As MEED’s developer rankings show, bringing in the private sector is becoming widely accepted as the preferred way of getting power plants built across the Middle East. But with Gulf states struggling to meet soaring demand for energy, the current single-buyer model generally used for such projects may not be the most cost-effective or efficient.
Under the model, a government utility typically launches an international tender to build a new power station. It then selects the developer who offers the lowest cost to build and operate a facility that meets agreed output targets.
An offtake agreement is drawn up between the government and the developer, under which the offtaking body, usually the commissioning utility, agrees to buy the power and water produced from the project at a fixed price and sell it on to the end user.
In Europe and the US, however, a more complex merchant-market model predominates. This involves multiple buyers and sellers trading power and water through an agreed settlement system for dealing with trade imbalances and, most importantly, metering arrangements to assist with accurate tariffs.
For Gulf states, moving towards a merchant market would potentially allow a reduction in public spending on power subsidies and a redirection of resources into areas requiring investment, such as infrastructure.
With the summer of 2007 over, Gulf state utilities are reviewing some of the lessons learned from the latest period of peak demand. The clearest example of what not to do comes from Kuwait, which just about pulled itself through the summer period thanks to belated efforts from the government to encourage customers to use less electricity and the installation of emergency power capacity.
The Kuwait example serves as a timely reminder to other states that rapid economic and population growth needs to be supported by a continuous commitment to building power infrastructure to ensure demand does not outstrip supply.
There are significant obstacles to building up capacity in the Gulf. An increasing shortage of gas-fuel feedstock, on which most regional plants are run, will remain a problem and a lack of engineering, procurement and construction (EPC) contractors to take on planned power projects will also be a challenge.
In Kuwait in particular, perhaps the main benefit of having a market with realistic tariffs would be that it is proven to significantly reduce the rate of consumption.
Additional failings that are adding to Kuwait’s power shortages include outdated tender regulations that are unattractive to contractors and faulty population projections, with no new plants built over the past four years.
The result is that the government has to retain the services of emergency power contractors to cover the shortfall and rush through an awareness campaign – the National Project for Energy Conservation (Tarsheed Campaign) – aimed at getting people to reduce their power consumption.
The biggest challenge in the Gulf is that most states have allowed their citizens to become accustomed to unlimited power and water, while allowing them to pay virtually nothing for these services.
‘These are all challenges that utilities in the region are addressing,’ says Sohail Barkatali, a partner at law firm Berwin Leighton Paisner, which operates in the region. ‘Some are more advanced than others in dealing with these matters.’
In Saudi Arabia, for example, a new tariff is already under consideration. Currently, tariffs vary according to the category of consumer, with different rates for residential or commercial users, and mosques and hospitals. In the industrial city of Yanbu, for example, commercial and residential customers pay SR 0.05-0.26 ($0.01-0.07) a kWh, although homeowners tend to be towards the lower end of the scale. Industrial clients are charged slightly more, at SR 0.12 ($0.03) a kWh.
A study on a possible new tariff has been prepared by the US’ London Economics International on behalf of the regulator, the Electricity & Co-Generation Regulatory Authority (Ecra). Riyadh is considering several potential reforms, including introducing a pre-paid metering system, a distribution tariff similar to the present one, and separate regional and local tariffs.
So far, most private sector activity has involved power generation and distribution, and Oman and Abu Dhabi have been at the forefront of Gulf power sector reform. ‘Oman and Abu Dhabi have unbundled the activities of generation, transmission and distribution, all of which are now being undertaken within a regulated framework,’ says Barkatali. ‘Unbundling in other Gulf jurisdictions is not as advanced.’
But they approached privatisation from a slightly different perspective. In Abu Dhabi, the Abu Dhabi Water & Electricity Authority (Adwea) offers concessions on IPPs on a build-own-operate-transfer basis and retains 60 per cent of the shareholding in the IPP project company. Foreign investors take a 40 per cent stake. At the end of the terms of the power and water purchase agreement, the government takes over the power assets.
