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Industry Report- Saudi Arabia Energy Industry

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Globalization has become the essence of international trade and has been the primary reason why companies have gone beyond their national boundaries and setup production centers in different countries. As a consequence, consumers today are getting high quality, low priced and technologically enhanced products and services all over the world. Some commodities that have been widely affected by globalization are oil & gas, our primary sources of energy. World energy sector has been booming as giant corporations go to different countries in the search of new sources of energy. Saudi Arabia since its inception and the discovery of oil has been the center of the world oil trade and politics. It plays a major role in the supply of oil and keeping the prices in balance. So, it naturally attracted the major oil exploration and production giants from all over the world to extract the biggest source of energy. This paper gives an overview of the multinationals operating in the Saudi Arabian energy sector and how they have impacted the growth of the sector.
This dissertation through use of secondary resources and qualitative analysis intends to add value to the existing literature by bringing out a new perspective in the international business research. Literature Review forms the base of the dissertation and is essentially divided into three parts. The first part explores the existing theories relating to Multinational companies and Internationalization. It explains the evolution of the theories and presents counter views on the internationalization of companies. The second part talks about the macroeconomic environment of Saudi Arabia using the PESTLE framework and describes the factors any company should consider before investing in Saudi Arabia. The third and the last part of the Literature review we discuss the energy sector of Saudi Arabia and the major companies operating in it. It uses the well known Porter?s Five Forces model to understand the competitive structure of the Saudi Arabia energy sector.
The next section of the dissertation is key findings where the information received from the previous section is analyzed. The impact on the energy sector is discussed followed by the gaps in the existing studies and the future prospects of the Saudi Arabian energy sector. The dissertation concludes by summarizing the key findings obtained from the various studies and paves way for further research on this topic.

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Industry Report- Saudi Arabia Energy Industry

  1. 1. The Impact of multinational companies A case study of the energy industry in Saudi Arabia
  2. 2. 1 Abstract Globalization has become the essence of international trade and has been the primary reason why companies have gone beyond their national boundaries and setup production centers in different countries. As a consequence, consumers today are getting high quality, low priced and technologically enhanced products and services all over the world. Some commodities that have been widely affected by globalization are oil & gas, our primary sources of energy. World energy sector has been booming as giant corporations go to different countries in the search of new sources of energy. Saudi Arabia since its inception and the discovery of oil has been the center of the world oil trade and politics. It plays a major role in the supply of oil and keeping the prices in balance. So, it naturally attracted the major oil exploration and production giants from all over the world to extract the biggest source of energy. This paper gives an overview of the multinationals operating in the Saudi Arabian energy sector and how they have impacted the growth of the sector. This dissertation through use of secondary resources and qualitative analysis intends to add value to the existing literature by bringing out a new perspective in the international business research. Literature Review forms the base of the dissertation and is essentially divided into three parts. The first part explores the existing theories relating to Multinational companies and Internationalization. It explains the evolution of the theories and presents counter views on the internationalization of companies. The second part talks about the macroeconomic environment of Saudi Arabia using the PESTLE framework and describes the factors any company should
  3. 3. 2 consider before investing in Saudi Arabia. The third and the last part of the Literature review we discuss the energy sector of Saudi Arabia and the major companies operating in it. It uses the well known Porter’s Five Forces model to understand the competitive structure of the Saudi Arabia energy sector. The next section of the dissertation is key findings where the information received from the previous section is analyzed. The impact on the energy sector is discussed followed by the gaps in the existing studies and the future prospects of the Saudi Arabian energy sector. The dissertation concludes by summarizing the key findings obtained from the various studies and paves way for further research on this topic.
