The accession of Saudi Arabia to the World Trade Organization (WTO) is the outcome of 12 years of extensive negotiations that led to the adoption of 42 bylaws in the last four years or so.
Overall, the WTO membership calls for a lowering of tariffs and subsidies on a wide range of goods and services; a strengthening of the protection accorded to intellectual property rights; and measures for a speedier resolution of all trade grievances and disputes, which would provide extra assurance to foreign investors in Saudi Arabia and lead to greater prospects for inward investment. In addition, the WTO will provide a good platform for settling the cases of dumping petrochemicals in the Kingdom by producers in tariff-protected economies.
It is largely believed that the Saudi accession to the WTO will further enhance the competitive advantages enjoyed by the Saudi petrochemical industry and strengthen its position in the international market. However, the full impact of the WTO on the industry will not be observed immediately. Being export-oriented, the Saudi petrochemical industry stands to gain from the WTO provisions, including its extension to services, particularly to finance, insurance and transportation, whose prices, following this extension, may decrease significantly. These services are purchased in fairly large quantities by the Saudi petrochemical industry and the resulting cost reductions may further add to the competitive advantages of the industry.
Overall, adhesion to the WTO bestows benefits and poses potential challenges to Saudi Arabia’s petrochemical producers.
On the benefits side, the removal of trade barriers called for by WTO bylaws will allow Saudi petrochemical producers to offer lower prices to tariff-protected markets, such as the EU, US and Japanese markets. The tariff reduction in these economies may induce a sizable increase in Saudi petrochemical exports to those economies, depending on the response of supply and demand to the lower prices resulting from tariff reduction. For instance, tariffs on polymers (polyethylene, polystyrene, PVC, polypropylene) in the EU are to be reduced by approximately half, from 12.5 percent to 6.5 percent. As a result, it will be difficult for high-cost producers in these economies to meet the lower market prices caused by the tariff reductions. In the short-run, they may reduce their production levels and possibly sell at a lower profit margin or at a loss. The petrochemical output in these economies may thus decline less proportionately than prices. In the long run, the high-cost producers will exit the industry and thereby reduce the number of producers. Inversely, the increase in demand caused by the lower prices will benefit Saudi petrochemical exports.
The tariff reductions will benefit these exports through a direct or price effect and an indirect or income effect. The lower prices, caused by the lower tariffs, will produce the direct (price) effect. Concomitantly, the increased real income attending the lower prices will induce an increase in demand, producing the indirect (income) effect.
In return, Saudi Arabia has to lower its own tariffs and open its market to imported petrochemical products. The tariffs on key secondary petrochemicals, such as polyethylene, polypropylene and polystyrene, are at present set at 12 percent, with a provision that it be reduced to 8 percent within an interim period ending in year 2008, followed by a second interim period ending in year 2010, by which time the tariff will drop to 6.5 percent. Though the volume of imported polymers is small, the tariff reduction may induce a strong competition among petrochemicals producers as they seek to secure a share in the domestic market.
This may result in a pricing ramification leading to narrow profit margins on local sales. The petrochemical producers may thus need to focus attention on regularly reducing their production costs and ensuring that their product qualities match or exceed the world standards. Given the strong competitive advantage enjoyed by the Saudi producers, it is likely that they will meet the competitive challenges and retain their market share in the domestic market.
The downstream petrochemical industries in the Kingdom stand to benefit from the expanded markets caused by lower prices. However, the Kingdom is committed to reduce the tariffs on processed plastic imports, from a ceiling of 20 percent to 6.5 percent over an interim period ending in 2010. This may increase the imports of finished plastic products from lower cost Asian producers, including China. However, the WTO provisions allow the developing countries to restrict their imports in order to protect their infant industries in the event that imports from particular countries increase disproportionately. The downstream industries will need to restructure, with the small players consolidating and merging to reach a critical mass, which is essential to competitiveness in domestic and global markets alike.
The key accomplishment of Saudi Arabia with respect to the accession to the WTO of its petrochemical industry is perhaps the fact that the accession has been achieved without compromising on the current feedstock pricing, which underlies its strong competitive advantage. The EU, pressed by the political clout of its petrochemicals producers, placed the last obstacle in the Kingdom’s accession to the WTO, arguing that the double pricing of liquefied natural gas (LNG) conflicts with the WTO guidelines. This argument is groundless in view of the fact that the price support for using LNG, which includes natural gas and LPG, as a feedstock for petrochemicals was determined taking into account its alternative use, i.e. exports. In the case of exports, the alternate cost consists of the cost of developing the infrastructure and of shipping the product to the major export markets. The cost of logistics was estimated to be about 30 percent of the Saudi export price. Accordingly, were the LNG used at home for petrochemicals, the price would be 30 percent less than the export price, reflecting the savings in logistics costs. On the basis of this argument, and also given that the lower cost is available to anyone willing to invest in Saudi Arabia, the Saudi negotiating team proved that the Kingdom is in full compliance with the WTO rules and regulations, and does not fall in the area of the WTO concerns regarding preferential treatment.
While this argument proved to be convincing, the issue is likely to receive continued scrutiny in the EU and the US, even after Saudi Arabia’s membership in the WTO. This issue may be among others that may catalyze a future reconsideration of the current pricing formula. The Saudi position is based on a clause outlined in the accession documents that reads: “Saudi Arabia will ensure that its producers and distributors of liquefied natural gas (LNG) will operate on the basis of normal commercial considerations, based on the full recovery of costs and a reasonable profit”. Given that LNG is primarily extracted from associated gas, which is a byproduct in the crude oil production, its production cost is modest. Thus, it is likely that the feedstock prices in the Kingdom will remain competitive on regional and global levels.
This accomplishment is by far more important to the petrochemical industry than the impact of tariff-reduction in protected economies for two main reasons, namely that more than 50 percent of the Saudi petrochemical exports are destined to non-tariff-protected Asian markets and that the competitiveness of the Saudi petrochemicals industry depends primarily on competitively priced feedstock, which represent as much as 60 percent of the integrated cash cost in the industry.
In turn, this will expedite the pace of the on-going shift in the center of gravity of the global petrochemical industry toward the most cost efficient areas with close proximity to markets. Saudi Arabia is rapidly emerging as a global petrochemicals hub and the premier location for future investment in the petrochemical industry.
(Dr. Abdulwahab Al-Sadoun is director general, energy sector at Saudi Arabian General Investment Authority (SAGIA).)
