Saudi Arabia using its industrial resources to make future growth less reliant on hydrocarbons

Historically, oil has generated the majority of Saudi Arabia’s revenues and around 50% of its GDP. However, in recent years an emphasis has been placed on growing the Kingdom’s non-oil private sector by bringing in manufacturing and other industries to diversify the economy. The National Transformation Programme (NTP) has replaced the Kingdom’s 10th Development Plan and establishes the means by which the Kingdom will meet the objectives set out in Vision 2030, whose main goal is to move Saudi Arabia’s economy away from oil through economic diversification, with value-added industry and mining set to play substantial roles.

Importance has been placed on projects that will utilise the Kingdom’s raw material wealth, whether petrochemicals, metals or phosphates, and develop a full chain of upstream and downstream opportunities for both local and international firms. “The regulatory framework to encourage foreign direct investment is taking shape,” Gasem Al Shaikh, CEO of Petroleum, Chemicals & Mining Company, told OBG. “Now is the time to attract foreign companies and find mutual synergies between local and foreign investors for new downstream industries, especially in petrochemical specialties plants. Such downstream initiatives are in line with the goals of Vision 2030, helping develop the Saudi workforce and ultimately increasing Saudiisation,” he added.

Areas Of Priority

Investment is being channelled into the industrial sector through the opening of economic and industrial cities, as well as the provision of industrial incentives, including soft loans and inexpensive infrastructure such as land, utilities and petrochemical feedstocks for joint ventures and Saudi firms. “We are seeing foreign firms beginning to invest, because industry is now being incentivised by beneficial regulation,” Hisham Atalla, managing director of Saudi Total Petroleum Products, told OBG. “Vision 2030 highlights this sector as one of the main areas for growth, so we expect a lot of opportunity going forward.”

However, due to the countrywide cuts in energy subsidies in December 2015 (see analysis), and a decrease in the government budget for 2016 due to lower energy receipts, funding to develop the industrial capacity of the Kingdom could be slower for the near future. “The past 12 months have presented the Kingdom of Saudi Arabia with an opportunity to reinforce its economic fundamentals, while spurring a move towards greater diversification. Looking at 2016, we see a number of challenges facing markets regionally and globally, which will require careful management and prudent preparation to weather potential headwinds,” said the “Alkhabeer Capital Outlook” Report, released by the Jeddah-based Alkhabeer asset management fund, in early 2016.

By The Numbers

It is more attractive than ever for Saudi Arabia to diversify its economy away from energy revenue. The Kingdom’s non-oil manufacturing sector grew by 3.2% in 2015, the Ministry of Finance (MoF) said in its 2016 budget announcement. According to the MoF, the non-oil private sector grew by 3.7% in 2015, while the oil sector was up 3%. The fastest-growing sectors were transport, at 6.1%; construction, with 5.6%; and utilities, at 5.1%.

However, the Kingdom’s real GDP growth dropped slightly to reach 3.4% in 2015, down from 3.6% in 2014. This contraction was mainly the result of a slowdown in the non-oil sector. In December 2015 Saudi Arabia’s non-oil commodity exports registered a 3.5% year-on-year (y-o-y) decline, according to the General Authority for Statistics. Plastics, rubber and related industries dropped by almost 19%, while transportation equipment increased by just over 21% and exports of regular metals and their related segments, machines and equipments, electrical devices and their parts expanded by 13.6% between December 2014 and December 2015.

The Kingdom’s non-oil sector is forecast to increase by 1.2% in 2016, according to the IMF, and has been impacted by reduced overall government spending in the face of cheaper oil. Despite the slower growth predicted for 2016, Jadwa Investment, a Saudi Arabia-based asset management company, sees the non-oil private sector continuing to be the main engine for growth in the Kingdom, but stresses that government spending remains central to expansion in the private sector.