  4. 4. 3 Contents Part 1 of the dissertation ........................................................................................................... 4 1. Introduction........................................................................................................................... 4 1.1. Background and Rationale of the Research ................................................................... 6 1.2. Aims & Objectives of the Research.............................................................................. 8 1.3. Key Research Questions.................................................................................................. 9 2. Literature Review................................................................................................................ 10 2.1. Overview of Multinational Companies: Definition & Theories.............................. 10 2.2. PESTLE Analysis of Saudi Arabia.................................................................................. 15 2.3. Energy Sector Structure in Saudi Arabia.................................................................... 23 2.4. Porter Five Forces Model for analysis of Energy Industry ..................................... 24 2.5. Major Companies in the Energy Sector in Saudi Arabia........................................ 30 References for Part 1 ................................................................................................................ 35 Part 2 of the dissertation ......................................................................................................... 39 3. Research Methodology ..................................................................................................... 39 4. Key Findings & Discussion ............................................................................................... 46 4.1. Impact on the growth of Saudi Arabia Energy Sector............................................ 46 4.2. Gaps in the existing studies ......................................................................................... 48 4.3. Future Outlook of the Saudi Arabian Energy Industry ........................................... 50
  5. 5. 4 5. Conclusion ........................................................................................................................... 57 References for Part 2 ................................................................................................................ 60 Part 1 of the dissertation 1. Introduction In this era of globalization, there has been a fundamental change in the way international business is being done. Due to the ease of communication and advances in the sophisticated communication systems more and more companies are becoming global and expanding their operations and creating production facilities away from their home countries. This trend has given rise to today’s Multinational Corporations (MNCs) whose role in the international scene is increasing rapidly. With increased international development and cooperation, the MNCs have been able to create such a network that their budgets, organizational structure and influence on the world trade stage rivals many nations (UN Conference Proceedings, 2006). With their immense economic power and strong political connections and the fact that globalization is seen as a ―Business driving phenomenon‖, MNCs are in a strong position to influence the economies
  6. 6. 5 of the countries they operate in (Nourafchan, 2011). Today, MNCs not only impact the trade and the economy of the nation in which they operate but also impact the social and cultural aspects. In the world energy market dominated by oil, the role of multinational companies in the oil exploration and supply has been tremendous. As oil became the most important commodity in the energy market, the Multinational oil companies found new markets and opened up sites in various countries to produce and supply crude oil and petroleum products. With increasing demands in the oil, there was a need of inexpensive supply of oil and this led the MNCs to the shores of South America, Pacific countries and Middle East countries. Saudi Arabia with its vast amount of oil reserves became one of the most important oil production destinations in the world. Saudi Arabia has been blessed with huge amount of oil and natural gas resources that essentially drive the economy of the kingdom and form a huge part of their energy industry. The Saudi Arabia Energy sector is mainly dependent upon its petroleum resources. Electrical energy is mainly produced in thermal power stations that are run using natural resources. The demand for energy is increasing due to industrialization and growing population by around 7% per year. To meet the demand, the government has taken several steps like consolidation in the energy sector and has created a public company called Saudi Electric Company to manage the energy operations. The government has also lowered restrictions on Independent Power producers (Federal Research Division, 2006) Foreign investment in Saudi Arabia has a complicated history since its inception in the oil energy sector. It started in 1933, with a concessional agreement between the Saudi Arabia Government and the Standard Oil Corporation of the United States to explore oil in Saudi Arabia. Further, the establishment of Arabian American Oil Company (Aramco) in 1944 was another significant step
  7. 7. 6 in this direction. In 1988, Saudi Aramco was established as the National oil corporation of Saudi Arabia that took full control on oil exploration and supply activities in Saudi Arabia. Saudi Arabia’s Accession to World Trade Organization (WTO) is also considered a major step in its integration into the modern international economic relations (Law Teacher, 2011). After several years of negotiations and trade agreements, Saudi Arabia became a member of WTO in 2005 in order to achieve sustainable growth, increase international trade cooperation and for creating stable and beneficial conditions for foreign investment. This has led to favorable conditions of foreign investments in the country as MNCs are no longer required to take Saudi partners (except banking and insurance services)(Law Teacher, 2011). The government is also encouraging foreign investments in several sectors including energy and power. This dissertation analyses the impact of the multinational companieson the various aspects of the Saudi Arabian economy through the example of the Saudi Arabia energy sector. 1.1. Background and Rationale of the Research The development of Saudi Arabian Economy goes hand in hand with the development and expansion of its energy sector. During the last 70 years the idea of building the state, fortified by oil revenues distributed through the modern institutions of bureaucracy, has worked to unify this economically diverse country(Mongabay, 2011). The establishment of the ―Kingdom of Saudi Arabia‖ that led to the unification of diverse regions and the discovery of oil in 1938 can be considered major events that have shaped its economy. The rebuilding of Europe after the World War II also played a major role in solidifying Saudi Arabia’s position in world oil industry. These events led to an exponential increase in the oil revenues of the kingdom and resulted in widespread economical changes and a shift from the traditional economy.
