Optimizing capital allocation in the Saudi energy sector

Disclaimer: This article was written by Todd Barclay in his personal capacity. The opinions expressed in this article are my own and do not necessarily reflect the view of KPMG.

Introduction

The Saudi Arabian energy sector, like much of the global energy industry, is undergoing a rapid transformation driven by rising demand, the integration of renewable energy, and the Kingdom's Vision 2030 goals. Capital allocation has become a critical area of focus, requiring energy companies to strategically balance investments between traditional infrastructure and emerging technologies.

To succeed, these companies must adopt advanced methodologies such as zero-based budgeting (ZBB), activity-based costing (ABC), and portfolio-based planning. This article explores these methodologies, their applications in prioritizing renewable energy investments, transmission projects, and operational improvements, and how they can drive measurable cost reductions and return on investment (ROI) improvements.

The capital allocation challenge in Saudi Arabia's energy sector

Saudi Arabia's energy sector is at a pivotal juncture, balancing the need to meet escalating domestic energy demands with the strategic imperative to diversify its energy portfolio in line with Vision 2030. This ambitious initiative aims to reduce the Kingdom's reliance on oil revenues by increasing the share of renewable energy and enhancing energy efficiency.

Escalating energy demand: The Kingdom's energy consumption has been on a steady rise, driven by population growth and industrial expansion. In 2021, Saudi Arabia's total energy supply reached approximately 10,960,948 terajoules, climbing to approximately 11,600,000 in 2023 (official statistics for 2023 are expected to be published by relevant authorities in the coming months). In any case, this reflects a significant increase from previous years. This surge necessitates substantial investments in energy infrastructure to ensure reliable supply.

Vision 2030 and renewable energy targets: Under Vision 2030, Saudi Arabia has set ambitious goals to diversify its energy mix. The National Renewable Energy Program aims to achieve a renewable energy capacity of 71.6 gigawatts by 2040, with significant developments in solar, nuclear, wind, geothermal, and waste-to-energy sectors. Achieving these targets requires strategic capital allocation to fund large-scale renewable projects.

Financial implications: The financial commitment to transform the energy sector is substantial. The Saudi Green Initiative has activated 77 initiatives, representing an investment of more than US$186 billion, to drive sustainable growth. Additionally, the Public Investment Fund (PIF) has been instrumental in financing domestic projects, including those in the energy sector, to diversify the economy.

Challenges in capital allocation

Allocating capital effectively in this context presents several challenges:

• Resource optimization: Balancing investments between traditional energy infrastructure and renewable projects to ensure energy security and sustainability.
• Economic diversification: Aligning energy investments with broader economic diversification goals to reduce oil dependency.
• Technological integration: Incorporating advanced technologies such as energy storage systems and smart grids, which require significant capital outlay.
• Regulatory compliance: Navigating evolving regulations aimed at promoting sustainability and reducing emissions.

Opportunities for strategic capital allocation

Despite these challenges, there are significant opportunities:

• Renewable energy investments: Prioritizing funding for solar and wind projects to meet renewable energy targets.
• Infrastructure modernization: Upgrading transmission and distribution networks to enhance efficiency and integrate renewable sources.
• Technological advancements: Investing in smart grid technologies and energy storage solutions to improve grid reliability and flexibility.
• Public-private partnerships: Leveraging collaborations to share risks and mobilize additional capital for large-scale projects.

The capital allocation challenge in Saudi Arabia's energy sector is multifaceted, involving the need to meet growing energy demands, achieve Vision 2030 objectives, and manage substantial financial investments. Strategic capital allocation is essential to navigate these complexities and capitalize on the opportunities presented by the Kingdom's energy transformation.

Methodologies for enhancing capital allocation efficiency

1. Zero-based budgeting (ZBB): Building from the ground up

ZBB is a budgeting methodology that requires organizations to justify all expenses for each new budget period, starting from a "zero base." This approach is particularly effective for energy companies in Saudi Arabia seeking to rationalize costs and prioritize high-value projects.

By implementing ZBB, energy companies can scrutinize spending across functions like power generation, maintenance, and workforce management. For example, a utility company in Saudi Arabia could use ZBB to eliminate redundant expenses in fossil fuel operations and redirect funds to renewable energy projects.

