LONDON, 31 January 2005 — The planned debut bond issue in early 2005 by Saudi Basic Industries Corp. (SABIC), the state-owned petrochemicals giant, to largely finance its ambitious global expansion, is raising as many questions about the Saudi petrochemical utility’s favored status as its choice of financing.
SABIC, like the other entities of the Kingdom’s oil sector, has been leveraging the opportunities of the consistently high world oil prices over the last year or so. In mid-January 2005, it announced a record net profit of SR14.25 billion for 2004 — an increase of 113 percent on 2003, primarily due to high global prices for its products, and which sent the share price of the entity on an upward spiral to close at SR919 in mid-January 2005.
This despite the fact that SABIC had to make provision for a SR1.563 billion compensation payout to Exxon Mobil Corp. awarded under a US court order ($416.8 million) in early 2003. SABIC lost the subsequent appeal to overturn the award in January 2005. The award was over a contract dispute over their joint operations in Saudi Arabia.
SABIC, which is 70 percent owned by the Saudi government, enjoys a privileged position, like most other state-owned entities, in the Kingdom’s economic structure. As such, subsidized feedstock prices for products such as ethylene, and therefore much lower production costs, stress the company’s foreign competitors and local rivals, has put SABIC at an unfair advantage. Not surprisingly, this has contributed significantly to the corporation’s record profitability.
SABIC Chief Executive Mohamed Al-Mady rightly maintains that “this is the highest ever profit earned by SABIC since its inception.” Returns were boosted by high world prices for SABIC products such as basic chemicals, polyolefins, fertilizers and metals. SABIC too has gained efficiencies through integrating its business activities, upgrading technology, and improving its marketing and customer development infrastructure. This has markedly lowered operating costs.
But for how long is SABIC ‘s favored status for feedstocks and cheap energy be sustainable? Saudi Arabia is trying to diversify its economic base and encouraging a greater role for its private sector in contributing to GDP. While the private sector too enjoys generous handouts from the government, the state-owned entities are almost a law unto themselves.
For instance, SABIC enjoys ethylene feedstock prices more than seven times cheaper than those in the US, Japan and Europe. This means that its production costs are much lower. But at the same time SABIC sells its products to the local Saudi market ate the same price its sells them on the international markets. This despite the fact that there are no customs duties to pay in Saudi Arabia, and negligible transport and other costs.
Privately-owned chemicals and plastics companies such as Al-Sharq Plastics for instance are crying foul, although a level playing field may ironically be imposed once the Kingdom accedes to membership of the World Trade Organization, which is almost certainly to happen during 2005. Analysts stress that this overtly favored treatment of SABIC is hampering the development the private sector in the Kingdom and in this particular case the petrochemicals and plastics industry.
SABIC’s main plants are in Jubail and Yanbu. Last October, CEO Mohamed Al-Mady announced at the K2004 Exhibition in Dusseldorf in Germany that SABIC had completed the “landmark acquisition” of Dutch-based DSM Petrochemicals and was finalizing a 50 percent stake in Mexican petrochemicals company, Pemex; and interests in two further joint ventures in China totaling between $2 billion and $5 billion.
SABIC, whose revenues totaled SR68.7 billion in 2004, is now a major global player with 17 affiliate companies, with around 15 major projects at various stages of development worth around $3 billion. The company has also approved a SR24 billion budget for projects to be completed within Saudi Arabia by 2008.
SABIC’s planned $1 billion bond issue, mandated to HSBC to arrange, has also raised questions in the financial market. It is not clear whether the issue will be a conventional bond or an Islamic bond (Sukuk). The issue is significant because it will be SABIC’s debut issuance and will be the Kingdom’s first major corporate bond.
Given the spectacular rise of the Islamic bond market in the Gulf countries in recent months; and the record $1 billion Sukuk Al-Ijara issuance by the Dubai Department of Civil Aviation (DCA); the Islamic banking sector is hoping for greater leadership and uptake from key markets such as Saudi Arabia, by far the largest liquidity pool for both conventional and Islamic banking.
While the SABIC bond, which still has to get regulatory and legal approval from the Saudi authorities, is primarily aimed at raising funds for the entity’s expansion activities, it is also aimed at being a benchmark corporate bond for the nascent Saudi market. Recently Saudi Hollandi Bank went to the market through an SR700 million issuance in support of its Tier II capital.
However, Islamic bankers stress, that if SABIC opted for a Sukuk it would be a major psychological boost for the global Islamic bond market, even though it could be construed more as a quasi-sovereign issue due to the 70 percent ownership of the Saudi government in SABIC as opposed to a classical corporate issue. On the other hand, opting for a conventional bond could be construed as a slap in the face for the Islamic bond market, which is in urgent need of building a critical mass of issuances to precipitate a secondary market and trading.
Islamic finance including bond issues has been largely absent from the oil and gas sector, although a US$300m Islamic trance for the $600 million bridge financing for Eqaute II Petrochemcials Company was recently completed in Kuwait. At the same time, Qatargas II is also including a large Islamic tranche for its funding requirements for its expansion activities.
However, Islamic finance has a downside in terms of market perception. It is averse to long tenors and risk. Promoters of the Al-Taweelah II Independent Water and Power Project (IWPP) in Abu Dhabi, for instance, have dropped a planned Islamic tranche because appetite for a 20-year exposure by Islamic banks and investors has been very lacking.