  8. 8. 7 Due to its prominent location as the oil hub of the world Saudi Arabia became an important part of the West’s strategic plans. Moreover, a steady flow of oil was considered as an essential element for the worldwide economic development. For United States, the importance of Saudi Arabia as a trade partner became clear during the Gulf war of 1991, when they sent troops to expel Iraq from Kuwait. Saudi Arabia was clearly seen as the biggest oil producing country that had the excess capacity of crude oil production and a strong hold on the oil supply and prices. Globalization has affected almost every citizen of the world and this through is very well reflected in the products and services we used today. Multinational companies have served as the carriers of growth and development in international trade, economic development, human resource development and industrialization across national boundaries (Mababaya, 2002). They are also responsible for advanced technology transfer and innovative products availability across the national boundaries. In all they are affecting every sphere of business cycle across globe and adding to the human welfare by providing products and services that were not available before. Multinationals in Saudi Arabia have been playing the role of country’s development through numerous joint ventures, contracting projects, outsourcing projects, consulting & financing activities and in return they have enjoyed beneficial business conditions from the government of Saudi Arabia. The energy sector in particular has seen many International companies like Exxon Mobil, Shell, and Conoco Philips setting up oil exploration and production projects in Saudi Arabia. It can be safely said that their contribution in the development of the Saudi Arabian Energy sector and the economy as a whole cannot be ignored and needs to be studied in detail. Moreover, the effect of MNC’s on Saudi Arabian society and culture needs to be understood in detail.
  9. 9. 8 There aren’t many research studies that have been done in this particular are. Some studies talk about the Role of Multinationals in Saudi Arabia, but do not focus on the energy sector in particular. At the same time there are various studies and reports on the energy sector in Saudi Arabia. But there is hardly any study that links the impact of multinationals and the energy sector in Saudi Arabia. Hence, this dissertation brings out a completely new view on this topic and would be a good add on in the research domain of international business. 1.2. Aims & Objectives of the Research The main aim of the dissertation is to understand the impact of the various multinational companies who have invested in Saudi Arabia Energy by studyingits business environment, structure and policies and the factors that have been affected the most. The dissertation strives to achieve the following objectives –  To review the existing theories on internationalization and multinational companies  To understand the Saudi Arabian Energy Sector in terms of its major players governance structure, investment policy and other factors  To review the latest trends in the Saudi Arabian foreign investment policy, especially after its accession to WTO  To review the growth of major international companies having operations in Saudi Arabia in the energy sector  To identify the factors that play a major role in the successful operations of MNCs in Saudi Arabia  To understand the working environment for the international companies  To understand the impact of the multinational companies on the energy sector growth and its future prospects
  10. 10. 9  To evaluate the effect of unconventional sources of energy on the growth prospects of Saudi Arabia Energy Sector 1.3. Key Research Questions This dissertation aims to answer the below mentioned research questions –  How is the macroeconomic environment of Saudi Arabia for foreign investors?  What are the latest trends in the Saudi Arabia Foreign Direct Investment policy?  What is the structure of the energy industry in Saudi Arabia?  What are the major players in the Saudi Arabian Energy industry and their significance?  What is role played by the multinational companies in developing the energy sector in Saudi Arabia?  What is the impact of the multinational companies on the economy and the growth Saudi Arabia?  What is the impact of unconventional sources of energy on the Saudi Arabia Energy sector?
  11. 11. 10 2. Literature Review Literature Review is the process of gathering and evaluating information on the chosen topic from a wide variety of sources. Literature Review as a section is the most important section of the dissertation as it provides the independent views of previous studies done on the topic and this knowledge helps to create a consolidated view to assess the chosen topic. This section helps in understanding the sub topics through an array of readings and builds the base of the dissertation. Literature Review should be clear and concise, well structured so that the reader of the dissertation understands the depth of information and the reasons of choosing the topic (Loughborough University, n.d.) 2.1. Overview of Multinational Companies: Definition & Theories A Multinational Enterprise (MNE) or Multinational Corporations (MNC) can be generally defined as an organization operating in several countries but managed from one home country (Business Directory, 2011). Another definition given by (Caves, 1996) states “Multinational corporation is a firm which control and organize production using plants from at least two countries”. Multinational companies can be found in four different forms – 1) A decentralized organization with a strong base at home 2) A global centralized organization with major operations concentrated at one place 3) International company that builds on Parent company’s brand name
