Legal System for Foreign Investments in Saudi Arabia in the Field of solar power
June 1, 2011 By Talal Abu-Ghazaleh Legal (TAGLegal)
It is not recommended to think, ...that the idea of using solar power for mechanical operations is recent. (1)
Saudi Arabia is known to be the first oil producing country in the world. Its exports are a reliable source of energy for industrialized countries. However, while the hydrocarbon energy reserves are beginning to decline (2), after causing hardly repairable damage to the global environmental system (3), many industrialized countries (4) pushed by the problem of energy security, are starting to seek alternative sources of energy. Along with the technological evolution of the energy industry, the production rate of electricity based on renewable sources is yearly increasing in industrialized countries.
Globally, electricity production is facing three main challenges: reducing the effects of climate change, guaranteeing the energy security (5) and promoting the competitiveness of private companies. Among these three challenges, Saudi Arabia offers, on one hand, promising productivity opportunities (6) given the 2200 hours thermal kilowatt (kWh) per square meter (7) yearly sunshine on its territory, and on the other hand, it is showing a high annual increasing rate in electricity needs. Solar power is supposed to provide a strategic contribution to energy needs in this country. “Green” companies seeking to sell electricity at a significantly low cost should head to this country. Saudi Arabia has recently acknowledged the importance of renewable energy and their role in an economic future limitedly dependent of oil. The King Abdallah City for Nuclear and Renewable Energy was created in April 2010. It has the mission develop a national energy policy based on nuclear energy and renewable sources, and it would bring to the Saudi market the related technology. Investments in the solar power sector in Saudi Arabia are commercially promising (8) and legally permitted. By following the European model (9) of electricity market liberalization, the Saudi government has established a national authority of control and regulation and a modern system for licensing.
This article aims to evade the legal aspects concerning foreign investments in Saudi Arabia in the field of solar power. The followings will be analyzed: The legal framework for investments (I), Property law (II), Official authorizations (III), Connection to public electricity network (IV), financing (V) and construction contracts (VI).
I- The legal framework for investments
Commercial exploitation of solar power is not specifically regulated in the Saudi Law; only the oil sector is well regulated. Yet, a comparative approach between hydrocarbons and renewable sources of energy would enable to outline the legal characteristics that could serve as a discussion basis for this new market.
The right of exploitation of solar radiation is substantially different from oil. Oil reserves ownership can be legally unstable (10) . This characteristic comes from the fact that oil, being a fluid located in deep fields exposed to high pressure, tends to move to other fields when the pressure rate falls. Legally speaking, this fluidity can generate a change of ownership in case oil moves across the border of two neighboring countries, or across the limits of two exploration or exploitation fields coming under two private entities. An American court has clearly noted this aspect by the following terms: “Oil is an independent category among minerals, a mobile mineral... Unlike other solid minerals, it has the intrinsic capacity to move to other fields. Its location in a defined field is uncertain. It belongs to the land owner while located in it and depends on his willingness to exploit it... Thus, owning the land does not necessarily mean owning the oil (11)”
This characteristic of unstable property concerning oil is not transposable to solar radiation. Sun rays are, by nature, directed. Since they are projected, they follow a fixed destination. Dynamic and moving, solar radiation follows a fixed trajectory and targets a given point of the globe. The fact that there is no possibility of sun rays deviation, any movement of sun rays from one country to another, from one production site to another, is inconceivable. Since sun rays end up on a certain site, they lose any mobility and become an exclusive right of exploitation of the site owner. The right of exploitation of sun rays is thus a certain and definite right.
As for the legal basis of commercial exploitation of solar radiation in Saudi Arabia, it is beneficial to refer to the religious thought existing there since it is a new matter and since the legal framework dealing with it expressly is to be elaborated. The Saudi Law is becoming more and more positivist and is straying from the classic methodologies, but religious law is always used as a legal discussion basis for any recent legal problematic issue. Hanbalism, the theological school dominating Islam in Saudi Arabia, seems to welcome favorably the commercial exploitation of solar radiation. According to this school’s theologians, it is accepted, for natural sources property, that the land owner acquires and gets the right to exploit the resources that can be found above ground only; land owner has no entitlement over the underground resources and cannot exploit them. The Roman law maxim “Cajus est solum, ejus est usque ad coelum et ad inferos” isn’t taken into consideration. By analogy to above ground mineral sources, solar radiation can be privately exploited. This is a basic solution since it rejects the approach consisting to subject these investments to the concessions system applied to oil sources.
II- Property law:
Property, lease and access rights are among the sine qua non conditions for an electricity production project based on solar power. The Saudi Law of foreign investment allows the foreign investor to acquire or to rent the necessary real estate properties for his professional activity. The country’s large areas can have favorable or unfavorable legal repercussions in relation to the projects of solar power production.
On one hand, the investor, looking to rent a large area (12), can easily find one with competitive rents; moreover, the nearness of solar power stations to urban areas doesn’t raise legal risks as for windmills installation (13) elsewhere, since they can generate sound vibrations harmful to health. On the other hand, projects of solar power production are usually located on city limits; since the lands surrounding the cities are a desert that is often a State property, it is somehow difficult to negotiate ‘commercially’ a lease or a purchase contract. In industrialized countries having developed large solar power production sites, the rent can be calculated through many ways: according to the site’s market value, according to the site’s sunshine average or the potential profitability of the produced electricity. Negotiating these rent evaluation techniques with a public entity seems quite complicated and, afterwards, many investor prerogatives may not be raised or accepted by the state.
Moreover, Saudi Arabia has installed a vast pipeline network going beyond its borders. There are also mineral products mines with important reserves for Saudi Arabia. Therefore, it is imperative, in the west side of the country in particular, to take these pipelines into consideration for they can give the State a right of access, inspection or maintenance.
Solar power is produced according to two techniques: photovoltaic panels (PV) or concentrated solar power (CSP). Choosing one of these techniques affects the choice of the land type and the legal foundation of property law (rental or purchase). It is admitted that in the case of a site using the CSP technique, a lease contract is more appropriate since the land owner intends to continue the land’s exploitation (specially in the case of an agricultural activity that won’t be hindered by the installation of concentration panels). In Saudi Arabia, this concern doesn’t exist because of the country’s large area and the rare agricultural activity. On the other hand, it is advisable to rent a land without giving the owner the right to practice any activity, given the necessity to have the private operational means for the panels’ periodical cleaning, due to the frequent dust storms.
agricultural activity. On the other hand, it is advisable to rent a land without giving the owner the right to practice any activity, given the necessity to have the private operational means for the panels’ periodical cleaning, due to the frequent dust storms.
