Moving energy-intensive industries to the Gulf

Transcription

1 Moving energy-intensive industries to the Gulf 95 Moving energy-intensive industries to the Gulf Multinational producers of energy-intensive commodities must rethink their approach to crafting deals in the Gulf. Jaap B. Kalkman, Laurent Nordin, and Ahmed Yahia With energy prices soaring in Asia, Europe, and the United States, the states of the Gulf Cooperation Council (GCC) Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE) are becoming increasingly attractive locations for energy-intensive industries such as aluminum, petrochemicals, and steel. To date, most multinational companies have had only limited success in seizing this opportunity. To do better, they must offer more than technology and operational skills when they seek deals with the region s governments and companies. Natural gas, the preferred fuel in many energy-intensive industries, is abundant and cheap in a number of GCC states, especially in Qatar, Saudi Arabia, and the UAE. Moreover, their labor costs remain competitive, and the business environment is favorable, with low corporate-tax rates. The Gulf now has, on average, only 5 percent of the total production capacity of six of the world s most energy-intensive commodities aluminum, ethylene, polyethylene, propylene, styrene, and steel. Yet it s no wonder that companies in the region have announced plans to develop almost a quarter of the world s capacity expansions over the next five years (Exhibit 1, on the next spread). Traditionally, multinational companies have contributed little to building production capacity in the Gulf, in part because the region has been relatively closed to foreign investment and because the differential in energy

2 96 The McKinsey Quarterly 2007 special edition: Reappraising the Gulf States Article at a glance Soaring energy prices in the West have made the Gulf an attractive location for multinational producers of energy-intensive commodities such as aluminum and petrochemicals. But as homegrown companies improve their skills and technology and national leaders seek business partners that can help develop the economy and create jobs, many multinationals are failing to gain entry to the region. To succeed, multinational companies must fully understand the needs of governments and other stakeholders in the Gulf and manage relationships with them during a potentially complex deal-making process. Multinationals must then structure broad deals that offer value to all the government and business partners involved. Related articles on mckinseyquarterly.com National oil companies: The right way to go abroad, Web exclusive, November 2005 A guide to doing business in China, 2004 special edition: What global executives think What s next for Big Oil? 2005 Number 2 prices was less wide until recently. Now the region is opening up and Western gas prices are soaring, which makes the cost advantages look very compelling indeed. Yet few multinationals have succeeded in forming joint ventures with Gulf governments or national or regional players to exploit the structural advantages. In primary aluminum production, to cite just one opportunity, the region will probably boost its share of global production capacity to 13 percent, from 7 percent, over the next five years. Gas prices in the Gulf are likely to remain three to five times lower than those in China, India, and the United States for many years to come. But multinationals are currently involved in little more than one-tenth of the planned expansion. The main problem is that the operational skills and technology the multinationals bring to the negotiating table are usually not sufficient to secure a deal: many states in the region are developing their own talent pools, while national and regional companies often have good technology systems. Moreover, many potential multinational entrants fail to recognize that Gulf governments which control the supply and price of gas and also often hold important stakes in major national companies are intent on using the local cost advantages to diversify oil-dependent economies and to create large numbers of muchneeded jobs. To be successful, multinational entrants must therefore craft broad, innovative, and sometimes complex deals that take these political and competitive realities into account. Emerging leaders with structural advantages The competitive challenges that multinationals face in the Gulf reflect a powerful trend: the appearance of new global leaders from emerging markets in the metals, mining, and petrochemicals sectors. At the same time, Gulf States are creating their own regional leaders. In the aluminum industry, Aluminum Bahrain (Alba) and Dubai Aluminum (Dubal),

