By Claire Ferris-Lay
Tabreed CEO Karl Marietta on how he plans to tackle rising costs hitting the district cooling industry.
The region's insatiable appetite for real estate has driven demand for district cooling plants. But the rising cost of power and water is hurting the industry. Tabreed CEO Karl Marietta explains how he plans to tackle the changing market.
Karl marietta's office in Abu Dhabi Mall is filled with flowers congratulating him on his new position. The new CEO of the DFM-listed National Central Cooling Co, known as Tabreed, is now in charge of the world's largest district cooling company. But he doesn't look like a man whose been celebrating since his appointment last month.
Fueled by record high oil prices and a booming real estate industry, demand for energy efficient district cooling services has increased dramatically over the last five years. But threats of a real estate slowdown, power and water shortages and the rising cost of materials could be jeopardising the industry's growth.
"The availability of electricity is a critical part of our business. The utilities are struggling to keep up with the amount of new customers that are asking for services, including us so there are sometimes delays and issues related to getting new services," he says.
After an explosive start, fears are now growing that the region's district cooling industry may be running out of puff.
District cooling has grown in tandem with the Gulf's booming construction industry, that has recorded double digit growth over the last five years in Dubai.
A 2007 National Investor report predicts total installed district cooling capacity in the UAE will reach four millions tonnes of refrigeration (TR) by 2012, at a compounded annual growth rate of 63 percent. Across the Middle East the industry could reach $30bn in the next 10 years according to the International District Energy Association in the US.
"District cooling goes hand-in-hand with the greenfield construction industry," says Shafiq Khoury, managing director of Dubai-based Palm District Cooling.
The region's desire to transform itself into a more sustainable country is further boosting demand for the technology. While traditional forms of air conditioning technologies rely on individual air conditioning units, district cooling systems work on thermal energy from chilled water in a centralised cooling plant, using up to 40-50 percent less energy.
"If you compare district cooling with a traditional cooling system it will only cool half of the development. Comparatively on the consumption side you [also] save around 20 percent electricity," says Khoury.
Tabreed is currently in talks with Masdar, the Abu Dhabi-based green city initiative, to convert the air conditioning in hundreds of buildings across the emirate of Abu Dhabi. The plan, which will significantly reduce energy use, will also see carbon credits being sold in Europe.
Demand for the industry's services has boosted competition in the form of state-owned companies.While Palm Utilities unified Palm Water and Palm District Cooling last year, Emirates Central Cooling Systems Corporation (Empower) joined Dubai Electricity and Water Authority together with the Dubai Technology and Media Free Zone in 2003. According to the Abu Dhabi Environment Agency, the firm will supply a total of 815,000 TR in the UAE over the next 25 years.
All three UAE-based companies have formed partnerships with real estate companies, boosting the number of regular projects and minimising the more traditional tender processes. "There aren't too many [traditional forms of tender processes], because the major real estate companies have tied themselves up [with real estate firms] one way or another," explains Marietta.
As an Abu-Dhabi based firm Tabreed has partnered with Abu Dhabi real estate heavyweights Sorouh and Aldar Properties. Empower has a partnership with state-owned Dubai Properties while Palm Utilities has signed up with Nakheel to provide its services to many of its developments.
Yet the industry's correlation with the region's construction boom means that the growth of district cooling is likely to be affected by the industry slowdown. "There is a tremendous amount of construction going on and there is no secret that there is shortage of materials and contractors," says Marietta.
Power shortages, the rising cost of materials and labour as well as the substantial upfront costs required to build, operate and maintain district cooling plants are all likely to affect the industry.
Power shortages throughout the GCC are already threatening to slow down the region's nascent district cooling industry, a problem that only increases during the power-hungry summer months. Electricity demand across the Gulf region is projected to grow between 5-12 percent annually and already power cuts are commonplace, and not limited to small companies.
In August Middle East heavyweight Saudi Basic Industries Corporation was forced to temporarily shutdown a number of its plants in the kingdom due to power outages, while Kuwait has been forced to introduce scheduled power cuts to cope with rising peak demand.
