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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Saudi Arabia Opening Up For Business As Oil Strategy Takes Its Toll

Saudi Arabia Opening Up For Business As Oil Strategy Takes Its Toll

Saudi Arabia faces a problem. The G20 nation and de facto head of OPEC relies almost solely on oil to power an economy that has swelled five-fold in size since 1998. With oil prices in a rut and no one certain when they will recover, the country needs to diversify its economy. That need is driving Saudi royalty to approach American companies in the hopes of attracting foreign direct investment in a way that the country has not in the past.

Saudi Arabia, for all of its wealth, is essentially still an emerging economy. The country has an enormous oil industry, which accounts for 80 percent of budget revenues, 45 percent of GDP, and 90 percent of export earnings. The oil industry is critically reliant on thousands of foreign workers for the know-how to run its operations, and domestic workers are not well trained for many technical fields. Given all this, it is not a surprise that the country’s leaders want to diversify, but with the government strongly controlling the economy, it’s not clear how western European and U.S. companies are going to feel about making big investments.

Part of the problem for the western companies is that government ownership of companies within the Kingdom is strong and foreigners cannot own many companies in their entirety. Ownership restrictions that force western companies to partner with locals are not going to be popular with western investors as such restrictions hinder operational oversight and reduce profits. In addition, Saudi Arabia has corruption issues to overcome.

Related: 3.1 Million Barrel Draw In U.S Stockpiles Stimulates Oil Prices

All of this may be starting change though. For instance, the Kingdom recently announced that foreign investors will now be allowed to own 100 percent of businesses in certain industries like retail and wholesale goods. That type of reform is critical. Foreign ownership restrictions are not uncommon and many other countries have them. This has not stopped substantial foreign direct investment in India and China. But the difference is that India and China have enormous populations that are rapidly moving from the bottom of the economic classes to the middle. As they do so, western companies are very eager to access huge new emerging markets. For population-light Saudi Arabia, there is no such built-in advantage. Related: Is A Coal Price Recovery Near?

That fact must be obvious to Saudi royalty who seem eager to roll out the red carpet for western investors and companies with initiatives like the new Saudi Aramco projects in distribution and support services that will be open to foreign participation. In addition, with sanctions starting to ease on Iran, and it becoming increasingly clear that Iran will not be forced to give up its nuclear ambitions, Saudi Arabia needs to beef up its defensive capabilities. That means turning to U.S. defense contractors like Raytheon and Lockheed Martin. Related: For Canadian Oil Sands It’s Adapt Or Die

Between these oil and non-oil projects and relaxed rules on investor ownership in retail and wholesale industries, there are new opportunities emerging for many U.S. firms. Companies like Fluor and Chicago Bridge and Iron may be able to work with Saudi Aramco, while retailers from Apple and Best Buy to Home Depot and Walgreen’s can now access a new market. Saudi Arabia may not be the size of China, but it is a wealthy country and that level of income will play well with retailers interested in accessing an upscale clientele. Even U.S. banks could find new opportunities in the country with firms like Citi having the most experience in operating overseas.

Overall, in a global economy sorely short on cheer for investors right now, Saudi Arabia’s economic reforms are a welcome sign.

By Michael McDonald of Oilprice.com

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