The property rights being guaranteed, the electricity sector laws provide additional prerogatives and property restrictions.
The Executive Decree ruling the duties of the Electricity Regulation Authority (the Authority) published in May 2006, allows the Authority to intervene in case of negotiations’ failure between an investor having the official authorizations to build a solar power site and a land owner. This intervention aims to help the investor to acquire the property needed to practice his activity. The Authority examines the acquisition request sent by the investor and has the right to suggest three solutions: the resumption of private negotiations between the investor and the land owner, suggesting new sites, the acquisition of the location to benefit the investor.
Another prerogative consists in granting the investor a right of way in a third party property in order to connect the site to the public network or to connect a client to the given site. This right of way can’t be freely practiced: it concerns the investor, his employees and his equipment, and must be preceded by a notification sent to the owner. The way must be limited in time and the investor has to choose qualified technicians who will be able to complete, as soon as possible, the connection or rehabilitation work.
In general, the investor is requested to protect sites of cultural, natural or historical significance. Any damage must be reported to the related authorities (Ministry of Culture or Ministry of the Environment).
III- Official authorizations
The liberalization of the Saudi power sector was inspired by foreign experiences, which were based on a privatization process accompanied by an increased state control (14). The strategic importance of this sector leads to the establishment of a control and regulation body (15).
Yet, as for the Chinese case, the liberalization of the electricity sector confronts Saudi structural barriers related to the centralization of the licensing authority, despite the geographical big size of the country.
1. Privatization:
Like any other developing country, Saudi Arabia is keen to provide the process of industrialization of its economy by the technologies developed in industrialized countries. New technologies in the field of renewable energy will constitute a large added value to the energy-industrial sector of Saudi Arabia. To achieve this goal, the process of privatization of the electric energy sector started in 1998 (by Decree N. 169/1998 of the Cabinet). All public companies operating in the electricity sector were merged into a public company (Saudi Electricity Company - SSE) governed by the regulation of commercial companies. In terms of electricity production, the concession system was not adopted and remains, therefore, limited to the oil sector.
Decree N. 169/1998 turns to the private sector in order to participate in the construction and management of electric energy projects. The SSE is also authorized to create commercial companies or partnerships with private companies (national or foreign).
State control is provided through the Managing Commission of Electricity (Commission, governed by Decree N. 154 of the Cabinet, published in 2008) and Resolution N 66/429 of the Commission’s Governor, published in 2008, establishing the Department of Legal Affairs and Authorizations.
Finally, the Decree of Application of Electricity Regulation (Decree of Application), published by the Commission in May 2006, mentions that, among the objectives of the national electricity plan, there is the establishment of an electric energy sector based on private sector intervention. Access of private entities to the electricity market being claimed, it is still required to obtain official authorizations to implement a preliminary and continuous control in relation to electricity projects.
2. Official control:
The official control requires requesting a preliminary authorization (i) followed by a final authorization (ii). Over time, the project is subject to a relatively strict official supervision (iii).
(i) The preliminary authorization:
The texts governing the electricity sector in Saudi Arabia does not specifically address the solar radiation as a source of electricity; however, no text provides an exhaustive list of sources of electricity. Article 5-1 of the Application Decree lists, as examples, several activities related to the electricity sector and requiring, thereafter, an official authorization. In terms of production activity, Article 5.1 states, in general terms, that "Any electricity production” requires an official authorization. With no specification of the source used for electricity production, this article allows to note that solar power can be among sources of electricity that require official authorization. Article 5-2 of the Application Decree stipulates that the Board of Directors of the Commission has the right to issue new authorizations related to new techniques of electricity production.
The official process is initiated by a request of a preliminary authorization addressed by the investor to the Commission. Usually, authorization requests must be equally processed by only taking into account the technical capacities of the project, its economic size and its place in the national electricity plan.
During a primary control, the Commission ensures that the project is in line with the national electricity plan. The investor must disclose information related to his legal profile, technical and logistical aspects of the project and the objectives of use of the produced energy.
The granting of preliminary authorization does not guarantee getting the final authorization. While studying applications, the Commission has a discretionary power. The reference criteria consider the technical, financial and industrial aspects of the project and the industrial know-how transmitted to the Saudi market. The Commission has the right to issue additional authorizations to other investors at the same site and for the same type of activity. Projects of which electricity production is destined to self-consumption are exempt from the obligation to ask for authorizations.
(ii): The final authorization
After getting the preliminary authorization, and before seeking the final authorization, the investor must submit to SAGIA (Saudi Arabian General Investment Authority) the application for investment license which aims to disclose the legal profile of the investor and his previous projects to the Ministry of Commerce. After getting the investment license, the investor shall submit to the Commission the request for final authorization of electricity production. The request must provide detailed information on the following aspects (16):
1. The official structure of the holding company and the Saudi subsidiary;
2. Documents proving the property rights related to the site of the station;
3. The capital invested through the Saudi subsidiary;
4. Studies on the environmental effects of the station and the authorization issued by the Environmental Protection Authority;
5. The technical data of the station;
6. Copies of contracts with other local investors (distribution, sales ...);
7. Proof of financial funds necessary to build the station and, if needed, a commitment to provide additional funding;
8. Proof of technological know-how to build and operate the station;
9. Proof of compliance of the project’s various sections with the Electricity Regulation;
10. Declaration of ownership of any shares or equities in companies managing similar projects in Saudi Arabia;
11. The accounting system of the Saudi subsidiary;
12. Electrical activities (17) directors’ names of the Saudi subsidiary.
Transparency of the information exchanged during the authorization process is basic. The Commission considers the technical data of each production site in order to evaluate the progress in implementing the national plan of electric growth. Thus, any inaccurate information provided to the Commission, would directly lead to the refusal to issue the authorization. The Commission has the obligation to publish all its decisions concerning authorization requests. Yet all that was marked by the investor as part of his trade secrecy and techniques will be a strict obligation of confidentiality.
With the granting of the authorization, the investor’s supervision by the Commission comes into force. It includes several areas of his activity.
