Part 3: Setting up the Saudi Arabia Food Security Partnership

Inquiry into the Saudi Arabia Food Security Partnership.

3.1
In Part 2, we described significant problems and complexities related to live sheep exports that arose in the relationship between New Zealand and Saudi Arabia. In this Part, we explain how the Partnership was developed as a solution to resolve some of those problems and complexities.

The Gulf Strategy and establishing the Saudi Arabia Food Security Partnership

The Gulf Strategy

3.2
New Zealand has a significant trading relationship with the Gulf Cooperation Council. In 2012, when the Partnership negotiations were under way, New Zealand exported goods worth $1.53 billion to the Gulf Cooperation Council, making it our seventh largest export market. New Zealand exports to Saudi Arabia alone were worth about $700 million in 2012. New Zealand's two-way goods trade with Saudi Arabia totalled $1.44 billion in 2013.

3.3
The Government's strategy for the Gulf (the Gulf Strategy), published in July 2013, noted the importance of food security for the Gulf Cooperation Council and that New Zealand, as an exporter of high-quality food, is a "natural partner" in this regard. The Gulf Strategy set out aspirations for increasing trade with the Gulf Cooperation Council in areas where New Zealand has "relevant public and private sector expertise". In 2012, the top five exports were milk powder, butter and dairy spreads, sheep meat, cheese, and chilled beef meat.

3.4
The Gulf Strategy explained that "while the [Gulf Cooperation Council] states have high per capita GDP fuelled by huge oil reserves ... they share a serious shortage of both water and arable land". As such, food security had become an important concern in regions such as the Gulf. Food exporting countries are "natural partners" for the Gulf Cooperation Council in their food security goals, which include increasing the number of domestically raised sheep and developing sustainable husbandry techniques.

3.5
Maintaining the existing trade relationship was an important factor influencing decisions about exporting sheep for slaughter. Given ceasing that export was (in the words of Ministry officials) a "poisonous" factor in New Zealand's relationship with Saudi Arabia, and consequentially the Gulf Cooperation Council, officials sought a commercial solution that would remove that factor.

Developing the Saudi Arabia Food Security Partnership

3.6
On 14 February 2012, Mr McCully and officials met to discuss an upcoming meeting with Sheikh Hmood and his companies' representative. This meeting, and a subsequent briefing, discussed solutions that included putting a food security proposal (the Food Security Arrangement) to Sheikh Hmood.

3.7
Mr McCully explained to officials that the purpose of the proposal was to consider committing some funding to make it possible to export sheep to the Gulf region for breeding rather than for slaughter, because the Government wanted to keep Sheikh Hmood's investment in New Zealand. The aim of the proposal was:

… to put in place the necessary governmental support … as well as the technical framework – to make possible the establishment of a third country breeding colony of Al Khalaf's stock.

3.8
In the 14 February meeting with officials, Mr McCully noted that:

  • A transparent and contestable process would be required – and that any private benefit should be incidental. If cash was invested in the proposal, due process would need to be followed – for example, approval by Cabinet.
  • He was aware that MAF was concerned that the proposal was creating a "back door" for exporting sheep for slaughter, and that the Ministry had to be clear this was not the case. He explained that "any [Sheikh Hmood] work would be part of a wider context".

3.9
On 27 February 2012, Mr McCully and officials met with Sheikh Hmood and his companies' representatives. Mr McCully talked about the history of the issue of the export of livestock for slaughter and said that, if he were in Saudi Arabian shoes, he would conclude that Sheikh Hmood had been misled. He commented on the shift in the political landscape.

3.10
Sheikh Hmood expressed his gratitude to the New Zealand Government and people for all of the support he had received over the years and explained that he had invested because of market forces and the better health of livestock in New Zealand. Sheikh Hmood said that "the Saudi side would like to see a solution around exporting animals for breeding purposes to Saudi", and was wary of the animal health issues that may arise in third countries.

3.11
The discussion also included greater co-operation with the Gulf Cooperation Council on food security and proposals that would meet Saudi Arabia's food security concerns, including exporting sheep for breeding.

3.12
On 1 March 2012, an official met with Sheikh Hmood and his companies' representatives. Three options were discussed:

  • option A (Sheikh Hmood's preferred option) – to "continue to seek live sheep for slaughter";
  • option B – "export of live sheep for breeding, small scientific trial for slaughter and financial compensation"; and
  • option C – "export of live sheep for breeding and financial compensation".

3.13
Sheikh Hmood's Australasian representative explained to an official that, if options B or C were progressed, the Al Khalaf Group would seek financial compensation for the eight years that they had been unable to export, which amounted to about $24 million.

