Will Middle East utilities react to disruption, or help create it?

By

Benoit Laclau

EY Global Energy Leader

Experienced energy leader and advisor.

9 minute read 30 Apr 2019

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Rising demand, volatile oil prices and renewables are driving the transition from carbon to clean. Here’s how utilities can get ready.

In the Middle East, fundamental change is coming to the region’s energy sector. In fact, EY and a global analyst house have identified three critical points when everything changes

These tipping points mark a radical shift away from the sector’s traditional status quo. In the six Gulf Coast Cooperation (GCC) countries — Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain and Oman — cheap electricity has been considered almost a birthright and electricity consumption per capita was among the world’s highest.

Drivers of change

So what is driving change? Two primary factors are resetting the foundations of the GCC energy sector:

  • Energy demand is rising as populations grow, industrialization and urbanization increase and water desalination plants ramp up electricity use. Electricity demand across the GCC has risen at 5% per annum since 2000, and will rise by an average 2.1% between 2015 and 2050.1
  • Oil prices are volatile and, while crude oil prices have recently improved, prices are far from peak levels. This is putting pressure on government revenues and prompting leaders around the region to re-evaluate the balance between the domestic consumption of crude oil and the allocation of resources for profitable export. We are also seeing unprecedented levels of investment into value-added oil products such as petrochemicals, plastics, petrol and diesel.
  • The energy industry is at the start of a period of unprecedented change, one that will fundamentally change the market place (presenting new challenges as well as new opportunities). Three tipping points will mark the emergence of a new energy system.

    • Tipping point 1: when self-generation reaches cost parity with grid-delivered electricity. To determine this date, we calculated the projected demand for electricity, future generation mix and cost of delivering electricity via a central grid between 2015 and 2050, and then compared it to the predicted cost of self-generating electricity using solar PV and battery storage.

      To help determine when these costs would reach parity, we worked with a leading global analyst house to model the expected adoption and interactive impacts on electricity demands and costs of 10 core distributed energy and information technologies: solar PV; battery storage; electric vehicles; microgrids; home and building energy management systems; P2P electricity exchange; smart meters; artificial intelligence; grid-edge technology; and cloud.
    • Tipping point 2: when the price of battery electric vehicles reaches cost and performance parity with traditional cars with internal combustion engines
    • Tipping point 3: when the mere cost of delivering electricity (i.e., the unit-cost of electricity transmission and distribution) exceeds the cost of self-generated electricity

    Because drivers vary across markets, the tipping points will hit different regions at different times. 

A culture of energy innovation

In response, GCC countries are moving fast to adapt their energy mix. Investment is rising in exploring the greater adoption of energy technologies, including battery storage. These initiatives reflect the GCC’s strong track record in innovation and adoption of new technologies — smart meters arrived relatively late to the region but their speed of deployment and acceptance by customers was much quicker than that seen in other regions. And anyone who has visited Dubai recently can attest to the fact that electric vehicle adoption is accelerating fast in the region, in a trend that is driven more by consumers’ eagerness for the technology than any economic benefit.

In particular, solar energy has clear potential in the GCC. The region enjoys more than 300 days of sunshine a year, has plentiful land and a deep talent pool to draw upon. Across GCC countries, investment in new solar is increasing in size and scope:

  • Saudi Arabia recently signed a memorandum of understanding (MoU) with Japan’s SoftBank Group to develop a US$200b solar power development that, if completed, will be the world’s largest.
  • Bahrain has raised its renewable energy target from 5% to 10% by 2035 and has mandated installation of solar panels on new buildings.
  • Renewables provide an opportunity to reduce water used in power generation by up to 15% and clean energy sources offer a more cost-effective option in water desalination projects.

Our analysis suggests renewables could contribute one-third of the region’s energy mix by 2050 from 0.3% today with solar PV and solar CSP making up 20% of this figure, if investment and regulatory commitment continue.

Subsidy cuts will be the game changer

Perhaps the biggest sign that the GCC governments recognize that their region’s energy markets must change are the solid commitments from many to cut the subsides that have kept energy prices artificially low, demand high and put the brakes on true progress in renewables. In one example, electricity bills for residential consumers in Saudi Arabia increased about three-fold from 1 January 2018 after the introduction of cost-reflective tariffs, as well as value-added tax. In Bahrain, household and business electricity and water prices are being increased for businesses in a multiyear plan, while Kuwait and Oman increased electricity prices for businesses and other big consumers in 2017.

