How clear is your crystal ball?

The United Arab Emirates and in particular Abu Dhabi, is certainly the place to do business in the Middle East. It has all the elements a power developer could want – demand is strong, the off-taker is financially sound, the government is a pioneer in the region for privatization and the rules of the market are clear. Looking into the crystal ball, the future is so bright, it’s almost blinding.

However, a potential danger – one that we have seen in many markets around the world – is the problem caused by inaccurate forecasting. It caused problems in China in the mid-1990s and more recently in other countries in southeast Asia.

On the face of it, there may seem to be no cause for concern. In 2004, growth in peak electricity demand in the UAE was 5 per cent. Yet how often have we seen forecasters over-forecast power requirements? Their general philosophy seems to be to err on the side of caution – it is better to have too much power than too little. The problem is compounded by large consumers who say they need more power than they do and usually sooner than they actually need it.

Forecasts are also done according to population growth but it should be remembered that the relationship between population growth and power demand is not necessarily linear. Certainly increasing population means more shopping malls, housing, etc. but many of these resources are shared. In developing countries, government census information may also be inaccurate. In countries like the UK for example, census information can be relied on to be correct to within one per cent but it is much more difficult in other parts of the world.

Planning capacity to cover peak demand is a tricky business in the UAE since system peaks occur at different times in the various emirates. The time of peak demand also depends on the weather. In the UAE for example, peak demand shifted to August in 2004, from September in the previous year. Predictions are further complicated in the UAE since expansion of the water system also has to be considered. And with water demand previously constrained by transmission development, it is difficult to see what the true water demand growth is.

Mark Clifton, director of economic regulation at the Regulation and Supervision Bureau for the Water and Electricity Sector in the Emirate of Abu Dhabi noted: “Demand growth has slowed over the last fours years and is probably now about 3-4 per cent since Shuweihat S1 came on line. There is also a lot of development going on which creates uncertainty. For example, there are new housing development projects around the Beach island area that will generate new demand. There is pressure on demand from the industrial sector in areas such as Musaffah. High numbers are being spoken about but you can’t be sure of what might happen.”

Poor forecasting can create problems in the sector. Abu Dhabi has based its payment structure on best international practices where there is a two-part payment based on the unit cost of electricity and available capacity.

Aftab Raza, senior economist at the Bureau noted: “Two years ago we reviewed markets around the world to see if we had the right structure in place. We noted that the two-part payment structure has a risk for the off-taker. In this scenario, IPP planners tend to go for larger plants since the off-taker has to carry the burden of capacity payments.”

We have seen what can happen in markets where the state utility is committed to long term PPAs and has to make capacity payments, whether electricity is generated or not. Financial difficulties can arise which in turn can lead to defaults on contracts. Rest assured, this is unlikely to ever happen in the UAE. In a country that generates so much revenue from oil and gas, the creditworthiness of a utility is never likely to be called into question. Further, developers in the key market, Abu Dhabi, have an added level of comfort since the government has a 60 per cent stake in the projects.

Nevertheless, it would be prudent for developers and the government of the UAE to be mindful of past oversights in other developing countries. Yes the future is bright, but sometimes the picture in the crystal ball is not crystal clear.

Junior Isles
Publisher & Editorial Director

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