Oversupply of building materials in Saudi Arabia causing cost fluctuations

The building materials sector serves as both a barometer of the wider health of the construction industry and as a critical factor in the bottom line of local contractors. As with the industry in general, sub-sectors such as cement have entered a period of uncertainty. While the government’s extensive development programme has buoyed cement sales and demand over the last decade, current uncertainties surrounding the labour market and global oil price have led to short-term challenges for producers.

A DEMANDING MARKET: Between 2005 and 2011, Saudi Arabia’s per capita cement consumption grew at a compound annual rate of 7%, hitting 1677 kg per capita – one of the highest levels in the world. Kuwait Finance House (KFH) forecasts that this trend will have continued largely unabated in the half decade to the end of 2015.

Indeed, KFH predicts a compound annual growth rate (CAGR) of 6% for this period, with overall cement demand in the Kingdom reaching some 57m tonnes per year by the end of 2015.

Ahmed Zugail, CEO of Yanbu Cement Company, told OBG, “Thanks to the numerous infrastructure projects around the Kingdom, we are expecting the demand for cement to grow rapidly in the next few years. For instance, the new ‘white land’ regulation is expected to boost residential development.”

Although these figures appear positive and supply is growing at a level below that of demand, increasing at a CAGR of 5.5% up to 2015, according to KFH, the industry is still carrying a supply surplus. Indeed, capacity from Saudi producers could hit 66m tonnes by the end of 2015.

However, producers are hitting a roadblock in the form of an export ban, which prevents them from selling cement to any country but Bahrain. Producers are also challenged by the drop in global oil prices, which is leading to concerns that the construction industry could face a slowdown on the back of a cutback in public spending. Additionally, the clampdown on illegal labour in the last quarter of 2013 and the push on Saudiisation targets are squeezing the contracting industry.

TRYING TIMES: As such, the longer-term trends mask what is currently a testing time for the Kingdom’s cement industry. “Demand for cement has not normalised and accordingly clinker inventories are expected to continue building up after reaching a record high by the end of 2014,” Mohamed Tomalieh, an independent financial analyst, told OBG. “As a result of the slow pick-up in construction, sales are expected to record a maximum growth of 5% in 2015 on an annual basis, after recording 3% expansion in 2014 and flat sales in 2013.”

The government imposes a price cap of SR240 ($64) per tonne on cement in the local market, offering producers subsidised fuel and protection from imports to maintain the price cap. However, the current conditions have meant that many cement manufacturers are not even achieving this capped price.

“As a result of the slowdown in the construction market on the back of changes in the labour market and Saudiisation, smaller players in remote areas have begun offering discounts to sell in key demand areas in the Western and Central regions,” Tomalieh told OBG. “They’re offering a price below SR200 ($53.30) per tonne, compared to the SR240 ($63.96) per tonne that is commanded by larger operators. However, with the continued slowdown, larger players began offering discounts as well. Prices in Saudi Arabia are among the lowest worldwide, and may be attributed to the subsidised fuel that allows companies to achieve 55% gross margins.”

However, even larger firms are struggling. In September 2014 Saudi Cement Company, the largest listed cement firm in the market, said it would keep two of its kilns at its factory in Hofuf closed after refurbishment because of weak demand in the market. In the third quarter of 2014, volumes at the company were down 13% year-on-year to 1.5m tonnes. Net income at the manufacturer was consequently suffering, remaining almost flat for the year and down 20% on a quarterly basis to SR232m ($61.8m).

INVENTORY OVERLOAD: Indeed, producers are facing an inventory pile-up, with the market registering a record high clinker inventory of 21m tonnes in December 2014. Consequently, although producers appear optimistic that the industry will pick up in 2015, they have been lobbying the government to permit cement exports once more in a bid to absorb the growing surplus in the market.

Guy Chaperon, CEO of Al Safwa Cement Company, told OBG, “Because of a massive clinker import in 2013 and the ongoing export ban, the cement market had been over-supplied by around 10m tonnes. Nonetheless, cement producers are willing to increase their production capacity given the growing demand for cement in the country.”

Cement is not the only building material facing a price drop. In December 2014, the price of steel bars fell by SR100 ($26.65) per tonne, while steel foils dropped by more than SR300 ($80) per tonne. Given this movement and the general demand dynamics in the market, industry leaders have had to move to assuage fears of a steel market collapse.

Shuail Al Ayed, the chairman of the Steel Committee in the Council of Saudi Chambers of Commerce and Industry, told the local Alriyadh newspaper in January 2015 that there were “rumours that steel prices will soon collapse, but they are not true”. Al Ayed predicted that prices would rebound in the following months on government announcements that it is committed to its capital spending programme under the current budget.

PRICE CONCERNS: However, this suggests an element of uncertainty about the Kingdom’s ability to sustain its ambitious building programme in a low-oil-price environment. On paper, there should be high demand for steel products in the country. For example, the Kingdom Tower, projected to be the world’s tallest skyscraper and the first to exceed 1 km in height, which is currently under construction in Jeddah, will alone require as much as 80,000 tonnes of steel. Before the drop in the oil price, RNCOS, a business consulting service, forecast that Saudi Arabia’s steel demand would grow at a CAGR of 11.7% between 2013 and 2017.

While the drop in oil prices is undoubtedly bad news for manufacturers, for those contractors and construction firms that can still do business, it will be welcomed. In the short term, contractors’ and the wider construction industry’s cost calculations seem to be improving as a result of the softening oil price and the subsequent fall in material costs.

“Materials are not going to present the same problem as the last four years because of the reduction in global economy and oil prices,” Ra’ed Tahseen El Jarrah, the manager of project development and controls at Saudi Binladin Group, told OBG.

COST RELIEF: Indeed, the softening in material costs should help offset the general cost escalations faced by contractors. Labour availability and costs have been a substantial challenge for contractors in the last 18 months. However, in a bid to support the sector and combat potential future inflationary pressures in the industry, the government announced plans in June 2014 to further lessen the cost burden for hiring expatriate workers.

Under the new regulation, there will be a partial exemption on the annual levy of SR2400 ($640) on foreign workers at contracting firms with nine employees or less. Furthermore, companies that signed contracts before the levy was first introduced in November 2012 would also be reimbursed for the charges they have already faced.

This should help reduce the cost pressures on smaller firms and sub-contractors that have been hit particularly hard by recent labour policies and initiatives. It should also keep general construction costs down across the industry.

Saudi Arabia is currently the third-most-expensive place to build in the region behind Qatar and the UAE, according to the Arcadis International Construction Cost study. Hisham Malaika, the head of KSA property at EC Harris, an Arcadis company, told the local press, “Similar to neighbouring markets, Saudi Arabia is less affected by fluctuations in global currencies, and market constraints are driving inflation and price movements.” For certain projects and types of building, Riyadh is the most expensive city in the region in which to build.

However, in global terms, construction costs in the Kingdom remain competitive. Building prices can range from SR4200 ($1119) per sq metre for a finished hotel and SR4000 ($1066) per sq metre for a fully fitted shopping mall to SR2600 ($693) per sq metre for a residential compound development. While labour issues have been putting pressure on these prices, a continued drop in the oil price should ease material costs and lead to a subsequent softening in overall construction costs in the market.