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Oman, vibrant and electric

Interview - November 15, 2012
John Cunneen, Executive Director, and Qais Saud al-Zakwani, Deputy Executive Director of Oman's Authority for Electricity Regulation, discuss with United World the current events within the country's electricity sector

2004 was a major milestone in the history of Oman’s electricity sector, when the Royal Decree for the sector’s restructuring was issued, and an independent Authority for Electricity Regulation (AER) was established. How would you describe the process that took place?

For many years, Oman’s electricity sector fell under the jurisdiction of the Ministry of Housing, Electricity and Water, a self-regulated, vertically-integrated entity.

The law promulgated in August 2004 implemented policies that had been approved by the Oman Council of Ministers in 1999 to facilitate a comprehensive restructuring of the electricity sector. Between 1999 and the passing of the law in 2004, a steering committee comprising senior representatives of the major government ministries led preparations to implement what would be far-reaching reforms.

The restructuring was consistent with broader policy objectives articulated in Oman’s Vision 2020. The vision considered where Oman wanted to be in 2020, and what would need to be done to get there. Many policy objectives emerged from that analysis, two are particularly important. First was to diversify economic activity and reduce reliance on hydrocarbon activities. Second was to increase the private sector’s contribution to GDP. The government knew that to meet these objectives, it would be essential for a healthy private sector to have the required utilities and infrastructure to facilitate economic activities within the various industries. For example, to attract private sector investment in industrial/tourism/commercial activities it would be important to ensure investors could be confident of reliable and secure electricity supply.

The government recognized that to meet the 2020 vision, significant investment in new power plants, transmission systems, and distribution systems would be required, but that a vertically integrated, self-regulated Ministry was not a structure that could attract the private sector finance needed to fund the investments needed to take Oman through to 2020. So the government began to look at alternative market structures that would encourage private investment, and ensure that investment was efficiently deployed.

In May 2005, the new market structure implemented by the law was fully corporatized with electricity generation, transmission, distribution and supply undertaken by companies regulated by the newly established AER.  The Ministry was no longer responsible for providing electricity services but retained responsibility for certain areas of policy.

The new market structure operates under a more transparent governance framework including a system of economic regulation administered by AER (the scope of economic regulation includes capital investment approvals and determining the returns investors can expect to earn provided companies perform their activities efficiently and in accordance with stipulated performance standards). 

AER is also responsible for administering a subsidy mechanism through which the government ensures tariffs paid by final consumers of electricity are less than the cost of electricity supply.

Linking the new market structure back to the 2020 vision, I think it is fair to say that the electricity sector reforms emerged from the need to ensure the sector could grow efficiently using resources from both the private sector and the government to meet the Sultanate’s 2020 objectives. 

As to whether the reforms have been successful, I would point to Oman’s very successful I(W)PP program under which more than 5,000MW of new efficient production capacity has been developed using private sector funding. We now have enough capacity to ensure security of supply to the benefit of business and industry, as well as general consumers. It is important to understand the status and role assigned to the “private sector” in the new arrangements: the law grants private sector investors the right to own 100% of a new power station for an initial period (which allows investors complete control of project development risks) with a requirement to offer within three years from COD typically 35% of its shares to Omani investors through the local capital market.

The government has benefited from the electricity reforms in two ways. First, it no longer has to provide capital for new production capacity because all such investments are financed by the private sector. Secondly, the introduction of transparent incentive based regulation and a requirement to conduct fair and transparent competitions for new power stations have driven efficiency improvements and reduced the amount of required subsidy.

How will this new price mechanism affect the existing and potential investors in Oman, considering that the low cost of electricity is one of the main competitive advantages for setting up a business in the Sultanate?

The usual presumption is that electricity costs will go up as a result of the CRT, but this line of thinking might not always be correct and we need to provide more information to make people understand.

During the consultation process, we went to our largest customers and asked them for their daily profiles of electricity demand. They all told us that while they were happy to help, they did not have that information because they felt that they did not need it.

