Egypt's energy sector undergoes reforms to regulations, energy mix

Egypt’s power sector is racing to cope with demand, which is growing at the relatively high rate of about 6% per year. The rate is attributed to a fast-growing population and a subsidy regime that suppresses the price of electricity below a cost-reflective level that would normally encourage conservation. The state has a long-term plan to phase out the subsidies, encourage efficient use and broaden the energy mix. Egypt currently relies on natural gas for approximately two-thirds of its power generation – and more gas plants are under construction – but diversity of energy sources is a priority. The country has increased its focus on renewables, recently signed an agreement for nuclear power and approved the use of coal for power production.

Investment

Power plants that feed the national grid are state-owned in Egypt, as are the distribution networks and the grid itself. However, investment opportunities are proliferating, primarily thanks to the government’s long-term liberalisation plan and its immediate desire to pay companies to build new plants as quickly as possible; most of which are completed through contracts to provide engineering, construction and procurement, as well as financing.

Beyond the immediate and medium-term future, there will be further openings to investment according to a 2015 presidential decree on electricity reform. Law No. 87 of 2015 removes the state’s monopoly over the energy sector and creates two parallel markets: a regulated one for retail customers and a competitive market that private investors can use for local distribution networks to sell at negotiated prices. The law’s elements are to be phased in over an eight-year period and they may mean the eventual privatisation of state assets, although a specific process for this was not specified in the law.

Future Needs

According to the Ministry of Electricity and Renewable Energy (MoEE) there are plans to spend LE130bn (equivalent to $6.9bn as of December 2016) to add more than 8 GW of capacity over 2016-17, and a further 13.9 GW over 2018-19. In FY 2015/16, Egypt disbursed a total of LE52bn ($2.8bn) to bring on 3.5 GW of new generation capacity and for improvements to transmission and distribution. The ministry’s overall estimate is that another 54 GW of new capacity will be needed by 2022, and it hopes private investors will play a major role in reaching that. It intends to award contracts to build the generation capacity by 2019.

Engaging the private sector for power production will be a multi-pronged effort involving more than the state-owned utilities. For example, Egyptian Natural Gas Holding (EGAS) is looking to sign agreements to import more liquefied natural gas.

Public Players

Egypt’s six generation companies and nine distributors are owned by the Egyptian Electricity Holding Company (EEHC). Total generation capacity was 32.02 GW according to the company’s most recent published annual report for FY 2013/14. The average availability of power production capacity was 86.8% and network losses reached 11.7%. Peak load on the year was 26.14 GW and 30.6m customers were served. Transmission losses reached 12%, which the MoEE aims to reduce to 8%.

In addition to the MoEE and EEHC, the key public agencies involved in the energy sector are the Egyptian Electric Utility and Consumer Protection Regulatory Agency, known as EgyptERA; the Egyptian Electricity Transmission Company (EETC), which handles the grid; the New and Renewable Energy Authority for the emerging renewables segment; and the Nuclear Power Plants Authority.

Regulatory Changes

The 2015 law changes some of the roles and responsibilities of these organisations. It assigns additional regulatory responsibilities to EgyptERA to oversee the emerging deregulated market, including determining qualified consumers and the rules of engagement. It also makes EETC an independent state agency rather than part of EEHC, and formalises EETC’s monopoly role over transmission. EETC is now also the market operator, giving it responsibility for matching supply and demand, and accounting and settlement between generators and producers. This formal independence is an important reform, but it is also notable from an investor’s perspective because deals signed with the EETC cannot receive a sovereign guarantee from the Ministry of Finance (MoF). The state gave the MoF the ability to guarantee EEHC obligations in 2013, but will no longer cover the newly independent EETC.

The competitive market described in the 2015 law is nascent, and for now the vast majority of customers use and pay for power at prices capped far below what would be necessary to justify commercial investment in the sector – anywhere from about 25% of the actual cost to roughly 50%.

