Saudi Arabia has struggled to diversify its economy in the past, but the lower-for-longer oil price cycle has spurred unprecedented determination in the kingdom. Melodie Michel reports.


When Saudi Arabia announced its National Transformation Programme (NTP, part of its Vision 2030 initiative) in June 2016, many probably thought: “We’ve heard this before.” And they would be right. In 2010, the kingdom’s ninth five-year plan involved a government budget of US$385bn to spend on non-oil projects, with a strong focus on education (50% of the budget) and “economic resources”, namely agriculture, water, electricity, mineral resources, and tourism (15.7%).

In 2014, hydrocarbons still accounted for 85% of export revenues and 90% of government revenues. Some experts believe that Saudi Arabia will never be serious about diversification.

But that was before the oil price glut observed since 2014. Oil prices, which had recovered from a sharp drop in 2009 and traded between US$90 and US$120 a barrel for most of 2011 to 2013, started plummeting again and dropped to below US$30 in 2016. The
recent recovery observed in the market hasn’t been very significant – prices averaged US$55 a barrel at the start of 2017.

“Saudi Arabia started to push forward with these diversification efforts in its 2010 five-year plan, realising that they really needed to push the economy into more education and training, etc. Part of the underpinnings for Vision 2030 and the NTP had already started to become apparent in 2010, but the conditions with the lower-for-longer oil price outlook certainly hastened those plans,” IHS Markit director Bryan Plamondon tells GTR.

In fact, some of the initiatives announced last year are already being implemented, namely a 20% cut in ministers’ salaries and the reduction of many public sector bonuses and energy subsidies. These efforts are paying off: Saudi’s budget deficit went from 15% in 2015 to 11.5% in 2016.

Bankers interviewed by GTR have seen a spike in non-oil projects in the past two years, naming hospital, airport, port and manufacturing developments as some examples. Foreign companies are showing a lot of interest, particularly in the infrastructure sector, they say.


Mining potential

The Saudi government officially inaugurated the Ras Al-Khair complex on the northeastern coast of the country at the end of November.

The industrial city cost US$35bn, took 10 years to build, and is one of the cornerstones of the kingdom’s Vision 2030 diversification plan. It includes a US$5.6bn integrated phosphate plant operated in partnership between the Saudi Arabian Mining Company (Ma’aden) and diversified manufacturing company Saudi Basic Industries Corporation (SABIC), and a US$10.8bn integrated aluminium complex operated jointly by Ma’aden and Alcoa. The complex features an aluminium refinery with a production capacity of 1.8 million tonnes a year and aluminium recycling facilities.

Phosphate, bauxite ore and minerals extracted from mines in the kingdom’s northern and central regions are now sent to Ras Al-Khair via a 1,400 km railway line, processed at the new plants, and exported via an US$800mn port developed by the Saudi Ports Authority.

In addition, Saudi Aramco has teamed up with GE and Cividale of Italy to build a US$400mn steel forging and iron casting manufacturing facility to serve the region’s maritime and energy industries, due to be operational by 2020.

“We have earmarked Ras Al-Khair to be a centerpiece of our strategy to create a world-class mining industry. We are confident that the kingdom will be a global mining leader in the future thanks to the continuous support of all our partners in the public and private sectors in establishing this critically important project,” said Khalid Al-Falih, Saudi minister of energy, industry and mineral resources, upon inaugurating the complex last year.

According to an Australian Trade and Investment Commission (Austrade) brief, from 2015, Saudi Arabia has some of the world’s largest reserves of phosphate and tantalum, and up to 20 million ounces of gold in known deposits. The central and northern parts of the country contain large amounts of bauxite, silver, zinc, copper, magnesite and kaolin, and over 40 types of mineral deposits have thus far been identified in the kingdom, with at least 15 with potential for extraction.

The government revised its mining investment code and mineral resources executive regulation in 2004 to encourage private (domestic) investment in the sector. In the same year, it began to privatise Ma’aden, selling 50% of its share in a 2008 initial public offering that raised US$2.47bn.

