The fruits of liberalisation: A decade has passed since the generation sector was opened

One of the most open in the region to foreign investment and private ownership of assets, Oman’s utilities sector is expanding to meet growing demand for power and water. Independent water and power plants (IWPPs) and independent power plants (IPPs) are flourishing under the sultanate’s investor-friendly Sector Law, enjoying healthy profits from favourable financial terms and the expansion of the market. Liberalisation and unbundling has been to Oman’s benefit, and may continue in the future. Separating power supply and distribution is being explored, with an eye to increasing competition and private participation.

With the economy recovering, demand has been rising and is forecast to continue (see analysis). In this environment, competition, in transparent and open tenders, is intense. “A number of projects arising in the oil and gas, power and water segments have lead to a mass of new players within the industry, which has increased competition as never before,” Vinod Shah, the managing director of consultancy Mott MacDonald, told OBG.

Major Bodies

Royal Decree 78 of 2004 established what is known as the Sector Law, which laid the foundations for the unbundling, liberalisation and privatisation of the power and related water sector. It aimed to separate different elements within the industry and open it up to greater private investment, starting with the IPPs and IWPPs in the generation segment. It also established the Authority for Electricity Regulation (AER) as an independent regulator. The AER is responsible for protecting consumer interests; guaranteeing open, fair competition; and ensuring power and related water supply across the country.

Another body, the Public Authority for Electricity and Water (PAEW), established in 2007, is a multi-faceted organisation that operates as the main supplier of water (except for the city of Sohar and the Dhofar governorate in the south), as well as effectively operating as the sector regulator, and helping formulate electricity policy. Like the AER, it is specifically detailed to encourage private investment and competition.

Royal Decree 78 also established the Electricity Holding Company (EHC), which comes under the aegis of the Ministry of Finance, and acts as a holding company for two generation companies (gencos), three distribution companies, a procurer, one rural area system, and one system in the Salalah area of Southern Oman. As S Vishwanath, the firm’s chief financial officer, puts it, “EHC is the guardian of the government’s stake and investments in the sector.”

Distribution Model

The distribution firms have a combined licence for distribution and supply. The power sector works on a straightforward single-buyer model, with the government-owned Oman Power and Water Procurement Company (OPWP) responsible for off-taking water and electricity generated by the gencos. The reform process has created one of the region’s most open, competitive and privatised power systems, at least on the generation side. Oman, unlike many countries, allows, indeed encourages, 100% private ownership of generation assets, with the government not taking a stake in these firms. “There was a conscious decision made to unbundle and move generation to the private sector, with the government as procurer,” Vishwanath told OBG, “This was to bring in foreign investment and expertise, which means efficiency and the latest technology, and it has worked very well.”

Systems & Sources

Oman’s three power systems are the Main Interconnected System (MIS), the Salalah Power System and the rural system. There are eight independent companies operating on the MIS, plus two owned by EHC. As listed in AER’s 2012 annual report, the EHC companies are Wadi Al Jizzi, with installed capacity of 325 MW, and Al Ghubrah, with 475 MW and 40m imperial gallons a day (MIGD) of water. The independent power companies are Sohar 2 (745 MW), Barka 2 (745 MW), Al Rusail (687 MW), Al Kamil (297 MW), and UPC (Manah) with 273 MW. The remaining three companies on the MIS run as IWPPs: SMN Barka (710 MW and 26 MIGD), Sohar (600 MW and 33 MIGD) and AQWA (450 MW and 20 MIGD).

The MIS has three suppliers and distributors: Muscat Electricity Distribution Company (MEDC), which in 2012 supplied 7451 GWh to 239,870 customers; Majan Electricity Company, which supplied 5693 GWh to 162,517 customers, and Mazoon Electricity Company, with 5267 GWh to 292,963 customers.

Other Systems

The rural system, administered by the Rural Areas Electricity Company (RAECO), has an installed capacity of 282 MW and 2.2 MIGD of desalination capacity. The system distributed and supplied some 559 GWh to 25,375 customers in 2012. In the south, the Salalah Power System had installed capacity of 256 MW in 2012, to which has since been added the Sembcorp SLL IWPP, with 445 MW and 15 MIGD of installed capacity. On the Salalah system, 1896 GWh were supplied to 69,552 customers in 2012.

