Manufacturing diversification: The government is supporting activity across a wide range of sectors

With plans in the works to inject significant investment into expanding its output of metals, petrochemicals and plastics over the next several years, Saudi Arabia continues to dominate the region’s industrial activity. This should keep the Kingdom at the forefront of the world’s industrial exporters, at a time when global economic uncertainties are subduing demand for many commodities. While some fear that recent discoveries of unconventional hydrocarbons in the US could ultimately reduce the competitiveness of Saudi Arabian petrochemicals, the country still offers some of the world’s cheapest feedstock and energy inputs.

As for downstream manufacturing, the government hopes to expand this sector rapidly over the next couple of decade, taking care to tailor new upstream and midstream activities accordingly. Not everybody is sure that Saudi Arabian manufacturers can compete internationally in the long run, but the fact that investments – both Saudi Arabian and foreign – have continued to be announced in 2012 suggests that the Kingdom is still seen as a land of opportunity.

Non-Oil Growth

Several studies and surveys have suggested that the non-oil sector is currently enjoying favourable conditions in the Kingdom. A 2012 report by the International Monetary Fund (IMF) states that real non-oil GDP grew by 6.2% and 8% in 2010 and 2011 respectively, and projects growth of 6.5% in 2012. While the annual growth rate is expected to drop off in the years ahead, the fund nonetheless projects that it will not fall below 5% up to 2017. As for non-oil exports – the bulk of which are currently made up of petrochemicals and plastics – these have contributed around 10% to total exports in 2011 and 2012 but are projected to contribute 15.5% by 2015 (see chart).

“Diversification away from the oil sector has started to gain genuine traction in Saudi Arabia,” Jarmo Kotilaine, the chief economist at NCB Capital, told OBG.

Not all indicators are positive, though. At a time of uncertainty in the global economy and given the resulting impact on demand for petrochemicals and other commodities, it is no coincidence that the Kingdom’s Business Optimism Index for non-oil industries – to which petrochemicals and plastics make by far the largest contribution – dropped from 54 in the first quarter of 2012, to 52 in the second, and 37 in the third.

However, while business optimism may have taken a hit in 2012, a more positive story is told by the monthly Purchasing Managers’ Index (PMI) released by SABB, which tracks the performance of the non-oil manufacturing and services sectors. Despite falling significantly in 2011 from a high point at the end of 2010, it has remained above 55 throughout the last three years and rose to 58.1 in August 2012. Any score above 50 means an improvement in output, new orders, employment and other indicators. Compare this to the PMIs for the eurozone and the US – the former scored under 50 for almost all of 2011 and 2012, the latter hovered in the low fifties in the same period – and the relative health of Saudi Arabian counterparts becomes clear.

Looking Downstream

Given these essentially amenable conditions, Saudi Arabia can on the whole remain upbeat about progressing towards the goals of its National Industrial Strategy (NIS) until 2020, as well as its Industrial Clusters Programme (IC). Ratified in 2009, the NIS’s main aim is to diversify the sector through the support of industries with a comparative advantage, the creation of infrastructure and industrial cities, as well as the streamlining of the regulatory and business environments, and the support of small and medium-sized enterprises (SMEs). The strategy also includes some ambitious numerical targets: for example, boosting the contribution made by manufacturing to GDP from its current 11% to 20%, and raising the representation of nationals in the workforce from 15% to 30%. The IC programme is designed to flesh out the NIS and other state development plans. Most notably, it specifies five priority clusters: minerals and metals processing, automotive industries, plastics and packaging, home appliances and solar energy. Although the IC programme notes that other industries in the Kingdom have significant growth potential – ICT, pharmaceuticals, medical technology, agrochemicals and food processing, for example – the specified five are receiving special attention from policy makers. By broadening the industrial sector in this way, the country hopes not only to diversify its still oil-dependent economy but also to create jobs for a young population faced with high rates of unemployment.

Saudi Arabia, along with neighbouring Gulf states, is still at an early stage of its attempts to develop downstream manufacturing, and some believe the road ahead is long and uncertain. A few industrialists told OBG that, while they were confident in the Kingdom’s ability to continue expanding base industries such as petrochemicals, plastics and minerals, they did not feel that downstream manufacturers would be able to compete with global rivals who enjoy access to larger markets and cheaper labour costs. Others have higher hopes for certain categories of manufactured goods.

“Saudi Arabia can compete well internationally when it comes to value-added products, but cannot compete with the likes of China and India for cheaper goods,” Hisham Bahkali, president and CEO of GE Saudi Arabia and Bahrain, explained to OBG. It has also been remarked that the country is best placed to serve the region’s heavy industries, such as large-scale infrastructure for transportation, water and power projects. Aviation is often marked out as a sector with high growth potential, given the large and increasing demand in the Gulf region for air passenger and freight services.

