Today, small electricity consumers are subsidizing the power producers for their back-up and grid management costs - costs that the producers do not have to pay.
Azrieli malls, Intel's fabs, the Ministry of Defense, the banks, Mekorot National Water Company facilities, Fattal Hotel Management Ltd., Tnuva Food Industries Ltd., Strauss Group Ltd. (TASE:STRS), and many other large electricity consumers will soon switch from government-owned Israel Electric Corporation (IEC) (TASE: ELEC.B22) to independent power producers. They will buy their electricity from the first private power stations, which will come on line this year: Dorad Energy Ltd's plant in Ashkelon, and Israel Corporation (TASE: ILCO) unit IC Power Ltd's OPC Rotem plant near Dimona.
The entry of independent power producers is good news for Israel's electricity sector, big business, and especially for the power stations' owners. But the private consumer will not benefit, at least not in the short term. On the contrary, unless the Public Utilities Authority (Electricity) does not change the current situation, households will indirectly subsidize the independent power producers, by financing the costs of the back-up systems they currently receive from IEC for free.
For 20 years, there has been talk in Israel about the need to establish independent power producers, but the major legislation allowing them only came into effect in 2005 when MK Binyamin Ben-Eliezer (Labor) was minister of national infrastructures. In the background was the threat of commercialization of electricity. The government, which banned IEC from building more power stations by law, found itself with no choice but to consent to the construction of power stations under emergency plans at much higher costs.
"There was a critical need for independent power producers to boost the electric production capacity," said Shahar Harari, an energy consultant, who was an IEC director at the time. "We wanted the private companies to bring capital and skill and build efficient power stations. No one talked about lower electricity prices for the small consumer."
The monopoly of IEC controls Israel's electricity sector. Opening the market to competition requires giving start up protection or government incentives to minimize the independent producers' risks on one hand, and maximize their returns on the other.
The main risk, which materialized, was the exhausting approval process the company had to undergo to obtain the permits to build the power stations. Dalia Power Energies Ltd., which is building a power station at Tzafit on the Coastal Plain, estimates that it burned NIS 200 million from the moment it began planning until it secured the bank financing and obtained the green light to begin construction. "No one believed that it would take ten years to build a power station here," said Harari.
But once the financing is secured for building the power station, the bonanza begins. For example, Dalia Power Energies, is using a fixed availability model, which means that the government will assume 97% of the power station's operating risk. For example, the company will receive a full refund from the government for any financial loss caused by the purchase of natural gas to generate electricity, failure in the gas pipeline, or force majeure. The government also assumed market risk, or finding customers to agree to pay a good price. The government undertakes to pay the company the full price in exchange for availability, or willingness to generate electricity.
The price set gives Dalia Energies a return of at least 15% on the project's capital. As for equity, interestingly, the company's innovative financing model allows its shareholders extraordinary leverage: they only had to provide NIS 240 million equity out of the NIS 4 billion needed to build the power station, and they raised the remaining NIS 3.75 billion through issues of bonds and preferred stock.
"The fixed availability model effectively guarantee the developers the risk of government bonds with a 15% yield," said an independent power producer.
Government bonds with a 15% yield sounds like a good investment, but this is small change in the private electricity market. For the developers, the fixed availability model is only a default option; their real objective to switch to a variable available model, where the really big money lies.
Under the variable available model, the government assumes "a mere" 80% of the venture's operating risk, even as it directly challenges IEC. But this competition is not powerless. To find customers, the independent power producer has to offer its electricity at a price that is a few percent less than the electricity tariff. The electricity tariff reflects IEC's costs, which include employing 13,000 workers, interest payments on its huge debt, the construction and maintenance of the national grid, planning units, and grid management.
Competition is not equal in the electricity market: IEC is required to keep a reserve, or power stations which only operate as back-up, and are shut down most of the year. IEC is required to use a range of fuels to generate electricity, because of the national risk of relying on only one fuel, even if it is the cheapest. IEC also operates old power stations, some of which are almost 40 years old.
The resulting numbers look more or less like this: the marginal cost of generating one kilowatt/hour at an independent power producer which uses natural gas is NIS 0.20-0.30. A power station, such as Dorad's, which was designed to operate at peak hours when rates are higher, receives an estimated NIS 0.65-0.85 per kilowatt/hour. The return on capital under this operating model is 18-21% a year.
The Ministry of Finance says that, naturally, the first players entering the electricity market and which face high entry barriers should benefit from the highest returns. Lower electricity rates for small consumers will only be seen when there are seven or eight independent power producers in Israel and there is real competition.
Meanwhile, the Ministry of Finance hopes that the small consumer will benefit indirectly through lower power generating costs for big business, either through economic growth, which will create jobs, or through lower prices of end products. But Moshe Tzur, a former top official at the Public Utilities Authority says that this is not enough. Currently, small electricity consumers are subsidizing the power producers for their back-up and grid management costs - costs that the producers do not have to pay. "I do not envy the industrialists who will profit from the cheaper electricity, but it is unacceptable that I, a small consumer, will pay the extra," he says.
Published by Globes [online], Israel business news - www.globes-online.com - on April 30, 2013
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