Saudi Arabia Overhauls Electricity Supply

Saudi Arabia Overhauls Electricity Supply

January 01, 1999

The Council of Ministers in Saudi Arabia approved proposals for a significant restructuring of its electricity sector on November 30. The changes are the result of almost two years of internal deliberation on how to meet the high projected growth levels in electricity consumption in the Kingdom for the next 20 years. The changes are also directed at better facilitating foreign investment in the power sector.

Reforms

The principal reforms are as follows:

  • a decision has been made to merge all electricity companies into one joint stock company, Saudi Electric Company (SEC), resulting in the dissolution of the General Electricity Organization (GEO) and the merger of the four Saudi Consolidated Electricity Companies and other smaller electricity companies in various provinces into the new SEC.
  • New increased electricity tariffs will be effective a month after SEC is launched.

SEC will be able to establish and own subsidiary companies for electricity power generation and distribution. It is anticipated that the merger of the electricity companies will strengthen the sector and enable SEC to set up large generating plants and link different regions with a single power grid, while at the same time reducing the cost of production and distribution.

Background

Saudi Arabia needs approximately SR438 billion (US$116.2 billion) for electricity projects in the next 20 years. Annual growth of power demand in the Kingdom is estimated at 4.5 per cent. This will necessitate an increase to the country’s power generating capacity from the current 21,000 megawatts to 70,000 megawatts by the year 2020.

Electricity in Saudi Arabia is currently produced and supplied to the central, eastern, western and southern regions by four vertically integrated Saudi Consolidated Electricity Companies (SCECOs). The northern region is supplied by the Electricity Corporation, except Tabuk, Haql, Tayma, Dawmat, Al Jandal, Rafha and Arar are supplied by six smaller electricity companies. SCECOs are joint-stock companies operating under the supervision of the Ministry of Industry and Electricity. The government owns 78% of the equity of all eleven companies; the remaining equity is owned by the private sector. Each region has its own electricity transmission grid. Only the central and eastern grids are linked together.

The four SCECO companies have been running at a deficit because of charges to consumers that are lower than production costs. Government subsidies to the four SCECO companies amounted to SR32 billion (US$8.5 billion) in 1997 while loans reached SR28.6 billion (US$7.5 billion).

The proposed reforms are a clear acknowledgment by the government that the current system in which power generation and distribution is divided between four regional SCECOs and seven other regional companies is unsustainable. The SCECOs have been burdened with heavy losses for many years. Unable to sell power at cost, they have had to rely on unpredictable treasury subsidies to remain solvent. When times are hard (and the price of oil is the primary determinant of this) they have been the first to have their payments deferred by the government, leaving them short of capital and unable to plan effectively for the future.

Forces Prompting Change

Saudi Arabia’s impressive developing industrial economy, together with its subsidized rates for electricity and high population growth, have created a demand for electricity that is far greater than existing capacity. Between 1985 and 1995 demand for electricity increased by over 300%. During the same 10-year period, however, the SCECOs increased their load capacity by only 50%. Recent dramatic falls in oil prices also galvanized the Council of Ministers into action. Other factors cited as the reasons for the new policy include the need to attract private sector investment into new power projects, raise tariffs to permit gradual reduction in government subsidies, link the western and central electricity grids, and link up to a proposed regional grid serving members of the Gulf Cooperation Council.

Lingering Difficulties

Indecision on the part of the Saudi authorities administering power projects is one of the main criticisms cited by many developers with respect to their activities in the region.

The last couple of years have seen a reluctance on the part of the Saudi authorities to assist in providing the necessary elements to make classically-structured project financing viable. Projects have been funded either on a delayed payment basis (e.g., the 1,200 megawatt PP9 project north of Riyadh being built by GE) from funds contributed (through increased electricity tariffs) by wealthy domestic users to a fund set up by the Saudi authorities, or on the basis of corporate loans (e.g., the Ghazlan-2 expansion project). Neither of these methods of financing has proved particularly attractive to developers.

The difficulties in carrying out a privately-financed power project have been particularly evident in the recent process of awarding a contract to build the Shuaiba plant. More than five international consortia submitted bids to the Saudi Consolidated Electric Company for the western region in May 1997 to build the 1,750 megawatt plant on a build-own-operate (BOO) basis. One year later, the Saudi authorities decided not to proceed with the BOO option. A delayed payment scheme was then considered and dropped. It is still not certain what the structure will be.

Enough Reform?

Provided SEC is adequately capitalized, the announced changes will do much to allay existing private investor concerns about the credit worthiness of the SCECO companies. The revised tariff structure may also act as a significant impetus to private sector investment. While investors will no doubt welcome the changes which have been announced, the approach by the Kingdom to other important concerns that potential investors have often raised in the past will need to be considered seriously during implementation of the reforms. A willingness to address these other concerns will determine whether Saudi Arabia is going to become a viable market in future for private investors interested in the project financing of power projects.

Developers still have the following concerns:

  • whether the regulatory system will be adequately clarified for private electric power producers;
  • whether government support will be necessary or available for a power purchase agreement (PPA). The fundamental question is whether SEC will become a creditworthy purchaser or whether some government support will be necessary to ensure that it will have adequate funds to meet its obligations under any PPA;
  • determining the precise role of the government as a shareholder and the extent of the control which it may wish to retain over any project;
  • whether the fuel supply arrangements with Aramco, the government-owned oil and gas company, can be satisfactorily negotiated to meet foreign investors’ expectations;
  • whether an adequate security package over project assets will be available, allowing lenders to register mortgages and direct the sale of real property in the event of default;
  • whether an adequate security package over project assets will be available, allowing lenders to register mortgages and direct the sale of real property in the event of default;
  • whether the rules for obtaining concession agreements, site leases and other permits from the government will be adequately clarified;
  • whether foreign law and arbitration will be acceptable together with enforcement of foreign arbitral and judicial awards in the Kingdom; and
  • whether private producers will be allowed to sell electricity directly to industrial end-users.


by Kevin Jordan and Stephanie Conaghan, in London