Lighting Up Economic Cities: Establishing Utilities in Fast-evolving Communities
Setting up an electrical utility service is a challenging process when providing for a city not yet in existence.
A decade from now, the Arabian Peninsula will be dotted with new “economic cities” dedicated to attracting and incubating industries such as financial services, technology, and communications media. Offering special incentives and amenities to attract businesses and encourage investment, economic cities will be critical to the financial development and economic diversification of Gulf Cooperation Council (GCC) countries. To ensure that these cities can meet their potential, GCC governments must make sure that the cities have the necessary elements to provide an efficient and cost-effective electric utility service, according to a new study by Booz & Company.
Powering Economic Cities
“The presumption is that economic cities will be developed primarily through private investment. However, as these cities move from concept to plan to construction, their developers will encounter some issues that can likely only be solved with the assistance of public resources,” stated George Sarraf, a partner at Booz & Company.
Economic cities will be built from the ground up through a process of accelerated community engineering, which is often unpredictable. Urban environments involve multiple interdependencies of services and institutions. The evolution of these interdependencies typically occurs in parallel with population expansion and cultural and economic development. “To establish all these elements de novo and shape them to a population that does not yet exist is inherently difficult,” said Tim Gardner, a senior executive advisor at Booz & Company.
In these circumstances, even familiar municipal issues can create unfamiliar challenges. The challenges consist in supplying the three institutional conditions on which electric utility service depends: a source of investment, a mechanism for cost recovery, and a framework for regulation.
Investment: The provision of electric power is widely regarded as a low-risk business, with a predictable and secure customer base, and cost coverage virtually guaranteed. In economic cities, the size of the market is uncertain, and if the service price seems excessive, it may discourage potential customers from locating there. Start-up investment in the power distribution infrastructure of an economic city therefore, could be a high-risk undertaking.
Pricing: In the typical power utility system, tariff levels are determined by dividing total production costs by the number of consumption units expected. Given the market uncertainty faced by nascent economic cities, the prospective tariff level is difficult to calculate, resulting in a wide variety of potential outcomes. This pricing challenge is compounded if customer electricity tariffs in the larger market are subsidized, as this will make rates appear comparatively uncompetitive.
Regulation: The standard role of a power regulator is to preserve the viability and health of the provider and protect the public from any abuse of economic power. In practice, this role typically is exercised through a quasi-judicial, often adversarial, process of hearings and reviews, which is ill-suited to the circumstances of an economic city. The economic city requires a scheme of regulation that recognizes the common interests of the developer, city utility, and city residents and employs innovative means of achieving them.
“The issues posed by investment, price, and regulation raise doubts as to whether utility service in economic cities is achievable through private initiative alone. Instead, it will likely require a well-coordinated combination of public and private measures,” explained Sarraf.
During a city’s start-up period, the public sector may need to bear much of the initial risk of utility infrastructure development. Over the medium term, the public sector may need to commit to purchasing whatever excess power is generated for the city but not consumed by it. “Such a guarantee would provide an assured level of consumption and an efficient alignment of the city’s supply portfolio with demand, thereby permitting tariff requirements to be reduced substantially,” continued Gardner.
If the economic city does suffer a power-price disadvantage in comparison to other siting alternatives, it will need to focus its sales efforts on small industrial, commercial, and residential customers, for which modest increments in utility bills will seem far less important than for energy-intensive industries. As for regulation, it should be conducted by an agency that has a flexible perspective and is committed to consumer fairness and to the overall success of the economic city.
In the case of economic cities, as in many other areas of social innovation, addressing any development challenges and building tomorrow’s cities is clearly within the grasp of the public and private sectors acting together.