3 Moving energy-intensive industries to the Gulf 97 e x h i b i t 1 Great expectations Gulf Cooperation Council (GCC) states 1 Rest of world Announced capacity expansion, % 100% in million tons per annum 2006 global capacity, % 100% in million tons per annum Aluminum Ethylene Polyethylene Propylene Styrene Steel , Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates. Source: Bloomberg; broker reports; Chemical Market Associates (CMAI); Factiva; International Finance Development (IFDC); J. F. King; Platts; SRI International; Tecnon Orbichem; WM; McKinsey analysis founded less than three decades ago and still unknown in the late 90s, are now the world s seventh- and eighth-largest aluminum producers, respectively, and they continue to grow. Similarly, in petrochemicals, Gulf companies have almost a 30 percent share of announced additions to global capacity in ethylene and polyethylene well above the region s 8 percent share of current capacity. Saudi Basic Industries (Sabic), one of the largest corporations in Saudi Arabia, is an emerging global leader in petrochemicals, with annual revenues above $20 billion. Emerging global leaders in the Gulf benefit from a number of structural advantages. The region has 24 percent of all known natural-gas reserves; gas there costs much less than it does, for instance, in the United Kingdom and the United States (Exhibit 2, on the next page). In addition, the GCC states have the advantage of cheap labor, largely from India, Pakistan, and the Philippines. Although employment costs will rise as Gulf governments reform the labor market to create higher-paying jobs for their own citizens, this development will do little to erode cost advantages based primarily on the price of energy. Moreover, soaring oil revenues make capital cheap. Taken together, such advantages mean that aluminum production is 30 percent cheaper in the Gulf than in China or Western Europe, with a cash cost of less than $1,200 a ton (Exhibit 3, on the next spread). Beyond cost advantages, companies operating from the Gulf benefit from low corporate-tax rates (0 to 20 percent, depending on the state), so higher

4 98 The McKinsey Quarterly 2007 special edition: Reappraising the Gulf States e x h i b i t 2 The price advantage Price of natural gas, 2005, $ per MBTU 1 Japan South Korea European Union (EU 25) United Kingdom United States China 6.80 GCC Million British thermal units; equivalent to 1 decatherm (10 therms). 2 GCC = Gulf Cooperation Council; includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates. Source: Energy Information Administration, United States; Eurostat; interviews; Korea Gas (Kogas); Tokyo Gas; McKinsey analysis profits can be reinvested to spur faster growth. Meanwhile, the rapid growth of local and regional demand provides small yet attractive home markets for basic materials: for example, the construction market, for both public and private projects, is booming, which fuels demand for steel, aluminum, and glass. Furthermore, the GCC states provide a convenient stepping-stone into potentially larger neighboring markets for example, Iraq, with its massive requirements for reconstruction, and Iran. New deals for the Gulf Although many multinational commodity producers have lately sought to set up shop in the Gulf, few have succeeded. The reason is often that they haven t fully understood either the region s fresh political and social agenda or the new competitive realities. Consequently, these companies have not been able to craft deals attractive enough to Gulf governments and potential business partners. Their offering usually a straightforward production joint venture in which their contribution would be technology, production expertise, management capabilities, and access to Western markets is not sufficient to clinch deals in the Gulf. In reality, the region s governments are more interested in developing their national talent pools than in importing technical and management expertise. What s more, technology is becoming universally accessible, while some emerging leaders (such as Dubal) have even built their own systems. Moreover, the technology edge that multinationals still possess makes far less of an impact on operating costs than does low-cost energy, so these companies have a hard time convincing Gulf governments to trade it for access to technology. Finally, as growth in demand

5 Moving energy-intensive industries to the Gulf 99 has shifted east, multinationals can no longer argue that access to Western markets is the key to selling indigenous production. If anything, regional producers, because of their relative proximity to Asian markets, have the advantage, which allows them to deliver products to customers faster and with lower transport costs. Despite these disadvantages, multinational companies still have plenty to offer in helping to design and run large industrial complexes that include manufacturing facilities and other value-added activities, which can create the many thousands of new jobs that the GCC states need so badly. In addition, certain management skills, such as continual coaching and the transparent management of people and their performance, remain scarce in the region. Blue-collar productivity is half that in the West and has shown little improvement over the years the result of a virtually unlimited supply of cheap Asian labor that has obscured the need to enhance efficiency. Finally, Western companies still largely control some raw materials, such as alumina, so they can guarantee a stable supply to any joint venture they might have in the Gulf. To compete in the Gulf s new business environment, multinational producers of energy-intensive commodities would do well to learn from those companies, in the energy and basic-materials sectors, that have successfully established joint ventures or subsidiaries in the region. Such e x h i b i t 3 The structural advantage Estimated 2006 cash cost 1 for primary aluminum production at smelter gate, $ per ton Others, eg, alloys, petcoke, pitch Labor Energy Alumina 1, , , Middle East advantages Low energy cost $0.70 $1.30 per MBTU 3 Access to competitive capital weighted average cost of capital (WACC) at 7 8%, depending on location 4 Favorable business environment 0 20% corporate tax, cheap industrial land Western Europe 2 China Middle East 2 1 Assumes Western Europe smelters: $3 per MBTU (million British thermal units) gas cost, $18 hourly wage; Chinese smelters: $6 per MBTU gas cost, $3 hourly wage; Middle East smelters: $1 per MBTU gas cost, $6 hourly wage. 2 For Western Europe, data primarily for Germany but indicative of region; Middle East includes Bahrain, Saudi Arabia, United Arab Emirates. 3 Million British thermal units; equivalent to 1 decatherm (10 therms). 4 Assumes 70/30 debt-to-equity ratio. Source: Metal Bulletin; McKinsey analysis

