implementing best practices in electricity sector evolution in saudi arabia prepared by: a.j....

Implementing best practices in electricity Implementing best practices in electricity

sector evolution in Saudi Arabiasector evolution in Saudi Arabia

Prepared by:Prepared by:

A.J. GouldingA.J. Goulding

[email protected]@londoneconomics.com

November 6, 2006November 6, 2006

Riyadh, Saudi ArabiaRiyadh, Saudi Arabia

2

Key messagesKey messages

Restructuring will strengthen the Saudi electricity sector, and Restructuring will strengthen the Saudi electricity sector, and create a set of create a set of vibrant new entitiesvibrant new entities

Saudi Arabia is able to learn from the experiences of other Saudi Arabia is able to learn from the experiences of other jurisdictions, and jurisdictions, and improve upon global best practiceimprove upon global best practice

Tariff design process has been specifically designed to allow Tariff design process has been specifically designed to allow the the maximum degree of flexibilitymaximum degree of flexibility in future market design in future market design

Whatever arrangements are decided upon, they must provide Whatever arrangements are decided upon, they must provide revenue sufficiencyrevenue sufficiency for efficient providers for efficient providers

Overall structure should Overall structure should embody incentivesembody incentives for efficient for efficient production, transportation, and usage of electricityproduction, transportation, and usage of electricity

Suppressing tariffsSuppressing tariffs in the short run inevitably in the short run inevitably leads toleads to even even more more difficult policy choicesdifficult policy choices in the long run in the long run

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Plan of presentationPlan of presentation

Best practices in electricity sector restructuringBest practices in electricity sector restructuring

Creating an independent grid companyCreating an independent grid company

Using a Principal Buyer to provide stabilityUsing a Principal Buyer to provide stability

4

Vertically integrated self regulated monopolies Vertically integrated self regulated monopolies often starting point for restructuringoften starting point for restructuring

Generation

IPP contracting

Retail

Distribution

Transmission

Metering

Billing and settlements

Po

ten

tial

ly c

om

pet

itiv

e se

cto

r

Network O&M

VERTICALLY INTEGRATED MONOPOLY Vertically integrated quasi-self Vertically integrated quasi-self

regulating monopolies were the regulating monopolies were the starting point in many jurisdictions:starting point in many jurisdictions:

ChileChile ColombiaColombia HungaryHungary ItalyItaly PolandPoland RomaniaRomania SingaporeSingapore UK (England and Wales)UK (England and Wales) ……many others…many others…

Often, internal transfer pricing not Often, internal transfer pricing not even established appropriatelyeven established appropriately

5

Strong, independent institutions are at the heart Strong, independent institutions are at the heart of a successful restructuring processof a successful restructuring process

Key success factor checklistKey success factor checklist

Competent regulator with clear Competent regulator with clear mandatemandate

Phased in process of market Phased in process of market openingopening

Multiple gencos createdMultiple gencos created Contract cover stabilizes prices Contract cover stabilizes prices

during transitionduring transition Policymakers able to ride out Policymakers able to ride out

periods of price volatilityperiods of price volatility Performance based rates for Performance based rates for

monopoly elementsmonopoly elements Attention to affiliate abuse issuesAttention to affiliate abuse issues

National National PowerPower

PowerGenPowerGen

British British EnergyEnergy

Central Electricity Central Electricity Generating BoardGenerating Board

Power Power PoolPool

National National GridGrid

Office of Electricity RegulationOffice of Electricity Regulation

55

66

77

88

11

22

33

44

99

1010

1111

1212

GencosGencos Regional wire Regional wire companiescompanies

Case study: initial E&W structureCase study: initial E&W structure

evolved intoevolved into

TransmissionTransmission

Price Price discoverydiscovery

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ChileChile

Saudi Arabia can draw upon twenty years of Saudi Arabia can draw upon twenty years of restructuring experiencerestructuring experience

AlbertaAlberta

AustraliaAustralia

UKUK

1994

Victoria electricity

market established

NSW electricity market

established

NEM begins operation

NSW and Victoria full

retail competition

1996 1998

AER established

2002 2004

1983

Open access to grid

established

Offer established (regulator)