3.14
On 5 March 2012, Mr McCully met with Sheikh Hmood and his companies' representatives again. In this meeting, exporting sheep for slaughter and a joint farming operation or sheep-for-breeding project in Saudi Arabia were discussed. An official's report on the meeting states:

The Minister noted that he did not want any (financial) contributions to be treated as compensation as this would involve a plethora of lawyers and bureaucrats. Rather he would prefer an investment in a partnership to achieve the objective that could have been achieved by exporting [sheep for slaughter].

3.15
The actions recorded from the 5 March meeting, and confirmed in a letter from Mr McCully to Sheikh Hmood in March 2012, included:

  • completing a Memorandum of Understanding for trade in live sheep between New Zealand and Gulf countries, including Saudi Arabia; and
  • developing a food security partnership with an immediate focus on exporting sheep for breeding purposes.

3.16
In a letter dated 9 April 2012, Sheikh Hmood responded to Mr McCully's letter. Sheikh Hmood expressed his pleasure that the issues that delayed the signing of the Memorandum of Understanding were to be resolved and that there would be a partnership for a breeding venture in Saudi Arabia. He also said that the then Saudi Arabian Minister of Agriculture was pleased by the content of Mr McCully's letter.

3.17
A Ministry paper to Mr McCully and the Minister of Primary Industries (and referred to the Prime Minister, Mr Groser, and the Associate Minister of Primary Industries) on 19 April 2012 records the recommendation from officials that work streams begin on:

  • establishing protocols for exporting sheep for breeding to Saudi Arabia;
  • establishing a joint-venture sheep breeding operation in Saudi Arabia; and
  • finding an appropriate mechanism to meet Sheikh Hmood's concern for "compensation" (possibly through the joint venture).

3.18
Agreement was also sought from Ministers to appoint a Special Envoy for Food Security Issues. The Ministry contracted an official in June 2012 "to build public-private partnerships in pursuit of commercial opportunities in the Gulf and potentially beyond". This role was called the Special Envoy for Government-Commercial Partnerships. The ratification of the free trade agreement was noted in the contractor's offer of employment as an associated issue. As well as one other project, the contracted official was asked:

  • to explore establishing a food security co-operation partnership with the [Gulf Cooperation Council] states;
  • to oversee the work of a group of technical experts on scoping and developing sheep breeding joint ventures; and
  • to lead negotiations with Saudi investors.

3.19
Officials told us that they needed to "change the narrative" with Sheikh Hmood and his companies' representative from one of compensation to one that was "future-focused". The language of partnership was used as a means to achieve this "change in narrative". The Special Envoy told us that a Ministry official on the Middle East desk made it clear to him that exporting live sheep was the biggest issue needing resolution. Accordingly, the Special Envoy and other Ministry officials met with Sheikh Hmood's Australasian representative in July in the Hawke's Bay and also travelled to Australia to meet with him.

3.20
The file note of the Hawke's Bay meeting on 23 July 2012 estimated that the investment required would be $5-$10 million. The Special Envoy told us that his job was to work with the Ministry and the Al Khalaf Group to prepare a partnership with a budget of $10 million.

3.21
Further evidence from interviews and documents indicates that Ministry officials discussed the split between the payment for services from HAATT Est and the payment to New Zealand companies to provide services and equipment to the Agrihub being set up in Saudi Arabia, within a $10 million budget. The Agrihub is a term used to describe the agri-business operation located on Sheikh Hmood's Um Alerrad farm.

3.22
In a Ministry internal memorandum dated 7 September 2012, it was requested "that subject to ministerial, and then Cabinet approval, a contingency of NZ$10 million be made to fund a potential partnership with Al Khalaf Group as a key part of a New Zealand / Kingdom of Saudi Arabia food security arrangement …".

3.23
Negotiations resulted in agreement that a partnership was the way forward. An undated briefing paper to Mr McCully commented that, "[w]hile this is a great opportunity for New Zealand, due consideration must be given to what New Zealand requires from this process." It went on to note that consideration had been given to how New Zealand could benefit from strategic engagement with a substantial business in the Middle East.

3.24
An exchange of letters took place between Mr McCully and Sheikh Hmood in November 2012 that described a mutual commitment to a partnership between the New Zealand Government and the Al Khalaf Group (we discuss these letters in paragraphs 4.2 and 4.3).

3.25
A meeting between Ministry officials and the Ministry's external lawyers took place on 10 January 2013 about how to structure the relationship with the Al Khalaf Group, by a licence, contract for services, or a joint venture.

