Seoul strengthens regional ties

19 June 2009

South Korea’s links to the Middle East have been founded on the region’s energy exports. But thanks to the persistence of its contractors, trade is no longer one way.

In the second week of June, the foreign ministers of the UAE and South Korea met in Seoul to look at ways of further strengthening business ties between the two countries. The visit by the UAE’s Sheikh Abdullah Bin Zayed al-Nahyan was timed around the emirates’ recent push into nuclear power.

A Korean consortium is bidding for the construction deal and already appears well placed to win the contract. The two ministers also discussed how Korean companies could further expand their share of the energy and construction markets, a concern for US and European contractors already struggling to compete with Seoul’s strength in the contracting sector.

Traditionally, oil and gas have been the bedrock for South Korea’s economic ties with the Middle East. The region provides 85 per cent of South Korea’s energy supplies, which makes the Asian industrial giant the world’s fifth-biggest oil importer.

South Korea’s reliance on the region shows few signs of abating. In the first two months of 2009, the latest period for which figures are available, its crude oil imports from the Middle East rose by more than 13 per cent year on year after shipments from Africa dropped.

Two-way trade

But the trade flows are not just one way. South Korean contractors are adapting to the changing global economic climate by tapping into a host of new business opportunities in the Middle East, including the power, water and nuclear sectors.

South Korea also continues to make the most of a strong appetite in the region for its exports, including electronics, cars and plant machinery. Sales of South Korean automobiles, ships, trucks and heavy construction equipment to the region all increased strongly in 2008, with demand from Saudi Arabia and the UAE in particular.

Despite the Asian financial crisis of the late 1990s and the current global economic downturn, trade flows between Seoul and the region remain in good shape. While cars and consumer goods have historically typified the connection between the two, Korea’s enterprising contracting companies are now the lynchpin of its success in the region.

A decade ago, Korean contractors were struggling to establish any sort of permanent foothold in the Middle East. Even as recently as 2003, many of the top engineering and construction firms were largely excluded from bidding for work in much of the region.

This was largely due to the fact that they were pigeonholed as civil contractors lacking the relevant experience and engineering capabilities, even though many of the leading players could point to experience in Asia.

Despite these barriers, the Middle East remained a highly attractive proposition, offering cash payments and the lure of long-term, high-volume business.

The persistence of Korean firms over many years is finally paying off. A decade on, Korean contractors form the basis of almost every bid list across all types of sector. For many Korean companies, it is their second or even third assault on the market.

Korean contractors first ventured into the Middle East in the oil-boom era of the 1970s, when they mainly focused on heavy civil engineering. Hyundai and Daewoo Corporation carried out a string of prestigious projects in the construction sector, while contractors such as Dong Ah Industrial Company built much of Libya’s Great Man-made River in the 1980s.

But many departed just as quickly, following the six-year oil slump that began in 1980, when it again proved more lucrative to concentrate on the East Asian infrastructure boom. Most Korean firms were content to expand closer to home in the 1990s, until the South Korean economic miracle came to a grinding halt in 1997.

When the economy contracted by 3.8 per cent in the first quarter of 1998, it was the first time since 1980 that Seoul had experienced negative growth. Debt-laden business conglomerates, or chaebol as they are known locally, found themselves in the unfamiliar position of having to restructure their unwieldy business empires.

With massive debt burdens and banks facing difficulties raising their own financing, the government was forced to intervene with a $58bn rescue package provided by the Inter-national Monetary Fund (IMF).

The effect on the chaebol was immediate, with 11 of the 30 largest collapsing between July 1997 and June 1999.

Probably the most high-profile collapse involved Daewoo, which was declared bankrupt in 1999, owing its creditors $10.6bn.

The massive Hyundai group was also dismantled with its subsidiaries spun off in varying states of financial health.

For several years afterwards, Korean companies were seen as a poisoned chalice.

One former senior executive at state-run oil giant Saudi Aramco recalls the doubt about Asian, and in particular South Korean, companies at the beginning of the decade.

“There was nothing wrong with their project skills, but we did have doubts over the health of the actual companies themselves,” he says.

Aramco staged a visit to Korean contractors in 2003 to assess the extent of their recovery since the 1997 financial crisis.

