Putting weight on heavy industry for when the oil runs dry

The audience of Arab steel executives was sombre last Monday as they contemplated the effects of one of the worst downturns in their sector's history. But Hussain al Nowais, the chairman of Emirates Steel Industries (ESI), could barely suppress a smile as he told the conference his company would spend Dh10 billion (US$2.72bn) over five years to triple output "without any delay". Less than 2km away, executives at Borouge, the petrochemical division of the Abu Dhabi National Oil Company (ADNOC), were delivering their own verdict: they would go ahead with a multibillion-dollar expansion to more than double expected output, even as petrochemical firms across the world were closing up shop because of a collapse in chemical prices.

"A downturn is the best time to invest so that we can capture the benefit of lower investment cost and be ready to start up when the market improves," said Abdulaziz al Hajri, the chief executive of Borouge. "We forecast positive demand growth in our key market sectors - infrastructure, automotive and advanced packaging." The industries Mr al Hajri mentioned will eventually be developed in Abu Dhabi, according to long-term government plans, providing jobs to residents and helping insulate the economy from the whims of the unpredictable oil market. The billions poured into the metal and chemical industries will provide the bridge between today's oil-dependent economy and an economic future neatly diversified into energy exports, basic commodities and advanced manufacturing, officials say.

But in the interim, economists say these investments will leave the emirate's economy tied to cyclical and volatile prices of energy-intensive commodities, which have historically moved with the price of oil. And government planners will face a tricky balancing act as they try to grow these companies with government funds into efficient, private enterprises, even while they are encouraged to hire Emiratis and serve larger social and political goals associated with development.

The Middle East's economic history is littered with examples of state-led industrialisation that ultimately failed to create sustainable enterprises during the last great oil boom of the 1970s. Pessimists could point to Algeria, where a state-led mass industrialisation scheme focused on basic industries left a rabble of overstaffed and notoriously inefficient firms in its wake. The risk is that the huge state-backed companies created in Abu Dhabi never evolve into efficient, self-sustaining entities, says Jean-François Seznec, an associate professor at Georgetown University who specialises in Gulf economics.

"It is a danger that you could get into an Algerian-like situation," he says. "These companies have to be as independent from the government as possible." Government planners say they are mindful of the past, but heavy industry still represents the surest route to a secure economic future after the oil reservoirs run dry. Sultan al Mansouri, the Minister of Economy, told the steel conference that the Government saw industrialisation as the "top priority in terms of contribution to the GDP".

In Abu Dhabi in particular, "we have ambitious plans which capitalise on the energy sources and strategic location, in addition to the developed infrastructure, where the government has embarked on a broad spectrum of industries with particular emphasis on main industries which require huge investments", he said. The size of the investments in government-led basic industries speak for themselves. Total commitments to the emirate's flagship developments - ESI's three plants, Borouge's first petrochemical expansion, Emirates Aluminium's (EMAL) smelter and the Chemaweyaat chemical industrial city - is already more than Dh117bn, a figure that does not even include the cost of second-stage expansions at EMAL and Borouge, both of which are assumed to be going ahead.

That figure represents 21 per cent of the UAE's total economic output last year, not including the tens of billions of dollars to be invested in oil and gas capacity and transportation infrastructure to support these plants. The figure also does not represent the expected cost of Chemaweyaat, which could grow to include 12 stages of development similar in size to the current $20bn project. Investment in the complex of petrochemical plants could top $50bn, according to Khadem al Qubaisi, the managing director of the International Petroleum Investment Company (IPIC), a partner in the development.

The UAE's industrialisation drive gathered steam after a long lull in 2001, when the first steel production began at the Emirates Iron and Steel Factory, later taken over by ESI. Polymers production also began that year at Borouge, which was formed in 1998. With oil revenues pouring into the government coffers, government planners looked to add value to the emirate's energy resources by channelling them into energy-intensive industries. Oil and gas would create more income for the country if they were turned into plastics and chemicals, it was reasoned. Low-cost power generation from gas could offer a competitive setting for aluminium smelting and steel manufacturing.

One of the architects of the policy was Mr al Nowais, who now serves as chairman of ESI, Abu Dhabi Basic Industries Corporation (ADBIC) and the Higher Corporation for Specialised Economic Zones, among a long list of industry-related firms. Government industrial policy, he says, is "based on the conviction that the only way to create sustainable development, diversify the sources of income and achieve economic stability is through the establishment of an economic system supported by strong basic industries, on top of which is the steel industry, and which also includes aluminium, copper, petrochemicals and other industries".

In the long term, increased polymers production by Borouge and Chemaweyaat will provide the raw materials for an expanded "polymers park", a collection of downstream plastics industries that is taking shape in Musaffah under ADBIC. A similar "metals park" is planned for Taweelah. This diversification further "down stream", it is reasoned, will steadily insulate the economy from volatile commodities markets as the chemicals and metal are turned into useable consumer goods.

The strategy of first creating basic industries had been followed by nearly every developed economy, says MR Raghu, an economist at the Kuwait Financial Centre (Markaz) who has studied GCC diversification closely. "If you go back to the industrial revolution of each country, they started with projects of this type," he says. "They form the first leg of diversification activity, and once these legs start working fine, then you can start building the value-added ones. You cannot jump ahead because the value-added ones require a lot of building blocks." But this latest round of investments into commodities industries has gathered steam just as the commodities bubble burst.

In the past six months, prices for all commodities have closely tracked the fall in oil prices. As crude fell by more than 70 per cent to its low point in late December, spot prices for steel and aluminium dropped by 76 per cent and 61 per cent respectively. A contract for polyethylene, a petrochemical product, lost 60 per cent of its value on the London Metal Exchange. Prices were driven lower by the economic crisis, which reduced demand for energy and all commodities.

In some respects, the long-term link between oil and metals has been overstated, says Dan Smith, a metals analyst at Standard Chartered. The link between oil and petrochemicals is more direct since hydrocarbons serve as the feedstock for chemicals production. However, transforming energy into chemicals and metals does stretch the use of Abu Dhabi's resources and cushions the immediate impact of price swings, says Mr Seznec.

"It's not true diversification in the sense that they will still be relying on energy production, but they will have five to six times the income on the same barrel of oil," he says. "Mostly, it will make them much less dependent on the vagaries of the NYMEX," referring to the New York Mercantile Exchange. Mr Seznec also notes the example of Saudi Basic Industries Corporation, the Middle East's largest non-oil company, which has managed to make considerable investments in training Saudi talent even while remaining competitive with petrochemical firms from other parts of the world.

John Mitchell, an expert in energy economics at the British think tank Chatham House, suggests firms stand a better chance of succeeding if they focus on export markets, are privatised at least in part, and embrace free-market principles put forward by the World Trade Organisation. Fortunately, the emirate has time to sort out these issues before industry becomes critical to the economy, Mr Mitchell says.

"Unlike Algeria, which is faced with rapid oil decline in the near future, the UAE and Abu Dhabi in particular can take time to develop the non-hydrocarbon sector well: the ambitious targets of the UAE 30-year vision are not driven by the prospect of low or falling revenues," he says. "Abu Dhabi can afford to take a considered and careful approach to diversification and can integrate this with realistically overcoming the more difficult constraints of population, human resources and institutional development."

@Email:cstanton@thenational.ae