Banning Exports of Cement in Saudi Arabia - Assignment Example

Banning Exports of Cement in Saudi Arabia Introduction Amongst the GCC states, Saudi Arabia ranks as the leading producer of cement. This is however, a far cry from the rising cement and building materials shortages that reached a peak in 2008. In response, the government imposed a ban on cement exports from the country. The ban was partially lifted in 2009 following further discussions and considerations between the ministry officials and stakeholders in the local building and construction industry. However, in 2012 the Ministry of Commerce revoked the partial uplift on the ban leading to a halt in the export of cement and total ban on importation of the same. This ban in led to a 58 percent slump in the cement index and reduced profits for most cement producing companies. The decision by the Saudi government to stop and ban the exportation of cement was prompted by the soaring domestic prices of building and construction materials. In the subsequent discussion, we will attempt to identify and explain the cause(s) of such a shortage, and factor(s) leading to the imposition of the ban. In addition, we will assess the reasons for its partial uplift and subsequent reinstatement, how the government’s actions translate to monopolistic behavior. Finally, we will analyze the impact, and effectiveness of the monopolistic strategy on the economy and in particular in relation to the country’s projected economic growth. Discussion and analysis Despite being the highest producer of cement among GCC countries, Saudi Arabia has recently been experiencing cement shortages. This is because the manufacturing companies export most of their products to international market to fetch higher prices. The exportation of cements has grown steadily between 2004 and 2007. In 2006, the cement export volume was quoted as 2.26 million tones. Total production over the same period was estimated at 33.1 million tones against a local consumption level of 31.2 million tones. This translates to a shortage of approximately 0.36 million tones locally. Figure 1: Trends in cement export from Saudi Arabia Source: El-Quqa, O, Hasa, F, Desai, A, Rout, B & Gupta, S 2007, p.8 The table below provides the total production of clicker and cement as between regions in the Kingdom in 2006.. Table 1. Regional actual production of cement and clinker Source: El-Quqa, O, Hasa, F, Desai, A, Rout, B & Gupta, S 2007, p.7 These statistics show the total production of cement in Saudi Arabia was 33.1 million tons in 2006. However, the total consumption of cement in the same year was about 31.2 million tones (El-Quqa, Hasa, Desai, Rout & Gupta 2007, p. 9). Comparing the above statistics, it is evident that there has been a shortage of cement in the local market. Since this trend has continued, the government responded by banning exports of cement to alleviate the shortage in the local market. In 2009, the ban was partially lifted following an upsurge in demand in the Middle Eastern countries. Other factor was the continued fall in country’s GDP growth rate projections for the past 2 years forcing the adjustment on foreign trade policies to boost the balance of payments. The ban has had little effect on the cement manufacturers. According to Jimaa (2011), cement sales in the Saudi Arabian market (local market) had grown from “3.61 million tons to 4.61 million tons between April 2010 and April 2011” despite the 2009 export ban (p. 2). In 2011, domestic demand for cement in Saudi Arabia rose to 48 million tons, and Economists predict that the demand is likely to rise to more than 50 million tons by 2013. Based on the increasing construction projects currently taking place in Saudi Arabia, economists have predicted growth in demand throughout this year (2012). This means that companies will have sufficient demand in the local market. Therefore, the government ban on exports will not affect the sales for the companies. The figure below shows forecasts for demand in cement since 2007. It is evident that the demand has been increasing gradually throughout the years. Economists predict similar trend between 2011 and 2013. This implies that sales per company shall increase within the local market now that the government has banned the export of cement. Figure 2: Trends in cement demand Source: Hasan, K, Karman, H, Faruqui, U& Alyaqout, T 2011, p.15 Thererfore, the inference is that the current ban on export and high levy on cement imports by the government will not affect the performance of the cement manufacturers in Saudi Arabia. Saudi Arabia has been experiencing growing economy since 2010. The average growth in GDP of the Kingdom is about 6.8% for the last four or so years. Construction industry accounts for more than 8% of the Saudi’s economic growth. In fact, it has the “… largest construction market is in Middle East” (Al-Nagadi 2008, p. 104). As illustrated by the figure below, economists predict an increasing GDP throughout this year. Figure 3: Trends in GDP of Saudi Arabia Source: El-Quqa, O, Hasa, F, Desai, A, Rout, B & Gupta, S 2007, p.4 Arab News (2012) interprets that growth in the economy