Non-Payments Could Delay Projects Implementation
BMI View: A steady flow in public construction contract awards has ensured that the Saudi construction market will maintain its bullish real industry growth in 2013 and beyond. The infrastructure industry is supported by flagship projects, most notably within the growing transport sector. There is also considerable scope for growth in the energy sector, with billions of dollars worth of contracts already awarded or in the pipeline. In the residential/non residential sector, growing religious tourism will prompt a 60% increase in hotel capacity over the coming years. We also note an upside risk concerning the new mortgage law, if implemented and if accompanied by corresponding uptick in banks' willingness to lend.
2012 saw a peak in the value of GCC projects awarded. With an estimated value of US$358bn (25% of expected GDP for the region, according to MEED, and almost four times the value of projects awarded in 2005) in the pipeline the region's governments continue to step in and support their economies. Most prominently, the region's largest economy, Saudi Arabia, made up for 40% of the total awarded projects in the region. As a result Saudi Arabia's buoyant construction sector continues to show strength. The total value of contracts issued in the Kingdom's construction sector grew by 50% in H212 (following a 140% year-on-year increase in contract awards during 2011). Taking into account the normal lag of these types of flagship awards, we expect 2012 real construction industry growth of 9.3% and a similarly positive picture for 2013, where we forecast 7.5% growth. However, on the back of the sheer size of the Saudi construction industry, we forecast this growth to be contained in the longer term - largely due to base effects - and we therefore posit a much more moderate, yet still healthy, average growth rate of 5.1% between 2013 and 2022).
However, though having the Saudi government as guarantor fuels the pipeline and limits the credit risks, it also exposes projects to the dilemmas of moral hazard. In an economy where the government is largely responsible for the generation of the state's entire GDP, any budget delays (however - in relative terms - small) is causing a significant negative chain-reaction with non-payments to contractors. An issue increasingly raised by industry participants, even those favoured by the government such as the Saudi bin Laden Group. The issue is not helped by an often perceived lack of clarity concerning tendering processes, and the negative repercussions experienced by those having taken the concern to court. In fact, reputation, long-standing relationships, and seniority are major determinants within the Saudi industry, having deterred many from taking the matter further (though no less of a risk) for fear of future project draught.
|Continuing To Build...|
|Construction Industry Value (US$bn), Real Growth (%)|
The Middle East and North Africa (MENA) construction and infrastructure market is one of the world's most attractive, given its sheer size and potential rewards (correlating to risks discussed above). Amongst its members, Saudi Arabia takes the lead in terms of construction and spending, as the Kingdom continues - largely unhampered by any financial woes - to respond to pressing needs after years of underinvestment. The latter has certainly been made more urgent following post Arab Spring pressures.
The majority of these contracts are procured by government or semi government institutions, as part of the country's implementation of its Ninth Development Plan, which forecast public spending of almost US$385bn between 2010 and 2014. Included in that, is a US$16.5bn transport revamp to modernise the transport system in the holy city of Mecca (including an 88 stations and 182km-long metro system) in order to cater for a growing religious tourism sector. Saudi saw more than 15mn foreign visitors in 2011, of which 10.5mn were travelling as religious pilgrims. As a result, Saudi is planning to increase its current hotel capacity of 53,000 rooms (32,000 of these are in Mecca and Medina), about the same as Dubai, by 60% over the next few years. Billions of dollars is also being spent on upgrading the transport system in the capital Riyadh and a US$9.4bn high-speed rail-line connecting Mecca with Medina.
