By Marwa Rashad and Stephen Kalin
RIYADH (Reuters) - Saudi Arabia began courting Toyota two years ago to build a large car plant as part of Crown Prince Mohammed bin Salman's grand plan to wean the kingdom off oil revenues and create jobs for young Saudis.
But the Japanese carmaker has rebuffed Riyadh's overtures following talks that dragged on without tangible results because high labour costs, a small domestic market and a lack of local supplies gave Toyota pause for thought, four sources said.
Securing a deal with a major automaker by 2020 for a car plant is a key target in the Gulf state's national industrial strategy, part of a broader agenda to diversify the economy of the world's largest oil exporter.
Failure to do so would be a setback for Prince Mohammed, coming after the listing of oil giant Saudi Aramco was shelved and the killing of journalist Jamal Khashoggi tarnished the kingdom's image.
"Nobody would say 'No, full stop' ... but they politely conveyed they're not interested," said an industry source familiar with the Toyota talks.
Toyota said it could not comment on the current internal discussions and communication with the Saudi government.
Saudi Arabia's ministry of energy, industry and mineral resources and the government media office did not respond to requests for comment.
As part of measures designed to create 1.6 million manufacturing and logistics jobs by 2030, Prince Mohammed wants to localise half the production of imported vehicles and weapons - which are expected to account for up to $100 billion in spending by Saudi government entities and consumers by 2030.
Under the deal Toyota signed in March 2017, the Japanese company agreed to conduct a feasibility study for an industrial project to make vehicles and car parts in the kingdom.
Two sources familiar with the matter said Toyota concluded after the study and negotiations that Saudi Arabia would need to provide huge subsidies for the project to be viable.
"They found that production costs will be similar to other countries only if there is a 50% government incentive. But even then, they aren't sure it will be profitable," said one source with knowledge of the negotiations.
TOUGH SELL
When it comes to establishing manufacturing, Riyadh hopes to replicate its 1980s push into petrochemicals - the cornerstone of an industrial drive that turned Saudi Basic Industries (SABIC) into the world's fourth biggest petrochemicals firm.
Hundreds of thousands of Saudis work in petrochemicals, one of the biggest contributors to the economy outside oil. But it took decades to build up the industry, even with huge government funding and cheap raw materials.
Saudi Arabian Military Industries, owned by the kingdom's sovereign wealth fund, is spearheading the drive to localise military spending. It aims to generate $10 billion in revenue over the next five years and hopes to generate 30% of revenues from export markets by 2030.
For cars, the National Industrial Development and Logistics Program (NIDLP) wants half the roughly 400,000 vehicles bought each year in Saudi Arabia to be made there by 2030, one source said.
But Toyota, which has a 30 percent market share, only proposed a small plant producing up to 10,000 vehicles using imported goods and the Saudis wanted a bigger factory, the industry source and the source familiar with the talks said.
A strategy document posted on NIDLP's website acknowledged that Saudi Arabia had a major competitive disadvantage and state incentives would be needed to create "substantial commercial justifications" to attract carmakers.
It did not provide specifics about the disadvantages, nor the size and kind of state incentives required.
At NIDLP's launch in January, the state approved 45 billion riyals ($12 billion) of incentives to develop an auto sector, including duty rebates, human resources subsidies and tax holidays, but it wasn't enough, the industry source said.
NIDLP did not respond to requests for comment.
Asked if it would consider the project if the economic conditions changed, Toyota said: "We do not comment on assumptions about the current and future situations."
JOBS PUSH
The NIDLP is aiming to create 27,000 jobs in the automotive sector by 2030 by attracting so-called original equipment manufacturers (OEMs).
One obstacle, though, is the absence of a local supply chain for car parts, three automotive industry executives said.
Riyadh would need to build integrated economic districts producing components such as windows, batteries and wheels to lower costs, a senior executive at a Western auto firm said.