will result to investment into housing and other infrastructure such as roads and hospitals both at private and public levels (p. 110). This means that domestic demand for cement will rise; the sales and hence the performance of these firms in Saudi Arabia will not be affected by the government decision. Furthermore, the increasing population in the Kingdom provides a bright future for the cement firms. Since 2010, the Kingdom has recorded high rate of population growth. It has a growth rate of about 2.4%. The population has grown from 27.6 Million people to about 29 Million in 2011. Analysts project that by 2025 the population will grow to more than 40 million people. Population growth increases strain on thee available infrastructure and therefore necessitates more investment into construction. The government decision to levy high taxes on cement import means reduction in supply. According to theory of monopoly and law of demand/supply, reduction in supply increases price. Therefore, local firms will sell their cement at higher prices and achieve equal profits they used to realize before the ban. A monopoly is defined as one having the exclusive control of a commodity or service in a particular market, or a control that makes possible the manipulation of prices. In other words, a monopoly is the presence of only one firm within an industry. The power that a monopoly firm possesses will always depend on the existence of comparable substitutes produced by rival industries and the barriers to entry, which the monopolist is able to create. The current ban limits licensed exports to 10% of the reserves held by a producer, a 10 riyal per bag ex-facto price and high tax on cement imports. In effect, the government is behaving monopolistically by creating barriers to entry of the local market by other firms. Reasons for the export ban include: 1. To match growing demand in the local market especially with multibillion, dollar infrastructure projects underway e.g. Dubailand project quoted at $5B. 2. To ensure price stability over the commodity locally 3. To ensure there is enough supply. The government’s strategy is one designed to create efficiency and legislative monopoly in the industry. Legislative monopoly is achieved through the Ministry of Commerce’s limit on the quantity exported, the pricing, and the tax levy on imports. This reduces the competition level between local manufacturers ensuring that each firm best meets its quota of local market demand. Efficiency monopoly is established in view of the diminished cost of production. Cement production is highly energy dependent amounting to 30-40% of total production costs. Saudi Arabia is the world’s largest oil producer resulting into relatively low fuel prices, consequently lowering the marginal cost for these firms. Barriers to Entry A barrier to entry is a restriction or impediment, which works to exclude new firms from entry into a particular market. Such barriers may be economic, social, or even politically motivated. For example, a government can create a monopoly over an industry that it wants to control by placing restrictions on trading terms or supply. Another way a government may create a monopoly is by holding the exclusive rights to some natural resource. Such is the case in the Saudi Arabia, the world’s largest oil producer, where the government has sole control over the oil industry, which accounts for approximately 45% of the Kingdom’s Gross National Product. In recent years, the Saudi Government has looked to an economic growth strategy of diversification to reduce its economic dependence on oil and as such, has targeted the cement industry. In order to implement this growth strategy and create a monopoly, the Saudi government has created several barriers to entry. Sloman and Jones (2011, p122) considers several forms of monopolistic entry barriers; two of which are particularly relevant to the situation in Saudi Arabia. These are discussed and analyzed below. Ownership of, or control over, key inputs or outlets Generally, where a firm governs the supply of vital inputs it can deny access to these inputs to potential rivals. Cement production is one of the most energy intensive operations in the world accounting for 30-40% of total productions costs. As mentioned previously, Saudi Arabia is the largest oil manufacturer in the world; this results in relatively low fuel prices and translates into a major competitive advantage for cement producers on the world. It also resulted in a cement shortage in the local market when in 2008; domestic prices soared due to companies exporting large quantities of cement in order to take advantage of higher profits. In response to this, on 18 February 2012 the Saudi government implemented a total ban on cement exports in order to meet the demands of the local market where multi-billion infrastructure projects are currently underway, have sufficient home supply and, to stabilize local prices. In this case, the Saudi government is the firm who, through the introduction of an export ban, has gained controlled over local cement suppliers, and created a barrier to entry, by denying foreign buyers