Benefits:

• Identifies and eliminates unnecessary costs, resulting in immediate savings.
• Enhances alignment between spending and strategic priorities, such as renewable energy targets.
• Promotes a culture of cost-consciousness across the organization.

Case study 1: Reducing maintenance costs

A global energy utility faced escalating maintenance costs across its fleet of power plants. The traditional incremental budgeting process failed to identify inefficiencies in spending, leading to bloated budgets.

The utility implemented ZBB to rebuild its maintenance budget from the ground up. Instead of carrying over past spending patterns, each line item had to be justified based on current needs and strategic objectives.

Outcomes:

• Maintenance costs were reduced by 18 percent within the first year.
• Low-priority maintenance activities, such as aesthetic upgrades, were deferred in favor of critical system repairs.
• Savings were redirected to renewable energy pilot projects, aligning with the company’s sustainability goals.

Applicability to Saudi Arabia:

A Saudi utility could apply ZBB to prioritize investments in renewable energy projects. For example, rather than allocating funds uniformly across all generation assets, ZBB would allow the utility to concentrate spending on wind and solar projects with higher ROI potential, supporting Vision 2030 targets.

2. Activity-based costing (ABC): Pinpointing cost drivers

ABC is a cost accounting method that assigns costs to activities based on their consumption of resources, providing a detailed understanding of what drives costs and where inefficiencies lie.

In Saudi Arabia, ABC can be used to evaluate the true cost of energy production by breaking it down into specific activities, such as transmission, energy storage, and maintenance. This enables energy companies to identify high-cost activities and explore optimization opportunities.

Benefits:

• Improves cost allocation accuracy, enabling better financial planning.
• Supports data-driven decision-making for resource prioritization.
• Highlights cost drivers that can be reduced without compromising operational quality.

Case study 2: Improving cost allocation in renewable energy projects

A European renewable energy company struggled to allocate costs accurately between its wind, solar, and hydroelectric operations. Traditional accounting methods grouped all overhead costs together, obscuring the true profitability of each energy source.

The company introduced ABC to allocate costs to individual activities, such as site preparation, turbine maintenance, and grid connection.

Outcomes:

• Identified that wind energy projects had significantly higher site preparation costs due to location-specific challenges.
• Reallocated resources to solar energy projects, which offered higher margins.
• Achieved a 12 percent reduction in overall project costs by addressing inefficiencies in high-cost activities.

Applicability to Saudi Arabia:

For a Saudi energy company investing in a mix of renewable projects, ABC can pinpoint cost drivers unique to each project type. For instance, solar farms in desert regions may incur higher costs for dust management and cleaning; and wind projects may require more robust logistics planning due to remote site locations.

Joint Application of ZBB and ABC: Strategic budgeting for Energy Storage Systems (ESS)

Case study 3: Integrating ZBB and ABC in Energy Storage System (ESS) Deployment

A North American utility company sought to expand its energy storage capacity to enhance grid stability amid increasing renewable energy integration. To achieve cost-effective deployment, the company implemented a combined approach of ZBB and ABC.

The utility re-evaluated all expenses from the ground up, justifying each cost component of the ESS projects. This approach ensured that funds were allocated based on current needs rather than historical expenditures. By analyzing the specific activities involved in ESS deployment, the company then identified high-cost drivers and areas of inefficiency. This detailed costing method allowed for targeted cost reduction strategies.

Outcomes:

• The combined ZBB and ABC approach led to a 15 percent reduction in ESS deployment costs. This was achieved by eliminating unnecessary expenditures and optimizing resource allocation.
• By prioritizing investments in regions with significant renewable energy variability, the utility improved the ROI of ESS projects. This strategic focus ensured that storage solutions were deployed where they could provide the most value.
• The optimized deployment of ESS contributed to enhanced grid stability, reducing downtime and minimizing the curtailment of renewable energy sources.

Applicability to Saudi Arabia:

With its ambitious renewable energy targets, Saudi Arabia must scale up its ESS investments. By combining ZBB and ABC, Saudi utilities can ensure that ESS projects are funded based on strategic priorities, such as regions with the highest solar or wind output; and optimize costs associated with battery procurement, installation, and maintenance, making these projects financially viable.

