Saudi Aramco’s local content program is a game-changing approach

Nowadays, the issue of increasing local participation in major Saudi projects has assumed great importance. This approach did not come out of nowhere, but it has a renowned pedigree at Saudi Aramco.

In December 2015, the oil giant officially rolled out its In-Kingdom Total Value Added program, IK-TVA, for local and foreign contractors.

Although IK-TVA is specifically focused on Aramco’s energy-related procurement plans, the concept of an “in-Kingdom” localization emphasis is part of a much wider strategy to diversify the Kingdom’s economic base, create sustainable employment and reduce foreign reserve outflows. The successful implementation of Aramco’s IK-TVA program, as well as others planned and underway for the rest of the economy, especially in the high-value military manufacturing sector, can be a game changer if properly managed to the mutual benefit of both international contractors and the host country.

Saudi Arabia has made its objectives very explicit: Increase local content and create new jobs from current and planned projects. The choice is stark for international contractors: Join the Kingdom in fulfilling this “made in Saudi Arabia” vision or lose out on lucrative project awards. The rewards are tempting — for example, Saudi Aramco announced that $334 billion has been earmarked for its capital program expenditure for the period 2015-2025 during the IK-TVA launch, and it provided a detailed breakdown for an average year spend of $33 billion over the period, with a high level of transparency not often seen in the Gulf region.

The company also provided detailed project submission matrixes in how they will evaluate contractors’ compliance for more enhanced local content, the utilization of local material and supply chain partners and the quantity and quality of local job creation.

This has been a model for others to build upon. The mode of participation for foreign contractors was left open: Through wholly owned local manufacturing plants, through joint ventures or through technology transfer licensing to Saudi operators without compromising on quality or price competitiveness. But a national framework was needed.

To this end, Saudi Arabia finalized its long-awaited National Transformation Plan 2020 to be implemented over the next couple of years to help boost non-oil revenue and improve public sector efficiency beyond 2016.

Key elements included diversifying government revenue sources, including privatization of state assets such as Saudi Aramco’s downstream operations, the national airline, hospitals and the water sector, and introducing specific numerical targets to cap fiscal spending and debt accumulation over the next few years. Energy subsidy reforms, hitherto a taboo subject, has started as well as the introduction of value-added tax.

The NTP program has, at its heart, the establishment of “Key Performance Indicators,” hitherto an unknown phenomena for many government ministries but widely used by Saudi Aramco, to ensure goals are met, and the setting up of a dashboard for the Council of Economic Development Affairs to monitor these KPIs.

A central element in assessing KPIs would be local content and job creation. Aramco’s IK-TVA’s goals are set at 70 percent local content and the creation of an additional 500,000 new direct and indirect jobs from its own capital expenditure by 2020.

Given that around 1.8 million Saudis worked in the private sector in 2019, such an incremental job creation by Saudi Aramco alone would represent a significant increase to wean Saudis from public sector job preferences. It is not only in the energy sector that localization has been given a high priority, but also in other large expenditure government sectors such as procurements in the defense sector, where a targeted program has been introduced to increase local content.

Saudi Arabia’s local content program is laudable, but international contractors are only too well aware that not all such initiatives have fared well around the world, despite initial high optimism.

Over the years there have been many models for localization drives such as in Brazil, Angola, Norway, Mozambique and Nigeria. Brazil achieved a degree of rapid industrialization, R&D capacity building and workforce development but localization also led to significant delays in field development and production and, more crucially, to significantly increased cost. Hence Saudi Aramco’s caveat that increased local content objectives must not come at the expense of either quality or cost competitiveness.

Norway, on the other hand, has had a very successful local content program with requirements to establish local manufacturing, services and R&D emphasis, with spill-over into an export-led energy-related manufacturing base. Given the Saudi emphasis on AI and new technology, this will be an important element in local content partnership. Notably, Saudi Aramco’s new contractor evaluation matrix also assesses for local content export potential.

In the final analysis, the host government and institutions such as Saudi Aramco have to create an appropriate enabling climate for localization measures to succeed. These can include creating appropriate business ecosystems for local suppliers to participate, especially by fostering high-quality small and medium-sized enterprises, re-investment by local suppliers and the right FDI environment, improved logistics and transportation and a capable and technical educated labor force.

Above all, a synchronized strategic direction and focus is required that promotes a business-friendly environment that promotes and encourages international contractors to undertake local higher risk/higher value industries.

The Aramco IK-TVA program has set the stage for what can be realistically achieved across the wider economy.

• Dr. Mohamed Ramady is a former senior banker and Professor of Finance and Economics at the King Fahd University of Petroleum and Minerals, Dhahran.