The offsets program in the United Arab Emirates.

The offsets program in the United Arab Emirates. Middle East Policy - January 1, 1997 Amin Badr El-Din

The mission of the UAE offsets program is to create wealth-generating opportunities for the private sector. In the 1960s, industrial-cooperation mechanisms were introduced between industrialized and developing countries in order to allow the developing country to recoup some of the economic benefits they were losing as a result of sizable and necessary public-sector expenditures on foreign products, services and advanced technology. Such mechanisms are. referred to as offsets.

Direct offsets are coproduction or buy-back agreements directly related to the procurement itself. Indirect offsets involve projects or ventures in industries different from that of the specific procurement, for example, when a supplier of aircraft undertakes to form a joint-venture in the buyer country to service power-plant turbines. Output-based offsets such as the UAE offsets program are tied to the financial gains made by joint-venture projects.

Offsets programs are usually applied within the context of an overall national economic strategy. For instance, most Southeast Asian countries require offsets in the form of technology transfers or licensing to encourage foreigners to develop an industrial base in those countries. In Western Europe, the emphasis is on maintaining the home industrial and employment base by entering into in-country, coproduction deals with the foreign seller. In the former communist-bloc countries, barter was used to save and acquire hard currency.

The UAE offsets program came about as a result of the modernizing of the UAE armed forces in the late 1980s. This called for the acquisition of sophisticated defense systems that used limited manpower. The considerable funding required for the procurement of modem weapons systems posed a dilemma to decision makers: Should spending on defense be undertaken et the expense of domestic wealth redistribution and the development of the county?

The UAE offsets program was devised to take advantage of stiff competition within the defense industry to achieve both ends, to restructure its armed forces and establish an offsets program consistent with the government's overall economic strategy. This strategy utilizes the positive attributes of the UAE--its geographic location, its infrastructure, its liquid capital markets and its vast oil and gas reserves to redistribute wealth to the citizens of the UAE, create added value for the economy, enhance competitiveness and encourage strategic alliances with multinational corporations.

The offsets obligation of foreign suppliers is determined to be 60 percent of the value of the procurement contract. In other words, by entering into profitable and sustainable joint ventures with members of the local private sector, the supplier will have to bring back to the UAE economy some sort of "value-added" worth 60 percent of the supply contract. By law, local interests must retain 51 percent of the capital of joint-ventures.

The UAE Offsets Group (UOG) does not favor a particular sector of the UAE economy. The program is characterized by a market-led approach that stimulates multinational corporations to seek business opportunities and local private-sector partners in a number of fields, from technology services to health care to solar energy to shipbuilding. As a result, a consistent "deal flow" of several hundred projects has been created. Fewer than 20 of them overlap, indicating that there are sufficient viable project opportunities in the local economy. In fact, as short-listed contending suppliers are awarded contracts, certain projects are implemented while others may be pursued by or with local partners outside the program. Furthermore, local participation is broadened by a number of private funds that invest in joint-venture projects.

An output-based formula related to profits generated by a joint-venture project and incorporating certain multipliers is used to calculate offset credits. The UOG's evaluation of each short-listed supplier's offsets proposals takes into account the value-added expected for the national economy, the amount the government needs to spend to generate comparable value- added, and the ability of the supplier to achieve what is proposed. This is used to help determine the effective cost of the proposal.

Offset requirements on civilian procurements are determined case by case. Suppliers that are short-listed for a particular procurement are required to enter into an offsets agreement with the UOG in anticipation of a final award of the contract. The offsets obligation does not become effective until a supplier has been awarded a contract. However, a number of suppliers choose to enter into projects prior to the awarding of a contract. These "pre-offsets" can later be qualified as offsets projects that generate credits. Offsets credits are bankable and transferable.

If a foreign supplier has signed a legally binding contract for a civilian procurement, they are also qualified as suppliers to the UAE armed forces. For UAE armed-forces procurements exceeding $10 million, foreign suppliers are required to undertake proposed offset projects within twelve months of signing the contract.

Offsets credits are awarded to the supplier regardless of whether the suppliers invest themselves or cause third parties to enter into the joint venture. This allows for the expansion of trade and for a greater variety of companies to enter into new markets. The period of performance of the offsets obligation is generally seven years with intermediate achievement milestones after three and five years. Failure to perform the specified amount of offsets obligation by each milestone will result in the application of cash damages worth 8.5 percent of the unfulfilled portion of the obligation.

Today the total offsets commitment in the UAE is in the range of several billion dollars. Since the inception of the program in the early 1990s, over 15 projects have been started. As in other developing economies, projects sometimes face delays due to red tape. In response, the UAE government is working to develop and clarify local business laws (including environmental legislation), create much-needed capital markets and possibly privatize certain sectors such as public utilities.

The UAE offsets program was first perceived as an anomaly because it was based on outputs rather than inputs and was actively resisted. However, today the UAE model is being emulated by several industrialized nations in Europe, Southeast Asia and Africa Moreover, by getting suppliers to become involved in local joint ventures, the program has caused a number of global corporations to gain a vested interest in the security and stability of the UAE.

