The following article by Ali Aissaoui, Senior Consultant at the Arab Petroleum Investments Corporation (APICORP), is published concurrently in APICORP’s Economic Commentary dated April-May 2012. The views expressed are those of the author only. Comments and feedback may be sent to aaissaoui@apicorp-arabia.com.

Since the onset of the global financial crisis in 2007, energy investment growth in the Middle East and North Africa (MENA) has seriously contracted.¹ As the ‘‎option to wait’ was becoming more valuable for some investors, we advocated the exclusion of enabling ‎energy infrastructure such as power ‎from any such option. Long-standing underinvestment in this sector has caused shortfalls in electricity supply and led to serious economic ‎bottlenecks and social frustrations. Ongoing turmoil in parts of the region has somewhat vindicated our stance. Power may indeed emerge as a critical sector featuring prominently on top of governments’ policy agendas. Catching up ‎large unmet potential demand needs massive ‎investment, which cannot be achieved without addressing broader challenges.‎

This commentary discusses the growth potential of MENA power sector, the investment requirements and the challenges involved. Contrary to previous analyses, which focused on the generation link of ‎the electricity value chain, investment is extended to the transmission and distribution (T&D) systems. The commentary is in three parts. The first provides a descriptive overview of the growth pattern and performance of MENA power generation. The second assesses the potential for capacity growth and the resulting capital investment in new power plants as well as in T&D for the five-year period 2013-17. The third discusses the major challenges associated with implementing policies and programs.‎

Growth Pattern And Performance

In a move to improve efficiency and lessen funding constraints, the power industry has undergone significant institutional and regulatory changes in many MENA countries during the last decade or so. However, despite governments being able to shift part of the burden of developing and financing projects to the private sector, the industry has continued to struggle to keep pace with fast-growing demand. Electricity demand and the resulting generation capacity and production have been driven by rapid population growth and greater urbanization, sustained economic and industrial development, and heavily subsidized electricity tariffs for consumers. This is not to mention the changing characteristics of the electricity demand profile – in particular its summer peak – which, in a context of hotter climate, has increasingly been shaped by air conditioning load.

These drivers cannot easily be captured in a succinct overview. However, Figure 1 provides some insight into the growth pattern of the region’s power sector based on the evolution of key indices. It shows that over the last three decades, staring from the common base year of 1980 (index 100), capacity and production have consistently grown more rapidly than GDP, actually much more during the last decade or so. Furthermore, during the 1980s, then later in the 2000s, capacity and production grew in close parallel with each other. Meanwhile, however, in the 1990s and early 2000s, production grew faster than capacity as excess capacity inherited from past periods of high infrastructure investment had to be absorbed. However, this trend analysis is not enough to evaluate the performance of the power system.

Before delving more specifically on performance, it might be useful to briefly examine the patterns of growth at the country level. Fully available data for 2010 indicate that ‎11 countries (out of 23), whose installed capacity is higher than 5gw, generated a little more than 90% of total ‎output. Among them, the six countries of the Gulf Cooperation Council (GCC) accounted for 43% of MENA total and 54% of the Arab world.² We should expect country differences to reflect different ‎demographic and economic levels and structures, as well as contrasting climate conditions. A 2010 cross-section regression analysis highlights these differences. As shown in Figure 2, on a log transformed basis per capita capacity increases with per capita GDP in a nearly linear pattern. This stems from the fact that GDP per capita is a proxy for domestic factors that are strong determinants of electricity demand in the region. Accordingly, the GCC countries have ended in the high-end tier.

Figure 1: Evolution Of MENA GDP, Capacity And Production

Figure 2: MENA Power And GDP – A Cross-Country Snapshot

As for the performance of MENA power generation (19 countries with available data), it can more adequately be assessed on the basis of two key indicators: capacity factor and load factor. Because of ‎the demand profile (peak load and seasonal variations) and the inability to store electricity, generators need to maintain a substantial back ‎up reserve, which bears on the efficiency of the power system and its economic performance.