Electricity sector unbundled

NETA replaces power pool

1989

BETTA implemented

2001 2005

Full retail competition

1998

1995

Electricity Utilities Act –deregulation

AEUB (regulator)

created

Retail competition introduced

MSA created

2001 2003

Power pool begins

operation

1978

CNE (regulator) established

New electricity law – sector unbundled

Privatization process begins

Last govt. –owned utility

privatized

1982 1986 1998

CDEC (power pool) created

1996

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Benefits of restructuring arise from several Benefits of restructuring arise from several sourcessources

Innovation in product offerings Innovation in product offerings and deliveryand delivery

Reduced costs and prices of Reduced costs and prices of generation and supplygeneration and supply

Improved resource utilization Improved resource utilization and allocation, through and allocation, through improved economic dispatch improved economic dispatch and generation planning and generation planning (medium- and long-term)(medium- and long-term)

Reduced conflict of interests in Reduced conflict of interests in the regulatory processthe regulatory process

In Singapore, restructuring resulted in a more efficient

use of fuel In 2000, oil accounted for 77%

of generation In 2005 the more efficient

natural gas accounted for 70% of generation output

Resulted in a 5% increase in gross system efficiency

After restructuring, the UK witnessed annual electricity sector productivity gains of

3.5%

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Failures were a result of poor regulatory Failures were a result of poor regulatory decisions, not of marketsdecisions, not of markets

Flaw/Flaw/JurisdictionJurisdiction Insufficient number of Insufficient number of

generators created/generators created/UK, UK, Ontario, Italy, FranceOntario, Italy, France

Prices to final consumers Prices to final consumers held below cost/held below cost/California, California, Ontario, Maryland, ArgentinaOntario, Maryland, Argentina

Transmission not Transmission not independent/independent/most of US, most of US, GermanyGermany

Failure to honor regulatory Failure to honor regulatory contracts/contracts/California, California, ArgentinaArgentina

Cause of most Cause of most accidents: accidents:

• over-power, over-power, • over-brake, and over-brake, and • over-steerover-steer

Policymakers tend to Policymakers tend to forgot the first lessons forgot the first lessons

from Driver’s Ed 101from Driver’s Ed 101

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Independent grid companies are the norm in Independent grid companies are the norm in many well-designed jurisdictionsmany well-designed jurisdictions

JurisdictionJurisdiction Setup dateSetup dateEntityEntity Primary rolePrimary role

Transmission owner & system operatorTransmission owner & system operator

UKUK

SpainSpain

NEDNED

AUSAUS

BCBC

ChileChile

MichiganMichigan

ItalyItaly

19901990

19971997

19981998

19961996

20032003

19931993

20022002

19991999

Transmission ownerTransmission owner







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US shows the drawbacks of failing to force full US shows the drawbacks of failing to force full separation of transmission and generationseparation of transmission and generation

Some companies accused of Some companies accused of deliberate underinvestment deliberate underinvestment in grid so as to prevent in grid so as to prevent access for competing access for competing generationgeneration

Preferential knowledge of Preferential knowledge of planned expansionplanned expansion

Risk that gridco may favor Risk that gridco may favor affiliated gencos for affiliated gencos for connectionsconnections

Constant suspicion that Constant suspicion that transmission capacity transmission capacity reservations riggedreservations rigged

Substantial number of the Substantial number of the transmission challenges have transmission challenges have been in the Southeastern USbeen in the Southeastern US

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Newly formed gridcos may take on a variety of Newly formed gridcos may take on a variety of roles, including system operationsroles, including system operations

Own and maintainOwn and maintain existing transmission existing transmission lineslines

Coordinate flowsCoordinate flows across the entire across the entire transmission system, including lines transmission system, including lines owned and maintained by others owned and maintained by others

Create 10 year generation and Create 10 year generation and transmission system planstransmission system plans, updated , updated annually and with major assumptions annually and with major assumptions examined and revised every five yearsexamined and revised every five years

