After five years of soaring materials costs, falls in the commodities markets are set to bring some relief to the Gulf’s overheating construction sector.
With commodities prices continuing their five-year climb throughout the first half of 2008, there seemed little sign of any respite for the Gulf construction industry as it continued to struggle with rising construction materials costs. But the slowdown in demand for materials in the US and Europe has caused a dramatic change.
With the crunch in the global credit markets triggering fears of slowing economic activity in the US and Europe, demand for commodities has fallen, leading to falls in the cost of key materials. The falls are set to take some of the steam out of the rising cost of construction in the Gulf. But with construction activity continuing to boom, it may be some time before the benefits are felt in the region.
At the start of August, cement, rebar (reinforcement steel bars) and diesel prices in the Gulf were at record highs, according to the latest data from UK-based cost consultant Davis Langdon. In the six-month period from February to August 2008, the cost of cement increased by 12.5 per cent in Saudi Arabia and 23.5 per cent in the UAE.
Price increases for rebar were even higher, with costs in Bahrain climbing by 49.5 per cent over the period to $1,900 a tonne, and in the UAE by 43.5 per cent to $1,525 a tonne. In the region’s biggest steel processor, Saudi Arabia, rebar peaked at $1,600 in August, a rise of 54 per cent in six months. While an easing in global commodities prices would help to take some of the heat out of rising construction costs, there is no sign of any let-up in the other driver of prices: the Gulf’s booming projects sector.
According to Gulf projects tracker MEED Projects, the GCC project market grew more than 25 per cent in the six months to August, with the total value of projects planned or under way in the GCC rising to $2.1 trillion, from $1.7 trillion in February. “There is a tremendous amount of work coming on stream now,” says Steven Coates, regional director at Davis Langdon. “We have been scraping the surface of what is planned in the next five to 10 years.”
Rising materials and labour costs have forced many projects to run over budget and led to governments placing restrictions on the export of key materials in an effort to ensure supply.
“Steel, cement and scrap metal are all banned from export,” says one executive at Al-Ittefaq Steel in Saudi Arabia. “We have had no news as to when this might end but we initially thought it would be about a year. The main reason for the ban was to allow Saudi Arabia to meet its current requirement for projects and to drive down prices. Now that the world markets have seen steel prices cooling, maybe the government will look again at the ban.”
The export ban was introduced at the start of the summer as prices began to reach their peak. One official at Saudi Arabia’s Yamama Cement says the ban came into force two months ago.
“The Saudi ban has definitely had an impact on its neighbours,” says one Qatar-based contractor, who identifies this as the main driver behind Bahrain’s spiralling steel price.
Riyadh has also acted to help contractors that have been adversely affected by the soaring raw materials costs. A royal decree was issued in late June stating that contractors would be compensated for rises in the price of steel, copper, wood and cement. The decree also allows for a doubling in the size of advance payments on government contracts, from 10 per cent to 20 per cent.
The Qatari government has similarly acted to reduce inflationary pressures. “The government has intervened and fixed the price of cement and fuel,” says Phillipe Dessoy, general manager at Belgium’s Six Construct. “It is effectively paying the difference. Anything over QR3,000 ($1,000) a tonne for steel, the government is paying. When you consider it costs $1,400-1,500 a tonne in the UAE, that is a big help.”
This only applies to state-owned producers, which the government has pledged to reimburse. It does not apply to private sector firms, who are responsible for aggregate supplies from Ras al-Khaimah. For aggregate, prices are expected to rise in line with shipping costs.
But there could be some relief on the horizon for the GCC construction sector. Globally, steel prices have collapsed. “Internationally, steel has lost 25 per cent of its value,” says John Short, executive director, steel and base metals, at the Dubai Gold & Commodities Exchange (DGCX). “But these prices are yet to be really absorbed into the local market. Those who bought steel at peak prices in July will not necessarily receive it until October.”
Analysts say numerous factors are respon-sible for the falling prices, but the economic downturns faced by Europe and the US are the biggest contributors. The world’s biggest importers are simply not buying as much steel, while producers have been increasing capacity.
At the same time, costs for producers have risen, which is a key factor behind the peaks in prices demonstrated in the summer. Overheads such as energy prices, iron ore and scrap steel prices have soared.
The cost of iron ore has doubled from 77.35 cents a dry metric tonne unit in mid 2006 to 140.6 cents a tonne in mid-2008.
“It is a growing concern in the steel industry that the iron ore market is dominated by only three companies [Australia’s BHP Billiton, Brazil’s Vale and the UK/Australian Rio Tinto],” Ian Christmas, secretary general of the International Iron & Steel Institute (IISI), told the Arab Iron & Steel Union conference in Doha in March this year. “The increase in the real price of iron ore is well above the real economic cost and is a major problem for the steel industry.”
But as the global market has begun to cool, there are signs that the price drops are beginning to have an impact on the Middle East. “Steel futures on the DGCX were trading at $700 [a tonne] at Christmas,” says Short. “By July, it was $1,530. It peaked at $1,540 and over the past four weeks has fallen to just under $1,400.”
Steel futures trading was introduced to the region in October 2007 and approximately 6,250 futures contracts have traded since then, representing 62,500 million tonnes of rebar. “In that period, 3 million tonnes of physical rebar has been traded in the UAE, and more than 100 million metric tonnes has been traded in EurAsia,” says Short.
