terms of other commercial banks, they would share the same position.

“How do you get projects away? Well, it comes back to the multilaterals: the World Bank, the IFC [International Finance Corporation], the World Development Bank. What I am seeing in Egypt - which is less challenging but still has particular challenges - is a lot of government-to-government [G2G] sponsorship, and G2G brings capital flows; equity probably more than debt in the Iraq context. Maybe that’s an option. Maybe ECAs could help. But it is a tough risk allocation for a bank to take.”

Government support

The project financier agrees that government support and guarantees are vital if Iraq is to succeed in attracting interest from project financiers. “Any revenues received would be in local currency, so there is a big forex [foreign exchange] exposure there. So, for even much more established jurisdictions, you would want some sort of central bank or ministry of finance support. And you’d certainly need that in Iraq.”

If Baghdad is able to improve the political situation and assure international power and banking sectors that it can offer a viable place to develop long-term utility projects, it does not have to look far to learn how to implement a successful IPP programme. While Iraq’s Electricity Ministry has struggled with previous attempts at implementing an IPP programme, the Kurdistan Regional Government (KRG) has managed to successfully execute several projects to meet growing demand for power.

The central government in Baghdad has struggled to keep up with demand, but the semi-autonomous northern Iraqi region of Kurdistan has raced ahead with reforming its power sector. In 2013, the region was generating 22 hours a day of power, compared with an average of between four and six in the rest of Iraq. The KRG was able to turn around its power sector in a decade, increasing its generation supply ten-fold since 2002.

KRG success

The Kurdish government was able to boost its supply through an IPP programme that accounts for more than 75 per cent of power provided across the region today. In 2014, construction work on Kurdistan’s fifth IPP began, with the first four up and running and all undergoing further expansion.

“The KRG has been very successful with its IPP programme,” says a developer active in the Kurdish region’s power sector. “It was able to set out the model and get things passed quickly to facilitate execution of the projects. But it had the important element of stability, and from that everything else can fall into place.”

The IPP model is a tried and tested method that can deliver large and reliable generating capacity over a long period of time, and the Iraqi government is wise to try and implement it as it seeks to reduce the significant shortfall in capacity. However, to attract the required international partners and expertise, Baghdad will need to ensure it can offer a stable political and economic base from which to proceed. Iraqi citizens and businesses will hope this can be achieved before the electricity crisis worsens further.