Bridge to a Brighter Future? South Korea’s Economic Relations with the Gulf

This essay is part of a MAP series that aims to shed light on Korea-Middle East relations — their historical and cultural underpinnings, their energy-based and other economic aspects, and the geopolitical and other factors that have facilitated and constrained their development. See more ...

A little over five years ago, South Korea’s Hyundai Engineering & Construction[1] teamed up with Combined Group Contracting of Kuwait to lead the design and construction of the soon-to-completed Sheikh Jaber Al Ahmad Al Sabah Causeway that will span Kuwait Bay, linking Shuwaikh Port with the Doha motorway. This massive infrastructure project, which is intended to put Kuwait on the global investment map, should also be viewed as part of a broad effort by Korean firms — supported by three successive administrations — to enhance their position in a fiercely competitive regional market at a time when the domestic economy is sputtering.

Twin Pillars of Korea-Gulf Economic Relations: Energy and Construction
 

Traditionally, South Korea’s economic relations with the Gulf countries[2] have centered on the energy and construction sectors.

1. Oil and Gas in the Korean Economy: The Role of Gulf Suppliers

The Republic of South Korea is home to some of the largest and most advanced oil refineries in the world and is one of Asia’s largest petroleum product exporters.[3] However, the country lacks domestic energy reserves, and relies on imports for nearly all its fossil fuel consumption.[4] Gulf producers accounted for more than 82% of the country’s 2017 crude oil imports.[5] [See Figure 1.] In recent years, Qatar and Iran have been South Korea’s leading suppliers of condensate (ultra-light crude oil), which serves as a feedstock for the country’s petrochemical industry.[6] However, South Korean refiners and petrochemical producers suspended shipments of Iranian crude and condensate last July [7] and subsequently obtained a 180-day U.S. sanctions waiver that will expire in May 2019.[8]

Figure 1. South Korea’s Crude Oil Imports by Source in 2017

Source: Adapted from U.S. Energy Information Agency (EIA), Country Analysis Brief: South Korea, July 16, 2018.

South Korea is the third-largest importer of liquified natural gas (LNG) in the world after Japan and China. Just over two-fifths of the country’s LNG imports in 2017 originated from Gulf producers, with Qatar accounting for 31% and Oman 11% of Korea’s requirements.[9] Though reportedly determined to diversify its LNG portfolio,[10] Korea’s robust supply relationship with Qatar is fortified by Kogas’ standing agreement with Rasgas (until 2024-2026) and by the fact that most of Qatar’s LNG carriers are built by South Korean shipyards.[11] [See Figure 2.]
 

Figure 2. South Korea’s LNG Imports by Source in 2017

Source: Adapted from U.S. Energy Information Agency (EIA), Country Analysis Brief: South Korea, July 16, 2018.

Note: Others include Algeria, Angola, Equatorial Guinea, Norway, Papua New Guinea, Peru, Trinidad and Tobago, and re-exports.
 

South Korea’s dependence on energy imports is likely to grow in the coming years. For one thing, the country’s petrochemical capacity will require increased volumes of condensate whether to serve as a raw feedstock or to produce naphtha for refining. For another, under President Moon’s energy policy reforms, South Korea has embarked on a drive to replace nuclear power and coal-fired thermal power plants with increased natural gas usage (and renewables), which will in turn necessitate a larger intake of liquified natural gas (LNG) sourced from abroad.[12] It is difficult to conceive of circumstances where the Gulf will cease to be a major source of LNG and condensate for South Korea and other Asian end-users.

2. South Korean Construction Companies and the Gulf Market
 

South Korean construction firms gained a foothold in the Middle East (mainly in the Gulf) during the early 1970s. The development of South Korea’s economy and the rise of its business conglomerates (chaebols) propelled a search for foreign markets and overseas projects that dovetailed with oil-producing nations’ ambitious publicly funded infrastructure projects.[13] Korean companies — supported by generous government loans and tax deductions — won numerous contracts to build housing units, roads, and port and power facilities.[14] The Middle East emerged as a major destination of expatriate workers and a valuable source of foreign currency for South Korea, helping accelerate the country’s economic development and industrialization.

By the mid-1980s, building on a successful project track record in Bahrain, Saudi Arabia, and the United Arab Emirates (UAE),[15] Korean firms were a major force in the Gulf construction market.[16] Capitalizing on their low fees, flexibility and willingness to take on risky, fixed-price projects, Korean companies’ involvement in the region progressed beyond labor-intensive civil engineering and construction projects. In 2004 Samsung Corporation was awarded the main contract to build Dubai's landmark Burj Khalifa tower. Two years later, Hyundai Heavy Industries (HHI) broke into the lucrative energy services and construction sector with an engineering, procurement, and construction (EPC) contract to enhance production at Abu Dhabi’s Umm Shaif oilfield.[17]

Gulf Economic Diversification and Korean Economic Revitalization

Over the past decade, three successive Korean administrations have sought, with varying degrees of creativity, sustained commitment and success to harness economic cooperation with Middle Eastern countries to the task of reinvigorating the domestic economy through expanding the range of economic interaction beyond the traditional energy and construction sectors — this at a time when economic diversification has been high on the agendas of the Gulf Arab countries as well as Iran.

