Oman's electricity regulator extends market reforms

For the Omani power sector, 2015 was a year to look back and take stock. In the 10 years since market reforms were introduced, the industry has witnessed a 164% increase in supply and a 75% increase in the number of accounts.

Expansion on such an unprecedented scale is, according to the Authority for Electricity Regulation (AER), a testament to the transformative effect of the market structures introduced by the 2004 Law for the Regulation and Privatisation of Electricity and Related Water Sector (also known as the Sector Law), which has enabled producers to keep pace with a rapid growth in demand. Now, as the sector reaches greater maturity in terms of capacity, the regulatory focus is beginning to shift, with authorities increasingly looking to improve price efficiency and increase market competition as a way to ensure the security and sustainability of Oman’s electricity supply going forward.

Structure 

Reforms introduced through the Sector Law have thus far succeeded in unbundling Oman’s previously state-run power industry into a partially marketised four-tier system. Within the main interconnected system (MIS), independent producers sell power to the Oman Power and Water Procurement Company (OPWP). Transmission is handled by the Oman Electricity Transmission Company (OETC), while distribution and supply is divided among three companies: the Muscat Electricity Distribution Company (MEDC), and the Majan and Mazoon electricity companies.

The primary element of competition within this structure is in the market for power generation, with would-be producers competing to secure power purchase agreements (PPAs) with the OPWP for a 15-year period and water purchase agreements for 20-year periods. As a result, the majority of power plants in Oman are now in private hands, with the remaining government-owned facilities held at arm’s length through the Electricity Holding Company (EHC) until decommissioning.

Transactions between the other tiers of the system (i.e., between the distributors and the OPWP and OETC) are regulated by the AER through price controls on a cost-reflective basis (i.e., not involving a direct subsidy). Instead, direct subsidies are channelled to the sector via distribution companies according to the difference between the cost of providing electricity (which varies according to the price controls established by the AER), and the official permitted tariff, which is the amount the distributors may charge consumers per KWh, and which is set by the Council of Ministers. This latter figure has remained unchanged for over 20 years.

The complexities of the present structure reflect both the transitional nature of current arrangements (with the sector having moved from total state ownership toward increasing degrees of liberalisation on the supply side), as well as the government’s continuing policy of maintaining a heavily subsidised tariff for end consumers. Two new policies, however, are set to significantly expand market reforms on both the production and consumption sides.

New Tariffs 

The first significant reform is the possible introduction of cost-reflective tariffs (CRTs) among new large-scale consumers ( typically industrial, government and commercial customers). The introduction of CRTs will remove the subsidy entitlement from these large consumers and ensure that the price they pay for electricity better reflects the cost of production at a given time of the day or year. According to the AER, CRTs will thus provide an incentive for large consumers to better manage their demand and will reduce consumption during peak hours.

Speaking to OBG, Hassan Taqi, director of economic and financial affairs at the AER, emphasised that CRTs represent a “significant step” in advancing market reforms in the energy sector. “We strongly believe that CRTs will give consumers an incentive to manage their consumption away from peak periods,” he said. “They are a significant step toward rebalancing tariffs that are currently significantly lower than the cost of production.” CRTs are expected to be introduced following a phased approach, with new large customers being required to use a CRT from January 1, 2016, and existing customers moving over a year later. It should be emphasised, however, that CRTs will not affect residential customers, who currently account for the large majority of subsidies.

Spot Market

The second reform currently under consideration relates to the production end of the market. As the final government-owned power plants reach the end of their life cycle, by 2018 the OPWP is looking into shifting from PPAs to a spot market for wholesale electricity purchasing. There would be several benefits to such a shift. First, providing existing producers with the option of shifting to a spot market once current PPAs expire could unlock some not currently contracted-for additional capacity within plants. This would provide an “easy win” for increasing production capacity in a market that continues to see strong growth in demand.

Secondly, establishing a spot market could drive down the price of future PPAs, by providing the OPWP with a benchmark against which to negotiate, leading to possible negative consequences. In this respect, a spot market could also drive down wholesale prices more generally by introducing competition in, and not merely for, the production market. The AER is keen to emphasise, however, that regardless of any eventual decision taken regarding a spot market, all existing contracts relating to PPAs will continue to be honoured.

Both of these reform measures are in line with current general trends in the Omani energy sector, which seems to be moving not only towards the introduction of greater liberalisation, but also towards a pricing system which better reflects the opportunity costs involved in the different uses toward which hydrocarbons may be put. For instance, the doubling of the wholesale price for natural gas from $1.50 per million British thermal unit (Btu) to $3 per million Btu on January 1 2015 resulted in a significant increase in the total system cost for electricity generation, which by necessity was absorbed via a significant increase in the direct subsidy to the sector.

Primarily as a result of the increasing gas price, the power sector subsidy is expected to rise by 56% in 2015 to OR448.3m ($1.16bn). However, as Taqi is quick to point out, this subsidy was always present indirectly within the sector, in terms of the loss in higher value uses (such as liquefied natural gas export) to which such gas could otherwise be put. “This new price is now better aligned with the opportunity cost of using gas in Oman,” Taqi told OBG. “It therefore better reflects a subsidy to the electricity sector that was always present.”

Indeed, before the gas increase the subsidy per unit in Oman, OR0.025 ($0.064), remained practically the same in 2014 as it was in 2006 (although this figure did fluctuate marginally within that period). The greater transparency afforded by a more realistic gas price thus helps to measure the true economic cost of subsidised hydrocarbons, and also brings alternatives such as renewables into play on a direct cost comparison basis.

Liberalisation

As well as these measures, the Sector Law calls for the AER to provide an annual assessment of the readiness of the market for further liberalisation according to four categories: privatisation of government holdings in the sector; the introduction of competition in procurement; liberalisation of import/export capacity; and the creation of supply competition.

As it currently stands, the AER assesses the Omani market as being unready for further liberalisation in the first and third categories, although Oman’s accession to the GCC Interconnection Authority in 2014 provides at least for the technical possibility of future import/export liberalisation further down the line.

In the fourth category the AER has judged the market ready for liberalisation, although a consultation must be conducted before the AER can submit proposals to government. Rather, it is in the second category – the introduction of competition in procurement – that the next significant liberalisation measures look set to take place.

According to the AER’s 2014 report on energy and privatisation, at the request of the Public Authority for Electricity and Water, the EHC are undertaking a strategic study for the privatisation of the Muscat Electricity Distribution Company.