New Contracts Offer Synergies Between Players in Iran's Power Industry
Iran’s power industry is one of the most strategic and advanced industries among the country’s diversified industrial-based economy. The industry is not only strongly positioned to play a crucial role in Iran’s overall economic growth and industrial exports post-sanctions, but it is also a strategic component of the country’s geoeconomical importance in the South Caucuses and Central Asia.
In this new era of possibilities and opportunities, the outlook for the industry’s rapid expansion and economic growth is promising. This expansion is supported by the country’s abundant fossil fuel resources, over 600 different equipment-manufacturing companies and contractors, and over four million specialized technicians with electrical engineering backgrounds. Additionally, Iran’s large reserves of copper, aluminum, zinc, polymer, and other major raw materials allow robust capabilities for the domestic manufacturing of turbines and electrical components.
Nevertheless, considerable inefficiencies affect all segments of Iran’s power industry value chain. These deficiencies will continue to create challenges for the sustainable development of the sector. While foreign investment, and its hype, have become the main focus for meeting development objectives, other critical factors should be taken into account as the country makes its way back to the global arena.
Investment Incentives and Barriers
To attract new sources of capital to efficiently and quickly develop the power sector (for which the utilization of Class F and H turbines with net efficiency levels of 56% and 61% respectively are required), the Ministry of Energy (MoE) has introduced Energy Conversion Agreement models (ECAs) within Build-Own-Operate (BOO) and Build-Operate-Transfer (BOT) frameworks. In an attempt to reduce bureaucracy and increase efficiency in the processing of investment applications, MoE established Iran’s Thermal Power Plants Holding Company (TPPH) in early 2016, assigning it with the overall responsibility of negotiating investment deals and issuing required permits and licenses.
The Iranian power ECAs are based on two major principles: 1) free feedstock gas supply and 2) guaranteed electricity off-take at competitive tariffs. Both of these components are offered over five-year periods. The MoE has reached an agreement with the Ministry of Petroleum for the supply of gas which is converted to electricity for consumption in domestic markets. As such, these agreements are considered Energy Conversion Agreements as opposed to conventional Power Purchase Agreements (PPAs) offered elsewhere. The gas supply agreement has not been immune from political clashes between the two ministries, however. Officials of the Oil Ministry contend that by giving the project owners the opportunity to export electricity, the free supply of gas to power plants could undermine Iran’s gas export capabilities when the ECA’s term comes to an end.
- Fixed 5-year agreement with free supply of feedstock gas
- Guaranteed off-take agreement at pre-determined prices (which will be adjusted annually to protect investors against inflation and exchange rate fluctuations)
- Guaranteed (almost) free access to the grid for 20 years
- TPPH fixed financial modeling offering a 20% IRR
- After period of five years, the power plant can trade its electricity at the Energy Exchange market, or sell it to national or international off-takers at market prices
In order to ensure investor confidence, Iran’s Ministry of Economy and Finance backs the ECA agreements with a sovereign guarantee for the FIPPA-registered equity capital and incurred interest, which in turn, facilitates the means for investors to acquire finance at a low interest rate from international banks. In light of these attractive terms—often described as “too good to be true”—many international power companies, particularly those from Germany, Turkey and South Korea, have already signed MOU's with TTPH for multi-thousand megawatt power projects across the country.
While the MoE has been successful in attracting foreign investment, it has been less successful in engaging the Iranian private sector—namely manufacturers and contractors active in electric engineering, consultancy, and power plant construction. The post-sanctions policy of creating a "resistance economy", endorsed by Supreme Leader Ayatollah Khamenei, puts a great emphasis on the importance of empowering and supporting Iranian companies in their post-sanctions reintegration into the international economy. Entities that worked diligently and successfully during the era of sanctions to ensure the generation and flow of electricity are specifically rewarded. The requirement for establishing partnerships with competent Iranian companies – a requirement also included in the Iranian Petroleum Contracts (IPCs) - should be incorporated in power sector development contracts as well.
Another major development barrier in Iran’s power market is that despite a massive installed capacity of 75,000MW, a large number of power plants operate using extremely inefficient single-cycle E-class turbines with a stagnant efficiency of 30-35%. This level of inefficiency is even higher when combined with the energy loss in the transmission and distribution systems caused by old, inefficient and depleted network utilities and technologies. Half of the electricity appliances and cables in the distribution system are over a quarter-century old and cannot withstand heavy loads during peak times. According to a report published by the Parliament Research Centre in July, 2015, the actual level of power loss in Iran’s power system (energy conversion and transmission and distribution networks), ranges between 19-22%, and increases to over 25% during summer peak times. In practice, this means that for every 1000 MWh electricity generated during the peak time, a staggering 250MWh is wasted.
Heavy state subsidies and underpriced natural gas supplied to power plants result in depleted efficiency in Iran's power grid. A low tariff structure has caused a trend of excessive and inefficient consumption pattern per capita and the resulting inability to recover costs has led the industry to accumulate significant debt. The situation has been recently exacerbated by the urgent requirement for capital investment in developing new capacities to meet an unprecedented growth in demand. This requirement is expected to increase even further in light of post-sanctions economic growth. The expanding structural deficit has been a daunting burden on both the government and the private sector. A yearly investment of USD $5-6 billion has been required to meet the annual growth demand of 6% (or 5000 MW).
Iran as a Regional Energy Transit Hub
Iran’s power industry could play a critical role in enabling Iran to become a major regional electricity-dispatching hub, connecting the Caucuses and Central Asia with the Middle East. In addition to the realization of this project, the development of the larger alliance of the North-South corridor, which is being created among Russia, Azerbaijan and Iran, also has a strategic value for Iran. Unlike gas exports, which always face political barriers and fluctuations, electricity exports portend not only revenue, but also Iran's geo-economic relevance by creating economic and energy interdependency.
One of the major geopolitical objectives of the Iranian government is to ensure its regional ambitions by promoting energy diplomacy. While substantial progress has been made to date, (such as the synchronization of Iran's extensive national grid with all of its immediate neighbors, including Turkey, Iraq, Pakistan, Afghanistan, Armenia, Azerbaijan and Turkmenistan), this corridor requires substantial cross-border infrastructure development. The Iranian power industry, with the help of the private sector, should be at the forefront of this development. By allowing investors to solicit customers both domestically and regionally, these projects would also provide an attractive opportunity for investors to tap into regional markets for export of their generated electricity once their five-year power purchase agreement comes to an end. The ever-growing electricity demands of the Emirates, Oman and Kuwait offer a unique opportunity for power project developers in Iran.
The market knowledge and engineering know-how of Iranian companies, combined with the technological capabilities of foreign companies, will result in lucrative and substantial endeavors. As Iran re-engages with international markets, the most important policy for both government officials and Iranian power sector players is to grow sustainably, with a view to the long-term interests of the country.
Photo Credit: GE