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Silk Road

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  • 1. Atlantische Initiative CONFIDENTIAL Berlin, 10 May 2007 Beyond Oil – Opportunities on New Silk Road This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company, Inc. This material was used by McKinsey & Company, Inc., during an oral presentation; it is not a complete record of the discussion.
  • 2. 6 questions we hope to answer today • What specific countries in the Middle East are we focusing on? • Why do we believe that changes in the region are important on a global level? • Why should the changes matter to the international business and government community? • How big is the opportunity? • What are others doing? What can we learn from them? • What are the potential barriers that exist? 1
  • 3. Overview Beyond oil – major changes in Gulf economics of global significance Re-awakening of historically significant 'Silk Road' Huge potential for deepening and broadening the relationship Key challenges – A few obstacles that need to be overcome 2
  • 4. Beyond oil – major changes in Gulf economies Focus are of global importance of discussion The GCC by far is the wealthiest of the 3 areas that make up the Arab world Population, 2006 Nominal GDP, 2006 GDP per capita, 2006 m $b $000 GCC 36 702 19.2 Levant** 29 68 2.4 North Africa*** 194 392 2.0 'Arab World'**** 329 1240 3.7 Total * Arab world as defined by the Arab league includes 22 states ** Includes Jordan, Lebanon, Syria. Does not include Palestine *** Includes Algeria, Egypt, Libya, Morocco, Sudan and Tunisia **** Includes GCC, Levant, Yemen and Iraq Source: Global Insight World Market Monitor 3
  • 5. Changes occurring in GCC are different than during previous oil booms Unique ingredients for radical change • Means – An increased oil price Early evidence that results are different (structural) will cause an additional • Reduction of external debt – Saudi USD 2 trillion to flow to region over Arabia cut external debt from 97% of next decade GDP in 2002 to less than 30% in 2007 • Necessity/urgency – Growing young • Controlled government spending – populations and spiralling unemploy- Revenues increase by 300% and ment with no remaining room in public government spending only by 74% sector. Also, a falling per capita (education/healthcare) oil/gas production • Non-oil GDP growth – GDP growth in • Leadership – New ambitious leaders non-oil sectors is now beginning to have taken power in several Gulf exceed the oil sector states with explicit goal of diversification from oil • FDI – Increased from $2b in 2001 to $20b in 2005 • Reformed institutions – Investment laws, capital markets and trade Source: Global Insights, United Nations Conference on Trade and Development (UNCTAD) 4
  • 6. Old Dubai – Sheikh Zayed Road (1990) 5
  • 7. New Dubai – Sheikh Zayed Road (2005) 15 Years later 6
  • 8. Economic growth rates in GCC match or exceed those of other 'BRIC*' countries Nominal growth Real growth (2004–06), % (2004–06), % 6.6 GCC 20.8 10.6 China 16.6 26.0 Brazil 2.6 28.6 Russia 6.6 14.1 8.9 India * Brazil, Russia, India, China Source: Global Insight World Market Monitor 7
  • 9. Saudi Arabia is by far the largest economy in the GCC The Gulf Cooperation Council states Basic demographics Nominal GDP Real (2004–06) Population, 2006 per capita, GDP growth rate m 2006, $ Kuwait Jordan • Saudi Arabia 24.5 14,161 11.5% • UAE 4.2 37,357 16.6% Bahrain Qatar • Kuwait 16.6% 2.8 34,711 UAE Saudi • Oman 9.0% 2.5 13,867 Arabia Oman 15.8% • Qatar 0.8 62,293 15.5% • Bahrain 0.7 20,860 Source: Global Insight World Market Monitor 8
  • 10. Foreign investors have significantly increased their interest in the region over recent years FOREIGN DIRECT INVESTMENT INFLOWS $m CAGR*, 2001 - 06 2001 2006 % United Arab 1,200 9,260 50 Emirates Saudi Arabia 504 16,510 101 54 Qatar 296 2,580 Bahrain 3,560 114 80 178 Oman 5 837 13 Kuwait -112 98 * Compound Annual Growth Rate Source: EIU WorldData 9
  • 11. Overview Beyond oil – major changes in Gulf economics of global significance Re-awakening of historically significant 'Silk Road' Huge potential for deepening and broadening the relationship Key challenges – A few obstacles that need to be overcome 10
  • 12. Re-awakening of historically significant trading route Middle East – China Middle East – China Oil flows, QBTU Trade flows, $b 2.7 59 CAGR= CAGR= 25% 25% 0.7 6 1999 2005 1995 2005 Middle East – Asia Capital flows, $b 15 CAGR= 21% 7 2001 2005 Source: BP Statistical Yearbook; IEA; Global Insights; McKinsey analysis 11
