Africa, Middle East, Middle East & Africa, Middle East MENA Gulf, Renewables, Solar, Strategic Development, Wind

How to unlock MENA power investment

Issue 9 and Volume 23.

Energy demand in the Middle East is expected to increase threefold in the next 15 years, far outstripping today’s supply.

The Middle East and North Africa are forecast to account for most of the world’s energy demand growth well into the 2030s and beyond. But many areas of the region face limited investments in new generation capacity and distribution, and some countries have restricted or no supply of indigenous hydrocarbon resources.

In a report released this year called Financing the Future of Energy, the National bank of Abu Dhabi states that “to close the gap will require huge levels of investment in projects that provide additional generation capacity and improve the efficiency of our energy use”.

The bank’s chief executive Alex Thursby stresses that “we should not underestimate the scale of the task facing us all. But, for the region, it gives us the opportunity to create solutions for highly efficient energy systems that both supply our energy needs locally and connect to a growing world market in energy technology”.

And he adds that “since this will require innovative approaches to financing energy, we believe it also presents real opportunities for the region’s banking sector”.

IPP3 power plant in Jordan: a success story of financing and engineering
IPP3 power plant in Jordan: a success story of financing and engineering
Wartsila

The bank says that “what at first appear to be challenges as the region makes the transition to a new energy future can become the source of the opportunity, when it is recognized that the situation will demand innovative responses in technology, industry and infrastructure – all of which need to be financed”.

NBAD believes that existing progress in developing the Middle East’s energy mix – particularly with regard to renewables – provides evidence to convince financiers that the investment opportunities in the region’s power sector “are real, large and happening now”.

One key recent development being highlighted is the successful bid at the end of last year by the Dubai Electricity and Water Authority (DEWA) for 200 MW of solar power at $5.98/kWh, a game-changing price that has set a new world benchmark for utility-scale solar PV costs, putting photovoltaic technologies on a competitive level with oil and gas.

Roberto Vigotti, secretary-general of RES4MED, says the DEWA deal “is a game changer. Solar in the GCC can compete with gas and oil”.

Roberto Vigotti: DEWA solar deal “is a game changer”
Roberto Vigotti: DEWA solar deal “is a game changer”
Credit: Eurelectric

Vigotti adds that “renewable energy is no longer being driven by climate change – it’s a commercial decision”.

Paul van Son, RWE’s country chairman for MENA and Turkey, says that “we have witnessed a paradigm shift in electricity supply. Renewables have become competitive on their own without subsidy.

“This is the first time that the sustainable power is winning over the non-sustainable power from a market point of view.”

However, realizing the power investment opportunity in the Middle East will, according to NBAD, “require collaboration between policymakers and financial institutions”.

“The banking sector has a major part to play, but so too do other financial services actors such as insurance companies or global institutions.”

“Alongside the financial sector, though, governments have a continued contribution to make, from establishing power purchase agreements or procurement frameworks that enable new technologies to be deployed at scale and drive down costs.

Thus the key contribution of governments is to provide the longer-term certainty that is a prerequisite for new project development.

But the bank stresses that “making the transition smoothly requires strategic decisions in the short term – over the next five to ten years – to avoid locking the energy system into further investments that will need to be rethought as unavailability of competitively priced conventional fuel sources mounts and environmental sustainability becomes an increasingly important performance criterion”.

European electricity trade group Eurelectric believes that a “concerted effort is needed to attract investment in the electricity sector in the Middle East and North African region”.

It says that although many countries have set ambitious targets to revise their energy strategies and are increasingly turning to renewable energy and energy efficiency measures, they are “not attracting sufficient private capital and investment in electricity generation assets and infrastructure”.

Eurelectric recently published a policy document in which it outlined recommendations on how to secure investments in the MENA region.

In the document, it put forward eight key recommendations:

Make regulatory agencies fit for purpose: put in place an enabling regulatory environment

Heightened political uncertainty and political crises in a number of countries in the region have adversely impacted investor confidence and foreign direct investment over the past year.

Reducing this uncertainty is essential to ensure that the ambitious investment challenges can be met. A first prerequisite to a stable investment climate is therefore the establishment of a capable, independent, determined and empowered regulator.

