Generation game: the struggle for power in the Gulf

The oil price decline has left a huge funding gap for the Gulf’s power and water giants, which are facing soaring demand from fast-growing populations. Experts say that it’s time for the private sector to take up more of the slack
Generation game: the struggle for power in the Gulf
By Neil Halligan
Fri 12 Aug 2016 12:34 AM

In case you hadn’t noticed, there’s a conservation drive under way across the region.

Governments all over the Gulf have been engaged in various ways to cut costs, and whether that’s investing in the cheapest available source of power, or cutting back on subsidies, the water and power industry is in a period of transformation.

While the GCC has in previous years made plans to reform its subsidy programmes, the 70 percent drop in the price of oil and subsequent budget deficits has forced countries to devise plans to reform local energy and water policies.

“The drop in the oil price has spurred governments’ determination to diversify — they have no choice,” says Glada Lahn, senior research fellow in energy, environment and resources at Royal Institute of International Affairs at Chatham House.

“And how energy prices are reformed will really be key to whether that diversification is real and sustainable.”

Pan-Arab energy investment bank Apicorp estimates that the GCC power sector, which generates 148GW of power, will require $85bn for the addition of 69 gigawatts (GW) of generating capacity and another $51bn for training and development over the next five years.

A recent analysis piece from consultancy Research and Markets claims energy demand is expected to grow in the GCC by between 8-11 percent by 2017, which is three times the global average, and that an estimated $29bn needs to be invested in desalination over the next 15 years.

Lahn, who penned a detailed research paper entitled ‘Fuel, Food and Utilities Price Reforms in the GCC — A Wake-up Call for Business’, says each country’s spending had to change in the face of the significant fiscal imbalance.

“Take gas prices for example — these are central to GCC power and industrial competitiveness. But over the last decade, the costs of meeting demand — such as through LNG imports in the UAE and Kuwait and exploiting new tight and sour gas reserves — began to outweigh the benefits,” she says.

“If you are importing more and more LNG at $7 to $16/mBtu [million British thermal units] to fill the gap and selling it at $1.10 to burn for electricity, that’s an unsustainable drain. Not only this, but the cheap prices are themselves damaging long-term competitiveness through depleting a national asset and at the same time encouraging inefficiency.”

Over the years, the GCC is spending billions on desalination plants as water demand grows.

She says the change in fuel prices in Bahrain, Oman, Saudi Arabia and the UAE has implications for the costs of producing water, electricity, petrochemicals and steel.

“If high enough, it should force efficiency improvements and in the long run it will assist with reorienting the economy away from oil dependence,” says Lahda.

“By international averages, the new prices don’t seem high — like going from 7-8 [US] cents to 12 [US] cents a litre for diesel in Saudi Arabia. But that change alone will add well over half a billion [dollars] to costs for the logistics industry.

“Companies like agribusiness firm Almarai said at the outset they’d be losing $80m this year from the new energy and water prices. In reality, though, this is about efficiency and productivity. It’s likely that most energy and water-intensive industries could do exactly the same with less, they just haven’t had the incentive before.”

The underlying issue remains, however, that current fuel prices and tariffs are well below international market levels, and so demand has historically been exorbitantly high.

Dubai Electricity and Water Authority (DEWA) recently launched its annual ‘Peak Load’ campaign, which aims to raise awareness about adopting a more sustainable lifestyle and rationing electricity and water use.

The campaign encourages the public to cut down on using energy during the peak load period of 12 noon to 6pm in the summer. The state-owned utility says air-conditioning accounts for about 60 percent of peak load usage. It’s an initiative that shows authorities in the region are being proactive, but also underlines that demand hasn’t dissipated at all.

“Keeping up with the growth of the electricity sector is a major challenge,” says George Sarraf, partner with Strategy& and the leader of the firm’s energy, chemicals, and utilities practice in the Middle East.

While each country in the GCC will have differences in terms of needs and how it meets those, Sarraf says there’s a common issue of “finding the right resources to fuel that expansion — both funding and fuel to keep up with that growth.”

While the demand remains strong, Sarraf remains cautious about referring to the utilities sector as ‘recession proof’.

Jon Blackburn, director at Ernst & Young (EY).

“It is impacted by economic growth. However, the relationship between economic growth and electricity demand has been a bit difficult to predict,” he says. 