access to lower priced cement. Legal protection A firm’s monopoly may be safeguarded by some form of legal protection. A clear example of how the Saudi government has created a barrier to entry to protect its monopoly is through the creation of legal impediments. Due to the local cement shortage in 2008, the Saudi government initially responded by placing a trade restriction on cement exports. From May 2009, cement makers in Saudi Arabia were only allowed to export up 10 percent of their cement reserves if they held a Ministry of Commerce issued license. As mentioned above, in recent weeks an extreme version of legal protection in the form of a complete ban on exports was implemented; again, this keeps supply of a necessary raw material (cement) from consumers such as rival nations and foreign companies. Advantages to the Firm The advantage to the firm is guaranteed low cost and abundant raw material (cement) to meet its political agenda i.e. “to build homes and create jobs and to stave off regional protests that toppled leaders in Tunisia and Egypt and sparked an armed rebellion in Libya” (Businessweek.com) This monopoly puts Saudi Arabia in a stronger economic position in relation to comparable nations who also demand large quantities of cement for essential infrastructure projects (as well as the resultant economic benefits such as low unemployment), but do not enjoy the control of low cost supply. Measuring effectiveness of the strategy Guaranteed supply of cement offers a boost to the intense construction projects undergoing in Saudi Arabia. A shortage means delays; delays translate to monetary losses i.e. operational costs to the construction firms and lost revenue to a government keen on changing the country’s GDP base from oil-dependency to tourism and cultural dependency according to forecasted depletion of oil reserves within the next 50 years. The ban has had little effect on local cement manufacturers. According to Jimaa (2011), cement sales in Saudi Arabia has increased by 1 million tones in 1998-1999. It is expected that this demand will grow to over 50 million tones by 2013. This means that the local demand would be large enough to meet the production over the same period. Conclusion Lasting monopolies are those sustained through government policies. With the GDP growth rate in Saudi Arabia projected at an average of 6.8% over the past 4 years and in view of the immense expenditure on infrastructure alongside the anticipated population, growth of 2.4% the demand for cement in the building and construction industry seems secure-for the moment. The change in foreign trade policy serves to guarantee this position in accordance with the country’s growth objectives. Therefore, we can conclude that Saudi Arabia has been able to strengthen its economic power in two ways: being one of the largest oil producers and through complete ban of cement boosting its local markets. Saudi Arabia has been able to thrive in doing this through establishing impediments like increased taxes on exports. This has enabled other growing sectors like construction sector to stabilize simply because the local production and consumption of cement creates easy access and enough supply. With all these in place, many construction projects have been commenced and commissioned. This in turn has led to the rapid growth of this economy. In addition to that, it is one of the largest oil producing economy. With this monopoly that the government has over industries engaged in production of cement, they are able to compensate on subsidies from the sale of oil. By doing this, the government ensures that all projects in Saudi Arabia are done with the required speed and period. This move has also led to creation of employment; increased demand for this commodity has led to increased production, which requires increased labor. It is therefore recommended that Saudi Arabia should continue with the complete ban and impose more impediments like making it illegal to export cement. Another recommendation is that the government should subsidize prices of cement for the local consumers. The government should reduce the taxes on production of cement. Bibliography Al-Nagadi, M 2008, ‘Saudi Arabia-Concrete construction industry-Cement based materials and civil infrastructure (CBM & CI)’, Presented at CBM-CI International workshop, Karachi, Pakistan, 2008, viewed 21 February 2012, http://enpub.fulton.asu.edu/cement/cbm_CI/CBMI_Separate_Articles/Article%2010.pdf Arab News 2012, ‘Export ban on cement enforced rigorously’, 20 February, p. 3, viewed 20 February 2012, http://arabnews.com/saudiarabia/article577722.ece El-Quqa, O, Hasa, F, Desai, A, Rout, B & Gupta, S 2007, ‘Saudi Arabia Cement sector’, Global Research, pp. 1-82. Hasan, K, Karman, H, Faruqui, U& Alyaqout, T 2011, ‘GCC Cement sector quarterly-3Q11’, Global Research Sector, pp. 1-19. Viewed 21 February 2012, http://www.globalinv.net/research/GCC-Cement-Sector-Quarterly-3Q2011.pdf Jimaa, R 2011, ‘Export has little effect on KSA cement firms’, Construction Week Online.com, http://www.constructionweekonline.com/article-13370-export-ban-has-little-effect-on-ksa-cement-firms/ Read More