  • 13. The rise of direct airline links another indication of increased activity U.S. GCC China Number of direct flights per week GCC to U.S. GCC to China 7 2000 11 48 2006 20 12
  • 14. Growth in trade flows primarily driven by rise of oil imports MIDDLE EAST – TRADE WITH MAJOR REGIONS $b, CAGR CAGR (1995 - 05) % 703 China 25.4 59 13.2 Asia* 240 362 6.8 62 Japan 16 104 250 6 237 EU 8.5 49 69 32 130 105 105 10.5 US 63 38 1995 2000 2004 The rise in trade between the Middle East and Asia has outstripped the increase between the Middle East and the US * Asia: Asia excluding China, Japan Source: Global Insight using IMF's Direction of Trade Statistics database 13
  • 15. OIL DEMAND FROM CHINA WILL GROW FASTER THAN THE REST OF WORLD Primary demand for petroleum products QBTU CAGR 2003-2010 % 2.1 207.3 6.0 29.0 167.8 3.5 8.1 4.5 19.5 19.1 145.1 China 6.0 12.7 12.9 India 1.1 4.7 41.0 9.5 Middle East 36.6 34.0 Europe 1.4 45.3 39.6 35.9 U.S. 1.5 64.3 53.5 48.1 RoW 2003 2010 E 2020 E Source: McKinsey Global Institute; Energy demand model 14
  • 16. Asia and the Middle East today are the major net providers of capital to the rest of the world Share of net Net capital outflows capital $b %, 2006 1,426 Other 15 220 Petro- dollars*** 1,047 Middle 20 280 Asia and the Middle East** 162 East are the major net providers of 132 capital to the world 450 Asia* 32 • More than 50% of total net capital to 378 the world 436 97 Western 28 54 398 Europe 308 174 86 ROW 5 78 67 24 2000 2005 2006e Note: Only includes countries in any given year with a current account surplus/capital account deficit * Asia and petrodollars estimated based off of current literature; W.E. and ROW extrapolated over 5-yr CAGR ** Includes Algeria, Iran, Kuwait, Saudi Arabia, Syria and Yemen *** Includes Indonesia, Nigeria, Norway, Russia, Venezuela Source: Economist; Wall Street Journal; McKinsey Global Institute Capital Flows Database; McKinsey analysis 15
  • 17. For Japan, the Middle East (Gulf) is a strategically important trading partner Share of Japanese oil imports by country Volume (Ml), m Share, % 1. KSA 73 29 2. UAE 61 25 3. Iran 32 13 For both Japan and the Gulf, the trading relationship is important 4. Qatar 24 9 5. Kuwait 18 7 • Japan is the 2nd largest trade partner for Saudi Arabia after 6 6. Oman 3 the U.S. 7. Neutral 5 2 • UAE/Saudi are the 3rd and 4th territories largest import countries for 3 8. Other ME 1 Japan (mostly oil) 9. Indonesia 8 3 Japan receives 6 10. Sudan 3 89% of oil from region compared to 2 11. Nigeria 1 19% for U.S. 12. RoW 11 4 Source: JETRO, China Statistical Year Book 16
  • 18. Recent transactions/deals Emirates-based China's Sinopec Etisalat paid USD 2.6 Egypt's Orascom invests as much as billion for a 26% stake picked up 19% of Hong USD 100 billion in in Pakistan Kong's Hutchison Tele- Iran to secure Telecommunications com for USD 1.3 billion supply of energy Damac Holding is Majid Al Futtaim Group building a USD 2.7 ties up with Japan’s top billion residential, office finance houses to launch Emaar – MGF and leisure complex in premium credit cards Land plans to Tianjin, China invest USD 4 billion in India Emmar and Saudi Prince Bandar bin Limitless Mohammed plans to announced buy a majority stake of USD 40 billion real Bangladesh's Rupali estate projects in Bank Pakistan * FTA = Free Trade Agreement Source: Internet research 17
  • 19. No longer merely portfolio, cross border investments are becoming more long term ILLUSTRATIVE Countries Sample Deal • quot;Deal of the centuryquot; – USD 100 billion energy deal. China Iran China will pay Iran USD 30 billion over next 25 years for oil and LNG. China will also provide USD 70 billion for a • Both Middle East 51% stake in Iran's Yadavaran oil field which has and Asian estimated reserves of 3 billion barrels countries investing with • The UAE's Emirates Telecommunications Corporation UAE Pakistan more strategic (Etisalat) acquired 26% management stake in Pakistan focus Telecommunication Corporation for USD 2.6 billion • Recent flurry of • Egypt's Orascom picked up a USD 1.3 billion worth Hong big non-oil deals Egypt Kong 19% stake in Hong Kong's Hutchison Telecom in additional to giant petro- projects • Indian joint-venture Emaar-MGF Land has planned to • Energy, Real UAE India invest USD 4 billion in projects ranging from townships, Estate & Telecom hotels, hospitals and golf courses. The company attracting the expects USD 8 billion in revenue from the projects most deal interest • Damac Holding is building a USD2.7 billion residential, UAE China office, and leisure complex in Tianjin 18