3.26
Documentation shows that the arrangements needed to be concluded urgently to enable a payment to be made, based on Mr McCully's exchange of letters with Sheikh Hmood. With that constraint, it was decided that the Ministry should be the contracting party. We describe the contractual arrangements that were made in Part 4 and the implementation of the Partnership in Part 7.

3.27
A draft paper to Mr McCully refers to the "capital contribution"13 as a "one-off, ex-gratia payment". The final paper, dated 14 January 2013, did not categorise the payment as an ex-gratia payment but sought approval from Mr McCully to make an initial capital payment to the Al Khalaf Group as a necessary first step in establishing a partnership. Notes on the paper record that Mr McCully requested officials to prepare a Cabinet committee paper on this to advise his Cabinet colleagues and confirmed his oral advice to officials that appropriate probity standards be applied for any procurement.

Advice to Cabinet

3.28
The Cabinet Manual14 provides guidance on which issues Ministers should submit to Cabinet and what is more appropriately dealt with by departments.15 The Cabinet Manual states that Ministers should keep their colleagues informed about matters of public interest, importance, or controversy.16

3.29
When the Partnership was being developed, Cabinet Office Circular CO (11) 6 (dated 18 October 2011) set out the guidelines and requirements for Ministers and departments seeking approval of proposals with financial implications, including any changes to appropriations.17 We discuss appropriations further and specific types of payments that require Cabinet approval in Part 5.

3.30
In January 2013, Mr McCully put a paper entitled "Food Security Partnerships in the [Gulf Cooperation Council]" to the Cabinet External Relations and Defence Committee. This January 2013 paper proposed to the Committee that it note the steps being taken by Mr McCully to promote food security partnerships with the members of the Gulf Cooperation Council, including steps being taken with Saudi Arabia to promote "agricultural partnerships taking into account the cessation of live sheep exports since 2002". The main features of the proposal were explained in this paper as:

  • Initial funding of $4 million increasing over time depending upon progress with the partnership (with the possibility of additional contributions from participating firms and the government of Saudi Arabia) to provide a hub of New Zealand agribusiness partners working alongside Saudi co-investors to showcase New Zealand agricultural expertise and technology. The initial $4 [million]in funding will come from operational savings achieved through 2011/2012 and rolled over for future NZ Inc. leveraging purposes.
  • Possible export, once or twice a year, of a significant number (in the tens of thousands) of pregnant livestock for breeding purposes to form the basis of a New Zealand hub in Saudi Arabia. These arrangements will need to satisfy the normal MPI criteria. However, this is well explored territory given that NZ has exported over 85,000 head of livestock in the last three years for breeding purposes.
  • Provision of genetic and breeding technology and scientific support services from New Zealand companies.

3.31
After the paper "Food Security Partnerships in the [Gulf Cooperation Council]", in February 2013 (the recommendations in this paper were noted by the Cabinet External Relations and Defence Committee), Mr McCully submitted a further paper to Cabinet entitled "Saudi Arabia Food Security Partnership". We were told that Ministry legal advisers were not asked for input or made aware of this Cabinet paper or earlier related Cabinet papers. Officials emphasised to us that the February 2013 Cabinet paper was, for the most part, drafted and revised in Mr McCully's office with involvement from Mr Groser. Mr McCully told us that the Cabinet paper was his responsibility.18

3.32
The February 2013 paper provided the following major context to Cabinet:

  • It provided an update on progress with addressing the live sheep for slaughter export issue, which was a significant impediment in the bilateral relationship between New Zealand and Saudi Arabia.
  • The proposal to invest in a pilot agri-business operation with Saudi Arabia was a means to resolve that impediment as well as a dispute between New Zealand and a Saudi Arabian investor.
  • There was a serious threat to existing trade in goods and services with Saudi Arabia because of the live sheep for slaughter export issue.
  • The Gulf Cooperation Council had asserted that the live sheep for slaughter export issue was the only obstacle to ratification19 of the free trade agreement and the issue had suspended the ratification of the free trade agreement.
  • The member states of the Gulf Cooperation Council had acute food security concerns and prioritised food security projects.
  • Mr McCully and officials had spent three years working to resolve the relationship issue with Saudi Arabia as a consequence of the live sheep export issue.
  • "Saudi parties" (we interpret those parties to be only the Al Khalaf Group) would have preferred to enter discussions on the basis of seeking compensation for commercial loss as a result of Government decisions. Some consideration had been given to purchasing the Saudi Arabian parties' investments in New Zealand, but this would not address the grievances as perceived by the Saudi Arabian Government.
  • The proposed arrangement would result in strong incentives for the Saudi Arabian parties to promote the ratification of the free trade agreement, but that there was no written understanding on this.
  • The paper advised on a risk of a WTO case being taken against New Zealand and significant risks to New Zealand's reputation as an investment destination.