While removing subsidies risks public backlash against higher prices, the economic burden of subsidies which cost the region as much as US$105b in 2015 — mean governments may be prepared to address the disquiet in exchange for boosted revenues. In 2016, the UAE’s energy minister, Suhail Al Mazrouei, told the World Economic Forum in Davos that the UAE population could be persuaded to accept increased electricity prices: “If you have a good story and tell it to local people, they will be convinced. The majority of the population is young and they’re different from past generations … We are redirecting the subsidy as an opportunity to invest in other parts of the economy, like building schools and hospitals. It’s a convincing story. It’s not so difficult to understand.”

This will be a critical issue to watch the removal of subsidies will be a big determining factor in just when the tipping points will arrive. In fact, EY analysis found that if subsides are cut, grid parity will arrive as early as 2032 — nine years earlier than if subsidies continue. And, without subsidies, electric vehicles will reach price and performance parity with traditional vehicles between 2025 and 2029. (The timing of the arrival of the third tipping point is the same, whether subsidies remain or are removed.)

Can GCC utilities adapt in time?

But with or without subsidies, change is on its way to the GCC energy sectors. The question is — can the region’s state-owned, vertically integrated utilities adapt in time? Signs are positive. Utilities here are different — they don’t fit the typical stereotype of the slow-moving incumbent utility. They operate within a fast-moving culture that has been shaped by innovation, rapid growth and a willingness to invest in high-quality infrastructure.

Even so, success in a new energy market will require decisive action now from utilities, with support from governments and regulators.

Four action points for utilities include:
  1. Build the right operating and business models: Once subsidies are removed and the tipping points hit, the traditional business models of GCC utilities will no longer be viable. Reshaping for success in a very different energy world will require similarly transformed models that position utilities for new roles. Time is short to get these in place, especially as tipping point 1 may hit certain customer segments, such as large industry, ahead of others. This presents opportunities for utilities to play a partnering role as big Gulf companies explore self-sufficiency and off-grid options.
  2. Develop new skills and capabilities: A digitally-enabled, renewables-centered energy market will require utilities to develop an entirely new tranche of skills and capabilities. Some may develop these in-house while others will use strategic collaborations or joint ventures to tap the talent they need. GCC utilities are fortunate to have access to a large pool of high-quality talent and a growing population.
  3. Become customer-focused: Developing a new customer focus may be an even bigger challenge. In some countries, there are indications that energy reforms may go beyond the removal of subsides to include opening the electricity market to private players. This will create an urgent need to put the customer at the center of the business. Developing new ways to create value for different customer segments will be critical to growing revenue and maintaining the continued competitiveness of the region once cheap fuel is no longer an inherent advantage.
  4. Reconsider investment strategies: As the tipping points loom, utilities will need to consider the implications for project payback. Decisions will need to be made about whether to continue existing infrastructure projects as planned, adapt financing models or even delay or discontinue altogether.
Two action points for governments and regulators to enable a smooth energy transition include:
  1. Clarity and commitment around subsidies: How and when governments reduce or remove energy subsidies will determine the pace of change and the arrival of the tipping points. Clarity and commitment around the process will help utilities prepare with confidence.
  2. Consider how to introduce competition: As some governments consider opening electricity markets to private investors, policymakers will need to carefully consider how best to introduce competition. Opening markets to private players would accelerate innovation and possibly bring the tipping points closer, but governments will need to make certain that reforms do not jeopardize the ability of incumbent utilities to fulfil their vital role in water desalination.

Bold action needed now

The countdown is on to a new energy market in the GCC — one reshaped by renewables, digital technologies and changing consumer demands. For the region’s utilities, adapting to very different conditions will require overcoming some significant challenges and supportive policies from government and regulators.

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Summary

Utilities must decide now which role they will take in this new energy market, and how they will develop different capital strategies and operating models for changing conditions. As bold decisions are made about future strategy, the biggest risk may be to move too slowly — the tipping points of change are on their way.

About this article

By

Benoit Laclau

EY Global Energy Leader

Experienced energy leader and advisor.