Gulf project market: The $2 trillion question

City of Silk, Kuwait

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In the end, it was Saudi Industrial Property Authority's announcement of its Sudair Industrial City development in late February that was responsible for the Gulf project market breaking through the $2 trillion barrier. According to the MEED Projects tracker, the $40bn scheme means the value of projects across the region now exceeds this figure for the first time.

It is fitting that the project to take the market over the threshold was in Saudi Arabia. With the largest population and huge oil reserves, the kingdom is responsible for much of the Gulf's growth. Alongside other relatively underdeveloped markets, such as Kuwait, it can also do much to help sustain that growth.

However, the region as a whole faces huge challenges in maintaining its momentum, and it is not yet clear how it will deal with them.

The $2 trillion event is an important watershed, marking not only a significant milestone in the development of the Gulf, but also demonstrating that the regional boom is far from over. It is now on the verge of transforming the Gulf from a wealthy but sleepy oil hub into a global powerhouse.

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Regional transformation

"The scale of the project market and the pace at which it is growing underscores just what a transformation is taking place in the region," says Simon Williams, economist at HSBC. "We are going to look back on this time as the period when there was a fundamental shift in the scale and nature of the regional economies, and  these projects are idiomatic of that change."

The figures are impressive. The $2 trillion total is more than double the combined gross domestic product of the six GCC economies. And far from slowing down, the projects market is growing faster, rising by 40 per cent, or nearly $500bn, over the past year. Indeed, at the current rate of expansion, the total could hit $2.5 trillion by the end of 2008. The question now is whether the kind of growth experienced so far can be sustained in the long run.

There are signs that it may not. The construction sector, which includes air and sea ports, roads, rail, real estate and general civil engineering work, is by far the largest component of the project market, accounting for more than $1.17 trillion of the total. Spurred on by legislation first introduced by Dubai (UAE) in 2002 allowing non-GCC nationals to buy property, and since copied elsewhere, the sector has prospered by tapping into hitherto hidden demand.

But as thousands of new housing units and real estate projects are built across the region to cope with the population influx, questions have been raised about the ultimate demand for all these developments. A comprehensive study carried out by MEED last year revealed demand should stay marginally ahead of supply in the largest market, Dubai, until 2010. But beyond that, it is less clear if there will be enough people to fill all the schemes that are planned.

Population growth

Elsewhere, the outlook is even less certain. The untested market of Saudi Arabia is building at least five new cities to house a growing population. Kuwait is also planning the gigantic City of Silk project, which, at a cost of $77bn and with housing for up to 750,000 people, is the largest project in the region.

In the absence of legislation to encourage demand from outside the GCC, it is difficult to see how such massive developments will be filled. If they do not attract enough residents, it could prompt a slowdown in the project market.

Another factor that could dampen growth is the steep increase in housing costs. In Dubai and Abu Dhabi, it costs about twice as much to rent the same property as it did three years ago, despite the introduction of rent caps. A three-bedroom villa in Dubai costs AED2.4m ($654,000) today, compared with AED700,000 four years ago. If the cost of accommodation keeps increasing, it may simply slip out of the price range of most people, killing demand and threatening the viability of future projects.

Rising material costs, a general lack of contracting capacity and a shortage of skilled and unskilled labour are other vital factors. For example, a tonne of steel today costs $4,000, compared with $2,000 four months ago. Aggregate in Qatar now costs three times as much as it did five years ago. There is a severe shortage of cement across the region, and projects are having to slow down while waiting for materials to become available.

The most recent study carried out by international cost consultant Davis Langdon for MEED shows that average wage rates for skilled labour have jumped threefold in as many years. Unskilled labour rates are also rising fast. Threatened with industrial action, contractors are quickly raising basic rates of pay for labourers, buffeted by the falling value of the dollar-pegged currencies and the rising cost of living.

The issue is particularly pertinent given the fact that of the $2 trillion being spent on Gulf projects, just $490bn, or less than 25 per cent, is actually under construction. If the situation is bad now, it can only get worse when work starts on the other 75 per cent.

"It is all growing too fast," says Phillipe Dessoy, general manager of Belgium's Six Construct, one of the largest contractors active in the region. "There is a shortage of equipment, staff and cement. In my view, it is not sustainable."

The hydrocarbons and power and water sectors face the same problem. Today, more than $420bn is being invested in the region's oil and gas industries as crude exporters ramp up capacity to meet soaring global demand. Delays are commonplace as engineering, procurement and construction (EPC) contractors struggle to keep up. Saudi Aramco, one of the most experienced and professional of the world's national oil companies, has admitted to delays on several of its largest upstream developments.

"EPC costs have risen by about 50 per cent," says Filippo Fantechi, general manager of Dubai-based research company Contax Group. "The reality is that a cracker today costs $1.4bn compared with $900m in 2005. We keep saying we have reached a plateau, but we haven't."

Falling margins

There have already been some casualties. The US' ConocoPhillips, for instance, pulled out of the planned Fujairah refinery project, citing falling margins and cost concerns, while the US' Dow Chemical Company did the same on its planned Sohar project for the same reason.

Delays are even more common. Kuwait lost a year of work after it had to retender its new refinery project at Al-Zour when bids came in two and half times over budget. Qatar's liquefied natural gas trains, which are under construction, are facing delays of several months.

Realistically, however, it is difficult to see a situation where state-sponsored investment in the upstream oil and gas sector falls, because of the urgent global demand for more oil and gas. Similarly, the region's governments have no choice but to invest in the utilities sectors if they are to avoid power and water shortages.

The same cannot be said for the industrial sector. With nearly all available gas being allocated for power generating requirements, several planned projects are without a feedstock allocation. For example, Aluminium Bahrain (Alba) cannot expand because it cannot get any gas to power capacity increases. Progress on a handful of ethylene crackers in Saudi Arabia has stalled because they face similar issues.

Ultimately, it seems inevitable that not all projects that have been announced will be completed. Some, particularly those that rely on private sector funding, will fall victim to rising costs.

But some markets still seem to have plenty of untapped potential. Oil-rich countries such as Saudi Arabia and Kuwait have only just started on their project drives.

It is clear that the projects market is as much a generator of economic growth as a result of it. But it has far wider significance. At a time when the region is often the subject of a negative press around the world, the rise of the new Gulf economies symbolises the potential for a region that embraces modernity and provides better opportunities for its people.

For that reason, it is even more important that the region finds a way to sustain its growth into the future.

Table: The Gulf's top five projects

Source: MEED Projects