  12. 12. 11 , technology or product 4) A transnational enterprise that companies the previous three approaches (Business Directory, 2011). A study by UNCTAD shows that the number of Multinational Corporations in the world is in the excess of 63,000 and they contribute to about 25% of the world’s output and employ about 83 million people (Ionescu, n.d.). About 2/3rd of world’s export is manufactured by MNCs (Dunning, 2003). Multinationals are being considered as the most flexible actors in promoting globalization (Ionescu, n.d.). The contributions of MNCs in the country they operate in are multifold – cross border value adding transactions, joint ventures, project management, increase in the investments, infrastructure upgrade, job creation and others. Some of the important organizations that affect the evolution of any multinational company are WTO, IMF, OPEC, UNCTAD and regional associations like European Union and Arabian states. There have been various theories developed to understand the concept and trends of the MNCs. Some of them focus on the international production and FDI, while others are talk about other modes of internationalization such as joint ventures, subsidiaries or licensing. According to (Ietto-Gillies, 2003), it was the era of 1950s and 1960s which saw the inception of the trend of FDI by most Western companies and then it flowed towards the developing countries. One of the well known theories of internationalization was developed by(Hymer, 1976) which was based upon two critical components – 1) Concept of Control that differentiates between a company’s intention of FDI or other modes of internationalization 2) Market imperfections – that explain why firms want to invest abroad. Another author (Vernon, 1966) bases his theory of internationalization on dual concepts of – 1) International product life cycle and 2) Theory of trade based on technology gap. He states that product innovation is the key to
  13. 13. 12 internationalization as it gives the firm to exploit the markets at home and when the product reaches maturity they can exploit the same abroad. He further iterates that as the product goes from innovative to maturity phase in one country there is a need to find new markets for it. Thus, innovation and technological changes form the main base of Vernon’s theory. Most of the other theories of internationalization find their roots in the theory developed by Ronald Coase who states that firm grows as a result of attempts to economize on the costs of market transactions (Coase, 1937) and (Coase, 1991). This theory was further developed by O.E. Williamson who applied the concepts of transactional costs to explain the development and growth of a modern organization (Williamson, 1975) and (Williamson, 1981). This approach is different from that of Hymer and Vernon and as it places transactional market imperfections at its core as opposed to imperfections of structural types. To summarize, market imperfections generate cost issues and uncertainties that can be avoided by internationalization and hence the concept of FDI and the MNC. Another expert, John Dunning has been a major figure in the internationalization theory domain and has developed a theory called ―systematic theory‖ or a ―paradigm‖. His framework answers basic questions like why do MNCs engage in new markets, what method of internationalization they choose, how the country of investment is chosen and others. His three point proposed framework helps to answer the above mentioned questions. He points out that a firm can have 3 types of advantages- 1) Ownership advantages – To determine why a firm is better placed than its rivals to go ahead with the foreign investments 2) Location advantages – It explains why a particular location is chosen and why it is preferred over any other location 3) Internationalization advantages – It explains under what conditions will the firm choose direct production or licensing (Dunning, 1977) and (Dunning, 1980).
  14. 14. 13 Another thinker Cantwell has put forward a modern and evolutionary approach to explain the growth of MNCs. His model is based on the concept of innovation and technological accumulation. It is different from the theory of Vernon has his model was that of technology transfer while Cantwell model proposes technology creation and diffusion. He explains that firms invest in innovation in order to stay head of their competitors. They invest in several centers and gain experience from the diverse environments. The resulting benefits would spill over to the other industry and locations where the firm operates. Thus, there is a technological diffusion taking place (Cantwell, 1989) and (Cantwell, 2000). Thus, the different theories that have been highlighted are different and yet have many common points. The evolution of the MNCs is not always helpful to the countries in which they operate. Two views have been propagated about the impacts of multinational companies in a country. The first view argues whether the multinational companies actually help in the development of the host country and whether national states have to defeat their interests against multinationals (Ionescu, n.d.) There is sometimes a standoff between the intentions of a multinational company of maximizing profits and the legislations of the country they are operating in. It is alleged that Multinational firms driven by their own profit maximization agendas tend to propagate destructive competition and try to manipulate the entire economies. Due to their large scale operations they are perceived to be sole profit making entities and encouraging practices like sweat shops and child labor.Moreover, there are other concerns like loss to the domestic industries, environmental issues especially in case of oil & gas industry.It is also perceived that MNCs tend to exploit the labor and the natural resources of a country. This leads to protectionist
