Wednesday, November 18, 2015

Saudi Arabia's Airports to be Privatized to Lower Budget Pressures

* Privatization of Saudi Arabia airports will reduce budget requirements over the next several years

* Over the next decade it two it could make a difference because of economic diversification, but not in the near term

* Vulnerability of Saudi Arabia to low price of oil

The cost of engaging in a long-term battle for oil market share is starting to weigh more on Saudi Arabia, which has drawn down reserves and borrowed in order to maintain most of its budget requirements because of falling revenue. Consequently, it has also had its credit rating lowered
by Standard and Poor's.

That will likely continue to be detrimental to the country as it has plans to increase it debt by issuing of billions more in bonds, which will probably result in more credit rating cuts, resulting in higher costs of doing business.

Saudi Arabia, at best, has about 5 years of reserves left, standing today at about $647 billion. Its budget deficit is now at about $100 billion a year.

Among the steps taken to slow down the process is to drop proposed projects, eliminate non-essential one's, and find ways to lower dependence on government largesse, which is about 90 percent dependent on the energy sector to drive revenue. The low price of oil is of course the negative catalyst driving the challenge.

Recently it was announced Saudi Arabia is going to privatize its airports in order to allow it to be freed from having to prop them up.

Airport strategy

Most Saudi cities of any decent size of a domestic airport in them, but the bulk of the value of privatization will be at its three international airports located in Riyadh, Dammam and Jeddah. The goal is to have all airports in the country privatized by 2020.

The project is scheduled to be launched in the first quarter of 2016, starting with the key international airport located at Riyadh. Once that is completed, all remaining airports will go private.

All the privatized airports and associated services will be managed by the Saudi Civil Aviation Company Holding, according to Business Times.

Some believe this is aimed at economic diversification. I don't. I see it as budgetary diversification, meaning it's cutting budgetary costs to reduce pressure on its reserves over time.

Value of the action

Saudi Arabia without a doubt knows the days of oil above $100 per barrel are over. It may even be making decisions on it struggling to reach $80 per barrel over the next five years. There is no way it can continue to afford the types of perks and subsidies its people have gotten used to, so it must take steps to reduce costs.

This is important to understand because it could be viewed as a growth mechanism if it is believe it's a move to diversify the economy, rather than to lower the budget.

That doesn't mean there won't be added value once the privatization takes place. In doing research over the years concerning the difference in performance of state-owned companies versus privately-owned companies, the private companies have always outperformed the state-owned companies. A good example of that is the Mexican oil industry.

What this should do is reduce the budgetary requirements over the next several years, as the airports start to compete on their own. This very well could be a benefit for the economy, as the increased efficiencies and customer satisfaction could boost revenue and earnings, and result in more hiring.

In my opinion that's not the reason for the move though. It's driven by the numerous risks associated with declining oil revenue. 

Saudi vulnerability to oil and oil prices

With about 90 percent of revenue coming from oil, the risk to Saudi Arabia is obvious. The current price war shows how quickly even this energy giant, which has the largest oil reserves in the world, can be taken down.

It's not taken down yet, but we now know it only has at most about a five-year time period to solve its problems under a low-cost oil environment.

That five-year period is subject to understanding it must take action long before that. Five years is how long it has before running out of reserves. It can't wait that long to deal with it, and it isn't.

Saudi Arabia basically makes the decisions on behalf of OPEC, and controls the economic fate of the Middle East members. There is risk there because it refused to give up market share, which has been putting enormous pressure on about half of the OPEC members, several of which are located in the region.

Even though Saudi Arabia has some time to respond to the issues, the other countries in the Middle East don't. If the result is unrest, the Middle East could go up in flames; far worse than we're seeing now with the ongoing wars there.

This has historically turned in to a contagion spreading across the region, which could easily appear in Saudi Arabia. On top of this Saudi Arabia is underwriting some of the wars against ISIS in different countries.

There are more risks, but you get point, which is the low price of oil, which will remain subdued, will only magnify these challenges until a decision is made or agreed upon to slow down production in order to support the price of oil.


I don't believe investors should consider this an attempt at economic diversification. After all, a publicly run airport still sends a passenger out on a plane in the same way a privately run airport would.

There will be some savings and possible an increase in revenue and earnings from the private airports, but that will be only a small part of the revenue the country takes in, and will have little effect on the reserves.

This is a cost-cutting move to remove some of the pressures on the budget of Saudi Arabia, to work in conjunction with the stoppage of projects it had in its pipeline, and the removal of those services that aren't considered of major importance to its people.

A lot further down the road this could be very important and productive, but over the next several years the value will primarily in reducing costs so its revenue can target those services considered essential to maintaining order in the country.

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