“It used to be highly correlated but a combination of factors has made this correlation not work out. For example, the influx of people to the region following the Arab Spring created a big influx of people in the Emirates and many parts of the GCC which has contributed to some kind of growth as well.

“On the other hand, the oil price creates a growth that is actually at a lower level than it used to be, but there is still growth. The reality is all the forecasts indicate that the growth is still there and there is still a need to provide more electricity.”

David Lloyd, MENA Power and Utilities Transactions Leader at EY, says the growing population in the region, particularly the urban regions, will continue to exert pressure on demand.

“You have young and growing populations, and increasingly urbanised populations, which all drives capacity need, and in particular infrastructure connection needs, both in electricity and water, but that also requires production capacity. Saudi electricity production capacity is projected to need to double over the next five to ten years, depending on which forecast you take.

“The trends that operate slightly in a different direction is that the Gulf consumers are very, very heavy consumers per capita of electricity and water and there is a strong drive to try and manage both electricity and water consumption in the region.”

There is a strong drive and focus on reducing the subsidy requirements in both electricity and water sector across the Gulf but it has done little to cool demand in the short term, but Sarraf says it’s probably a bit too early to assess its real impact.

“The relationship between price and the demand for commodity actually is somewhat stronger with electricity than it is with water. With electricity you can always find ways to manage and conserve, whereas with water sometimes you need a minimum level, especially in hot climates,” he says.

“In Saudi Arabia it (the tariff) was at a very, very low level. Sometimes the increases are so relatively minimal compared to the disposable income, it doesn’t have a real big impact yet. There has been some issues in applying the new tariffs, as you know in Saudi Arabia, so there is a need for a bit more time to assess what has this done to demand.”

The decision to increase the tariff in the Gulf region in both electricity and water is part of plans, progressively and incrementally, to move the sectors towards a functioning where the costs can be more fully covered in the tariff the customers pay rather than in public subsidy, according to Lloyd.

Mohammed Bin Rashid Al Maktoum Solar Park aims to produce 5,000MW of electricity by 2030.

“There’s a move towards seeing tariffs increase over time so that costs can be more fully recovered in those tariffs and at the same time putting pressure on reducing costs and costs efficiency,” he says.

“The ultimate aim of Saudi Arabia and other countries in the Gulf is to move to a zero-subsidy electricity and water sector.”

Jon Blackburn, director of power and utilities at EY, says there’s a lot of demand management required with the tariff increase, as utilities look at how best to introduce it and still keep customers happy.

“Increasingly, what we see from a retail side of things is a focus on the consumer as well,” says Blackburn.

“There is a lot of focus within the industry on how to best implement the tariff increase in such a way as to keep populations happy. There has certainly been some dissatisfaction in Saudi Arabia as some of those things have happened. The need to engage customers and actually understand how to help them reduce consumption, be that through some form of incentive taxation or other controls. There is a very strong drive, certainly in the UAE and in Qatar to a lesser extent and Saudi Arabia to maintain the satisfaction of the customers.”

A significant way of reducing costs for utilities is privatisation. One example has been Saudi Arabia’s Saline Water Conversion Corporation (SWCC), the kingdom’s second-largest power producer, which has been working for years on plans to go public.

“I think privatisation is a must, especially in the utility sector because in times of reduced government spend, you want the government to spend in areas where the private sector is not willing to invest, and so the government spend should focus on healthcare, schools, building government institutions, developing remote areas, new industries that are in their infancy and really need a government kick,” says Sarraf.

He says spending money on power-generating assets, which the private sector is more than happy to fund, doesn’t make sense.

“Utilities is a very attractive investment for the private sector. There is a model — the IPP (independent power producer) — which is working pretty well in the region, which is a kind of a private public partnership where the private sector funds pretty much the whole asset in return for guaranteed uptake for 20 years. It’s a very attractive investment but it needs to be managed well,” Sarraf says.

Lloyd adds that when it comes to privatisation, he believes that it will most likely to occur at the production end rather than at the transmission distribution and supply end.

Nuclear energy is estimated to produce nearly a quarter of the UAE’s electricity needs by 2020.

“With SWCC, the precise details of how that’s intended to be done and over what timeframe remains still to be seen, but Saudi Electricity Company (SEC) has itself announced its intention, in the coming years at least, to spin off and part privatise stakes in its own electricity generation,” he says.

