Since the onset of the global financial crisis in 2007, lagging power sector investment has been a leitmotif of APICORP’s economic commentaries on MENA1 energy issues. We have always contended that underinvestment in this sector, and the resulting shortfall in electricity supply, are likely to inhibit economic growth and exacerbate social frustrations. Ongoing turmoil in parts of the region has completely vindicated our concerns. Stable and reliable power supply has now emerged as a major policy goal in most countries.
Catching up with fast growing demand needs massive investment, which cannot be fully realized without addressing significant issues. This argument is developed in three parts. The first provides an overview of the growth pattern and performance of MENA power generation. The second assesses the medium-term potential for capacity growth and the capital required for both new power generation and the associated transmission and distribution (T&D) systems. The third discusses the investment climate and the major constraints facing investors.
GROWTH PATTERN AND PERFORMANCE
Before examining the patterns of growth and performance of MENA power generation it is worth noting that despite public utilities’ substantial investment in digital systems, automated measurement and reporting, the data they have been willing to release to the public has remained scant. When pressed for better disclosure some utilities invoke the potential threat public data availability may pose for the protection of their infrastructure (sic).2 Anyway, of the 23 MENA countries, nineteen (excluding Comoros, Djibouti, the Palestinian Territories and Somalia) can be said to offer some basic electricity statistics. A handful is able to put more elaborate data in the public domain. But none has, for instance, ever published a national load curve. The 19 countries which underpin our analysis account for the quasi totality of installed capacity and production. Among these, 11 have a capacity higher than 5gw representing 88% of MENA total capacity and nearly 92% of the region’s electricity output.
Sustained population and economic growth, expanding urban and industrial sectors, increasing access to air conditioning and heavily subsidized electricity tariffs mean many of our large sample of countries have been struggling to meet fast-growing electricity demand.
In order to capture the region’s growth patterns, we calculated the growth indices of capacity, production and economic output over a period of just over three decades, starting from the base year of 1980. As shown in Figure 1, during the 1980s and later in the 2000s, capacity and production grew in close parallel. In between, in the 1990s, production grew faster as excess capacity arising from past periods of relatively high infrastructure investment was absorbed.
Consistently, however, capacity and production have been growing more rapidly than GDP. Of particular relevance to later discussion is the fact that capacity growth has in recent years tended to be double that of GDP.
We should expect differences in growth patterns at the country level to reflect diverse demographic and economic structures, as well as disparate climate conditions. A cross-section regression analysis for 2011 (the year for which all statistics are available) highlights these differences. Figure 2 shows that, on a log-transformed basis, per capita capacity increases with per capita GDP, which is an adequate proxy for the key drivers of electricity demand growth. The wealthier the country (and the larger the subsidies), the higher is electricity demand. The fact that the regression curve is slightly concave provides no evidence for inferring that the top ranking GCC countries are near saturation point. Saudi Arabia, which has the largest population and biggest economy, is still in a lift-off phase.
The performance of MENA power generation is more difficult to characterize. Because of variations in electricity demand (a power system faces a high load during a short time and a relatively low load during most of the time) and the inability to store electricity in any useful amount, generators need to maintain a substantial back up reserve, which bears on the performance of the system. This is evidenced by two key indicators: system capacity factor and system load factor, noting that the difference between the two is an indication of reserve capacity.
The system capacity factor is a measure of capacity utilization. It is calculated as the ratio of the electricity the power system actually generates to the electricity it could generate if capacity was fully operated all year round. This factor has improved from about 40% in the 1980s and early 1990s to about 50% currently. In 2012 it was the highest in Egypt and Algeria with 62% and 59% respectively and the lowest in Morocco with 43%. Contrary to Egypt and Algeria, where generators have had to struggle to compensate for an acute under-capacity, in Morocco alternative supply in the form of lower cost imports was available. Indeed, Morocco covered 18% of electricity demand with imports from Spain and to a much lesser extent from Algeria through existing interconnections.
The system load factor is the ratio of electricity actually delivered in a year to electricity which would have been delivered if the peak load were maintained over the entire year. The closer to 100% the better.
However, the system load factor can be interpreted in two contrasting ways. The first is that a too low ratio may indicate an inefficient power system. The second is that a too high ratio may signal that the system is stretched to its limit and could collapse should peak demand end up being higher than anticipated. Excluding the dramatic circumstances of Syria, where the system has collapsed for other obvious reasons, load factors within MENA range from 49% in Lebanon to 71% in Egypt, indicating sound systems overall but with lesser efficiencies in countries at the lower end of the scale. In addition to Lebanon, these continue to include Bahrain, Morocco and Tunisia.