It is widely agreed that stable, fair, cost-reflective and performance-based regulation leads to much lower investment risks and hence to larger investments, improved choice of contractors and lower financing costs. At the same time, a properly functioning regulator should guarantee that consumers benefit from sustainable investments, more transparency and better quality of service with reasonable electricity prices. All in all, independence represents the essence of regulators’ mission, along with the need for autonomy and accountability in their decision-making process.

While arbitrating fairly between consumers, producers and investors, regulators should put in place clear rules that boost investors’ confidence in generation and transmission and distribution infrastructure projects.

To successfully fulfil their role, regulatory agencies should take care to foster relevant capacities and competences.

In the longer term, regulators of neighbouring countries, or of countries hosting common infrastructure, could work to harmonize rules, including through the opening of access to infrastructure on a non-discriminatory basis, thereby fostering further investment in upstream resources.

Enable cost-reflective energy prices – remove domestic electricity subsidies

At present, electricity prices across most MENA countries tend to be too low for investors to recover the cost of generating electricity. Electricity subsidies in the MENA region widen the price gap between the costs of producing and the price of electricity for consumers. Unfortunately, most governments continue to provide substantial subsidies for fossil fuels, thus imposing further disadvantages on other technologies, including in particular renewable energies.

Complicating matters further, the true cost of electricity production using fossil fuels is not clearly understood by the general public or, in some instances, by policymakers themselves. This often results in misleading conclusions due to inappropriate comparisons between end-user tariffs, the cost of subsidized hydrocarbon-based generation and the cost of renewable energy.

The existing price levels therefore cannot support new generation investments, either by attracting private investors or by providing domestic utilities with the means to invest on their own. The cost structure of retail energy prices are also not transparent to customers, and do not incentivize responsible customer behaviour, for example with respect to energy efficiency.

Eurelectric Secretary-General Hans ten Berge at the launch in Brussels of its MENA investment plan
Eurelectric Secretary-General Hans ten Berge at the launch in Brussels of its MENA investment plan
Credit: Eurelectric

Phasing out subsidies, ensuring fair prices that reflect the real cost of electricity products and improving efficient energy use have become imperative to stimulate investment in much-needed generation capacity and grids to attain the growth goals of these countries. This challenge is particularly great considering the high population growth and unemployment rates, as well as poverty levels and social equity concerns in these countries.

Shifting subsidies away from fossil fuels is important, but the short-term impact of these changes on energy consumers must be carefully managed to avoid political backlash. Low electricity prices as a support means for vulnerable customers are not an adequate response: they incentivize the waste of energy and allow those who are not in need to unnecessarily benefit.

Formulate sound and transparent energy policies

Eurelectric member companies mention the lack of stimulating investment policies as well as the general lack of transparency on energy strategies and policies as important investment barriers.

In some countries, uncertain policies create an ambiguous investment climate. It is therefore evident that credible policy and maximum market transparency is required to generate private sector interest in this sector, and the lack of supportive, long-term, consistent or stable policy regimes constitutes a big barrier to investment.

Mobilization of financing requires a holistic energy policy strategy that is tailored to the local context and that combines a sound organization of the market and a supportive regulatory framework with targeted interventions to address market failures. Effective national policy is critical to create the kind of markets that financiers will find attractive.

Investors need this transparency on national energy strategy, the choices made in this context, and the rationale for those choices.

Facilitate technical and political co-ordination and co-operation on grid investments

Facilitating new regional-scale generation and transmission projects is seen as the key investment priority of the MENA region. The construction and financing of new transmission networks will continue to act as a barrier as generation capacity increases. New large-scale projects rely on sufficient transmission components with well-planned financing of grid extensions and improvements.

Furthermore, it is urgent to develop interconnectors in the region in order to ensure security of supply for interconnected countries and to support economic optimization. Expanding cross-border trade can indeed be a cost-effective way to increase reliability and affordability, but technical and political barriers persist. To overcome such barriers, the development of intense technical and political co-operation is fundamental. Institutions like MEDREG, MEDGRID and MEDTSO are increasingly involved in developing strong institutional partnerships at the regional and international levels, promoting effective exchange and leading to further integration of the region’s countries.

Synergy between these organizations is crucial, notably to encourage the adoption of compatible cross-border network codes.

