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Sun 24 Apr 2011 05:59 PM

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Crude control

In a twist of irony, social unrest in other parts of the Arab world has boosted Saudi Arabia’s economy. Sky high oil prices mean that the kingdom will easily be able to fund its long-awaited and much-needed spending plans

Crude control
Spiking oil prices will come as a relief to Saudis King Abdullah, who marked his return earlier this year with two major spending plans, worth an estimated $130bn

Imagine, for a moment, that the us had near-to-zero net debt - instead of the estimated $14 trillion it has currently - and cash in the bank equivalent to 100 percent of its GDP. For the world’s biggest economy, that enviable position is unthinkable, and yet this is the situation in which Saudi Arabia finds itself today. Given that one of the kingdom’s major headaches has not been how to fund its spending plans, but exactly how to disburse its wealth, it’s somewhat surprising that economic growth in Saudi Arabia has been relatively soft, trundling along at an average of around five percent over the last five years or so. That performance looks good in comparison to OECD countries, but pales next to growth being posted by China and India, and falls far short of Qatar’s projected near-20 percent hike this year.

Of course, comparisons between Saudi Arabia and Qatar are not entirely helpful. While both nations are resource-rich, Qatar’s smaller population means it is far easier to disseminate riches amongst its people. Unlike many of the countries in the Gulf, however, Saudi Arabia has a still-growing population, with more than 50 percent of them under the age of 30. Too few of them have jobs, housing is under-supplied and overly expensive, and their job opportunities are limited. That the kingdom has not already succumbed to the pressure cooker of unrest that has affected North African nations and neighbouring Bahrain is due in large part to its oil wealth, although the early months of 2011 have shown that the government has no plans to leave anything to chance.

After a period of convalescence, HRH King Abdullah marked his return to Saudi Arabia earlier this year with two major spending plans, worth an estimated $130bn. Those plans included a new unemployment benefit, a new minimum wage and bonus payments, as well as significant investment in the Saudi real estate market. Given that the kingdom’s projected budget spend for 2011 was $155bn, that gives some indication of the magnitude of the king’s order. While only a portion of the $130bn social spending package will be spent this year, that kind of budget increase - up to 40 percent more than last year - would cripple most economies. But Saudi Arabia can afford to take on the extra spending while barely missing a beat.

The reason? First and foremost, the kingdom has benefited, and will continue to benefit, from the high oil price. Saudi Arabia’s previous 2011 budget would have been balanced by a fee of around $80 a barrel, which still represents a significant outlay. But with prices currently looking quite entrenched at around $107 a barrel, it looks like the kingdom won’t even need to dip into its mammoth foreign reserves, which sat at a record high $445bn earlier this year. Given the unrest in Libya, Saudi has also stepped in to increase its production capacity to 9.5 million barrels a day, and has even marketed new mixes of crude to match the Libyan light sweet crude type that is so popular in the market. That said, the Saudis also confirmed that they were still 3.5 million barrels short of their maximum capacity, with that extra capacity alone being more than the full total being pumped daily by any other of the Gulf nations. The oil giant also felt confident enough in the strength of the global markets to lower its capacity last week.

“The Saudi Arabian response sent out a powerful message, amplified very clearly by [oil minister Ali] Al Naimi, that the country was ready and able to raise its output radically within a very short space of time and develop new blends at the same time to replicate the characteristics of lost volumes,” says IHS Energy analyst Sam Ciszuk. “The gist of the argument made by Al Naimi… is the swiftness with which Saudi Arabia could supply the markets in a time of uncertainty and its willingness to make volumes available to buyers even when the fundamental reasons to do so might have looked weak. Saudi Arabia’s, and a large part of OPEC’s, interest in tempering radical crude price increases also plays a part in that strategy.”

In pure financial terms, Jadwa Investment has estimated for every extra $10 that goes on the price of crude for the year, Saudi Arabia will collect around $24bn extra in oil receipts. So if the oil price stays at around the $100 mark, the kingdom will easily be able to use the extra $50bn or so to fund the first tranche of its social spending plan this year, without either pushing the budget into a deficit or dipping into foreign assets. There can be no doubt that Saudi Arabia is in a markedly solid fiscal position.

So where will that largesse be spent? Overall, the king called for 500,000 new units to be added to the market over an unspecified period. Given that new home sales in the US hit 250,000 last year - in a market for 310 million, compared to a market of 18 million in Saudi Arabia - and given that almost six Saudis live in each household, on average, that adds up to a lot of housing. Furthermore, this tranche comes on top of already-announced plans, meaning that the kingdom will add a total of 1.65 million homes over the next five years, or 275,000 units annually.

