Contracting and Construction Sector: Building on a Solid Foundation

by Mohammed Shariff | Apr 02, 2014

The focus on improving the Kingdom’s physical and social infra-structure as was planned by the government in its 2014 budget was evident as approximately SR11.7 billion worth of contracts were awarded for physical infrastructure projects. Sectors within the social infrastructure category, such as healthcare, residential real estate and education, contributed approximately SR28 billion of the overall value of awarded contracts, the signs are clear, its again yet another year of multimillion contracts. Will the companies that are crippled with labor issue can tap into it this market, Saudi Commerce & Economic Review's reality check.  

By Mohammed Shariff

The Kingdom of Saudi Arabia's contracting and construction growth index has been showing upward trend despite its crippled with challenges. Though new labor regulations which has dented many projects for few months, seems to be on path of revival, especially after the announcement of amnesty for status correction.

According to Forrester Research analysts, while Saudi Arabia may be teeming with construction opportunities, the growth of activities in the sector is expected to be subdued in the second half of 2014 at between 5 percent and 15 percent. The projection proves smaller compared to a November 2013 poll where industry players predicted a 20 percent to 30 percent growth in construction activities for 2014. The lower growth rate has been attributed to delays in project implementation brought about by a recent labor market correction in the kingdom. According to George Berbari, CEO of DC Pro Engineering , "The corrective measures being undertaken by the Saudi Ministry of Labor to legalize the status of foreign workers is (understandably) a good and necessary initiative. However, it led to a shortage of manpower and a 20 percent drop in construction activities. While companies are trying to straighten the situation and comply with the law.  The labor correction has not just affected construction, but also the manufacturing and other industries as well."

The sub-contractors contacted by Saudi Commerce And Economic Review have noted that current market conditions point to a robust construction market in Saudi Arabia.

Sources at Layan Construction and Contracting Company Ltd said, there is more work in terms of social infrastructure such as schools and housing. In terms of industrial growth, we are seeing growth on the West coast in Jeddah, Rabigh and east coast of Jubail. Saudi is the fastest growing market in the Gulf Cooperation Council (GCC). Dubai's activity is moving higher while Abu Dhabi is showing strong growth. But the growth rate in Saudi Arabia is not as high as in 2012 and 2013. The industry see a possible growth rate of 5 percent to 15 percent in the coming year. However, there are issues related to labor supply, which needs to be streamlined in order to implement the projects.

Around $442 billion of projects are in the design, bidding or construction stage in Saudi Arabia, according to Zawya projects data compiled for the period ending September 2013. The NCB Construction Contracts Index reached 250.53 points at the end of the second quarter of 2013, while the total value of awarded contracts reached SR 53.6 billion.

According  to the statement by Raed Aqeili, member of the National Committee in the Council of Saudi Chambers, which he made in November during the conference at Asharqia Chamber,   "the Saudi government's commitment to boost spending on social infrastructure and the construction industry's low funding costs will likely be the major drivers of growth in the coming year.  According to the media reports the number of registered construction contracts in the kingdom was 250,000 before the first grace period to legalize expatriate workers ended. However, around 90,000 of these registered contracts belonging to small contracting companies have been cancelled."

This raises a question, weather the sector is facing labor problem or implementation problem. Most of the experts say that. Its mere management problem those who are complaining about the labor shortage.

Saleh M. Al-Jewair, HR Consultant and Architect of United Contracting Company in Eastern Province said, "The complaint about the labor shortage is not valid as the number of foreign workforce remains same even after  the Nitaqat period. The basic issue is project management, which is very poor in the Kingdom. The poor management will give you poor return on investment, thus pave the way for all problems in the construction sector."

The value of awarded contracts maintained a steady pace of increased spending across the construction sector as approximately SAR53.6 billion worth of contracts were awarded during the second quarter of 2013. A majority of the con-tracts were dominated by the real estate sector (residential and mixed-use) as it accounted for 39% of the total value of awarded contracts during Q2’13. Furthermore the real estate sector accounted for 30% of the value of awarded contracts during the first half of 2013. The government sector played a significant role as it accounted for 19% of the value of awarded contracts during Q2’13. Contracts in the power, oil & gas and transportation sectors sustained the growth of the projects market by accounting for 23% of the total awarded contracts during Q2’13.

According to NCB Index report of Q3 2013, the extended growth in the value of awarded contracts during Q2’13 resulted in approximately SR102.7 billion worth of contracts during H1’13. The strength of the Saudi construction market is manifested by the exerted pressure borne by government and private sectors to diversify expenditures across all sectors. There was a 19 percent slip in H1’13 compared to H1’12, which registered an impressive SR126.7 billion worth of awarded contracts. Nonetheless, the second half of 2013 is likely to be infused with a high number of mega projects across numerous sectors, which in turn will lessen the difference in the value of awarded con-tracts with 2012. The Construction Contracts Index (CCI) ended the quarter at 250.53 points.

