The New Middle East Oil Bonanza

Beyond the Dubai Ports deal: Where all those billions are going.


If the Burj Dubai development isn't the biggest project in the world, it must be close. At night under floodlights thousands of mostly Asian workers in hard hats swarm over a 500-acre building site in the heart of Dubai, the Persian Gulf emirate that is tiny in size but limitless in ambition. Emaar Properties, a local company, is carving out of the desert a new $20 billion district with 30,000 homes, a Giorgio Armani-designed hotel, an ice rink, and a 30-acre man-made lake.

The centerpiece of the project, which employs more than a dozen American firms, is Burj Dubai, a $1 billion tower. It was designed by Chicago architects Skidmore Owings & Merrill LLP, and its construction is being managed by New York-based Turner Construction Co. "We are moving up one floor a week, and we are now on the 31st floor," says Mohamed Ali Alabbar, Emaar's chairman. The exact planned height is shrouded in secrecy to foil competitors, but Alabbar promises that the luxury residential complex, more than 2,500 feet high, will be "40% taller than anything else."

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The world's tallest building? In Dubai? The city-state in the United Arab Emirates captured headlines in the U.S. recently when government-owned Dubai Ports World, through its purchase of Britain's Peninsular & Oriental Steam Navigation Co. for $6.8 billion, agreed to take over management of several major ports, from New York to Miami. The deal has sparked an outcry among politicians worried that an Arab-owned company could be a vehicle for al Qaeda operatives. The uproar has forced the company to delay its plans in the U.S.

The Dubai Ports deal, though, is just one relatively small episode in the second great Mideast oil boom. The boom is characterized by hugely ambitious projects that are transforming the shores of the Persian Gulf into a Xanadu with some of the most fantastic and expensive structures on earth. The rush of petrodollars is creating enormous private and public wealth and reshaping Gulf business and society.

All this is happening when the other Mideast -- of Iraq, radical Islam, and Palestinian-Israeli relations -- is wracked by violence and strife. That turmoil could certainly threaten the Gulf's prosperity. Just look at what happened in late February when al Qaeda fighters unsuccessfully attacked a key oil facility in Saudi Arabia. But for now the authoritarian regimes running the Gulf are seizing the opportunity to build new economies and satisfy their restive populations with a new level of affluence.

The tale of Mideast money is not just a local story, however. This year, with oil prices stuck in the $55-to-$65-per-barrel range, perhaps half a trillion dollars will land in OPEC coffers -- more than at any time since the boom of the 1970s and 1980s. The Mideast oil states alone will gather in $320 billion in oil and gas export revenues.

Where is that money going, how is it affecting the global economy, and what impact will the boom have on U.S. relations with the region? Those are crucial questions. The last oil boom, from 1973 to 1985, had dire consequences. The oil price spike created a lethal mix of inflation and slow growth worldwide. Arab states, unprepared for their newfound wealth, socked too much money away in U.S. Treasuries and a few international banks. The banks in turn lent the money to Latin American governments. In the end, these countries couldn't pay it back -- and instead triggered a debt crisis that shook the global financial system.

This time around the impact of money-flows from the Mideast does not appear quite so toxic. The oil exporters are spending much more at home on investment and consumption, helping to shore up global demand for goods, and balancing out the effect of their huge export earnings.

But Mideast money is definitely venturing abroad. For starters, a chunk of the billions is going to deals in the U.S., Europe, and Asia. Dubai Ports did not just cut a deal for P&O: It also bought the port operations of Florida's CSX Corp. (CSX ) for $1.2 billion. Last year, Dubai luxury hotel group Jumeirah bought the swanky Essex House in New York for an estimated $400 million. Dubai International Capital, the private-equity arm of Dubai Holding, the government's oil money depository, paid $1.5 billion for Madame Tussauds, the British wax museum, and an additional $1.2 billion for a 2% stake in DaimlerChrysler (DCX ). Mubadala Development Co. of Abu Dhabi acquired a 5% holding in Italian carmaker Ferrari (FIA ). In the biggest Mideast deal of all, Egyptian cellular operator Orascom Telecom Holding formed a consortium to buy Wind, a top Italian mobile network, for $13 billion. "These investors have an incentive to invest in assets outside the petroleum industry," says Thomas J. Barrack Jr. His Colony Capital LLC recently partnered with Saudi Prince Alwaleed bin Talal to buy the Toronto-based Fairmont Hotels & Resorts Inc. (FHR ) for $3.9 billion.