Table 1: MENA Power Capacity and Investment, 2014-18
|*Installed capacity (GW)||*Electricity output (TWh)||Medium-term annual growth (%)||2014-18 capacity addition (GW)||2014-18 capital requirements ($B)|
|Rest of Arab world 4||4.5||14.5||6.3||1.7||2.2|
Table 2: Total Investment in MENA Power Sector, 2014-18
|Investment in $B||Generation (G)||Transmission (T)||Distribution (D)||Total(T,D)||Total(G, T, D)|
|Rest of Arab world 4||2.2||0.5||1.2||1.7||3.9|
Due to the highly specialized nature of the economics of electricity supply, the determination of investment in different types of plant (or technologies) to meet expected demand (characterized by a load duration curve) involves sophisticated modeling and analysis far beyond the analytical scope of this commentary. Instead, our intention is to provide a broad estimate of the level of investment required so as to better appreciate the relevant issues investors will be facing.
Accordingly, a simple country-by-country analysis of peak load demand and reserve capacity requirement leads to an aggregate MENA annual rate of capacity growth of 8.4% for the period 2014-18. Such a growth would likely be higher if derived from the ratio of capacity growth to GDP growth of 2 noted earlier. Conversely, capacity growth would surely be lower if demand-side management (DSM) was adopted more decisively and electricity tariff subsidies phased out more resolutely.
The annual rate of growth of 8.4% translates into a five-year capacity increment of 140gw above the anticipated 2013 base-level, partly through combined power/water desalination plants. Therefore, with current reference costs – reflecting prevailing prices of engineering, procurement and construction (EPC) which include project risk premiums – the resulting capital requirements will be in the order of $167bn for the forecast period (expenditures for renewable and nuclear power generation are implicit).3
As shown in Table 1, although capacity growth in the GCC is slightly higher than MENA average, it is significantly below that in the Maghreb. Indeed, Algeria, which is fast catching up, is expected to nearly double its generation capacity during the 5-year period (MEES, 3 September 2012). Still, investment in power generation in the GCC accounts for 44% of MENA total and 51% of the Arab world.
Capital requirements for power generation should be complemented with that for transmission and distribution (T&D). This stems from the need to develop adequate transmission and distribution networks to supply electricity to industry, businesses and households. Transmission grids 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 structure,4 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’s 2012 World Energy Outlook, projected worldwide investment in T&D infrastructure accounts for 43% of total power sector investment, with regional variations reflecting land occupation and population density. A simple transposition of relevant ratios to respectively the Maghreb, Mashreq, the GCC and Iran, results in MENA T&D investment of $116bn for the period 2014-18. As detailed in Table 2, this translates into a total investment in MENA power sector of about $283bn, 59% in new generation capacity and the remaining 41% in T&D.
ISSUES AND CONSTRAINTS
Investment in new capacity will not be fully realized without addressing three major issues: the investment climate and the constraints on fuel and funding. The challenges each issue presents are beyond the scope and resources of any public utility or private developer.
The first issue is the deteriorating investment climate in parts of the region. In the wake of the so-called “Arab Spring”, Tunisia, Bahrain and more severely Egypt, have seen their sovereign ratings downgraded, while Libya’s rating was suspended altogether. In contrast, with Bahrain’s outlook back to stable, the GCC countries are expected to continue retaining their higher investment grades.
Unfortunately, in addition to Libya other countries such as Iran, Algeria, Iraq, Syria, Yemen, Sudan (both north and south) and Mauritania are not rated. But sovereign ratings only reflect opinions by the credit rating agencies on the ability and willingness of governments to service their public debt. To gauge the energy investment climate we need a different framework. The one we have developed at APICORP is a “perceptual mapping” based on a multi-dimensional scaling (MDS) analysis combining three attributes: potential investment, country risk, and the enabling environment for business. The current mapping highlights a significant repositioning vis-à-vis an ideal investment configuration. As shown in Figure 3, the strengthening of the business climate within core GCC countries contrasts with its weakening in most other countries.
The second issue is the availability of natural gas. Electricity can be generated using different technologies and a variety of fuels. Reflecting the region’s energy resource endowment, MENA’s power sector relies heavily on thermal plants fueled essentially by hydrocarbons. In 2011, about 62% (58% in the Arab world) of output was generated using natural gas and 34% (40% in the Arab world) using oil products. The remaining 4% (2% in the Arab world) was from hydro and smaller amounts of imported coal, not to mention the still negligible aggregate contribution of nuclear, solar and wind power (Figure 4). 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 issue of future sustainability of proven reserves. Already an increasing number of apparently well-endowed countries have been unable to balance their domestic natural gas market, shifting supply back to oil products or filling the gap with imports, both at a very high opportunity cost. To get a clear-cut picture of each country’s supply sustainability, we have developed a metric that measures the trend towards an optimal supply threshold (OST). 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 close (or far) countries are from that threshold. This is illustrated by the 2011 cross section in Figure 5. Progressing towards the OST line should not be worrisome, unless such a move is perceived too expeditious as a result of demand growing faster than reserve additions. This appears to be the case for Iraq, Yemen, the UAE, Tunisia, Saudi Arabia, Kuwait, Libya and Bahrain. While the case of Iraq underscores the urgent need to limit gas flaring, that of Bahrain suggests that the country is using more gas than it could possibly afford from domestic sources.5
The third issue is funding. Many regional governments have long embarked on power sector reforms with the major aim of shifting part of the financing burden to the private sector. While these reforms have key common features, they differ somewhat in terms of institutional design and regulations. The common tendency, however, is towards a phased approach to competitive markets, allowing private participation in power generation while public utilities retain regulated monopoly over transmission and distribution. Under the prevailing model - the ‘single buyer’ - the incumbent utility acquires competitively priced electricity from independent power and power/water producers (IPPs and IWPPs).