Invest & Grow

The increasing role of non-oil industry in generating revenue can be seen in growing competitiveness in individual segments, which is prompting Saudi firms to think about ways to differentiate themselves from the competition. “In manufacturing and distribution in the Kingdom, where there is significant market competition, the ability to offer aftermarket services and quality maintenance is a key competitive differentiation,” Nader Antar, managing director of Otis Elevator Company Saudi Arabia, told OBG. In 2014 the government approved a new fund, the Saudi Arabian Company for Industrial Investment, to invest in manufacturing. The $2bn fund, a joint venture between the Public Investment Fund, Saudi Aramco and Saudi Basic Industries Corporation (SABIC), aids conversion industries that rely on non-oil manufactured products, such as petrochemicals, plastics, fertilisers, steel, aluminium and basic industries. However, according to Abdullatif Al Abdullatif, CEO of Al Abdullatif Industrial Investment Company, quality standards and regulatory measures to enforce anti-dumping policies should be put in place. “There is a strong need to enforce quality standards and anti-dumping regulations for imported manufactured products. It is crucial that the issue is addressed in a timely matter, as foreign manufacturers in the region are now focusing more on Saudi Arabia as an export market following the instability in other traditional export markets, such as Syria, Libya or Lebanon.”

In 2015 the Saudi Industrial Development Fund, a governmental agency set up in 1974 to grant medium- and long-term loans to encourage industrial development, approved loans totalling more than SR11.4bn ($3bn), up 94% y-o-y and the highest amount by value since the fund was established. “Industry is seeing great support from the government because it sees this sector as a major growth driver for the non-oil economy,” Tameem Alshebel, CEO of Saudi Mechanical Industries, an engineering manufacturing company, told OBG.

Labour Market

In recent years the Kingdom has attempted to tackle the issue of unemployment among Saudi nationals by incentivising the employment of Saudi workers over non-nationals. The NTP’s targets include decreasing unemployment for Saudi citizens from 11.6% to 9% by 2020.

Chief among the measures is the Nitaqat programme, also known as Saudiisation, launched by the Ministry of Labour, which divides employers into a number of different groups based on the proportion of Saudis they should be employing. Under the Nitaqat programme, different industries are expected to meet different Saudiisation targets and are given financial incentives or penalties if they succeed or fail to reach their goals. The Nitaqat programme was adjusted again under Vision 2030; instead of being based strictly on numbers and percentages, it is now based on sector, pay scale and several other factors that are intended to create a more equitable system. Banks employing more than 500 people should reach a minimum of 49% Saudi employees, for instance, while the media sector and commercial operations should have 19%.

According to the Ministry of Economy and Planning’s “Saudi Economic Report 2014”, released in May 2015, the number of unemployed Saudis rose from 622,533 in 2013 to 651,305 in 2014. Currently, 66% of employed Saudis work in the government sector, with men making up 53% of this figure and women around 13%. However, there have been some positive signs for the government regarding the private sector. Growth of employment in the private sector accelerated to reach 14.2% in 2014, compared with 3.3% growth in the government sector, according to the ministry’s report. Non-Saudi workers are largely concentrated in the retail and wholesale trade, and construction sectors, at 22% and 21%, respectively, while Saudis typically work in the areas of general administration, defence and social security (35.8%), and education (23.6%).

Employment Dynamics 

According to the “Saudi Economic Report 2014”, the Saudiisation ratio increased in manufacturing, financial services, communication and retail and wholesale trade, but declined in the Kingdom’s mining, trade, agriculture, health, transport and hotels industries. The NTP aims to decrease the cost of employing Saudis compared to expatriates from 400% to 280% by 2020. Using the 2014 labour force survey, as well as realised growth rates for the period 2009-14, the executive summary of the Riyadh Economic Forum Seventh Session, held in Riyadh in December 2015, predicted that the number of employed citizens in the manufacturing sector would rise from 188,895 in 2014 to 327,631 in 2020, representing a compound annual growth rate of 9.6%. In addition, the mining and quarrying industries would see an increase from 99,795 to 137,124, while building and construction would see an annual rise of 8685 employed citizens, from 130,435 in 2014 to 182,546 by 2020.