3.33
Further, the financial matters highlighted to Cabinet in the February 2013 paper were:

  • New Zealand goods exports to the Gulf Cooperation Council exceeded $1.57 billion and had grown at an average of more than 10% in the past three years.
  • It was estimated that New Zealand exports to the Gulf Cooperation Council could double to $3 billion in five years if the free trade agreement could be achieved.
  • The Al Khalaf Group had received legal advice that it could pursue a claim against the Government for between $20 million and $30 million.

3.34
The February 2013 paper explained a proposal to:

… work with the existing Saudi investors in New Zealand to relocate the parts of their business that are no longer able to operate here as a result of the ban on live sheep exports for slaughter. The objective is to use the investment they have made in the genetic development of the Awassi breed, their logistical, supply chain and market connections to create a base for New Zealand service suppliers to leverage the New Zealand brand and reputation for agricultural excellence in the Middle East market.

3.35
The proposal included:

… a $4 million commitment to acquire from the Saudi investors the components of the platform to conduct a three year pilot.

The allocation of up to $6 million for a project to use the platform as a hub for New Zealand agriculture service providers to build an enduring presence in the Middle East and African markets. This will depend on securing relevant New Zealand company commitment to the project.

3.36
The February 2013 paper further explained "the platform" for the Crown's investment into an agri-business operation or demonstration farm (the Agrihub). It was confirmed that funding for the $4 million contribution, and allocation of $5.5 million to the project, would be met from reallocated Ministry baseline savings. It was also explained that NZTE had "allocated approximately $500,000 for this project within [its] Agribusiness High Impact Programme".

3.37
The January and February 2013 Cabinet papers show the expectation that NZTE would, in due course, become involved. The paper states that "NZTE view this project as an extension of their normal activity, and support for this project will be via the New Zealand companies, and is conditional on company support, commitment and co-investment." We were told by NZTE that, although this was within NZTE's usual scope of activities, the rationale for the NZTE Board supporting this initiative was to deliver on a wider NZ Inc. strategy to resolve complex diplomatic issues in pursuit of the free trade agreement.

3.38
Officials from the Treasury20 briefed the Minister of Finance on several versions of the draft Cabinet paper. The Treasury's pre-Cabinet briefings to the Minister of Finance on 4 February and 11 February 2013 noted that:

  • It had not been consulted about the financial implications of the proposed expenditure.
  • It had concern about the lack of clarity with the benefits of the business case.
  • It understood that the proposal was a goodwill initiative21 intended to help progress the free trade agreement, and it noted that there was no guarantee the proposal would benefit the free trade agreement.
  • Alternative options were not presented to Cabinet.
  • Cabinet was originally asked only to note the proposal (as opposed to agree to it) – the Treasury considered that the proposal met the criteria for needing Cabinet approval.
  • The Treasury recommended that, given its concerns, the Minister of Finance not support the proposal.

3.39
After reviewing the final Cabinet paper, the Treasury continued to recommend that the Minister of Finance not support the proposal because "it remains unclear what the benefits for New Zealand firms from the proposal will be, whether the spending will benefit the [free trade agreement], or what precedent it could create for other trade agreements".

3.40
The recommendation from the Treasury was that, if Cabinet decided to proceed with the proposal, Cabinet "direct [the Ministry] to work with the Treasury, NZTE, and MBIE on the execution and management of this contract". It appears that the Treasury accepted the funding arrangements for the proposal and the intended transfer of funds to NZTE. However, it thought that a new appropriation for the $4 million payment might be required. We understand that the Treasury's concern at the time was that there was an authority to charge the expense against the relevant appropriation.