To support this flurry of transport contracts the government has set up a Public Transport Commission to oversee many of the projects in the pipeline. According to a cabinet statement, the body will enjoy both financial and administrative independence. That said, we do note that the Transport Minister will be the chairman of the commission's board of directors, accompanied by representatives from a number of government bodies; questioning the suggested independence.
|Plenty In The Pipeline|
|Projects Planned or in the Pipeline per Subsector, US$bn, % split|
Power Sector Ignited
However, beyond the infrastructure sector, there is considerable scope for construction activity that incorporates social infrastructure, real estate and industrial projects. Industrial projects, mostly related to the hydrocarbons sector, are a major source of construction output growth in Saudi Arabia. A growing number of petrochemicals projects are also boosting construction activity, as the country attempts to diversify its industrial sector away from oil and gas. Indeed, Saudi Aramco's (Aramco) US$1.4bn engineering, procurement and construction (EPC) contract awarded to Petrofac for the Jazan Refinery and Terminal project seals the deal to what we have long argued to be an increasing trend in the Middle East downstream markets: A move away from independent refineries towards an integrated value-chain with both upstream and downstream operations under the same roof. In fact, we are seeing a rapid expansion of downstream capacity to meet the growing economic needs of the region, with operators rushing to capture an increasing slice of the market. This presents new opportunities for the oilfield engineering companies, that will see the number of greenfield projects rise in these two regions.
Another angle to the diversification strategy is Saudi's effort to use solar energy to generate 10% of its electricity needs by 2020. The government expects the country's solar energy sector to create 15,000 jobs through the development of solar farms and the establishment of factories for the treatment and collection of raw materials from the related utilities. Over SAR3bn (US$800mn) has been invested in solar energy plants in Yanbu Port in the Madina region and Jubail in the Eastern Province.
To support the Kingdom's increasing power demand ( BMI forecast 6.6% growth in 2013) from a rapidly-growing population, as well as a private sector aiming to diversify away from a reliance on oil, Saudi Electric Company ( SEC) continues to award a steady stream of contracts. In October 2012, SEC awarded US$494mn worth of projects to build new substations and networks to improve the country's electricity supply, as well as the high-profile US$3.12bn contract for the 2.7GW power station in Jeddah, and theUS$1.01bn desalination deal. As for the latter, Saudi is currently looking to complete a number of desalination plants as it seeks to attain its target of having 30 facilities operational.
BMI forecasts that another 30GW will be added to the current estimated capacity of 51,6000MW by 2020. The exact price tag still varies from one press release to another, yet the trend is clear: the Saudi government is ready to pay, and has thus far been true to its word. Saudi Arabia remains the top-performing market in BMI's MENA Power Risk/Rewards Ratings (RRRs) with an overall score of 62.69, well above the regional average of 50.04.
Social infrastructure has likewise received a significant boost from the government as a means of placating growing unrest in the country. Saudi Arabia has not escaped the political challenges that have gripped much of the MENA region. In response, the country announced two packages of social benefits (part of the Ninth Development Plan) amounting to around US$130bn, providing funds for education, healthcare and housing projects. A total of SAR250bn (US$66bn) was pledged for housing alone, with 500,000 new units in the pipeline. If forthcoming, these projects will provide further upside to our construction sector forecasts.
Furthermore, a draft law revolutionising the mortgage market has also been approved in Saudi Arabia, presaging the formation of a more liberalised housing sector. We believe that the move could prove a huge boon to both domestic firms and international players looking to capitalise on the significant growth potential possessed by the Kingdom. The current state of the mortgage financing market is well below that of other countries with a similar level of GDP per capita. Thus, an introduction of a new mortgage law, if it goes ahead, and if accompanied by corresponding uptick in banks' willingness to lend, would be a major development in the sector - fundamentally changing the approach to home buying in the country, followed by a significant increase in credit growth and construction activity. In fact, since news initially surfaced in early 2012 we have already seen a significant increase in real estate lending as reported by SAMA. The latter indicates a shift away from traditionally conservative policies and a belief in the successful implementation of the new law.
That said, the mortgage law has been under discussion for the last three decades due to resistance from religious scholars concerned about its appliance with Islamic, or Sharia, law. Hence, although the new developments have been praised, it is still not clear what progress has been made. The government has revealed that legislation on the topic has indeed been approved, but has not yet divulged details as to what issues had been specifically addressed. Therefore, in light of the long and torturous history of the law, we treat the news with caution.
However, we believe the regional political upheavals, which were largely triggered by youth unemployment, lack of proper housing and economic pressures, will help to push the law on top of the political agenda.