The existing tariff gives no incentives or signals to any large customer about what it costs them to purchase electricity at peak times. It is the same tariff. Our analysis confirms that most electricity subsidy goes to residential customers; large customers are not getting that much subsidy. The question is: would taking them out of subsidy increase their costs? Not necessarily, provided that we give them a replacement tariff and price signals (which gives them the hourly cost of electricity). This gives the customer enough information to manage their consumption (i.e., if they can switch their demand, they can reduce their cost). The consequent reduction of peak demand would mean that we could build less capacity in the future. There are mutually reinforcing concepts here. Our model suggests a reduction of electricity bills for a number of customers (provided we give these customers a tariff signal to help them manage their demand to lower cost periods). We do not presume that costs will necessarily go up. Of course, it goes without saying that if we take them out of subsidy (if we, for example introduce economic gas costs), this would go straight through to customers, and they will face higher costs. However, what one person calls higher costs, we see as an incentive for people to use electricity more efficiently. They can reduce costs by looking at their cost management, and giving their usage efficiency more consideration.

Consumers, and particularly the large ones, need to make a contribution. If they want their electricity bills to be as low as they can be, they have to work a little bit harder on how they design their systems in terms of efficiency. I see significant scope for cost reduction for large customers, provided we get the tariffs right. We are working towards the implementation of the CRT. Hopefully, next year, will see the first tariffs introduced for large customers.

One of the benefits of having a regulator under the new structure is that we are required, by law, to calculate subsidy and present it annually to the government. That is our job. We have to explain how we have arrived at a certain figure. Before 2005, the government did not know how much of electricity was subsidized. This is not just in Oman. Before Abu Dhabi implemented their market reforms in 2002, they did not know either. The Oman government provided money to Ministries, with little reconciliation with revenue. 

All this has changed under the new arrangements. As the level of subsidy is now very clear, we can ask the government about their subsidy objectives. If the objective is to give low income citizens as much subsidy support as possible (to help them live in a difficult environment), then let us do that. We can then stop leaking subsidy support to customers who neither need it nor want it.

I recently met American lawyers who were pursuing an action against Oman on behalf of American steel producers who claim that Oman steel producers benefit from subsidized electricity prices. Our view has always been that we should not subsidize electricity prices to industrial and commercial customers. It is inefficient and does not produce long-standing benefits. There are other ways to help them. I found it very helpful to be able to explain Oman’s position that there are no special subsidies for individual companies here, and we are moving towards removing all subsidies from large consumers.

It is also worth noting that during the consultation process when we were contemplating introducing CRT to industrial and commercial consumers, the response was to include the government, so that they would also be incentivized to use energy more efficiently. It is important to point out that it was the government who proposed this.

: People are looking at the magnitude of subsidy. They can look at the growth in electricity supply and see how as the level of subsidy goes up with demand subsidy per kWh is going down because we are getting more efficient output. The key question now is: is this a sustainable model? Can we just keep chasing demand and subsidizing tariffs?

You are currently working on introducing new power supply companies across Oman in order to improve customer service in the sector. How will increased competition benefit the customers?

MR. J. CUNNEEN: If you look at the structure of electricity markets around the world, depending on their size, getting competition in generation is pretty much a straightforward matter. In Oman, we have competition to enter the market, but we do not have competition in the market for generation because the market is too small. Had the market been big enough, we could have had competition. That is the way certain American states and European markets are—they immediately have competition in generation.

Transmission and distribution are described as having characteristics of natural monopoly. You do not want competition in building transmission systems. You want one transmission system that is regulated. However, in a large enough market, there is no reason why you should not have competition in supply. In Oman, however, the market is relatively small. As such, we have decided to introduce competition in supply that would follow the models that I have referred to earlier. As you know, when they introduced supply competition, they did not suddenly allow competition for all supply.