3. Portfolio-based planning: Strategic resource allocation

Portfolio-based planning involves grouping related projects, programs, or initiatives into portfolios to optimize resource allocation and assess risks and opportunities comprehensively.

Saudi energy companies can use portfolio-based planning to prioritize investments in renewable energy, transmission upgrades, and ESS. This approach enables a holistic view of capital allocation, ensuring that resources are deployed where they generate the greatest impact.

Benefits:

• Improves strategic alignment by focusing on portfolio-level objectives rather than isolated projects.
• Facilitates scenario planning to adapt to market changes, such as fuel price volatility or shifts in regulatory requirements.
• Enhances ROI by concentrating investments on high-performing portfolios.

Case study 4: Integrating renewable and traditional energy investments

A Middle Eastern power and water utility implemented a portfolio-based approach to manage its growing investments in renewable energy while maintaining its traditional energy infrastructure. The utility's challenge was to balance competing priorities, such as expanding solar energy projects while ensuring the reliability of natural gas-based power generation.

The utility grouped its projects into distinct portfolios based on their energy source (e.g., solar, gas, hybrid). Each portfolio was evaluated against key metrics, such as ROI, sustainability impact, and risk exposure, then scenario planning was used to simulate the effects of market fluctuations, such as fuel price changes and renewable energy availability.

Outcomes:

• The utility achieved a 15 percent improvement in cost allocation efficiency.
• By reallocating funds from lower-performing projects to high-ROI renewable energy initiatives, the utility accelerated its transition to sustainable energy.
• Enhanced the reliability of its energy supply by ensuring that investments in traditional infrastructure were strategically planned.

Applicability to Saudi Arabia:

Saudi utilities can adopt this approach to manage portfolios for solar, wind, and traditional energy projects. For example, group solar projects into portfolios based on geographic regions, such as those in the western desert versus urban rooftop installations; and use portfolio performance metrics to prioritize high-impact renewable projects while ensuring reliability through strategic investments in natural gas or nuclear energy.

Case study 5: Optimizing transmission and distribution investments

A US-based energy company faced challenges in modernizing its aging transmission and distribution (T&D) infrastructure while integrating renewable energy sources. With limited capital, the company needed a method to prioritize upgrades.

The company grouped T&D projects into portfolios based on geographic regions and strategic importance (e.g., urban grids versus rural connections). Each portfolio was assessed for cost, impact on grid reliability, and potential to support renewable energy integration, then predictive analytics were used to forecast the future demand and performance of each portfolio under different scenarios.

Outcomes:

• Optimized investment across portfolios, ensuring that the most critical upgrades were funded first.
• Achieved a 10 percent reduction in transmission losses by prioritizing high-efficiency grid technologies.
• Enhanced the integration of renewables by strategically upgrading rural transmission lines to support wind and solar farms.

Applicability to Saudi Arabia:

Saudi energy companies can use portfolio-based planning to group T&D projects into portfolios based on their role in supporting renewable energy integration; and prioritize upgrades to grids in high-demand regions, such as Riyadh or Jeddah, ensuring efficient energy delivery and reliability.

Case study 6: Balancing energy storage and renewable energy projects

A European utility faced challenges in scaling its energy storage systems (ESS) to support intermittent renewable energy sources. With limited funds, the utility needed to decide whether to prioritize additional ESS capacity or invest directly in new renewable projects.

The utility grouped ESS and renewable energy projects into separate but interlinked portfolios. Financial modeling was used to evaluate the ROI and risk profiles of each portfolio, then scenario planning assessed how fluctuations in renewable energy production (e.g., solar output during cloudy seasons) would affect portfolio performance.

Outcomes:

• By focusing initial investments on ESS, the utility reduced energy curtailment from renewable sources by 25 percent.
• Subsequent investments in renewables were more effective, as the ESS provided a stable foundation for integrating additional capacity.
• Achieved long-term cost savings by reducing reliance on external power purchases during peak demand.

Applicability to Saudi Arabia:

Saudi Arabia’s energy companies can apply this approach to balance investments in ESS with large-scale renewable projects, ensuring that storage capacity is scaled appropriately to support solar and wind output; and use portfolio-based metrics to determine the optimal sequencing of investments, reducing wasted capital.

