Complementary investments: Defence offset programmes bolster the economy and boost employment and training prospects

Saudi Arabia was declared the world’s fourth-largest defence spender after the US, China and Russia in the International Institute for Strategic Studies (IISS) 2014 “Military Balance” report. It estimated the Kingdom’s defence budget for 2013 was $59.6bn, putting it ahead of the UK, France, Japan and Germany. According to the Saudi Arabian Monetary Agency, the 2013 budget for defence and security was SR251.3bn, ($67bn), equivalent to 8% of GDP and accounting for 30.6% of the total budget for the Kingdom. The total proportion of the budget dedicated to defence and security actually fell slightly from 30.7% in 2012, but at a time when the IISS reports global expenditure on arms is falling, the Kingdom is clearly keen to bolster its defences against potential threats beyond its borders. For more than 30 years, Saudi Arabia has pursued a policy of indirect offsets when negotiating substantial arms deals with the likes of the US, France and the UK. The principle has been to bolster the Saudi economy and boost employment and training prospects for its people by requiring vendors to invest in developing business opportunities in the Kingdom that may be unrelated to the contract itself.

OFFSET HISTORY: The Ministry of Defence first introduced the notion of offset deals in 1983, when it called for bids for a $3.94bn contract to build a military command and control centre. The deal stipulated that the successful bidder would be obliged to invest the equivalent of 35% of the value of the technical and service part of the contract in joint ventures (JVs) that would create businesses able to grow and offer high-quality technical jobs to Saudi workers. The contract was won by Boeing and Westinghouse and the offset programme was dubbed Peace Shield. The Boeing Industrial Technical Company was created to fulfil the offset requirement. Similar contracts were created when the French company DCN won the contract to supply the Royal Saudi Navy with four frigates and two replenishment tankers, and in 1987 when the UK’s BAE Systems successfully negotiated the sale of Tornado aircraft and subsequently secured a £4.5bn contract to supply 72 Eurofighter Typhoons. The two programmes with France and the UK were called Al Sawary and Al Yamamah, respectively.

The French firm DCN, which later became DCNS, signed a subsequent deal, Al Sawary II, and delivered three new ships, HMS Al Riyadh, HMS Makkah and HMS Al Dammam, between 2002 and 2004 and offered to train 700 personnel as part of the deal. Thales is a 35% shareholder in DCNS, and Christian Lamoureux, its chief operating officer in Saudi Arabia, told OBG his company sees great potential in the Kingdom. “There is a growing talented labour force, especially in engineering, where many Saudis are going abroad to elite universities or attending local universities that have top-notch programmes in their own right.”

For Ghassan Al Shibl, the CEO of Advanced Electronics, offset deals offer strong prospects to many of these young people. “With hundreds of thousands of students graduating every year, it is imperative that there are adequate job opportunities available in the Kingdom for these graduates,” he told OBG. “In strategic sectors such as defence, we have the opportunity to develop an entire support industry which can employ these young Saudis.”

Middle East Propulsion Company is a JV including US, German and Saudi firms that specialises in aero engine repair and inspection, mainly for the Ministry of Defence. The company grew out of the Economic Offset Programme (EOP), and it sees plenty of opportunity for its business to expand. The CEO, Abdullah Al Omari, says EOP had enabled his company to make a positive contribution to the Saudi economy. “It is important for companies to invest in their employees, especially in technical fields such as ours. The spending pays for itself in the long run by enabling companies to boost the quality of their workforce and thereby their service,” Al Omari told OBG.

UK INVESTMENT: The offset scheme is promoted in the UK through a Ministry of Defence department known as the Directorate General for Saudi Armed Forces Project. Its website, Britishoffset.com, explains how the British Offset Office can help companies in the UK to secure funding and help to create JVs in Saudi Arabia under the Saudi-British EOP. The assistance is open to companies involved in downstream petrochemicals, water, power, transport, health care, pharmaceuticals and renewable energy, with consideration also given to education and training providers, logistics companies, agri-businesses and mining firms. Projects that have already been completed include a £100m sugar refinery built near Jeddah as a JV between Tate and Lyle, the Savola Group and other Saudi companies; the Saudi Polyolefins Company, a JV producing polypropylenes for domestic consumption and export, which sees the Saudi joint-stock National Petrochemical Industrialisation Company (Tasnee) partner with Basell, while Saudi Aramco provides the feedstock; and the SA TALKE logistics centre at the port of Jubail, a JV between TALKE Logistics Services, the Al Jabr Group and Saudi Industrial Services Company, which will provide 150 jobs when it is completed.

These projects have come to fruition against a backdrop of significant Saudi investment in British defence products and services. In July 2013 the UK’s Foreign Affairs Select Committee reported that the UK had issued 417 extant standard individual export licences to Saudi Arabia for defence equipment worth £1.863bn, or $3.2bn, making the Kingdom one of Britain’s most significant trading partners.

US TRADE: However, offset agreements are not a feature of all major defence contracts, and a differentiation is made between foreign military sales and direct commercial sales. In the US, foreign military sales tend to be made by the US government with the armed forces of other nations, but with US companies often supplying hardware, support and some training. Announcements about potential deals are posted online by the US’s Defence Security Cooperation Agency. From June 2013 to April 2014, nine contract notices for Saudi Arabia were posted on the DSCA’s site with a combined value of $15.5bn and in each case the contract notice stipulated that there were no offset deals included in the contract. The contracts included missiles systems, modernisation programmes, training, munitions and technical support packages with US companies Raytheon and Boeing supplying some of the hardware and expertise. The contracts provided equipment and services to the Royal Saudi Air Force, the Royal Saudi Navy (RSN), the Saudi Arabian Army and the Saudi Arabian National Guard (SANG) as well as the Ministry of the Interior. Deals included a $6.8bn contract to supply parts, training and equipment to support an earlier contract for F-15SA fighter jets, a $4bn contract to modernise the organisation of SANG and a $1.2bn deal to supply 30 Mark V patrol boats to the RSN. Although these particular deals may not have involved offset elements, US companies with a presence in Saudi Arabia are keen to see the idea work. Walid Abukhaled, the CEO of Northrop Grumman, told OBG the US company, which has had a presence in Saudi Arabia since the 1960s, is now refocusing on opportunities in the Kingdom and is keen to utilise the EOP. “Given the high defence spending levels, we will use the EOP to grow our portfolio. With the new leadership at the helm we hope to see further development and investment in this programme. The key to changing the EOP is changing the mind-sets of the companies involved. Right now they look at these expenditures as commitments, but should instead view them as opportunities for investment and growth outside of their core areas of business.”

Alan Chinoda, the CEO of Lockheed Martin in Saudi Arabia, told OBG he believes the EOP will create jobs, diversify the economy and help the Kingdom face new threats. “Cyber security is a critical issue that will only grow in importance in the coming years,” Chinoda said. “The government of Saudi Arabia recognises that and as such takes the matter very seriously.”