3.41
In keeping with the February 2013 paper, the Cabinet Minute22 records that, on 18 February 2013, Cabinet:

  • noted the progress reported by the Minister of Foreign Affairs to address a significant impediment in the bilateral relationship between New Zealand and Saudi Arabia, as outlined in the paper under CAB (13) 71;
  • notedthe proposal to invest in a pilot agribusiness operation with Saudi Arabia as a means to resolve this dispute and form a long-term food security partnership;
  • noted that the cost of this food security platform will be $4 million initially, which recognises the intellectual property which the Saudi investor brings to the platform and the services and in-market networks he will contribute, as well as the settlement of the long-running dispute;
  • agreed that there will be an ongoing investment in the pilot agribusiness operation of up to $6 million for the delivery of services by NZ agricultural service entities, and that the $6 million will be undertaken in strict conformity with government procurement requirements;
  • noted that the costs of these initiatives will be met from within the Ministry of Foreign Affairs and Trade's baseline;
  • noted that the procurement and selection of New Zealand firms and services to participate in the food security partnership will be done with the agreement of the Saudi partners, the Ministry of Foreign Affairs and Trade, and New Zealand Trade and Enterprise;
  • noted that any related proposal to export livestock for breeding purposes must meet existing Ministry for Primary Industries criteria and be the subject of an application in the normal way.
  • note that any export of livestock for breeding purposes under the partnership must be undertaken to achieve the effective relocation of breeding stock to Saudi Arabia for the purposes of shaping the new business model, and not to establish a new business in New Zealand for the export of livestock for breeding;23
  • directed the Ministry of Foreign Affairs and Trade to work with the Treasury, the Office of the Auditor-General24 and New Zealand Trade and Enterprise on the execution and management of the contract.

Our comments on these matters

3.42
The intention behind Mr McCully's early negotiations with Sheikh Hmood was to find a "commercial solution" to address Sheikh Hmood's sense of grievance. However, we did not find evidence of officials' real analysis of other options. We also did not find evidence of Ministers or officials requesting or receiving internal or external legal advice on the extent of the risk of a claim for compensation from the Al Khalaf Group against the Government.

3.43
We found significant shortcomings in the February 2013 Cabinet paper, including that it:

  • did not clearly explain that the Al Khalaf Group would own the goods and services,25 costing the New Zealand Government $6 million;
  • did not identify how the $10 million figure was arrived at (a figure that has since risen to $11.5 million);
  • signalled the risk of a claim against the Government based only on the $20-$30 million figure that the Cabinet paper said was suggested by the Al Khalaf Group (there was no assessment by Ministry officials of the substance of that legal risk);
  • did not include any analysis about whether there were any other potential obstacles to the signing or ratification of the free trade agreement, other than the concerns of the Al Khalaf Group about the export of live sheep, or the assertion by the Gulf Cooperation Council that this was the only obstacle to the free trade agreement;
  • identified risk in the form of a WTO case, without including any analysis in the Cabinet paper; and
  • identified that New Zealand exports could double to $3 billion in five years if a free trade agreement was signed with the Gulf Cooperation Council, without including any analysis.

3.44
Mr McCully told us that it was unfair to criticise the Cabinet paper for failing to analyse the consequences of a litigation or a compensation negotiation process that it had expressly ruled out.

3.45
We found no evidence that officials substantially reviewed other potential obstacles to the free trade agreement with the Gulf Cooperation Council, the strength of the relationship between the Al Khalaf Group and the Saudi Arabian Government, or the risk to existing trade with Saudi Arabia or elsewhere referred to in the February 2013 Cabinet paper. We are concerned about the lack of robust analysis and the quality of information provided to Cabinet on this matter.

3.46
In our view, a consequence of the shortcomings of the Cabinet paper was that the settlement component relating to the grievance was not reflected in any subsequent arrangements. This lack of transparency about how the contract for services would settle the dispute has led to the concerns from the New Zealand public about the nature of the payments made.

13: See paragraph 4.3 – this was the $4 million payment.

14: The Cabinet Manual is available on the website of the Department of the Prime Minister and Cabinet, www.dpmc.govt.nz.

15: See Cabinet Manual, pages 63-64. Part 3 of that manual covers the general framework of Ministers' relationships with the State sector.

16: Cabinet Manual, paragraph 5.11.

17: CO (11) 6. This was subsequently replaced by CO (15) 4, 3 June 2015, Proposals with Financial Implications and Financial Authorities.

18: The Cabinet Manual states at paragraph 5.37 that "Ministers are responsible for the papers they submit to Cabinet ..."

19: The Cabinet paper uses the term ratification. However, before the drafting of the Cabinet paper, officials advised that the obstacle was to the signing and ratification of the free trade agreement with the Gulf Cooperation Council.

20: The Treasury must be consulted on all papers with financial, fiscal, economic, or regulatory implications, or that contain recommendations on expenditure or revenue.

21: The two forms of settlement payments that the government can make are compensation payments and "ex gratia" payments (payments made out of a sense of goodwill). Compensation payments envisage that there is a policy decision to settle a potentially valid legal claim and that the settlement will provide the government with legal reassurance that no future claim can be filed against it on the particular issue. "Ex gratia" payments envisage that the government makes a policy decision that there is a moral obligation to settle a wrong (that is, create goodwill with the payment), even if there is not a legal claim that has been or will be filed against it.

22: CAB Min (13) 4/7.

23: See paragraph 7.31 and footnote 41.

24: We discuss our role further in Part 4.

25: See footnote 26.