Give Them a Chance: Helping Local Suppliers in the oil and gas industry

By Basskaran Nair, Visiting Professor at Nazarbayev University, Graduate School of Public Policy and Murzakulova Zhanat, PhD Student, University of Groningen

Basskaran Nair
Basskaran Nair

Kazakhstan has one of the largest oilfields in the world operated by international investors. There are basically three major oil projects of truly global scale in Kazakhstan—Tengiz, Karachaganak and Kashagan. All three projects are of high importance for the nation’s economic development. The oilfields are not only a source of rents paid to the state budget but more importantly provides a potential platform for the growth of local industries as suppliers and local manufacturing industries.

International investors have a global footprint creating an efficient and cost-effective network of supply chains across borders. Their international operations require the use of wide range of intermediate goods and services, specific technology and specialised knowledge. Where possible, these firms outsource their non-core activities to reliable, low cost and high-quality suppliers. Outsourcing activity unfolds in stages as the firms search first for reliable “global” suppliers with strong competence and then extend further to proximate local (“follower”) suppliers, especially in places where uncertainty about logistics are high.

By plugging into this outsourcing supply chain, Kazakhstan entrepreneurs contribute to creating a more diversified economy and help enlarge the local entrepreneurial environment. By getting this right, local entrepreneurs as seen in many other countries can grow and be part of the companies listed on the Kazakhstan Stock Exchange, creating further depth to its capital markets. It will also avoid the “resource curse” where extraction decreases rather than develops and deepens the economy of resource-rich countries. However, this ecosystem of outsourcing the supply chain activities to local entrepreneurs within the oil industry is limited when it comes to sectoral machinery. Why?

The international oil companies will outsource their non-core activities only to reliable, cost effective and high-quality suppliers. They look for companies with certain market size, have technological capability and ensure absorptive capacity, according to their stringent global standards. Weak local absorptive capacity within a host country such as Kazakhstan remains one of the stumbling blocks to transfer economic benefits from extraction of oil to manufacturing industries.

In the Kazakhstan oil and gas industry, the weak local absorptive capacity of equipment suppliers is seen on several fronts. One is the weak economies of scale, that is the demand flow from the international firms is not large and regular enough to induce local entrepreneurs to build large scale production lines. Besides the international firms do not treat local firms as the preferred suppliers but tend to open up the outsourcing to regional competitors for their supply, thereby discouraging local suppliers from heavy investments. Two is the high production costs. For example, some types of steel required by the international firms are too expensive to be produced locally. Local suppliers find that it is a better to purchase from regional competitors and supply to these international operators rather than build their own local capacity. However, when the sources of supply are not in the region but further afield, it puts further cost pressures on local entrepreneurs, undermining their competitiveness and capacity as local suppliers. Three is the technological gap, meaning while a conservative industry, the oil and gas industry follows global technological trends; the sub-soil users for instance demand state of the art technological decisions. Under such circumstances, most of the local producers seek and supply imported technological solutions but generally they lack behind in adaptation and adoption to new technologies. This leads to the fourth constraint faced by local supplier chain operators and that is limited access to finance. Installing production line requires capital and the cost of money in the economy remains high. Access to finance is one of the main constraints for the growth of private sector and entrepreneurship in Kazakhstan in general.

How can the state play a role in giving a leg-up support for these entrepreneurial supply chain providers and in the process attain one of its 2050 goals of being in the Top 30 strongest economies in the world?

A significant contributory factor is proper coordination of efforts to help these local entrepreneurs cross over the high barriers they face as suppliers to these multinationals. Currently, in order to satisfy requirements of the international firms, the local producer has to go through multi-level procedures starting from online registration and going to on-site technical audits, international certification and so on. Understandably, international oil operators are very risk-averse and feel more comfortable with stable international suppliers. Engaging new contractors require a high level of scrutiny of absorptive capability, financial strength and skilled competencies.

This is where the government can step in and do what other countries like Singapore have done when attracting international firms. They help with international governance arrangements to support investments in building the local talent pool and training the skilled workers at vocational and tertiary centers needed for the industry; support local firms with public-private financing and infrastructural support; identify all the requirements that will help change perception towards local suppliers at all levels of project management including awareness of local technological capacity. Often these international companies do support the training of local staff as part of their corporate social responsibility as well as have vendors development programs. However, in the interim period, the Kazakhstan government should show political will to support local producers by promoting efficient collaboration and fair deliberation processes for policy innovations aimed at building the local knowledge base, provision of market analysis, contribute on marketing and production strategies, technology transfer and other strategic decisions to increase competitiveness of local machinery suppliers. This is common in countries that are focused on capturing positive spillovers from foreign direct investments in extractives and the growth of the domestic business environment, especially for technological firms.

Going forward, state authorities have contributed to the growth of the oil and gas industry through an assiduous cultivation of the international firms to operate in the country. They could go further and lubricate the ecosystem of the industry to support the emergence of dynamically learning local enterprises to be competitive as suppliers to the industry in the region. Perhaps in time they may be become the preferred partners of these international firms in their global supply chain. The presence of such enterprises will push industrial transformation forward, help diversify the economic structure by leveraging on Kazakhstan’s natural wealth and achieve its Top 30 strongest economies in the world before 2050.

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