To align with Vision 2030, Saudi energy companies can group initiatives into strategic portfolios such as:

1. Renewable energy investments: Solar, wind, and nuclear energy projects aligned with Vision 2030 targets.
2. Grid modernization: T&D upgrades to support renewable energy integration and reduce energy losses.
3. Energy efficiency: Investments in smart grids, ESS, and fuel efficiency measures.
4. Traditional energy reliability: Critical maintenance and upgrades for existing oil and gas infrastructure to ensure energy security during the transition.

Prioritizing investments: Key applications

Effective capital allocation is not just about managing budgets - it’s about directing resources to initiatives that deliver the greatest strategic value. In the context of Saudi Arabia's energy sector, prioritizing investments across renewable energy, transmission, and operational improvements is essential to achieving Vision 2030 goals. This section provides practical scenarios and examples - using dummy numbers - to bring the theory to life, illustrating how energy companies can make data-driven, impactful decisions.

1. Renewable energy investments

Saudi Arabia has set an ambitious target to generate 50 percent of its energy from renewable sources by 2030. Meeting this goal requires prioritizing investments in solar and wind energy projects while managing costs and ensuring ROI.

Practical scenario:

A Saudi energy company is deciding between two solar energy projects:

• Project A: A large-scale solar farm in the desert with high capital costs but significant energy generation potential.
• Project B: A series of urban rooftop solar installations with lower upfront costs but limited scalability.

Approach:

• Portfolio-based planning: Group these projects into a "Renewable Energy" portfolio and evaluate them based on ROI, sustainability impact, and alignment with Vision 2030 goals. Scenario modeling predicts that the desert solar farm will achieve a higher ROI over ten years due to economies of scale.
• Activity-based costing (ABC): Assess cost drivers for each project. The desert farm incurs higher logistics costs due to its remote location, while rooftop installations face higher maintenance costs.
• Zero-based budgeting (ZBB): Build a detailed budget for each project from scratch, ensuring that every expense aligns with the company’s strategic objectives.

Decision:

The company chooses to fund Project A while allocating a smaller budget to pilot Project B in urban areas to assess its long-term viability.

Hypothetical result:

The solar farm accelerates renewable energy adoption in the Kingdom, contributing significantly to Vision 2030 targets, while the rooftop pilot provides insights for future urban initiatives.

2. Transmission projects

Expanding and modernizing transmission networks is critical to integrate renewable energy sources and meet growing demand in urban and rural areas.

Practical scenario:

A utility is evaluating two transmission upgrade projects:

• Project X: Upgrading urban transmission lines to reduce energy losses in Riyadh.
• Project Y: Extending transmission lines to connect a remote wind farm to the national grid.

Approach:

• Portfolio-based planning: Categorize these projects under a "Transmission Infrastructure" portfolio and analyze their strategic importance. Scenario planning reveals that Project X offers immediate cost savings, while Project Y enables long-term renewable energy integration.
• Activity-based costing (ABC): For Project X, high labor costs drive expenses. For Project Y, transportation and logistics costs dominate due to the remote location.
• Zero-based budgeting (ZBB): For Project X, prioritize budget items related to advanced grid technologies, such as smart meters and dynamic line rating systems. For Project Y, justify investments in logistics optimization to minimize costs.

Decision:

The utility prioritizes Project X for immediate implementation while phasing Project Y over three years to manage costs.

Hypothetical result:

The urban grid upgrade reduces transmission losses by 12 percent (hypothetically), delivering quick financial and operational gains. The phased approach to Project Y ensures sustainable integration of renewable energy over time.

3. Operational improvements

Operational inefficiencies, such as high maintenance costs and suboptimal workforce deployment, increase costs and reduce profitability.

Practical scenario:

A power company identifies excessive downtime in its natural gas plants, driven by reactive maintenance practices.

Approach:

• Portfolio-based planning: Create an "Operational Excellence" portfolio focused on maintenance optimization, workforce efficiency, and cost reduction.
• Activity-based costing (ABC): Break down maintenance activities into specific cost drivers, such as labor, spare parts, and unplanned downtime. Analysis shows that unplanned downtime costs are 40 percent higher (hypothetically) than planned maintenance.
• Zero-based budgeting (ZBB): Justify every maintenance activity. Invest in predictive maintenance systems that use IoT and AI to anticipate failures before they occur.

