Energy Shortages Build Construction Inflation Concerns
BMI View: Egypt's construction industry has failed to regain momentum followi ng the 2011 revolution. Even though the sector was previously a high-growth market with strong growth potential , it has so far struggled to rebound. We expect t his growth trajectory to be further weighted to the downside by rising building material costs (brought on by energy price hikes ) , with limited hope of a resolution on the horizon. Fuel cuts and electricity price hikes are negatively impacting on the cement industry, as we expect them to lead to shortages and rising prices for building materials. This would in turn depress activity in the construction sector .
Egypt's cement sector is at the centre of a dispute in the country over fuel price hikes, supply cuts and subsequent cement price hikes. As a result of rising input costs, namely natural gas and mazut prices - which together account for around 50% of the cost of cement production - cement prices have been increasing. However, the government and consumer protection agency has accused the industry of capitalising on inflation trends to make excessive price increases. Whether this increase in cement prices is in line with fuel price-hikes or not, the impact of rising cement prices has been severely detrimental to the construction industry, where projects have stalled and many companies are nearing bankruptcy.
With this in mind, we have increased our inflation outlook for the construction sector over the near term, which has in turn weighed down our real growth outlook for the 2012/13 financial year (July-June) to 1.9% (from 3.3% growth in 2011/12), and to 1.8% FY2013/14.
|Input Costs Place Downward Pressure On Growth|
|Egypt Construction Net Output Inflation Rate, %|
Cement companies have been struggling to generate profits and maintain production against a backdrop of steep fuel price increases. Natural gas prices for energy intensive industries were increased from US$4 per MBTU to US$6/MBTU in February 2013. At the same time, Mazut prices were increased 50% in Dec ember 2012 . The industry is also suffering from fuel shortages and electricity blackouts which ha ve resulted in production cuts.
F uel price increases have been passed onto consumers as cement producers struggle, with average prices increasing by 20% in the first quarter of 2013 alone, to an average of EGP670/tonne. Companies have also be en forced to cut production. This is partly due to fuel shortages, but also because high prices have been demand destructive. Suez Cement has reportedly cut production by 20-30% in response to the high prices .
Cement companies have been struggling since the Egyptian revolution in 2011, with share prices continuing in a downward trend. We see little upside to this over the near term as their operating environment is on the cusp of deteriorating further. The government is proposing a price cap on cement prices in order to regulate the industry and sustain the construction sector. It is also considering an increase in sales tax on cement from 5% to 10%. In addition, there are also reports that natural gas supplies to the sector are to be cut by 50%, in order to conserve supply for domestic consumption. This is in addition to anticipated electricity shortages as summer arrives. If implemented, these measures could cripple the industry, and have a counter-productive impact on the construction sector.
|Hit When Down|
|Suez Cement, Sinai Cement & Hermes Index, Rebased As Of 10/04/2010|
The broader fundamentals causing the challenges facing the cement sector are unlikely to ease any time soon. Egypt has contracted out much of its domestic natural gas production under long - term contracts to countries such as Israel and Jordan , and is obliged to stand by them despite significant expansion in domestic gas consumption . Although production is increasing slowly, demand has been outp acing this rate of increase in production volumes . However, we are forecasting that consumption growth will not reflect this as the impact of price hikes filters through to c onsumers. At the same time, IMF pressure on Egypt to reduce fuel subsidies , to improve its public finances , could see further price increases for fuels across the board. Although measures to achieve this have been delayed repeatedly and creative solution proposed, eventually, prices will have to rise further. In order to meet demand , Egypt has been increasing imports of natural gas and is even considering a liquefied natural gas ( LNG ) import terminal. However, current prices cannot sustain expensive natural gas imports, and this price gap would have to be picked up by the government, further exacerbating the issue.
With this in mind, we believe the impact on the construction sector will be notable for a number of years, although most keenly felt over the near term. The construction industry has been growing, whilst production of cement has declined, resulting in shortages which are forcing project delays and suspension. Consequently , we are factoring in a slowdown in real industry growth in 2012/13 and 2013/14. The housing sector will be hit especially hard, exacerbating an existing, and troubling housing gap.
|Energy Sector Woes Hit Construction Recovery|
|Egypt Construction Industry Value And Growth|