Clean energy in the Gulf region – a paradigm shift

Infrastructure and pension funds are increasingly targeting renewable energy assets. Renewable energy investments share many of the same characteristics of other regulated infrastructure projects with steady income streams and high barriers to entry. A number of clean energy deals will be coming on stream in the Middle East. But will existing funds be prepared to act upon this opportunity?

Several Gulf countries have recently turned towards renewable energy, which became economically attractive. Kuwait has a formal target of sourcing 15% of the country’s total power generation from renewable by 2030. Oman aims to produce 30% of its energy needs from renewable sources by 2020. Qatar has set the goal of attaining 20% of its energy from solar power. Saudi Arabia had its first solar plant built in 2011 and is aiming to have 27GW of installed renewable energy capacity by 2024. The UAE eyes 50% power generation from renewables by 2050 is well ahead of the game in the region, transitioning away from a power system that is built predominantly on gas-fired generation.

Sun-drenched Kuwait deserves special attention, because of the major shift in the gas supply landscape. Electricity demand is growing fast and domestic electricity consumption more than doubled in the last 10 years driven by air-conditioners, consuming 70% of the energy produced in the summer. Summer temperatures in Kuwait reach 50C, but people enjoy room temperatures set at levels that make you want to wear a jumper in the midst of the summer.

At the moment there are no strong regulatory incentives to support renewables in the Gulf regions. The power generators get highly subsidized fuel, and customers get up to 95% of electricity-free. So the main incentive for renewable investments is likely to be not a regulatory drive or electricity bills, but export revenues. Oil production is capped by OPEC, and increasing the oil consumption for power and desalination will negatively affect the budget. Of course, there are some regional differences as for countries like Saudi and Qatar the desire to be on top of the league guides renewable investment decisions, but for Kuwait, it is the basic economics.  And economics is progressing rapidly.

Kuwait started importing natural gas in 2009 and currently imports around 20% of its natural gas consumption. This means that Kuwait is now competing for Qatari’s gas head-to-head with the UK, though of course there are some differences that tell apart two countries, e.g. it is two weeks journey from Qatar to the UK and just a few hours to Kuwait. Early this year Kuwait signed a 15-year contract to import LNG from Qatar (Gulf News, 5 January 2020). Gas contracts are confidential, but it is unlikely that Qatar will be selling gas to its neighbor at prices significantly lower than market prices, especially as there is a strong demand from Japan. Contrary to the UK, Kuwait doesn’t have an anti-hoarding mechanism in place to avoid a situation where a company buys a capacity, but not uses it waiting for prices to spike. All these developments mean that Kuwait will become as sensitive to fluctuations in the gas prices as all non-OPEC countries. This is a paradigm shift.

Kuwait’s renewable market is gaining momentum with Government-funded schemes. Kuwait is rich in solar radiation. At the moment, Kuwait’s power generation capacity consists of oil-fired and gas-fired power plants.  To meet fast-rising electricity demand rates, Kuwait will have to import LNG on a permanent basis, and that will be part of their future energy mix.

In the Middle East, the timing when you get solar to fruition is cloudy. The land is an issue for renewable, not so many countries can do that, but Gulf countries have the benefit of having vast areas of unpopulated lands.

Dash for renewables is a reflection of developments in Kuwait’s energy market. Economic and industrial growth led to a sharp rise in domestic energy demand, which is likely to continue in the near future. The Government abandoned plans for four nuclear power plants, a decision influenced by the Fukushima disaster. So the question is what this means in terms of the investment requirements in the renewable sector.

The Ministry of Electricity and Water, a key decision-maker in the power market is firmly behind Kuwait’s renewable-energy plans. However, decision making in the Middle East takes time, and the government still hasn’t decided which technologies are better to use. In Kuwait wind and solar will be the key technologies, other renewable energy resources like biomass, waste to energy and others are not feasible in the immediate future. The peak demand for electricity is in July and August when solar resources at their best. Also, barriers to entry in Kuwait are low, as the level of planning / permitting restrictions is non-existent compared to Europe.

Domestic gas is in short supply, oil products such as diesel are expensive, and Gulf neighbors with large gas reserves are unlikely to agree to provide gas supplies by pipeline. The higher the price of imported natural gas, the more economically viable are renewable sources of energy. Kuwait’s government has a strong drive to look for alternative sources of energy. In Kuwait, there are also plans for enabling home-generated power using panels.

Power plant construction contracts signed in Gulf countries have indicated a wide range of unit prices for solar collectors and solar field equipment. The cost of building a solar power project includes EPC costs, civil works, power block, commissioning, transport, and operation & maintenance which vary significantly.

