Existing government contracts, known as standard purchasing regulations, do not allow for inflation, with no escalation clauses included to take account of prices rising during the term of the contract.
This places all the risk of rising prices onto contractors who, as a result, are becoming more nervous about getting involved in government-led projects.
Several contractors have written to the government calling for changes to the terms of their contracts because they are understood to have complained about struggling to deliver projects on budget and are facing massive losses on fixed-price contracts entered into two or three years ago.
The contracts did not take into account the massive rise in steel and cement prices.
As yet, there is no indication of when or how the compensation will be carried out. However, the firms are likely to have to complete the contracts before any additional payments are made.
“They have written to the Council of Ministers asking for some kind of resolution,” says Khaled el-Sief, chairman of the local El-Sief Engineering & Contracting.
“A decision was taken to agree to compensate contractors for the physical increase in prices, but this has still not been implemented. Provided they can document it, and they must finish the job first, they can apply to the Finance Minister for compensation.
“No one understands how this mechanism is actually going to take place, however. It is still under study at the Finance Ministry.”
While such measures will be welcomed by large contractors, smaller firms could still be financially crippled by attempting to complete a project before claiming for compensation.
The cost of steel has increased from SR2,400 ($641) a tonne to SR4,000 a tonne in less than eight months. Such price rises over a fixed-price, three-year contract can be devastating for smaller contractors.
Bilal Ansari, division manager at the local Saudi Oger, the largest contractor in the region, confirms that the government is planning to help companies struggling with price rises. “It has set up a committee at the Finance Ministry to receive the claims, but there is nothing done yet, and how it is done I don’t know,” he says.
“There is now a committee to study the claims of the contractors, especially on long-term contracts signed in 2004, 2005 or 2006, over which period the price of steel has more than doubled. But so far, nothing has materialised. They say they are willing to look into this.”
Contractors are attempting to offset potential losses by incorporating higher contingency clauses into their bids for new projects.
“Before we put a contingency of 2 per cent, now it could be 5 per cent or even 7 per cent,” says Ansari. “Now when you are pricing, contractors are afraid. It would be better if the government were to take on the risk itself.”
Despite the difficulties, most contractors are still keen to bid for projects. Shibh al-Jazira Contracting Company, which is constructing the SR900m northwest section of the Riyadh ring road, has made a SR100m loss on the project because of steel price rises.
Despite the losses, Nayef Othman, deputy project manager, says the alternative of not taking on the work is even worse. “What can you do?” he says. “Our biggest projects are with the Transport Ministry, with which we have been involved for 30 years. If you stop, you will just lose more.”
However, the number of bidders for contracts is falling. According to Othman, 15 to 20 contractors would previously bid for work, but on many occasions recently government contracts have had to be tendered several times to attract competitive bids.
Ahead of any wider changes by Riyadh, some government-linked bodies are considering introducing escalation clauses to ensure their projects attract enough interest and do not suffer delays.
“We may consider inflation clauses in contracts so as not to put off developers,” says Tawfig al-Rabigh, director general of the Saudi Arabia Property Investment Authority (Sapia), which is developing the $40bn Sudair City north of Riyadh.
Reimbursing contractors for losses through inflation is not the only measure being undertaken by the government. Abdullah ibn Ahmed Zainal Alireza, the Commerce & Industry Minister, recently set up a taskforce to find ways of easing the impact of inflation on the construction sector.
“You have to understand that this situation was not anticipated,” says El-Sief. “When a country has been operating for the past 10 to 15 years in minimal inflation, to be hit with this massive increase is difficult.”
The taskforce will explore ways to help reduce the impact of inflation, such as increasing capacity in the local market and making it easier to import some materials by eliminating customs duty.