GCC’s power generation model needs changes

Independent power projects (IPPs) model in the GCC is vulnerable to long-term aggregate risks, and the structure needs changes to preserve its benefits, according to a study.

Rational choices made at the case-by-case project level have left the IPP model vulnerable to long-term aggregate risks, such as accumulated off-taker liabilities, a potential shortfall of plants capable of providing mid- and peak-load service, and the postponement of fully liberalised electricity markets, said a study by Booz & Company, titled ‘The Future of IPPs in the GCC: New Policies for a Growing and Evolving Electricity Market’.

In recent years, countries in the GCC have increasingly turned to IPPs and independent water and power projects (IWPPs) as alternatives to government-financed power and cogeneration plants.

The basic IPP model is consistent across the region: The amount of power to be sold is stipulated in a power purchase agreement (PPA) at a fixed price, the PPA is guaranteed by a creditworthy off-taker backed by the government, and the price of fuel is fixed by contract. The model eliminates market and fuel risk for the IPP developer, and the remaining risk consists of difficulties the developer might encounter with financing, construction, and operation.

“This modest risk profile permits IPP developers to use limited-recourse, high-leverage project financing schemes, with debt ratios averaging 75 per cent and reaching as high as 85 per cent. Consequently, IPPs have been exposed to the global credit crunch; although there have been recent adjustments to financing terms, they have not fundamentally stopped IPP growth,” said Walid Fayad, Partner, Booz & Company.

However, all progress carries with it inherit risks, the study pointed out. The first and most obvious limitation is inherent in the practice of amortising present investment.

GCC nations are tying up increasing shares of GDP in explicit and implicit IPP/IWPP obligations.

“In the UAE, 0.8 per cent of the country’s GDP is tied up in explicit and implicit IPP/IWPP obligations,” said George Sarraf, Partner, Booz & Company.

A second long-term risk concerns the fact that IPPs are biased toward providing base-load power, which could ultimately leave system planners struggling to meet daily and seasonal fluctuations in demand.

The third risk of IPP dependence is that it can inhibit the natural evolution of the power sector toward increased liberalisation.

However, the study said, GCC governments can counter and even avoid these long-term drawbacks if ministries, regulators, and public utilities act now to introduce some changes to the IPP model.

These changes would be reflected in the regulatory framework and the electricity system plan, as well as in the way IPPs are packaged, tendered, and structured.

These changes consist of introducing IPP liability indicator, encouraging additional buyers, procuring different IPP loads, and building buyout mechanisms, the study said.