The Saudi potential

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The Saudi Arabian power and water sector is undergoing significant changes. What are the key challenges – and opportunities – for investors? Rami Migally reports.

Saudi Arabia has seen energy demands soar by about 9%, spurred by its economic and population growth. Meeting this increased demand will mean upgrading and investing in the country’s power and water sector at a cost estimated to reach more than US$130 billion over the next decade.1

But attracting this investment amidst continuing global slowdown and regional political uncertainty will not be easy.

Challenges ahead

The state-owned Saudi Electricity Company (SEC) currently controls Saudi Arabia’s generation, transmission and distribution network. The government has established a regulator and new licensing rules that will pave the way for reform and open up the sector to private investors. This will help:

  • Attract investment
  • Reduce state debt
  • Introduce innovation

This reform process, which includes unbundling the SEC and privatizing the major components of Saudi Arabia’s electricity sector, is expected to be mostly complete by 2014.

While the privatization of the sector offers opportunities, key challenges remain for those considering investing in Saudi Arabia’s power and utilities industry:

  • Lack of transparency, especially in taxation, legal, regulatory and policy frameworks, as well as fuel supply and power purchase agreements.
  • Cumbersome bureaucracy, while improving, continues to hamper approvals and other administrative procedures.
  • Talent shortages because of a lack of Saudis with the requisite technical skills, limited female participation in the workforce and difficulty attracting foreign workers due to the country’s conservative culture.
  • Political instability in other Arab countries has created some uncertainty.

Diversifying the energy mix

One of Saudi Arabia’s key energy challenges is the need to diversify its power, to both address energy demands and preserve oil reserves for lucrative export markets.

In December, the Kingdom’s KACARE (King Abdullah City for Atomic and Renewable Energy) announced that it is working to develop alternative sources of power, including nuclear energy (approximately 18GW) and renewable energy (54GW), mainly solar thermal, by 2032.

There is still much work to be done in this area, though, with less than 1% of Saudi Arabia’s energy generated from renewables in 2011.2

Attracting investment for power generation will require increased certainty regarding expected rates of return. Clear and transparent rules and regulations are needed to govern the operation of generators in the market. This will ensure investors have confidence in the contractual structure that governs their relationships with the independent system operator and the central power supplier that will purchase power from the generators.

Key questions relate to the:

  • Dispatch mechanism to be used
  • Wheeling arrangements
  • Pricing

For example, will generators have fixed contracts with set prices and gain priority access to the grid? Or will the generators operate in a deregulated environment that prioritizes optimized economic dispatch?

Water worries

Saudi Arabia’s extreme water scarcity poses a significant risk to the feasibility and profitability of many energy projects.

This means investors may target projects where water is less important – such as solar PV, wind and natural gas – and avoid those that involve high water usage, such as biofuels.

Another issue is the role of energy in the extraction, treatment and transport of water. About half of Saudi Arabia’s domestic oil consumption is used to desalinate water. Attracting investment in independent water projects will require a focus on increasing the rate of return for investors and reducing their risk exposure.

Providing incentive mechanisms, longer contract periods and public-private partnerships (PPPs) have been successful. Legal and contractual frameworks and mechanisms as part of a clear national policy are needed to provide support for investors in these projects.

Local advice crucial

While the future promise of Saudi Arabia’s P&U sector is significant, so are the challenges.

Investors must be aware of the market structure, its governance mechanism and contractual obligations to accurately predict expected returns and gauge the viability of projects. Local advice is key to navigate potential pitfalls and optimize the chances of success.

Creating an energy-efficient culture

Saudi Arabia has one of the world’s highest rates of energy consumption per capita. Unsurprisingly, the Kingdom has identified energy efficiency as a national priority to curb domestic consumption, related greenhouse gas emissions and the loss of potential export revenues.

But while Saudi Arabia recognizes the need to become more energy efficient, progress has been slow. Historically low electricity prices have created consumers accustomed to a certain lifestyle, and there are few signs this is changing.

As prices do not reflect the true cost of the electricity consumed, most energy efficiency measures are not seen to be economically prudent given that the avoided costs of electricity do not match the investments needed, especially in the short term.

Although electricity tariffs have increased, the gains have been slow because of potential social and economic implications. While some organizations have attempted to implement energy efficiency measures, most of these have been limited in scope and poorly coordinated.

Recognizing the need for coordinated action, Saudi Arabia has established the Saudi Energy Efficiency Center to help manage its energy needs and develop energy-efficient technologies and conservation policies.

For more information

Read Shifting perspectives: EY 2012 Middle East Attractiveness survey to discover more about the investment environment in this rapid-growth market.

Issue 13 of Utilities Unbundled also includes a feature on the National Water Company and its investment plans.

  • 1 “Saudi power investment to reach $133 billion in decade,”, 4 December 2012
  • 2 “Mecca to Become First Saudi Arabian City to Generate Electricity from Fossil Fuel-Renewables Mix”, IHS Global Insight Daily Analysis, 24 September 2012, via Dow Jones Factiva, © 2012, IHS Global Insight Limited.

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