In Oman, concessions are offered on a build-own-operate basis so private power generators keep the assets without them reverting back to the government. In both cases, the single-buyer model is still preferred. But this could change over time.
‘In each case, it is possible to see the emergence of a merchant market in the medium to long term,’ says Barkatali. ‘Legislation also supports this view.
‘For example, in Oman, the law for the regulation and privatisation of the electricityand water sector envisages further market liberalisation.
‘The relevant provision requires the National Economy Ministry and the Authority for Electricity Regulation to undertake a review of the status of the electricity and related water sector on an annualbasis and to report on whether or not the sector is ready for further liberalisation.’
But for some states, fully opening up their power markets may prove a step too far. ‘On power generation, the desalination and wastewater markets, the private sector can extend its reach,’ says a financial adviser working in the Gulf. ‘But the issue is how far states want to deregulate. I don’t see a merchant market happening soon. The single-buyer model is likely to be favoured for some time.’
‘One of the biggest problems is the issue of volume and price,’ he adds. ‘The hardest thing in the Gulf is the seasonality factor, which can prove difficult for clients. There is peak demand in the summer for power and water but much less in the winter. Then there are the tariffs. In a real merchant market these will have to go up, and that is a very political decision if people are used to paying virtually nothing.’
The feedstock challenge is also an obstacle. ‘A third problem is the issue of feedstock for the power plants,’ says the adviser. ‘Much of it is presently subsidised or free. In a merchant market, from whom would developers get the feedstock, at what price and to whom would the profits go?
‘From the point of view of a feedstock provider, if a developer is making a huge profit then it is giving away the fuel too cheaply.’
Although moving towards a merchant market might have long-term financial advantages for states, many governments and developers prefer the single-buyer model for its simplicity and guaranteed price, and are likely to stick with it over the short to medium term.
However, if the Gulf is to create a merchant market in the future, one key area that needs to be developed is regulation, a relatively new feature in the Gulf power sector. One of the first regulators to be set up, in 1998, was the Regulation & Supervision Bureau (RSB) for Abu Dhabi, covering electricity, water and wastewater. In 2004, Ecra was set up in Saudi Arabia. And in Oman, the Authority for Electricity Regulation was established in 2005.
‘It is important that regulators in the region do not fall foul of policy that erodes their independence or impedes their ability to act in the public interest,’ says Barkatali. ‘This can result in weak regulatory regimes that do not always protect consumer interests, and that can potentially jeopardise privatisation.’
A recent example in Abu Dhabi tested the powers of the RSB. In February 2007, Abu Dhabi National Energy Company (Taqa) bought the US’ CMS Generation for $900 million. The deal gave Taqa a 94 per cent stake in the Taweelah A2 plant in the UAE and a 74 per cent stake in the Shuweihat S1 plant, again in the UAE. Taqa is majority owned by the state-run Abu Dhabi Water & Electricity Authority (Adwea), and as such the deals were widely regarded as going against the spirit of privatisation.
The RSB in turn notified Taqa of its position with regard to the two plants, and of taking future stakes in other plants above the 60 per cent it allowed. In early October, Japan’s Marubeni Corporation agreed to buy a 40 per cent stake in the Taweelah A2 plant from Taqa.
In announcing the deal with Marubeni, Taqa was keen to emphasise its commitment to privatisation. ‘As Taqa, we want to actively support the privatisation process,’ said Peter Barker-Homek, chief executive officer of Taqa, at the time. ‘The Marubeni deal is an important message to send to the global market.’
More importantly, the federation’s regulator appears to have passed an important test by exercising its authority in the market.
The most pressing challenge for the Gulf states remains a shortage of skilled EPC contractors because of the construction boom in the region. Added to this are a limited number of steam turbine suppliers to serve the power sector.
Over the short to medium term, these practical problems will remain the main challenges for states trying to build up capacity and deliver schemes on time and within budget.