Wednesday, 16 November 2016

Egypt’s power sector: on the right track?



With demand outstripping capacity additions, Egypt’s government urgently needs to bring new power

projects on line to fill the gap. But there are serious financing challenges. In order to overcome them, the

government has been pursuing an aggressive reform agenda aimed at restructuring the power sector and

removing subsidies. The government’s objective is to attract Independent Power Producers (IPPs) to revive

the industry. The failure to do so will mean that power outages will persist.

Egypt’s electricity consumption has been rising at an annual

rate of 5.6% in the past ten years. Driving this growth is a rising

population, improving income levels, industrialisation, but also

subsidised electricity prices. Egypt’s estimated capacity of

34GW is not sufficient to meet this rising demand, and power

outages are frequent – especially in summer months – when

people can experience blackouts more than three times a day.

The country has ambitious plans to invest and increase its

capacity in the medium term. Our estimates suggest that Egypt

will need to invest $28bn in power generation and a further

$15bn in transmission and distribution (T&D). This would

increase capacity in MENA’s most populous country by

approximately 20GW to reach 54GW in 2020.

To address the acute power shortage, the country has

ambitious plans to diversify its power generation mix – currently

dominated by gas-fired power plants – by introducing nuclear

and coal plants. Renewable energy will also be at the forefront

of Cairo’s efforts, with 4.3GW of wind and solar targeted by

2020. However, an ailing economy, and significant political

uncertainty will make investors wary. Financing challenges

remain the government’s biggest obstacle, with a weakening

currency and tightening financing terms from international

banks. It is therefore imperative that the government pushes

ahead with the market and price reforms that it has announced.

The country has relied on the state utility - the Egyptian

Electricity Holding Company (EEHC) - to increase capacity, with

the private sector responsible for only 10% of generating assets.

This has to change, and moving forward, IPPs will be key to the

future of Egypt’s power sector.

Ambitious plans

In 2015, Egypt announced plans to invest $43bn in the power

sector over the medium term. The country suffers from a

shortage of gas, typically prioritised for power generation. But

the discovery of the giant Al-Zohr field, coupled with BP’s West

Nile Delta upstream developments and several LNG import

contracts should improve gas supply. Meanwhile, Orascom and

Siemens are currently constructing three 4.8GW combined-
cycle gas-power plants, which will be among the largest in the

world. The three mega-projects will represent 75% of the 20GW

of projects under development and are expected to come on

line between now and 2020. Overall, gas-fired power plants

represent nearly 19GW of the 20GW of projects under

development.

In terms of renewables, the country announced plans to develop

2.5GW of wind, 1.7GW photovoltaic (PV), and 100MW of

Concentrated Solar Power (CSP) capacity by 2020, but has

been struggling to kick-start the programme. In the short term,

the country will add nearly 400MW of wind capacity in Gebel El

Zeit – expected on line in 2017. Overall, 20GW of generation

capacity is in execution and ready for commissioning by the end

of the decade, still leaving Egypt a little short of what is required

for the period 2016-20.

Beyond the medium term, Egypt has signed memoranda of

understanding with several companies for the construction of

four coal plants with a combined capacity of 12GW. However,

no investment decisions are expected until the end of the

decade. Nuclear is also part of the diversification strategy, with

preliminary agreements between Egypt and Russia in place to

build four 1.2GW reactors. The deal involves a Russian loan of

$25bn to cover 85% of the cost of the project, while the

Egyptian government will fund the remaining. Although a flurry

of optimism surrounded Egyptian nuclear plans, many financial,

political, and regulatory obstacles still need to be addressed

before any concrete progress is made. This will leave coal and

gas as the main components of new capacity beyond 2020.

The financing debacle

Financing remains the biggest threat to the government’s plans

to increase capacity in power generation. Investments and

capacity additions have long been the responsibility of the

Egyptian government, but increasing demand and low

government revenues have meant that the country has not been

able to build capacity in time to meet rising demand.

Consequently, the government is having to look abroad to

provide the necessary financing.

Although there is strong overseas interest in the Egyptian

market, the country’s acute financial situation, diminishing

foreign reserves, and weakening pound are all of major concern

to international investors. Egypt’s foreign reserves reached

$19.6bn in September 2016, down from an all-time high of

$36bn in December 2010. To help assure investors, the central

bank agreed to give currency conversion priority to the utilities

sector. This, though, is not enough, because international

commercial banks will want currency availability guarantees,

which the government is unlikely to give. Additionally, the

government’s insistence that it will purchase electricity from

private generators in the local currency has also deterred

potential investors at a time when Egypt has just adopted a

flexible currency regime. The currency was devalued by 48%

earlier this month while uncertainty of the pound’s health could

stall some projects. Earlier this year, Italian utility company Enel

withdrew from a 47MW solar PV project due to further

devaluation fears.

2 Vol. 02 No. 02 | November 2016

In response, the Egyptian government has also turned to

international lenders such as the International Finance

Corporation, part of the World Bank, and the European Bank for

Reconstruction and Development (EBRD) for financing. The

EBRD alone will provide $500m in funding in 2016 for renewable

projects. However, these organisations are not capable of

providing sufficient financing for projects, nor are they interested

in financing conventional power projects. The government is

therefore having to step up efforts to secure alternative sources

of financing. Moving forward, the UAE and Saudi Arabia are also

set to invest in conventional power sources, while the Russian

and Chinese governments, as well as private organisations in

those countries, are potential financiers for mega nuclear and

coal projects.