  • 20. Overview Beyond oil – major changes in Gulf economics of global significance Re-awakening of historically significant 'Silk Road' Huge potential for deepening and broadening the relationship Key challenges – A few obstacles that need to be overcome 19
  • 21. Huge potential 1. Energy • China demand for energy will account for 50% of total increase during the next 15 years • Japan relies on the Gulf for 89% of it's oil needs • $155b in power sector expenditures in MENASA region required over next 10 years 2. Infrastructure • Saudi Arabia has $650b in infrastructure spending plans over next 10 years • China has $1 trillion infrastructure needs over next 5 years • Significant SOE privatization/IPOs 3. Capital flows/ • Shift in Gulf investor portfolio from West to Asia FDI ~250b • More direct investment by both Gulf and Japan 4. People • Between 2003-2006 there were 2589 Japanese living in the GCC (half of them in Dubai) and only 168 GCC nationals living in Japan • Gulf provides significant jobs in construction for China and Asia Source: ANRE, Ministry of foreign affairs Japan, Saudi Chamber of Commerce and Industry, Abraaj Capital 20
  • 22. Significant infrastructure expenditure is required in GCC GOVERNMENT SPENDING Projected required expenditure through 2016* Examples of investments $b • Roads, airports, railway, shipping Transportation 188 • Power plants Power & Utilities 155 • Desalination plants Water 133 • Hospitals, clinics Healthcare 49 • Schools, universities, research Education 18 centers • Feedstock, olefins, aromatics Petrochemicals 87 * MENASA region, conservative estimates Source: Abraaj Capital report 21
  • 23. China has equally impressive infrastructure requirements GOVERNMENT SPENDING Projected expenditure through 2010 $b Example of Investments Road (22,000 km extension of national truck highway system) Transportation 512 Airports (50+ new airports) Electrical power generation (increase capacity by 350 GW by Energy 381 2010, 160 GW already under construction or green-lighted) Water supply (develop 600 billion Water 65 tons of new water supply per year) Beijing Olympics 2008 International (stadiums and other facilities) 80 events Expo 2010 (venues, city infrastructure) Source: McKinsey Analysis 22
  • 24. Total cross-border capital flows between the Middle East and Asia will grow to $300b by 2020, with cross-border investments climbing to $1.6 trillion Cross-border capital flows* between the Middle East and Asia $b 300 CAGR 22.2% 110 40 15 7 China today 2001 2005 2010e 2015e 2020e accounts for ~50% of all capital inflows and Cross-border financial holdings* outflows for Asia 1,600 between the Middle East and Asia (including Japan) $b CAGR 24.5% 540 180 60 25 2001 2005 2010e 2015e 2020e * Cross-border holdings and flows include debt and equity securities, cross-border lending, and foreign direct investment Source: McKinsey Global Institute Capital Flows Database; McKinsey Global Institute Cross Border Holdings Database; McKinsey Analysis 23
  • 25. What are others doing? quot;Opening a corporate headquarters in the United Arab Emirates city of Dubai and moving its chairman and chief executive, David J. Lesar, there.quot; - NYT quot;Goldman Sachs, Dubai, Qatar movequot; – Reuters quot;the U.S. buyout firm that manages quot;Morgan Stanley Licensed To more than $44 billion worldwide … Establish First Middle East plans to raise as much as $1 Office At Dubai International billion for a fund targeting the Financial Centrequot; – Mondo Middle Eastquot; – Bloomberg Visione 24
  • 26. Overview Beyond oil – major changes in Gulf economics of global significance Re-awakening of historically significant 'Silk Road' Huge potential for deepening and broadening the relationship Key challenges – A few obstacles that need to be overcome 25