For companies operating in certain sectors of the economy, meeting Saudiisation obligations can be a challenge, with some Saudis unwilling to do low-skilled jobs or, if they are willing, costing significantly more to hire. The average monthly salary of Saudi workers in the wholesale and retail sector in 2014, for example, was an estimated SR3619 ($965), compared with SR1204 ($321) for a non-Saudi worker, according to the Ministry of Economy and Planning. “Saudiisation is a challenge. You can hire an expat for SR3500 ($933) a month, whereas a Saudi will cost you SR8000 ($2133), and that is a fresh graduate just starting out, whereas the expat employee will have experience,” Ayman Al Hazmi, general manager of Wahaj (Saudi Specialised Products Company), an affiliate of Sipchem, told OBG. “However, often businessmen don’t see the big picture. If you have Saudi men and women, it is more expensive in the short term, but long term it is better. In the beginning they will cost more, but in a few years they will give you better quality and stability, and they will stay, whereas the expat will go home. If you have Saudis and train them for four to five years, your productivity will increase by 40-50%.”

Incentives

In February 2015 the Ministry of Labour made slight amendments to the Saudiisation monitoring rules in order to assist companies in meeting their targets and deter those who were letting employees go after their numbers had been recorded. Under the new regulations, Saudis would be counted as soon as they were hired, and also would be withdrawn at the time they left. In the past, new Saudi employees counted as one-third of an employee in the first month, two-thirds in the second month, and only in the third month would they be counted as a full employee.

Building Economic Cities

A critical component of Saudi Arabia’s drive to create manufacturing and industrial hubs has been the development of specific economic and industrial cities. Economic cities are expected to contribute 20% of the Kingdom’s GDP by 2020, according to the Saudi Arabian General Investment Authority (SAGIA), which was set up in 2000 to be the driving force behind the Kingdom’s investment programme.

In 2006 the Saudi government launched the Economic Cities Authority (ECA) as an agency within SAGIA, which was subsequently spun off into a separate entity in 2010. The ECA acts as the regulator and supervisor of the economic cities programme. Each economic city is being fully planned, developed and operated by a master developer from the private sector, with a total of four economic cities currently under construction, each focused on specific industries or opportunities.

On the whole, the majority of sector stakeholders have welcomed the regulatory environment that the ECA has worked to create. “In the current economic environment it remains difficult to produce certain machine parts locally; however, the regulatory framework and the government support has created a significant opportunity for the growth and development of manufacturing in the Kingdom,” Ayman Abdul Ghani, CEO of Abdul Ghani Hussain Group, told OBG. “The industrial cities are particularly well set up for industrial investment.”

The largest, King Abdullah Economic City (KAEC), was launched in 2006 and is being built by Emaar, The Economic City. KAEC has a total area of 168 sq km and is expected to have a population of more than 2m by 2025. The city’s industrial zone will cover an area of around 64.8 sq km and will accommodate over 2500 manufacturers and logistics companies. King Abdullah Port, the first privately owned and funded port in the Kingdom, began operations at KAEC in 2014 and already has an annual container capacity of around 3m twenty-foot equivalent units (TEUs), with an eventual target of 20m TEUs.

The Prince Abdulaziz bin Mousaed City ( PABMEC), at Hail in the north of the country, is aiming to become a logistics and transportation centre for the Middle East and should be completed by 2025. PABMEC will also have a separate petrochemical industries district, with an oil refinery, natural gas processing plant and production facilities for pharmaceuticals, rubber, fertilisers, plastics and basic chemicals. Knowledge Economic City, launched in 2006 in Medina, is focused on knowledge-based industries like IT and life sciences, while Jazan Economic City (JEC) aims to utilise its location on the Red Sea coast between major international shipping routes to grow its manufacturing industry. JEC will include a port, oil refinery, aluminium smelter and processing facilities for metals and minerals, as well as agro-based industries. The construction of the four integrated economic cities should transform the economic landscape, while also providing new greenfield opportunities for investors.