On the Hunt

The numbers involved in these deals are still small compared with the billions being spent in the region. Bankers in the Mideast, however, say both governments and family companies controlled by Gulf billionaires are becoming more adventurous. Beat Naegeli, the Dubai-based head of Credit Suisse Dubai (CSR ) private banking in the region, says big Arab investors, while still predominantly invested locally, are increasingly on the hunt for equity stakes in overseas companies and real estate deals in New York, London, and Paris. Many of these investors, he says, are currently expanding their private-equity positions rather than putting money into hedge funds -- a good way to diversify. Abu Dhabi and Dubai have multibillion-dollar funds that are scouting for equity investments abroad. "We will see more of that," says Brad D. Bourland, chief economist at Riyadh-based Samba Financial Group, a leading Saudi bank. "This is the tip of the iceberg."

Then there's the Mideast money flowing into U.S. Treasury securities and other passive investments. U.S. government data indicate that OPEC countries held only $67 billion in Treasuries as of December. Most of that was held by the Gulf states, but it's small compared with the giant holdings of China and Japan.

The official figures, though, probably underestimate the clout of Arab money in world capital markets. According to PFC Energy, an energy consultant in Washington, the Mideast oil states hold a cumulative $1 trillion in foreign assets -- stocks, bonds, government debt, real estate, and other investments. In fact, the money isn't easy to trace because unlike the oil boom of the 1970s, today's petrodollars aren't being parked in a few big American and European banks. Instead they are sprinkled around the world through an intricate network of private banks, funds, and offshore financial centers. "There's a distinct lack of hard information on where this money's going," says Mohsin S. Khan, director of the International Monetary Fund's Middle East and Central Asian department.

What's more, the Arab states are now major buyers of goods from Japan, China, and the rest of Asia, where they sell the bulk of their oil. So these petrodollars get recycled as Japanese yen or Chinese yuan -- which the Japanese and Chinese governments convert into U.S. Treasuries. Indirectly, then, oil money is bankrolling U.S. deficit spending. Paul Donovan, a global economist for UBS Investment Bank (UBS ) in London, estimates that petrodollars, mostly channeled through Asia and Europe, are funding up to 45% of the U.S. current account deficit.

While these billions circulate through the global money system, you only have to look around the Persian Gulf to see that huge amounts of oil wealth are staying in the region. Fueled by the oil boom, local stock markets have risen anywhere from over 200% to more than 1,000% in the past four years, despite current sharp corrections in Egypt and the United Arab Emirates. Imports from the U.S., Europe, and Asia are soaring.

Yet in contrast to the helter-skelter development of the 1970s, a new and better-planned Middle East economy is rising, shaped by a well-educated business class and powered by a youthful population seeking prosperity. "Look at the demographics of these nations," says Alabbar, 46, who graduated from Seattle University. "They all see what the outside world is all about, and they dream to live like that." Some 65% of Saudis, for example, are 24 years old or younger.

Another important difference: Governments in the region learned harsh lessons when they fell into dire financial straits during the lean period of low oil prices in the early 1990s. They began shifting economic policies to cut waste and make room for once-tiny private sectors to create jobs. Those moves created a healthy environment in which growth could catch fire once oil prices took off starting in 2000. In 2005 real gross domestic product grew a healthy 6.5% in Saudi Arabia, by far the most important economy in the region. "Improved confidence, fear of investing in the U.S. and Western Europe, and the massive amounts of private capital brought home have led to an unprecedented boom," says Fareed Mohamedi, chief economist at consultants PFC.

The region's governments have developed more careful spending strategies. The Saudi government, for instance, has been very conservative in its budgeting, assuming until this year that oil prices would return to $25 per barrel. Now, with $150 billion or so stashed away, Riyadh plans to increase its spending by 20% this year, to about $90 billion. Capital outlays are set to nearly triple, to $33 billion.

Planning Ahead

Much of this money is earmarked for long-term projects. They include a $50 billion, five-year program to build new roads, schools, and hospitals in rural areas; a $9 billion modernization of an oil refinery at Rabigh, with Japan's Sumitomo Corp.; and $14 billion for new production-capacity expansion at Saudi Aramco, the national oil company. "The number of megaprojects with five-year time frames is so big that it ought to sustain a lot of the private sector through this decade," says Samba's Bourland. He figures the private sector will record 8% growth this year, vs. 5% for the overall Saudi economy. In the UAE, private-sector growth has been hitting double digits.

Governments have smartened up in other ways. They are tailoring their infrastructure projects to attract clusters of similar businesses, which gain from being close together. Dubai has established Internet and Media Cities -- office parks wired for high-speed data transmission. Not to be outdone, the Saudis have brought in Emaar to develop a new $27 billion King Abdullah Economic City on the Red Sea coast north of Jeddah. The planners of the new metropolis envision a giant port, and manufacturing businesses including petrochemicals and pharmaceuticals. Some 30% of the equity in the project may be offered to investors on the stock exchange.