While the long-term future for the Saudi Arabian manufacturing sector is not yet certain, new investments over the last couple of years suggest that confidence in the industrial sector as a whole remains strong. “Industrial investors are certainly affected by the current uncertainties in the global economy, but Saudi Arabia’s macroeconomic and political stability remain massive draws. The Kingdom is the largest contributor to a $1trn regional economy that is managing to maintain its status as a safe haven,” Kotilaine told OBG.

Industrial Cities

The majority of the Kingdom’s new industrial investments are to be found in an increasing number of industrial cities. The majority of these are managed by the Saudi Industrial Property Authority (MODON), although three of the largest – at Yanbu, Jubail and Ras Al Khair (RAK) – are under the authority of the Royal Commission for Jubail and Yanbu.

A phosphates complex has been up and running in RAK since 2012, while its aluminium complex is due to be up to full speed by 2014 (see Mining chapter). The rapid emergence of new cities over the past five years has been remarkable: in 2007 MODON was in charge of 14 cities, which had increased to 28 by mid-2012. During the same period, the number of domestic industrial operations nearly doubled, rising from 1600 to 3000. Ambitiously, the authorities are hoping to see the number of industrial cities increase to a total of 40, covering some 160m sq metres, by 2015. Some recent advances include the announcement of an additional 40m sq metres for Jeddah’s third industrial city and the beginning of construction of Dammam’s third city.

While new cities are springing up, existing ones are continuing to expand. The first phases of Jubail and Yanbu extend back to 1975, attracting more than $100bn between them in foreign investment, as well as close to $150bn in Saudi Arabian investment. The largest ongoing development at Jubail II is the $20bn Sadara Chemical Complex, the result of a joint venture between the US’s Dow Chemicals and Saudi Aramco: by 2016, the project’s 26 chemical manufacturing units should be producing at full capacity – around 8m tonnes of chemicals and plastics per year, including products that will diversify the Saudi Arabian petrochemical mix. The project has provided a raft of engineering, procurement and construction work to firms from South Korea, the US, Germany, Italy and Spain. The bulk of new industrial investments continue to be in upstream activities, but downstream manufacturers have also started to show considerable interest. At the $100bn King Abdullah Economic City (KAEC) under development around 100 km north of Jeddah, for example, pharmaceutical companies– including the US’s Pfizer, France’s SanofiAventis, and Saudi Shamla Pharmaceuticals – have shown particular interest in the project, and other tenants to have recently signed up include Mars Saudi Arabia and Al Marai, the dairy giant. New manufacturing has come on-line in the heavier industrial segments, too: at the industrial city of Dammam, the US firm GE opened the GE Energy Manufacturing Technology Centre (GEMTECH) in 2011, and announced SR600m ($160m) worth of additional investment for another manufacturing centre for advanced technology. This centre is to manufacture components of turbines and other large equipment, serving markets not only in the Middle East but also Africa, Asia and Europe. “You would have to go to the US to see a manufacturing centre of a similar calibre and size,” Alhassan Hamideddin, the market analyst at GE’s Riyadh office, told OBG.

Railway Freight

As significant as the industrial cities themselves is what links them together: new rail freight lines, many of which are to be completed within the next few years. The first phase of the North-South railway was completed in mid-2011. This $3.6bn project now links the phosphate mine at Al Jalamid to a large new phosphates complex in the industrial city of RAK, although the freight of minerals is not scheduled to reach full capacity until mid-2013. In addition to this, plans have been announced in 2012 for a $177m rail link to join the industrial cities of Jubail and RAK, as well a rail link to the recently announced Wa’ad Al Shimaal Mining City (see mining chapter). With rail infrastructure seen as especially important for the phosphates industry, new mining investments appear to have been given priority in this regard. However, the government has also revealed plans for further freight lines. In October 2012, officials told local press that work would begin in the first quarter of 2013 on a three-section rail network in Jubail designed to link facilities with ports. One will be dedicated to the Sadara chemicals complex, another to the SATORP refinery and a third to other petrochemicals facilities. The government also plans to build the $7bn Saudi Landbridge Project, laying 945 km of new railway between Riyadh and Jeddah, as well as a link between Dammam and the North-South line.

