Catalysing Diversification: Private Equity and the GCC

The remarkable growth of the industry in the GCC in recent years, which has propelled it to global prominence, means that addressing this information deficit is becoming increasingly critical.

The necessity of economic diversification – or creating an economy which does not depend on a limited range of sectors – is widely recognised as the greatest long-term challenge facing the region. Our view is that a tripartite framework – maximising, transforming and creating businesses – is an original and vital way of thinking about diversification, and that the unrivalled expertise of private equity in these areas means that it can function as a genuine catalyst for GCC economic maturity.

The reliance of the GCC region on fossil fuels is one of the great accepted truths in macro-economics – and, like most clichés, it has an element of truth. At present, the hydrocarbon sectors form a central pillar of the overall GCC economy – more specifically, oil and gas currently represent approximately 73% of total export earnings, 63% of government revenues and 41% of gross domestic product (GDP). Such a situation appears to be realistically sustainable, at least in the medium term, due to the confluence of several factors:

i.) The four GCC OPEC states enjoy proven crude oil reserves of around 480 billion barrels, and natural gas reserves of 41 trillion cubic metres;

ii.) Global demand for oil and gas is projected to be more than 50% higher in 2030 than at present, with China and India accounting for 45% of this increase; and

iii.) Consistently high energy prices will push total GCC oil revenues to approximately five trillion dollars over the next 25 years.

This is unsustainable in the long term due to two factors:

i.) Hydrocarbons are finite resources with an obvious extraction lifecycle; and

ii.) The GCC faces a socio-demographic challenge impossible to resolve through a hydrocarbon-focused economy. The population of the MENA region is the world’s fastest-growing and will double in the next 50 years, with Bahrain seeing a 56% population increase, Kuwait 84%, Oman 42%, Qatar 55%, Saudi Arabia 80%, and the United Arab Emirates predicted 90%. These new populations are remarkably youthful, and will require 90 million jobs to be created across the region. The hydrocarbon sector, which currently employs only 3% of the GCC workforce, is unable to meet these demands – and future socio-political stability is jeopardised as a result.

GCC private equity is also growing rapidly. In 2007, the total amount raised in the region was $6 billion, compared to $2.4 billion in 2005, giving an average fund size raised of $274 million, up from $204 million in 2005. Venture capital, although still in its infancy, is also on the rise. Private equity and venture capital, by their very nature, are optimally positioned to support the GCC economies in their moves towards diversification.

Level One – MAXIMISE

The first stage of GCC diversification consists of creating a platform, composed of two components, on which a mature economy can be constructed. These components are energy (Part One) and infrastructure (Part Two). Economies need to grow to a certain level before they can be diversified, and sustaining current economic growth is conditional upon full development of these sectors. This will require investment of at least $500 billion for energy and $700 billion for infrastructure, and private equity involvement encompassing project finance, business structuring and M&A expertise, and world-class technical and managerial competencies. GCC governments are already devolving significant responsibilities to investors and explicitly factoring their involvement into regional energy and infrastructure development strategies.


Economies are truly successful in the long term to the extent that they are built on comparative advantage. The central question is not which GCC industries become more feasible or profitable as a result of energy and infrastructure development, but which offer a global comparative advantage and can meet the employment and market needs of the region.

The comparative advantages of the GCC include i.) Low energy input costs; ii.) Substantial natural resources; iii.) Access to global distribution channels; iv.) Expanding and liquid domestic consumer markets; and v.) Incentivising government policies.

The sectors which should be developed as a result include i.) Steel and aluminium; ii.) Mining and natural resources; iii.) Petrochemicals; iv.) Industry and manufacturing; and v.) Free zones and economic cities.

These industries do not require creating from scratch. All have so far failed to build fully on their natural advantages and respond in the most economically meaningful fashion to demand. Such a failure means that these industries are still not in a position to assume their rightful share of meeting socio-economic demands, and are inhibiting the development of a mature economy. The momentum for change is increased by a more competitive, post-WTO operating environment in which growth is necessary even to maintain a consistent market share. GCC economic diversification has thus far been fundamentally misunderstood as requiring creation – whereas what is needed is growth and transformation.

Private equity investors bring unrivalled expertise in transforming comparative advantage into growth and industry leadership, and can therefore function as a genuine catalyst for diversification. This follows from the very nature of private equity itself, which seeks to create business value to a point at which a profitable exit becomes feasible. Given the necessity of GCC businesses embracing transformation as an essential strategic device, the value-add of private equity becomes increasingly apparent. Whether through M&A or more organic growth, the market knowledge, global matrices of partners and strategic relationships, structural optimisation focus and unrivalled human capital of private equity are all essential in creating the critical mass required for long-term competitiveness.

The opportunity has hitherto been understated. Amidst the discussion about how non-oil GCC industries are necessary, the real possibility that these industries could actually become global leaders has been comparatively unarticulated. With proper guidance and support, parts of the GCC economy have the dynamics and characteristics of real industry champions.

GCC economic diversification is, in essence, a case of shifting priorities properly. The long-term effect of private equity arranging and shaping the elements of competitiveness in GCC businesses will be to effect a similar transformation in the economy as a whole.

Level Three – CREATE

The final level of the diversification architecture is a knowledge economy. This allows the creation of new comparative advantages which are difficult to replicate and therefore function as ultimate economic differentiators. Private equity has a vital role in establishing four factors identified by the World Bank as essential to the development of such an economy.

Factor I – Education. Education in the GCC is a revenue-generating and demographically-driven sector. Educational investment, especially at university level, allows private equity to stimulate activity in industries of interest, encourage start-up activity, improve future management pools, and address the current disconnect between educational priorities and the actual needs of GCC economies. Job creation is only part of the GCC challenge – employee creation is an equally urgent task.

Factors II & III – Government Policy & Information Infrastructure. Despite reforms, a fully competitive GCC business environment has yet to be created. Social concerns may also limit the circulation of information and the optimal functioning of a true knowledge economy. The deepening relationships between private equity and governments, and ongoing infrastructure privatisations, may have a positive influence.

Factor IV – Innovation. Creating an innovation-orientated culture is the biggest challenge. The GCC consumes technology rather than creates it. The combined total of 200 patents held by the six GCC nations is insignificant. A risk-averse culture which focuses on wealth preservation is not conducive to innovative activity. The private sector is already functioning as a primary source of innovation in the GCC, and private equity – through its more specialised venture capital form – offers the tools to support early-stage technology companies. Private equity, due to its need to deliver tangible returns, has a pronounced influence on the economic significance of patents and offers the growth through world-class governance, connectivity, transparency and efficiency which will be essential if these businesses are to take their place in a diversified economy. This success will also enable a progressive, visible precedent to be set and break down some of the cultural barriers to innovation.

The efforts of private equity must run in parallel to the public sector. The ideal government role may well be as a facilitator of innovation, rather than the sole instrument through which it is attempted. Governments and private equity should engage in a sustained co-operative effort, rather than a competitive dynamic, through which these four factors can be laid down and the GCC can emerge as a fully diversified economic power.

The whole diversification process represents the biggest challenge to the GCC nations in their history. GCC economic and demographic growth, approached in the correct fashion, offers a unique opportunity – whilst there may never be another chance to effect transformation, there may also never be a better time. The GCC can be globally competitive across numerous sectors – given a radical engagement with private equity and venture capital.