  15. 15. 14 policies by the host country resulting in trade barriers, closing of economy, high taxation, limited operations etc. The second view counteracts the first view and proposes the benefits of the MNCs in the developing world. One of the reports called Home and Host Country Effects of FDI (NBER Working Paper No. 9293), the author Robert Lipsey propagates there is very little evidence that MNCs are guilty of the many evils that they have been accused of (Robert Lipsey, n.d.). The study was undertaken to find out whether foreign investments by a multinational firm actually lead to unemployment, depressed wages and exploitation of cheap labor as widely believed by the critics of globalization. His research shows that the benefits of MNCs in the host country are multifold as they not only pay higher wages as compared to the national companies but also tend to increase productivity through their sophisticated large scale operations. Another author, Gary Quinlivan in his article ―Multinational Corporations: Myths and Facts‖ has countered the critics of globalization and MNCs by presenting a view that global competition is not destructive, but rather has benefitted the entire world by giving high quality, diverse and low priced products (Quinlivan, 2000). He strengthens is point further by stating that there are studies that show foreign investment in the host country has actually boosted domestic investment. Two studies cited by United nation’s ―World Investment Report, 1999‖ gives evidence that ―an additional dollar of foreign direct investment increases domestic investment in a sample of sixty-nine developing countries by a factor of 1.5 to 2.3‖ (Quinlivan, 2000). The study by Quinlivan further dismisses the notion that MNCs siphon jobs from high wage to low wage countries. Evidence by World Bank and United Nations strongly supports the view and further concludes that MNCs have been a key factor in the welfare of developing countries in the past forty years. MNCs no matter make profits but that doesn’t mean it is at the expense of the host country. It is mutually
  16. 16. 15 beneficial as the host country also receives bigger tax base, investments, jobs and better technologies. Thus, we can see that both critics and proponents of the MNCs have different views, but given the growth of MNCs it is evident that the positives are more than the negatives. 2.2. PESTLE Analysis of Saudi Arabia As we have seen from the previous section, one of the biggest concerns for any multinational company that wants to invest in other countries is to consider its macroeconomic environment. Some of the factors that determine the macroeconomic environment of a country are Foreign Direct Investment (FDI) policies, tax rules, trade laws, government policies, demographic changes and political outlook. The knowledge of these factors helps the organization and its managers to decide the quantum and the period of investments. It also helps in determining the type of investments whether a joint venture, wholly owned subsidiary or just a representative office (Oxford University Press, 2007). One of the most important and widely used frameworks to assess any country’s macroeconomic environment is the PESTLE analysis framework. Using this framework we can analyze any country’s macroeconomic environment on six important factors viz. Political, Economic, Social, Technological, Legal and Environmental. “A PESTLE Analysis is one of the most important frameworks of macro-environmental scanning, framework which comprises the most important factors used in environmental scanning, as part of advanced strategic management” - (Marketing Minefield, 2011) Saudi Arabia as a country has risen tremendously due to its oil reserves and offers wide opportunities for the multinational companies. However, rising incomes has not entirely
  17. 17. 16 benefitted the majority of population resulting in unemployment and income inequality. More over its education sector is not well developed. The government has not done enough to improve the status of women. Environmental regulations also need to be improved. So considering such issues it is important for any multinational company to undertake an in depth analysis of Saudi Arabian macro environment before investing in it. The figure given below summarizes the PESTLE analysis of Kingdom of Saudi Arabia – Figure: PESTLE Analysis of Saudi Arabia. Source (By the author, adapted from (DataMonitor, 2008)) HF Highly Favorable F Favorable LF Less Favorable PESTLE ANALYSIS OF SAUDI ARABIA Political Analysis (F) Economic Analysis (HF) Social Analysis (LF) Technological Analysis (F) Legal Analysis (HF) Environmental Analysis (F)
  18. 18. 17 Political Analysis Kingdom of Saudi Arabia’s political system has remained unchanged since its current existence in 1932 and is currently ruled by King Abdullah. The regime is intolerant to any opposition parties and has restrictions on media. The country has a strong influence in the Middle East region as far as regional politics is concerned and is going to have a major say in World Oil prices in the years to come. Its political environment remains stable given King Abdullah’s popularity and good relations with the religious leaders. The table given below summarizes the political landscape of Saudi Arabia – Current Strengths Stable Government and stable policies - Due to the fact that Saudi Arabia is being ruled by the members of the same dynasty, it is political stable and the policies have been stable without any radical changes. Legislative Reforms - Due to the establishment of the Central government, there have been improvements in the legislative process. The Central council nominated by the king advises the country on the formulation of general policies. Current Challenges Lack of Democratic Setup – Saudi Arabia is ranked very low on one of the World Bank Governance indexes of Voice and accountability due to restrictions on media, political parties and freedom of expression Poor implementation of regulations- Saudi Arabia’s performance in keeping up with laws and control of corruption has been poor and moreover its rank in governance and quality of regulation do not match up to acceptable standards. Future Prospects
