Analysis of Saudi Electricity Company reforms and subsidy cuts under NTP 2020

Utility sector: sharing the capex burden and achieving cost reflective tariffs Ali Dhaloomal MLI (UK) ali.dhaloomal@baml.com Eight strategic objectives aimed at being self-funding The electricity sector is mentioned in eight strategic objectives of the NTP 2020. The two most important measures in our view are the one related to subsidies cuts and the one on the liberalisation of the sector which should free out financial resources to fund the future capex burden as well as the other targets under the NTP. This is even more relevant as the NTP doesn’t provide any additional funding for the sector. Unanswered questions as to impact on electricity sector While we think these initiatives should be welcomed as they would reduce the financial burden on Saudi Electricity Company (SEC) from its ambitious capacity expansion plan (SAR240bn / USS64bn to be spent over the 2016-21, mostly in generation), some questions remain unanswered, especially in regards to SEC’s capital structure and financial sustainability on a standalone basis. It remains unclear if the proceeds from the disposals of the minority stakes in the GenCos will be used to fund future capex plans or to alleviate SEC’s commercial debt (US$16.3bn as of FYE15) and government and government-related debt and payables (c.US$46bn as of FYE16). Also, it remains unclear if on the back of the NTP, SEC would start paying its current payables (fuel sourced from Aramco, electricity sourced from SWCC and fees owed to municipalities) instead of accruing these amounts as it does now. 1. Saving SAR200bn annually by cutting the water and electricity subsidies: The current print of the NTP doesn’t give any detail about how this target will be split between water and electricity subsidies, but we note that the plan aims to reach full cost reflective water tariffs by 2020 (from 30% cost coverage at the moment). Recall that starting from January 1st, electricity prices have been increased by a weighted average of close to 20%, with residential prices (half of the consumption) now ranging SAR 0.05-0.30 / KWh vs SAR 0.05-0.26 previously. The highest increases are for the commercial sector, the governmental entities and the agricultural sector. SEC’s management recently indicated to us that they expect a neutral impact over the long term from this decision as it mirrors an increase in feedstock price charged by Aramco. However, over the short to medium term, SEC cash flows are expected to benefit from the tariff decision given that the company books all its fuel costs in payables without disbursing any amount to Aramco. 2. Increasing the percentage of power generation through strategic partners to 100% from 27% now: We believe that the aim here is to bring industrial or financial partners in all SEC’s and Saline Water Conversion Corporation (SWCC) generation units, in line with the electricity sector reform which expected to be implemented by late 2016 / early 2017. According to SEC’s management, the most likely scenario involves SEC’s generation assets to be split into four separate regional GenCos where minority stakes would be sold to major global utilities or sold in the public market. 3. Increasing the efficient use of “fuel” in power generation to 40% from 33% now: We think that this objective entails increasing the share of efficient combined cycle gas turbines (CCGT) plants. Given that SEC currently represents 73% of the country’s installed capacity and that 19% of its electricity is generated via efficient combined cycle gas turbines (CCGT), this means that 71% of the remaining tier party capacity is “efficient”. We note that another 39% of SEC’s installed generation capacity is made of less efficient open cycle gas turbines (OCGT). OS Merrill Lynch GEMs Paper #26 | 30 June 2016 73 HOUSE_OVERSIGHT_016183