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Analysis

Can optimism exist in a time of cheap oil?

Plunging oil prices and economic uncertainty have sparked jitters in the GCC construction industry. But there is good reason for optimism, say analysts. By Joanne Bladd

For the GCC construction industry, August was an uneasy month. First was news of heavy losses at Dubai’s largest-listed contractor Arabtec; a first-half loss of Dh1.3bn, prompting a 5.3 per cent slump in its share price. Then came one of the worst day’s trading in years on regional stock markets, triggered by China’s cooling economy and swelling alarm over plunging crude prices. Days earlier, global ratings agency Fitch had cut its outlook on Saudi Arabia’s economy from ‘stable’ to ‘negative’, while its counterpart Standard & Poor’s predicted an up to 20 per cent slide in Dubai property prices; a bellwether for the wider region. There was much news, fretted investors, and most of it was negative.

For contractors, some still nursing bruises from the 2008 financial crisis, fears were raised of a wider slowdown as Gulf states grapple with shrinking oil revenues and wider global instability. But while governments may be reining in budgets crafted in a time of $100-plus barrels, the industry still has grounds for cautious optimism.

“We are not in the same place we were in 2007/2008; that is quite clear,” says Farouk Soussa, chief economist for the Middle East, Citi. “Despite spending cuts, I think there will be a push in some construction, with transport and housing moving up the agenda. Any slowdown won’t be nearly as deep or as sharp as that seen previously.”

There are clear difficulties. At the crux of market fears is the global fall in crude to less than $50 a barrel. The Gulf is sharply exposed to oil swings, with up to 80 per cent of regional governments’ income raised via hydrocarbons. The Washington-based IMF estimates the price slump will translate into $380bn in lost export revenues for the trade bloc.

While there is little doubt the GCC six are feeling the pinch, it is to varying degrees. Kuwait, according to the IMF, is still set to post a fiscal surplus this year, and has more than trebled its contract awards. Bahrain and Oman, however, are squeezed: the pair require breakeven barrel prices of $127 and $102.6 respectively to balance their budgets. Further complicating matters is that oil markets are showing little appetite for a rebound.

“I don’t expect to see a major gain, though I think there will have to be some movement as current prices are so low,” says Robin Mills, head of consulting at Manaar Energy in Dubai, and nonresident fellow, foreign policy, at Brookings Doha Center. The impending return of Iranian exports will not help matters, he notes.

“We may well see another year of depressed prices, and only really see some kind of recovery after that.”

In January, the IMF cut its growth forecast for the Middle East’s oil exporters to 3 per cent from the 3.9 per cent it projected in October. The GCC specifically will have a collective deficit of 8 per cent of gross domestic product (GDP), it said in May.

“I think there was initial hope oil prices would bottom out in the $60-70 range, and [GCC governments] wouldn’t have to curtail spending too much,” says Soussa. “That hasn’t played out. Budget deficits have grown beyond what the Gulf states were initially expected to see, and there has been a belated realisation that something must be done to consolidate public finances, put expenditure on a more sustainable path, and to raise non-oil revenues.”

It is this spectre of austerity that has given rise to jitters in the construction industry. With much of the GCC’s $194bn projects market backed by government cash – from the $32bn expansion of Dubai South, to Saudi Arabia’s railway plans – moves to trim budgets and rationalise spending on capital projects could have wider industry repercussions.

“It is inevitable that spending will come down, and certain projects will be delayed or cancelled,” says Soussa. “I think it is also inevitable that you will start to see arrears in contracts build up, as governments face greater liquidity constraints. The overall environment is, I think, becoming more difficult.”

OPEC kingpin Saudi Arabia has already put a spending review into play in nine ministries, and cancelled some hydrocarbon-linked projects. The UAE, the GCC’s second-largest economy, plans to slash spending by 4.2 per cent this year, a Central Bank report revealed in July. The same month saw the Arab state push through a politically tricky ruling to deregulate domestic fuel prices, reflecting a more cautious fiscal stance.

The regional projects market has not been immune to the scale down. In August, a report by research firm Ventures Onsite forecast a fall in the value of GCC contract awards this year to $194bn, down $2bn on 2014. For much of this year, it had been expecting awards to rise by 4.5 per cent, hitting $205bn by end-2015.