At the technical level, the exploitation’s period is related to the period of viability of the equipment installed in the station. The scope of the exploitation is strictly limited to the authorized activity. An investor cannot stop electricity production unless there is force majeure situation. Throughout the authorization’s period, specifications and technical criteria of the Electricity Distribution Code should be followed, including the conditions for good quality service. The Authorization also includes an obligation to sign a contract concerning the connection of the station to the national network of electricity.
In case of technical accident, the Commission has the right to grant the investor a temporary authorization allowing him to start the production until the request for the final authorization is decided (18).
In general, the Commission has the right to inspect the electricity production sites to test the nature and rates of gaseous emissions, noise pollution and proper treatment of industrial waste.
On a legal level, the production authorization is granted in consideration of the specific characteristic of the investor. Thus, any restructuring, assignment, merger and / or expansion of the project, any sub-contract, lease, exchange or allocation of a right related to the Authorization shall be notified in advance to the commission to be approved. The same condition applies for the station equipment; the reason is the concern of the Commission to ensure that the transferred assets, subject to any transaction, should be immediately replaced by assets having the same efficiency and productivity.
Individuals or entities constituting the holding company are required to sign a commitment addressed to the Commission stating their undertaking to refrain from taking measures that could hinder the Saudi subsidiary to fulfill its commitments towards the authorization terms.
In electricity production projects, the investor (either the holding or the Saudi subsidiary), the directors and the subsidiary employees are required to refrain from purchasing electricity in order to sell it back.
It is up to the Commission to monitor the negotiations between the investor, other licensees (distribution, transmission...) and the consumers.
On an accounting level, the Commission bans the internal accounting system of the Saudi subsidiary by requiring an accounting separation between electrical activity and any other possible activity. The accounting information must be periodically submitted to the Commission.
On an administrative level, any change of management, including the production section, shall be notified to the Commission in advance so that the latter considers the impact of this change on a possible modification of the Authorization terms.
In general, the investor shall notify the Commission of any change (technical, administrative and / or legal) and any major incident that could occur during the exploitation of the Authorization. This authorization notes the obligation of the investor to take measures to prevent any harm to the environment and to provide the industrial safety for the station. Insurance contracts for staff and station’s equipment are specifically required. In case of emergency, all production facilities become de facto under the direct control of the Commission.
(iii) Monitoring the market:
The implementing decree provides for regulatory measures to ensure the principle of free trade in the electricity market. It provides to the Commission the power and the legal tools to control concentration and fight anti-competitive practices. The implementing decree prohibits any merger or purchase (even for a rate of 5% of shares) if the transaction would create a situation of dominance in the electrical industry market. This restriction allows the Commission to check the operators’ identity in the national electricity sector. The approval of the Commission must be requested and received in advance by means of a notification submitted by the investors themselves. The request for approval must disclose the new investors’ identity (owning more than 5% shares), the total value of their investments and their income in the Saudi power sector. The Saudi subsidiary, the holding company, the directors and the employees must also refrain from practicing any activity that could affect competition in the market.
The Commission has a discretionary power to determine whether any act should be considered as unfair competition. It may call for the immediate end of acts of unfair competition and force the investor to take palliative steps.
The Commission is empowered to set rates for electrical services and control those which are issued by investors. Exceptionally, the investor has the power to freely negotiate its rates only in the case of a contract with a major consumer provided that in this case, the Commission is informed in advance about the agreement.
IV. Connection to the national electricity network:
The transportation of the produced energy is provided by the public network. A framework-contract between the investor and the SSE regulates the connection of the station to the public network.
The framework-contract is not to be based on the free consent of the investor; it contains several stipulations which reflect the dominance of the ESS versus the investor. The contract’s performance is suspended until the SSE makes sure that the equipment installed in the station is effectively functional, that all the technical information has been presented, that the official fees were paid, that financial guarantees have been well provided, and that authorization and missions have been duly received.
The delivery of electrical energy is limited by the rate fixed in the framework-contract. Whatever the station’s production capacity is, the investor cannot exceed the limits of supply as they were set in the framework-contract. The investor must pay the charges for the SSE network use public electricity and must also provide bank guarantees covering the payment obligation. The SSE keeps the right to recalculate the amount of these fees once the investor has obtained the necessary authorization.
By the framework-contract, the investor is required to install an equipment in good operating conditions, providing a stable productivity of the station. The ownership and exploitation of the equipment is guaranteed by the framework-contract: no party can submit a charge or do any test on the equipment of the other party unless by written consent. The investor and the SSE can use real estate properties to install or inspect the equipment required for the transportation of the produced energy.
The Distribution Code is the technical reference for the electricity delivery service. Non-compliance by the investor of this code’s prescriptions may lead to the termination of the framework-contract.
In case of dispute, the investor and the SSE should start direct negotiations and, later, through the commission’s Dispute Settlement Committee. If private negotiations fail, the commission’s Dispute Settlement Committee will resolve the point at issue. In fact, the Committee is a jurisdiction body but extra-judicial; it is a common practice in Saudi Arabia whose objective is to spare sensitive sectors of competence and the judicial ban of the courts applying religious law.
V. Financing
Concerning the financing of the solar power project, the investor generally expects tax benefits/incentives, public support as well as competitive pricing for electricity.
In Saudi Arabia, unlike the industrialized countries, projects of solar power are not yet subjected to tax benefits/incentives. The government does not feel confronted to a challenge in providing energy and, subsequently, does not consider encouraging the private sector fiscally to promote renewable energy sources as a priority.
However, despite the current global crisis, Saudi banks hold an unprecedented liquidity. The Saudi government, through the Industrial Development Fund, lends any project ensuring the transfer of new technologies to the Saudi industrial market.
The multiple financing methods of construction projects are not easily transposable in Saudi Arabia. The Foreign Investment Act has some conditions that make some financial arrangements unworkable.
