By Shihab Elborai
The outlook for renewables in the Middle East is encouraging. Recent tenders, such as in Saudi Arabia and neighboring Egypt, have demonstrated considerable investor appetite, competitive prices, and a strong market for clean energy.
In Saudi Arabia, just one of eight bidders submitted a proposal of over US $0.03 per kWh for the 300-MW Sakaka Solar tender. In Egypt, only one of six major bidders offered a price for the 200-MW Kom Ombo Solar tender above US $0.035 per kWh. These are impressive results.
These tenders reflect the region’s advantages in renewables and its need for these technologies. The region has abundant high-yield resources. A solar-photovoltaic panel in the Gulf Cooperation Council (GCC), for example, could have as much as twice the output as it would have in west Europe. (Note the GCC is comprised of Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman.)
There is also a positive global trend, as developing countries now attract the majority of investments into renewables, which is encouraging for the Middle East. The GCC, in particular, has another advantage in the form of a proven financing model for private investors through the independent power plant (IPP) model. The IPP model’s limited recourse financing works well with renewables projects that require large up-front capital costs followed by minimal operations and maintenance expenditure.
The Middle East also needs renewables due to its region-wide shortage of natural gas. The gas shortage is obliging countries to invest in expensive and difficult new gas resources, with some countries importing fuels or consuming crude and liquid fuels for electrical generation. Renewables, properly deployed, could alleviate these problems while gas supplies are under development.
There are, however, risks that can throw renewables investments off course. Energy investments, even in relatively modestly sized renewables plants, are a long-term commitment that needs proper timing and appropriate risk management. Among the risks are that the region continues to subsidize non-renewables directly and indirectly, subsidies that may prove hard to remove.
Strategy&, for example, estimates that the true cost of electricity generation (excluding transmission and distribution costs) in the GCC is US $0.08 to 0.09 /kWh, 25 to 30 percent more than in the U.S., if true cost of fossil power were included.
Other risks are that, with the exception of the IPP mechanism, regional credit markets are not sophisticated enough to deal with the unique nature of renewables projects with their substantial initial costs. There are also concerns that some of the region’s transmission and distribution networks are fragmented.
The broader fiscal and economic climate is also unfavorable because of cuts to investment. The lower oil price makes the cost of capital for renewables higher and the fossil fuels more competitive.
Further risks are that the very success of recent tenders can, if not carefully managed, lead to an unsustainable downward price spiral that makes renewables unattractive to investors.
There are also policy risks, most significantly that there is still a preference in the region for large projects to fulfill fast growing demand rather than smaller renewables projects. The region already has made substantial investment in large-scale baseload capacity whose viability renewables could undermine. Among policymakers, there is insufficient exposure to these new technologies, while the regulatory and policy environment is not predictable and stable.
Planning the Path Forward
To get the most out of the promise of renewables in the Middle East, policymakers must use two main methods: a deliberate policy of risk mitigation and aiming for the right pace of development.
First, each government needs a comprehensive and integrated national energy plan that incorporates renewables, and sets realistic targets. The national energy plan should seek to optimize the whole value chain including the fuel delivery infrastructure. This can be done by using a mix of technologies that provides lowest-cost energy according to daily and seasonal requirements.
The plan should be grounded in an understanding of the true costs of electricity supply to consumers and should consider all possible energy choices. The existence of such a plan mitigates risk by including generation capacity targets and a schedule. These signal to private firms and investors that they should prepare financing and consortia long before the government announces tenders, thereby increasing private sector confidence and deepening the pool of available capital.
Risk mitigation also demands a national energy governance architecture within which institutional roles and responsibilities are clear, along with enhanced policymaking and regulatory capabilities. Each government must enforce a separation among its functions as asset owner, policymaker, and regulator, thereby providing the space in which the private sector can succeed despite centrally run electricity provision. Separation will help to make decisions related to the electricity sector transparent, open to external input, accountable, and without favoritism.
Governments can also lower the level of risk specifically for solar projects, such as through extensive pre-development work. This could involve resolving ownership rights for project sites, and conducting the necessary resource measurements and technical assessments.
Second, the right pace for renewables deployment is critical as governments in a hurry can make mistakes that are expensive to correct later, whereas governments who do not act risk missing on the savings opportunities presented by renewables.
Eventually governments could share the burden of setting the right pace of renewables deployment by gradually shifting some demand risk to private investors. This means deepening liquidity, ensuring competition to provide financing, and encouraging credit innovation to manage risk.
One way to provide lower-interest costs and longer maturity financing is improved access to corporate and sukkuk (Islamic law-compliant) bond markets. Another is new legal instruments that put the risk of a renewables project onto the partner that can manage it best during each project phase, with the result that risk is allocated variably and so effectively. Instruments that achieve this can be partnership flips, sale and leaseback, and securitization of future IPP cash flows into publicly traded yield companies. The introduction of derivatives into GCC capital markets would also provide more liquidity.
Along with more financing options, governments should reform fossil fuel and energy subsidies so that resources are invested properly with minimal disruption to the current electricity systems. Governments must in due course eliminate subsidies and price electricity realistically to ensure the financial sustainability of electricity generation. By making data more transparent, governments can understand the cost of generation and provision of a kilowatt-hour and begin to create price support mechanisms that include all the various kinds of direct and indirect subsidies. Investing just a small part of the current fossil fuel subsidies into renewables will give an important boost to the development of new fuel sources.
Finally, governments should create unified regional standards to promote cross-border electricity trading. Such standards would remove barriers that fragments the regional market. There are already accepted standards for many solar-photovoltaic technologies.
Renewables are now an established part of the energy mix. The challenge for Middle East countries, with their tremendous renewable energy potential, will be to get the strategy right so that they avoid mistakes, remove risk, and advance at just the right pace.
Shihab Elborai is a partner with Strategy& Middle East (formerly Booz & Company), part of the PwC network.