Construction

Given large government spending on infrastructure, housing, hospitals, and universities, the resulting construction boom should create substantial demand for many Saudi Arabian industrialists. According to a July 2012 report by Bank of America Merrill Lynch, years of underinvestment in combination with recent government commitments to massive projects mean that the Kingdom will “take the lead in terms of construction spending” in the Middle East and North Africa (MENA). This positive projection comes at a time when the GCC region and Saudi Arabia in particular are seeing subdued demand for construction work.

Oil and gas work, for instance, shrank markedly in the region during 2012, with Saudi Arabia and Qatar amongst the worst affected markets. Taken altogether, contract awards in the Kingdom stood at 10,312 in the period from June 2010 to May 2011; this number fell by 29% to 7323 in the period from June 2011 to May 2012, according to Bank of America Merrill Lynch. As for 2012-13, the Saudi Arabian project pipeline slowed by 4%. In other sectors, however, the country appears to be bucking regional trends: while contract awards in the whole MENA region declined by 41% year-on-year in the first half of 2012, in Saudi Arabia the construction and infrastructure subsectors together grew by 177%. As such, the Kingdom accounts for some 46% of the estimated $448bn worth of projects scheduled in MENA for 2012 and 2013, said the report.

While some observers may be concerned to hear that around 43% of all construction projects in the GCC region are on hold – according to a September 2012 report by BNC Network – it is notable that Saudi Arabia is one of the countries that has been least affected by this problem: just $101bn, or 22%, of its $451bn worth of ongoing projects fall into this category.

“There may be projects on hold, but do not forget the accelerating factors that are coming to bear on the Saudi Arabian economy,” said Hamideddin. “One is more focus on spending for projects targeting transportation, educational and medical infrastructure. Another is the concern that Saudi Arabia’s growing domestic consumption of energy will reduce the amount of oil available for export if it continues on this trajectory; this incentivises industrial investment in the likes of solarpanel manufacturing and energy-efficient technology,”

The recent ratification of the mortgage law should also help to drive construction demand in the housing sector, although many caution that the effects are unlikely to be felt in the immediate term and that both banks and developers will be looking carefully at further supporting regulation from the Ministry of Finance. Yet even without the law, the fact that the government has committed itself to building 500,000 housing units in the next few years will be a very significant driver.

Metals

Strong demand in the construction sector should create significant work for Saudi Arabian steel producers, which churn out more of the metal than any other Gulf country. Recent market research suggests that while supply of Saudi Arabian steel is due to grow by a compound annual average of 9% until 2015, demand in the Kingdom could surge each year by an estimated 19.5%. The industry is not without regulatory issues, but the pace of development suggests that Saudi Arabia will remain the regional leader in this sphere for the foreseeable future (see analysis).

Where Saudi Arabia is streaks ahead of its neighbours in its steel production, it has traditionally lagged behind in aluminium. However, this is now changing: as the only Gulf producer to boast locally available bauxite reserves and $10.8bn in integrated aluminium facilities – a mine, a smelter and a rolling mill, all due to come on-line by the end of 2014 – the Kingdom will soon be on the leader board. This should cater to what is already a relatively well-established downstream manufacturing sector for aluminium products. Export markets will soak up much of the output, and while producers globally have been hit by low prices, this could encourage aluminium multinationals to head for locations with low-cost energy inputs like Saudi Arabia (see analysis).

Automobiles

The government has dedicated one of its industrial clusters to the promotion of an automotive sector. The main goal is for 600,000 vehicles to be assembled every year in Saudi Arabia by 2025, but it is also looking to develop all other aspects of the vehicle supply chain. Some industrialists harbour doubts about the competitiveness of such a sector in Saudi Arabia: its market is large and growing but still pales in comparison with other regions of the world, while liberal tariffs enable cheap access to imported cars.

Despite the apparent barriers, even sceptics admit there have been encouraging developments in the last couple years. Indeed, Jaguar Land Rover announced in September 2012 that it was mulling the construction of a new assembly plant in the country and more recently, in December 2012, Isuzu Motors inaugurated a new manufacturing plant in the Kingdom.

At the same time, new industrial projects – notably in the aluminium, petrochemicals and plastics sectors – are due come on-line by 2015, increasing the availability of local raw materials (see analysis). Abdul Wahab Tawfik, managing director of corporate affairs at auto retailer Abdul Latif Jameel explained, “Thanks to low utility rates and an abundance of raw materials from the petrochemical and mining sectors, Saudi Arabia could be a very cost effective place to assemble vehicles.”

Petrochemicals

Given the sensitivity of petrochemicals markets to the health of the overall global economy, it is not surprising to find the Kingdom’s major players reporting reduced profits in 2012, a year when worries persist over a debt crisis in the eurozone and a slowdown amongst Asian manufacturing giants, such as China and India, which absorb a large portion of Saudi Arabia’s petrochemicals output.