The technique of Project Finance appears to be one of the first approaches to be implemented given the fact that during the project’s preparatory phase, a sale contract of electricity should be concluded with the SSE (or a major consumer). Thus lenders will find in this contract the necessary guarantee to be paid back. Yet, legal difficulties arise: the Project Finance operations often follow the corporate model (consisting of setting-up a subsidiary involving all partners, each one being in charge of a given section of the project) much more than the contractual model (based on a joint venture agreement governing the division of obligations and responsibilities among the various contracting parties). But with the corporate model option, and under the conditions issued by SAGIA, the subsidiary will get the investment authorization only by the condition that the commercial and technical profile of each partner should belong to the industrial sector subject to authorization. This is not always the case, especially for members whose contribution is purely financial, administrative or logistical. This leads to the fact that partners whose contributions are outside the production of electricity, cannot be part of the project unless through a joint venture contract. The solution might be a financing method mixed between corporate and contractual constituents.
Moreover, it isn’t easily possible that a foreign company seeking to enter the Saudi market opts for a legal structure without responsibility and risk limitation; thus, the option of creating a branch, which financing, risk taking and management are directly provided by the holding company, is to be ignored. Another local legal particularity should be taken into consideration; the Saudi corporate law still doesn’t recognize a private company owned by one partner; the foreign company needs to search for another company having at least the same technical profile, in order to make sure to get the investment authorization.
From the legal obstacles raised above, the palliative can consist of a PPP structure (Public-Private Partnership) with various advantages: the SSE is already allowed to invest with private entities; by having a public law entity as a partner, the administrative support is more secure and can operate with more transparency; the financing by the Industrial Development Fund becomes more guaranteed.
VI. Construction Contracts
The construction project of an electricity production station using solar power involves bringing in many suppliers (of services and equipment). There are engineers, equipment suppliers, builders, labor suppliers and testing and rehabilitation companies. In such projects, the contractual structure commonly used by investors is the contract “EPC - Engineering, Procurement, Construction” where the investor assigns to a single contractor engineering works, construction and equipment supply. The advantage of this contractual technique is to allow the investor to avoid negotiating with many suppliers. The builder shall provide the required services by himself or through sub-contractors. The EPC contract normally provides for the obligation that the builder should test the installed equipment and ensure its proper functioning.
Yet the Saudi law does not recognize to a company, registered in Saudi Arabia, the right to combine the activities of engineering and construction(19). Each one of these activities has its own legal and administrative system. This leads the foreign investor to face two strategic choices: using local expertise (yet rare in the field of solar power stations) with the potential contractual complexity that might result, or bringing in European and North American companies whose technology in the field of large solar power stations is essential, taking into consideration the cost of travel of the experts.
Conclusion:
The energy market is of strategic importance for an emerging economy with liquidity as that of Saudi Arabia: The Saudi government seeks to meet its energy needs having a 5% annual increase; domestic water is mainly produced by the desalination stations with massive electricity consumption; furthermore, the government has just launched a ten year plan to modernize the infrastructure of the entire country. Government authorities in Saudi Arabia would probably favor the use of renewable sources to supply energy to these projects, given the low risks and costs that are incurred.
In the near future, the legal system for renewable energy projects in Saudi Arabia will be affected by the regional policy adopted by the leaders of the Gulf countries consisting of following, in one way or another, the European model (20) of renewable energy, aiming to take advantage of new technologies to provide reliable regional energy security, meeting the requirements of economic development and reducing dependence from fossil sources of energy. Projects of linking the national electricity networks are beginning to emerge. With all the above, Saudi solar power market is of high economic promise, framed by a relatively transparent legal frame.
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1. Augustin Mouchot, during the Universal Exhibition of Paris, 1878
2. Hermann Scheer, “Energy autonomy”, Earthscan 2007 (“The question has never been whether the world would run out of oil, but when… We must quickly move the transition away from using oil as fuel…”). Mattew R. Simmons (author of “Twilight in the desert”, John Wiley & Sons, Inc. Edition, 2005), considers that the start of the decline in oil production is sooner than anticipated.
3. John Dernbach and Seema Kakade, “Climate change law: An introduction”, Energy Law Journal, Vol. 29. N. 1, 2008, p. 1.
4. Matthew Holden, “Energy policy and the Obama administration: some choices and challenges”, Energy Law journal, Vol. 30:405., p. 406 et 408.
5. Japan is the industrialized country most dependant of foreign energy supply (96% of national consumption), Junko Ogawa, “Peaceful use and acceptance of nuclear energy in Japan: A personal perspective”, in. “Nuclear energy in the Gulf”, The Emirates Center for Strategic Studies and Research, 2009, p. 211; P. Fox-Penner, “Smart power: climate change, the smart grid and the future of electric utilities”, Island Press, 2010, p. 7.
6. Riyadh Aba-Alkhail, “Investment opportunities in the utility sector”, Energy Sector – SAGIA, May, 2009.
7. S. M. Said, I. El-Amin and A.M. Al-Shehri, “Renewable Energy Potentials in Saudi Arabia”, p. 4, King Fahd University of Petroleum & Minerals, Dhahran, Saudi Arabia.
8. During the next twenty five years, the Saudi government will invest 117 billion dollars in the energy sector.
9. Report of the International Energy Transactions Committee, Energy Law Journal, 2009, Vol. 30:207, p. 216.
10. Yazid Nasir, “ Legal aspect of oil sources property”, Legal magazine, Jordan, 2008, p. 357.
11. Yazid Anis Nasir, Ibid.
12. This is the result of two main objectives: in order to produce a megawatt, a land of one acre area is needed; in order to have a maximum sunshine capacity, the investor looks for a land large enough to allow him to move the panels easily.
13. Brit T. Brown et Benjamin Escobar, "Wind power: Generating electricity and lawsuits", Energy Law Journal, Vol. 28.489, p. 490.
14. Thomas Von Danwitz, "Regulation and liberalization of the European electric market: A German view", Energy Law Journal, Vol. 27.423, p. 423.
15. Robert W. Gie, Songbin Zhu et Xiaolin Li, "China's power sector: Global economic and environmental implications", Energy Law Journal, Vol. 28, p. 426
16. Article 8 of the electricity regulation implementation decree.
17. Concerning the station’s executive directors, the Commission has the right to refuse to issue the authorization if it has any conditions towards one of the appointed directors.
18. Article 3.5.1 of the resolution N. 66/429 of the Commission’s governor (66/429 dated 21/11/1429 H) concerning the Department of Legal Affairs and Authorizations
19. Only companies working with the Aramco benefit from an exception allowing them to combine such activities.
20. Pekka Voutilainen, "Developing energy policy for Europe: A Finnish perspective on energy cooperation in the European Union", Energy Law journal, Vol. 29, 2008, p. 121.