Open market structures, in particular for renewable energy-based generation projects

Competition should be introduced where possible, notably in power generation, trade, ancillary services and electricity supply, provided that a level playing field is established and that national markets are sufficiently large, or that interconnections exist, giving room to larger regional markets.

Deregulation within national and regional energy markets is important to allow free entry and exit of new players and to create and facilitate competition among providers, in particular for the development of large-scale renewable energy generation projects.

Design and implement the right financing mechanisms to stimulate exploration of renewable energy potential

Despite the substantial economic potential of renewable energy across the MENA region, a number of factors currently make such projects economically unviable without targeted government support. The main barriers include:

l Market risks: MENA economies generally experience wider fluctuations of macroeconomic indicators, making their investment climate harder to forecast for investors. This in turn results in higher borrowing costs, shorter loans, and higher equity requirements for finance;

l Technology and capacity risks: The limited expertise and experience (of the labour force) can lead to misjudgments, decrease anticipated productivity, and unexpectedly increase costs. Relevant knowledge and capacity is often also limited among relevant public administrations;

l Access to finance: High up-front payment and risks associated with renewable energy projects will typically lead to high premiums required by banks. Cost transparency needs to be improved and organization questions regarding market integration need to be better answered.

Due to the structure of the energy markets in the region and because energy prices, including fuel oil and electricity, are subsidized for end users, there is an identifiable need for well-designed and targeted government investment incentives and support mechanisms in order to develop private investment in renewable energy projects in the region. A lack of clarity and coherence regarding available opportunities currently undermines private sector participation and competition in most of the countries.

MENA governments should therefore design incentives that drive private investment to take advantage of the private sector’s financing capacity, to profit from technology transfers, to optimize their oil and gas trades and to benefit from positive environmental externalities (e.g., a lower carbon footprint).

The most meaningful public finance programmes employ a package of financing mechanisms rather than relying on any single mechanism or fixed set of mechanisms. These packages may include lines of credit to local finance institutions; project debt financing; loan softening programmes; guarantees to mitigate lending risk; grants and contingent grants for project development costs; equity, quasi-equity and venture capital; or carbon finance facilities. The programmes should seek to leverage additional private financing to the largest possible extent, and adopt a portfolio approach that avoids creating path dependency on any specific set of technologies.

Improve education and technology transfer

Too few incentives exist to encourage the private sector to hire and train local staff or to create business linkages with local SMEs. There is a need to shape strategy further by providing dedicated training for key energy decision-makers within the MENA countries in order to improve competence and share knowledge and information between EU member states and the region, e.g., on network codes, technical standards, and renewable energy project financing.

Enhance the EU-MENA Energy Cooperation: extend the Energy Community concept towards the south

The MENA countries stand to benefit greatly from the EU’s energy strategy, certainly with the new momentum brought by the Energy Union. Whereas most MENA countries were traditionally relevant to the EU’s energy market because of their vast fossil fuel resources, they have recently become increasingly relevant because of their substantial renewable energy potential.

Within the framework of the Energy Union, there is now a clear opportunity for the EU to become more aware of its role and influence in the MENA region and to start thinking about long-term engagement. The European Commission (EC) has already envisaged the concept of a Mediterranean Energy Community by 2020. The EC should continue to develop ideas to open a credible window of opportunity for the integration of Southern Mediterranean energy markets within the EU market.

The main challenge for the EU will be to incentivize its neighbours to strive to adopt EU regulations without being able to rely on a well-developed institutional framework for energy co-operation and without offering them fully-fledged EU membership.

Energy regulation diffusion to other regions has, however, proved to be successful in the past, for instance with the enlargement of the Energy Community to countries like Ukraine or Moldova.

In order to persuade MENA countries to join the Energy Community, the institution should however be much more supportive to organizing a broad knowledge exchange and having a closer look towards the barriers and weaknesses in implementation of the Treaty, rather than focusing too much on the legal enforcement aspects.

The right way forward for the South will most likely be a step-by-step approach that leads to better framework conditions for a possible set-up of a Southern Mediterranean Energy Community in the long run. Setting up industry and regulatory forums and workshops to enable necessary regulatory and market reforms and grid infrastructure is a priority first step.

This could be followed by initiating the design of a centralized control centre to monitor the activities of electricity TSOs in the Mediterranean region.