The state utility is introducing a series of changes to improve efficiency and performance.
Saudi Electricity Company (SEC) is the largest utility in the Gulf, both by market capitalisation and in terms of its installed power generation capacity. The company was formed in 1999, as the result of a merger of the country’s 10 regional power companies.
“This marked the first step towards the deregulation of the market,” explains Ali Saleh al-Barrak, the company’s chief executive officer (CEO). “SEC began operating in April 2000 with a natural monopoly in generation, transmission and distribution. Now it is one of the largest entities in Saudi Arabia in terms of market capitalisation and shareholder equity.”
Headquartered in Riyadh, the utility operates as a vertically integrated company. It is 74 per cent government owned, with the rest of its shares held by the private sector. In turn, it owns 50 per cent of Water & Electricity Company, the single off-taker for independent water and power (IWPP) projects in the kingdom.
Last year, SEC hired the US’ McKinsey & Company to prepare a plan to improve efficiency and performance. Its recent financial per_formance highlights the need for change. In the first quarter of 2008, it recorded a loss of SR771m ($205.6m), its largest in at least four years.
SEC has already started implementing the changes recommended in the plan. In March, it issued a tender for its first ever independent power project (IPP), to be located at Rabigh. “The next step is to improve project procurement,” says Al-Barrak.
Instead of tendering engineering, procurement and construction projects individually, SEC has started to bundle them into groups to attract the biggest contractors and increase competition. It has also begun buying materials in bulk. “To save time and cost, we bought 25 generation units from [the US’] GE for $1.5bn last year,” says Al-Barrak.
The company is also working on improving the efficiency of its workforce. The company had a problem with long-term staff who, despite having high salaries, were no longer considered to be productive. Already, almost 800 people have accepted redundancy packages and will be replaced with new employees.
“We are not hiring the same number,” says Al-Barrak. “If we get 800 leaving, we will hire 200 that are more efficient. The cost of the old guys is high. They have been in the company for 15-20 years and their pay is high compared to their productivity.”
SEC owns assets with a generation capacity of 33,000MW, which accounts for 85 per cent of the country’s total. Its portfolio of projects under way is worth SR40bn and another SR30bn worth of projects are being tendered.
With demand for power in Saudi Arabia growing at 7-8 per cent a year, SEC cannot afford to slow down. It estimates that 35,000MW of new capacity will be required over the next 10 years to cover demand growth and build up 15 per cent reserves. Some $53bn in capital expenditure will be needed for generation, transmission and distribution projects.
“The main driver is to maintain adequate power supply to consumers, to sustain the current level of industrialisation and boost the economy,” says Al-Barrak.
The company is the largest shareholder in the GCC interconnection project, holding a 35 per cent stake. Together with the Egyptian Electricity Holding Company, it also financed a study into an interconnection between the kingdom and Egypt.
Domestically, 8,000MW of its own new capacity is under construction and it is a shareholder in the Shoaiba and Shuqaiq IWPPs. Its first IPP, at Rabigh will provide 1,200MW of new capacity by 2013. This will be followed by the 2,000MW Riyadh P11 IPP in 2014 and a second 2,000MW IPP in Qurayah by 2015.
SEC will not stop at three IPPs. At least 30 per cent of all capacity introduced over the next 10 years will built by private developers. “SEC will continue building at some locations where we are expanding a power plant or at locations that are not attractive for IPPs,” says Al-Barrak. “If we can achieve more than 30 per cent, we will definitely do it. But from what we see in different parts of the world, IPPs are not taking 100 per cent of the market.”
Already, two more IPPs, to be located in the south and northwest of the country, are being studied.
Eventually, SEC plans to encourage investors to sell part of their IPPs in initial public offerings (IPOs). The Riyadh plant will be the first to go through the process. “We are planning to include in the request for proposals that developers should take into consideration that they should make part of their investment available for an IPO,” says Al-Barrak.
