Saudi power, water sectors occupy center stage

While water and power generation projects are a top priority for the Saudi government, the utilities sector has suffered from insufficient investments by the public and private sectors in the past decade. This will need to be rectified in the coming years simply to complement domestic demand for utilities growing at a rate of around 8 percent per year.

According to Banque Saudi Fransi estimate Saudi Arabia's power and water sector will require at least SR1 trillion of investments through to 2025 to build capacity at a pace that caters to a population that has grown around 2.5 percent per year in recent years and is likely to continue expanding about 2 percent annually over the next decade. Power demand is rising due to the Kingdom's burgeoning industrial base, which has grown in size by more than a fifth since 2005. By the end of 2008, 4,167 factories were operating in the Kingdom employing 466,661 people, up 7 percent from the year earlier.

But the government, sitting on a comfortable cushion of surplus foreign assets, should not be expected to foot the bill on its own; private sector partners must play a major role in the process of building Saudi Arabia's utilities infrastructure through the formation of strategic public-private partnerships.

In the 2010 fiscal budget, Saudi Arabia boosted the allocation for the water, agriculture and infrastructure sector by 30 percent to SR46 billion, accounting for 8.5 percent of the total budget. It specified that this spending would go toward new projects designed to enhance water resources, build dams and wells, improve water and sewerage networks, and develop and upgrade water desalination plants.

While these steps are laudable, the urgency of designing new and improving existing municipal sewerage systems became evident in November 2009, when mass floods and sewage leaks in the Red Sea port city of Jeddah killed more than 120 people, and damaged thousands of homes and vehicles.

In the next 15 years, Saudi Arabia's Ministry of Water and Electricity expects some SR300 billion will have to be invested in electricity generation, another SR200 billion into water desalination projects and SR200 billion in the sewerage sector. In our perspective, this SR700 billion is certainly a step in the right direction - but at least a third more in funding would be required to bolster capacity in a way that comfortably cushions demand.

While peak power demand jumped almost 85 percent between 1998 and 2008, the Kingdom's electricity generation capacity expanded by a lower 70 percent. Water resources have also been strained, with available water per capita dwindling by almost a quarter in the past decade, coinciding with greater industrial, agricultural and personal use.

But transforming the power and water sector is not purely a matter of throwing funds at capacity-enhancing projects; the Kingdom's utilities sectors also require reform. A substantial 88 percent of total water consumption in the Kingdom is exploited in agriculture, according to the Saudi Arabian Monetary Agency's (SAMA's) last annual report. This policy has depleted non-renewable groundwater resources since the 1980s.

Considering changes to the tariff scheme to promote more responsible use of resources is one avenue that can be pursued. Low tariffs on power and water for personal and commercial use, as well as distorted incentives, have encouraged over-consumption and wastage by industries and individuals. These realities are no longer sustainable and efforts to rationalize power and water use must speed up.

Only by implementing a holistic approach that includes public-private partnerships can Saudi Arabia hope to sustain a balanced level of power and water supply and demand. Private sector participation has been put to the test during the global financial crisis, which choked access to bank credit lines and placed hurdles before the public-private financing model. While the bank regards this as a temporary phenomenon, mobilization of state funds has nonetheless been forced to plug the gap.

The state's aggressive spending program has provided a backdrop for private sector momentum, but private firms need to regain their place and pick up some of the slack in financing projects. Surplus state funds should not be viewed as ad infinitum.

Dwindling resources

That Saudi Arabia's water and power sectors need urgent and drastic improvements is crystal clear. Per-capita availability of renewable water resources in the Kingdom deteriorated quickly over the past two decades as high population growth rates and galloping consumption by the industrial and agriculture sectors stressed domestic resources.

Between 1980 and 2006, Saudi Arabia's pursuit of desert agriculture tripled the volume of water used for irrigation to about 21 cubic kilometers, according to Food and Agriculture Organization (FAO) estimates. Despite having sparse renewable water resources, Saudi Arabia paradoxically developed itself into a global exporter of wheat and dairy products, effectively exporting water. By contrast, other global wheat exporters rely on rain water to harvest their crops, not non-renewable groundwater.

This imprudent policy was not without consequences. Per-capita water resources in the Kingdom fell by almost a third between 1992 and 2008, FAO data show. Total surface water and groundwater withdrawal represented 936 percent of the total renewable water resources as of 2006, the body said. Water withdrawal is an indicator of the pressure on renewable water resources, and signals the country's ability to rely on its own renewable water sources.