ABOUT THE AUTHOR: Naïm S. Al Chami
Legal Consultant, Talal Abu Ghazaleh Legal "TAG-Legal", Riyadh - Saudi Arabia
Copyright Talal Abu-Ghazaleh Legal (TAGLegal)
More information about Talal Abu-Ghazaleh Legal (TAGLegal)
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
Globally, electricity production is facing three main challenges: reducing the effects of climate change, guaranteeing the energy security (5) and promoting the competitiveness of private companies. Among these three challenges, Saudi Arabia offers, on one hand, promising productivity opportunities (6) given the 2200 hours thermal kilowatt (kWh) per square meter (7) yearly sunshine on its territory, and on the other hand, it is showing a high annual increasing rate in electricity needs. Solar power is supposed to provide a strategic contribution to energy needs in this country. “Green” companies seeking to sell electricity at a significantly low cost should head to this country. Saudi Arabia has recently acknowledged the importance of renewable energy and their role in an economic future limitedly dependent of oil. The King Abdallah City for Nuclear and Renewable Energy was created in April 2010. It has the mission develop a national energy policy based on nuclear energy and renewable sources, and it would bring to the Saudi market the related technology. Investments in the solar power sector in Saudi Arabia are commercially promising (8) and legally permitted. By following the European model (9) of electricity market liberalization, the Saudi government has established a national authority of control and regulation and a modern system for licensing.
This article aims to evade the legal aspects concerning foreign investments in Saudi Arabia in the field of solar power. The followings will be analyzed: The legal framework for investments (I), Property law (II), Official authorizations (III), Connection to public electricity network (IV), financing (V) and construction contracts (VI).
I- The legal framework for investments
Commercial exploitation of solar power is not specifically regulated in the Saudi Law; only the oil sector is well regulated. Yet, a comparative approach between hydrocarbons and renewable sources of energy would enable to outline the legal characteristics that could serve as a discussion basis for this new market.
The right of exploitation of solar radiation is substantially different from oil. Oil reserves ownership can be legally unstable (10) . This characteristic comes from the fact that oil, being a fluid located in deep fields exposed to high pressure, tends to move to other fields when the pressure rate falls. Legally speaking, this fluidity can generate a change of ownership in case oil moves across the border of two neighboring countries, or across the limits of two exploration or exploitation fields coming under two private entities. An American court has clearly noted this aspect by the following terms: “Oil is an independent category among minerals, a mobile mineral... Unlike other solid minerals, it has the intrinsic capacity to move to other fields. Its location in a defined field is uncertain. It belongs to the land owner while located in it and depends on his willingness to exploit it... Thus, owning the land does not necessarily mean owning the oil (11)”
This characteristic of unstable property concerning oil is not transposable to solar radiation. Sun rays are, by nature, directed. Since they are projected, they follow a fixed destination. Dynamic and moving, solar radiation follows a fixed trajectory and targets a given point of the globe. The fact that there is no possibility of sun rays deviation, any movement of sun rays from one country to another, from one production site to another, is inconceivable. Since sun rays end up on a certain site, they lose any mobility and become an exclusive right of exploitation of the site owner. The right of exploitation of sun rays is thus a certain and definite right.
As for the legal basis of commercial exploitation of solar radiation in Saudi Arabia, it is beneficial to refer to the religious thought existing there since it is a new matter and since the legal framework dealing with it expressly is to be elaborated. The Saudi Law is becoming more and more positivist and is straying from the classic methodologies, but religious law is always used as a legal discussion basis for any recent legal problematic issue. Hanbalism, the theological school dominating Islam in Saudi Arabia, seems to welcome favorably the commercial exploitation of solar radiation. According to this school’s theologians, it is accepted, for natural sources property, that the land owner acquires and gets the right to exploit the resources that can be found above ground only; land owner has no entitlement over the underground resources and cannot exploit them. The Roman law maxim “Cajus est solum, ejus est usque ad coelum et ad inferos” isn’t taken into consideration. By analogy to above ground mineral sources, solar radiation can be privately exploited. This is a basic solution since it rejects the approach consisting to subject these investments to the concessions system applied to oil sources.
II- Property law:
Property, lease and access rights are among the sine qua non conditions for an electricity production project based on solar power. The Saudi Law of foreign investment allows the foreign investor to acquire or to rent the necessary real estate properties for his professional activity. The country’s large areas can have favorable or unfavorable legal repercussions in relation to the projects of solar power production.
On one hand, the investor, looking to rent a large area (12), can easily find one with competitive rents; moreover, the nearness of solar power stations to urban areas doesn’t raise legal risks as for windmills installation (13) elsewhere, since they can generate sound vibrations harmful to health. On the other hand, projects of solar power production are usually located on city limits; since the lands surrounding the cities are a desert that is often a State property, it is somehow difficult to negotiate ‘commercially’ a lease or a purchase contract. In industrialized countries having developed large solar power production sites, the rent can be calculated through many ways: according to the site’s market value, according to the site’s sunshine average or the potential profitability of the produced electricity. Negotiating these rent evaluation techniques with a public entity seems quite complicated and, afterwards, many investor prerogatives may not be raised or accepted by the state.
Moreover, Saudi Arabia has installed a vast pipeline network going beyond its borders. There are also mineral products mines with important reserves for Saudi Arabia. Therefore, it is imperative, in the west side of the country in particular, to take these pipelines into consideration for they can give the State a right of access, inspection or maintenance.
Solar power is produced according to two techniques: photovoltaic panels (PV) or concentrated solar power (CSP). Choosing one of these techniques affects the choice of the land type and the legal foundation of property law (rental or purchase). It is admitted that in the case of a site using the CSP technique, a lease contract is more appropriate since the land owner intends to continue the land’s exploitation (specially in the case of an agricultural activity that won’t be hindered by the installation of concentration panels). In Saudi Arabia, this concern doesn’t exist because of the country’s large area and the rare agricultural activity. On the other hand, it is advisable to rent a land without giving the owner the right to practice any activity, given the necessity to have the private operational means for the panels’ periodical cleaning, due to the frequent dust storms.
agricultural activity. On the other hand, it is advisable to rent a land without giving the owner the right to practice any activity, given the necessity to have the private operational means for the panels’ periodical cleaning, due to the frequent dust storms.
