Insights for success in the Saudi renewables market
The business of localization: Insights for success in the Saudi renewables market
There are two sides of the coin when it comes to promoting local content in the renewables industry. In emerging markets like Brazil, South Africa and India, incentivizing and promoting local industry benefits the domestic economy. However, it also results in (initially) higher prices for generated electricity. This article will focus on the solar industry and explain the mechanism Saudi Arabia has implemented to bolster its domestic industry. Apricum will provide insights about the current local content scheme in the Kingdom and what this means for market participants.
Many of the aforementioned nations follow today what might be called ‘solar mercantilist’ policies in different forms. Much like the European powerhouses in the early modern ages, the aim is to maximize the exports and minimize the imports of an economy through protectionist policies. Higher tariffs for imported goods, and subsidies, tax cuts or rebates for domestic production, are the most common examples of this in the solar PV industry. In light of ambitious PV targets and record-low prices around the world, the Kingdom of Saudi Arabia is following other prominent examples of emerging PV markets to support local value creation.
The evolution of Saudi Arabia’s local content mechanism
Saudi Arabia is a country blessed not only with oil and gas but also with abundant sunshine that can be harvested as a natural resource. This is evidenced in the impressive tariff result in the first tender of 2.36 USDct/kWh issued by the Renewable Energy Project Development Office (REPDO). In April 2020, REPDO announced the shortlisted firms among bidders for the second round, where multiple proposals below 2 USDct/kWh have been reported. Apricum expects the installed PV capacity in Saudi Arabia to exceed 12,000 MW by 2024, more than 20 times the current installed capacity of ~500 MW.
The ambitious KSA “Vision 2030” program has set an installed solar energy target of 40 GW by 2030, creating a euphoric mood in the PV industry. The program does not only aim to reduce dependency on oil by increasing the development of renewable energy in the Kingdom, but also supports the localization of components. As in many other emerging PV markets, the Saudi local economy is envisioned to profit in the long term. Likewise, there is an intention from authorities to increase Saudization across multiple sectors. Local content requirements were introduced to increase the value-added contribution of products and services in KSA’s economy and to establish a local supply chain for the renewable energy industry. However, local content evaluation methodologies have been in constant and gradual evolution.
In the first round of REPDO tenders, a system called the NREP Saudization Compliance Metric (NSCM) was utilized. NSCM evaluated the level of Saudization and local spending as a proportion of total CAPEX. Simply dividing the local spending by the total project CAPEX yielded the final score. Bidders in the tender were required to have a score of at least 30% with a penalty of USD 1M for each percentage point below this score.
The Local Content and Government Procurement Authority (LCGPA) was created and authorized in 2018 to define a more sophisticated and consolidated methodology to evaluate localization. LCGPA aimed for an overarching scheme across sectors and developed a system called the Local Content Mechanism (LCM). LCM is being used for the second and the third rounds of REPDO tenders.
Tender rounds 2 and 3 of REPDO require a minimum local content score of 17% and 18% in the construction phase, respectively. Bidders participate in tenders with their projected local content scores. Realized local content scores are officially checked only after the COD. Hence, the timeline gives companies some flexibility as they do not have to bind themselves to agreements (with suppliers, EPC or O&M contractors etc.) and can adjust their business plans before and during construction. Companies who fail to comply with the local content requirements need to pay liquidated damages proportional to the deviation from the local content goal, with a range of USD 0.15-4.5M per 1% deviation (example from REPDO round 2). A significant deviation may even result in being excluded from future rounds. In REPDO round 2, consortium members of the winning bid can be excluded from further rounds for three years if the audited final local content score is below 11.5%.
The mechanics of calculating a project’s local content score
A local content score can be obtained by two different means. Either through predefined scores from LCGPA or through third-party auditors.
- Predefined scores: LCGPA periodically reveals a list of specific types of products, materials and services and their respective local content scores. The figures are obtained from industry surveys and benchmarks. LCGPA periodically updates the list. Any product or material “Made in KSA” automatically inherits the scores from the list. These automatically qualified scores vary significantly. For instance, financial services procured in the Kingdom have a 75% localization score. Hence, 75% of expenditure to financial services will count towards any project’s local content. On the other hand, PV panels have a much lower score at 22%, resulting in less local contribution per dollar spent.
