Electricity pricing reforms are a bitter pill for GCC industry to swallow

13 January 2020
Tariff reforms must be structured correctly and the transition made palatable so all sides benefit, says Strategy & Middle East

The GCC’s electricity pricing policy is unsustainable. Decades of subsidies have led to high consumption rates and wasted power, costing billions of dollars. Yet when policymakers propose reforming electricity tariffs, they run into stiff resistance. Large industrial companies argue that pricing reforms will make them less competitive, just when the region is trying to grow its industrial base.

Electricity PricingWe have a counter-intuitive argument: electricity pricing reforms can actually make industrial companies more competitive provided the reforms are structured correctly.

Subsidies have deep roots in the region, and they were long considered a success in helping governments use high state revenues to improve societal wellbeing. However, they have led to waste in both the supply and demand of power.

We estimate in our recent report, Electricity pricing reform: A bitter pill for GCC industries, that by keeping energy prices artificially low, subsidies boost consumption by roughly 70 terawatt-hours each year in the GCC, or about 11 per cent of the total. In financial terms, electricity subsidies have cost GCC countries more than $120bn over the past 20 years.

Growing burden

Leaving these policies in place until 2030 would cost an additional $150bn, because demand is growing due to governments’ push to industrialise GCC economies and bring manufacturing supply chains to the region.

At the same time, population growth and quality of life improvements, along with the region’s hot climate, have translated into an ever-rising residential demand for electrically powered cooling and refrigeration.

For the first time in the history of the region, policymakers need to make tough economic choices about how to remove subsidies for different end users of electricity. Any tariff reforms will need to meet two goals: making the electricity sector self-sufficient while also industrialising the economy. These two would seem to be in opposition – governments could meet one or the other, but not both.

Prescription for change

However, we have a different approach. Governments can achieve both goals with well-structured tariff reforms. More specifically, governments should apply a segmented approach that categorises companies into two groups based on the costs they impose on the electrical system and on the role electricity plays in their cost structure.

Energy-intensive users

Electricity PricingThe first group consists of large end users – energy-intensive, export-focused industries such as aluminium smelting, cold storage and refrigeration, data centres and inorganic heavy chemical production.

This is a relatively small set of customers that consumes a large amount of electrical power. Yet their consumption is steady and at high voltage, making them less expensive to serve than other types of customers.

For that reason, any subsidy reform should reduce the electricity tariffs this first group pays – not merely to the average system cost, but at least 25-35 per cent lower.

That approach may seem surprising: customers that consume more power should pay lower rates. However, it makes sense, for several reasons. These are the industries that can help GCC governments hit their ambitious industrialisation goals.

They are also the most sensitive to electricity prices, in that electricity is a huge contributor to their costs – the single biggest line item for many of them.

Most importantly, these customers require less in the way of generation, transmission, and distribution infrastructure.

Lower consumption group

The second group of customers consists of non-power-intensive industries and commercial users. These companies consume less power overall at lower voltage and have large spikes in demand, making them more expensive for an electricity provider to serve. Companies in this group should pay higher tariffs.

Yet because electrical power is, by definition, not a major component of the costs for these companies, they are better able to absorb higher tariffs. They have several options to mitigate the increase, such as reducing costs in other areas or passing modest increases on to their customers.

Also, paying electricity prices more in line with costs will likely lead to changes in behaviour, such as being more energy-efficient, that will reduce the overall cost to serve everyone, even the industrial companies that pay higher tariffs.

Electricity Pricing

Helping the medicine go down

These reforms could still lead to opposition, as any change means some users will pay more for electricity. However, governments can smooth the implementation process by anticipating any potential opposition and proactively taking steps to mitigate the economic shock that companies in the second group will face.

For example, governments can offer financial support during a transition period of several years, or help cover the cost of more energy-efficient equipment. Governments can also designate some non-energy-intensive industries as more strategic and continue to support them with higher subsidies.

Current electric power tariffs in the GCC are unsustainable, in light of growing demand, but simply charging all users a higher tariff will not work. By charging tariffs that more accurately reflect customers’ actual cost to serve, governments can make the electricity sector financially self-sufficient and still boost the industrialisation of local economies. It is a policy reform in which all sides will benefit.

About the authors

Electricity PricingClockwise from top left: Shihab Elborai, Yahya Anouti and Raed Kombargi are partners and Ramzi Hage is principal at Strategy & Middle East, part of the PwC network. Click here for the full report

 

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