When Lee Myung-bak, who championed an “export-led economic growth model,” assumed the presidency in February 2008, it was perhaps not surprising that the erstwhile Hyundai executive with personal experience of the region would seek to capitalize on the “second Middle East boom.”[18] Under Lee’s stewardship (2008-2013), Korean firms won bids to build power and water facilities, distillation units, refinery tank farms, and high-profile property development projects in the United Arab Emirates (UAE).[19]

Between 2009-2013, individual Korean contractors or consortia in which Korean companies participated were awarded seven of the 10 biggest EPC energy sector contracts in the Gulf Cooperation Council (GCC) market.[20] In 2009, at the height of this flurry of activity, a South Korean consortium led by Korea Electric Power Corporation (KEPCO) secured a landmark deal to build and operate four nuclear reactors at Barakh in the Al Dhafra Region of Abu Dhabi. Overall, Korean companies managed to weather the Arab Spring uprisings that swept the region in 2011, undertaking a slew of new projects in Saudi Arabia, Iraq, and elsewhere in the Gulf.[21]

Though lacking the firsthand experience in the Middle East of her predecessor, President Park Geun-hye (2013-2017) nonetheless made a strong effort to tap into Gulf markets and thereby help pull the Korean economy out of its extended slump. Speaking at a trade promotion meeting in March 2015, she identified the region as a possible “answer to our prayer for economic revitalization.”[22] Korean SMEs won $55.66 million in export contracts as a result of meetings arranged during her visit that month to Kuwait, Saudi Arabia, the UAE and Qatar.[23] This period was also notable for efforts aimed at expanding business relations to the renewable energy, medical services and information technology sectors — part of the Park administration’s broader aim of fostering a new “creative economy.”[24]

The implementation of the Joint Comprehensive Plan of Action (JCPOA) and lifting of nuclear-related sanctions against Iran in January 2016 paved the way for Korea firms such as Daelim and Hyundai Heavy Industries to garner hundreds of millions of dollars in new export orders.[25] Accompanied by a business delegation of over 230 executives, President Park made a three-day state visit to Iran in May 2016, which yielded agreements to undertake 30 joint economic projects totaling more than $37.1 billion.[26] And with the lifting of sanctions, South Korean oil imports from Iran surged. During this period, Korean companies were awarded contracts to build and upgrade energy infrastructure, construct residential housing and other facilities in Iraq as well.[27]

Since taking office, President Moon Jae-in has advocated investing in next-generation technologies and supporting SMEs and start-ups as the means to unlock the potential of the Fourth Industrial Revolution. Moon’s visit in March 2018 to the UAE, following an initial stop in Vietnam, was his first overseas trip as president. Eager to support local firms’ efforts to win contracts in the region in the development of smart cities, airports, and intelligent transport systems (ITS),[28] Moon and his team also sought to promote enhanced cooperation and inward investment in artificial intelligence, semi-conductors, space development, and information and communications technology (ICT).[29]

During the Moon visit, the UAE-Korea “strategic relationship” was elevated to a “special strategic partnership.”[30] In terms of the economic dimension of the bilateral relationship, this upgrade was as important for what it symbolized as for the immediate concrete outcomes it produced: Korean officials and powerful economic actors alike have come to view the Emirates both as a market and as a gateway or model from which to extend their reach within and beyond the region.[31]

The Moon administration has waged a parallel campaign to build out economic cooperation with the Kingdom of Saudi Arabia (KSA), spearheaded by the Saudi-Korean Vision 2030 Committee, which is organized into working groups focused on five key sectors: energy and manufacturing, smart infrastructure and digitization, capacity-building, health care and life sciences, SMEs and investment.[32] State-run utility Korea Electric Power Company (KEPCO), determined to expand its overseas presence, stepped up marketing efforts in Saudi Arabia, and has been shortlisted to bid on the Kingdom’s first nuclear project.[33]

Challenges and Risks Abound

In recent years, South Korea has deployed new “soft power”[34] and security-related tools[35] to protect and promote its economic interests in the Gulf region. Nevertheless, challenges and risks abound.

