Bottoming out

30 July 1999
SPECIAL REPORT CONSTRUCTION

The rapid recovery in oil prices since the latest OPEC cuts began to bite bodes well for construction projects that have stalled because of the downturn. Contractors are still short of new commissions but the rebound in business confidence should stimulate activity after a quiet period. MEED reports

Like the swing of a pendulum, construction activity in the oil- producing states of the Gulf states goes up and down in tune with broad movements in the oil price. Until the spring of this year, prices had been heading down remorselessly for more than two years. The decline in earnings had stifled economic growth, sent state budgets deeper into deficit and dented confidence among private sector investors. The downturn in new project activity that ensued was predictable as governments reduced capital spending and investment in the all-important energy sector nose- dived in response to the gloomy prospects for oil, gas and downstream products.

It may be too early to say that the market has bottomed out but the key ingredient for an upturn is now in place. Oil prices are back around $18 a barrel and are strengthening by the day. The consensus view is that they should stay in the $18-20 range through to next year, even allowing for a weakening of OPEC's remarkable compliance rates. Budget deficits will not be as bad as expected, making possible the release of funds for urgent projects. Stronger commodity prices may revive some of the stalled industrial expansion projects, particularly in the petrochemicals sector, making them more bankable. Private investors should also find the return to growth encouraging after the stagnation of the past 18 months and new project commissions can be expected to come forward.

Exceptions

Despite the sluggish pace of major project activity in some markets, there are noteworthy exceptions. Egypt has become a magnet for new investment as quickening privatisation and an increasingly confident and ambitious private sector stimulate demand. Prestige hotel and residential developments have been matched by major infrastructure developments such as the Toshka irrigation scheme in Upper Egypt and new ports at Suez and East Port Said.

In the Gulf, the markets in Dubai and Abu Dhabi remain extremely active, with the slowdown that some contractors describe being strictly relative, given the hectic pace of activity in recent years. Despite the seeming profusion of upscale facilities already available, several new luxury hotel projects are planned in Dubai and will be up for bidding in the coming months. The main complaint among contractors is that the buoyant market has attracted so many contenders for new contracts that margins are being squeezed to the limit.

It is a similar story for the major industrial engineering projects. Many have been put on hold or scaled down due to high cost or cash shortages or both, but those that have survived are attracting intense competition from international companies hungry for work. South Korean engineering and construction firms, many with spare capacity due to the downturn in Asia, are bidding particularly aggressively, to the concern of rivals from Europe, the US and Japan that have traditionally dominated the market. Some say they simply cannot compete at the prices being quoted by the Koreans, who are overcoming the legacy of doubt about quality and technical competence on sophisticated projects which has hampered their progress in the Middle East in the past. Bidding with bargain basement prices, the Koreans seem set for a sharp rise in their portfolio of regional work.

Activity in Saudi Arabia has been hard hit by the slowdown in spending by state energy company Saudi Aramco and the industrial giant Saudi Basic Industries Company (Sabic). Aramco is concentrating its capital resources on a major gas project and Sabic affiliates have delayed or cancelled several schemes because of low commodity prices and the uncertain outlook. By contrast, the Saudi electricity sector has been quite active and most of the contracts have been let for the new power station project at Shuaiba, where construction work has begun.

The mid-July release of tenders for two major gas pipelines in Oman is a welcome boost for international contractors after a fallow period in a market with huge potential for downstream industrial growth. The two lines, which will be built by separate consortia, are part of the core infrastructure to supply new industries and power stations which will depend on the gas supplies they will bring from central Oman to the coast at Sohar and Salalah. The consortia, which include two Korean groups, will have to raise commercial financing to fund the two projects, which are expected to have a combined value of around $580 million.

In the northern Gulf, market conditions in Kuwait have been subdued. The suspension of parliament delayed approval for many government projects and there is now a backlog waiting to be cleared. Kuwait is keen to develop the potential of build-operate-transfer solutions (BOT) and the method is being applied to an increasing number of projects. In a recent first, Kuwait International Airport let a landmark contract to develop facilities at a new arrivals terminal on a BOT basis and the concept is soon to be tested on the $350 million Sulaibiya wastewater treatment plant.

Qatar responded bluntly to the oil price crash, slashing capital spending on state projects, which has left local contractors ever more reliant on civil works associated with the big ticket industrial schemes. Most of these have succeeding in raising commercial financing and have also found their costs falling as contractors compete fiercely for the business.

Across the Gulf in Iran, most of the activity of immediate interest to international contractors is in the oil and gas sector where foreign firms are returning to the upstream for the first time in decades. Sanctions are now a fading issue and the restoration of export credit facilities could generate more business of interest to international firms.

If oil prices can hold onto the gains of recent weeks, international interest in the region as a whole is likely to pick up as the prospects for activating key projects improve accordingly.

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