The property rights being guaranteed, the electricity sector laws provide additional prerogatives and property restrictions.
The Executive Decree ruling the duties of the Electricity Regulation Authority (the Authority) published in May 2006, allows the Authority to intervene in case of negotiations’ failure between an investor having the official authorizations to build a solar power site and a land owner. This intervention aims to help the investor to acquire the property needed to practice his activity. The Authority examines the acquisition request sent by the investor and has the right to suggest three solutions: the resumption of private negotiations between the investor and the land owner, suggesting new sites, the acquisition of the location to benefit the investor.
Another prerogative consists in granting the investor a right of way in a third party property in order to connect the site to the public network or to connect a client to the given site. This right of way can’t be freely practiced: it concerns the investor, his employees and his equipment, and must be preceded by a notification sent to the owner. The way must be limited in time and the investor has to choose qualified technicians who will be able to complete, as soon as possible, the connection or rehabilitation work.
In general, the investor is requested to protect sites of cultural, natural or historical significance. Any damage must be reported to the related authorities (Ministry of Culture or Ministry of the Environment).
III- Official authorizations
The liberalization of the Saudi power sector was inspired by foreign experiences, which were based on a privatization process accompanied by an increased state control (14). The strategic importance of this sector leads to the establishment of a control and regulation body (15).
Yet, as for the Chinese case, the liberalization of the electricity sector confronts Saudi structural barriers related to the centralization of the licensing authority, despite the geographical big size of the country.
1. Privatization:
Like any other developing country, Saudi Arabia is keen to provide the process of industrialization of its economy by the technologies developed in industrialized countries. New technologies in the field of renewable energy will constitute a large added value to the energy-industrial sector of Saudi Arabia. To achieve this goal, the process of privatization of the electric energy sector started in 1998 (by Decree N. 169/1998 of the Cabinet). All public companies operating in the electricity sector were merged into a public company (Saudi Electricity Company - SSE) governed by the regulation of commercial companies. In terms of electricity production, the concession system was not adopted and remains, therefore, limited to the oil sector.
Decree N. 169/1998 turns to the private sector in order to participate in the construction and management of electric energy projects. The SSE is also authorized to create commercial companies or partnerships with private companies (national or foreign).
State control is provided through the Managing Commission of Electricity (Commission, governed by Decree N. 154 of the Cabinet, published in 2008) and Resolution N 66/429 of the Commission’s Governor, published in 2008, establishing the Department of Legal Affairs and Authorizations.
Finally, the Decree of Application of Electricity Regulation (Decree of Application), published by the Commission in May 2006, mentions that, among the objectives of the national electricity plan, there is the establishment of an electric energy sector based on private sector intervention. Access of private entities to the electricity market being claimed, it is still required to obtain official authorizations to implement a preliminary and continuous control in relation to electricity projects.
2. Official control:
The official control requires requesting a preliminary authorization (i) followed by a final authorization (ii). Over time, the project is subject to a relatively strict official supervision (iii).
(i) The preliminary authorization:
The texts governing the electricity sector in Saudi Arabia does not specifically address the solar radiation as a source of electricity; however, no text provides an exhaustive list of sources of electricity. Article 5-1 of the Application Decree lists, as examples, several activities related to the electricity sector and requiring, thereafter, an official authorization. In terms of production activity, Article 5.1 states, in general terms, that "Any electricity production” requires an official authorization. With no specification of the source used for electricity production, this article allows to note that solar power can be among sources of electricity that require official authorization. Article 5-2 of the Application Decree stipulates that the Board of Directors of the Commission has the right to issue new authorizations related to new techniques of electricity production.
The official process is initiated by a request of a preliminary authorization addressed by the investor to the Commission. Usually, authorization requests must be equally processed by only taking into account the technical capacities of the project, its economic size and its place in the national electricity plan.
During a primary control, the Commission ensures that the project is in line with the national electricity plan. The investor must disclose information related to his legal profile, technical and logistical aspects of the project and the objectives of use of the produced energy.
The granting of preliminary authorization does not guarantee getting the final authorization. While studying applications, the Commission has a discretionary power. The reference criteria consider the technical, financial and industrial aspects of the project and the industrial know-how transmitted to the Saudi market. The Commission has the right to issue additional authorizations to other investors at the same site and for the same type of activity. Projects of which electricity production is destined to self-consumption are exempt from the obligation to ask for authorizations.
(ii): The final authorization
After getting the preliminary authorization, and before seeking the final authorization, the investor must submit to SAGIA (Saudi Arabian General Investment Authority) the application for investment license which aims to disclose the legal profile of the investor and his previous projects to the Ministry of Commerce. After getting the investment license, the investor shall submit to the Commission the request for final authorization of electricity production. The request must provide detailed information on the following aspects (16):
1. The official structure of the holding company and the Saudi subsidiary;
2. Documents proving the property rights related to the site of the station;
3. The capital invested through the Saudi subsidiary;
4. Studies on the environmental effects of the station and the authorization issued by the Environmental Protection Authority;
5. The technical data of the station;
6. Copies of contracts with other local investors (distribution, sales ...);
7. Proof of financial funds necessary to build the station and, if needed, a commitment to provide additional funding;
8. Proof of technological know-how to build and operate the station;
9. Proof of compliance of the project’s various sections with the Electricity Regulation;
10. Declaration of ownership of any shares or equities in companies managing similar projects in Saudi Arabia;
11. The accounting system of the Saudi subsidiary;
12. Electrical activities (17) directors’ names of the Saudi subsidiary.
Transparency of the information exchanged during the authorization process is basic. The Commission considers the technical data of each production site in order to evaluate the progress in implementing the national plan of electric growth. Thus, any inaccurate information provided to the Commission, would directly lead to the refusal to issue the authorization. The Commission has the obligation to publish all its decisions concerning authorization requests. Yet all that was marked by the investor as part of his trade secrecy and techniques will be a strict obligation of confidentiality.
With the granting of the authorization, the investor’s supervision by the Commission comes into force. It includes several areas of his activity.
At the technical level, the exploitation’s period is related to the period of viability of the equipment installed in the station. The scope of the exploitation is strictly limited to the authorized activity. An investor cannot stop electricity production unless there is force majeure situation. Throughout the authorization’s period, specifications and technical criteria of the Electricity Distribution Code should be followed, including the conditions for good quality service. The Authorization also includes an obligation to sign a contract concerning the connection of the station to the national network of electricity.