All this creates huge opportunities for U.S., European, and Asian companies. Dubai's Internet City has attracted the cream of technology companies such as Microsoft (MSFT ), Hewlett-Packard (HPQ ), and Cisco Systems (CSCO ). "This is a mini Silicon Valley," says Ghazi Atallah, Cisco's Dubai-based emerging-markets honcho. The Middle East represents Cisco's fastest-growing region, with double-digit annual revenue increases thanks to local telecom deregulation and the increasing sophistication of private businesses. Mideast companies are also buying a very high proportion of advanced technology like combined video streaming and data services. "In some cases [customers in the region] are leapfrogging Europe and the U.S.," Atallah adds.

Other international companies such as Fluor Corp. (FLR ) and Bechtel Group Inc. are likely to benefit from the frantic pace of construction, especially in the oil fields. Aircraft makers Boeing Co. (BA ) and Airbus are selling squadrons of planes in the region, which is seeing the rise of fast-growing carriers like Dubai's Emirates. That airline has an astonishing $37 billion worth of planes on order, including 45 of Airbus' new A380 -- the biggest order placed by any airline for the double-decker megaplane. And between them, Emirates and Qatar Airways have ordered 49 Boeing 777 jetliners. "The Middle East has become one of the three big reservoirs of aircraft sales in the world," along with China and India, says Habib Fekih, president of Airbus Middle East.

Meanwhile, Nabil A. Habayeb, Dubai-based President and CEO for the Middle East and Africa for General Electric Co. (GE ), says the company's orders for the region leaped by close to 80%, to $8 billion, from 2004 to 2005. Much of that is in big-ticket items like power-generation equipment and aircraft engines, as well as oil-, gas-, and water-treatment facilities. But state-of-the-art health-care equipment and even theme parks are in demand, too, says Habayeb: "The priorities are health care, education, and diversification away from an oil- and gas-based economy."

It's not just the big U.S. manufacturers that are benefiting. International investment bankers are being called in to raise capital for regional corporations interested in taking advantage of the red-hot markets. Saudi Arabia's Prince Alwaleed raised $397 million on Feb. 23 for his Kingdom Hotel Investments, which will be listed on the new Dubai International Financial Exchange and in London. "There is a big backlog of IPOs," says May Nasrallah, head of Middle East investment banking at Morgan Stanley (MS ) in London, which managed the Kingdom IPO. Among IPOs expected, according to bankers, are an offering by Alwaleed's main vehicle, Kingdom Holdings, and a listing of Showtime Arabia, a broadcaster partly owned by Viacom Inc. (VIA ).

Bankers say the deal flow could really pick up if governments start to sell off their still-considerable holdings. "If governments see the opportunity to tap into this pent-up demand for financial investments and transfer ownership of public entities as the British did [under Margaret Thatcher], I think that would be very good for the market," says Osama Abbasi, co-head of the European fixed income group at Credit Suisse First Boston.

Plenty could still go wrong. Despite all the private-sector growth, the economies of Saudi Arabia and the rest of the Gulf countries are nailed to oil. Oil and gas production is more than 50% of GDP in Qatar and Kuwait and 42% in Saudi Arabia, according to Credit Suisse. Overheating is also a concern, with investors borrowing money to chase local stocks and consumer debt growing to worrying levels in some of the Gulf countries.

The political problems around the region are far from solved. In the worst case, Iraq's troubles could spill over into conflicts between Sunni and Shiite Muslims around the region. How U.S.-Arab relations play out will also prove hugely influential in containing potential strife. The U.S. is on the receiving end of a lot of criticism now, mostly aimed at its conduct of the war in Iraq. Should the U.S. withdraw, though, the Gulf states might find themselves once again under pressure from their bigger, poorer neighbors, Iraq and Iran.

But if the Gulf regimes need the U.S., the opposite is just as true. America needs a stable source of oil for itself and the world, and U.S. companies dearly want to increase an already booming trade with the Mideast. The indirect but powerful role these oil states play in financing the U.S. deficit further enmeshes Washington's interests with the region's, no matter how contentious relations may get over America's foreign policy.

These factors increase the challenge Washington faces in encouraging reform. The authoritarian governments in the Gulf will have to change to keep pace with their wealthy, better-educated populations. They have a long way to go on improving opportunities for women, for instance. While more money in people's pockets buys time, the rulers are facing demands for greater accountability and wider political participation. Some business people even think that oil money could have negative consequences. With financial pressure off, governments may be more likely to delay privatization and other reforms.

Yet it doesn't look like this Gulf boom will fizzle anytime soon, since oil is in such demand. One possible scenario: As global interest rates rise with the recovery of Japan and Europe, worldwide competition for capital will heat up, and the well-heeled investors of the Mideast will become pivotal players in future deals. Oil money's role, then, could just get bigger.

By Stanley Reed, with Peter Coy, John Cady, and Diane Brady in New York, Christopher Palmeri in Los Angeles, and Carol Matlack in Paris

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