6 100 The McKinsey Quarterly 2007 special edition: Reappraising the Gulf States companies approach deal making in two steps. The first is to understand fully the diverse needs of the different Gulf stakeholders and to manage relationships with them through a complex deal-making process. The second is to use an understanding and a cultivation of key relationships to structure broad deals that offer value to all parties. Understanding and managing the stakeholders Gulf governments face many major economic and social challenges. They need to double the number of jobs over a ten-year period, improve the standard of living, and build a sizable middle class. What s more, they must diversify their economies while reducing the present dependence on oil and gas. 1 Real annual economic growth of 5 to 10 percent will be required over the next decade to provide enough jobs for a rapidly growing population and to maintain or lift the average GDP per capita. Understanding these challenges is important for multinationals because the region s decision makers think in these terms: for example, complementing a proposal to build an aluminum smelter or steel mill with support for the development of facilities that manufacture aluminum or steel components would multiply a new project s employment effect and so give a multinational s bid an edge. The governments top-level goals are straightforward, but a number of domestic stakeholders with varying interests may also influence the selection of international partners. Moreover, there are significant differences between doing deals in the West and in the Gulf. To manage stakeholders successfully, companies must therefore tailor their approach to the region s specific power structures and business culture. Map the relationships An effective way to understand the interplay between different interests is to develop a relationship map that assesses the important players roles, objectives, and agendas, including the national leadership; potential business partners; various national and local government bodies that decide on matters such as gas contracts and land lease agreements; the leading national and regional commodity-producing companies; and other business interests that a deal might affect. Such insights make it possible to plan an appropriate structure for a deal and to prepare the sequence of discussions needed to clinch it. Understanding the motivation of individual stakeholders also makes it easier to determine the appropriate scope of a project, to define the optimal roles of the parties, and to ensure that they and the multinational itself receive fair value. 1 The GCC states non-oil trade deficit is currently 24 percent of the non-oil GDP, or $64 billion annually.

7 Moving energy-intensive industries to the Gulf 101 It is important to build an insider perspective, not least to acquire a deeper understanding of who the true decision makers are in each of any project s areas of interest. (In one GCC state, for instance, the ministry of finance and the royal cabinet share the responsibility for land allocation.) Indeed, in an effort to short-circuit red tape, the region s government leaders have even created parallel institutions for example, the energy councils that several states have established to complement their energy ministries led by technocrats empowered to make decisions. Multinational companies that opt for seemingly obvious yet potentially wrong channels or institutions may find the whole project evaluation process derailed for months. Whether or not a multinational thinks of partnering with the leading national and regional companies, 2 it needs a solid understanding of their agendas, their level of influence within the target country, how their agendas correlate with those of the country s leadership, and any possible conflict between their agendas and the needs of the multinational company s planned project. Such an understanding is important for many reasons. One is that the government will expect a multinational project to help build the economy, and not necessarily by competing head to head with regional players. Understanding this and other realities makes it possible to identify stakeholders who might have reason to oppose a project and the power to block or delay it for instance, board members of competing companies who have influence over potentially important local decisions. Such decisions might include the registration of the new company, access to port facilities and other infrastructure, and the issuance of construction and transportation permits. One way for a multinational company to complement its market due diligence and learn about such issues is to draw on the local knowledge of its global network of business partners that have a strong position in the Gulf. Connect with the ultimate decision makers Ideally, the multinational company s CEO should seek an audience with the state s ultimate decision maker, often the king or the crown prince, as soon as a project s early-stage feasibility study has been successfully completed or even at the business-planning stage. A discussion with the national leadership about the project s benefits for the country and the multinational company s commitment to it can boost momentum and facilitate execution. But be aware that an unfulfilled promise destroys a company s credibility forever. 2 Although often run and governed solely by business executives, these may be fully or partly owned by the government.