First, although over the past decade South Korea has managed to maintain a positive trade balance with the rest of the world, its yawning trade deficit with the Gulf region has not narrowed. [See Figure 3.] The fact that South Korean exports to the Gulf have not increased appreciably is one reason for this persistent imbalance. But the main reason is South Korea’s continued heavy reliance on oil sourced from the Gulf — a feature of the relationship that the practice of supply diversification can ameliorate but not fundamentally change.

Figure 3. South Korea’s Trade with the Gulf Region (2009-2018)

Source: Korea Customs Service, http://www.customs.go.kr/kcshome/trade/TradeCountryList.do

Second, South Korea’s energy-dependent relationship with the Gulf carries with it a relatively high degree of risk exposure. In conducting business in the region, South Korean firms have had to grapple with fluctuating oil prices as well as with regional conflict and instability. For the past three years, EPC orders from the Gulf have fallen sharply due primarily to lower oil prices and political uncertainties.[36] The reinstatement of U.S. sanctions against Iran has led to Korean companies’ cancellation or suspension of work on lucrative projects there[37] and a significant drop in non-oil commodities bilateral trade.[38] Korean refiners have had to scramble to secure alternative oil supplies,[39] snapping up shipments of U.S. Eagle Ford, Australian Wheatstone, and Kazakh CPC Blend condensate to make up for the shortfall.[40] However, completely replacing Iranian condensate on a long-term basis with U.S. and Australian substitutes would require costly retrofitting of Korean facilities.[41] Meanwhile, the uncertain duration of the new sanctions regime, coupled with some confusion as to what is permissible under the waiver Seoul obtained from the Trump administration has added to Korea’s predicament.[42]

Third, lagging domestic economic reform could undercut South Korea’s efforts to further diversify economic cooperation with the Gulf countries. Chaebols continue to dominate the Korean economy and exert powerful influence in its politics. Thus far, President Moon has been unable to enact the structural reforms that would curb the power of these corporate behemoths and help unleash SME entrepreneurialism. The result is that state-supported chaebols remain the powerful and privileged vanguard of Korea’s economic penetration of the Gulf — retaining advantages that, while redounding to their own and the country’s benefit, nonetheless could come at the cost of stifling more innovative services-oriented economic activities propelled by SMEs.

Fourth, in recent years Korean construction companies have had to contend with the limitations of their standard business model and navigate in an increasingly crowded field of rivals for Gulf business. As domestic demand weakened a decade ago, Korean contractors flocked to the Middle East where their ambitious bidding enabled them to undercut their competitors but ultimately yielded narrower profit margins than expected for some and substantial losses for others.[43] In the ensuing years, South Korean companies have found themselves competing not just with Western incumbents but also with new, agile Chinese and Indian contenders. The upshot is that Korea’s competitive edge in sectors such as shipbuilding, electronics, and automobiles appears to be eroding.[44]

Fifth, it is difficult to gauge exactly how effective Korea’s recent “sales diplomacy” in the Gulf has been. The widely reported “successful” undertakings of President Moon and his predecessor produced dozens of memoranda of understanding, though it is unclear how many of these have translated into concrete outcomes. Furthermore, the current policy direction of the Moon administration could prove counterproductive, notably the push to phase out the very technology at home that it is seeking to export, which could damage its credibility, disrupt the supply chains and experienced workforce and thus undermine efforts to expand its nuclear portfolio in the Middle East and beyond.

Finally, it is important to mention that President Moon’s energy and enthusiasm is focused primarily on the prospects for inter-Korean economic cooperation, and not on the Gulf. His conciliatory approach to dealing with the Democratic People’s Republic of North Korea (DPRK) reflects his belief that lasting peace on the peninsula will provide “new growth engines” for the economy.[45]

Conclusion

South Korea’s energy-dependent and export-driven economy binds the country to the Gulf. Many Korean companies — having built a large presence and compiled a strong track record of success in the Gulf — are seeking to retain and expand their business activities in the region and to exploit its potential as a gateway to more distant markets. The Moon administration has reaffirmed its commitment to promote Korean companies’ efforts to sustain and generate new business in the Gulf and wider Middle East.

Nevertheless, entering 2019, South Korea is bracing for a further economic slowdown — facing multiple downside risks, including rising U.S. protectionism, decelerating Chinese growth, sluggish corporate investment, and weak consumer spending.[46] As Hyundai Engineering & Construction and its local partner work to complete construction of the Sheikh Jaber Causeway across the Kuwait Bay, South Korean officials are drawing up a detailed blueprint for reconnecting road and rail links across the divided Korean peninsula. Both projects evoke bright new possibilities for improving South Korea’s economic prospects. However, the symbolism and aspirations associated with the projects tend to mask the high level of risk exposure and uncertainty that South Korea faces, whether in managing relations with the DPRK or in steadying, much less expanding its economic engagement with the Gulf.