Lower oil prices may force Gulf countries to increasingly rely on independent power producers (IPP) as private sector alone will be responsible for adding more than 20GW of generating capacity in the region over the next five years, according to Arab Petroleum Investment Corporation (Apicorp).
Although IPPs has been beneficial to electricity market in the Gulf region, their growth can "prove distorting and inefficient" in the longer term if not properly managed as IPPs usually sign long PPAs (power purchase agreements) that can range from 20-30 years. But demand growth is slated to slow beyond 2020, resulting in overcapacity and costly obligations to the GCC (Gulf Cooperation Council) governments, it said in a report.
Estimating that GCC power capacity needs to expand at an average annual pace of 8% between 2016 and 2020, Apicorp said to meet rising demand, the GCC will need to invest $85bn to add 69GW of new generating capacity over the next five years. But declining oil revenues mean that GCC governments can no longer continue to support the provision of cheap power - and have looked towards IPPs to play an increasing role in power generation.
Highlighting that the region still relies on single-buyer model where a state-owned entity is the only wholesale purchaser from power-generating companies; it said the current market structure in the GCC has served IPPs well as governments assume most of the risks.
IPPs are usually offered 15 to 25-year PPAs by which the government agrees to buy the electricity at a 'take-it-or-leave-it' basis at a previously agreed price for the duration of the contract, thus mitigating demand-side risk.
Although there are potential implications of over-reliance on IPPs, which represent the majority of new capacity and continue to replace government power plants; Apicorp said, "Going forward, we can discern several benefits to the GCC power sector." IPPs allow investments in power generation without the need for governments to pay the entire upfront cost. Low oil prices mean that cash will not flow easily from governments to state utilities, it said.
Highlighting that IPP projects are usually more cost effective than government power plants, it said contracts under the IPP model are usually awarded to developers who provide the lowest levelised cost of electricity - the price per kWh that represents all fixed and variable costs of a project throughout its lifetime.
Finding that IPP projects are quicker to execute, it said with an additional 69GW that needs to be added in the next five years, projects must be implemented swiftly.
IPPs provide governments with the flexibility to identify projects and capacity needs while leaving developers to execute, it said, adding on average, an IPP takes 3-4 years to be commissioned after tendering.
Unlike government projects that usually face delays due to technical specification changes and conflicting roles of various government entities, "it is in the interest of IPPs to bring on line the project as soon as possible - given that delays translate into higher costs," it said.
While the advent of the IPP model in recent years has been beneficial to the electricity market in the GCC, Apicorp cautioned that the current trajectory of IPP growth can "prove distorting and inefficient" in the longer term if not properly managed.
Highlighting that the GCC governments have limited options in the medium-term and IPPs will continue to be at the forefront of governments' strategies to add generating capacities; it said as they pursue their own paths towards market reform and liberalisation, they need to ensure that the new IPPs fit into the broader picture, and are not just a quick fix to the problem of rising electricity demand.