Natural gas accounted for 82% of Oman’s electricity generation capacity in 2013, according to the US’s Energy Information Administration – roughly 7.2 GW. The next largest contributor was waste heat ( generated in industrial processes and used for power and heating) with 15% (1.3 GW), diesel and distillate (200 MW) and oil (100 MW). Total gas use at major plants grew 12% in 2012, to 7.47bn standard cu metres per hour, from 6.62bn in 2011, according to the AER.

Transmission

Oman has two power grids, the Northern and the Southern, which are not connected. Given the distance between them, it has not made sense to do so, though the possibility of connection has been discussed in the past, as it would bring the benefit of plants in the north being able to supply the south, and vice versa, when the need arises.

With consumption growing strongly – and generation to match it – the ETC subsidiary Oman Electricity Transmission Company (OETC) has acknowledged the need to upgrade the transmission network. Some $1bn is being invested in distribution over the next five years, and potentially beyond that if necessary, according to Vishwanath. Oman’s backbone power transmission network is 220 KV, and delivers power from major plants such as Barka 1 and Sohar 1. The OETC is in the process of installing sections of Oman’s first 400-KV lines in some areas, partly due to the impending launch of the 2000-MW Sur IPP. Serbian contractor, Energoprojekt, has three engineering and procurement contracts from the OETC to build 400-KV overhead lines and substations, supplying Muscat with power from the Sur plant.

“The 400-KV system is advantageous for transmitting the huge power from Sur,” Milan Maksimovic, the general manager of Energoprojekt, told OBG. “The higher voltage means a lower current, which in turn means less losses and smaller conductors.” The benefits of the higher-voltage transmission mean that all new plants in Oman are expected to deliver straight to 400-KV networks, though 220-KV lines will remain in place. End users will continue to use 1.4 watts. Maksimovic believes that Oman will probably not install networks above 400 KV in the foreseeable future, given its size. Though parts of Europe and Russia use a 700-KV system, 400-KV networks are more common. As new plants come on-stream over the coming years further upgrades to the transmission system will be needed, providing additional opportunities for utility companies.

Efficiency

Losses, both technical and non-technical, remain a concern, reached 14.2% of the total units entering the power systems in 2012, up somewhat on 13.6% in 2011. Losses varied from 11% in the rural systems to 14.4% for MIS – in the latter case, the highest losses since 2005. The power companies have blamed the losses on industrial action by staff in their customer-facing contractors, including meter reading, billing and collection operations. The fact that losses are more than 10 percentage points below the 25% of 2004 is testament to the successes of privatisation and unbundling in terms of efficiency gains. Nonetheless, AER’s annual report expressed disappointment with the losses, encouraging companies to accelerate ongoing initiatives to bring key elements of meter reading, billing and collection services in-house and to deploy automated reading technology for the biggest electricity consumers. Since unbundling, there has been progress on reducing technical losses, but relatively little has been made on demand management. The government has promoted more efficient electricity usage through advertising, but this can only have a limited impact. The fact remains that electricity is cheap enough for Omanis and their businesses not to feel a great cost impact of over-use and even waste.

Capital Investments

The regulator has approved a capital expenditure programme worth OR175m ($453.3m) for MEDC. This will include investments in the 33-KV network, which will enhance security. MEDC is also in the process of installing automatic meter reading for the top 20% of customers by consumption, with the first smart meters expected over the next year, followed by an ongoing programme of investment. Other investments include replacing power meters, gas insulated switchgears (GIS) and broader network expansion to keep pace with Muscat’s growing population and economy. The company said that demand is growing by 7% to 8% annually.

“Security and losses are two areas to which we have to give more attention,” Mansoor Al Hinai, chief operations officer at MEDC, told OBG. “We are working on improving system design, and trying to buy transformers which minimise technical losses. For commercial losses, metering is the most important factor – we can reduce losses dramatically, so we are replacing old meters. For the first few years after liberalisation, firms were establishing themselves. Now demand management and efficiency are at the top of the agenda.”

Subsidies

Energy subsidies have not changed for 18 years, and account for around 40% of the price of power, according to Vishwanath – that is, for every $1 that the government spends on electricity, it recovers 60 cents. This rate is seen as unsustainable in the long term if Oman is to maintain a budgetary balance. “We have to address the gap – that is the crux of the situation,” said Vishwanath. EHC’s net government subsidy rose 30% in 2012, to OR199.23m ($516m) from OR153.44m ($397.4m) due to rising “purchase cost from commissioning of new plants and growth in business infrastructure… along with an increase in volume procured,” according to the company’s 2012 annual report.