Industrial Hubs

In addition to the large-scale economic cities, Saudi Arabia is also developing industrial centres that target certain geographical regions and industrial sectors. In 2001 Saudi authorities established the Saudi Industrial Property Authority (MODON), responsible for the development and operation of industrial cities, with integrated infrastructure and services to meet the varying needs of investors and businesses.

MODON is currently overseeing a total of 34 existing and under-construction cities, including sites located in Riyadh, Jeddah, Dammam, Makkah, Qassim, Al Ahsa and Medina. Industrial cities in the planning stages are situated in Salwa, Dhuba and Nawan, among others. According to MODON, its goal is to have 40 cities within the next five years, encompassing more than 178m sq metres of developed industrial lands. There are currently an estimated 5800 factories operating in the existing industrial cities, with close to 500,000 employees and overall investment of more than SR500bn ($133.3bn).

Opportunities For Women

In November 2015 MODON announced it was planning to establish four new industrial cities, in Jeddah, Yanbu, Qassim and Al Jouf, that would be specifically designed for female workers. Employment among women in Saudi Arabia is low, with social factors such as the requirement for workplaces to be gender-segregated and the ban on women driving, limiting female employment opportunities. The MODON Oasis in Al Ahsa is the first industrial city in the Kingdom to be entirely run by women. The Oasis, which operates on land encompassing 500,000 sq metres, has cost a total of SR85m ($22.7m) and has 80 factories involved in the industrial, trade and service sectors.

While industrial cities are specifically aimed at bringing in large-scale companies, the majority of which are foreign, there is an overall plan to begin to nurture the growth and development of homegrown Saudi businesses and build up clusters of industries. There is also a hope that the economic and industrial cities will help the development of those regions of the Kingdom located outside of the major cities. “Developing industries in other regions is important in order to support economic growth outside of the Kingdom’s main urban centres. It will also reduce emigration to big cities, which is currently bringing the customary challenges of rapid urbanisation,” Alshebel told OBG.

Petrochemicals

At present, most of Saudi Arabia’s petrochemicals are exported overseas as basic commodities. However, major opportunities exist for the Kingdom to move up the value chain into semi-finished and finished products. According to local media, diversification into specialty chemicals is expected to increase returns from roughly $500 per tonne to around $2000 by 2040.

Refineries

Over the last decades major investments have helped expand Saudi Arabia’s refining capacity to add more value to the Kingdom rather than simply shipping out unrefined crude oil. Saudi Aramco, the national energy giant, has two large-scale, joint-venture refineries, Yanbu Aramco Sinopec Refining (YASREF) and Saudi Aramco Total Refining and Petrochemical Company (SATORP). YASREF, which was established in the Yanbu Industrial City in 2012, has a refining capacity of 400,000 barrels per day (bpd) of Arabian heavy crude, producing over 13.5m gallons per day of ultra-clean transportation fuel. It shipped its first 300,000 barrels of clean diesel in January 2015.

SATORP, also one of the largest refineries in the world and a joint venture with France’s Total, has the capacity to fully convert 400,000 bpd of Arabian heavy crude oil into low-sulphur petrol, diesel and jet fuel. In addition, the complex also produces more than 1m tonnes per year of paraxylene, benzene and high-purity propylene. In 2018 Saudi Aramco’s refinery in Jazan is expected to come on-line, with a capacity to turn 400,000 bpd of crude oil into petrol, benzene, low-sulphur diesel and paraxylene. In January 2016 the Wall Street Journal reported that Saudi Aramco was in advanced talks with two of China’s leading energy firms, China National Petroleum Corporation and Sinopec, related to a number of refinery projects in China that would increase the Saudi company’s sales in Asia (see analysis).

Opportunity Knocks

Outside of refining, opportunities exist all along the hydrocarbons value chain. In December 2015 SABIC announced that commissioning would soon begin at its new $3.4bn Al Jubail Petrochemical Company elastomers facility, a 50:50 joint venture between SABIC and Exxon Chemical Arabia, following the completion of construction. The plant started trial production in April 2016 and is expected to produce more than 400,000 tonnes per year of rubber, thermoplastic speciality polymers and carbon black. It will be the first synthetic rubber plant in Saudi Arabia.

