How to reboot the Saudi construction market?
Tough times lie ahead for the Saudi construction sector but the low oil price environment could provide the catalyst for more private investment. Jason O’Connell writes
It’s fair to say that these are uncertain times for the construction industry in Saudi Arabia. A sense of pessimism seems to have gripped the sector as Riyadh reins in spending on projects while it grapples with a low oil price environment that some believe is likely to be the new normal rather than just a passing phase. But amid all the gloomy talk of delayed payments, a freeze on new contracts and tightening of government belts, there are those who see an eventual silver lining if the cloud of low oil prices accelerates plans to reform the kingdom’s economy.
The price of crude oil, which accounts for over 80% of government revenues, has fallen to around $35 per barrel currently from over $90/bbl 18 months ago. As a result the Saudi government reported a budget deficit of $97.9bn in 2015 and is expected see a deficit of around $87bn for the coming year.
The 2016 budget includes a raft of measures to cut spending, overhaul subsidies and introduce taxation in a bid to make up for the shortfall left by dwindling oil revenues. For construction contractors the result has been a cut in advance payments for government projects, fewer contracts, and slowed payments for services rendered. Some firms have even delayed paying their staff or laid off thousands of workers. Reuters reported in November that the kingdom’s largest construction contractor, Saudi Binladin Group, planned to cull 15,000 of its 200,000 workforce.
This desperate situation has led one Saudi Arabian businessman to plead for royal intervention to prevent companies from going under. “If the delay in payments continues, these companies will be at risk of default, or go completely out of business,” Abdulrahman Al Zamil, president of the Council of Saudi Chambers business association, wrote in a letter to King Salman.
Other project developers hit by the downturn have begun talks to reschedule debt payments. Jabal Omar Development, which is developing a multi-billion dollar project next to the Grand Mosque in Mecca, signed an agreement in February with the Ministry of Finance to defer payments on a $800m loan after failing to make a repayment of $173.3m on 1 January this year.
The bleak outlook for the Saudi construction sector was reinforced by comments made by Fawwaz al-Khodari, the CEO of major contractor Abdullah Abdul Mohsin Al-Khodari Sons, who attributed at least part of the pain the sector is going through on recent labour market reforms.
“I think we should expect the difficult situation in the sector to go on for 18 more months,” Fawwaz al-Khodari, told Reuters in an interview late last year. “Companies are facing troubles mainly due to the labour reforms. We will see the result of the budget deficit later, but now we are in a situation where the pain is already there. I believe many projects that are not seen as being essential will be first to be shelved, including those that were tendered but not awarded.”
Abdullah Abdul Mohsin Al-Khodari Sons reported a second successive loss in the fourth-quarter of 2015 which the company blamed on a drop in revenue and a rise in construction costs, partly due to the government’s decision to hike energy prices in the kingdom.
The pessimism gripping the construction sector is reflected in a recent survey by law firm Pinsent Masons which found that optimism surrounding Saudi Arabia saw a pronounced decline year on year. Asked which country will provide the strongest growth opportunity in 2016, just 12% of respondents said Saudi Arabia, a big drop from the 40% who believed it would be the strongest market during 2015.
Faithful + Gould believes some Saudi infrastructure projects are more at risk than others. The consultancy says residential, retail and power infrastructure projects are likely to escape the worst of the cutbacks.
“In addition to not awarding new construction contracts, decisions have already deferred on major infrastructure projects in Mecca, Medina, Jeddah and Dammam,” it said recently. “The massive rail projects for the Saudi Rail Organisation (SRO) must also be at risk. Station redesigns are being implemented on the Riyadh Metro project in an effort to reduce expenditure.”
However it added: “Social infrastructure projects such as the Ministry of Housing’s $70bn programme and power projects may escape the brunt of the cut-backs. With consumer spending remaining unchanged, the retail sector represents one of the only short term opportunities with multiple regional and super regional mall developments planned in Riyadh and Jeddah over the next 12 months.”
Economic shakeup
The government is said to have called in an army of consultants to help it reboot its economy and navigate the country through a sustained period of low oil prices. The National Transformation Programme 2020 will focus on ways to boost economic growth through greater efficiency and more involvement from the private sector.
In a December 2015 report titled Saudi Arabia Beyond Oil: The Investment and Productivity Transformation, McKinsey & Co said Saudi Arabia may need public and private investments of up to $4tri by 2030 to boost productivity and create jobs.
“Over the next 15 years, the Kingdom is likely to face critical challenges, both fiscally and in its demographics, with heightened competition in the energy market and a big increase in the number of Saudis reaching working age,” the report said. “As a result, the economy is at a transition point. While much of the outside world has focussed on the very real challenges, we believe there are also substantial opportunities for the Kingdom to transform its economy to become more sustainable and less oil-dependent.”
Significant reforms in the labour market, business regulation, and fiscal management could usher in a new cycle of prosperity for the Kingdom, McKinsey says. However it warns that the transition will not be easy. Saudi Arabia will need to shift from its government-led economic and social model to a more market-based approach that brings it into line with other modern economies. The government is already doing this in some areas and has accelerated its efforts in the past few months.
Towards privatisation?
Mohammed bin Salman, the kingdom’s deputy crown prince, shocked the financial world recently when he raised the possibility of a part sale of Saudi Aramco, the world’s largest oil producer, possibly through an Initial Public Offering (IPO). While talk of such a move has since been played down, it does seem that Saudi Arabia is very serious about opening up its economy to more private investment.
Saudi Minister of Economy and Planning Adel Fakeih recently said: “The ministry examined 146 fields and services and that 26 fields will be chiefly privatised and thoroughly addressed this year.” Privatisation will include the sale of assets such as airports, municipalities, hospitals and education, he said.
BMI Research has urged Saudi Arabia to use the public-private partnership (PPP) model to overhaul more of its airports following the successful completion of the new $1.2bn Prince Mohammed bin Abdulaziz International Airport terminal in Medina airport last year, adding that the success of the project meant that a model is already in place. The government subsequently announced that King Khaled International Airport in Riyadh will be the first asset to be privatised this year.
For new projects, PPPs could offer a way to encourage private investment in the construction sector while easing the financial burden on the government. These arrangements have become widespread elsewhere in the region, notably in Kuwait and Oman, while Dubai introduced a PPP law in November 2015.
But though Saudi Arabia has undertaken some power and water infrastructure projects through the Independent Power Project (IPP) model, which involves private companies taking on part ownership of the projects, it has been relatively slow to consider the benefits of PPPs until now. The government will need to follow the example of its neighbours by putting in place a solid legal framework before it can move forward with PPPs.
Despite the negative sentiment swirling around the construction sector, Pinsent Masons says Saudi Arabia is likely to remain a highly attractive market with economic reforms now firmly on the government’s agenda.
“As the Kingdom’s economy adjusts to lower oil prices, there have been some positive diversification measures discussed in the Kingdom, which if implemented should enable greater private participation in the economic development of the country,” the report said.
Image copyright of Barnuti Daniel Loan
