Egypt's cement industry overcomes energy challenge with coal

In countries around the world, the cement industry is often seen as a bellwether. When it is performing well, it suggests an economy in full flow, moving in the right direction. It is hardly surprising, therefore, that much like the rest of the industrial sector and the economy at large, Egypt’s cement producers – which account for 3.7% of GDP, or LE60bn ($8.2bn) – have experienced mixed fortunes in the last few years, with some encouraging signs and promising long-term prospects alongside short-term turbulence.

Production slowed in the immediate post-Arab Spring era, before rebounding in 2013 and 2014, and seeing slower growth in 2015. The country is well-placed to benefit from steadily rising demand in the medium and long term, although producers will need to ensure a stable supply of inputs, including energy.

Recent History

Prior to the Arab Spring, Egypt’s cement industry had been growing strongly. Production increased from 30m tonnes in 2006 to 50m tonnes in 2010. While cement production capacity in 2014 reached 70m tonnes, total production was only 45m tonnes. In 2013-14, cement prices increased by 20% on an annual basis, partly as a result of supply constraints. By the end of 2014, prices were at import parity or a figure of approximately LE600 ($81.80) per tonne. However, 2015 has been more modest.

While some additional supply has hit the market, consumption has been weak. Indeed, demand has contracted by up to 2% and prices for the first half of the year have declined by 6%, according to Beltone Financial. This is largely the result of low construction activity and, according to HC Securities, cold weather hitting the productivity of the building industry in the first quarter of 2015.

Upward Trajectory

However, while demand is currently subdued, most analysts remain bullish about the construction industry moving forward and are thus positive about the future domestic market for cement producers. Construction spending is expected to reach $7.3bn by the end of 2015. Moreover, that does not include recently announced mega-projects, such as government plans for a new capital city on the outskirts of Cairo.

This level of spending augurs well for the nation’s cement producers. The growth in bulk cement versus packed cement is an indication that the market might already be returning to health. It suggests that producers are witnessing an increase in business from the formal, large-scale, construction industry. “We still believe in the long term story of construction given a lucrative projects pipeline, but in the short term so far demand has disappointed, especially on the building materials front, and hence the cement market for instance is suffering from oversupply and pricing pressures. However for the long term we see cement demand growing at c.6% CAGR up to 2020,” Ghada Alaa, researcher at Beltone Financial, told OBG. Indeed, in all segments of the construction market, there are reasons to remain positive.

Challenges

In the short term, however, the industry faces significant supply side issues. The country’s ongoing energy crisis has had an outsized influence on the cement industry, with the gas and power shortage hitting producers hard.

The cement industry accounts for 59% of primary energy consumption and 46% of natural gas consumption among domestic energy-intensive industries. Given the government emphasis on the power sector and minimising load-shedding, the cement industry has seen a significant curtailment of its natural gas allotment. As such, producers have been reducing output and looking to the international market for gas imports, which makes inputs pricier. Consequently, Suez Cement saw its energy costs increase by as much as 35% in 2014.

In 2014, the problem of power shortages and gas allocation has led many within the industry to turn to imports to meet their clinker needs. Back then, local clinker utilisation was hovering around 50%, while cement utilisation was close to 70%, suggesting a significant reliance on imported clinker. “Starting in 2015, however, after the domestic cement price got hit, it became really unfeasible to import clinker. Companies would break even at best. So at the moment, companies are only phasing out the inventory of imported clinker. With improved fuel supply to the industry, following progressive coal transformation steps, clinker utilisation rates have already picked up significantly in 2015, and hence low cost supplies are hitting the market with producers competing aggressively over market share,” Alaa told OBG.

Boosting Supply

In April 2014 the government approved the use of coal for industrial purposes, paving the way for producers to start converting their facilities to use the fuel. Each company will still need to get approval from the government on a case-by-case basis. In May 2015 the Industrial Development Authority announced that 90% of cement plants have agreed to switch to coal use to boost production.

While this is causing a dip in production in the short term, there is a sense that it will be a positive move overall for the industry in the medium to long term. “This is one of the best moves the sector is taking. The cost savings going forward will be in two areas. Cement producers were having to import clinker and this had a cost 1.6 times higher than internally produced clinker. And secondly, they were paying $8 per mmbtu [for gas], compared to $5 per mmbtu [for coal]. The savings will definitely justify the capital expenditure,” Alaa told OBG.

High Returns

In the longer term, analysts predict that profitability will grow for the major cement players. Indeed, given that fuel accounts for 40% of costs, according to Beltone Financial, the savings here will significantly help the producers’ bottom line. “If on average, the industry is making gross profit margins of 20% to 30%, we would expect them to increase to 30% to 40% going forward, all else constant. Yet unfortunately the current pricing pressures will wipe out most of the margin expansion,” Alaa told OBG.

The upfront costs to install coal-fired facilities to operate a cement plant could come to LE150-200m ($20.5m-27.2m), according to Beltone Financial. However, this should not prove a problem for most of the major companies in the market. Indeed, in early 2015 Suez Cement announced that it plans to spend $84m in 2015 to convert two of its cement plants to use coal. The company began testing coal use at its Kattameya plant in September 2014. Two other major players in the industry have already taken significant strides in transitioning to coal. Arabian Cement was estimated to have imported close to 1m tonnes of coal from markets such as South Africa, Spain and Ukraine in 2014. Lafarge Cement, the French producer that has one cement plant in Egypt, converted to coal in 2014 and applied for a permit to import the fuel.