'Value-added' across the board

This is a good thing, not just for the Kingdom, but for the GCC as a whole. Adding value to a national commodity domestically is far better than simply exporting it 'raw' and allowing other nations to add value to it and keep the proceeds in the process. Developing a bigger refining and petrochemical sector will also create numerous employment openings and opportunities for the region's private sector.

Saudi Arabia started the ball rolling in late 2004 when it signed a deal with Japan's Sumitomo Chemical to build, what is billed to be the world's largest, integrated refinery and petrochemicals complex; PetroRabigh. The complex estimated to cost about $10bn, will produce 18.4 million tons per annum of high value petroleum products and 2.4 million tons of ethylene- and propylene-based petrochemical derivatives annually.

Then, just last week Saudi Arabia signed two major deals with international oil companies, both for constructing multi-billion dollar refineries. One will be built on the Kingdom's east coast and one on its west coast. Total, France's major oil company, signed a deal with Aramco, estimated to be worth $6bn, to develop one of these refineries. It will be built in Jubail on the Gulf coast and is forecast to be able to produced 400,000bpd of refined products.

Under the deal, Aramco and Total will form a new joint venture company and will each hold stakes of 35 percent. According to an Aramco press statement, released at the time, the remaining 30 percent stake will be offered to the Saudi public in the not too distant future.

A few days after the Total deal, in what seems to be a 'carbon copy', Aramco and ConocoPhillips signed a $6bn deal to build a 400,000bpd oil refinery in the Red Sea city of Yanbu. It was reported that Aramco and the Houston-based company will also offer 30 percent of their new joint venture in an initial public offering. Both of these refineries are scheduled to come online in 2011.

Staking Out A New Economic Role

For all the talk of economic diversification, every state has certain inherent competitive advantages and these are best utilised. Yes Saudi Arabia should endeavour to move away from an overdependence on oil, but it would be uneconomic not to take advantage of it. Depending upon oil export receipts alone is not fruitful, and diversification into refining, downstream activities and investing in industries that depend on a heavy oil feedstock is the optimal way forward.

The recent Aramco joint ventures are part of a much larger $50bn investment program to refine more domestically and at refineries built in partnership with other states. Aramco is planning to build new refineries or expand existing ones in China, Indonesia and South Korea. Crucially all of these off-shore refineries will be optimized to work with Saudi Arabia's heavier grade of crude oil. In the next decade the Kingdom hopes to increase its refining capacity by as much as 60 percent.

One considerable advantage that Saudi Arabia will gain by building more refining capacity domestically and investing in refineries globally (predominantly in Asia) is that most if not all of these will be tailored for Saudi 'heavy crude'. Unlike many Western refineries that are geared for lighter varieties of crude Aramco's refineries will be designed to utilise the Kingdom's heavier grades of oil. Therefore Saudi Arabia can count on its oil being purchased even if there were to be a future drop in aggregate demand for oil.

Total will share the marketing of the refinery production, a joint press release said. This presents Saudi Arabia with another advantage: transfer of knowledge. By forming joint ventures with leading international oil companies enables the Kingdom to acquire knowledge and technical competence. Furthermore by partially floating these joint ventures enables all Saudi nationals to benefit by investing in this lucrative sector.

Sumitomo Chemical believes that their joint venture with Aramco, PetroRabigh, will benefit from economies of scale and a stable supply of cost competitive feedstock which will be provided by Aramco. These combined advantages should make the Rabigh complex one of the most competitive refining and petrochemical operations worldwide.

Other GCC states, particularly Kuwait, should follow Saudi Arabia's lead. It may never happen but there is no reason why GCC states should not ultimately aim to export nothing but refined products. Indeed just this week the head of state-owned Kuwait Petroleum Corporation, Hani Hussain, said that Kuwait intended to spend as much as $17bn on its refining sector and hopes to increase its capacity to 1.5mn bpd in 2010 from 940,000bpd currently.

Creating Jobs, Supplying Demand

Saudi investments today, may well help ease global oil prices, but not for several years to come. Lack of refining capacity is often sited as a contributing factor to the current phenomena of high oil prices. Saudi Arabia's Oil minister, Ali al Naimi, has repeatedly blamed high oil prices on a lack of global refining capacity. But refineries take a long time to construct and additional refined out put from Saudi Arabia is around five years distant.

It has been estimated by Will Rathvon, global head of project finance at Standard Chartered Bank, that more than 30 new or expanded refineries will come on line in the next 10 years, adding around 6.5mn bpd of much needed refined products. Refineries in Asia are operating at 95 percent capacity according to Rathvon and operating this tightly "has put prices up." It therefore follows that what ever Saudi Arabia can produce will happily be consumed.

The other advantage of so much 'value-added' investment is the jobs it will provide Saudi nationals with. Not only will these be skilled, and thus desirable jobs, but they can also be fairly considered as private sector jobs. Referring to the recently signed deals, Saudi Aramco's head, Abdullah Jumah said that they help attract foreign investment into the Kingdom's economy and expand it.

The merits of partially floating these new joint ventures should not be underplayed. By listing them on the Tadawul Index, the Saudi Authorities are ensuring that any national can hold a stake in this lucrative sector, and reap dividends from the Kingdom's national resource.

Saudi Arabia seems set to become a key player in the refining and petrochemicals sectors. It has a few key advantages over the incumbents in industrial oil importing countries. Firstly it does not have any regulatory problems in terms of building refineries. The concept of 'not in my back yard' is not as strong as it is in North America and Western Europe. But secondly, and perhaps far more importantly, it has the world's largest oil reserves.