Construction market to get worse before it gets better

09 November 2015

Tightening market means 2016 will be a challenging year for construction companies in the region

Special Report contents:

Heightened political instability and weakening economies across the region have meant 2015 has been a year of change for the region’s construction sector.

Unlike the previous years, when the GCC was in an expansionary mode, 2015 has been a disappointing one for contractors and consultants. Decision-making has been sporadic and new contracts have been slow to be awarded as security issues and low oil prices negatively affect the region’s economies.

As firms prepare for 2016, the expectation of company executives who attended the advisory panel for the MEED Construction Leadership Summit in Dubai on 22 October was that the negative headwinds of 2015 will remain, meaning the prospects for the construction sector are likely to get worse before they get better.

“Political instability is part of the region, it is always there,” says a regional consultant. “To some degree for the GCC, it is a good thing as it tends to drive up oil prices. The problem now is that there is political instability and low oil prices.”

Political instability has preoccupied the region’s leaders, who, instead of focusing on development projects, are now concentrating on foreign policy and military operations in regional hotspots such as Yemen and Syria.

Opportunity cost

There is also an opportunity cost. Saudi Arabia, the UAE, Qatar and Bahrain, have committed forces to these conflicts and the funds spent pursuing military and political objectives will not be spent on development projects at home.

“The region will be spending tens of millions of dollars every day on military operations,” says an international contractor. “With budgets already squeezed by lower oil prices, you have to ask whether this spending is being made at the expense of investment in infrastructure at home.”

The sector most obviously hit by low energy prices is the hydrocarbons sector. Over the past 18 months, many projects have been cancelled, and although there has been progress on some schemes – notably in Kuwait, where multibillion-dollar refinery contracts have been signed – for the most part progress has been slow.

Instead of refining and downstream investment, national oil companies (NOCs) are concentrating on maintaining production so they can pump record volumes of crude and maximise their revenues when prices per barrel are low. “The focus now placed on maintaining production means we have been quite busy this year,” says a regional contractor working in the oil and gas sector.

Greater impact

International oil companies (IOCs) are feeling the effects of low oil prices even more sharply than the NOCs. UK/Dutch Shell recorded a loss of $6.1bn for the third quarter of this year, compared with a $5.3bn profit last year. The UK’s BP fared better; it registered a profit, yet was still down by 40 per cent in the three months to the end of September, compared with the same period last year. Commenting on their results, both firms said they will have to find billions of dollars more savings in the coming year.

Although the majority of these savings will come from cutting investments in regions where the cost of extraction is higher, budgetary pressure is expected on projects in the Gulf also.

“We are working for an IOC on two projects,” says an international contractor. “One project is proceeding well, but there are major concerns about the other and we are having a tough ride.”

While the economic viability of developing new oil and gas schemes is questionable, the need for developing civil and social infrastructure remains a clear priority for the region’s governments. “The oil price is what it is,” says a US-based consultant. “Populations are still growing so the development objectives remain the same.”

Infrastructure demand

The problem in late 2015 and 2016 will be that although the need for new infrastructure remains, the ability to pay for it has weakened. This funding conundrum did not manifest itself until later in the year as project owners remained busy tendering new work. But now, with tenders submitted and evaluated, they do not have the funding required to proceed.

The most explicit evidence of the predicament regional clients face came when the Saudi Finance Ministry ordered government bodies to not award any contracts for the rest of the year.

According to regional projects tracker MEED Projects, the negative outlook for the rest of 2015 is a major change from the strong start to the year, when $8.4bn of deals were awarded in January, followed by $6.4bn of awards in February and $7.2bn of awards in April. From May, the market has been in steady decline, with just $10.9bn of awards over the past five months, giving a monthly average of just $2.2bn.

Costly funding

Lower oil prices have depressed government revenues and reduced their deposits with the local banks. This has negatively affected loan-to-deposit ratios, making it much more difficult for both private and public sector projects to attract funding.

“We have a tough two or three years ahead of us,” says a UAE-based banker. “Liquidity will be a problem and it will drive up the cost of funding. If the Fed [US Federal Reserve] increases interest rates, there will be a double impact. Costs will go up even more.”

Although liquidity has tightened, the region still has money. The concern is that unlike before when the region offered compelling investment opportunities, funds are now leaving the region and moving to markets such as North America and Europe.

“There are concerns about the absence of liquidity, but I would suggest there is liquidity in the market; we just are not watching where it is going,” says an international contractor. “If you look at where regional organisations are investing, it is outside the region.

Overseas investments

The most recent example of regional players investing outside the region came in late October, when Qatar Investment Authority (QIA) bought a 44 per cent stake in the $8.6bn Manhattan West mixed-use development project in New York along with Canadian developer Brookfield Property Partners.

Although Qatar continues to invest in infrastructure, growth rates in the region are expected to be subdued at about 3 per cent over the coming years. As a result, Doha and other regional investors are now making investments in markets such as the US, which have become relatively more attractive than in the past.

The flow of money from east to west reverses the post 11 September 2001 trend, when the region withdrew funds from the West and instead invested in the region, notably in Dubai’s then nascent freehold property market.

The liquidity crunch is preventing projects from securing the funding they need to move forward, and for the projects that are financed the cash flow has tightened. “Advanced payments have been slashed so projects are cash-negative from the start,” says an international contractor. “Contractors are becoming banks as we are funding the first year of construction on most projects.”

Stage payments have also been affected. “Clients have been close to bankruptcy in the recent past, so they are reluctant to release payments unless they really have to,” says an international contractor.

Payment blues

Laggard payments are beginning to have serious consequences for the industry. Some major contractors have been unable to meet their payroll obligations this year, leaving employees, normally professional staff rather than labour, unpaid.

In the longer term, the challenge will be to keep these people employed. Work secured in 2013 and 2014 is now being completed, and unless the pace and scale of contract awards improves, resources will have to be pared.

The immediacy of the problem will depend on the company and the scheduling of its order book. Firms working on contracts that tend to have shorter programmes, such as smaller building schemes, are feeling the impact first, whereas the companies working on larger infrastructure schemes with longer delivery periods can rely on these projects for turnover for a few more years.

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