The $2.7bn contract to build Jabal Omar, the enormous mixed-use development located next to the Grand Mosque in Mecca, involves the kingdom’s two biggest contractors joining forces to build a project that will include the world’s largest retail area.

The contract between Saudi Binladin Group and Saudi Oger embodies the new wave of opportunities sweeping the kingdom, and provides an example of how Saudi Arabia is pursuing its economic diversification.

Capitalising on record oil revenues, the kingdom plans to redirect investment inwards and encourage greater foreign direct investment (FDI). Plans to build six economic cities in Jeddah, Rabigh, Medina, Tabuk, Hail and Jizan are alone expected to attract $80bn in investment and create 1 billion jobs.

Inherent challenges

By stretching resources and manpower, projects such as the $26.6bn, 168-square kilometre King Abdullah Economic City (KAEC), in the Western Region, highlight inherent challenges as well as opportunities for the construction sector. A raft of further projects are set to be announced throughout 2008. MEED Projects puts the total value of work planned in the kingdom at $170.6bn, but less than 10 per cent of this is currently under way.

Although some major companies are capable of delivering projects on such a scale, smaller firms will simply not be able to compete with the resources or capability of Saudi Oger and Saudi Binladin, and will therefore be forced to operate at a secondary level.

MEED’s top 50 contractor survey demonstrates the size of projects in Saudi Arabia, as firms from the kingdom dominate the list. Saudi Oger tops the 2008 survey, doubling the 2007 figure of new project wins from $2.5bn to $5.35bn. This is buoyed by the Jabal Omar development. The project will be built over 230,000 square metres and includes six five-star hotels, seven 35-floor residential towers, a four-level retail concourse and a car park for 12,000 cars.

Once completed, the development will accommodate up to 40,000 residents and have a traffic network capable of transporting 8 million pilgrims. Other key projects include the $132m contract to build residences at KAEC, and $186m for the first phase of the development of King Abdullah road.

Saudi Binladin may have lost the top spot to its closest rival, but has again significantly expanded of its order book, building on its $4bn project wins in 2006 with an estimated $4.5bn worth of new projects awarded in 2007.

For the first time, railways account for part of the firm’s project wins, including the $700m Saudi Company for Railways (SAAR) minerals railway, package 1. The company could add to this in 2008 if successful in its bid to build the landbridge rail link between Jeddah and Riyadh.

Another key project secured in 2007 is a $275m contract for the residential district in the KAEC. The development, which comprises a sea port, industrial district, waterside resort, financial island, residential district and education zone, is expected to be completed in 2016.

According to the survey, firms that enjoyed a strong 2006 have not necessarily repeated it in 2007. Saudi Freyssinet’s 2006 figure of $260m has more than halved to $137m. Shibh al-Jazira has suffered an even bigger reduction, going from $400m worth of projects awarded in 2006 to $137m in 2007. Awards for Al-Khodari & Sons Company, meanwhile, have fallen from $132m to $46m.

Several contractors say that despite submitting the lowest bids for contracts, awards have often failed to materialise. The contractors question whether some public projects are being financed on current cost estimates.

One contractor, based in the Eastern Province, says the company turned in the lowest bids for 10 government projects totalling $491m, but the orders received were just a fraction of this figure. The government says budget set-up complications were to blame, and the contractor was asked to extend the period for which the bids were valid.

Cost increases

“It is evident that tenders are being called for based on budgets worked out some years back,” says the contractor. “Thus they do not consider the significant increases in almost every cost component, be it materials, equipment or manpower - and not forgetting the eroded purchasing power of the dollar, and therefore the Saudi riyal.”

Another Saudi-based contractor estimates that at current inflation rates, construction costs in the region will increase by 5-10 per cent on some packages from a year ago. In addition, many firms are taking on more work.

Al-Arrab Contracting Company increased the value of its new projects from $732m to $1.36bn in 2007. The bulk of this came from securing the third phase of the Health Ministry’s $959m programme to build 1,030 healthcare centres. Al-Arrab, in a consortium with Haif Trading and Al-Mansouri Contracting, won a $426m package in August 2007.

The company was also recently awarded eight construction packages for the Umm al-Qura University complex in Mecca. The SR550m ($146m) deal includes lecture buildings, student accommodation, a medicine college, a pharmacy college and extension of the university hospital.

Such acceleration in the construction landscape in a short space of time has naturally had an impact on those operating in the sector. “In terms of project diversity, size and number, it was very positive,” says a Riyadh-based contractor. “But in terms of capacity, we started experiencing problems with resources, manpower and lead items.”

Saudi Arabia has particular problems attracting manpower. “One of the main problems in Saudi is finding people,” says a Jeddah-based contractor. “It is very difficult to get people to come here when they can find work elsewhere in the Gulf.”

The Riyadh-based contractor says while the smaller contractors may have escaped these problems in 2007, there will be a more general impact in 2008. “Before it was just the big firms; now contractors and clients, even the smaller ones, are going to feel it,” he says.

In 2007, the contractor adds, delivery challenges emerged as resources became stretched. “In 2008, the main challenge will be getting good people in the construction industry,” he says. “Clients are also understaffed, in terms of providing personnel for the ministries, for the clients and for investors. It is a serious issue.”

Contractors say complex projects are most likely to suffer from cost escalations, especially in the energy sector. “The more complex projects - the ones that include mechanical or electrical packages such as power plants, oil and gas installations, and petrochemicals plants - are going to experience serious delays from their anticipated finish dates,” says the Riyadh-based contractor.

But some contractors point to their diversified base of companies as the reason they will not struggle to meet demand. Such companies are supported by a large number of affiliates and sister firms, which ensures resources are not lacking.

“The big projects need this size of company, which can secure resources, and have the ability to work together [with affiliates] towards a plan,” says one contractor.

Contractors are aware of the opportunities facing them in 2008. The range of projects, in terms of scale and ambition, overshadows virtually every other country in the region. But there are concerns that some could struggle to meet demand, capacity and delivery challenges on large-scale projects.

Two major contracts due in 2008 are the Saudi Landbridge and Mecca-Medina rail link, worth an estimated $5bn and $6bn respectively. The Landbridge will link Jeddah and Jubail, and it is hoped it will boost cargo volume at Jeddah port by 19.5 per cent to 30 million tonnes. Pacific National, Samsung Corporation and Saudi Binladin are among the firms bidding for the construction contract.

Alleviating congestion

The Mecca-Medina rail link is designed to alleviate congestion between the two cities, especially during the busy pilgrimage season. The route will stretch for 444 kilometres and Saudi Oger, Saudi Binladin, OHL, Al-Rahji and Al-Shoula Holding Group are prequalified for the job.

With larger projects and restricted access to skilled labour and resources, smaller companies may need to merge to match the larger players. Contractors say this is a possibility and although there has been no merger and acquisition activity so far, it could be on the horizon as the market grows in 2008.

“For 2008, the secret is delivery,” says one contractor. “The contractor who can deliver is the contractor who will get the job. It is not a matter of being better or more competitive, and it is not about being the lowest bidder now. It is about delivery.”

Table: Saudi Arabia project award ($m)