The first performance indicator is a measure of capacity utilization. Capacity factor has improved from about 40% in the 1980s and early 1990s to a little more than 50% currently. In 2010 it was the highest in Syria with 63% and the lowest in Morocco with 41%. Contrary to Syria, where generators have had to struggle to compensate for lagging capacity, in Morocco alternative supply in the form of import was available. Indeed, with soaring oil prices Morocco’s better option was to substitute up to 20% of its thermal generation capacity with lower cost electricity from Algeria and to a much larger extent from Spain, through existing interconnections. In any case, capacity factor should be interpreted with caution since, at the high ambient temperatures prevailing in most of the region, actual capacity is lower than nameplate capaciy.³

The second performance indicator is defined as the ratio of average load to peak load. Load factor can be interpreted in two opposing ways. On the one hand, a too low ratio may indicate an inefficient power system. On the other hand a too high ratio may signal that the system is stretched to its capacity limit and could collapse should peak demand be higher than anticipated. Load factors within MENA range from 56% in Qatar to 71% in Algeria, indicating sound systems overall but with lesser efficiencies in countries at the lower end of the scale. In addition to Qatar, these include Bahrain, Morocco and Tunisia.

Investment Outlook

Due to the technical and specialized nature of the economics of power supply, the determination of investment involves sophisticated tools far beyond the analytical scope of this commentary. Instead, the intention is to provide a broad estimate of the level of investment required so as to develop a good understanding of the challenges ahead. Our estimates are based on a simple but duly qualified analysis of past trends. Extrapolating the average ratio of capacity growth to GDP growth observed in recent years of about 1.45 may lead us to accept that, under an assumption of GDP growing at 4.5%, future capacity would increase at an annual rate of about 6.5%. However, factoring in unmet potential demand for electricity may warrant higher rates. Similarly, an incorrect interpretation of the cross-section shown in Figure 2 can lead us to believe that the top ranking GCC countries are near saturation point. But this may not be the case if we consider that Saudi Arabia, by far the biggest social and economic state, is still in a lift-off phase, not to mention the much higher potential for growth in the other MENA lagging countries. To be sure, future growth may take a more efficient and less intensive path. But this depends on promoting demand-side management (DSM) and eliminating electricity tariff subsidies, both of which will be hard to achieve in the medium term.

Based on these considerations, medium term capacity growth, which has been worked out on a ‎country by country basis, is expected to be much higher than that of economic output: 7.8% for the period 2013-17 against 4.5% for GDP. As detailed next, this would require an investment in MENA power sector of about $250bn, 59% for new generation capacity and the remaining 41% for T&D.

The growth rate of 7.8% translates into a five-year capacity increment of 124gw above the 2012 level, partly through combined power/water desalination plants. ‎Therefore, with current reference costs – reflecting prevailing prices of engineering, procurement and ‎construction (EPC) and country investment climates – the resulting capital requirements will be in the order of ‎‎$148bn for the forecast period. As shown in Table 1, the GCC area, which will continue to grow at the highest rate, ‎accounts for 43% of MENA total and 53% of the Arab world total‎ (expenditures for nuclear power generation is implicit in the case of Iran and the UAE).⁴

Table 1: MENA Power Capacity And Investment, 2013-17

* 2011: Estimates.

1. Maghreb: Algeria, Libya, Mauritania, Morocco and Tunisia.

2. Mashreq: Egypt, Iraq, Jordan, Lebanon, PT and Syria.

3. GCC: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE.

4. Rest of Arab world includes Sudan and Yemen but excludes Comoros, Djibouti and Somalia for lack of data.

Source: Compilations and projections by APICORP Research.

As for investment in T&D, it derives from the need to develop adequate transmission networks to supply electricity to industries, businesses and households. These networks are differentiated between transmission and distribution grids. The former consist of high voltage lines designed to transfer bulk power from generation plants to large industrial customers and distribution centers, generally over long distances. In contrast, the function of low voltage distribution grids is to supply power to final consumers in urban and, whenever socio-economically desirable, in rural areas as well.