Also located in Yanbu is the High Institute for Elastomer Industries, jointly funded by ExxonMobil and SABIC. The institute aims to train and equip Saudi technicians with the knowledge and tools to work in the developing domestic elastomers conversion industry. There are 60 students in each of the institute’s two-and-a-half-year programmes, with the first graduating class in 2015.

Meanwhile, in late 2015 Petro Rabigh, a joint venture between Saudi Aramco and Japan’s Sumitomo Chemicals, launched engineering, procurement and construction tenders for a polyether polyols plant that would have a capacity of 220,000 tonnes per year, as well as a 17,000-bpd naphtha treating unit that would produce clean fuel and a 106,000-tonne-per-year sulphur recovery unit.

The Sadara Chemical Company, a joint venture between Saudi Aramco and Dow Chemical, was established in 2011 and the company has almost finished constructing the largest integrated chemical complex ever built in a single phase in Jubail Industrial City, which will have 26 separate manufacturing units and will cost $20bn. “Sadara is very important, it is moving from producing basic materials to products with added value,” Abdullah Ali Al Subaith, director of research and development at the Royal Commission for Jubail and Yanbu, told OBG.

Many believe there are still plenty more opportunities available. “Now we are mostly using oil, but it is just one of our resources. Crude oil has a lot of chemicals you can get out of it. We have not developed them enough yet,” Talal Awad Aljohani, co-director of King Abdulaziz City for Science and Technology-Cambridge Centre for Advanced Materials and Manufacturing at the Joint Centres of Excellence Program, told OBG. Aljohani believes there is a wide range of opportunities for polymers, which he suggested was one particular area where the Kingdom should aim to become a global leader, as well as carbon-based fabrication, such as carbon fibre and carbon nanotubes.

Others within the industry point to the necessity of focusing development primarily on downstream petrochemicals. “Don’t go trying to create a company downstream if the raw material needed is then imported from China or South Korea. You will fail,” Al Hazmi told OBG. “Look at raw materials in the Kingdom, and then go downstream with backward integration or forward integration. If we do not close the chain when it comes to oil and gas, which is the heart of the country, there is no chance for downstream businesses to succeed.”

Government officials seem to be largely on the same page. According to Abdullatif Al Othman, then-governor of SAGIA, speaking at the Gulf Petrochemicals and Chemicals Association conference which took place in Dubai sometime in November 2015, the Kingdom is targeting a total of $150bn in potential investment in the downstream hydrocarbons industry, with upwards of 200,000 direct industrial jobs to be added over the next 10 years as a consequence. “Our aim is to double jobs, double investments and double economic growth over the next 10 years,” he told those in attendance.

Plastics

With the abundance of petrochemicals, there are significant opportunities for the development of a downstream plastics industry in Saudi Arabia. The Kingdom currently accounts for around 64% of regional plastic production, followed by the UAE with 20%. The GCC moulded plastics market was valued at $7.2bn in 2014, but with an expected growth of around 8.3% per year it could almost double in size to $14.2bn by 2023, according to a March 2016 report by Transparency Market Research, an India-based market research company. This growth would facilitate other business opportunities. “Saudi Arabia is importing whole moulds from outside the country. This is a SR400m ($106.6m) business opportunity, and in the past no one was targeting this sector,” Al Hazmi told OBG.

Targeting the manufacturing of plastics is also a way for the Kingdom to link its upstream capacities with its goals to develop industrial sectors like automotives: cars today use around 150 kg of plastics and polymer composites per car, up from about 10 kg in 1960. As the Kingdom pushes to develop a domestic automotive industry, this sector of the economy could well flourish.

Building Materials

Given the scale of infrastructure projects in the Kingdom in recent years, the construction sector has been growing strongly, and this has worked its way down to the building material industry (see analysis).