The FAO considers pressure on water resources to be high when the value is above 25 percent, with ratios of more than 100 percent indicating that non-conventional water sources are being drawn on to supplement internal renewable resources. By comparison, the water withdrawal ratio for water-rich Canada is 1.58 percent, while in hyper-arid UAE, the ratio is a massive 1867 percent, FAO data show.

Even by regional standards, Saudi Arabia and neighboring Gulf oil exporters are home to among the lowest renewable water resources. At 95.23 cubic meters per person per year, Saudi Arabia's renewable water resources are less than a seventh the size of Egypt's and less than a tenth of the size of Lebanon's. With rapid population growth, the Middle East-North Africa region could witness a sharp 50 percent drop in per-capita water availability by 2050, according to World Bank estimates, possibly leading to more-frequent droughts across the region.

The groundwater resources that Saudi Arabia does have, drawn from deep aquifers, are being depleted rapidly, with some estimates suggesting these may not last more than 25 years. According to a study released by the US-Saudi business council in October last year, 80 percent of Saudi Arabia's water supply comes from underground water, 14 percent from renewable surface water and 6 percent from desalination of sea water.

The FAO's Aquastat database shows Saudi Arabia's proven water reserves amount to 338 cubic kilometers, with probable secondary reserves of 500 cubic kilometers. Groundwater resources are centered in six old-age aquifers in the eastern and central parts of the country which have a natural recharge of only about 3.5 million cubic meters per day, it said.

The strain on Saudi Arabia's electricity grid has also become greatly evident with high economic growth rates this past decade. At 37,152 megawatts of peak load in 2008, the Saudi electricity system is the largest in the Arab world. State-owned Saudi Electricity Co. (SEC) currently has a monopoly over electricity distribution to consumers. In 2008, the company delivered a total of 181,089 gigawatt hours (GWh) of energy to local customers, up 6.7 percent from the prior year.

The number of consumers in 2008 rose 4.6 percent to 5.42 million - having jumped almost 61 percent between 1999 and 2008, and SEC expects another 20 percent rise by end-2012. Energy sales over the same time frame have soared 66 percent to 181,098 GWh, while peak demand grew upwards of 70 percent to 37.152 GW in 2008, according to data of the Electricity and Cogeneration Regulatory Authority (ERCA), the body responsible for regulating the Kingdom's electricity and water desalination industries. Power demand will continue to grow rapidly in the coming decade as demand increases for industries and households alike. In 2008, residential users accounted for 53.4 percent of total power consumption, followed by industry at 17.9 percent, government at 13.4 percent and commercial enterprises at 11.6 percent, according to ERCA. The population, meanwhile, is poised to reach almost 32 million by 2020, the bank estimates show, placing further strain on electricity supplies.

Firing on all cylinders

Given pure demand prospects in the coming decade, it is no wonder a great deal of emphasis is being focused on ways to augment water supplies now, as well as upgrade existing infrastructure. The Saudi government, in its current five-year plan spanning 2009 - 2013, has committed to keeping public spending high predominately to develop infrastructure. The allocation for water, agriculture and infrastructure in the 2010 budget is more than double 2005 levels, while its ratio to total spending has risen to 8.5 percent from 6.9 percent over the period.

The urgency of building new and improving existing municipal sewerage systems became evident after November's Jeddah floods, which brought to light the necessity to improve utilities infrastructure. The lack of an adequate underground sewage system was a factor behind the deaths and destruction that occurred. Custodian of the Two Holy Mosques King Abdullah ordered an investigation into management of Jeddah's sewage system and some have called for the construction of three dams linked to rainwater drainage canals to prevent flooding in Jeddah's eastern districts.

It is difficult to estimate the amount of funds that will be needed to rectify the situation in Jeddah. Prior to the floods, the second-largest Saudi city announced a SR170 billion development plan in 2009 to modernize itself into a trade and tourism center.

In 2009, some 73 percent of spending on water-related projects by the National Water Co. (NWC) occurred in Jeddah. Water production projects valued at SR18.8 billion were pursued in 2009, according to NWC data, including 30 projects in Jeddah and 115 projects in Riyadh. Of these projects, about 70 percent were in the wastewater segment, including 90 projects costing SR13.2 billion. For 2010, NWC expects another SR7 billion of new projects in water production would be launched.

In late December, NWC tendered management, operation and maintenance contracts for the water and wastewater sector in the cities of Makkah, Taif, Madinah and Dammam, with bidding for these public-private contracts expected by the end of the first quarter. Under the schemes, the private sector partner would oversee the development, management, operation and maintenance of water and wastewater systems, as well as develop services, collect revenues, reduce leakages and train employees.