At the input end, gas is also provided at remarkably low rates. Gencos receive gas at $1.50 per million British thermal units, less than 20% of the global rate of $8, according to Vishwanath. If Oman sold its gas on the international market, rather than providing it at discounted rates to local producers, it would generate considerably more revenue. The widespread expectation is that Oman will reform subsidies in the medium to long term – but nobody can say exactly when, or what form these reforms will take. In any case, it is likely that any reduction in subsidies will be incremental, with the authorities aware that any rapid increase could have social and economic impacts.

Price Sensitivity

Electricity prices are a sensitive issue in Oman, for two main reasons. First, as in most places in the world, they are a cost that almost every resident must bear – an increase in prices affects everyone. In Oman, which is among the least affluent Gulf countries in per-capita income terms, low electricity prices are a way of ensuring greater disposable income for the population, thus a significant increase in power costs, to near market levels, would be felt more acutely than in many other countries in the region.

Second, cheap power is playing an important role in Oman’s economic diversification. Many of the industries that the sultanate is promoting, including petrochemicals and steel, are power-hungry. Tourist resorts and hotels, while less electricity-intensive, are still major consumers of power, and cheap electricity rates allow them to offer lower prices to their customers.

Supply

Pricing is based on a fixed tariff schedule that is set for a three-year period. Current prices were set at the end of 2011 and will run until 2014. Prices are outlined by the Cabinet, following recommendations from the regulators. Price controls act as an incentive for distribution companies to reduce technical and commercial losses, as they cannot pass the cost of such losses onto the consumer.

Tariffs vary depending on sector, region, intensity of usage and, in some cases, time of year. Sectors are defined as residential, commercial, industrial, government, Ministry of Defence, tourism and hotels, and agriculture and fisheries. Dhofar has a separate tariff structure from the rest of the country in most sectors. For the current period, tariffs vary from OR0.10 ($0.26) to OR0.30 ($0.78) per KWh. The lowest rate applied only outside Dhofar, to categories such as residential, government and tourism addresses consuming less than 3000 KWh, and agriculture and fisheries consumption up to 7000 KWh. Industrial users pay OR0.12 ($0.31), doubled to OR0.24 ($0.62) in summer. The highest rate applies to residential and government users in Dhofar using 10,000 KWh or more.

More Liberalisation

Further unbundling is in the pipeline. In the next two to three years, the regulator is expected to segregate supply and distribution. It is also considering introducing competition in the supply sector. According to Al Hinai, the expected unbundling of supply and distribution, and the potential introduction of greater competition in the sector, is already driving companies like MEDC – which would lose its monopoly – to improve its service standards to retain customers. The unbundled companies under EHC have been structured in a way that leaves future privatisation as a viable option. However, privatisation of distribution would be difficult without reform of the subsidy system, because investors are likely to be unwilling to bridge the gap between purchase cost and sales price, and currently a mechanism does not exist to deliver subsidy benefits to a private distributor.

“Generation of power is not an issue, as it is bought at high cost, but pricing of downstream sales is more difficult,” said Vishwanath. Elsewhere in the world, transmission at least has tended to remain a public enterprise, though distribution has been liberalised in many markets. Nonetheless, he expects the logic of introducing competition to the supply sector to strengthen, and for reforms to be introduced in the next five years. This would be likely to go hand-in-hand with the easing of subsidies, though some mechanism might have to be implemented to bridge the gap between purchase and sales price nonetheless. “My view is that supply is an attractive sector for private players to invest in,” Al Hinai told OBG. “The government will continue to pay subsidies to the relevant companies, and this gives credibility for investors. While distribution is a natural monopoly, the regulator states that the market is ready for supply liberalisation. Certain regulatory tools can be used to allow competition. Players can compete on costs, margins and efficiency of supply.”

Renewable Energy

Investment in renewable energy sources has not made as much headway in Oman as in some other places in the region. One reason may be the AER’s reluctance to establish a system of feedin tariffs, systems of paying producers per KWh produced over the course of a long-term contract, which are commonly used by governments to pay for renewable energy generation elsewhere. However, there is confidence that, as technology develops and private sector interest in the segment grows, the potential for renewables development can be realised.