At home, too, some are concerned that the reduced availability of locally produced natural gas, coupled with the emergence of cheap shale gas in North America, could hinder the competitiveness of the Kingdom in the eyes of new potential investors. On the plus side, however, the country still offers among of the most competitive feedstock prices in the world, while new operations that are looking to use heavier feedstock such as naphtha will produce the sort of higher-value chemicals that could support new manufacturing industries. Backed by a macroeconomically and politically stable government, the petrochemicals sector is aiming to increase its output capacity more than any other country in the Gulf. To do so, industry players have arranged a raft of joint ventures with international majors, which are due to come on-line before 2015 (see analysis).

Cables

Saudi Arabia’s base in petrochemicals and aluminium has enabled cable manufacturing. Established in 1975, the Saudi Cable Company is a serious regional contender, with a wholly owned subsidiary in Turkey. Another major player is the Middle East Specialised Cable Company, which launched a new facility in May 2012 for polyvinyl chloride production. “In terms of production capacity, 8% of the world’s cables are produced in the Kingdom,” Talal Idriss, the CEO of Bahra Cables, told OBG. “Though there is strong domestic demand coming from government housing, transport and infrastructure expansion projects, to reach the total capacity, the cable sector relies heavily on export.”

Fertilisers

Like cables manufacturers, fertiliser producers are not new to Saudi Arabia, but are expanding rapidly. The Saudi Arabian Fertiliser Company (SAFCO), a publicly listed company in which the Saudi Arabian Basic Industries Corporation (SABIC) holds a 43% stake, first began in 1969 in Dammam and now operates in the industrial city of Jubail, producing urea and ammonia. In May 2012, it was awarded a SR200m ($53.3m) project for producing a further 3.6m tonnes of urea at Jubail. Perhaps the most significant new capacity, however, has been added by the $5.5bn Phosphate and Fertiliser Complex, which has been built by a joint venture between the Ma’aden Phosphate Company (MPC) and the SABIC at RAK on the eastern coast.

Since 2011, the venture has been transporting phosphate ore from the Al Jalamid mine in the north on a newly constructed rail line that leads to RAK, where it is processed along with locally available natural gas and sulphur in order to produce the fertiliser known as diammonium phosphate (DAP), as well as excess ammonia. The DAP is primarily for export, the first shipment of which departed in mid-2011. In 2012 the facility’s commercial operations began, albeit not yet at the full capacity of 3m tonnes per year, due to technical difficulties with the phosphoric-acid facility.

Another development in 2012 to have caught the eye of most in the fertiliser business will be the ratification in February by the Council of Ministers of the Wa’ad Al Shimaal Mining City, which is to host seven large plants capable of producing some 16m tonnes per year of phosphate concentrate, sulphuric acid and phosphoric acid, amongst others. Valued at around $5.6bn, this second phosphates project will certainly be in the same league as the first.

The short-term outlook for fertilisers appears shaky, with demand and profitability being negatively affected by uncertainties in the global economy. Like other companies in the petrochemicals sector, SAFCO experienced markedly reduced profits during the first half of 2012, year-on-year, although it still pulled in SR784m ($209m). Yet in the longer term, fertiliser is expected to be pivotal in supplying the world’s population with food. According to the UN Food and Agriculture Organisation, agricultural output will need to increase 60% in the next four decades to keep up.

Current capacity expansions in Saudi Arabia and among other Gulf producers should ensure that the region takes a larger share of the global fertiliser market in the coming decades, according to the Gulf Petrochemicals and Chemicals Association.

Solar Panels

Ambitious government targets have the potential to make Saudi Arabia a regional leader in solar panel production, but to date the industry is significantly less developed than in neighbours such as the UAE and Jordan. There is reason to believe, though, that the pace will pick up. The much-discussed projection by Citigroup in 2012 that Saudi Arabia could become a net importer of oil by 2030 is likely to galvanise thinking into delivering on the government’s plan to invest a remarkable $109bn in the industry.

Annual electricity demand is expected to grow by 200% between 2009 and 2032, and by that year the government is looking to gain as much as a third of its total energy needs from solar – either concentrated solar power or photovoltaic panels. Prospective investors would also benefit from the availability of cheap inputs: energy, aluminium, steel and plastics in particular.

