BOARD OF DIRECTORS' REPORT
On behalf of the Board of Directors of Sohar Power Company SAOG (“Sohar Power” or the “Company”), I am pleased to present you with the fourteenth Annual Report of the Company for the year ended 31 December 2018, corresponding to the twelfth year of operations of the Company.
Sohar Power was incorporated in 2004 after the award of the Sohar IWPP project resulting from a competitive bidding process and started its operations in 2007. The Company owns and operates the 585MW electricity generation and 33MIGD seawater desalination plant in Sohar Port and Freezone industrial area. It sells electricity and water to Oman Power and Water Procurement Company SAOC (“OPWP”) under a 15-year Power and Water Purchase Agreement (“PWPA”), in a regulated but not competitive environment. The Company has been listed on the Muscat Securities Market since 2008.
Health & Safety
The year 2018 has seen excellent Health and Safety performance for Sohar Power. There were no Lost Time Accidents (LTA), accumulating to 2163 days without LTA at the end of the year. Health and Safety of our employees, contractors and visitors remains the utmost priority for the Company and its operator Sohar Operations & Maintenance Company LLC (“SOMC”).
The demand for power has increased in 2018 compared with 2017. The demand for water remained high throughout both years. Accordingly, the load factors of the plant reached 69.1% for power (64.8% in 2017) and 82.3% for water (85.0% in 2017).
The plant was operated reliably during the period. An aggregate net power quantity of 3,543 GWh and a total volume of desalinated water of 45,032,236 m3 were delivered.
The plant achieved 98.3% reliability for power and 98.0% for water in 2018. Forced outages amounted to 1.7% for the power plant and 2.0% for the water plant.
The Contract Year number 12 started on 01 April 2018. The annual performance test was successfully undertaken demonstrating to OPWP the guaranteed capacity of the plant on both fuel gas and fuel oil.
In terms of maintenance, the Company was able to undertake the required annual maintenance activities of its key equipment during the 2017-2018 winter period.
Maintenance activities were performed by SOMC and its sub-contractors, in accordance with Original Equipment Manufacturers’ recommendations, while applying the best standards and practices for health & safety and maintenance of the industry. GT#1 and GT#2 underwent Major Inspections during the Winter Period.
Following the outcome of the assessment of the efficiency of technical operations and maintenance processes at site last year, the Company continues to implement actions to improve its business processes and manage in a better manner all the risks that could potentially be faced by the project.
The Board of Directors would like to announce that the Company has ended the year with a net loss of RO 10.939 million.
In comparison, the profit for the year 2017 amounted to RO 2.030 million. The decrease in net profit in 2018 is explained by the impairment of the Desalination Plant of RO 18.554 million recorded by the Company at the end of 2018, following the non-prequalification of the power and water offer by Sohar Power to OPWP during OPWP’s Power 2022 Tender process. As a consequence, the water production activities of the Company will have to be discontinued at the term of the Company’s current PWPA in 2022.
The revenues for the year 2018 amount to RO 66.5 million against RO 64.5 million for the year 2017, increased mainly by the increase in gas revenues (driven by the higher load factor), which is a pass-through item under the PWPA (and financially neutral to the Company).
The direct costs, besides the impairment matter, have also increased from RO 52.2 million in 2017 to RO 54.4 million in 2018, due to the increase in gas consumption.
Long term loans were repaid, and swaps were settled on their due dates. The hedging deficit on the Company's swap agreements, at the close of business on 31 December 2018 was RO 4.9 million, in comparison with valuations as of 31 December 2017 of RO 8.2 million. As per IAS 39, hedging deficit is calculated on each balance sheet date and it represents a notional loss, which the Company may incur, if it opts to terminate the swap agreements on this date. However, under the terms of Financing Agreements, the Company is not permitted to terminate its swap agreements and, as such, the loss is notional.
The reduction in finance costs by RO 0.5 million in 2018 in comparison to 2017 is associated with debt repayments during the year.
Under its Financing Agreements entered into with its lenders, Sohar Power is subject to a cash sweep mechanism which started on 30 September 2015 and will last until the full repayment of the long-term loans. The cash sweep mechanism prevents distribution of dividend to shareholders since all the available cash is devoted to the repayment of the loans. This mechanism is common in financing agreements throughout the region and helps providing a competitive tariff for an off-taker such as OPWP at the time of bid. As previously disclosed, the pay out of dividends ended in 2016 and there will be no more dividend distributions to shareholders unless the debt of the Company is refinanced and the cash sweep is successfully removed. The Company has explored and continues to explore opportunities to refinance its project finance debt, but the deteriorating credit rating of the Sultanate of Oman leads to substantially higher margins requested by the lending banks and renders a refinancing impossible.
As a consequence of the cash sweep the inability of the Company to distribute dividends, and the decrease of the worldwide and Omani Capital Market indices in 2018, the share price dropped from RO 0.150 to RO 0.120 during the year.
