Breaking The Curse Of Oil

One could be forgiven for assuming that record-high energy prices are a cause for celebration in the Persian Gulf. After all, the proven oil reserves that lie beneath the six primary gulf states now total some $65 trillion, more than the value of the world's equity markets. Yet even as sovereign-wealth funds across the region scramble to invest their petroleum windfalls, gulf leaders, who over the past half decade have raised nearly $1 trillion in oil-related revenue, are trying to get their nations out of the energy business. The higher crude prices climb, it seems, the harder the region is trying to break its habit.

From Riyadh to Dubai, the byword is diversification. After largely failing to smartly invest the oil windfall of the 1970s, the gulf monarchies and emirates are rushing to avoid the same mistake now. They're spending the new windfall to develop new industries from tourism to finance, medicine to education, while also opening to foreign investment, particularly outside the oil patch. The big emphasis is on hydrocarbon-related industries like petrochemicals and fertilizer production, processes that use byproducts and residuals of oil and gas refining. "The oil sector is one third of GDP," says Abdulrahman Al-Tuwaijri, the chairman of Saudi Arabia's Capital Market Authority, a stock-exchange regulator. "But it's capital-intensive, and it does not employ much. It's the non-oil economy that creates jobs—trade, industry, petrochemicals."

That makes Saudi Basic Industries Corp., Saudi Arabia's biggest public company, one of the Middle East's rising corporate stars. Already the world's largest petrochemical company by market value, Sabic, as it is known, has become a vanguard of a diversification drive that seems to be working. Even with oil prices spiking, the kingdom's non-oil exports, mostly chemicals and petroleum-based building materials like plastic, rose from 10 to 12.4 percent of all goods sold abroad between 2006 and 2007.

Local oil makes Sabic chemicals so cheap, investors argue, that eventually any product with substantial plastic content—casings for computers and MP3 players, for example, or bumpers and tires for automobiles—could be produced in the kingdom. Capturing that "downstream manufacturing" and the jobs that go with it is a key step toward building a stable middle class. "What's preventing us from setting up a factory for an electronics maker like Sony to produce covers for Walkmans and TVs?" says Prince Mohammed K.A. Al-Faisal, president of the Riyadh-based Faisallah Group, which manages a portfolio of companies and equity investments. "It's an advantage for them to produce close to cheap raw materials."

For years after its founding in 1976, Sabic did a respectable if sleepy business converting natural gas released from oil extraction into fertilizer for export. But over the past decade, Sabic has expanded aggressively through an acquisition drive propelled by CEO Mohamed Al-Mady, and it now does $33 billion a year in sales. Al-Mady has made his grand ambitions clear. "Sabic is the most profitable petrochemical company in the world, and that allows them to take risks," says Jean-François Seznec, a Middle East expert at Georgetown University. "Al-Mady has a vision for where he wants to go, and he's going after BASF." The German giant BASF is the world's leading chemical producer, with annual sales of $89 billion.

So Sabic has a long way to go. Al-Mady began to globalize the state-owned company in 2002, when Sabic secured its first overseas foothold by purchasing the Dutch chemical maker DSM for $2.2 billion. He followed up by buying the British assets of U.S.-based Huntsman Corp. for $700 million and, just last year, the plastics subsidiary of General Electric for $11 billion. The GE deal, the largest of its kind involving a Middle Eastern buyer, broadened Sabic's production base to include complex polyethylenes such as hexane octane, which are molecularly structured to strengthen everything from plastic bags to running shoes.

It also gave Sabic a production base for polycarbonates, which are used in riot shields and compact discs. The former GE division that Sabic now controls makes a high-strength polycarbonate for bulletproof glass, water bottles, iPods and even the helmet visors used by NASA astronauts. "Sabic is diversifying, which is roughly in line with what the kingdom wants," says Carlo Barrasa, a consultant at PFC Energy in Washington. "But it's also increasing the value of the company by going global. It's a smart move."

The GE plastics deal was emblematic of Sabic's enviable but controversial position in the global chemical industry. While GE was being driven out of the market by the rising costs of benzene, a petroleum derivative that is a vital component in its products, Sabic has ready access to the world's largest and cheapest oil supply.

That's unfair competition, according to the company's European rivals. In 2005, while Saudi Arabia was negotiating for membership in the World Trade Organization, the European Union protested what it said were subsidized rates Sabic pays for the raw materials it buys from Saudi Aramco, Riyadh's national oil company. In the end, Saudi Aramco was allowed to maintain its two-tiered fee structure—its exports sell at about a 30 percent premium over what they cost locally—because it does not discriminate against foreigners operating in the kingdom. It helped Riyadh's case, trade experts say, that the United States lobbied strenuously on its ally's behalf.

Other gulf states are pursuing a very different strategy because their small size makes it difficult to develop heavy industry. Dubai, for example, has identified finance as its future, while its slightly dowdy sister city, Abu Dhabi, is transforming itself into an epicenter for higher learning. But all appear to be taking much better advantage of high prices than they did in the 1970s. "Capital used to come from west to east," says Soud Baalawy, executive chairman of Dubai Group, an investment-management firm. "Now it's the other way around, and we need to exploit this." If oil prices stay where they are, that won't be a problem.

Breaking The Curse Of Oil | World