There are still those, however, who remain doubtful that solar panels are set for a boom in the immediate future. In late 2011, the CEO of Saudi Aramco said that the development of renewables was being slowed by high oil prices, the discovery of new hydrocarbons around the globe and the still relatively high capital expenditures required for large-scale solar projects. Nonetheless, according to local press, tenders for 2 GW worth of capacity – a massive amount – will be released in 2013. And the regional leader in solar projects, Abu Dhabi’s Masdar, has announced that it is looking to make investments in the country.

Although it is still very early days for the local production of polysilicon – used in the manufacture of photovoltaic solar panels – progress is being made on this front too: the government’s solar cluster is developing three projects which are to produce 12 kilotonnes of solar-grade polysilicon. Two of these projects are also looking into the production of ingots, wafer and cells, while other Saudi Arabian firms are conducting feasibility studies into the manufacture of thin films, according to local press reports in late 2011.

Furthermore, the polysilicon industry has taken a step forward in 2012 with the announcement of a new $1bn German-Gulf joint venture between Centrotherm Photvoltaics and the Gulf-based IDEA International Investment and Development Company. The facility is to be built at Yanbu and will be the largest polysilicon manufacturing facility in the Middle East.

Pharmaceuticals

Although not prioritised by the IC programme, the pharmaceuticals sector is seeing growing demand, on the back of increased government expenditure, rising GDP per capita, and state support for foreign and local pharmaceuticals production. The regulatory regime continues to be criticised by some foreign companies, which claim that an overly strict pricing regime favours local producers. However, international importers and manufacturers are operating in a market which continues to be dominated by their patented products, and free zones continue to lure in new investment from multinationals (see analysis).

Workforce

Like other Gulf nations pushing to expand their industrial sectors, Saudi Arabia is facing considerable challenges in sourcing labour locally. Around 92% of the private-sector workforce is expatriate, according to a July 2012 report by the Bank of America Merrill Lynch. Employers told OBG that Saudi Arabian graduates often lack the requisite skills.

A second challenge faced by the industrial sector is a cultural one: many Saudis prefer management-oriented jobs over technical ones – the reluctance to get a so-called “blue-collar” job. As in other countries with significant expatriate workforces, the white-collar jobs with higher salaries still enjoy enormous respect amongst the national labour force.

Consequently, some industrial sectors may have less trouble attracting nationals. “The petrochemical industry has one of the highest percentages of Saudiisation rates because it pays well,” said Suliman Al Mandeel, managing director of the Saudi Industrial Investment Group. Others observe that SMEs in the industrial sector, which often lack the resources required to create clean and comfortable working environments for their employees, may struggle to recruit Saudis more than multinational companies. However, some signs indicate that attitudes may be beginning to change.

“Today one can see Saudis occupying more and more types of jobs. It is fair to say that the stigma of the blue uniform is less influential than it once was,” said Hisham Bahkali, president and CEO of GE in Saudi Arabia and Bahrain. However, in the face of these challenges, government policy over the past couple of years has been notably more successful in getting Saudis into work than previous attempts. Local press reported in September 2012 that 380,000 locals got jobs over a period of 10 months through the implementation of a new scheme, called “nitaqat”, which stipulates quotas on the employment of Saudis, depending on the sector and the size of the company. That is 20 times as many jobs as were created in the five years prior to the nitaqat scheme. In this environment, foreign firms must make every effort to engage with the local workforce.

During 2012, progress was also made on improving access to work for women. With youth unemployment levels high, the fact that around 80% of unemployed women are university graduates could make them an attractive prospect for employers (see analysis). “Making a commitment to the country and its people is an essential prerequisite to conducting business successfully in the Kingdom,” said Paul Rawson, CEO of RollsRoyce Saudi. “To achieve this, businesses must take the time to understand unique environmental aspects, establish appropriate and effective local relationships, and, crucially, develop and exploit the growing pool of national talent that is now becoming available.”

Outlook

Despite a smaller project pipeline in hydrocarbons segments, the construction and infrastructure sectors are booming on the back of government spending. The steel, aluminium and petrochemicals segments are attracting huge investments and are expanding to gain a greater share of global markets.

Still, there are concerns about the global demand given economic uncertainty abroad and some limitations at home, notably the availability of gas feedstock and prospects for the development of a competitive downstream manufacturing sector. Still, the Kingdom does not have to worry about international competitiveness on other fronts. It ranked 12th of 183 countries in the World Bank’s 2012 Doing Business Index and is known for its investor-friendly approach. Some of the world’s least expensive energy, feedstock and land make it more attractive to multinational industrialists, as reduced global prices in aluminium and petrochemicals put extra pressure on profit margins. “I would say that investors are showing more interest in this jurisdiction than they were two years ago,” Kotilaine told OBG.