"If I have to open a manufacturing process in Saudi and then import every single component from abroad, I do not have any economical plus," he said. "The problem is not really setting up a plant, but having the entire value chain."
The local market is also relatively small. Demand for cars in Saudi Arabia has fallen by some 50% over three years to about 450,000 cars in 2018, as a drop in oil prices and departure of expatriates hit consumption, said Subhash Joshi, director of mobility practice at research firm Frost & Sullivan.
"Saudi Arabia and (Gulf) countries have been persistently disappointing in terms of sales in recent years, so it's not as if OEMs would be entering a booming market," said Justin Cox, director of global production at LMC Automotive.
Cox said countries such as Egypt and Turkey had more advantages for carmakers.
Toyota has a 1.2 billion euro plant with an annual capacity of 150,000 vehicles in Turkey, which is in a customs union with Europe. A plant Nissan set up in Egypt in 2005 with a $200 million investment will produce 28,000 cars this year.
Cars imported into the GCC customs union which includes Saudi Arabia only attract a 5% tariff, offering little protection against cheap imports for countries trying to get domestic car production off the ground.
CARMAKERS WARY
Turkey and Egypt also provide experienced, cheap manpower while Riyadh has been reducing the number of foreign labourers to create jobs for Saudis, who prefer higher-paying public jobs. Some 10 million foreigners have been doing the strenuous, lower-paid jobs largely shunned by the 20 million nationals.
Khalid al-Salem, who oversees the development of industrial cities, said the authorities were working on incentives to lure Saudis to industrial jobs instead of retail, where entry requirements are easier and pay is higher. He did not elaborate.
It's not the first time Saudi Arabia has attempted to lure automakers.
In 2012, Jaguar Land Rover signed a deal to explore producing 50,000 Land Rovers a year in the kingdom at a cost of 4.5 billion riyals (£955.3 million), but it never moved forward.
The industry source said the British luxury brand, owned by India's Tata Motors, got a better offer from a European country.
"We continually review our global manufacturing footprint. At this time, our focus remains on our manufacturing presence in the UK, China, Brazil and mainland Europe," Jaguar Land Rover said in an emailed response when asked about the Saudi project.
Two of the sources said Riyadh has also approached Nissan Motor Co in recent years.
They said the Japanese firm considered contract manufacturing through a 75% Saudi-owned venture - without the Nissan brand - but the arrest of former chairman Carlos Ghosn last year meant it was off the table for now.
Nissan declined to comment.
MINING AND PHARMACEUTICALS
While Saudi Arabia is struggling to lure carmakers, it does have a truck assembly industry. But analysts say assembling vehicles imported in kit form requires less investment and doesn't create as many jobs as building cars from scratch.
Economists say, however, that Saudi Arabia does have the potential to build competitive industries and create jobs in the mining and pharmaceutical sectors.
The state is looking to triple mining's contribution to gross domestic product by 2030 by focusing on untapped reserves of bauxite, phosphate, gold, copper and uranium.
Saudi authorities estimate the country holds 500 million tonnes of phosphate ore, about 7% of global proven reserves and a new mining law to boost foreign investment is being drafted.
Monica Malik, chief economist at Abu Dhabi Commercial Bank, said investment in mining infrastructure would likely have the most direct impact on developing new manufacturing industries.
Pharmaceuticals is another strategic sector for NIDLP. About 25 local manufacturing plants produce 30% of prescription drugs consumed now and the government wants to double the sector's contribution to non-oil gross domestic product to 1.97% by 2020.
Suhasini Molkuvan, programme manager at Frost & Sullivan, said the target was almost close to reality though a lack of investment in research and development and intellectual property left local firms dependent on multinationals.
"Diversity is easier said than done," said a senior Riyadh banker. "It might be achievable in 15 to 20 years if they continue to make the push."
(For a graphic on Saudi Arabia GDP breakdown, click: https://tmsnrt.rs/2WDjAZb)
(For a graphic on Economy by sector in 2018, click: https://tmsnrt.rs/2IUeZbs)