Oman’s year-round sunshine and large area of undeveloped land make it an ideal location for solar development. In 2009 the AER amended the Sector Law to allow for the development of small-scale renewables projects and established a Designated National Authority to oversee the sector. A study commissioned by the authority found that Oman has one of the highest “solar energy densities” in the world, with 5500-6000 watt-hours per sq metre (Wh/sq metre) a day in July to 2500-3000 Wh/sq metres a day in January.

Solar Sites

Researchers at Sultan Qaboos University identified a number of sites for possible solar plant development, identifying as the best a location at Marmul which could generate 9000 MWh at a cost of $210 per MWh – comparable to the cost of diesel-based generation. Other locations were less cost-effective however, with prices rising to $304 per MWh. “There is potential for investors in renewables once the sector opens up,” said Vishwanath. “It is only a matter of time.”

Development of renewables could also bring the substantial benefit of slowing the growth of gas and diesel consumption by the electricity sector, and potentially in the longer term, if enough efficiency gains are made, decreasing gas usage. With demand from the industrial sector growing, and continuing potential for gas exports (and possibly re-exports of Iranian gas), there could certainly be some benefits of trimming growth in usage from power plants, and slowing the erosion of Oman’s hydrocarbons reserves more broadly.

“Allocating feedstock for electricity generation and industry is an issue as gas resources are currently very tight,” Mary Allan, a partner at international law firm Curtis, Mallet-Prevost, Colt & Mosle, in Muscat, told OBG. “AER is quite interested in exploring renewables given the fuel situation and the environment.”

Challenges

As Vishwanath explains, subsidies are one of the stumbling blocks that hold up development of renewables. Such is the cost of renewable energy that the government would have to pay considerably more to renewable gencos than it does to those using Oman’s fairly abundant and cheap fossil fuels. And with subsidies, it would not be able to charge the end-user cost price – thus losing more than the current 40 cents a dollar. With a range of big-ticket infrastructure projects under way or being planned, the government has other budgetary priorities than subsidising relatively inefficient renewable development.

However, solar already has the potential to supply smaller settlements in more remote areas fairly costeffectively. Thus it is natural that the country’s first commercial solar plant will have RAECO as the off-taker. The company signed a power-purchase agreement (PPA) with investors in November 2013 for a 303-KW, 558-MWh plant in Dhofar. It should start to operate by June 2014, and doubtless other potential investors, and other players in Oman’s electricity sector, will be paying close attention to its progress.

Connections

The MIS is already connected to the wider GCC grid with a 400-KV interconnection, which should give it and its neighbours access to a bigger “spinning reserve” of on-line backup power capacity that can be deployed within 10 minutes. While detailed interconnection arrangements have yet to be agreed, there were more than 700 cross-border trades on the GCC grid from its establishment in 2009 to mid-2013.

Some have questioned how much impact a GCC grid can have at the moment, given the fact that all countries have highest demand in summer, and lowest in winter, thus running surpluses and occasional deficits in tandem. However, Oman’s summer power shortages, and its higher-than-average generation costs mean that the opportunity to import could prove a very useful one. At a conference in May 2013, Nasser Al Shahrani, director of operation and control at the GCC Interconnection Authority, explained that Oman had a power generation cost of $225 per MWh. In Qatar, the figure is $88, meaning that it can export to Oman for around $155 MWh, whereas the UAE’s cost of $104 per MWh could allow it to export power to Oman at $150.

The swing factor between lowest and peak consumption effectively means that Oman currently has a substantial amount of capacity idle during the winter, but growing demand is expected to bring them closer to full capacity in the future. In the meantime, topping up with imports at peak periods could be more efficient than building new plants to supply the top end of the demand spectrum. Imports are largely expected to be used in emergency cases in the near term.

Water

The transport of potable water is a government responsibility, while production is shifting towards the private sector. The Sector Law has largely been applied to power and “associated water” plants – that is IWPPs, rather than water-only plants. The government is planning to extend legislation to cover independent water plants (IWPs) as well, though the timing is not yet certain. Allan told OBG that the intention has been to bring IWPs under the existing law, which would mean establishing a legal requirement for off-taking from the plants. While greater legal clarity would be welcome, the current situation has not deterred IWP investors – one already exists, and two more are in the pipeline.