Much needed reforms finally taking place

Egypt’s financing struggles are also catalysing power sector

reforms. The country still relies on the single-buyer model, with

EEHC the government-owned state utility that is responsible for

the oversight of production, transmission, and distribution

through its subsidiaries. The sector is vertically and horizontally

unbundled, with several companies operating in generation and

distribution, although most of these companies are state owned

and fall under EEHC. The Egyptian Electricity Transmission

Company (EETC) holds a monopoly on transmission. It also acts

as the single buyer from the generation companies.

Power market structure

In total, six generation, one transmission, and nine distribution

entities operate in the electricity market under the umbrella of

EEHC. Additionally, three IPPs and the National Renewable

Energy Agency (NREA) provide private sector generation to the

market.

Like most power markets in the region, Egypt is undergoing

reforms with ambitious plans to promote renewable energy and

increase private sector participation. In 2015, the government

issued a new law to create a competitive electricity market

throughout the value chain. This will essentially pave the way to

end the single-buyer model and allow private generation to sell

directly to end users. At the same time, third parties will have

access to grids while the role of the EETC will become that of an

independent transmission system operator. The new law also

allows for the creation of two electricity markets. The first market

will permit large consumers to negotiate and purchase electricity

directly from various suppliers. The second market will be more

closely regulated where consumers will purchase electricity from

distribution companies at regulated prices. The transitional

period to complete the restructuring is expected within eight

years.

The government is also stepping up efforts to reform electricity

prices. Residential and commercial electricity prices have

substantially increased across all usage bands, with the

government claiming that these increases will reduce Egypt’s

electricity subsidy bill to 29bn Egyptian pounds (LE), down from

LE48bn had prices remained the same. Residential consumers

were hit the hardest, seeing increases of up to 47% in July, while

commercial customers will see their bills rise between 9-19% in

the same month with the government keen not to put additional

strains on businesses. Several factors pushed the government

to introduce these price hikes. First, a weakening Egyptian

pound has made imports of LNG and refined products more

expensive. Second, rising costs of new generation and

transmission have placed additional financial pressure on an

already constrained government budget. Third, international

development organisations – such as the IMF – have

demanded economic reforms as a condition for providing much-
needed loans. Price reform measures were fundamental in

securing the $12bn aid package by the IMF.

The 10 largest power projects seeking financing in Egypt

Project Cost Capacity Potential financiers Estimated debt gap

($bn) (MW) ($bn)

Shanghai Electric/EEHC: Coal plant 6.4 4,640 Industrial Commercial Bank of China N.A

Renewable energy feed-in tariff programme 8.0 4,300 Eight development banks 4.0

Al-Nowais Investments: Ayoun Moussa coal power plant 4.5 3,960 To be announced 3.0

Rosatom/EEHC: El-Dabaa nuclear power plant phase 1 4.0 4,800 Russian financial institutions N.A

Orascom/Ipic: El-Hamarawein coal power plant 3.0 3,000 Local banks 2.3

Benchmark Power International Kafr: El-Sheikh power plant 2.5 2,300 To be announced 1.9

Acwa Power/Hassan Allam & Sons: Dairut IPP 2.0 2,250 Chinese financial institutions, development banks 0.0

EEHC: Damanhour power plant 1.3 1,800 Development banks and funds 0.0

Engie/Toyota Tshusho: Gulf of Suez wind farm 0.5 250 Japanese and French banks 0.0

Kom Ombo solar projects 0.4 200 Development banks and funds 0.3

Source: MEED; MEED Projects

Generation

Transmission

and Single

Buyer

(EETC)

Nine Distribution

Companies

(state-owned)

Six generation

comanies (EEHC)

Three IPPs

NREA

3 Vol. 02 No. 02 | November 2016

IPPs are crucial to the sector

The primary objective of the government’s ambitious reform

agenda is to attract the private sector. Currently, IPPs have

limited presence in Egypt. Three IPPs were introduced in the

early 2000s with a combined capacity of near 2GW – offering

very competitive tariffs of 2.5¢/kWh. Like most IPPs in the

region, 20-year power purchase agreements were signed with

the state utility. Although there were plans to introduce twelve

additional IPPs, the currency devaluation in 2002 and 2003

shelved these projects. However, the government is now

becoming increasingly aware of the importance of IPPs in its

sector.

First, IPPs allow investments in power generation without the

need for the government to pay the entire upfront cost. This is

especially important for Egypt, as falling government revenues

need to be allocated towards other sectors such as education,

health and infrastructure. Second, IPP projects are usually more

cost effective than government power plants. Contracts under

the IPP model are usually awarded to developers who provide

the lowest levelised cost of electricity (LCOE) - the price per kWh

that represents all fixed and variable costs of a project

throughout its lifetime. Egypt’s first IPPs offered some of the

lowest tariffs at the time. Third, IPP projects are quicker to

execute. With at least 20GW of capacity 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. This is

especially important in Egypt where project delays due to

financial and technical issues are frequent.

Egypt’s power industry stands at a crossroads. An unfavourable

balance between rising demand and insufficient capacity can

only be addressed through investment, which we estimate to be

as high as $28bn. But low foreign reserves, concerns about

currency devaluation, and an outmoded industry structure and

pricing regime make financing harder to source. In the face of

these challenges, the government has little choice but to

restructure its power sector, remove subsidies and allow

competition in order to attract investment. But despite the recent

increases in electricity prices, the government will be reluctant to

pass all costs to consumers quickly. The good news is that the

restructuring of the power sector and the electricity pricing reform

have already begun. The government must ensure that it

completes these reforms; otherwise, the power outages will

persist.
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