Will privatisation work in the GCC?

Published in MEED, 6 December 2017

One of the most important pillars of Saudi Arabia’s economic reform programme is the push for more private sector investment and, as part of that, the privatisation of some key state assets.

At the top of the list is Saudi Aramco, but others include Saudi Arabian Airlines (Saudia), its low-cost rival Flyadeal, Riyadh Airports Company and several Saudi Electricity Company power plants, to name a few.

Privatisations are complex affairs and there are legitimate questions as to whether Riyadh will be able to sell everything on its list. But if it is successful, it will offer encouragement to other governments keen to follow suit.

In the past, Saudi Arabia has preferred to sell assets to local investors, and often at low prices – essentially handing them a guaranteed profit. But the scale of some planned deals is too large for the local market to swallow; Aramco, in particular, will need an international listing. That creates its own complications, not least the requirement to adhere to levels of transparency a state-owned company may find difficult to handle.

The Aramco deal involves just 5 per cent of its shares being sold, but sales of larger chunks of smaller businesses can equally lead to difficulties. Under the terms of the planned privatisation of Saudi Grains Organisation’s grain mills, the insistence on maintaining majority ownership by a Saudi partner is causing trouble. UK news agency Reuters reported in mid-November that some prospective foreign bidders were on the verge of pulling out due to the ownership stipulation.

But Saudi Arabia is far from the only country looking to sell stakes in prized assets. Another prominent example was the sale of up to 20 per cent of the UAE’s Adnoc Distribution oil company in late 2017. Cairo too has signalled its desire to divest some state-owned businesses in the coming years, while Muscat has suggested it could sell part of Petroleum Development Oman, among other state assets. The Omani government is proceeding with caution, but insists it is indeed moving forward.

“The idea is you bring the right management, the right networking, the economy of scale, and add value that way,” says one official from Oman’s Finance Ministry. “So privatisation in that sense is very much on. PPP [public-private partnership] is very much on.”

The reasons for this wave of activity are clear enough. Across the region, governments need to find ways to raise money to plug budget deficits caused by lower oil prices. They are also attracted by the notion that private sector expertise could be used to reduce inefficiencies within unwieldy state-run businesses. A further positive is the chance of bringing more capital into the economy, both from foreign investors and from the repatriation of capital that locals may have invested abroad. These privatisation efforts are also sympathetic to the wider goal of economic diversification.

“Privatisations are strategically important because what the Saudi government is really trying to do is change a whole economic model,” says Elliot Hentov, head of policy and research for the official institutions group of the US’ State Street Global Advisors. “It’s not as simple as just diversifying away from oil. They have to create new economic relationships and change how capital flows across the economy and how it’s allocated. Privatisations are incredible catalysts for all that to happen.”

However, such developments will not happen simply by running an initial public offering (IPO). Paul Stevens, a fellow at UK think-tank Chatham House, points out that switching from public to private ownership is not enough to improve a company’s performance on its own; it needs to be accompanied by measures that increase competition, reduce government interference and incentivise management to be more inventive.

Neither are IPOs the only way to attract investment. Recent years have seen a variety of financing models adopted to boost the amount of private capital coming into regional economies. These include build-operate-transfer deals for large infrastructure schemes, independent water and power plants (IWPPs) in the utilities sector, and PPPs in other areas.

However, enthusiasm for some of these models looks to be waning. In August, Kuwait cancelled the much-anticipated second phase of its Al-Zour North IWPP. The deal was meant to be the first project under the country’s revised PPP law, so the setback will severely dent market confidence in such deals in the future. Other promising PPP deals that have failed in the past include the Saudi Landbridge rail link and Qatar’s football stadiums for the 2022 World Cup.

That situation means that, for now at least, IPOs are the most likely way for governments to attract significant amounts of private capital into their economies in the year ahead. This is in spite of the political risk of such deals in certain sectors. In the case of utilities, for example, the need for privatised companies to remain profitable to keep their investors happy could require them to raise energy or water prices.

That process is already under way in the public sector in the region, with many Gulf governments cutting a range of subsidies in recent years, but raising prices could also lead to public discontent.
Ultimately, the authorities will be judged on what they achieve, rather than simply the plans they set out. Investors are both enthusiastic and realistic about what they can expect.

“The authorities need not get everything done that’s in the pipeline, but if they get a significant chunk of it done it will be very impactful,” says Hentov. “I’m tracking these privatisations with a degree of excitement.”