In 2012 OPWP purchased 167.68m cu metres (mcm) of water, up 15% from 145.18 mcm in 2011, and showing annual average growth of 11.6% from around 97 mcm in 2008, according to the company’s 2013 annual report. The total cost of water purchases rose 7% from OR80.12m ($207.5m) in 2011 to OR85.44m ($221.3m) in 2012, bringing the average cost per cu metre down 8% to OR0.51 ($1.32) as utilisation of available capacity improved. In the capital-intensive desalination industry, high capacity usage has helped to lower unit costs. Utilisation rates vary, but are fairly high across the board, from 97% for Barka 2, which produced 43 mcm in 2012, to 81% for Ghubrah (50 mcm).

New Facilities

As demand increased rapidly even during years of subdued economic growth, with the recovery now resurgent, further investments in capacity are ongoing. In May 2012 the PAEW announced that it would be investing OR2.9bn ($7.5bn) in water infrastructure over the coming 20 years. The substantial budgets made available for water supply include purchase agreements for new desalination plants, and investments in pumping stations, and pipes. SembCorp Salalah’s IWPP came on-stream in 2012, adding 15 MIGD to capacity as well as 445 MW of power.

The same year, OPWP awarded the contract for a new large-scale desalination plant, the $378m Al Ghubrah IWP, to Muscat City Desalination Company, in which shares of 45%, 45% and 10% are held by Malaysian power firm Malakoff, Japan’s Sumitomo and Spain’s Cadagua SA, respectively. The plant will have capacity of 42 MIGD and will be adjacent to the existing Ghubrah Power and Desalination Plant. Its commercial operation date is expected to be October 2014. Another major project in the pipeline is the Ouriyat IWP, with 40 MIGD of capacity, due in May 2016.

At the time of research, in late 2012, the Saudi-based ACWA Power firm was preparing to commission its long-awaited 10-MIGD brownfield desalination plant at Barka. Supporting infrastructure also continues to expand. In December 2012, Gulf Petrochemical Services and Trading (GPS) has won an $87.9m contract from PAEW to construct new water distribution networks in the Dakhiliyah governorate. The deal includes 90 km of water mains and nearly 600 km of service pipes, as well as tanker filling stations and groundwater facilities. The deal followed two others sealed by GPS, a $58m contract to expand Salalah’s water network and another worth $78m for a pipeline from Ghubra. Through 2013, PAEW has launched a number of water filling stations (from which water tankers can be filled for further distribution), particularly in rural areas.

Connectivity

“The government’s pledge to connect every house to water supply is particularly ambitious given the country’s size and the rapid development of new residential units (particularly in the Muscat area), and should provide continuing business for contractors in the segment,” Hussain Hassan Ali Abdul Hussain, CEO of the government-owned Haya Water, told OBG.

To achieve 80% connectivity of properties in Muscat, all network connections need to be completed and available. Treatment plants also need to be ready at the same time and so these two strategic projects are being done in parallel. This approach should minimise the cost and disturbance to local communities, according to Hussain. “Oman is also working on a number of farming programmes with the objective of supplying farms with adequate amounts of water and educating farmers on how to use resources efficiently,” he added.

Outlook

Oman’s unbundling, liberalisation and encouragement of international and private investment in its utilities sector has been a great success thus far, and is more advanced than in most countries in the region. With demand rising strongly from residential and industrial consumption, IWPP, IPP and now IWP projects will continue to roll out. There are some major schemes in the pipeline in various stages of planning and construction. Opportunities for generation continue, and more may also open up in the downstream power sector if the government pushes ahead with liberalisation. This may present some challenges, given the fact that the price regulations in the purchase market, but is far from impossible. In any case, the need to upgrade transmission systems offers opportunities for contractors in that segment – as they do for downstream water construction.

Over the longer term, the potential for renewable resources is expected to increase as the efficiency of the technologies involved improves and further resources become available through economic growth. Solar resources, in particular, are poised to free up some of the sultanate’s natural gas for industry and export. This may be linked to another long-term change that is expected to be introduced incrementally – the reform of electricity subsidies. Renewables and subsidies remain the main factors shaping Omani utilities.