That spells excellent news for Saudi Arabia’s construction sector, and in particular its ‘big three’ contractors: Saudi Binladin Group, Saudi Oger and El Seif Engineering and Contracting. However, with those firms mainly concentrating on the massive infrastructure projects already announced by the government, the way is certainly clear for Gulf companies looking to expand their presence in the market.

“The smaller contractors that are in Saudi Arabia are very good, but limited to building 20-50 houses - so it’s not a case of the 3,000-strong projects,” David Smith, deputy general manager of Alinma Bank, told an audience in Abu Dhabi last week. “So what we’re finding is a number of Dubai contractors who have that experience wanting that work.”

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Alinma is currently looking to provide project financing for companies wishing to carry out construction in the kingdom, but Smith also warns that recent regulations will require contractors to think a little harder about their plans. Changes include a requirement for mosques and educational facilities to be included in design masterplans once projects have reached a certain size, and also that contractors conduct all their own wastewater management, as current networks are unable to cope with the extra load.

Drake & Scull International (DSI), a Dubai-based firm with over 50 percent of its backlog now situated in the kingdom, has recently acquired two Saudi companies, and says that the new housing plans should play into its hands.

“Now with the local companies we have, we feel very bullish on the market,” says DSI CEO Khaldoun Tabari, of King Abdullah’s new plans. “So I think we will pick up some of that work. There’s so much villa work, but I think the price is the problem. I think eventually that they will have no contractors to do all those villas.”

But Smith also thinks there is plenty of room for private public partnership (PPP) arrangements, which have recently become less popular in the kingdom. The PPP model has become synonymous in the Saudi mindset with slow or cancelled projects. Responsibility for the Riyadh-Jeddah Landbridge rail scheme, for example, was given over to a PPP arrangement until that deal was cancelled in 2009. Likewise, the Ras Al Zour integrated power and water project - planned to be the largest of the kind in the world - was also brought back under state control in the same year due to the inability of the Malaysia-led consortium to find appropriate financing.

However, with non-oil private sector growth proving surprisingly weak in 2010 in comparison to the previous year, the government is clearly looking at any means to galvanise a greater contribution from the private sector towards economic growth. Matching private sector expertise to colossal infrastructure spending therefore makes sound sense.

“PPP is definitely going to become more prevalent,” Smith says. “The test case is Madina airport, which is currently under PPP.  The closing date is 2 May, and out of the ten original pre-qualified contractors, we’ll probably end up with five. So I can definitely see this situation arising in the future infrastructure developments - so, say, things like hospitals and universities.”

In tandem with the housing announcement, the kingdom’s highest consultative authority, the Shura Council, also hurriedly pushed through their approval of the much-delayed mortgage financing law, which now needs only to be approved by the king. There’s little doubt that the mortgage law can go some way to filling the undoubted gap in the market.

“There is a bottleneck in housing; that’s reflected in the component of inflation that’s most damaging in Saudi Arabia, which is increasing rents,” says Brad Bourland, chief economist at Riyadh-based Jadwa Investment. “The other component that people feel is increasing is food prices, but that’s global not local. The mortgage law can go a long way to starting alleviate that, and it will help because it will be market forces that allocate that money towards housing. So it will be the commercial banks that lend, and will complement what the government is doing by building housing, and it’s really targeted at very low income Saudis in rural areas all over Saudi Arabia.”

Previously, home financing options for Saudis tended to be limited to family wealth, a personal loan from the bank, or access to the state-backed Real Estate Development Fund (REDF). However, for low-income Saudis, bank loans have been hard to obtain during a cut in private-sector credit lending, and have generally been limited to payback periods of about fifteen years. The REDF has played its part, but had upper limits of $80,000 in place until this year, when King Abdullah ordered this threshold to be raised to $130,000. In addition, lengthy waiting lists have made the fund almost redundant for younger Saudis.

But even if the Saudi mortgage law is signed this year, observers are not expecting a complete rejuvenation of the home financing industry. Egypt passed similar legislation in 2001, but a decade on, little has changed, and there must be a focus on tailoring mortgage arrangements so that they are both affordable and effective.

“A lot of the issues that the banks always had was taking title,” says Alinma’s Smith. “So previously a lot was done on a personal guarantee, but now the banks can take title and transfer what they call ifraq to the bank, which gives you that formal security. From that point of view, I’d say banks like Al Rajhi and Samba will all gain comfort from that and develop the retail side of it.”