The problem is that investment in the sector is very recent – again, Saudi Arabia didn’t feel the need to expand its horizons until its main revenue source started to run dry – and that it is still widely closed to foreign direct investment (FDI).

But the oil price pressure has encouraged the country to allow more FDI (which has been on a downward trajectory since 2009 and amounted to just US$8bn in 2014) into the country, and mining is set to be a priority.

“That’s a sector that hasn’t really been tapped, much like the natural gas sector where they’re just starting to find ways to explore and leverage their mineral and hydrocarbon resources more fully. If they open up to more of the public-private partnerships they’ve spoken about, this is a sector that could develop nicely in the medium term,” says Plamondon at IHS.


Picking up the pace

New initiatives to diversify and strengthen the Saudi economy are published almost daily. Just as this publication went to press, energy minister Khalid al-Falih said the country was about to launch a renewable energy programme involving between US$30bn and US$50bn of investment by 2023. Green power currently represents just 1% of the kingdom’s energy mix, but there are plans to raise this to 4% by 2020.

In December 2016, the government announced an 8% increase in budget expenditure for 2017, to SAR890bn (US$237.3bn), including US$11.2bn for NTP initiatives.

Oil is still the driving force behind Saudi’s economic growth, therefore prospects have been hit by OPEC’s decision to cut output: the International Monetary Fund (IMF) reviewed its GDP growth prediction downward from 2% to 0.4% for 2018 after OPEC’s announcement. The revision was criticised by Saudi Arabia, with finance minister Mohammed Al-Jadaan saying he expects growth to be “north of 1%”.

But on the ground, experts agree with the more conservative outlook. “We expect it to be a tough year in Saudi,” says one international banker operating in the country. Despite noticing an increase in non-oil deals in the past two years, he observed a slowdown in activity as oil revenue dropped.

The IMF expects growth to return to 2.3% in 2018 – a sign that the country is on the right track.

“Our overall growth outlook for 2017 is a bit brighter,” says Plamondon. “We’re not expecting so much growth from the oil and gas industry given OPEC’s decision, but we expect that some of the liquidity conditions will improve given the recovering oil prices and the fact that the government is going into the debt market and issuing bonds. We expect more bond issuances to come out in 2017.”

Economists expect Saudi debt to remain attractive in international markets even with the negative impact of weaker growth, and its October 2016 sovereign bond issuance, attracting no less than US$67bn of bids, is proof of that.

But for GTR’s banking source, there are many obstacles to overcome before Saudi Arabia becomes more attractive to foreign investors. “It will take a bit of time before the budget deficit is under control, because the first bond they issued was a very small part of what they really need,” he says. “They also need significant improvements in regulations and requirements, as it’s very unclear in some sectors. Another big deterrent for companies wanting to operate in Saudi is the nationalisation requirement for Saudi staff. Despite investment in education, the story on the ground is that there are very few people that are qualified and skilled to take on those roles, and they are very expensive.”

He adds that the liquidity squeeze, an effect of the drop in oil prices has created payment delays, though he sees this as more of a short-term effect, which should be resolved as prices recover.


The golden egg

When it comes to improving liquidity and reducing the budget deficit, Saudi Arabia has one more trick up its sleeve: the country plans to sell up to 5% of its state-owned oil company Saudi Aramco, with an initial public offering (IPO) expected by the first half of 2018. When it goes ahead, Saudi Aramco is expected to overtake Apple as the world’s most valuable listed company, and the kingdom will cash in, allowing for more investment in non-oil sectors.

“There’s a lot of buzz around the Saudi Aramco IPO, it’s the blue chip of the kingdom,” says Plamondon. “It’s taking a lot of time to set the details of how they want to go about doing it, in which market, etc. They have to release information that was previously just held by the state: there are a lot of legal hurdles they have to make sure they’re addressing. They’re definitely serious about it, and this is a very complicated process to go through so it’s taking some time. It could possibly happen towards the end of 2017 but most likely it will happen in the first half of 2018.”

Saudi Arabia still has a long way to go to reach the type of economic diversification observed in the UAE, but there is no denying that it has set in motion a drastic reform plan with the potential to change the country’s revenue mix – if it can stick to its commitments and deliver its goals.