Under this grid-based supply perspective,⁵ the determinants of T&D investment vary from country to country, depending on the size and location of generation capacity, distances to end users, the extent of development and density of urban areas, as well as built-in redundancy in the transmission system to ensure reliability. According to the IEA World Energy Outlook 2011, worldwide T&D infrastructure accounts for 42% of all power sector investment, with significant regional variations for transmission and distribution respectively. A simple transposition of relevant regional ratios to respectively the Maghreb, Mashreq, the GCC and Iran, results in MENA T&D investment of $103bn for the period 2013-17, with further breakdown given in Table 2.

Table 2: Total Investment In MENA Power Sector, 2013-17 ($Bn)

1. Maghreb: Algeria, Libya, Mauritania, Morocco and Tunisia.

2. Mashreq: Egypt, Iraq, Jordan, Lebanon, PT and Syria.

3. GCC: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE.

4. Rest of Arab world includes Sudan and Yemen but excludes Comoros, Djibouti and Somalia for lack of data.

Source: Compilations and projections by APICORP Research.

Major challenges

Investment on this scale will not occur without addressing current challenges, prominent among which are fuel and funding. These challenges, which are considered far beyond the scope and resources of any public utility or private developer, are discussed next in turn.

Electricity can be generated by different technologies using a variety of fuels. Reflecting the region’s endowment in hydrocarbon resources, MENA power sector relies heavily on thermal plants fueled essentially from natural gas and oil products. In 2010, ‎‎about 60% (57% in the Arab world) of output was generated using natural gas and 37% (41% in the Arab world) using oil products. The remaining 3% (2% in the Arab world) was from hydro and smaller amounts of imported coal, not to mention the still immaterial contribution of nuclear, solar and wind power (Figure 3). ⁶

Figure 3: MENA Electricity Generation By Fuels

‎The fact that the power generation sector is the single most important ‎industrial user of natural gas in key countries in the region, raises the extent proven reserves can meet long-term fuel demand. Indeed, although most MENA ‎countries are endowed with substantial gas reserves, supply sustainability ‎‎should not be taken for granted. To gauge each country’s supply circumstances from publically available data, we have developed specific metrics. Although a clear-cut supply picture is not easy to draw, we have found that the trend towards an optimal supply threshold (OST) is a fairly good measure of gas supply sustainability. Reflecting the structure and use of hydrocarbon reserves (crude oil, natural gas and NGLs), OST is defined as the one set of ‎solutions that equalizes the share of natural gas ‎production in total hydrocarbon production with that of natural gas reserves in ‎total hydrocarbon reserves. A simple Euclidean distance, expressed in percent, shows how far or how near different countries are from that ‎threshold.

This is illustrated by the 2010 cross section in Figure 4. Keeping progress towards the OST line should normally be encouraged; unless such a move is ‎perceived too expeditious as a result of demand growing faster than additions to reserves. This appears to be the ‎case of Kuwait, Saudi Arabia, Libya, the UAE, and Iraq, whose distances to OST are lower than 5%. Therefore, each of these countries now runs the risk of not being able to keep its position once there.‎ Already this is the case of Bahrain, whose negative distance suggests that it is using ‎more gas than it could possibly afford. ⁷ In any case, switching to higher-value oil products entails an opportunity cost of foregone export revenues.

Figure 4: Distance To Optimal Gas Supply Threshold (OST)

As for funding constraints, they should be considered in the context of the restructuring and liberalization that has been taking place in the region. While these reforms have key features in common, they differ somewhat in terms of institutional design and application. The common tendency, however, is towards a phased approach to competitive markets, allowing first private participation in power generation while governments continue to hold some monopoly over transmission and distribution. In this context, the prevailing model is the so-called ‘single buyer’, whereby the incumbent public utility procures power from independent power and power/water producers. IPPs and IWPPS are typically tendered on a cost-competitive basis with projects structured to provide them with the option to build, own, operate or transfer.