In case of technical accident, the Commission has the right to grant the investor a temporary authorization allowing him to start the production until the request for the final authorization is decided (18).
In general, the Commission has the right to inspect the electricity production sites to test the nature and rates of gaseous emissions, noise pollution and proper treatment of industrial waste.
On a legal level, the production authorization is granted in consideration of the specific characteristic of the investor. Thus, any restructuring, assignment, merger and / or expansion of the project, any sub-contract, lease, exchange or allocation of a right related to the Authorization shall be notified in advance to the commission to be approved. The same condition applies for the station equipment; the reason is the concern of the Commission to ensure that the transferred assets, subject to any transaction, should be immediately replaced by assets having the same efficiency and productivity.
Individuals or entities constituting the holding company are required to sign a commitment addressed to the Commission stating their undertaking to refrain from taking measures that could hinder the Saudi subsidiary to fulfill its commitments towards the authorization terms.
In electricity production projects, the investor (either the holding or the Saudi subsidiary), the directors and the subsidiary employees are required to refrain from purchasing electricity in order to sell it back.
It is up to the Commission to monitor the negotiations between the investor, other licensees (distribution, transmission...) and the consumers.
On an accounting level, the Commission bans the internal accounting system of the Saudi subsidiary by requiring an accounting separation between electrical activity and any other possible activity. The accounting information must be periodically submitted to the Commission.
On an administrative level, any change of management, including the production section, shall be notified to the Commission in advance so that the latter considers the impact of this change on a possible modification of the Authorization terms.
In general, the investor shall notify the Commission of any change (technical, administrative and / or legal) and any major incident that could occur during the exploitation of the Authorization. This authorization notes the obligation of the investor to take measures to prevent any harm to the environment and to provide the industrial safety for the station. Insurance contracts for staff and station’s equipment are specifically required. In case of emergency, all production facilities become de facto under the direct control of the Commission.
(iii) Monitoring the market:
The implementing decree provides for regulatory measures to ensure the principle of free trade in the electricity market. It provides to the Commission the power and the legal tools to control concentration and fight anti-competitive practices. The implementing decree prohibits any merger or purchase (even for a rate of 5% of shares) if the transaction would create a situation of dominance in the electrical industry market. This restriction allows the Commission to check the operators’ identity in the national electricity sector. The approval of the Commission must be requested and received in advance by means of a notification submitted by the investors themselves. The request for approval must disclose the new investors’ identity (owning more than 5% shares), the total value of their investments and their income in the Saudi power sector. The Saudi subsidiary, the holding company, the directors and the employees must also refrain from practicing any activity that could affect competition in the market.
The Commission has a discretionary power to determine whether any act should be considered as unfair competition. It may call for the immediate end of acts of unfair competition and force the investor to take palliative steps.
The Commission is empowered to set rates for electrical services and control those which are issued by investors. Exceptionally, the investor has the power to freely negotiate its rates only in the case of a contract with a major consumer provided that in this case, the Commission is informed in advance about the agreement.
IV. Connection to the national electricity network:
The transportation of the produced energy is provided by the public network. A framework-contract between the investor and the SSE regulates the connection of the station to the public network.
The framework-contract is not to be based on the free consent of the investor; it contains several stipulations which reflect the dominance of the ESS versus the investor. The contract’s performance is suspended until the SSE makes sure that the equipment installed in the station is effectively functional, that all the technical information has been presented, that the official fees were paid, that financial guarantees have been well provided, and that authorization and missions have been duly received.
The delivery of electrical energy is limited by the rate fixed in the framework-contract. Whatever the station’s production capacity is, the investor cannot exceed the limits of supply as they were set in the framework-contract. The investor must pay the charges for the SSE network use public electricity and must also provide bank guarantees covering the payment obligation. The SSE keeps the right to recalculate the amount of these fees once the investor has obtained the necessary authorization.
By the framework-contract, the investor is required to install an equipment in good operating conditions, providing a stable productivity of the station. The ownership and exploitation of the equipment is guaranteed by the framework-contract: no party can submit a charge or do any test on the equipment of the other party unless by written consent. The investor and the SSE can use real estate properties to install or inspect the equipment required for the transportation of the produced energy.
The Distribution Code is the technical reference for the electricity delivery service. Non-compliance by the investor of this code’s prescriptions may lead to the termination of the framework-contract.
In case of dispute, the investor and the SSE should start direct negotiations and, later, through the commission’s Dispute Settlement Committee. If private negotiations fail, the commission’s Dispute Settlement Committee will resolve the point at issue. In fact, the Committee is a jurisdiction body but extra-judicial; it is a common practice in Saudi Arabia whose objective is to spare sensitive sectors of competence and the judicial ban of the courts applying religious law.
V. Financing
Concerning the financing of the solar power project, the investor generally expects tax benefits/incentives, public support as well as competitive pricing for electricity.
In Saudi Arabia, unlike the industrialized countries, projects of solar power are not yet subjected to tax benefits/incentives. The government does not feel confronted to a challenge in providing energy and, subsequently, does not consider encouraging the private sector fiscally to promote renewable energy sources as a priority.
However, despite the current global crisis, Saudi banks hold an unprecedented liquidity. The Saudi government, through the Industrial Development Fund, lends any project ensuring the transfer of new technologies to the Saudi industrial market.
The multiple financing methods of construction projects are not easily transposable in Saudi Arabia. The Foreign Investment Act has some conditions that make some financial arrangements unworkable.
The technique of Project Finance appears to be one of the first approaches to be implemented given the fact that during the project’s preparatory phase, a sale contract of electricity should be concluded with the SSE (or a major consumer). Thus lenders will find in this contract the necessary guarantee to be paid back. Yet, legal difficulties arise: the Project Finance operations often follow the corporate model (consisting of setting-up a subsidiary involving all partners, each one being in charge of a given section of the project) much more than the contractual model (based on a joint venture agreement governing the division of obligations and responsibilities among the various contracting parties). But with the corporate model option, and under the conditions issued by SAGIA, the subsidiary will get the investment authorization only by the condition that the commercial and technical profile of each partner should belong to the industrial sector subject to authorization. This is not always the case, especially for members whose contribution is purely financial, administrative or logistical. This leads to the fact that partners whose contributions are outside the production of electricity, cannot be part of the project unless through a joint venture contract. The solution might be a financing method mixed between corporate and contractual constituents.