  • 27. Interviews with CEOs indicate excitement but some lingering barriers Gulf – “Going East” China – “CHIME – a buzzword” • “We want to go global by going East, not West. The • “East-East transactions are reducing the traditional West is aging and losing momentum,”. “You’ve got deal flow to the West. The acronym CHIME for China, aging populations and an aging economy; the East is India and the Middle East, is now a buzzword in Hong where the true glamour is. The East is where your Kong.” $100 of investment, works the hardest.” – Victor Chu, Head of Far Eastern Investment Bank – Major investor, Dubai • “We see major investment opportunities certainly in oil related markets but also in construction and • “We believe the linkages between our region and infrastructure“ China are so important. The real change in last 5-10 – Chinese insurance company years is this: we went regional. Trading in each • “China has signed a variety of economic and trade other’s countries has given us confidence.” – Major investor, Abu Dhabi agreements with all 6 GCC member states, e.g., an Economic and Trade Agreement, Agreement of Investment Protection and Applicable Double Taxation • “Financing is easier in West but growth is slow. In the Agreement“ Middle East and Far East, you have to use cash but – Middle East expert, Ministry of Commerce, China the potential for growth is so much higher in China or • “China has made progress in Arab language education India. Instead of NY, Paris and London it’s now – there were only a handful of universities with Arab Shanghai, Mumbai and Cairo.” programs in 1990, now more than 20 universities offer – Major investor, Kuwait Arab language programs” – Middle East expert, Ministry of Foreign Affairs, China • “We are big believers in the flow of money East. • “We would like the Gulf’s ‘long term’ approach – it is We have seen huge demand in Chinese IPOs” similar to ours – we both have opportunities to invest and – Major global investment bank help with each other’s economies. We have identified 7 projects in the Gulf that we would like to pursue” – Chinese Logistics Company Source: Interviews; press articles 26
  • 28. Key challenges that you see Bureaucratic/system barriers • No approval and license / government systems as a manufacturing base Insufficient legal/ (ease of filing applications, process transparency) regulatory • infrastructure No legal system / regulations protect important business properties (example: patent protection, etc.) • I think a local partner is necessary, but we don’t have clear selection Process standards complication • There might be a difference in the business decision speed of Japanese companies and Middle Eastern clients and partners; this could be damaging to business • We see a problem with social instability and low levels of safety Lack of confidence in System stability Cultural/network gaps • Institutional understanding of Islamic culture is low, and there would be a Lack of cultural lack of personnel who could do internal management. It would be difficult for skills representatives dispatched to the Middle East to adapt • It takes time to get used to the local management style • We have low research capacity in the local market, and we would not be Lack of network able to market to local clients skills • Practically, there little information in Japan on Middle East business and managerial conducts. As such, I feel less confident doing business there Source: Japanese company survey 27
  • 29. Ways to strengthen the road ahead – public-private sector initiatives Examples Description • Key driver to smoothen trade & capital • FTA between Japan and GCC expected flows soon Free Trade Agreements • Bahrain considering FTAs with other Asian countries like India • SEZ usually served as quot;windowquot; and role • China investing in Dubai industrial & real model to attract foreign investment estate SEZs Special Economic Zones • Gulf countries showing strong interest in India's planned 150 SEZs • Secondments • Eisenhower Fellowship program Human capital • People exchanges • U.S.-Japan young political leaders exchange exchange program • Laying groundwork • Improving commercial services in embassies for better business dialogue • Japan-Arab Dialogue Forum Diplomatic platforms • Shanghai Co-operation Organization • Protect quot;lower endquot; of downside • Overseas Private Investment Corporation in the U.S. • Operating on market principles • Export development banks Government • Nurturing three to four high-profile investment agencies • Government agencies like SAGIA, ADIA, quot;cornerstone investmentsquot; KIA, Temasek, GIC and so on are helping to make quot;cornerstonequot; investments • Exchanges in sports, arts • Doha Games • Education programs • Language programs Cultural linkages • Student exchange Source: McKinsey Analysis, publication research 28