Provide system accessProvide system access under non- under non-discriminatory, transparent, and discriminatory, transparent, and economically rational tariffeconomically rational tariff

Assist in implementing pilot marketAssist in implementing pilot market and and ultimately spot marketultimately spot market

Coordinate with Principal Buyer regarding Coordinate with Principal Buyer regarding solicitations for new generation and solicitations for new generation and transmission transmission

Process for choosing new transmission providers:

1. 10 yr system plan approved by regulator

2. RFP issued on BOOT basis for new corridors

3. Technical and financial phases to bidding

4. Bids consist of 40 year stream of payments

5. Lowest NPV chosen

6. Some performance standards apply

7. No need to set efficient opex or choose cost of capital

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Gridcos can be established in a one to two year Gridcos can be established in a one to two year period with careful planningperiod with careful planning

Company JurisdictionCircuit miles

No. of Employees

EvolutionTime to

operationsTime to

independenceOwnership

BCTCBritish

Columbia, Canada

11,558 325Carved out of

BC Hydro3 months 2 years State owned

METCMichigan,

US5,400 75

Acquired from CMS Energy

7 months 7 monthsPrivately owned

ElectraNetSouth

Australia3,728 135

Carved out of ETSA Corp

- 2 yearsPrivately owned

RTE France 62,137 8,300Carved out of

EDF- 5 years State owned

ČEPSCzech

Republic2,763 427

Carved out of ČEZ

1 year 6 years State owned Gridco creation process typically occurs in two major phases Gridco creation process typically occurs in two major phases Phase I is the period when the new gridco is granted time for organizational Phase I is the period when the new gridco is granted time for organizational

purposes before it officially takes on transmission operations purposes before it officially takes on transmission operations ~ ~

3 months – 1 year3 months – 1 year

Phase II is the period it takes the institution to become fully independent Phase II is the period it takes the institution to become fully independent ~ ~

7 months – 2 years7 months – 2 years

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Steps to setting up gridco are straightforward, Steps to setting up gridco are straightforward, and may coincide with start of wheeling tariffand may coincide with start of wheeling tariff

Create independent

company

Hire staff to operate system

control room

Physical separation of system control

room

Hire efficient number of staff

from SEC

Transfer assets and staff to

gridco

Identify transmission

assets and their book value

Process 1

Process 2

Step 1

Step 2

Step 3

Calculated as the transmission revenue requirement divided by available Calculated as the transmission revenue requirement divided by available capacitycapacity

Designed so that if all customers were to migrate to wheeling, the entire Designed so that if all customers were to migrate to wheeling, the entire transmission revenue requirement would be recoveredtransmission revenue requirement would be recovered

Increase in wheeling revenue decreases transmission cost of captive loadIncrease in wheeling revenue decreases transmission cost of captive load

Denominated in currency/MW-month and has peak/off-peak differentiationDenominated in currency/MW-month and has peak/off-peak differentiation

Wheeling tariffWheeling tariff

Gridco setupGridco setup

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Principal Buyers focus on sector stability and Principal Buyers focus on sector stability and market developmentmarket development

POSSIBLE PRINCIPAL BUYER KEY RESPONSIBILITIES Serve as counterparty to existing PPAs and new ECAs Procure new generation and transmission through competitive auction

process until market is sufficiently robust Schedule power via gridco to meet captive load Purchase fuel necessary under ECAs Remarket capacity under contract consistent with the schedule for market

opening Promote and implement demand response programs Be the recipient of any subsidies necessary to assure financial viability of

the sector

Principal Buyers often remain in existence Principal Buyers often remain in existence longer than their creators intend, though longer than their creators intend, though sometimes their role becomes simply the sometimes their role becomes simply the management of residual contract obligationsmanagement of residual contract obligations

Principal Buyers we will Principal Buyers we will hear about today: hear about today:

• Ontario Power AuthorityOntario Power Authority• Northern IrelandNorthern Ireland

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Principal Buyer staffing may require unique skill Principal Buyer staffing may require unique skill setssets