“I think generally we’re seeing strong focus in the region on new ways in which utilities and services can be delivered, including a greater use of PPP (public-private partnerships) and private sector delivery mechanisms. We do see privatisation as a very strong theme in the Gulf.”

The other major theme, particularly in the area of power generation, is using alternative sources to fossil fuels.

The UAE has been at the forefront in its solar plans, setting world records in price per kilowatt hour (kWh) with both the Mohammed bin Rashid Al Maktoum Solar Park in Dubai and Abu Dhabi’s 350-megawatt (MW) Sweihan solar project, making them more than competitive when it comes to fossil fuels.

Despite the multi-billion dollar deals being signed across the region, Sarraf says the renewable energy sector has been “relatively untapped in the region” with significantly more space for growth.

“There are isolated cases, and the UAE is at the forefront, but they are still far from their targets. I think there is a big push, I can sense it now, for the solar and wind agenda,” he says. 

Saudi Arabia has long been mooted as becoming the centre for renewable energy, with plans announced years ago to develop 41 GW of solar capacity by 2040 at King Abdullah City for Atomic and Renewable Energy (KA-CARE).

In the kingdom’s National Transformation Plan, announced earlier this year by Deputy Crown Prince Mohammed Bin Salman, an initial target was set for the installation of 9.5GW of renewable energy, reported to be a combination of solar and wind at a cost of $20bn.

“The UAE has probably been the leader in the sense of being earliest to market in building solar,” says Lloyd. 

“The market is expecting Saudi Arabia to launch a large programme of renewable power and the renewable energy agency KA-CARE is preparing to do so, and has announced its renewed intentions in that area. In the meantime, the electricity utility in Saudi Arabia, SEC, has launched some solar PV (photovoltaic) projects of its own,” he adds.

Saudi Arabia relies on burning considerable amounts of its crude oil to meet increasing power demand.

The UAE has also led the way in developing nuclear power, building the $20bn Barakah nuclear power plant in Abu Dhabi’s Western Region.

“Nuclear will play a role in energy in the UAE; it will be one of many. The question is whether this will be replicated in the region. There are initiatives but they have been slow to pick up, for all sorts of reasons,” Sarraf says.

There is strong strategic interest in the Gulf for nuclear energy, and indeed the broader Middle East, says Lloyd, with Jordan recently selecting its technology and strategic partners in the form of Rosatom, the Russian nuclear generator.

“Sometimes that seems surprising to outside observers where you have a part of the world that’s well-resourced in terms of hydrocarbons and oil and gas, but I think there is a strong strategic interest in the region. It’s very clear that Saudi Arabia is interested in developing nuclear power and is very interested in things like small nuclear modular reactors, so it’s looking quite innovatively at how it might develop its civilian nuclear power capability in Saudi Arabia.”

He says the electricity utilities in each of those countries will have the considerable task of managing and looking at the terms of the power offtake from those nuclear plants.

With introduction of new energy sources, Lahn says there are new business sectors that stand to gain from these changes, if governments put the right regulation and support in place.

“For example, Dubai is capturing the wins from its 2011 power and water tariff reforms which are enabling the emirate to grow a market for efficiency services. Rooftop solar, solar water heating, district cooling — these all have potentially huge markets,” she says. 

Lahn says the business case varies dramatically across the region. For example, by reducing the energy use of an average high-consuming villa (4000kWh) by half — which is possible without harming comfort levels — a Kuwaiti household would save $240 over one year whilst one in Dubai would save almost ten times that, thereby justifying some care and investment.

“The recent moves will help governments reduce their costs a bit but in terms of conservation, most prices will have to move further to affect practices because the costs of energy are still so low as a proportion of the incomes of those who use most energy — households and commerce,” she says.  

The GCC countries are also collaborating in order to create savings. A joint Gulf power grid, which will develop the region’s electricity network, has already led to savings of $3bn in investments and $330m of operating costs and fuel, according to the Gulf Cooperation Council Interconnection Authority. It marks a significant step for the region in its efforts to deal with demand.

Lahn, in her paper, argues that in order to achieve their ultimate aim of reducing costs and rationalising fuel consumption, “governments must ensure that a programme of gradual price rises is accompanied by stronger institutional and legislative support for energy efficiency”.

“The question of how to make this dual approach work for business is pertinent to green growth agendas globally. In this context, the region that has some of the highest per capita carbon intensities in the world is worth watching,” she says.

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