Decision:

The company reallocates budget from reactive maintenance to a predictive maintenance program, reducing unplanned downtime by 30 percent (hypothetically).

Hypothetical result:

The predictive maintenance system saves the company SAR50 million annually (hypothetically), while improving plant reliability and workforce productivity.

4. Energy Storage Systems (ESS)

As renewable energy sources become more prevalent, energy storage systems are essential for stabilizing the grid and reducing curtailment of renewable energy.

Practical scenario:

A utility is evaluating two ESS investments:

• Project M: A large-scale battery installation near a solar farm to store excess energy during peak sunlight hours.
• Project N: A smaller ESS in an urban area to support grid stability during peak demand.

Approach:

• Portfolio-based planning: Group these projects into an "Energy Storage" portfolio and evaluate their strategic value. Scenario analysis predicts that Project M offers higher cost savings due to its scale, while Project N provides immediate urban grid reliability.
• Activity-based costing (ABC): Assess lifecycle costs for each project. Project M has higher upfront costs but lower operational costs, while Project N incurs higher maintenance costs.
• Zero-based budgeting (ZBB): Justify every line item in the ESS budget. Focus on scalable battery technologies for Project M and advanced grid integration tools for Project N.

Decision:

The utility prioritizes Project M for its long-term cost savings and allocates a smaller budget to Project N for short-term grid support.

Hypothetical result:

The large-scale ESS reduces curtailment by 20 percent (hypothetically) and improves solar energy utilization, while the urban ESS enhances grid stability, preventing blackouts during peak demand.

Concluding thoughts

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Saudi Arabia’s energy sector is at a transformative crossroads, navigating the twin imperatives of meeting surging energy demand while delivering on Vision 2030’s ambitious sustainability and economic diversification goals. As the Kingdom undertakes this complex journey, strategic capital allocation will serve as a cornerstone for success. Advanced methodologies like ZBB and ABC, and portfolio-based planning offer energy companies the tools to optimize their financial resources, improve operational efficiencies, and achieve measurable outcomes.

By leveraging ZBB, energy companies can challenge legacy spending habits and ensure every riyal is aligned with strategic priorities. ABC provides a granular view of cost drivers, enabling more precise resource allocation and exposing inefficiencies. Portfolio-based planning ensures that investments are evaluated and prioritized within a structured framework, balancing risk, return, and strategic alignment.

The real-world applications we explored—ranging from optimizing renewable energy investments to modernizing transmission systems and integrating energy storage solutions—illustrate the transformative potential of these methodologies. When executed effectively, these practices not only drive cost reductions and enhance ROI but also enable companies to build resilience in the face of market volatility and evolving regulatory landscapes.

For Saudi Arabia, the stakes are high. Achieving a 50 percent renewable energy mix by 2030 and reducing reliance on oil revenues demand nothing short of a paradigm shift in how energy companies operate and allocate resources. The opportunities, however, are equally significant. With disciplined capital allocation and innovative financial practices, the Kingdom’s energy sector can emerge as a global leader in sustainability and operational excellence.

The roadmap is clear: adopt advanced budgeting and planning methodologies, align every investment with long-term strategic objectives, and remain agile in the face of an ever-changing energy landscape. By doing so, Saudi Arabia’s energy companies will not only meet the demands of today but also lay the foundation for a future powered by innovation, sustainability, and financial resilience.

References

• International Renewable Energy Agency (IRENA) Statistical Profile: Saudi Arabia (2022).
• Statista. (2024). Primary energy consumption in Saudi Arabia from 1998 to 2023.
• Vision 2030 Official Site. (2023). Saudi National Renewable Energy Program.
• International Energy Agency (IEA). (2022). Renewable Energy Policies in the Middle East.
• Saudi Green Initiative Progress Report. (2024).
• PIF Annual Report. (2024).
• International Renewable Energy Agency (IRENA). (2017). Electricity Storage and Renewables: Costs and Markets to 2030.
• DEWA Annual Sustainability Report. (2022).
• National Grid Case Studies. (2021).
• International Renewable Energy Agency (IRENA). (2022). Energy Storage Systems for Renewable Integration.

Disclaimer: This article was written by Todd Barclay in his personal capacity. The opinions expressed in this article are my own and do not necessarily reflect the view of KPMG.