  19. 19. 18 Policies for economic and social reforms – Government has taken steps in the direction of improving foreign investment and infrastructure and social living through improve education, healthcare and women empowerment. Accession to WTO is one of the major steps. Future Risks Security Risks – Due to its location and its oil reserves Saudi Arabia could be a potential target for Islamic extremists from the neighboring countries. Table: Political Analysis of Saudi Arabia Economic Analysis Saudi Arabian economy has grown at a constant average rate of about 5% since 2003 and even during the global crisis of 2008 it showed a growth rate of around 3.4%. Government has taken several economic initiatives like opening up of power, oil, telecommunications and petrochemicals to the private sector. The foreign investment policies have been eased up to increase the FDI. Some of concerns relating to the economy are unemployment, inflation and a possible decline in the oil prices. Current Strengths Strong and stable GDP growth& Government Finances – The economy has been showing strong growth and the performance of all the sectors has been positive. The country enjoys positive trade balance and its current account balance has significantly increased from 7.6% in 2000 to 24.5% in 2007 as a percentage of GDP. With increasing oil revenues the government finances are in good shape. The fiscal balance is in the range of 15-20% of GDP. The government debt as a percentage of has reduced significantly from 93.3% in 2001 to 19% in 2007. Current Challenges
  20. 20. 19 Unemployment concerns – Despite its fast economic growth, the education sector in Saudi Arabia has remained underdeveloped leading to a dearth of required skills to succeed in the business environment. This has given rise to unemployment which stood at around 26% in 2007. Future Prospects Increase in infrastructure spending -The economy would be boosted by huge investments by the Saudi Arabian government in the infrastructure space. Projects equivalent to $480 billion are in place for various sectors like oil & gas, petrochemicals, transportation and others. The government is also promoting public-private partnerships (PPP). Future Risks Global Economic Slowdown – Due to the global crisis fears there is a possibility that oil prices would decline. Moreover, there are inflationary fears and the weakening of the currency. Also, discovery of unconventional sources outside Saudi Arabia could lead to decrease in reliance of Western countries on Saudi Arabian oil. Table: Economic Analysis of Saudi Arabia Social Analysis Saudi Arabia has ranked low in terms of Human Development Index (HDI) as compared to the other countries with similar GDP. The society remains conservative and the quality of living is low as compared to developed countries. Healthcare facilities also need investments and upgrade. Current Strengths Comprehensive Social Security system- Government has developed a robust social security system aiming at the welfare of citizens with schemes such as aids to poor, pensions to the old, land and house loans to all citizens, social development in small town and cities etc.
  21. 21. 20 Young society – One of the advantages for Saudi Arabia is its relatively young population with a median age of 21.5 years. Current Challenges Low rank on HDI and Income inequality–Saudi Arabia scores low in HDI and Gender related development index (GDI). One of the reports by UNDP shows that Saudi Arabia ranks 144/156 in both HDI and GDI values. Also, growing income inequality is a major cause of concern and can result into social unrest among the population. Future Prospects Government Reforms for improving Quality of life– Investments in healthcare, women education, steps for poverty reduction and disabled care are some of the initiatives undertaken by the Saudi Government. The budget for healthcare and social affairs was about $11.84 billion in 2008. Future Risks Restrictive immigration policies & growing populationneeds are some of the risks that Saudi Government would face in the future. Table: Social Analysis of Saudi Arabia Technological Analysis Saudi Arabia has created favorable policies for investments in R&D. Corporate tax laws have given boost to private investments in R&D in certain sectors. Current Strengths Strong financial position for technological development – Due to its consistent GDP growth Saudi Arabia is in a strong position to increase investments in technological development.
  22. 22. 21 Current Challenges Current low investments in R&D and technological education – As a percentage of GDP, the spending in investments in pretty low (around 0.25% in 2006) as compared to many developed countries like France (2%), Japan (3.18%) and US (2.68%). Also lack of investments in technical education and centers for higher education, Saudi Arabian workforce is not fir for technology intensive industries. Future Prospects Growing Focus on R&D and conducive FDI policies will help Saudi Arabia to improve upon its technological environment. Some steps like opening up of economic cities, investments in technological infrastructure, medical research and integrated medical services zones have already been taken. Future Risks Saudi Arabia lacks in implementation of laws and policies and one of the risks could be poor implementation of Intellectual Property Rights (IPR) leading to hampering of growth in the innovation environment Table: Technological Analysis of Saudi Arabia Legal Analysis Following WTO commitments, Saudi Arabian legal environmental is improving with reforms in privatization and liberalization. Current Strengths Better Business environment – Saudi Arabia has been ranked highly (ranked 25th in World Bank’s Ease of doing business report) in terms of ease of doing business. Radical changes in