These costs are highly sensitive to the character of project financing, debt to equity ratio, costs of funding as well as exchange rates. Exchange rates depend on the location of an EPC contractor, e.g. labor costs of the US and Australian contractors are higher than their European counterparties. The costs are higher if the power plant project is financed on credit. On actual projects, there can be a fairly wide range in prices, depending on current marketing strategies of the manufacturers and their competitive situations.

Kuwait doesn’t have a long history of building renewable power projects. Initial orders will be perceived by bidders as risky, resulting in large contingencies being required by the commercial departments of the bidders. Nevertheless, it is expected that the costs of building solar PV projects in Kuwait will come down, once the equipment suppliers and contractors build up their capacities and new competitors enter the market to take advantage of increased opportunities.

ISCC or hybrid power plants that combine concentrated solar with fossil fuel generation is appealing to some investors. These plants are best in desert locations. Concentrates heat of the sun to generate steam that can be used efficiently in turbines. However, it remains a less mature segment of solar energy infrastructure. It must be noted that most ISCC projects worldwide are in a planning stage, and only a few are operational e.g. 25MW in Algeria, 20MW in Egypt, 50MW in Saudi Arabia.

The technology which could also be very popular in the Gulf region is Concentrated Solar Power (CSP), a technique that uses mirrors to concentrate sunlight and convert it into heat. CSP could be used to produce cement, which is a very energy-intensive sector.

There is a long list of other innovative clean technologies, such as the hybridization of organic photovoltaic panels in a wind turbine tower to power a turbine in the wind farm. Research is currently going on to use CSP to desalinate seawater, which involves seawater being pumped into a hydrological solar container made from steel and glass before it is heated, evaporated, and eventually precipitated as freshwater.

Other technologies that could be considered are the solar-to-steam technology, examples include a 29MW solar facility built by Chevron to enhance oil recovery in California. Californian oil fields have been used for more than a century, and burning natural gas to produce steam to extract heavy-oil prompted Chevron to look for alternative solutions to supplement the gas-fired steam generators. Another promising opportunity is to link CSP with thermal energy storage, thereby increasing the value of clean electricity in a cost-effective way. These plants are enabling expanded electricity production by dispatching stored heat in the evening hours.

In terms of renewable plans, Kuwait today is perhaps where Europe was 20 years ago, however, it is wrong to assume that the country will follow the same trajectory in developing renewable energy projects. Despite the fact that there are many investment firms in the EU, it is hard to finance any project, and often the cost of capital becomes critical to the economic feasibility of these projects. As Kuwait doesn’t have liquidity constraints, it is likely that they will build large-scale, capital-intensive energy infrastructure projects ahead of small scale projects, whereas in Europe, and particularly in the UK there are more small-scale renewable projects. Of course, there are other factors contributing to this trend, such as green incentives. Our expectation is that Kuwait will go for large-scale infrastructure assets at a much faster pace.

If Kuwait to reach its emission reduction target, the total investment required in renewable projects is in the region of billions of dollars. This doesn’t include grid connection costs, and additional costs such as energy storage or cooling systems, which are needed for some solar PV designs. This growth will depend on project financing, incentives, natural gas prices, and expanded electricity transmission capacity. Kuwait’s renewable funding requirements are expected to increase due to the absence of grid regulations, grid connectivity, and transmission issues. Also, some locations of wind and solar plants will not be close to the cities or electricity grids, so there will be a need for additional investments to establish the grid.

Electricity transmission is an integral part of the renewable energy system. For example, the development of renewables in the UAE made it necessary to review the Electricity Transmission Code. Some changes are required in the operational regime to prepare the electricity network for the introduction of small generators. The renewable will have a material effect on the electricity transmission network. The question is whether the local transmission facilities be able to absorb all intermittent generation. Renewable generators are non-synchronous, whereas traditional power stations are synchronous. This means that if there is there are any planned outages in the transmission network, renewable generators do not have the same ability to withstand the disturbances resulting from the system faults.

Going forward, the growth of the renewable sector in Europe will largely depend on the level of regulatory support and the price of fossil fuels, in Kuwait it will be driven by the price of fossil fuels and reputation. Renewable energy stocks are generally more volatile than other sectors, but they are also highly correlated to oil given that they are substitutes.

In Europe, the solar boom is beyond peak, in Gulf countries, the solar age has just begun. What’s happening in the Middle East is part of a significant shift in global economic power from West to East. The Middle East is what connects China and India to Africa. As Asia and Africa continue to grow, there will be a greater role for the Gulf countries in the global economy. Kuwait is just an example to demonstrate that there is a strong economic case that underpins renewable developments in the Gulf region. Clearly, there will be good investment opportunities, but the fundamental question is whether European and American investment firms will embrace these realities and trends.