Moreover, it isn’t easily possible that a foreign company seeking to enter the Saudi market opts for a legal structure without responsibility and risk limitation; thus, the option of creating a branch, which financing, risk taking and management are directly provided by the holding company, is to be ignored. Another local legal particularity should be taken into consideration; the Saudi corporate law still doesn’t recognize a private company owned by one partner; the foreign company needs to search for another company having at least the same technical profile, in order to make sure to get the investment authorization.
From the legal obstacles raised above, the palliative can consist of a PPP structure (Public-Private Partnership) with various advantages: the SSE is already allowed to invest with private entities; by having a public law entity as a partner, the administrative support is more secure and can operate with more transparency; the financing by the Industrial Development Fund becomes more guaranteed.
VI. Construction Contracts
The construction project of an electricity production station using solar power involves bringing in many suppliers (of services and equipment). There are engineers, equipment suppliers, builders, labor suppliers and testing and rehabilitation companies. In such projects, the contractual structure commonly used by investors is the contract “EPC - Engineering, Procurement, Construction” where the investor assigns to a single contractor engineering works, construction and equipment supply. The advantage of this contractual technique is to allow the investor to avoid negotiating with many suppliers. The builder shall provide the required services by himself or through sub-contractors. The EPC contract normally provides for the obligation that the builder should test the installed equipment and ensure its proper functioning.
Yet the Saudi law does not recognize to a company, registered in Saudi Arabia, the right to combine the activities of engineering and construction(19). Each one of these activities has its own legal and administrative system. This leads the foreign investor to face two strategic choices: using local expertise (yet rare in the field of solar power stations) with the potential contractual complexity that might result, or bringing in European and North American companies whose technology in the field of large solar power stations is essential, taking into consideration the cost of travel of the experts.
Conclusion:
The energy market is of strategic importance for an emerging economy with liquidity as that of Saudi Arabia: The Saudi government seeks to meet its energy needs having a 5% annual increase; domestic water is mainly produced by the desalination stations with massive electricity consumption; furthermore, the government has just launched a ten year plan to modernize the infrastructure of the entire country. Government authorities in Saudi Arabia would probably favor the use of renewable sources to supply energy to these projects, given the low risks and costs that are incurred.
In the near future, the legal system for renewable energy projects in Saudi Arabia will be affected by the regional policy adopted by the leaders of the Gulf countries consisting of following, in one way or another, the European model (20) of renewable energy, aiming to take advantage of new technologies to provide reliable regional energy security, meeting the requirements of economic development and reducing dependence from fossil sources of energy. Projects of linking the national electricity networks are beginning to emerge. With all the above, Saudi solar power market is of high economic promise, framed by a relatively transparent legal frame.
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1. Augustin Mouchot, during the Universal Exhibition of Paris, 1878
2. Hermann Scheer, “Energy autonomy”, Earthscan 2007 (“The question has never been whether the world would run out of oil, but when… We must quickly move the transition away from using oil as fuel…”). Mattew R. Simmons (author of “Twilight in the desert”, John Wiley & Sons, Inc. Edition, 2005), considers that the start of the decline in oil production is sooner than anticipated.
3. John Dernbach and Seema Kakade, “Climate change law: An introduction”, Energy Law Journal, Vol. 29. N. 1, 2008, p. 1.
4. Matthew Holden, “Energy policy and the Obama administration: some choices and challenges”, Energy Law journal, Vol. 30:405., p. 406 et 408.
5. Japan is the industrialized country most dependant of foreign energy supply (96% of national consumption), Junko Ogawa, “Peaceful use and acceptance of nuclear energy in Japan: A personal perspective”, in. “Nuclear energy in the Gulf”, The Emirates Center for Strategic Studies and Research, 2009, p. 211; P. Fox-Penner, “Smart power: climate change, the smart grid and the future of electric utilities”, Island Press, 2010, p. 7.
6. Riyadh Aba-Alkhail, “Investment opportunities in the utility sector”, Energy Sector – SAGIA, May, 2009.
7. S. M. Said, I. El-Amin and A.M. Al-Shehri, “Renewable Energy Potentials in Saudi Arabia”, p. 4, King Fahd University of Petroleum & Minerals, Dhahran, Saudi Arabia.
8. During the next twenty five years, the Saudi government will invest 117 billion dollars in the energy sector.
9. Report of the International Energy Transactions Committee, Energy Law Journal, 2009, Vol. 30:207, p. 216.
10. Yazid Nasir, “ Legal aspect of oil sources property”, Legal magazine, Jordan, 2008, p. 357.
11. Yazid Anis Nasir, Ibid.
12. This is the result of two main objectives: in order to produce a megawatt, a land of one acre area is needed; in order to have a maximum sunshine capacity, the investor looks for a land large enough to allow him to move the panels easily.
13. Brit T. Brown et Benjamin Escobar, "Wind power: Generating electricity and lawsuits", Energy Law Journal, Vol. 28.489, p. 490.
14. Thomas Von Danwitz, "Regulation and liberalization of the European electric market: A German view", Energy Law Journal, Vol. 27.423, p. 423.
15. Robert W. Gie, Songbin Zhu et Xiaolin Li, "China's power sector: Global economic and environmental implications", Energy Law Journal, Vol. 28, p. 426
16. Article 8 of the electricity regulation implementation decree.
17. Concerning the station’s executive directors, the Commission has the right to refuse to issue the authorization if it has any conditions towards one of the appointed directors.
18. Article 3.5.1 of the resolution N. 66/429 of the Commission’s governor (66/429 dated 21/11/1429 H) concerning the Department of Legal Affairs and Authorizations
19. Only companies working with the Aramco benefit from an exception allowing them to combine such activities.
20. Pekka Voutilainen, "Developing energy policy for Europe: A Finnish perspective on energy cooperation in the European Union", Energy Law journal, Vol. 29, 2008, p. 121.
ABOUT THE AUTHOR: Naïm S. Al Chami
Legal Consultant, Talal Abu Ghazaleh Legal "TAG-Legal", Riyadh - Saudi Arabia
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