While district cooling systems are far less energy-consuming than more traditional forms of cooling, they do rely on power plants which are being affected by the regional squeeze on power, says Marietta who says delays in projects are likely as demand for the industry grows.
In addition to power shortages, Hala Fares, an analyst at Dubai-based investment bank Shuaa Capital, says water shortages represent another huge challenge for the industry as they rely heavily on desalinated water. "A growing economy and population are putting upward pressure on demand for water and electricity, the main components utilised in the district cooling industry, especially during the summer time," she says.
According to regional real estate developer, Al Mazaya Holdings, construction costs in the Gulf have increased by 50 percent during the first half of 2008 compared to 30 percent for the same period in 2007.
The rising cost of construction across the Middle East is delaying large scale developments. Research firm ProLeads predicts that Gulf projects worth $48.4bn are currently on hold or have been cancelled due to the rising cost of materials and labour.Record inflation levels and the rising cost of materials means budgets for district cooling plants, which require a huge amount of capital up front, continue to rise.
"District cooling firms are also exposed to these delays in construction. In addition, the rising inflation implies the capex requirements for expansion projects would have to be continuously revised upwards," says Fares.
A recent report entitled "Emerging Markets Utilities: The Track Ahead" by Standard & Poor's also predicts the utilities industry overall will face a number of other problems. Since October 2007 the credit ratings agency has downgraded several downward outlook revisions and placed a number of utilities on negative CreditWatch placements with negative implications.
Tabreed is among those who have been placed on CreditWatch following the announcement of its new business strategy in July. The firm is currently in discussions with S&P and anticipates the CreditWatch note will either be extended or removed, rather than result in being downgraded Marietta tells Arabian Business.
On the firm's new business strategy S&P notes; "there could be a negative impact on short-term cash flow, partly reflecting increased capital expenditure, or higher levels of outstanding debt than previously considered within the rating category, which could adversely affect the company's ability to generate positive free cash flows by 2010."
In line with the new strategy the firm created a new asset holding company in June and presented a revised financial forecast which anticipated a significant increase in future capital expenditure.
In addition Tabreed confirmed last month it would be selling a number of its UAE-based plants to increase its profitability and fund its regional expansion plans.
Tabreed said the plan would involve selling between $136-272m of district cooling assets to long-term investors each year for three years.
Tabreed has already completed a successful partnership with Japan's Sumitomo Corporation and J Power in which it sold a 30 percent stake in Sahara Cooling Limited to each company whilst maintaining 40 percent for itself. According to Shuaa Capital Tabreed reported an $11m gain on the sale.
"One of the main things we are trying to accomplish by these sales is to improve the profitability of the company because the shares are down significantly," says Marietta.
"The historic way of trying to own everything ourselves becomes very difficult because we have to raise more equity at a time when share prices are low and we have to raise lots more long term debt at a time when it could potentially make our [balance] sheet look weak," he adds.The plan will see the company sell off its assets in the first quarter of next year. Failure to raise enough capital could see the firm head back to the debt market.
"Because we know we have continuous revenues coming from sales [of assets] we would be getting short term financing rather than long term financing," explains Marietta.
The company's growth plan and the huge costs required up front for a plant are likely to be the reason for the sales. "Despite the fact that these new projects are jointly financed between Tabreed and their counterparts such as Aldar, there is a huge capex involved with the construction of heavy plants and they need the financing," says Fares.
While the sales could provide Tabreed with the huge cash injection required to fill the gap in the budget that is expected to be generated as the cost of materials increases and won't harm the company equity, Fares warns it could result in increased pressure on profit.
"What could worry markets, investors and rating agencies is that when [you make the sales] you signal to the investors that you are selling your operating assets and therefore are putting pressure on operating profits," says Fares.
"Therefore the timing of these transactions is important. The sale of these plants should only occur when new and higher capacity is added," she warns.
It's a dilemma, both for Tabreed and rival district cooling providers as they address the possibility of cooling demand in markets across the region and an uncertain supply of the power needed to keep their customers cool.