Revenue recognition issue and qualification of financial statements
Following the decision issued by the Appeal Committee of CMA (Decision 2/2018) dated 3 October 2018 ("Decision") confirming the Decision 10/2018 of the Disciplinary Committee of the CMA issued on 16 May 2018, warning the Company that it is in violation of Article 5 of the Capital Market Law and instructing it to restate its financial statements, and after consulting with its legal advisor, the Company appealed against the Decision before the Administrative Court of Oman. The Company has consistently applied the same accounting treatment allowed under IFRS since the beginning of the project and adequately disclosed such accounting treatment information to its shareholders and the investors’ community.
It is important to note that the differing views on the accounting treatment between the Company, AER and CMA are not linked to the cash sweep agreed under the Company’s Financing Agreements. The former discussion relates to the timing of revenue recognition (Sector Law versus CMA regulation), whereas the latter refers to an agreement between the Company and its lenders to assure the Company’s outstanding debt repayment would be accelerated from a certain point in time, as is customary for the development of Independent Power (and Water) Projects in the Omani market. Cash sweeps are a common denominator across the power and water sector in Oman.
Subsequent to year-end, on 3 March 2019, the Administrative Court issued its judgment, allowing the appeal in form and rejecting it in substance. Once the detailed judgment becomes available to the Company and, after consulting its Board of Directors, the Company will seek legal advice with regard to its right to appeal against the Judgment and will continue to engage with relevant regulatory authorities.
Please refer to the audited financial statements of the Company and to the Notes 3a and 4 in particular for more detailed information on this matter.
There are no other legal proceedings against the Company as of 31 December 2018.
In line with efforts deployed in previous years, the Company ensured that its organization, systems, policies and procedures follow the highest standards of governance in order to comply at all times with the Code of Corporate Governance promulgated by CMA, including the new Code requirements effective since July 2016.
The appraisal of the Board was conducted during the year 2018 by an independent consultant, appointed at the AGM held on 27th March 2018. Based on the criteria approved at the AGM, the Board and its Committees were appraised. The report of the consultant was received by the Chairman of the Board. The appraisal concluded that the Board performance was Very Satisfactory during the year and has been effective in meeting Board’s objectives. Certain improvements were recommended, and the Board has committed to prepare an appropriate action plan.
Pursuing their continued efforts to develop, train and employ Omanis, the Company and its operator have maintained the Omanisation level at 76% at the end of 2018.
Corporate Social Responsibility
In 2018, the Company further extended its support to local community and municipality projects mainly in North Batinah Governorate, while focusing on education, health and safety, social development and environment protection. Sohar Power was able to contribute to local projects intended for the local communities and the people of the Sultanate of Oman, through financial contributions to local initiatives amounting to RO 10,669 in 2018.
Outlook for 2019
Looking ahead, the Company expects to operate reliably and to deliver uninterrupted supply of power and water to its customer, while undertaking periodic maintenance activities, in a safe working environment for its employees, contractors and visitors.
During the year 2018, the Company engaged in the ‘2022 Power Procurement process’ launched by OPWP. As part of the process, OPWP has notified the Company on 7 February 2019 that it has pre-qualified its Power only offer but did not pre-qualify its Power and Water offer. The Company has submitted a Binding Bid for its Power only offer on February 28, 2019 after seeking approval during the Ordinary General Meeting held on February 26, 2019.
As a consequence, the Company will not be able to extend the operations of its water desalination plant beyond the term of the current PWPA ending in March 2022. This situation triggered an impairment review of the Desalination plant which resulted in an impairment loss of RO 18.554 million that is recorded in the financial year 2018. The Useful life of the Desalination plant has also been revised to 15 years from the earlier estimate of 30 years. The Desalination plant will have a remaining useful life of three years starting January 2019 and the remaining book value will be amortized over the coming 3 years.
The Company’s main objective for 2019 is to secure a new PPA with effect from 2022. In case SPC is unsuccessful in the Power 2022 Procurement process, the Company may operate in the Spot Market currently being developed in Oman, for which the rules are not yet finalised. Revenues will not be contracted in the Omani Spot Market. In view of the uncertainties surrounding the Spot Market, it is very difficult to predict the future of the Company in its current technical configuration, should it operate in the Spot Market, but it will be very challenging.
The Company is also subject to the changes in regulations prevailing in Oman (Commercial Companies Law, Value Added Tax, Withholding Taxes…) and other uncertainties that might adversely impact its financial position and its shareholders.
The energy transition is accelerating in Oman, caused by the continuous drop in prices for renewable energy such as photovoltaics and wind. This is likely to impact the competitiveness of existing conventional thermal plants and might substantially reduce their value beyond the term of their current P(W)PA.
On behalf of the Board of Directors, I wish to thank our valued shareholders for their continued support, trust and confidence. I would also like to thank all the personnel associated with the operation and maintenance of the plant in Sohar and the staff of the Company for their loyalty, dedication and commitment.
I would also like to express our gratitude to His Majesty Sultan Qaboos Bin Said and His Government for their continued guidance, support and encouragement to the private sector.
May Allah protect them all.