Water storage projects are also on the agenda for Jeddah, which suffers from frequent power outages in the summer months when use of air conditioners hits a peak. The two projects would add six million square meters of storage capacity at two locations, according to NWC documents. Other projects underway involve expansion of Buwaib and Salbukh water purification plants north and east of Riyadh.

Much of the spending on power sector expansion, meanwhile, falls within the domain of state-run utility SEC, which expects to bring more than 30,000 megawatts (MW) of power generation capacity on stream by 2016 for projects it is undertaking on its own and with private sector partners.

Power production is set to surge 83.1 percent by 2020 compared with 2009, to 75,155 megawatts, SEC predicted in its 2008 annual report. Peak power demand, according to ERCA estimates, is set to reach more than 59 gigawatts (GW) in 2022, a jump of 59 percent from that recorded in 2008. That would represent a near tripling of power demand over the quarter-century to 2022. ERCA expects funding requirements for new expansion projects for power generation, transmission and distribution to top SR338 billion to 2020.

This may not be enough. Even after all of this investment, electricity reserve margins seem unlikely to improve markedly.

Saudi Arabia is also constructing the first solar-powered water desalination plant as part of plans to introduce solar energy. But such efforts will have little meaningful change in the country, which will continue to rely on rich fossil fuel reserves as feedstock for power and industrial sectors.

Saudi Arabia has, meanwhile, experienced challenges in securing enough gas feedstock for the electricity and petrochemical industries, which are growing rapidly. To bridge this divide, the government has launched plans to develop gas production specifically to meet domestic gas demand growing about 7 percent per year. Saudi Aramco, which has raised oil output capacity to 12.5 million barrels per day, is looking to boost gas supplies by 30 percent, to 8 billion cubic feet per day in five years.

Inefficiencies

As the government and investors pursue some projects to build up capacity, other initiatives must focus on improving existing infrastructure to reduce wastage. Due to the lack of freshwater resources, a great deal of water travels through pipelines spanning more than 4,000 kilometers. An average of 20 percent-25 percent of the Kingdom's water is wasted due to leakages resulting from old, outdated infrastructure.

A low-tariff environment, with water charges of just SR0.10 per square meter, doesn't help conservation efforts and it is widely expected that this tariff would be revised sharply upward in the years to come. Some are forecasting that plans are underway to increase the water tariff to as much as SR5 per cubic meter.

Saudi Arabia is trying to boost energy efficiency but this requires a great deal of work. Consumers and producers must undergo a change of mindset, while price incentives need restructuring in order to provide appropriate market signals. Done properly, consumers would adjust their behavior according to price incentives and become more energy conscious as prices gradually increase.

Charging more for water resources will undoubtedly support greater rationalization of water use by individuals and industries. The greatest burden on Saudi water resources has been the agriculture sector, which has used non-renewable water resources to produce wheat and milk domestically that could have been more prudent to import. Food self-sufficiency in desert climates is not an easy option, although agriculture can exist with prudent water management and the use of green houses and desert irrigation technologies.

The Kingdom began a process of phasing out wheat cultivation in 2008, and now expects to import 3 million tons of wheat per year up to 2016. Under the plan, the Kingdom intends to reduce domestic wheat production by 12.5 percent per year to conserve water, relying entirely on imports by 2016. In January, the advisory Shoura Council recommended banning dairy exports to conserve water.

"Due to the government's awareness of the scarcity of water, the Ministry of Agriculture implemented several measures to encourage farmers to apply irrigation water-saving techniques," the FAO said on Saudi Arabia's drastic agriculture reforms. "Furthermore, some of the subsidies and support programs that contributed to the depletion of groundwater resources in agriculture have been discontinued or revised," FAO said.

The decision to phase out wheat production by 2016 is a welcome step, but the government must be mindful that

inefficiencies in water usage can continue without adequate follow-up policies. With the decline in wheat production there has been a noticeable rise in harvesting of summer crops and alfalfa, which can use up to 16 times more water to cultivate than wheat does.

Low tariffs have also exacerbated power demand in the Kingdom. Saudi Arabia has not changed the electricity tariff it charges since 2000. According to the US Department of Energy's Energy Information Administration, Saudi Arabia's rapidly growing population and industrial base accounting for 60 percent of demand, have led to growth rates for electricity of 5 - 7 percent per year. Between 2005 - 2008, ERCA data show peak power demand climbed an average 7.5 percent per year.

Greater private sector participation in the Saudi utilities sector is increasing pressure on the government to gradually introduce market-based tariffs and enhance conservation efforts - although both will take time to introduce due to the sensitive nature of subsidizing tariffs.

