Sanctions benefit Gulf power developers

02 October 2008

While leading international developers remain deterred from investing in Iran, smaller regional companies have an opportunity to build up their power portfolios.

With electricity consumption rising by almost 10 per cent a year and subsidies being phased out, Iran’s power sector should be a highly attractive investment prospect for private developers.

Tehran has embarked upon a vast capacity-building programme in response to estimates that peak load will hit 69,500MW by 2015, up from the current high of 40,000MW.

Firm proposals are in place for the construction or expansion of 40 power plants over the next six years, 21 of which are private schemes, and there are provisional plans for an additional 37 gas-fired facilities to be built by private developers.

Combined, these projects will result in 40,000MW of additional generating capacity coming on stream, nearly doubling Iran’s existing installed capacity of 45,111MW at the end of 2006.

Encouraging investment

To fund this expansion, and to improve the efficiency and reliability of supply, the government is keen to attract both foreign and domestic investment into the power sector.

It has put a legal framework in place to facilitate private participation and has established a grid operator, Iran Grid Management Company, and a regulator, Electricity Market Regulatory Board, to oversee the market.

Under the legislation, independent power projects (IPPs) can be developed using the build-own-operate or build-own-operate-transfer models. The latter model is targeted at foreign investors.

For the time being, the electricity is sold to a single offtaker, the Iran Power Generation Transmission & Distribution Company (Tavanir), under long-term energy conversion agreements.

But ultimately the government intends to establish a competitive wholesale market and to allow direct sales to large end-users.

Despite early enthusiasm among private investors, the majority of the IPPs that are operational were developed by domestic, quasi-state entities.

Most schemes involving international partners stalled following the discovery in 2003 that for 18 years, Iran had been breaching the Nuclear Non-Proliferation Treaty by conducting uranium enrichment-related activities.

The UN subsequently imposed three rounds of sanctions on the country, which continue to deter many foreign companies from conducting business there.

The leading international private power developers, contractors and banking institutions behind the capacity boost in the Gulf region cannot afford to invest in Iran for fear that an association with a ‘rogue nation’ would damage their business interests in the US and elsewhere.

“With so many opportunities in the Gulf region, and so many power and energy projects around the world, particularly in Russia, Southeast Asia and the UK, why would they take the risk?” asks one industry source.

“There are a lot of investors ready to go into Iran but many companies have interests in the US and the threat of further sanctions is putting them off,” says another source. “Pacifying foreign policy would facilitate foreign investment.”

It is no small irony that Tehran’s determination to push ahead with an atomic programme, which it says is necessary to meet rising demand for electricity, is preventing much-needed foreign capital and technological expertise from flowing into the Iranian power sector and hindering its capacity expansion.

The controversial nuclear power plant currently being constructed by Russia’s Atomstroyexport in Iran’s Bushehr province will add 1,000MW of new capacity.

But even with two similar-sized facilities in the planning, there remains an urgent need to build and finance conventional power plants to avoid an electricity shortfall in the years ahead, particularly as atomic power stations can take more than 10 years to construct.

Supply weaknesses

Concerns over gas supplies are another, paradoxical reason why some foreign developers are now hesitant to go into Iran, even though it has the second-largest proven reserves of natural gas in the world after Russia.

An unexpected cold snap last winter left residents in parts of northern Iran without heating and electricity as gas supplies to the region failed to match demand.

This has led some industry observers to question whether there will be sufficient gas available to fuel all the power plants being planned.

With 981.75 trillion cubic feet of known reserves, there is clearly no shortage of gas in Iran. But a lack of investment in infrastructure and storage facilities, as a result of the prolonged under-pricing of natural gas, has meant supplies have been unable to keep pace with the growing requirements from the power sector and other industries.

“There is no shortage of gas in Iran, there is a problem with distribution,” says one Tehran-based source.

“The new government was inexperienced and in the early years not enough resources were allocated to the energy sector, and so the networks were not developed as they should have been.”

The government said at the time that gas flows to the north had been cut because of price disputes with Turkmenistan, which supplies that area of the country. Projects to expand and install pipelines are now under way.

Weaknesses in Iran’s power system were exposed again this summer when a 4,000MW shortfall in generation meant load shedding had to be implemented.

According to official explanations, a severe drought was preventing hydropower plants from running at full capacity.

With outages totalling up to four hours a day, the country’s economy started to suffer and accusations of mismanagement and incompetence have been levelled at the Energy Ministry.

There were even suggestions from some quarters that the power cuts had been engineered to justify Iran’s pursuit of nuclear technology or to help push through price increases, as in previous years droughts had not had such a severe impact on power supplies.

Controlling wastage

To slow the rate of growth in consumption, the electricity authorities are trying to curb wastage by reducing system losses and raising tariffs. B

ut this will only free up a relatively small amount of capacity and Iran still needs to build significant new generation capacity to meet the rising demand from its industrial sector and expanding population.

This represents a great opportunity for the smaller regional developers, which struggle to compete with the industry giants in the Gulf, to build up a Middle East portfolio, particularly as Islamic banks are still prepared to finance projects in Iran.

Dubai’s Quest Energy is one company that has seized this opportunity.

It is working on its first ever power project in a consortium with leading local developer Iran Power Management Company (Mapna).

The firms plan to build a 1,000MW open-cycle gas-fired plant at Shiraz. Dubai Islamic Bank is financing the scheme and the availability of gas supplies has been confirmed.

Mapna, which is constructing 22 power facilities in the country and has another 10 projects under evaluation, is regarded as the partner of choice for foreign firms seeking to break into the Iranian power sector.

In addition to its wealth of experience in the market, its subsidiary companies manufacture key power equipment, such as gas and steam turbines and boilers, and carry out engineering work.

“Mapna can do everything, including manufacturing,” observes one industry consultant. “It has lots of money and working with Mapna is easier [than with non-established players] as it knows how to work in Iran.

“If an investor comes in and the banks say they want Western companies to do the EPC [engineering, procurement and construction] work and supply turbines, that is when the problems start.

“It is difficult for companies to operate in Iran, to find contractors and people to work there because of the uncertainty of the sanctions, and that pushes up prices.

“Equipment delivery times are also longer as some orders have to go via third countries.”

But even working with Mapna does not mean everything will run smoothly. The consultant cautions that the electricity authorities’ slow decision-making processes have caused several projects to stall in the past.

“It is a problem trying to make them understand that prices discussed a year ago are no longer valid, that EPC prices have gone up and it is necessary to change the offtake tariff,” he says.

Although sanctions are hampering the pace of development, the Iranian power sector has the potential to become the most profitable market for private developers in the Middle East.

Trading power

There is a clear commitment to removing subsidies ansd creating a merchant market, and there is plenty of opportunity for trading Iranian electricity with its neighbours.

Distribution networks with countries such as Afghanistan, Azerbaijan, Iraq and Turkey are already in place, and new links are planned, including a sub-sea connection to Dubai.

With pressure mounting for a fourth round of sanctions and a presidential election planned for June 2009, the business climate in Iran could change dramatically.

Investors will need to weigh carefully the perceived political risks against the benefits of gaining a foothold in a nascent market with a bright future.

Key fact


Projected peak demand in Iran by 2015

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