A formal market for commercial independent power producers (IPPs) is only just emerging, with some clarity coming in the recent legal reform but more is needed through detailed regulations. Private investors have already participated by building power plants for their own use or to service captive customers. TAQA Power, for example, has won contracts to distribute power to large-scale users such as hotels, resorts, manufacturers or retail outlets in tourist areas around Cairo.

Generation

EEHC’s plants rely on thermal-power using natural gas and heavy fuel oil (HFO) for 90.5% of all generation capacity as of 2014, according to the ministry. Hydropower from the Aswan Dam produced 8.2% of the total. The dam was built in 1971 and has 12 turbines that can produce a capacity of 2100 MW. Wind and solar provided the remaining 1.3% of EEHC’s generation capacity for the country.

More than one third of the thermal power plants are over 20 years old, and the plants’ availability and efficiency rates range from 5% to 8% below common global benchmarks, according to MoEE figures. The extent to which older plants must be retired or can be rehabilitated is unclear, but the government has been spending money on the latter, including a $148m contract awarded to General Electric to replace parts, boost efficiency and renovate the older facilities. In August 2016 the MoEE announced the average cost of production increased from 47 piastres per KWh to 63 piastres.

According to EGAS, the power sector accounted for 63% of natural gas consumption in Egypt in 2014 and 2015, equalling 1.04trn cu feet. With massive gas finds in recent years, such as the Zohr offshore field discovered in 2015, the commodity is likely to remain the preferred feedstock in Egypt, even if diversification efforts succeed. According to a ministry presentation, the government would like to see the use of natural gas and HFO shrink to 57% of the total mix by 2022, with wind and solar power jumping to 25%. The role of hydropower would shrink to 3%, as there are no plans for new capacity, and coal would account for 15% of use.

New Plants

In June 2015 Egypt contracted with Siemens – on what the German engineering giant termed the largest single order in its 168-year history – to build the largest power plants worldwide. The package is valued at $9bn. With this deal, Egypt will receive a total of 16.4 GW in new capacity: three new gas-powered plants each with a capacity of 4.8 GW, and as many as 12 wind parks which would host 600 turbines to add another 2 GW.

Siemens Financial Services structured the financing package, which will come from international and regional banks and backstopped by a guarantee from the Egyptian government, as well as other support instruments from German and Danish export credit agencies. Banks involved include a consortium of 17 lenders backed by a syndicate of others, with those in the lead group including HSBC, Deutsche Bank, Germany’s KfW IPEX-Bank and EFG Hermes. The first 4.4 GW of gas-fired capacity are expected on-line before the summer of 2017.

Coal

The use of coal was approved by the Egyptian Cabinet in April 2014 and requires importing the raw material. It comes with a tax to mitigate environmental impacts as well as potential strengthening of environmental standards in Egyptian law to increase penalties for regulatory violations.

At a March 2015 presentation, Egypt outlined plans to award contracts for 12.5 GW of coal-fired power by 2022, with individual plants as large as 4 GW in capacity. Coal’s share of Egypt’s total primary energy mix, could rise to 29%, with 30m tonnes burned annually. That would include the power sector but also other users, such as cement plants, which as of 2016 were converting their facilities to burn coal because of the shortage in natural gas.

For now, early-stage coal developments in the power sector include an agreement between Japan’s Marubeni Corporation, Egypt’s Elsewedy Electric and EEHC to conduct a feasibility study. One proposed site for a coal plant is the West Mattrouh region, 450 km north-west of Cairo.

Wind

Alongside Egypt’s goal to add 54 GW of capacity by 2022 is the target of 20% renewable sources in the mix by 2020. Egypt’s richest resource is wind, particularly in the Gulf of Suez region, where average wind speeds can exceed 10 metres per second. The 20% target was set in 2007 and highlighted a specific threshold for wind contribution of at least 12%.