8 102 The McKinsey Quarterly 2007 special edition: Reappraising the Gulf States Assuming that the ruler buys into the plan, he will very often choose to appoint a facilitator as the single point of contact to help a multinational s project team cut through red tape. This person, usually one of the few people empowered to engage with foreign partners on the ruler s behalf, has the authority to overrule potential deal blockers or at least to escalate issues to the highest level. The facilitator will also have a strong intuition, very early in the process, about whether the project will gain broad local support and what must be done to get a promising deal past the finish line. Joint ventures with local energy and basic-materials companies that can demonstrate a track record in expanding their businesses and managing large projects are the common and advisable way to go. These local companies often have very strong connections with government institutions and decision makers. If the partners can structure a mutually beneficial deal, a joint venture has the twin advantages of providing access to decision makers and of local experience in navigating red tape often critical even when a project is onstream. Craft deals that benefit all stakeholders Several Gulf governments have identified the aluminum industry as an attractive one to develop. It is an excellent example of an industry that presents a golden opportunity for multinational players, which tend to underestimate the challenges local and regional companies face in designing and running integrated industrial complexes. An international partner that can contribute to the design and planning of a complex project will be considered far more helpful and trusted than one that is simply trying to clinch the highly profitable smelting part of such a venture. Local companies often do not understand all of the elements sufficiently well or can t manage the complexity of large-scale projects requiring a combination of raw-materials sourcing, power generation, infrastructure and logistics, smelting, casting or rolling, and access to foreign markets. To use the analogy of a puzzle, the multinational has the role of helping its local counterpart to understand the different pieces and to identify those that the main partner and other local companies can supply. The multinational company needs to be very explicit about what it can provide in order to justify what it wants in return the smelter operations, an attractive long-term contract for the supply of gas, and, perhaps, low or no corporate taxation, as well as subsidies to train local workers. The offering s range and depth are critical to Gulf governments and the main local business partner a test of the multinational s long-term commitment to the project and intended role in developing the economy.

9 Moving energy-intensive industries to the Gulf 103 Helping to set up and run training facilities for employees is a good example of a deep commitment. More important in the long run is the multinational s willingness to provide valuable expertise and business connections that can help broaden a project s economic and social impact. The company may, for example, have the expertise needed to combine, in the same project, the smelting of aluminum with the manufacturing of aluminum products such as alloy rods, conductors, and cans. Many multinationals also have experience designing the governance and management structures of complex megaprojects. If the scope of a project goes beyond the capabilities and resources of the multinational, it can complement its offering with those of other industrial partners, either by creating a consortium or by bringing along preferred providers for the missing parts. A global aluminum producer might, for instance, invite some of its international industrial customers to set up manufacturing facilities for aluminum parts. The development of downstream industry clusters is very attractive to Gulf governments because these projects can create two to three times as many jobs as the smelter itself. The projects that Gulf governments have in mind are often part of a longterm industrial strategy, with the ultimate ambition of creating global leaders. A multinational company and its Gulf partner can further this quest by sharing risk, privileged relationships, and other assets beyond the region: the multinational might invite its partner to invest and participate in a Latin American project, for instance, while a partner with direct access to Gulf investment funds and good relationships with people in other Arab countries could invite the multinational to contribute its operating experience and access to raw materials to a joint project in another gas-rich country in the Middle East. The multinational could also accommodate other Gulf businesses as suppliers or partners for smaller or larger ventures. GCC states can offer attractive locations for energy-intensive industries, while Western multinationals have the project know-how that can help these states develop their economies. The mutual needs of the two parties are not being matched at the moment, but the opportunity can be unlocked if multinationals adopt a new approach to making deals in the Gulf. Q Jaap Kalkman, Laurent Nordin, and Ahmed Yahia are principals in McKinsey s Dubai office. Copyright 2007 McKinsey & Company. All rights reserved. Artwork Mona Hatoum, Undercurrent, Courtesy of Mona Hatoum Studio.