Therefore, T&D has continued to be financed from internal sources, ie utilities’ retained earnings (if any) and state budget allocations, eventually supplemented by external soft multilateral bank loans. In contrast, investment in power generation has mostly been undertaken on a project finance basis. In this context, with still limited opportunities for raising funds from capital markets, debt has typically been secured from the region’s loans market. Unfortunately, the global financial crisis and a protracted Eurozone debt crisis have resulted in most European banks significantly reducing their exposure to that market. As a result, and as shown in Figure 6, loans extended to the power and power/water sector have dropped by more than half from a record high of $16bn in 2008 to less than $7bn in 2012. Also, the cost of borrowing as measured by the ‘all-in-one’ price (above Libor), although coming down from a peak of a little more than 300 bps in 2009, remains challenging at 185 bps.
Even assuming a return of European banks, IPPs/IWPPs would have difficulty attracting debt financing without lenders being satisfied additional risk mitigation measures specific to the power sector were in place. These include higher quality developers, reduced tenors for long term debt, better risk allocation in power purchase agreements between private developers and public utilities, and effective hedging of fuel supply risks.
During the high tide of sector reforms, utilities were starved of funds in the belief that the private sector would be obliging no matter how volatile or uncertain the investment climate became. Now that the private sector is not completely forthcoming, utilities are pressured to catch up with the promise of more money from state budgets. The extent of such support depends on governments’ fiscal comfort and, in the case of the oil and gas exporting countries, on oil prices remaining above their fiscal break-even levels.6 Finally, there is the case of Iran, which is unique in several respects. As tougher economic sanctions have severely restricted external funding, the Iranian government has embarked on a review of electricity rates as part of a ‘Targeted Energy Subsidies Reforms’ plan. In addition to a new tariff structure to optimize load demand, tariffs have been significantly increased to allow public utilities to achieve a degree of self-financing.
Fast-growing electricity demand and lagging supply have led to chronic power shortages across many MENA countries. In the current context bridging the widening demand-supply gap through increased supplies is perceived as politically and socially more desirable. Without active demand side management and serious cuts in subsidies, this will entail a capacity growth of 8.4% per year, which translates into a five-year increment of 140gw above the 2013 level. Taking account of the associated investment in T&D, the capital required for the whole sector will be in the order of $283bn during the period 2014-18, 59% of which would be in new generation capacity.
This huge sectorial investment offers great opportunities but also raises major challenges. We have identified three issues in particular that should feature prominently on policy agendas. The first results from the perception, in the wake of the so-called ‘Arab Spring,’ of a deteriorating investment climate in most of the region. The second stems from the scarcity of natural gas in apparently well-endowed countries. The third follows from the inadequacy of internal and external financing. These issues cannot be resolved without supportive policies in the corresponding areas: first, by improving the investment climate and providing assurances critical to regaining private investment momentum; second, by providing the power generation sector with affordable fuel options; and third, fiscal space permitting, by increasing state budget funding of public utilities, which have become the investors of last resort. Otherwise, utilities will seldom catch up no matter how pressured they are.
1. MENA is defined to include the Arab world and Iran. Power generation in both Sudan and South Sudan is kept inconsequentially aggregated. Within MENA the Gulf Cooperation Council (GCC) area clusters together Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE.
2. The Secretariat General of the Arab Union of Electricity (www.auptde.org) offers an annual statistical bulletin, at a discretionary charge, compiled from what little it can gather from member utilities.
3. Civil nuclear power programs involve Iran and the UAE. In Iran, while Bushehr I was officially inaugurated in 2010 and operated a year later, there is currently no plan to complete Bushehr II. In the UAE, the first reactor of Abu Dhabi’s project is expected to be completed by 2017.
4. Off-grid supply may be more relevant for rural and remote areas.
5. For a thorough analysis of the pattern of natural gas supply in the region, see A Aissaoui, ‘MENA Natural Gas Endowment Is Likely to Be Much Greater Than Commonly Assumed’ in APICORP’s Economic Commentary dated December 2012.
6. For an estimate of these prices, see Ali Aissaoui, ‘Fiscal Break-Even Prices Revisited: What More Could They Tell Us About OPEC Policy Intent?’, MEES, 13 August 2012.
*Senior Consultant at the Arab Petroleum Investments Corporation (APICORP). This article is published concurrently in APICORP’s Economic Commentary dated April-May 2013. The views expressed are those of the author only. Comments and feedback may be sent to: [email protected]