The proportion of the IPP to be sold off has yet to be decided.
As part of the government’s programme to move to an open electricity market, SEC will be split into four generation companies, which will eventually be sold off to the private sector. For this reason, IPPs will be developed on a build-own-operate basis, rather than within a build-operate-transfer framework. “We have no intention of transferring any assets,” says Al-Barrak. “SEC in the future will go out of generation.”
SEC, like other utilities in the region before it, has recognised the need for greater private sector participation in power generation. Thanks to its IPP programme, it will be in a position to invest more of its funds in improving transmission and distribution networks in the kingdom.
However, in the context of market libera_lisation, long-term power-purchase agree-ments between SEC and developers may be a hindrance. Saudi Arabia’s low electricity tariffs, which are not reflective of the cost of production, are also a burden on the restruc_turing process.
Shortages in contractors and rising materials costs could also negatively impact SEC’s plans. Its Rabigh IPP is on the Gulf market at the same time as five other major power projects and is likely to face significant competition.
- Date established: 1999
- Main business sectors: Power generation, transmission and distribution
- CEO: Ali Saleh al-Barrak
Q&A Ali Saleh al-Barrak, CEO
Why have you decided to introduce private sector participation?
A power plant is a capital- intensive project. Independent power projects (IPPs) will assist SEC in meeting demand. They provide a financing option that will reduce the burden of having a fund for these projects.
We will direct these funds to transmission and distribution projects where we monopolise activity and will continue to do so for a long time.
We also want to improve the efficiency of our operations through competition - the power plants will operate on a competitive basis. We will move our expenditure from Capex to Opex.
Do the IPPs fit in with the government’s plans to create an electricity market?
We are not keen to have long-term take-or-pay power-purchase agreements because they are an obstacle to the open market.
It will not be easy to get rid of them when we have a market in 2016. So we have to limit the number of IPPs to those projects we cannot finance ourselves.
Does that mean you will encourage developers to sign shorter-term agreements?
So far, none have accepted this. Under the current contracts, we sign to buy all the energy from the IPP for 20 years. Even if we do not need it, we have to pay for it. Later, when we have a market, we will get stuck with this energy and will have to buy it at a certain price.
One solution would be to transfer the agreement to the consumer so that the generators would sell to the consumers directly.
What issues must be resolved before Saudi Arabia can have a functioning electricity market?
There are a several issues that have to be addressed. We need a cost-reflective tariff with no or low-cost subsidies.
The tariff is an important issue for any restructuring and for market evolution. It is one of the obstacles that is delaying our restructuring. The regulators are doing their best to rebalance this.
We also need a robust transmission system so that when we have a market we can move electricity easily. The critical situation is that there is a very low reserve margin in the system. We need 15-20 per cent reserves, but now they are below 5 per cent. That does not help. We also need to develop a regulatory environment and smooth decision-making processes.
How will SEC be restructured?
We are in the process of preparing to split our generation assets into four equivalent companies.
We are working with [US consultant] Booz Allen Hamilton to split them and make them equivalent in terms of technology and the size of power plants so they can compete in the future. At a later stage, they could be sold off to the private sector.
What are the major challenges that SEC will face in the coming years?
One of the main challenges is how we can meet this high growth in demand. Also, there is a high increase in capital costs, which is far above our expectations. We have a shortage of suppliers.
Even if we have the finances, there is a shortage of contractors and suppliers.
A major question is how can we supply people with low-tariff electricity as the government wishes to do, and at the same time run the sector in general, keep the lights on, improve operations and build a reserve margin?
Investing in the electricity sector is investing in Saudi Arabia, present and future.
What are you most excited about in terms of the work SEC is doing?
The most exciting thing is that we are really covering almost 98 per cent of Saudi Arabia with electricity and we are looking within two years to be covering 99.5 per cent of the country.
We are supplying all these industrial, petrochemical, oil and other industries as well as the residential sector and really adding value to people’s lives.