The program is maturing. As the economy progresses, increasingly the local component of joint- venture projects will go public. This was the case with the Abu Dhabi Shipbuilding Company venture with Newport News Shipbuilding of the United States. Its shares were many times oversubscribed. This reinforces the offsets program's objective to redistribute wealth to UAE citizens and to diversify the economy.

THE ABU DHABI SHIP BUILDING COMPANY

A Pre-offset Project

The Abu Dhabi Ship Building Company (ADSB) was established with the primary purpose of creating sustainable economic growth for Abu Dhabi and the UAE. This new joint venture was created as a public company with investors made up of UAE nationals, the UAE government and Newport News Shipbuilding.

The UOG identified a ship repair and construction company in Abu Dhabi as an offset-project candidate, and in 1993 developed a Terms of Reference document (TOR) to solicit bids from international competitors to vie for establishing the company.

Newport News Shipbuilding is the largest privately owned shipyard in the United States. The company has more than 110 years of experience in the design, engineering, repair and construction of commercial and military ships. Newport News Shipbuilding began working in 1993 to formulate the venture that eventually became ADSB.

The Process

The UOG enlisted the services of a consultant to perform a survey of existing commercial ship inventories in the Abu Dhabi region. The survey included the names, sizes, ages, owners and other pertinent data relating to boats owned by and supporting industry and commerce in the geographical target region. The consultant also worked with the UOG to establish the TOR that would be the document of proposal requirements issued to qualified international shipyards for bidding purposes. Subsequently, the consultant visited potential international bidders to conduct prequalification interviews. Those companies that demonstrated understanding of the project and capability for success were issued the TOR and invited to participate in the competition. The TOR was issued to companies from several countries.

The tender process took several months and included the steps of careful evaluation of the offers before reaching the selection of the top candidates. The companies selected for the final round were invited to present their proposals and be interviewed before a panel of representatives from the UAE government, the UOG and the armed forces. In December 1994, the UOG announced that Newport News Shipbuilding had won the competition and was awarded the opportunity to work with the UAE to establish the Abu Dhabi Ship Building Company.

Newport News Shipbuilding first passed the prequalification process and then won the international competition over many respected competitors. Although Newport News Shipbuilding did not have an existing offset obligation, the company saw this venture as a good investment opportunity and a solid basis for a long-term business relationship in the UAE.

The Newport News Shipbuilding Approach

Newport News Shipbuilding took a logical and comprehensive approach to establishing a ship repair and construction facility in Abu Dhabi. First, Newport News Shipbuilding considered the objectives of the UAE: a profitable investment opportunity for local shareholders, low-cost major services at world-class quality standards, developing the capabilities of UAE nationals and the potential for technology transfer--all in the field of ship building and repair.

Then Newport News Shipbuilding began to identify what would make a private shipyard a profitable venture with sustainable financial growth in the UAE. The company undertook a thorough market analysis, using shipyard personnel and consultants, looking at the regional competition as well as market demands. The result of this analysis identified a market niche where there is an immediate as well as future need in construction and repair of certain types and sizes of ships in the Arabian Gulf region. At that time, it was determined that the specifics of the mission of ADSB should include the construction and repair of naval and commercial ships up to 8,000 tons, servicing, in large part, the UAE Navy and the oil sector.

Further research involved a visit to Abu Dhabi Dry Docks Company, a small shipyard in the Musaffah Industrial area, in order to determine what steps should be taken to create the right kind of company to meet the objectives of ADSB. It was decided that a ship lift and transfer system, machine shops, electrical shops, offices and living quarters were needed for ADSB to operate as a modern, expanded ship construction and repair facility.

Newport News Shipbuilding then identified the human resources that would be required to make this a successful venture, including a start-up management team from Newport News Shipbuilding. One of the key objectives of the venture is to develop a management team of UAE citizens who will lead the success of the company into the future. There are many qualified UAE nationals available to work with the Newport News Shipbuilding team and become future managers. In addition, skilled shipyard labor is available from several sources.

Technology transfer is an embedded clement of the program. Facilities modernization, management training and workforce productivity gains will all be the result of technology transfer. Since shipbuilding and repair is the core business of Newport News Shipbuilding, the company has the know-how to effectively transfer technology to benefit ADSB and fulfill the other obligations of the offsets program.

Dr. Badr-El-Din, chairman of the United Arab Emirates Offsets Group (UOG) in Abu Dhabi, is credited with establishing the UAE Offset Guidelines. He wishes to acknowledge the contributions to this article of William Clay Bell, president, and F. Eileen Burldow, director, of Newport News Global, which supports the international marketing and development of Newport News Shipbuilding.

Citation Details

Title: The offsets program in the United Arab Emirates. Author: Amin Badr El-Din Publication: Middle East Policy (Refereed) Date: January 1, 1997 Publisher: Middle East Policy Council Volume: v5 Issue: n1 Page: p120(4)