Saudi Arabia was the eighth-largest producer of cement in the world in 2014; however, the slowdown of the economy and the energy price hikes of December 2015 have impacted the sector. “Lower oil prices and subsidy reductions have led to an uptick in overheads and manufacturing costs,” Sherif Megeed, managing director of Jotun Saudia, a Jeddah-based paint manufacturer, told OBG. Saudi Cement, the Kingdom’s largest cement company by market value, estimates that the price increases will raise its production costs by SR68m ($18.1m) in 2016, after the prices of methane and ethane rose from $0.75 per million British thermal units (Btu) to $1.25 and $1.75, respectively.

In a positive development, local media outlets reported in December 2015 that the government may be considering lifting the partial export ban currently in place for cement, and steel in order to allow domestic producers to sell overseas. The ban was subsequently lifted in April 2016 for both cement and steel rebar, which could help mitigate lost earnings from decreased public spending on infrastructure projects and real estate developments, although fuel subsidies for exported cement will have to be paid back to the government.

Pharmaceuticals

In 2014 Alpen Capital forecast a compound annual growth rate of 11.4% for the Saudi health care market between 2014 and 2018, reaching a projected market value of $31.5bn by 2018. An April 2016 pharmaceuticals and health care BMI Research report estimated that pharmaceutical sales would increase from SR31.6bn ($8.4bn) in 2015 to reach SR35.3bn ($9.4bn) in 2016.

At present, most pharmaceuticals are imported into the Kingdom from abroad. “Pharmaceuticals have across the board potential. 80% of pharmaceuticals are imported, which is very high for a middle-income country like Saudi Arabia. It is the same with medical devices,” Abdulkadir Farah, vice-president of business development at Modern Industrial Investment Holding Group, told OBG. “Just like in mining, there is a push to make health care the fourth pillar of the economy and tourism the fifth.”

A Helping Hand

Efforts are currently under way to help push the domestic pharmaceutical industry forward through the NTP, which aims to increase the proportion of local pharmaceutical manufacturing from 20% at present to 40%.

According to the Saudi Industrial Development Fund (SIDF), it has given financing to a total of 32 factories involved in the manufacturing of basic pharmaceutical products and pharmaceutical preparations since it was established in 1974, for a combined value of SR3bn ($799.8m) (see analysis). “The pharmaceuticals sector has great potential here. Interest is growing, but we would like to see much more investment in this area,” Abdul Karim Al Nafie, director-general of SIDF, told OBG.

Recent developments demonstrate that this process is in motion. In December 2015 Pharmaline Saudi Arabia, which is a joint venture between Al Rashed and the Malia Group, signed a land-lease agreement with KAEC for the company to build its first pharmaceutical facility in the Kingdom. Once on-line, the facility will act as a hub for the company to access both Saudi and regional markets.

French drug maker Sanofi Aventis and US firm Pfizer have already committed to establishing manufacturing facilities in KAEC. Sanofi Aventis is opening a 35,000-sq-metre manufacturing base, while Pfizer will have a 32,000-sq-metre facility that will produce 16 of the company’s top-selling medicines locally. The plant is set to open in 2017. In January 2016 Indian manufacturer Aurobindo also announced plans to construct a facility in KAEC to manufacture generic drugs. The company has more than 230 drugs certified by the US Food and Drug Administration and global sales of $2bn.

Research & Development

Most Saudi pharmaceutical firms remain focused on producing branded generics, though some are also involved in manufacturing drugs under licence agreements with major international manufacturers. However, the expected rise in the quantity of generics produced in low-cost countries on the market could put pressure on this business model (see analysis).

Outlook

There is good reason to feel optimistic about the development of the industrial sector in Saudi Arabia, as more industrial and economic cities come on-line and downstream industries continue to grow. Those industries targeting downstream petrochemicals are well placed to prosper and could benefit from the lower price of oil. However, the recent cuts in energy subsidies (see analysis) are likely to have a short-term impact on industrial growth, especially for mining and energy-intensive manufacturing operations, with a number of companies holding back on expansions or cutting capacity until their energy efficiency is improved.