Over the next five years the private sector will be responsible for adding more than 20GW of generating capacity in the GCC. This reliance on Independent Power Producers (IPPs) is set to increase as GCC governments face increasing deficits and lower budgets because of lower oil revenues, says a new report.

While private sector involvement eases financial burden on the states, governments need to ensure that IPPs fit in the larger picture of reformed markets, and not just a short-term solution to rising demand, according to the latest “Apicorp Energy Research” published by Arab Petroleum Investments Corporation (Apicorp), an investment company established to foster the development of the Arab world's oil and gas.

Electricity demand in the GCC has risen sharply driven by factors such as population growth, urbanisation, improvements in income levels, industrialisation, and low electricity prices. These factors will continue to place greater demand on power-generation capacities.

“We estimate that GCC power capacity needs to expand at an average annual pace of 8% between 2016 and 2020. To meet rising demand, the GCC will need to invest $85bn to add 69GW of new generating capacity over the next five years. But declining oil revenues mean that GCC governments can no longer continue to support the provision of cheap power – and have looked towards IPPs to play an increasing role in power generation,” Apicorp said in the report.

The structure of the electricity market has witnessed little change over the past few years, but reforms are gradually picking up throughout the GCC. At the heart of recent reforms were recent price hikes. Governments have increased water, electricity and fuel prices to ease the burden on state budgets. These efforts are part of a broader programme that aims to liberalise domestic energy prices over the medium-term.

Structural reforms are also taking place. Oman is leading GCC efforts to unbundle the power sector by privatising most of its generating assets and is considering to privatise transmission and distribution. The country will become the first GCC country to introduce spot trading in the electricity market by the end of the decade. In Saudi Arabia, state utility Saudi Electricity Company (SEC) has recently announced plans to break up into four independent power-generating bodies and an independent transmission company by the end of 2016.

The single-buyer model will remain

The region still relies on the single-buyer model where a state-owned entity is the only wholesale purchaser from power-generating companies. The single buyer is responsible for selling the electricity to distribution companies which then sell to the final consumers.

While the power-generating sector is open to the private sector, governments still have monopoly over transmission and distribution networks. The current market structure in the GCC has served IPPs well as governments assume most of the risks.

IPPs are usually offered 15 to 25-year Power Purchase Agreements (PPA) where the government agrees to buy the electricity at a ‘take it or leave it’ basis at a previously agreed price for the duration of the contract, thus mitigating demand-side risk. Most IPPs also sign fuel supply agreements with governments to mitigate feedstock price fluctuations.

These favourable terms came at a time when GCC governments were desperate to bring IPPs and quickly increase capacities. But it is unclear if these terms will continue, as prospects of liberalising the market and governments’ desire to reduce its off-taking risk may result in terms becoming less favourable. Yet IPPs know that lower government revenues and rapidly rising demand mean that their involvement in the sector is crucial, giving them strong negotiating power.

IPPs a quick solution for governments

The introduction of IPPs in the GCC has been instrumental in meeting rapidly rising electricity demand. Oman was the first country to open up its power-generating sector. Today, IPPs represent the majority of new capacity and continue to replace government power plants. Although there are potential implications of over-reliance on this strategy going forward, we can discern several benefits to the GCC power sector.

First, IPPs allow investments in power generation without the need for governments to pay the entire upfront cost. While fiscal buffers and substantial export revenue has allowed governments to invest heavily, governments are becoming increasingly constrained, as falling revenues need to be allocated towards other vital sectors such as education, health, and infrastructure. Low oil prices mean that cash will not flow easily from governments to state utilities.

This is particularly the case for SEC, which is aggressively tapping local and foreign debt markets. This year alone, SEC secured a loan of $1.4bn from Japanese banks and a $1.5bn financing deal with the Industrial and Commercial Bank of China. Overall, the state utility has received government and capital-market funding for more than $34bn since it launched its first sukuk in 2007. SEC is also planning a $3.3bn back-up credit facility.

Second, IPP projects are usually more cost effective than government power plants. Contracts under the IPP model are usually awarded to developers who provide the lowest levelised cost of electricity (LCOE) - the price per kWh that represents all fixed and variable costs of a project throughout its lifetime. Developers are therefore encouraged to maximise efficiency. Since the ability of developers to cut costs and improve technology differ, IPP bidders can have costs that vary by large margins.

For example, the Dubai solar park phase III received five bids for the 800MW project ranging from 2.99 ¢/kWh to 4.48 ¢/kWh. A consortium of Abdul Latif Jameel, Fotowatio Renewable Ventures, and Masdar broke the global solar record with 2.99 ¢/kWh. This comes after phase II of the same solar park broke the then world-record when a consortium of Acwa Power and TSK offered 5.85 ¢/kWh. Tendering projects to IPPs based on competitive bids will continue to reduce costs and prices for governments and consumers.

Third, IPP projects are quicker to execute. With an additional 69GW that needs to be added in the next five years, projects must be implemented swiftly. IPPs provide governments with the flexibility to identify projects and capacity needs while leaving developers to execute. On average, an IPP takes 3-4 years to be commissioned after tendering.

Unlike government projects that usually face delays due to technical specification changes and conflicting roles of various government entities, it is in the interest of IPPs to bring on line the project as soon as possible – given that delays translate into higher costs. – TradeArabia News Service