Despite such an open show of diplomacy, six years later, some Korean contractors are still waiting to be included on lists of approved contractors for Aramco projects.

After experiencing such volatility, it is little wonder therefore that the latest global economic downturn has privately been met with a degree of nonchalance by some Seoul-based executives.

“When you have survived what we went through a decade ago, you get a pretty thick skin for the ups and downs of the market,” says the chief executive officer (CEO) of one Seoul-based engineering, procurement and construction (EPC) contractor. “This is a big down for sure, but amazingly in Korea, we have seen worse.”

The restructuring of the large Korean conglomerates earlier this decade has largely laid to rest any lingering concerns over their balance sheets.

Through dozens of project wins in a variety of sectors in the region, Korean contractors have shed their ‘low-quality’ tag and become fearsome rivals to established contracting firms from the US, Europe and Japan.

Importing energy

Yet the structure of South Korea’s export market and reliance on importing 97 per cent of its energy means its export strategy remains massively skewed by international oil prices and the fluctuating exchange rate.

High oil prices over the past few years resulted in total imports from the region standing at $101bn in 2008, compared with exports of $26.6bn.

The sum of trade with the GCC countries, which comprises both imports and exports, increased by an average of 30.6 per cent between 2004 and 2008.

With the oil price plummeting to about $60 a barrel at the end of May – from a record of $147  a barrel in July 2008 – that trade deficit will almost certainly narrow this year.

Seoul says that in the first two months of 2009, the average unit price of crude fell to just $43.45 a barrel from an average of $90.92 in 2008.

While relief on the oil-price front is welcome, the global economic downturn has had a debilitating impact on Korean firms operating in the region.

National oil companies, utilities and cons-truction firms have either cancelled their mega-projects or put them on hold as they review the market and plan their strategies more carefully.

Korean firms, which have become used to healthy margins from their business in the region every year, are now in a holding pattern.

“We are sitting and waiting like everyone else,” says one executive at GS Engineering & Construction, which has about $5.2bn worth of backlogged work in the region.

“It is true we are facing a lot of difficulties, not only GS, but all other Korean companies operating in the Middle East.

“So many projects are delayed or frozen until the latter part of this year, and that is obviously a problem for us. We hope it will change later this year.”

Some of Korea’s biggest export industries have also been hit. The country’s shipbuilding yards have been unusually quiet, with orders falling by 32 per cent in 2008 and a similar decline expected this year.

This is partly down to a decline in new orders from gas-rich Qatar and oil-rich Saudi Arabia, which are now consolidating their fleets, rather than embarking on further -expansion.

The South Korean government recently pledged to double its planned financial -support for troubled shipbuilders to $7bn, in an effort to ease liquidity problems and an ongoing order drought, although the larger shipyards are unlikely to need such a lifeline.

One major concern for all Korean contractors is competition. In the Middle East, deep inroads are being made by local, Indian and Chinese contractors, particularly in the infrastructure and building sectors.

Consequently, companies are taking a more selective and cautious approach to projects and targeting specific business sectors when they bid for projects.

Korean industrial giants such as Samsung Engineering admit that some form of joint venture may be the most effective way of dealing with the new low-cost threat from China.

“Another method of adapting to Chinese contractors is by creating collaborations, or even using Chinese contractors as subcontractors,” says Yeon-Joo Jung, president and CEO of Samsung Engineering.

“There is a possibility of collaborating in the future. We are on track to expand in the Middle East, [but] we don’t have the capacity to collaborate just at this moment. However, you [never] know what will happen in business, and there is always the possibility.”

Despite the economic problems affecting both sides in the partnership, the Middle East’s links with Korea will undoubtedly strengthen.

Work may be drying up in traditional powerhouse economies such as the UAE and Qatar, but Koreans are also making impressive headway in North African markets.

With project-led liquidity likely to be a problem for at least the next 12 months, Koreans find themselves in a strong position, particularly in busy markets such as Algeria and Libya.

However, they know that declining project opportunities mean they will not have the market to themselves. With contract wins at a premium, Korea will need to be more adept than ever to stay one step ahead of the competition.

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