They set franchise market limits on supply competition (specifically, the limit above which you can, and below which you cannot choose a different electricity supplier). Over time, they gradually opened the full market to competition. We want to follow a similar approach and send a strong message to existing suppliers. We are looking to induce other people in the market to respond to the needs of customers—not just through purchasing their own electricity supply (for which there is little scope for alternative costs), but in the services they offer to customers (which has significant scope for improvement). Some companies here tend to view customers as captive monopoly customers.

Our strategy has been to work to introduce competition in supply. If we are not satisfied by the manner in which companies meet customer requirements (in terms of timely meter readings, comprehensive billing statements, advance notices for outages/maintenance work, recommending ways on how to reduce and optimize electricity consumption, etc.), we will find companies that will work harder to do so. We have been preparing for this for 5 years. My view is that we are about 2 years away from it. 

Companies have now woken up to what we call a “contestable threat”. While there is no competition in the market, there are people, ready to come in to the market. This is starting to change the behavior and performance of existing suppliers. I am very happy about that. For very specific reasons, we still have some way to go in terms of getting companies to interact with their customers (at the interface). I believe we are about 2 years away from completely addressing these issues and allowing supply competition.

From your experience of working in this part of the world, what advice would you give to an investor looking to set up his business in Oman?

I would expect any entrepreneur contemplating an investment in the region to undertake due diligence. People tend to view the GCC as a homogenous territory, but there are important cultural, social, and economic differences in each country, and all these have a bearing on the expected performance of a business.

It seems to me that people can be seduced by a particular country thinking that its large size makes it a fantastic potential market. They forget important criteria for market entry, such as the transparency of the legal framework, investor rights and protection, how a country has addressed existing challenges, how they define private investment, etc. These are issues to look at under due diligence. If you look at these things, you will see differences across the region. It would be for investors to decide whether they value transparency, a track record of enforcing property rights, or some other generally desirable attribute: the degree of risk aversion will also be important.
It is a simple matter of due diligence. Investors can assess countries such as Oman by looking at the electricity sector’s legal framework, or its track record. AER would be happy to provide all of our reports since 2005. That would tell investors about subsidy.

These are real tests that anybody who is seriously contemplating an investment in this region would look into—tests that determine whether a region or a country offers the conditions necessary to attract investment.

I would add that Oman has signed an international agreement that provides for the enforceability of international arbitration decisions (wherever they take place in the world). I do not think any other country in the region has done that. You have to look at the laws in every single country, recognize the heterogeneity of each country, and make your decisions accordingly.

What specific areas would you like to highlight for private sector participation?

A category for private sector participation is direct investment (which, at the moment, is restricted to the generating sector). We are talking about new power plants—be they conventional, fossil fuel-based, or renewable. One of the up-and-coming segments is renewable energy. We are really pushing the government to consider this. Rather like our IPP model, we believe renewable energy projects should be based on strong competition, and open to international investors.

As you know, this sector has grown out of companies unbundled from the Ministry in 2004. It has gone a long way since then. Our 2011 Annual Report reflects how the electricity sector has grown into a substantial corporate sector. Other than the IPPs, none of the transmission, supply, and procurement companies are quoted in the Muscat Securities Market (MSM). This means that they do not have the same visibility.

If we placed electricity companies in the MSM, 5 of our companies would go straight into the top 20. Because we have independent companies and not divisions under the Ministry, they require commercial and utility management expertise. They are growing fast and require skills to sustain growth. We are starting to consider partnerships with private sector utilities and companies—groups that can bring large corporate experience to Oman. Electricity companies are businesses that go beyond engineering functions. They need the skillsets that any good business needs. We need expertise to help us grow: we doubled in size in 7 years. Last year, supply was 94% higher than it was in 2005. That is an astonishing feat. The skills required to maintain efficiency, keep pace, and connect the power stations and the transmission systems to the distribution systems are significant. We need to look into how Omani companies can tap into international management and expertise. Right now, we are discussing this with the CEO of the Electricity Holding Company (EHC). We believe keeping pace with skillsets and expertise is one of the main challenges facing the sector.