PPPs in Saudi Arabia – bright opportunities or challenges ahead?

Publication | June 2016

Introduction

The economy is becoming increasingly challenging for many countries in the GCC. A low oil price environment has hastened the transition to new fiscal management policies. As part of this trend, Saudi Arabia has recently indicated that it will look to public private partnership (PPP) as a means to satisfy its immediate energy and infrastructure requirements.

With one full PPP project already completed (which you can read more about here) and increasing commitment to diversify Saudi’s economy, it is generally recognised that, as a jurisdiction, the right conditions exist for the development of a dynamic PPP market. Moreover, being the largest country by population and area in the GCC, and the fifth-largest state in Asia, the investment opportunity in Saudi Arabia is immense.

For the purposes of this article, by PPP, we are referring to a long-term contract between a private party and a government entity in relation to the provision of a public asset or service, in which the private party finances, constructs and operates the asset and also bears significant risk and management responsibility, and remuneration is linked to performance.

A new vision

On 25 April 2016, the Deputy Crown Prince, Mohammed bin Salman, released the Kingdom’s plan for the ‘2030 Vision’ which aims to achieve bold economic growth goals based on the principle of increased self-reliance and a diversified economy. The plan deals with, amongst other issues, the reduction of subsidies, the possible introduction of taxation and the strengthening of supply chain capabilities domestically. Such radical moves are guaranteed to bring opportunities for long-term foreign investment in the Kingdom.

In a recent interview with Bloomberg, the Deputy Crown Prince is also said to be ‘championing the private sector’ and the Government is reported to have engaged in the process of identifying projects suitable for PPP procurement. Following the successful completion of the Madinah Airport PPP project in Saudi Arabia (one of the first of its type in Saudi Arabia), and with new PPP projects in the rest of GCC tendered almost every week, there is an abundance of precedent models for PPP structures in the region.

Co-operation between the public and private sector in the energy and infrastructure sectors is not, however, a new phenomenon in Saudi Arabia. There have already been a number of successful build-own-operate and build-own-transfer projects in the Kingdom, mainly in the power and water sectors. Moreover, sectors such as wastewater and metro and similar mass transit projects have utilised or plan to utilise private sector maintenance and operations. There is also the successful Madinah Airport PPP project which achieved financial close in 2012 – the 25 year concession was the first full public private partnership (PPP) project in Saudi Arabia.

Challenges of PPP

Although there is clearly senior policy appetite for foreign investment, PPPs and privatisation, the framework for large-scale PPP projects in the Kingdom is yet to be developed. Save for the Madinah Airport PPP project which reached financial close in 2012, to date, Saudi Arabia has almost exclusively relied on traditional procurement when procuring large infrastructure projects.

To fully implement PPP-style procurement will require careful consideration of some key bankability issues, such as the legislative and regulatory framework (including in relation to foreign investment) and the creditworthiness of the procuring authority.

PPP procurement would, however, allow Saudi Arabia to benefit from access to private sector finance while maintaining control of project cost, quality and standards. Public sector control is expected to be a critical feature of the developing PPP model in the Kingdom, as it is (to a greater or lesser extent) in all regional models. As in other emerging PPP markets, international sponsors may experience frustration with issues such as inflexible specification requirements (typically driven by traditional procurement methodology) and stringent oversight of construction, testing and operational issues.

It is also expected that Shari'ah-compliant PPP structures, such as a design, finance, build, lease and transfer model will be a key requirement. International sponsors and lenders will need to develop quickly a comprehensive understanding of these models (which are unusual in most developed markets) and their strengths and weaknesses. Moreover, in sectors like airports which are considered strategic national assets, traditional Islamic finance structure models (such as the ‘procurement model’) may not be appropriate due to issues related to ownership of strategic national assets and innovative models will need to be developed and tested.

All PPP projects in Saudi Arabia will need to be financed, constructed and operated pursuant to the principles of Saudi law. Many international sponsors and lenders have become comfortable with such laws. However, an expanded PPP program will necessarily involve sponsors, contractors and lenders who may not have prior experience with the Saudi legal and judicial framework.

Obtaining and maintaining government approvals, and compliance with licensing, employment, tender and procurement laws have historically been a costly and time consuming part of doing business in the Kingdom. These issues together with issues concerning enforceability of key protections will have to be addressed in order to develop a scalable and robust PPP structure. Experience suggests that, in the absence of an empowered PPP unit to facilitate and manage the different processes, these issues are capable of causing frustrating delays in the procurement, financing and development of PPP projects in Saudi Arabia.

Finally, while adopting a legal PPP framework would be consistent with Saudi’s bold objectives, no plans to implement legislative reform have yet been announced. New laws and regulations dealing specifically with PPP procurement are not essential. However, sponsors and lenders may, in light of some of the challenges referred to above, consider the introduction such legal infrastructure as a welcome and positive step.

Conclusion

PPPs in Saudi Arabia are currently the talk of the town. There are, however, challenges ahead. Saudi Arabia’s historic commitment to the traditional procurement route is deep-rooted, and adopting a full PPP model will represent a significant change. Low oil prices and the increasing focus on vigilant fiscal management policies are expected to be the key drivers for the development of a sustainable and robust PPP market in Saudi Arabia. The investment opportunities in Saudi Arabia are immense and both international and regional sponsors and their lenders are likely to succeed with the right advice and strategy.


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John Boehm Jr.

John Boehm Jr.

Dubai Houston Riyadh