Achieving energy efficiency would also ease the burden of domestic energy consumption, which has risen rapidly in recent years, leaving the world's top oil exporter with lower quantities oil to sell abroad. Energy demand in Saudi Arabia is poised to rise 130,000 barrels per day to 2.76 million bpd in 2010, a level comparable with Brazil and Russia, according to the International Energy Agency's January Oil Market Report. Between 2007 and the end of 2010, domestic oil demand would have risen 27.2 percent, higher than the Middle East average of 15.6 percent and Asia's average of 12.2 percent, IEA data show.

Power play

The private sector's participation in the power and water segment has taken the form of independent power projects (IPPs) and independent water and power projects (IWPPs). Under such schemes, private sector companies develop power and water projects on a build-own-operate or build-own-operate-transfer basis.

Saudi Arabia has aimed to attract private sector investment for up to 60 percent equity in IWPP projects, with the remainder split between Public Investment Fund (PIF) and SEC, according to IEA estimates. In 2004, the government announced plans to launch 10 IWPPs by 2016, at a total cost of around SR60 billion.

Four of the original projects were envisioned to achieve more than 7,000 MW (at final capacity) of power and 600 million gallons of water daily. They would boost the total desalination capacity of the kingdom by 80 percent when they come fully online. Regarded as the world's largest IWPP, the Marafiq complex at Jubail is poised to be home to a 900-kilometre transmission system that will pump nearly 4 million cubic meters per day of water from Jubail Industrial City to the Saudi capital, Riyadh.

Saudi Electricity, for its part, has encouraged the private sector to invest in projects for electric power production. It is working on eight main power plant projects, including three in the eastern region, one in Riyadh, two in the western region, one in the southern region and one in the northwest.

Some of the expansion projects will be undertaken solely by SEC and others as joint ventures between the state-run firm and private sector partners. About three power plants expansion projects are due for completion during 2009 - 2010 adding 11201 MW of capacity, according to SEC's 2008 annual report. Another 9055 MW would come on stream in 2011 - 2012, 7190 MW in 2014 and 10,800 MW in 2015 and 2016. In January, a consortium led by Japan's Marubeni Corp. proposed the lowest tariff to build a 2,000- megawatt power plant in Riyadh for SEC.

For many projects, the company is seeking private partners on a long-term build-own-operate (BOO) basis. In the first phase of expansion, including the Rabigh power plant in the west, among others, the company anticipates investments topping SR25 billion.

The state's burden

For the time being, however, the financing onus will fall on state shoulders. Bank credit has all but stagnated in the past year due to a combination of risk aversion among banks and deleveraging among private sector entities. As a result, to keep projects moving forward, the state has needed to dominate project financing.

The global economic downturn has, thus, called into question the IWPP model due to deterioration in the availability of project financing. It seems probable that the government has been compelled to change some projects to engineering, procurement and construction contracts as a result of the turn of events.

This is what happened with the Ras Azzour power and water project, which the state's Saline Water Conversion Corp. (SWCC) re-tendered after changing the classification such that it is not an independent project. SWCC - which is in the process of being privatized - will review bids this year for the plant, projected to have the capacity to generate 2,400 megawatts of electricity and produce 1,025 million cubic meters of desalinated water per day when it is completed at the end of 2013.

The bank believes this trend will be a temporary fix to the situation, and that private sector involvement will need to be reemphasized once credit conditions improve and the private sector's appetite for projects is rejuvenated. Subdued credit conditions continued in January, with bank claims on the private sector climbing 0.2 percent from December to SR735.63 billion, a year-on-year gain of just 0.7 percent.

In our view, credit to utilities projects will continue to flow, as the sector will be one of the first to recover from the downturn. Saudi bank credit to the electricity, water and utilities sectors witnessed the most robust turnaround among other economic sectors after the second quarter of 2009, according to SAMA data. As total credit declined 1.8 percent in 2009, credit to electricity, water and utilities jumped 26 percent, although it accounted for only 1.8 percent of total outstanding loans.

Undoubtedly, however, keeping these crucial projects on track will demand greater involvement of state funds, whether those allocated in the state budget or granted as loans from the various state-run funds - including the Public Investment Fund and the Saudi Industrial Development Fund - that are working to keep infrastructure projects from languishing.

SAMA held SR1.54 trillion in foreign assets as of the end of January, up 1 percent from the month earlier, due to a continuation of solid oil price levels, which enabled the central bank to replenish its rich foreign asset pool after drawing it down in early 2009 to finance its budget.

Engaging the private sector by giving companies control of electricity distribution in specific areas and expediting the privatization of state entities such as SWCC should regain prominence once business conditions return to normal in the coming quarters, and more fully in 2011.

— John Sfakianakis is group general manager and chief economist at Banque Saudi Fransi, Riyadh