from Follow the Money

Abu Dhabi wants to make airplanes ... and it has a sovereign fund available to help make it happen

August 7, 2008

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Airbus is looking to source more parts (and produce more) in the dollar zone. Selling a product denominated in dollars with a euro cost structure isn’t currently a recipe for enormous profits.

China is part of the dollar zone, for better or for worse. It will soon be making A320s.

So is Abu Dhabi, though it is quite hard to see why an oil-exporter with a huge external surplus like Abu Dhabi should be in the dollar zone. Being a part of the dollar zone is a big reason why inflation is very high (and probably far higher than reported) in the Emirates.

Abu Dhabi could easily import all the airplanes and airplane parts it wants. $100 billion in export revenues split among a small population produces a lot of buying power. Abu Dhabi’s native-born residents are far too wealthy to spend their time building planes. They prefer flying them ...

But Abu Dhabi aspires to do more than pump oil. And its proliferating sovereign funds have the resources to make most dreams come true. Or try too.

ADIA is Abu Dhabi’s best known fund, but it is far from alone. Over the past few years it has been joined by Mubadala, the Abu Dhabi Investment Council (a fund set up to manage ADIA’s regional investments) and perhaps Taqa (an ambitious state energy company that is investing in energy projects outside of the Gulf -- and in effect doubling down on Abu Dhabi’s energy exposure rather than diversifying away from it). Wayne Arnold writes:

There are at least eight Government-owned or Government-controlled institutions now investing sovereign funds on behalf of Abu Dhabi. Far from just trying to drive up short-term gains, most share the goal of securing the long-term prosperity of the emirate, whether by providing nest eggs for retirement, securing long-term supplies of food and energy, promoting the development of new industries that create skilled jobs and reduce Abu Dhabi’s dependence on oil, or just amassing endowments.

While ADIA may have a portfolio that looks rather like a pension fund or a university endowment, Mubadala is more of a "sovereign economic development fund." Its mandate goes beyond returns. It is also supposed to promote Abu Dhabi’s internal economic development.

Mubadala was, I think, set up in part to manage the "offsets" -- basically contracts to produce parts -- that came with the emirates purchases of military planes. Abu Dhabi’s ambitions to challenge Dubai in the airline business have made it a new force in civil aviation. Etihad is a big buyer of planes. Mubadala is willing to invest in parts production. Stefania Bianchi of the Wall Street Journal reported last week:

"Oil-rich Persian Gulf states, whose airlines have ordered billions of dollars worth of jetliners, now plan to leverage their financial clout into making parts for those planes.

As Airbus, Boeing Co. and General Electric Co. struggle with soaring oil prices, slowing economies and squeezed delivery dates, multibillion-dollar aircraft orders from airlines in Abu Dhabi and Dubai, in the United Arab Emirates, provide much-needed investment, cheap labor and state-of-the-art facilities ...

Mubadala, which owns aviation maintenance, repair and overhaul firm Abu Dhabi Aircraft Technologies, in a statement said it wants to "work with the world’s very best partners to develop and operate businesses that generate outstanding financial returns." European Aeronautic Defence & Space Co., of which Airbus is a part, and Rolls-Royce PLC struck similar deals to develop aircraft and engine manufacturing facilities in Abu Dhabi, Mubadala said earlier this month.

The EADS partnership, which Mubadala expects to generate more than $1 billion of revenue for Mubadala’s aerospace arm over 10 years, will see the Abu Dhabi company produce aircraft components for Airbus and, eventually, construct entire jets. EADS will meanwhile work with Mubadala to develop an engineering center and research-and-development facility in Abu Dhabi so it will eventually be able to design, develop and manufacture complete aircraft in the United Arab Emirates’ capital. Emphasis added.

Anyone who claims sovereign funds invest only for commercial returns hasn’t looked very hard. There are a host of funds in the Gulf that are designed to help their respective city state compete with Dubai as a financial center, and to otherwise their own economic development. That isn’t entirely non-commercial, but it isn’t fully commercial either.

Does it really make sense for a country as rich as Abu Dhabi to make airplane parts, let alone airplanes? Remember, all the labor will be imported, adding to pressure on rents and the like. An obvious alternative would be to move the factory closer to the labor pool that is expected to staff that factory?

Would Mubadala ever invest in a facility in a rival city state like Qatar? Qatar, remember, also aspires to be an airline hub and is building a huge new airport ...

It is hard to see how Abu Dhabi’s plans pose much of a threat to the civil aviation industry in the US and Europe. Both Airbus and Boeing have long used parts contracts to help win business. Abu Dhabi simply isn’t big enough to become a major hub for high-tech manufacturing.

But the same forces that have pushed Abu Dhabi to create a sovereign economic development fund that invests at home and abroad in projects that sometimes seem motivated at least as much by Abu Dhabi’s internal plans as by a desire for financial returns are present in other, much larger countries. Abu Dhabi isn’t the only country with big plans.

That is one reason why I have criticized the decision to have the CIC manage the Chinese state’s controlling stakes in the state banks as well as an external portfolio. It suggests that the CIC isn’t purely a passive financial investor. I am not convinced that China can wall off the CIC from pressure to support China’s own firms as they go forth. I am pretty sure the state banks will face pressure to do so. And the CIC’s current ownership of these banks makes the state banks look a lot like the CIC’s fund managers -- and perhaps the CIC’s own economic development funds. If the CIC is ADIA, is the CDB Mubadala?

The FT’s Lex notes that China’s various sovereign investors seem to be jostling with each other as they forth rather acting out a perfectly choreographed central plan. True enough. But they are competing to implement a government policy decision to invest more aggressively abroad. And so long as the State Council has to approve big investment abroad, it ultimately gets the final decision. Coordination may happen at a level above the CIC ...

Addition references:

Wayne Arnold’s article on Abu Dhabi’s different investment funds provides a synopsis of the style of each fund.

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