Still, the GCC states have built resilience – and that bodes well for contractors. Both the UAE and Saudi Arabia are cushioned by huge reserves, and sizeable sovereign wealth funds – Abu Dhabi’s alone is estimated to have nearly $800bn of assets. This makes it likely that spending on key projects will sustain. In Saudi Arabia, projects such as the $23bn Riyadh Light Rail Network, and the government-backed $67bn housing programme are of both economic and social importance. According to the IMF, the kingdom needs to add some 180,000 housing units per year for the next decade, to keep pace with population demand.

“Dubai at its peak was building around 50,000 to 55,000 housing units; Saudi needs to produce three times that amount consistently over the next decade, ” says Soussa. “That is not something Saudi will shy away from for budgetary reasons. It is a political imperative, and this shortage is more material for the construction industry than anything we’ve seen for the last decade.”
Equally pressing are the Gulf state’s myriad transport projects, spanning from the Makkah Mass Rail Transit to expansion of its airport capacity.

“Apart from the fact that these projects help enable diversification of the economy, if Saudi is eventually going to cut subsidies on fuel, on energy, it needs to make public transport a cost-effective alternative,” adds Soussa.

In Qatar, the outlook is also rosy. Construction is the tiny emirate’s fastest-growing sector, with state spending set to reach $200bn to 2030, according to Qatar’s economic blueprint, spread over a raft of infrastructure schemes. Despite speculation around the future of the 2022 World Cup, Qatar has broadly maintained investment on related large-scale infrastructure projects. On a more micro level, Qatar’s Industry of Development Planning and Statistics (MDPS) reported more than 630 building permits were issued in June, a sign of the industry’s steady growth.

Dubai, once worst-hit among the GCC states by the global financial crisis, has rebounded strongly; notwithstanding still-softening property prices. The emirate has a slate of mega-projects, ranging from Dubai Holding’s $6.8bn Mall of the World, to the $7.8bn upgrade of Dubai International Airport, keeping local and regional contractors on their toes. Critically, despite an estimated $143bn overhang of debt from the last fiscal crash, there is still appetite to buy Dubai debt. This, underpinned by the city’s steady economic growth, means Dubai should have ready access to credit lines to finance its planned projects.

“Despite the headwinds from low oil prices, lower regional liquidity and so on… the news is pretty favourable for Dubai,” says Soussa.

These macro conditions are percolating down to contractors. UK-based Carillion in August posted a 54 per cent leap in revenues within its Middle East construction services division, which spans operations in the UAE, Qatar and Oman. Profit was up by 43 per cent to £18.9m, from £13.2m a year ago. Laing O’Rourke, meanwhile, which downsized its Middle East operations dramatically in the wake of the 2008 crash, has said it is on track to more than double regional turnover this financial year, thanks to a streak of contract wins.

Developers are also holding strong. State-owned Nakheel in September inked contracts worth a combined AED2.4bn with three construction firms, to build a residential and retail project in Dubai. More broadly, the first day of Citiscape Global, the region’s largest property show, saw the release of 11 real estate projects, worth upwards of $12bn.

Lastly, there is the question of post-sanctions Iran. Though an economic wildcard, the looming return of Tehran to the global stage opens up a sizeable investment opportunity for contractors, following three decades of isolation. Foreign firms are already jostling to gain access to Iran’s 80m-strong population – and more broadly to a country with vast infrastructure needs; ranging from railways, to housing, to energy. Though Iran’s crude exports will worsen an existing glut – and put further downward pressure on prices – the Persian country represents a two-fold opportunity for contractors. Not only is there pent-up demand for construction within Iran’s borders; but Gulf countries – and particularly Dubai – are likely to play host to foreign firms seeking to tap this need, offering a payoff to their own economies.

“For corporates wanting to reach into the Iranian economy, I think the platform they will use to do that will be Dubai,” says Soussa. “For the emirate, it means more inflow of population, it means more demand for housing and more demand for retail. Dubai’s economic model will be getting an additional and rather unexpected lifeline.”

For the GCC construction industry, the future may not hold a return to the feverish boom years, but neither is there an impending bust. And, as with non-oil growth in the Gulf economies, slow and steady wins the day.

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