Legal establishment

Step 1

Obtain ECRA license

Step 2

Staff hiring

Establish credit arrangement

Step 5

Creation of ECAs Establish flow of funds

Step 6

Step 3

Principal Buyer staff will need to have a fundamental knowledge of Principal Buyer staff will need to have a fundamental knowledge of

economic and financial drivers of the electricity businesseconomic and financial drivers of the electricity business

Staff background to be in finance/trading rather than engineeringStaff background to be in finance/trading rather than engineering

Contract administration and procurement experience will be crucialContract administration and procurement experience will be crucial

Step 4

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Independence and strong credit are essential for Independence and strong credit are essential for a successful Principal Buyera successful Principal Buyer

In nascent markets with history of below cost tariffs, In nascent markets with history of below cost tariffs,

sovereign support may be necessarysovereign support may be necessary

Principal Buyer should still be subordinate to regulator, Principal Buyer should still be subordinate to regulator,

and operate in a transparent fashionand operate in a transparent fashion

Procures according to plan developed by gridco and approved by Procures according to plan developed by gridco and approved by

regulatorregulator

Provided auction competitive contracts incorporated into ratesProvided auction competitive contracts incorporated into rates

Non-contract operating costs subject to periodic scrutinyNon-contract operating costs subject to periodic scrutiny

Government must resist temptation to bypass institutions Government must resist temptation to bypass institutions

once they are createdonce they are created

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Concluding remarksConcluding remarks

Properly done, restructuring can make Properly done, restructuring can make Saudi Arabia a regional Saudi Arabia a regional electricity hubelectricity hub, providing benefits in reliability and pricing , providing benefits in reliability and pricing

Revenue sufficiencyRevenue sufficiency is important component for long run is important component for long run success of restructuring agendasuccess of restructuring agenda

Stakeholder educationStakeholder education and human resource development also and human resource development also essentialessential

Biggest lesson from international experience is that Biggest lesson from international experience is that “big bang” “big bang” approach does not workapproach does not work; process must be deliberative but ; process must be deliberative but steadysteady

At the same time, the alternative of simply throwing more money At the same time, the alternative of simply throwing more money into into existing structure may also be suboptimalexisting structure may also be suboptimal

Over the near term, restructuring effort Over the near term, restructuring effort should not obscure should not obscure focus on reserve marginfocus on reserve margin and investment planning and investment planning

Background on presenterBackground on presenter

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LEI provides global perspective on electricity LEI provides global perspective on electricity sector restructuringsector restructuring

President of LEIPresident of LEI Experience advising regulators Experience advising regulators

worldwide, including Eastern worldwide, including Eastern Europe, North and South Europe, North and South America, and AsiaAmerica, and Asia

Professor at Columbia UniversityProfessor at Columbia University Working with private equity Working with private equity

funds investing in power sector funds investing in power sector assetsassets

Testified as expert before a Testified as expert before a number of legal and regulatory number of legal and regulatory bodiesbodies

A.J.A.J. GouldingGoulding Economic, financial and strategic Economic, financial and strategic advice to the energy and advice to the energy and infrastructure industriesinfrastructure industries

Our Saudi partners at Al Hoshan and Our Saudi partners at Al Hoshan and KFUPM have also made a large and KFUPM have also made a large and valuable contribution to our teamvaluable contribution to our team

Firm is currently in midst of Firm is currently in midst of multimillion dollar engagement to multimillion dollar engagement to design generation procurement design generation procurement process for state of Connecticutprocess for state of Connecticut

Performed Industry Structure Performed Industry Structure Review in AlbertaReview in Alberta

Australian counterpart and team Australian counterpart and team member is former regulatormember is former regulator

Firm’s power sector asset Firm’s power sector asset revenue projections have revenue projections have supported financings for billions supported financings for billions of dollars of investmentof dollars of investment

implementing best practices in electricity sector evolution in saudi arabia prepared by: a.j....

Documents

saudi electricity sector

electricity sector evolution

saudi arabia slide

restructuring generation

prices of generation

process of market opening

benefits of restructuring

regulatory process