Saudi oil diversification hits turbulence
Vision 2030 spearhead PIF damaged by high profile investment setbacks at key MbS ally Softbank
It has not been the best year for Saudi Arabia’s Public Investment Fund (PIF)— with high profile investments it has made through a fund in companies such as office space leasing firm WeWork and taxi alternative Uber coming unstuck. The value destruction has prompted questions about the performance and direction of PIF, chaired by the country’s de-facto leader Crown Prince Mohammad bin Salman (MbS).
PIF has been given a key role in modernising the kingdom by investing both domestically and overseas. It is viewed as an engine to fire up the Saudi private sector and significantly increase non-oil income. But its commitment to Japan’s Softbank Vision Fund— where $45bn of the $100bn available for investment has come from PIF—has been put under the microscope.
Of the six Vision Fund-backed companies that have gone public, only blood test firm Guardant Health and biotech company 10x Genomics are trading above their IPO prices. Shares in US software firm Slack and Uber are about 35pc and 25pc lower. Uber, where Vision has a 13pc stake, has seen its value plummet by $32bn in six months.
Softbank is run by Japanese businessman Masayoshi Son, who made a name for himself by taking a timely multi-million dollar early stake in Chinese e-commerce heavyweight Alibaba in 1999. But its Vision Fund has taken a pounding this year. WeWork, one of its largest investments, had to be rescued by its Japanese parent last month when it was valued at just $8bn, compared with $47 billion during an earlier funding round.
A reassessment by MbS and his aides of PIF’s positioning seems inevitable
The fund has been forced into write-downs on a number of its investments, but the WeWork debacle was a major reason why it chalked up an $8.8bn loss in the last quarter, some of which pain will have been borne by PIF. Softbank’s share price has been hammered, down by 27pc since July.
All this has raised questions about PIF and the way forward. It is not clear, for example, that having one centralized actor in charge of so many aspects of diversification is the way to go. The PIF discloses very little about its operations, less so than, say, the Saudi Arabian monetary authority (Sama), which has traditionally managed Saudi overseas assets.
“To the extent we have found out about the performance of [the PIF’s] key allocation in the Softbank Vision Fund, results have not been encouraging,” says Steffen Hertog, Mid-East Gulf expert at the London School of Economics. While other sovereign wealth funds in the region, such as the Abu Dhabi or Kuwait Investment Authority, could afford to take more risks as their time horizon is longer, “the kingdom might need liquid foreign assets much sooner given its fiscal and capital account”, he warns.
A reassessment by MbS and his aides of PIF’s positioning seems inevitable. “I suspect the externally focused strategy is being reassessed in light of the smaller proceeds from the Aramco IPO and the loss of lustre from Masayoshi Son—I doubt the PIF will plough more into [a potential second] Vision Fund [and they might even try to get some of their funds out,” says David Butter, Middle East analyst at UK thinktank Chatham House. “Supercharging PIF has been proclaimed as a key means to achieve diversification, but, in truth, it is not the only vehicle.
Other initiatives, mostly domestic-oriented, were laid out in the recently issued pre-budget statement from the Saudi finance ministry. They include a number of so-called ‘mega-projects’ in entertainment, housing and health. There is also the national development fund, established in 2017, that aims to support private sector growth via long-term financing and credit guarantees.
A further initiative, the national industrial development and logistics programme, focuses on industry, mining, energy and logistics. Defence has been identified as one of the key areas where Saudi Arabia can develop a local industry, with a goal of making half of the kingdom’s defence spending domestic. All this, as well as a rolling privatisation programme, could transform an economy that must provide jobs for young Saudis who make up a large proportion of the population.
The PIF’s main role is to help create new industries rooted in technology that can attract young people to the private sector. But top-down policy initiatives are also needed to reform education and build up the vocational skills of Saudi nationals to wean them off public sector jobs—bankrolled by income from oil sales.
FDI, which is critical to the success of Vision 2030, remains less than 1pc of GDP
The Saudis have made some progress with diversification. According to trade association the Institute of International Finance (IIF) in Washington DC, the share of oil revenue in total government revenue has been declining from 88pc in 2014 to a forecast of 63pc in 2019 due to lower oil prices and a significant increase in non-oil revenues, although the latter includes new taxes such as VAT.
The latest pre-budget statement from the Saudi finance ministry reported an expansion in the non-oil sector of around 2.5pc. Retail, restaurants and hotels, insurance, and real estate activities showed some upward momentum, but in low single digits.
“Our estimates show total assets of PIF of around $400bn. The objective is to raise the total assets of the PIF to $2tn by 2030,” says Garbis Iradian, chief Mena economist at the IIF. “Yes, diversification could work in the kingdom, but it is a long and painful process.” Bureaucracy, lack of transparency, inefficiency, and unpredictability remain major impediments to achieving sustained rapid private sector growth, An IIF Saudi research paper concluded earlier this year.
Foreign direct investment (FDI), which is critical to the success of Vision 2030, remains less than 1pc of GDP, one of the lowest ratios among emerging and developing economies, according to UN figures.
Domestic or international
A major issue will be how PIF’s firepower is divided between the domestic and international markets, says Ayham Kamel, senior analyst at the Eurasia consultancy. At present, about a quarter of PIF’s investments are overseas. “There are questions in my mind about prudent risk management,” says Kamel. “Some decisions will be taken at the very top but there is also an investment and allocation process that will need to be clearly delineated and communicated.”
"PIF can gear up its balance sheet to raise billions more," Salah Shamma
If Saudi Arabia is to move to the next stage of economic development it must develop export-driven industries, as countries such as Malaysia and Mexico have done in the past. That will take many years.
And PIF is far from a spent force, despite its setbacks. It has strengthened its financial position by selling state-owned oil firm Saudi Aramco its 70pc holding in petrochemicals company Sabic for $69bn. And, crucially, Aramco’s IPO next month, even though limited to the domestic Tadawul Saudi stock exchange, could raise between $20bn and $60bn for the PIF. Thereafter, the firm will likely pay dividends to its main state shareholder of between $70bn and $80bn annually, with a large chunk of those proceeds earmarked for the fund.
Critically, PIF can gear up its balance sheet to raise billions more, according to Salah Shamma, head of the Middle East region for fund manager Franklin Templeton Emerging Markets Equity.
And PIF certainly needs cash to fulfil MbS’ development plans. A key initiative unveiled two years ago was for a futuristic high-tech city on the Saudi Arabian coast called Neom, at a cost of $500bn. The funding needs to be off-balance sheet—i.e. via PIF—to avoid any risk to Saudi Arabia’s credit rating or adversely affecting the sovereign balance sheet. Indeed, Neom is very much PIF’s flagship project, as made clear by MbS at an investment forum in Riyadh two years ago. Thus, the kingdom really needs to get that one right.