  23. 23. 22 minimum capital requirements and reduction of required procedures from 13 to 7 has made Saudi Arabia a preferred investment destination. Current Challenges Underdeveloped judicial norms – One of the issues with the legal environment is that judicial system is not well developed and still follows capital punishment norms unlike many developed nations. The king is the head of the judicial system, thus making it an extension of political authority and not an independent entity. Future Prospects Plans of reforms in the legal environment – Initiatives like establishment of two different supreme courts – general court and administrative court, training of judges, infrastructure development and others have been taken in this direction Future Risks Preference to Saudi Nationals and lack of transparency in investment laws could hamper Saudi Arabia’s chances of attracting foreign investments in the future. Corporate taxes and laws of foreign arbitration need to become more transparent. Table: Legal Analysis of Saudi Arabia Environmental Analysis Saudi Arabia has been a late mover in implementing world standard environmental regulations. It is only after signing international Convention on Biological Diversity(CBD).The country has further restructured the prices of gasoline, diesel and cooking gas to control over-consumption Current Strengths Commitment to environmental regulations – Saudi Arabia has adopted many international and
  24. 24. 23 regional environmental conventions. Some of them include Basel convention, The Kuwait Regional Agreement for Co-operation on Protection of Marine Environment from Pollution, The Regional Agreement for Protection of the Red Sea and Gulf of Aden, The Protocol on Marine Pollution Due to Exploration and Exploitation of the Continental Shelf in the Arabian Gulf Sea Area and United Nations Framework Convention on Climate Change. Current Challenges Poor performance on environmental indexes – Due to air pollution and marine pollution near the Saudi gulf caused to incidents like oil spillage or waste dumping Saudi Arabia’s rank in environmental indexes is pretty low. Future Prospects Focus on Environment – Saudi Government has become more aware in terms of environmental issues and has even approved the Kyoto Protocol in 2004. It has also imposed restrictions on over consumption of oil and waste dumping. Future Risks Expected loss of revenue due to Kyoto Protocol – Due to Kyoto Protocol, the developed countries would be cutting down on their energy consumptions. It is estimated that the country could lose about $19 billion per year from 2010 and more after 2012 when the Kyoto protocol norms become more rigorous. Table: Environmental Analysis of Saudi Arabia 2.3. Energy Sector Structure in Saudi Arabia Saudi Arabia produces more oil and natural gas than any other country in the world. The growth in the economy is mainly dependent upon production and oil exploration that is mainly done
  25. 25. 24 through the Saudi Arabia oil company called Saudi Aramco (Federal Research Division, 2006). Oil plays a major role in the Saudi Arabian Economy and according to a US Energy Information Administration it forms 90-95% of Saudi Arabia’s export, 70-80% of country’s annual revenues and about 40% of the country’s GDP (Federal Research Division, 2006). It is estimated that Saudi Arabia has about 261.9 billion barrels of oil that could last for about 50 years (Federal Research Division, 2006). Saudi Arabia is also a highly influential member of the Organization of Petroleum Exporting Countries (OPEC). The boost in the oil production has been so tremendous that the country’s oil rigs nearly doubled between 2004 and 2006. Apart from the oil, country’s natural gas reserves are very high and form around 4% of the entire world production. It is estimated that total natural gas reserves amount to 235 trillion cubic feet. In 2002, Saudi Arabia created world’s largest natural gas plant based in Hawiya that would increase production by around 30%. Saudi Arabia has a very well structured network for electricity across the country and the electricity reach is about 97% (Reegle, 2007). However, one of the concerns relating to the reserve margin is that it is only 3% in Saudi Arabia as compared to world average of 10%. Due to this there is demand supply mismatch and hence the Saudi Electricity Company (SEC) has to cut down the supply to some areas during peak times. Saudi Arabia has opened up its economy after its accession to WTO. As a consequence, foreign companies are allowed to open up a 100% owned enterprise. But, the sector of oil exploration, drilling and production still remains protected. 2.4. Porter Five Forces Model for analysis of Energy Industry In his five forces model Michael Porter (1979) argued that the nature and degree of competition in an industry hinged on five forces: the threat of new entrants & barriers to entry, the bargaining power of buyers, the bargaining power of suppliers, threat of substitute products and competitive
  26. 26. 25 rivalry. The collective strength of these five forces determines the ultimate profit potential of an industry. This model would be used to evaluate the energy industry and the impact of the various players involved in its various sub sectors. Figure: Porter’s Five Forces Model. Source (Quick MBA, 2010) The table given below shows the importance of each parameter –
  27. 27. 26 Porter’s Five Forces Impact & Importance Threat of new entrants& Barriers to entry In ideal conditions, a free market should exist where in any firm and enter or exit easily. But in reality, the industry is dominated by large firms that inhibit rivals from entering the market and eat in to their profits. Barriers to entry have been used as a tool to maintain the market equilibrium. Some of the used methods are government regulations, patents, copy rights, economies of scale etc. Buyer Power Buyer power reflects the influence of customers and their power in making a product / service successful or unsuccessful. Buyers are normally powerful in those industries where product standardization is high, substitutes are easily available, buyers are few big institutions that dominate the market and buyers have the capability for backward integration. Some of the examples of such industries are automotive , retailers and others Buyer power is weak in those industries where there is a high switching cost for changing suppliers, any supply component is critical to the buyer’s end product, buyers are fragmented and where forward integration is possibility. Some of the examples are – movie industry, computer chip making industry etc. Supplier Power In any industry supplier’s influence the end product through the quality of raw materials and other supplies. Relationship with the suppliers is a critical component of an organization’s strategy. Suppliers are powerful in those industries where they are less in