The CCI registered a dip in April to achieve 236 points, while the slide continued in May where the CCI reached 225.68 points. The CCI registered a 19 percent drop compared to Q2’12, which reached 309.12 points. Nonetheless, the CCI has remained at healthy levels over the 200 point level for 26 consecutive months. The geographical breakdown of awarded contracts by value reveals that the Makkah region captured the lion share of contracts. The real estate sector was the main contributor to the Makkah region’s 36% share as one of the contracts was a SR13 billion mixed-use real estate mega-project. The Riyadh region captured a 20percent share of awarded contracts by value, which was spurred by investments across most of the sectors. The Eastern Province lacked the usual mega-projects that are commonly witnessed in the oil & gas, petrochemical and industrial sectors causing it to comprise a 14percent share of the value of awarded contracts. A number of significant contracts that were awarded by the Ministry of Interior led to healthy investments into the rest of the areas across the Kingdom.

The NCB report also predicts the market outlook saying that the Saudi economy continues to benefit from the ongoing diversification of development strategies set forth by the government and implemented in partnership with the private sector. The magnitude of construction activities in the real estate sector in particular, reflects the need for continual large-scale projects to accommodate growing demand. Furthermore, sectors such as petrochemical and industrial have yet to take off in 2013 but are expected to account for a respectable share of the value of awarded contracts for the remainder of 2013.

While the Saudi market continues to face its share of project delays, conservative banking policies, delays in execution of laws and lack of transparency and the adverse effects of the global economic slowdown, it continues to be a comparatively rising star. which is likely to witness a steady and healthy growth in it as construction industry in the medium and long term as compared to its counterparts due to the earnest efforts of the government through its planned diversification based investment schemes and its healthy demand growth across sectors.

Analysts have pointed out few recent developments that is promulgating the growth of contracting and construction sector in the Kingdom.  According to the IMF report of 2013, the Saudi economy has grown strongly, benefitting from high oil prices and output, strong private sector activity, and government fiscal spending. Following strong growth of 8.6 percent in 2011—spurred by higher oil output and large fiscal spending packages—the economy grew at a slower, albeit still robust, rate of 5.1 percent in 2012 as oil output and government spending growth slowed. During 2010–12, the non-oil private sector grew by an average of 7.5 percent per annum, with the manufacturing, transport, and retail and wholesale sectors all seeing double-digit growth. Labor productivity and TFP growth in the private sector have increased in recent years. High oil prices and exports translated into another large external surplus in 2012, boosting gross international reserves.

Outlook, Risks and Spillovers

The near-term economic outlook remains positive. Overall real GDP growth is projected at 4 percent in 2013 and 4.4 percent in 2014. Indicators such as point of sales transactions and the purchasing managers index (PMI) suggest the private non-oil sector is continuing to grow strongly, and large projects in the transportation infrastructure and mining sectors should help underpin a pick-up in private sector growth this year to 6.5 percent. Oil output is expected to decline by 3.3 percent from its average level in 2012 given conditions in the global oil market, before increasing slightly in 2014. Although crude oil exports have declined from their peak in mid-2012, oil prices of around $100 a barrel over the next two years and a slowdown in the pace of fiscal spending will help maintain large, although reduced, fiscal and current account surpluses. In 2013, the non-oil primary deficit is projected to narrow by 4 percent of non-oil GDP. Headline inflation is expected to move modestly higher in the next few months, before easing toward year-end as food price increases moderate, and average 4 percent in 2013 as a whole.

According to IMF report, Saudi Arabia is today by far the largest projects market of the Middle East, both by the value of contracts awarded in 2013 and in terms of the pipeline of future projects. As such, for most companies involved in the projects market, it is the number one priority in the region. The kingdom’s rise has been gradual. Until 2009, its projects market was eclipsed by the sheer scale of the Dubai real-estate boom and subsequently by the Abu Dhabi energy sector. However, with the UAE’s projects market now in steep decline, Saudi Arabia has come into its own, doubling in size over the past three years. Of the $110 billion-worth of contracts awarded in the GCC in 2012, just under half – $50 billion  were placed in Saudi Arabia. Apart from its size, what makes the Saudi Arabian market just as attractive is that it is driven by the twin fundamentals of oil prices and demographic growth, which together ensure the market’s relative stability and underpin its growth potential. What’s more is the fact that Saudi Arabia’s capital projects program covers all major sectors and industries, meaning there is work available for everyone. Admittedly, the kingdom remains somewhat challenging for non-local contractors. Outside the hydrocarbons and utilities process sectors, the market is dominated by local contractors, with international firms frequently having to partner with local companies in order to be successful. Nonetheless, such is the scale of Saudi Arabia’s current and future ambition that its projects market is one that no one can continue to ignore.

