Muscat’s model for power

02 October 2008
The privatisation of Oman’s electricity transmission company will be a first in the Middle East, creating a blueprint for other governments to follow.

By inviting international firms to participate in its power generation sector in the mid-1990s, Muscat has enabled its state utilities to build additional capacity and meet rapidly rising demand far faster than would otherwise have been possible.

Competitive tenders have brought cost-savings and efficiencies, and the sector has benefited from the international expertise that has been brought in to build power plants.

Following the success of this model, it is only natural that state power providers should want to explore the opportunities for private sector involvement in their transmission and distribution businesses, and Oman’s Electricity Holding Company (EHC) is doing just that.

In August, it appointed professional services firm KPMG to advise on the privatisation of the Oman Electricity Transmission Company (OETC), the monopoly provider of transmission services to the main grid in the north of the sultanate.

Privatisation strategy

Over the next six months, KPMG will define a strategy for the privatisation, recommending whether it should take the form of an asset sale or share sale, and whether the government should retain a stake in the grid operator.

A further five companies belonging to EHC have been earmarked for privatisation at a later date, including the Muscat Electricity Distribution Company.

The market has responded positively to the proposal to privatise OETC, with the owners and operators of international transmission grids expressing a keen interest, despite the absence of plans to liberalise electricity prices.

Subsidies will remain in place and the regulator will continue to set the tariffs for the sector.

But with high consumption growth and broad scope for efficiency savings, Oman’s transmission system is deemed an attractive investment opportunity that would provide predictable returns for stakeholders.

“The tariff is set by the regulator and it is just in the process of setting the next five-year price path that will apply from 1 January 2009,” says Anthony Cohen, head of mergers and acquisitions, corporate finance, at KPMG in Australia.

“So if you bought OETC next year, you would have five years of price certainty, and if you could run it more efficiently, that would benefit you.

As the regime is pretty transparent, you would also have a good understanding of the way the regulator will set prices for subsequent periods, how revenue will flow over the long term, and the areas in which your outperformance can give upside.”

If the sale goes ahead, it would be the first privatisation of a transmission operator in the Middle East, so the process is being closely observed by utilities across the region.

“Once they [regional governments] see the success of this, they will be encouraged,” says Cohen.

“There has been nervousness about privatising transmission businesses, but where it has been done before, it has been shown to be effective in both bringing in private sector skills and capital, and in making the systems more efficient over time.”

In particular, Saudi Arabia will be interested in the outcome, as it too wants the private sector to play a pivotal role in the restructuring of its power market (see feature, page 56).

Yet other countries in the region have conducted similar studies to OETC and despite advisers recommending some form of privatisation, the projects have not gone ahead.

In 2003, German consultant Fichtner studied the feasibility of privatising the power and water transmission and distribution systems belonging to Qatar General Electricity & Water Corporation (Kahramaa).

“We worked out different business cases showing the likely future development under private and publically organised systems,” says Peter Pintz, who managed the project for Fichtner.

“After comparing the two systems, we concluded that a privately run system would be more efficient and cost less.

"When we presented these results to the government and Kahramaa, we clearly indicated that if they were to go for privatisation, they would have to undergo a reform of the tariff system.

"The tariffs at that time were so low that no private operator or concession holder could have run the system unless huge subsidies were paid to the private company.”

Reluctant to raise tariffs, Doha decided to abandon its privatisation ambitions.

In the UAE, Abu Dhabi Water & Electricity Authority (Adwea) commissioned French bank BNP Paribas in 2005 to devise a blueprint for the privatisation of its two distributors: Abu Dhabi Distribution Company and Al-Ain Distribution Company.

As a result of the study, Adwea began outsourcing some key services in these companies, such as operations and maintenance. However, the process was halted soon after.

Job losses

“Our board decided it was not the right time to do it because if you outsource operations and maintenance, many people would lose their jobs from the sector, and as a lot of people had already been taken out [by the privatisation of] generation, we thought we would slow down and not do it for the time being,” says Abdullah Saif al-Nuaimi, head of privatisation at Adwea.

The authority still intends to sell off minority stakes in the two distribution companies, but the exact timeframe and structure for the privatisations has yet to be determined.

Al-Nuaimi says Adwea is not necessarily seeking a stakeholder to manage the companies as it might revisit the outsourcing option.

“Distribution is not as attractive as generation because the returns are regulated,” he says.

“In distribution, they [investors] get 6 per cent, compared with generation, where the return is around 13 per cent.”

Adwea has no plans to privatise its transmission operator, Transco. It is regarded as a strategic asset that the Abu Dhabi government wants to retain to secure the supply of power in the emirate.

Nevertheless, Transco is run as a commercial entity, recovering its costs through service charges and providing capital for expansion projects. As a monopoly, it is subject to price controls imposed by the regulator: the Regulation Supervisory Bureau.

With electricity supply essential to any economy, it is no surprise there has been hesitation in the region over relinquishing control to the private sector.

Even on the generation side, the approach has been cautious and only a limited form of privatisation has been implemented, whereby the utilities retain a majority stake in independent power projects.

But faced with rampant economic development and soaring power demand, governments are having to bring in outside help to maintain adequate and reliable electricity supplies.

Provided robust regulatory regimes are in place to guarantee fair access to networks and supplies, and to oversee pricing, governments should consider allowing transmission and distribution systems to benefit from external intervention as well.

Tariff reform is a controversial issue throughout the Gulf and attempts to reduce subsidies in the past have provoked social unrest, leading governments to back down, so the determination to preserve them at any cost is understandable.

Although these non-commercial practices create distortions in the sector and stand in the way of true competition, the private sector will not be deterred from investing in transmission and distribution businesses as long as governments are prepared to pay high subsidies and the tariffs allow owners and operators sufficient revenue to cover their costs.

For countries that still believe transmission and distribution are natural monopolies that should remain government-owned, alternative models can be considered - for example, where assets are not owned but merely operated by private companies, such as the delegated management contracts Saudi Arabia has introduced for its water and wastewater sector.

Others, however, may feel no need to squeeze out the last 3-5 per cent of efficiency gains rather than reform tariffs, and continue to run less efficient and less productive systems. Given the high price of oil, they can afford to do so for the time being.

Key fact


Return on investment in UAE electricity distribution

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