But banks are still wary of lending, and the authorities will also be nervous about the steady rise in property values, especially given the effects a housing bubble has had on nearby Dubai. In addition, given the rising prices, it’s entirely possible that many Saudis may put off buying a house for a couple of years to allow for the extra supply to come online and depress prices somewhat.

“What’s led to a slowdown in lending to the private sector is tighter credit monitoring and credit standards required for banks,” says Bourland. “With mortgage being a new product, and having a very long tenure - so giving someone a very large 20-year loan that he’s never had before will be taking some credit risks that the banks haven’t taken. So I think they’ll build up those portfolios of mortgages quite slowly.”

There may not be an initial explosion of lending, but there should be no doubt that the mortgage law can redefine the kingdom’s housing market. Saudi Arabia has one of the lowest mortgage-debt-to-GDP rates in the world, at around 6.8 percent, according to Banque Saudi Fransi (BSF). That compares to 15.5 percent in the UAE, and as much as 80 percent in the US and UK markets.

“If protections for banks are adequate, they will in the long run be willing to increase the risk profile for borrowers, which could create even greater loan opportunities for lower-income Saudis,” BSF said, in a recent research note on the housing market. “With a mortgage law in place, borrowers would also eventually be able to secure loans at lower costs because of the legal backing involved in mortgage financing.”

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Needless to say, banks will need to play a key role if the state is to divest itself of its current home financing responsibilities. But over the last couple of years, the kingdom’s finance houses have been happy to park assets virtually anywhere apart from loans to the private sector. Other than the tighter credit controls, Saudi banks have also suffered from having to provision against non-performing loans. But, according to research from Jadwa, the long period of provisioning is almost over. In data published in April, the investment house said that total provisions for credit losses had covered 109 percent of bad loans by the end of last year, in comparison to 86 percent at the end of 2009 (see box out). All that should - technically - translate into better profits in 2011. But thus far, results in the first quarter have been disappointing.

“In the first quarter you don’t get the full details of the balance sheets, so you don’t know how much provisioning there needs to be or not,” says Bourland. “But it looks like banks are not growing their lending much yet, and they’re also struggling to make a lot of money in their investments and their treasuries, because interest rates are so low, thus leading to disappointing earnings reports. But if that provisioning goes away, that by itself should show a good pop in profits.”

Better bank results, the surge in oil revenues and the government cash injection are all contributing to a degree of confidence in the Saudi economy. At the beginning of the year, the Tadawul All-Share Index (TASI), the biggest index in the Gulf, looked set for an excellent 2011. BSF’s highly-rated business confidence index for the first quarter showed that 75 percent of respondents thought that the outlook for equity markets would be positive over the next two quarters, up from just 35 percent in the bank’s last-quarter 2010 note.

Of course, that confidence was somewhat dented by regional unrest, with the TASI the second-most volatile of all Arab indices in the first quarter, behind Egypt. But after sliding dramatically in March, the exchange has nearly recovered all its losses, closing almost exactly where it had been at beginning of the year in the first days of April, with investors clearly feeling the worst was behind them.  However, the BSF study showed that business leaders are now seeing cash as their best investment bet - followed by bonds, equities and, lastly, real estate - in a marked change in the outlook from the first quarter.

“Business leaders indicated that holding cash would offer the best returns in the next six months as equity prices face an uncertain future,” the report said. “Executives would rather keep their funds in low-risk, low-yield instruments at this stage, rather than opt for greater potential returns on the stock market or in real estate.”

However, a major fear from last year - that of inflation - does not appear to be materialising. One of the core components in the cost-of-living index, food, has tracked downwards this year, while rental inflation has also trended south. From its six percent highs in 2010, inflation stood at 4.7 percent in March, its lowest for twelve months. Having said that, the impact of two-month bonus payments for many private and public sector employees could well push inflation up somewhat in the coming months. BSF points out that many employees will have seventeen percent more to spend this year than they did last year.

While it is far too early to give a strong indication of the impact of King Abdullah’s new spending plans, they still seem to be a strong step in the right direction, heading straight to the core of Saudi Arabia’s wealth gap between rich and poor. Ironically, while external media sources claimed that the kingdom might be subject to political upheaval as a result of contagion elsewhere, both the king’s quick steps and a resurgent oil price mean that Saudi Arabia’s economy is in ruder health than ever. The challenge for Saudi authorities is now to continue to use the country’s abundant funds in a way that will best serve the less fortunate sectors of its population.

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