The market suffered a large drop in activity in 2012 compared with the $70bn worth of deals compared in 2011. In most instance projects have not been cancelled. Rather, the fall can be largely accounted for by public sector clients finding it difficult to process all their project plans. There is some evidence to suggest that the contractor market is struggling to deal with the large workflow.

According to Saudi Arabian General Investment (SAGIA), the ninth development plan, which covers the period up to 2014, the government intends to spend $385bn on its capital projects program, a 67 per cent increase on the eighth development plan. This does not include the $120bn of extra-budgetary outlay on social measures announced in 2011. When considering Saudi Arabia’s economic fundamentals and its projects plans, it is difficult to see the kingdom losing its mantle as the number one projects opportunity in the region. And with its projects market only really gaining momentum over the past five years, there is still plenty of room for it to continue growing, which should ensure it remains the number one priority for many contractors, suppliers and consultants alike.

Al-Jewair said, " The Kingdom has the potential to overtake other GCC countries in terms of construction over the next year. "Certainly, if you include transportation infrastructure such as the Jeddah airport and Riyadh metro. But we might see investors pausing in some sectors and cities. In Riyadh, for example, the pipeline of new office space and hotel rooms will create risks for investors or developers of new projects. In 2014, the challenge is all about execution. We understand that the contractors have recently lost part of their workforce so some projects may experience delays."

The value of awarded contracts in the construction sector between 2008 and the third quarter of 2013 reached a staggering SR1.2 trillion, of which 68 percent or SR805 billion was spent on infrastructure related projects. The NCB Construction Contracts Index, which is measured on a six month moving average of awarded contracts, reflects the growth of the construction activities. Using January 2008 as its base, the Construction Contracts Index (CCI) reached 494.09 points as of September 2013. The breakdown of the expenditure between 2008 and Q3’13 reveals that the power sector accounted for 29 percent of the total contract awards for infrastructure related projects. The transportation sector came in second with 22% followed by the residential real estate sector with 12 percent.

New Regulations dents contracting sector

The growth of activities in the Saudi construction sector has been subdued in the second half of 2013. However, The  government’s continued effort to boost spending on social infrastructure and the construction industry’s low funding costs will likely be the major drivers of growth in the coming year.

The lower growth rate has been attributed to delays in project implementation brought about by a recent labor market correction in the Kingdom.

Ahmed Al-Dossary, Chairman of Construction Committee of Asharqia Chamber said, “The corrective measures  undertaken by the Saudi Ministry of Labor to legalize the status of foreign workers is a good and necessary initiative. However, it led to a shortage of labors in many projects. Many sub-contracting companies were not prepared for such scenario, thus many projects stalled for months."

The sub-contractor noted that current market conditions point to a robust construction market in Saudi Arabia. Shafeeq Ansari, Regional Manager of UAE-based sub-contractor said while the government’s efforts may offer a stopgap fix to immediate workforce requirement, it could have negative long-term repercussion if left unregulated.  “On the one hand, they extended the deadline for compliance. On the other, companies worth SR50-100 billion are now being allowed to rent labor. If done the right way, it could work well, but we hope that private agenda does not hinder the situation in the long run and affect the construction sector. If not regulated, this solution could have new problems.”

Additionally, a wage protection program has become mandatory from Oct. 1, 2013 for companies employing 3,000 or more workers.  “On the same lines as the UAE, it will work well with companies that maintain best practice standards. It will ensure that salaries are paid to employees on time and will help regulate the rights of the labor sector. But in the coming year, despite projects announcements, Saudi will not be able to catch up with the growth in the rest of the GCC construction sector due to the correction in labor laws. The tendering processes and the agendas of different stakeholders, along with the labor correction, will delay projects,” he said.

When asked how recent trends will affect kingdom’s real estate supply over the next few years, he said “for commercial schemes, it may actually allow the demand to catch up with supply. But in the housing sector, the need is now and may result in missed opportunities for some investors.”

The contracting and construction sector had raised much concern over new labor regulations. However, it seems they have situation which can be handled by having proper  project management. The present condition should not dent the contacting sector provided if they use the labor laws in proper way. Most of the leading contracting companies have already put their policy straight to adhere to the new regulations.



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