- Third-party auditors: Alternatively, verified auditors can calculate a specific score if a company chooses to apply for one. An audit process offers a chance to differentiate from competitors if higher localization has been achieved in the production. Building on the same example, if a PV panel supplier undergoes an audit process and proves that they have indeed higher local content compared to market averages, they have the chance to obtain a higher score than the default 22%. A higher local content score would differentiate their product from competitors.
LCGPA has made a calculation template available for bidders in REPDO 2 to calculate their LC scores. Companies participating in REPDO’s renewable energy tenders will have to fill out the “LCM Compliance Template”, which will calculate their local content score. The calculation consists of four main components:
- Labor: The total compensation for employees that are directly involved
- Capacity building: Total spending on the training and development of Saudis, development of in-Kingdom suppliers, and in-Kingdom research and development
- Depreciation: Total depreciation of in-Kingdom assets used for the purpose of project execution
- Goods and services (procurement): In-Kingdom expenditure on any goods and services necessary for project execution – caveat: products do not contribute 100% of their price but are multiplied with their local content score to truly reflect their localized value even if they are procured from a Saudi entity, e.g., 22% of purchase value of PV modules
Choosing the right localization approach is not straight forward
There are a number of business models to address novel local content mechanisms with significantly varying local content results. Choosing the approach with the highest local content score, the lowest investment and the fastest and simplest implementation is likely to be the target of all market participants. However, finding this optimal approach requires a diligent analysis of the market and individual parameters. Three main business models are shown as examples below in the context of the localization schemes in KSA. Naturally, a much wider variety of options exists with multiple variables, which can be specifically tailored to the company’s needs and the market’s requirements.
1. Pure import of components
It is still possible to directly import or export products in and out of the Kingdom. However, any product that is imported into the Kingdom will have zero local content score (if no additional services such as assembling are performed). Imported goods would have a local content score disadvantage but might have price advantages. This model would work for components/products that are either simply not available in the Kingdom or do not comprise a large portion of project costs, hence, can be neglected even with a zero local content score. For such products, the local content score is either not possible to achieve or is not a differentiating factor.
2. Collaborate with a local sales agent
According to the current local content scheme, any product that is imported by a Saudi entity before being sold to a third party qualifies for 5% local content score. Simply adding a Saudi intermediary is the simplest and quickest form of market entry to achieve this, for example via an agreement with a local sales agent. A foreign company can also set up their own sales office in KSA and qualify for a 5% local content score.
3. Full Saudization of production
At the other end of the spectrum lies the complete Saudization of the production line. It is possible to build a full production line in KSA, which will significantly increase the LC score. Theoretically, a 100% local content score is possible by sourcing each component and service locally. This would require third-party auditing as there is no predefined 100% local content score for any product or service.
Such a business model would be preferable when there is an existing local supply chain of suppliers, confidence in the market’s long-term growth and/or the local content score is a differentiating factor. Localizing the production might have other benefits besides a high local content score such as avoiding import duties, gaining a potential first mover advantage and making use of KSA’s international agreements, e.g., cooperation in GCC countries.
Opportunities lie ahead as the transition moves forward
Saudi Arabia has proven its intentions for PV market growth and higher localization rates with its persistent efforts. Companies should consider their options now to participate in this growing business opportunity. This holds true for Saudi companies wanting to move into renewable energy as well as international companies wanting to expand into the Kingdom. Despite the massive challenges of 2020 such as the global pandemic and decreasing oil prices, the Kingdom has shown it is serious about changing its energy system. Regardless of potential delays in renewable energy tenders, the business opportunity for PV in Saudi Arabia is compelling.
Saudi Arabia represents a regional hub for the industries that feed regional markets such as GCC and North African countries. The Kingdom has initiated support mechanisms for local Saudi manufacturers to access export finance through the Saudi Export Development Authority and the Saudi EXIM Bank. Both are already active and offer a menu of services that vary from conducting feasibility studies to providing loan and payment guarantees.
Companies are advised to carefully evaluate their needs to choose the most suitable business model for their specific purpose. The selected business model will determine the attainable local content score as well as required investment costs and possibilities for partnerships and ultimately the outlook for success.
Apricum has been active in Saudi Arabia for more than a decade and is ready to support both local and international clients in seizing the opportunities arising from the emerging Saudi renewable energy market. For enquiries, please contact Apricum Managing Partner Nikolai Dobrott.
Source: apricum-group
