Investment opportunities in the Middle East abound as the region strives to keep up with rapidly growing demand. But can this growth be sustained?

Siân Green

One need only take a glance at PEi’s news pages – on-line and in print – to realise that the electricity sector in the Middle East is booming. Each month, several key project contracts are signed and sealed in the power generation and the transmission and distribution sectors.

The frantic pace of growth in the region’s power and energy sector shows no sign of letting up. Rapid population growth, economic development and energy subsidies are driving demand for both energy and water. This, coupled with the fact that the region holds a large proportion of the world’s proven oil and gas reserves, has caught the attention of the world’s energy industry, says the International Energy Agency in its World Energy Outlook 2005.

The WEO 2005 focuses on the Middle East North Africa (MENA) region, and notes that it will play a critical role in meeting global energy demand. It contains possibly the strongest warning signal ever issued by the Paris-based agency, forecasting in its reference scenario that global energy demand will rise by over 50 per cent by 2030, that $17tr of investment is required to meet this demand, and that IEA countries will become increasingly dependent on oil and gas imports from MENA. Energy-related carbon emissions will also rise by 52 per cent by 2030.

The WEO forecasts that world primary energy demand will reach 16.3bn toe, more than two-thirds of which will come from developing countries. A policy environment that promotes energy efficiency and renewable energy could reduce the projected global primary energy demand by around ten per cent.

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In the MENA region itself primary energy demand more than doubles between 2003 and 2030 to 1.2bn toe – an average annual increase of 2.9 per cent, faster than any other region in the world. These countries will continue to rely almost exclusively on oil and natural gas for their domestic needs, while a surge in both oil and natural gas production will allow a boom in fuel exports.

Primary energy demand for natural gas will grow by 3.5 per cent per year in MENA from 288bn m3 in 2003 to 767bn m3 in 2030, overtaking oil to become the region’s major primary energy source. Almost half of the increase in gas demand will come from the power generation and water desalination sectors.

To meet the increase in energy demand in MENA, infrastructure investment of about $1.5tr is required from 2004 to 2030, equivalent to $56bn per year. The power generation, transmission and distribution sectors are expected to account for $458bn of this, says IEA. Power generation will take $2.3bn and transmission and distribution $255bn. Saudi Arabia’s power sector will need the largest investment of $110bn.

Demand for electricity is forecast to grow from 724 TWh in 2003 to 1799 TWh in 2030, a rate of 3.4 per cent per year, says IEA, and will be driven partly by the low cost of electricity in most of these countries. In the period to 2010, Saudi Arabia and UAE will see the fastest growth rates. Saudi Arabia’s growth will continue in the long term, but it will be joined by Iraq and Libya. By 2030, Saudi Arabia will have the largest power sector in the region, with generation reaching 426 TWh.

Installed capacity in MENA is predicted to grow from 178 GW in 2003 to 447 GW in 2030. Allowing for retirements, some 301 GW of capacity will be needed, over 40 per cent of which will be in Saudi Arabia and Iran. Over the projection period, gas-fired power plants will meet over two-thirds of new capacity needs in the region, and most (137 GW) will be in the form of combined cycle plants. Oil-fired capacity additions will amount to 63 GW.

The growing importance of natural gas and of combined cycle technology in MENA reflects the drive to reserve domestic oil for export, and the rising opportunity cost of natural gas. In fact, the share of natural gas in the electricity generation mix will rise from 56 per cent in 2003 to 69 per cent in 2030.

Of the IEA’s forecast investment requirement of $458bn, 80 per cent will be in the Middle East, with Iran requiring $92bn and UAE $35bn.

In the Middle East, the electricity sector is largely publicly-owned, controlled either by a government ministry or a vertically-integrated power company. In addition, electricity prices are often heavily subsidized. This means that power companies do not have sufficient funds for investment, and have to rely either on government budgets, or have turned to the private sector and the IPP model. This has certainly been the case in the Gulf states, and Iran and Saudi Arabia have also started to develop IPP projects.

The IPP model has the advantage of bringing power on-line quickly, and providing a long-term guaranteed source of revenue for the developer. However, the IEA expresses concern that IPPs in MENA are requesting sovereign governmental guarantees and high rates of return (15-18 per cent). This makes these projects potentially expensive, and a burden on state budgets. This is especially the case if much-needed power sector reforms are implemented.

Power industry reforms, starting with the distribution sector, would make the region’s electricity sector more commercially viable in the long-term. In addition, some countries in the Middle East may look to wider economic reform to address issues such as unemployment. Such transition periods can be painful, and often highlight past errors.

The power industry is no stranger to the difficulties that inflexible IPP contracts can bring in the face of economic difficulties, power sector reforms, or sudden changes in demand or energy prices. No doubt the developers and off-takers alike have factored such risks into their decisions, and they are committed for the long-term, in what is certainly a long-term market. Let’s hope that the ride is a smooth one.