In the heat of the Gulf summer, Dubai closed a deal to build solar power plants that will produce renewable energy at the world’s lowest production cost, 5.98 U.S.

Market Watch Blog AGSIW | Karen E. Young | Oct 22, 2015

In the heat of the Gulf summer, Dubai closed a deal to build solar power plants that will produce renewable energy at the world’s lowest production cost, 5.98 U.S. cents per kilowatt-hour. Dubai Electricity and Water Authority, or DEWA, the emirate’s utility provider, created a very competitive tender at a propitious moment in energy pricing. Solar power generation technology has finally become cost effective relative to gas and coal-fired electricity generation, and Saudi-based developer ACWA power was poised and ready to compete with international bidders. There is some irony in a Saudi company (privately owned by conglomerates and the Saudi public investment fund and pension agency) beating out competitors in a neighboring country, while Saudi Arabia has struggled to meet its own renewable energy targets.

Renewable Energy Targets by Arab Gulf States

Much of the debate in the shift to renewable energy in the Gulf has concentrated on the post-oil economy, making diversification in energy sources parallel to a process of diversification of state export revenue. Moving to renewable energy is logical, whether in the Arabian desert or United States. It’s safer, it’s sustainable, and it does less damage to the planet. The political challenges are also clear. Expensive electricity is not an attractive option for Gulf governments.

While both economic and environmental concerns are driving reform processes across the Gulf Cooperation Council states, the real innovation is in how Gulf states harness their business acumen to attract investment and design deals that work for local financial markets, governments, and developers. This is the trilogy of a Gulf model of infrastructure finance. In the case of ACWA, the company used debt financing to make its bid possible by going to regional banks (Abu Dhabi-based First Gulf Bank and Saudi-based National Commercial Bank and Samba Financial Group) to package a nearly $350 million loan to be repaid over 27 years.

This is where the financing matters. The renewable energy sector represents a source of fixed income to regional debt markets. Debt instruments are not well developed in the region and local investors and banks are eager to find ways to secure returns, especially in a moment of lower government deposits and projected spending. Some government utilities and developers make good partners when both can demonstrate that they can dominate their local market, are credit worthy, and are long-term partners. Dubai has demonstrated that this model works, especially with good timing in the adoption of proven solar technologies. (The Abu Dhabi solar project in Shams 1 and 2, led by Masdar, was an early adapter and likely over paid for a similar scale venture.)

Iran is looking for major infrastructure development and is following the Dubai model closely, especially in renewables with a policy commitment to generate 5,000 megawatts of renewable energy this year. German investors are flocking to Iran to build wind, solar, and thermal power plants in Khuzestan province worth at least $390 million. The German investment consortium Green Energy Group is also part of a plan to build a technology and educational center in Iran, modeled after the Masdar Institute in Abu Dhabi. The ability to transfer the collaborative Arab Gulf state finance model, mixing state-owned entities with regional banks and regional developers, will be an interesting trend to watch, especially if it can cross the Gulf.

This article was originally published by the Arab Gulf States Institute in Washington (AGSIW)

Dr Karen E Young is a former senior resident scholar at the AGSIW. She is a resident scholar at the American Enterprise Institute in Washington and a senior advisor at Castlereagh Associates.