The Public Utilities Authority (Electricity) is planning to end the bonanza anticipated by Israel's independent power producers and natural gas suppliers, which is based on an inflated electricity tariff that is subsidized by consumers.
The power station of Israel Corporation (TASE: ILCO) unit OPC Rotem Ltd. began electricity production in June, and the power station of Dorad Energy Ltd., owned by Israeli and Turkish companies, came on line in July. The two power stations will produce 10% of Israel's power.
Independent power producers lower the cost of electricity for customers and the economy, weaken Israel Electric Corporation's (IEC) (TASE: ELEC.B22) monopoly, and make huge profits doing so. Their business model is straightforward: generate electricity cheaply and efficiently, and sell it at a tariff that gives a high margin, but is still 7% less than IEC's rate. The independent power producers' profit margins are not known, as they are private companies, but market sources estimate that companies like Dorad can easily achieve a return on equity of 30% or more a year.
The entry of independent power producers has been accompanied by quite a bit of tension and struggles with IEC, but it turns out that IEC's employees are right about one thing: competition between IEC and the independent power producers is not on equal terms. It also turns out that IEC customers are subsidizing the independent power producers' customers, which include some of Israel's most powerful businesses, and that this subsidy will grow as the proportion of privately generated electricity in Israel increases.
As a government company, IEC suffers from a split personality. On one hand, it is supposed to operate as a business, solely on the basis of profit and loss; but on the other hand, it provides a critical service and is obligated to guarantee reliable electricity to all consumers in the country, wherever they may be. IEC has also been tasked with several "national" missions in recent years. It is required to sell electricity at a discount to disadvantaged customers, what is known as the "social rate" - a subsidy that costs NIS 240 million annually. On the production side, IEC is required to buy electricity from solar energy producers at an average rate that is several times higher than the cost of electricity it produces, at a cost of hundreds of millions of shekels a year.
The government also requires IEC to operate coal-fired power stations in the event of a breakdown in the natural gas system, even though operating these power stations forces the utility to invest billions of shekels in scrubbers and anti-pollution systems.
Do not pity IEC: all these added costs are passed on to consumers through their electricity bills.
But an undesired side effect of the special costs imposed on IEC is that Israel's electricity production tariff has effectively turned into a mix of special arrangements. So long as IEC produces 95% of Israel's electricity, this bothers no one, but a problem emerges the moment that large independent power producers enter the game, because they link their power purchase agreements to the official production tariff. Natural gas suppliers, such as the Tamar gas field owners, also benefit from this arrangement, because the tariff was inflated and higher than the real cost. The losers are electricity consumers who indirectly finance the inflated tariffs in the contracts.
To correct this distortion, the Public Utilities Authority is preparing a new rate component, which will be called the "grid management costs", which will include all the additional costs currently imposed on IEC, and are part of the production and transportation components. For example, the new item will assume the extra costs for the construction of coal-fired power stations compared with cogeneration power plants. The social rate, the extra cost of buying electricity generated from renewable energy sources, and availability, back-up, and grid management will also be transferred to the grid management costs.
Creation of the new component will definitely lower the electricity tariff per production unit. As a result, the price of gas in contracts linked to this rate can be expected to fall. Independent power producers will also lower the price of electricity in contracts with customers, and will have to absorb the new component, which will affect their profit margins.
"There is no reason in the world for the returns in Israel's energy industry to be different from most countries in the world. In most of the world, there are no returns of 30-40%," a top electricity industry source told "Globes".
Even after the change in the electricity tariff structure, there will be distortions in the electricity market. One of the biggest unsolved problems relates to settling the huge reciprocal loans between the Israeli public and IEC. The Egyptian natural gas crisis should have sent the price of electricity up by over 40%, because IEC was forced to buy more expensive fuels to replace Egyptian gas, at an extra cost of almost NIS 10 billion. In practice, the payments were spread over several years and the tariff hike was lower.
Independent power producers, which began production this year, benefited from the fact that the electricity tariff in 2013 is still NIS 0.04-0.05 higher than the cost of fuel, because of the rescheduling of the debt to IEC. This is a windfall for producers, which could total hundreds of millions of shekels. On the other hand, it should be remembered that the public lent billions of shekels to IEC and gave it in advance the capital to build power stations. IEC customers who switch to independent power producers are ostensibly eligible to get rid of the loan given to IEC.
Good substance but bad timing
The Public Utilities Authority says that the issue of including systems costs in the electricity tariff is not new, but taken in two decisions in recent years. It adds that the change in the tariff structure will help independent power producers build their business model for the next 18-20 years.
But the independent power producers say otherwise: the Israeli regulator has an obsessive need to constantly find reasons to make noise in order to be seen doing justice.
The CEO of one independent power producers told "Globes" today, "Even if the substance is right, the timing is bad." He adds, "It took a great many years to reach the initial stage where we are now. Barely one megawatt of private electricity is being generated, and independent power producers still only generate a few percent of the economy's electricity, and are far from the government's target, and regulations are already being constantly changed, creating uncertainty and noise in the system."
"Globes": Which measures bother the independent power producers the most?
The CEO: "We're beginning to see 'anti-concentration' measures, which put in doubt the possibility of building new power stations in the future. At the same time, there are changes, such as the change in calculating the kilowatt/hour rate, which have a material effect on capital-intensive and high-risk projects' models. A large independent power station costs $1 billion to build, and when fuel is included, the cost is $5 billion over 20 years. The regulator's job is to let the industry develop. If there are distortions, they should be corrected after the business is strong enough. At the moment, the smartest thing the regulator can do is to shut up."
Published by Globes [online], Israel business news - www.globes-online.com - on August 13, 2013
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