Wind capacity has grown from small, off-grid pilot projects to utility-scale, grid-connected production through the Zafarana project in a town of the same name on the Gulf coast. The wind farm has a 305-MW capacity which was installed in phases from 2001 to 2007. Egypt added another 200 MW of capacity at El Zayt in December 2015, commissioning a $359m, 100-turbine project led by KfW IPEX-Bank. The 2 GW of capacity from the Siemens deal will take a year or two before reaching commercial operation. Siemens will first build a blade manufacturing plant in Ain Sokhna to supply the wind farm, and that facility is expected to begin operations in late 2017.

Nuclear

Nuclear power has long been in the cards for Egypt, but a commitment to this form of energy has wavered over the years due to reports of leakage accidents at facilities elsewhere. The MoEE’s plan calls for 4 GW of capacity in this segment.

Egypt’s official gazette announced a $25bn loan from Russia in May 2016 to finance a facility that would be built by Rosatom, Russia’s state-owned nuclear agency. The deal includes two nuclear power units with an option to build two more at a site near El Dabaa, which was tabbed back in the 1980s as a suitable location for such plants. Final technical details were pending, but the facility is expected to be operational by 2022. The loan is expected to be at a 3% annual interest rate and payable through 43 instalments over 22 years, starting in 2029.

Private Interest

Egypt’s efforts to establish feed-in tariffs for renewable sources and concessions in specific markets are early steps that have created opportunities for private investment, which is expected to increase in coming years as the country moves forward with an overall liberalisation of the energy sector. Whilst EEHC’s distribution companies handle the vast majority of connections, it has allowed concessions to private entities as well as ring-fenced producers feeding their power to a small network of nearby customers rather than into the national grid. TAQA Power, for example, the electricity unit of Cairo-based TAQA Arabia, has around 2000 clients. It provides 400 MW of power to residential and commercial consumers, 250 MW to hotels and resorts, 50 MW to oil and gas producers and 300 MW to industrial zones.

Another private investor in the sector is Edison International, a part of EDF Group: the second-largest gas company in Italy. In addition to its upstream oil and gas business, Edison announced plans to develop a 180-MW power plant at the same site as its gas processing plant on the Mediterranean coastline west of Alexandria. The construction of the plant will be fast-tracked. From its announcement in July 2015 it is expected to be operational before 2018, helped in part by the fact that its location is near an existing Edison facility. Edison’s partner in the project is Qalaa Energy, a unit of the Cairo-based private equity group Qalaa Holdings.

Tariffs

The downstream energy market is shaped primarily by tariffs reflecting less than cost. A 2012 study based on FY 2009/10 prices suggested that residential connections are charged roughly 25% of the true cost of power production. The figure ranged from 26% to 44% for industry and 43% to 51% for commercial users. Egypt’s power sector suffers from familiar challenges seen in other subsidised markets such as the inefficient use of energy, state utilities that struggle to generate enough revenue to fund their needs for capital and operating expenses, and a distorted impact of the subsidy in which many of the advantages flow to higher income users rather than to the poor who are targeted to benefit most.

Cash flow is also a familiar problem observed in other subsidised markets. The MoF, for example, has built up arrears of subsidy payments to EEHC and some other public entities do not pay for the power they take, according to the MoEE. Concerns of future fiscal sustainability of the power sector include a total of $3bn in contingent liabilities at the MoF for IPPs, as of March 2015.

Revised prices for residential users were introduced by MoEE in August 2016, with hikes of 35-40% for low-intensity consumers. In the lowest bracket, users of 50 KWh or less will pay 11 piastres per KWh, up from 7 piastres per KWh. The sliding scale includes price points for users up to 650-1000 KWh, for which rates were hiked from 78 piastres to 95 piastres. In August 2016 the plan to do away with subsidies forecast spending of LE4bn ($212m) on the measures in 2017 and then fully eliminating them in 2018.

 

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The Report: Egypt 2017

Energy chapter from The Report: Egypt 2017