In this context, T&D is likely to continue to be financed from internal sources, ie utilities’ retained earnings and state budget allocations, eventually supplemented by external soft multilateral bank loans. Internal financing could only be secured if the level of electricity tariffs is enough to cover total system costs and generate some profits. As for governments’ involvement, it depends on their fiscal positions and, in the case of the oil and gas producing countries, on oil prices remaining above $100/B, which is our current average fiscal break-even price within the OPEC area.⁸

In contrast to T&D, financing power generation is assumed to be mostly undertaken on a project finance basis, via a non-recourse structure, whereby equity and debt are paid ‎back from the revenues generated by the project company. With still limited opportunities for raising funds from the capital markets, both domestic and international, debt is typically secured from the region’s syndicated loans market. Unfortunately, this market has been affected by the global financial crisis. More seriously, the resurgence of the Eurozone sovereign debt crisis has led most European banks to pull out from the region. As a consequence and as shown in Figure 5, the annual number of deals in the power and power/water sector has dwindled from a peak of 17 in 2008 to a bottom of 10 in 2011. Correspondingly, the annual deal value decreased from a record high of $23bn in 2008 to a low of $8bn in 2011. Also, the cost of borrowing as measured by ‘all-in-one’ pricing, although coming down from the peak of 302 bps in 2009, remains challenging at 191 bps.

Figure 5: MENA Power: Loans And ‘All-In-One’ Pricing

‎Even assuming a return of the European banks, IPPs/IWPPs would hardly attract debt financing without lenders satisfied with additional ‎risk ‎mitigation measures. These include higher quality of developers, reduced tenors for long term debt, better allocations of risks in the longer ‎term power purchase agreements between private developers and public utilities and ‎effective hedging of fuel supply risks.‎ ‎Furthermore, while current financing trends are common throughout MENA region, the case of Iran should be assessed based on its specific context. In this country, tougher economic sanctions are expected to deter reforms in the power sector and severely restrict funding.

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Conclusions

As a result of high population growth, fast expanding urban and industrial sectors, increasing needs for air conditioning, and heavily subsidized electricity tariffs, many countries within MENA have been struggling to meet fast-growing demand for electricity. With ongoing turmoil, catching up ‎with unmet demand may be perceived as socially and politically more desirable. In the absence of active demand side management, this will entail capital investment of about $250bn for the period 2013-17, 59% of which in new generation capacity and the remaining 41% in T&D. Investment of this scale will face many challenges, prominent among which are fuel and funding. The first stems from the scarcity of natural gas in key countries in the region and the opportunity cost of generating electricity using high-value export oil products instead. The second results from the inadequacy of internal and external financing and the reluctance of many MENA governments to support cash-strapped public utilities, which are committed to continuing to invest should the private sector be not forthcoming. Both fuel and funding challenges involve significant policy dilemmas that need to be addressed quickly and effectively.

1. MENA is here defined to include the Arab world and Iran. Power generation in Sudan is kept inconsequentially aggregated. Within MENA the GCC clusters Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE.‎
2. Detailed statistics for 2010 include those provided by the Arab Union of Producers, Transporters and Distributors of Electricity (www.auptde.org) as well as the US Energy Information Administration (www.eia.gov).
3. Nameplate capacity is determined at 15°C, which is far below prevailing temperatures in most MENA countries.
4. In Iran, while Bushehr I was officially inaugurated in 2010 (but operated a year later), there is no plan to complete Bushehr II. In Abu Dhabi the first such a plant is not expected before 2017.
5. Off-grid supply may be more relevant for rural and remote areas.
6. The figures for 2010 do not include electricity generated from Bushehr plant, which has been adding electricity to the national grid since September 2011 only.
7. For a thorough analysis of the pattern of natural gas supply in the region, see A Aissaoui, ‘MENA Natural Gas: A Paradox of Scarcity Amidst Plenty’ (MEES, 27 December 2010).
8. For the original methodology, see A Aissaoui, ‘Fiscal Break-Even Prices: What More Could They Tell Us About OPEC Policy Behavior?’ (MEES, 14 March 2011).