The MIDDLE EAST and North Africa should offer a heartening prospect for the global power industry. As the MEED figures for demand growth show, the region has a huge power generation requirement to meet (see page 24). Demand is rising by as much as 15 per cent a year in some of the Gulf states. MEED estimates that an investment of $57,445 million in new power generation is required over the next five years if all the region’s ambitions are to be realised, bringing as much as 46,200 MW on line.
The problem is that the Middle East has less money available to fund the necessary expansion. Populations have swollen and inflation-adjusted oil revenues have fallen sharply, to the extent that in 1994 they were worth about a quarter of their value in 1980.
This has concentrated minds and most states of the region are engaged in a process of economic reform which entails cutting budget deficits and tackling them at source. Historically, the power sector has proved an enormous drain on government resources in the developing world and it should be ripe for reform. ‘The power budget has typically accounted for 25 to 30 per cent of government expenditure, add transport and telecoms and it goes up to 50 or 55 per cent,’ says Ibrahim Elwan, the former World Bank official and promoter of the Hub river power project in Pakistan*.
A typical power utility in the Middle East is a department of government, provided with fuel that is priced far below international levels and delivering electricity to customers who are charged much less than the cost of supply. Elwan, who now heads the private sector Infrastructure Capital Group, recalls that when the World Bank advised Turkey on debt restructuring in the 1980s it found that 60 per cent of Turkish foreign debt originated in the electricity utility and had maturities of five to seven years.
The high cost and heavy burden of power sector investment should make it a natural candidate for privatisation in the restructuring of Middle East economies. Morocco, Oman and Pakistan have all adopted private power policies and have some results to show for it. After nearly a decade of failed attempts Turkey hopes to bring several independent power projects (IPPs) to financial closure this year. Egypt, Jordan and Tunisia are all inviting private sector proposals for future power plants.
In other Middle East states, where budget deficits are less pronounced, governments are still reluctant to accept that such a strategic sector must be allowed to slip from their complete control. However, a consensus is emerging that few developing countries can hope to enjoy the benefits of economic restructuring unless public sector investment is supplemented by private sector input. Countries like Pakistan have responded readily, creating the necessary conditions to attract IPP investors.
Yet, with the exception of Bahrain and Oman, most of the Gulf states are barely considering the concept of private power. In many states the concept of privatisation, in the sense of selling off assets so recently acquired at considerable cost, is anathema. IPPs face significant challenges in such developing markets as they often play the role of pioneer, prising open a highly restricted sector of the economy and relying on financial markets and regulations which are immature or unsuited to the needs of private investors.
Getting a project through to completion can take an improbably long time. Proposals for the Hub river project were first submitted to the government of Pakistan in July 1987; the ceremony to celebrate financial close was not held until nearly eight years later in January 1995. One US energy group recorded the signing of over 600 letters of intent or memorandums of understanding between governments and developers in just two years in the early 1990s for over 300,000 MW of capacity. Fewer than 10 per cent of such deals made it through to financial closure. Bids are also complex and can cost well over $1 million to put together for a larger contract. Today, few developers are prepared to carry the costs and risks that were entailed in sticking with the Hub river project. In that instance, the World Bank, a small group of developers and the government of Pakistan showed inordinate determination.
The model IPP in the Arab world – the Manah power station in Oman – enjoyed a similar level of exceptional support. Manah relied heavily on the International Finance Corporation (IFC), the private investment arm of the World Bank, to provide its senior debt. The IFC provided three loans totalling $72 million while the export credit agencies of France and the UK – Coface and the Export Credit Guarantees Department – provided $27 million and $38 million respectively. Local loans and working capital amounted to $28 million, or 17 per cent of the senior debt.
Elwan fears that future capital transfers from the OECD and private sector investment flows into developing country markets are likely to be much lower in the years to come, implying a greater reliance on the IFC, the World Bank and local capital markets to fund such schemes in the future. Manah attracted the support of four local corporations as shareholders in the development company, taking 5.47 per cent each, and another 40 per cent of the equity was raised on the Muscat Securities Market, suggesting a high level of local investor interest in a well-presented project.
Clear regulations and procedures are another key contributor to project success; both elements are conspicuously missing from many Middle East markets. Pakistan has been transformed by the experience gained from the Hub river project, going out of its way to speed up and simplify processes for investors. Pakistan’s investment package of March 1994 set out to improve the prospects for IPPs by meeting many investor demands. A bulk tariff for electricity prices was announced, instead of negotiating the rates for every project. There is a standardised concession agreement, covering implementation, power purchase and fuel supply. The government of Pakistan covers the risk of non-purchase of power by a public utility and the non-supply of fuel by public sector suppliers. Investor and lender risk is limited to the commercial risks associated with the financing, construction and operation of the plant. Investors are also free, within a policy framework, to select the technology, plant site and fuel themselves. They can also deal with a single dedicated agency, the Private Power & Infrastructure Board, and take advantage of various fiscal incentives.
The sophistication of this approach contrasts strikingly with the modest progress made in most Arab markets. In Jordan, which recorded a 13 per cent surge in demand in the first five months of 1995, a bill to create a three member regulatory body for the power sector, to be headed by a minister, is before parliament for consideration. Countries such as Egypt are offering specific projects on a build-operate-transfer basis but have yet to consider how their tariffs and regulations might affect prospective investors. Compared with the advances made in Pakistan to create attractive conditions for investors, most Arab states have barely made a start on creating a clear framework for private power investment despite a declared enthusiasm for the idea.
Pakistan’s big ambitions may yet be thwarted by the limits on its ability to service new debt in the power sector. According to one prominent developer Pakistan may only be able to service $2,000 -3,000 million worth of debt which translates into a maximum of 3,000 MW of new capacity and perfectly viable projects may not be realised because Pakistan cannot afford them.
The innovations were also driven by a desperate need to boost capacity fast, whereas few other Middle East markets are in such obvious difficulty yet. However, most electricity authorities accept the argument that privatisation, by stimulating competition, improving efficiency and passing the burden of future investment to the private sector, is a valid option. What is lacking in most markets is the political impetus to promote such reform. Political dogma drove the wholesale privatisation of the UK’s electricity industry in the 1980s but few other parts of the world have shown comparable enthusiasm, the Middle East included.
*Middle East & North African Power & Privatisation Conference, 18-20 June, Limassol, Cyprus