“There is a 98-99 per cent correlation between those forward prices and what happens in the physical steel market. So although we have comparatively little trade - 2 per cent of the total for the UAE - we provide a great insight into the direction of prices in the future.”
Regional capacity is also increasing. According to MEED Insight’s Middle East Steel Report 2008, the region produced 21.1 million tonnes of raw steel in 2006 and consumed 41.6 million tonnes of finished goods. Regional production and consumption levels are expected to rise to 35 million tonnes a year (t/y) and 60 million t/y respectively by 2010, with prod-uction reaching 83 million t/y by 2012, a near quadrupling of the 2006 figure. Prices for steel are therefore falling, and regional cement prices are expected to be next.
A series of key studies into the cement sector, one carried out by MEED in October 2007 and another by National Bank of Kuwait in March 2008, forecast overcapacity in the market by 2009-10.
More recent research by MEED demonstrates that in less than 12 months, an enormous 21.4 million tonnes a year of cement capacity has come on line in the Gulf, with the majority of the new capacity in Saudi Arabia and the UAE (see cement projects table at www.meed.com/construction). This brings current regional capacity to 74.5 million tonnes. A further 10.9 million tonnes is scheduled to come on stream by the end of the year, bringing total capacity to 85.4 million tonnes.
This means there could already be over-capacity. In 2006, regional cement consumption stood at 50.1 million t/y, and with dem-and growth forecast at 14 per cent a year, the figure for this year is expected to be 65.1 million tonnes.
Saudi Arabia may be the first place to experience a drop in prices. Despite the government appealing to cement producers to stabilise prices, a rise of 12.5 per cent since February has resulted in 50 kilogram bagged cement selling at $6.40. However, the current export ban is likely to affect prices, as is intended by the government.
Research by MEED shows that, in the past 12 months, 9.9 million tonnes of annual capacity has come on line, bringing production to 39 million tonnes a year. Consumption in 2007 stood at 33 million tonnes, and even at an estimated 10.5 per cent growth rate, consumption falls several million tonnes short of total production. At some point, prices will fall as, with an export ban in place, producers find themselves fighting for custom.
Meanwhile, in the UAE, where prices have peaked at $6.80 a bag, a raft of new cement plants have also come to market. Four new facilities - the Jebel Ali cement factory, the Fujairah cement plant, Nael cement factory and the second phase of the Mussafah plant - have brought an additional 8 million t/y of capacity into the UAE, bringing current production to 22.8 million t/y.
Demand in 2007 was 17 million tonnes and even though the UAE has the region’s highest demand growth, at a rate of 17 per cent a year, there is still expected to be a cement glut by the end of 2008. Demand is expected to reach 20 million tonnes but another two plants with an additional 4.1 million tonnes of capacity are set to bring total market production to 26.9 million tonnes.
The knock-on effect of such growth in capacity and potential oversupply is that the region’s fragmented market might become less resilient to the attentions of international companies as prices fall and competition increases. The world’s top-five producers - Switzerland’s Holcim Trading, Italy’s Italcementi, Mexico’s Cemex, France’s Lafarge and Germany’s Heidelberg Cement - have all been more active in the region in recent times.
All are seeking to increase further their penetration in the market, either through joint ventures, or through the acquisition of local companies. The most notable entrant is Lafarge with its purchase of Orascom Cement for $12.9bn in December 2007.
However, limits on international ownership will ensure that Gulf states retain control of the industry and joint ventures with the inter-national giants will be the more likely mechanism used by the global giants to enter the market. Italcementi has undertaken such a project by signing a co-operation agreement with Saudi Arabia’s Arabian Cement Company (ACC) to pursue joint opportunities in the Middle East, starting with the 3.2 million-tonne Labuna cement plant in Saudi Arabia.
Overall, the market is adjusting to the continuing high demand for construction materials and as Gulf capacity increases and imports fall, prices are likely to moderate, bringing construction cost inflation down to more manageable levels.
The global adjustment of oil prices will also ease the pressure, particularly for the UAE, where price rises are felt most acutely.
So it seems that in terms of materials price inflation, the worst is finally behind the Gulf construction sector.
Contractors seek compensation
As materials prices have escalated so quickly in reaching their summer 2008 peaks, contractors have found it increasingly difficult to predict how such changes will affect project costs.
“We are suffering a loss on some contracts and have gone back to clients and asked them to be fair,” says Phillippe Dessoy, general manager at Belgium’s Six Construct. “Some say they will consider it.
“It means we choose to work for clients such as Aldar [Properties] who compensate for escalations. Emaar [Properties] has also agreed to pay for some rebar [reinforcement steel bar] escalation.”
Most developers and government agencies are aware that to maintain good relationships with the best companies, they must share the risk. Escalation clauses are increasingly being included in contract terms.
“Contracts that have been signed in the past six to 12 months have escalation clauses for rebar and cement,” says Dessoy.
By far the most progressive developer to date has been Abu Dhabi government-owned Aldar, which has signed a swathe of joint venture agreements with contractors and suppliers.
By guaranteeing long-term supply of projects for contractors and sharing the risk of market price fluctuations, the company guarantees it gets the best firms to work with.
It has signed joint venture agreements for projects, including the UK’s Laing O’Rourke on Al-Raha beach and Bahrain-based Cebarco on Yas island.
At the same time, it is signing long-term agreements with materials suppliers, such as the UAE’s Arkan Building Materials Company, ensuring it can order materials early and secure competitive prices.
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