  28. 28. 27 number or manufacture critical components. While, the suppliers are normally less powerful if the buyer has large scale operations, their supplies are standardized and substitutes are easily available. Threat of Substitutes In Porter’s Model this factor refers to the alternative products or services from some other industry. As more substitutes are available the demand of the product goes down. For e.g. demand for beverage cans made of aluminum would go down if substitutes such as steel cans, plastic cans or glass bottles are available at a lower price even though they are not from the same industry. Competitive Rivalry Intensity of rivalry is influenced by several factors that determine the level of competition in a given market. In a market where there are large numbers of firms the rivalry would be high to gain the market share. Other factors are slow market growth, high fixed costs, low switching costs, low levels of product differentiation, high exit barriers, diversity of rivals etc. Table: Porter’s five Forces: Impact & Importance. Source (Quick MBA, 2010) The energy industry mainly consists of three types of companies – 1) Oil & gas exploration and production, 2) Energy equipment suppliers 3) Service Providers (Energy Business Daily, 2010). The application of five forces model on the energy industry gives the following results - Threat of new entrants and barriers to entry– The major revenue generators of the energy industry are the type 1 companies viz. Oil & gas exploration and production. Some of the biggest names in this fragmented industry are Saudi Aramco, Exxon Mobil, Royal Dutch Shell, BP, Chevron and others. These companies are vertically aligned and have strong hold in the industry
  29. 29. 28 and hence lowering the threat of new entrants. Due to their globalized large scale operations it is unlikely that any small company would be able to challenge their supremacy. Another factor that influences the threat of new entrants is the presence of these companies in several parts of the supply chain. They use vertical integration and large scale production to be more efficient and cost effective. Moreover, their huge investments in research & development of sophisticated techniques of oil exploration, rig equipments, technology and man power has made their position as incumbents in this industry. Another deterrent is the huge initial investment that is required to set up basic facilities. Regulatory environment with its strict laws is another concern for new entrants as it is very difficult to get permission for oil & gas exploration in new fields. Norms relating to taxation are complex and there are several other restrictions due to the environmental concerns. Also given the current economic situation and fear of recession, these big giants are better equipped to handle the crisis then other small companies. Thus, all these factors make the threat of new entrants very difficult. Competitive Rivalry – Energy industry is characterized by large scale operations, high fixed costs and high exit barriers for the players in the industry. As the world energy demand is increasing there is a need to find new sources of energy leading to increased rivalry among the major players like Saudi Aramco, Royal Dutch Shell, Exxon Mobil etc. As most of the companies have similar nature of operations there was a need of geographical and / or product diversification. Saudi Aramco has successfully created a monopoly in the Saudi Arabian energy sector. Exxon Mobil has taken the route of diversification and has ventured into refining and marketing of oil and gas. They have further invested in electricity generation and production of commodity petrochemicals to reduce their exposure on only one particular sector.
  30. 30. 29 Bargaining power of buyers – As discussed before, the energy sector has several subsectors and due to highly integrated nature of the large companies, they act as both buyers and players in the different sectors. Due to their large size and capacities the oil companies have significant power over their buyers. Also, the fact that oil, gas, coal and other commodities are in demand and strategically important to its users weakens the bargaining power of buyers. On the other hand some of the factors increase the bargaining power of buyers. Some of the institutional organizations tend to buy oil and gas in huge quantities and hence they are able to secure good discounts. Lack of brand loyalty and low product differentiation leads to increased bargaining power for institutional organizations. Crude oil & natural gas prices are regulated through mercantile exchanges throughout the world giving more options to buyers. The major buyers in this sector are electricity generators that look for sources to produce electricity at a lower cost. Such companies also have large size and huge financial muscle and command high bargaining power. If the same quality of coal is available at a cheaper price and other conditions remaining the same they would easily switch to a new supplier. Bargaining power of suppliers - As far as the equipment suppliers and service providers are concerned some of the major players are Halliburton, Schlumberger, Smith International, Baker Hughes and others. They are mainly the suppliers to the type -1 companies. This sector of the energy industry is characterized by highly specialized equipments, few suppliers and economies of scale and hence giving a considerable bargaining power to the suppliers. The companies mentioned are highly diversified and have huge product portfolios giving them a vantage point in the buyer supplier relationship. Baker Hughes as an example caters to most of the big companies of the oil and natural gas sector with its huge product portfolio. Apart from selling equipments it

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