A surge in activity: Numerous infrastructure and housing projects will keep contractors and developers busy

When the Diamond Cement plant in Aflao on Ghana’s eastern border was struck by lightning in April 2012, few could have predicted the extent of its impact on Ghana’s construction market. The nearly month-long shutdown that followed led to cement price increases of as much as 85% and industry layoffs by contractors struggling to cope. Although questions have since been raised about the structure of the cement market, little has been written about this illustration of rampant demand in the construction industry.

GOOD SIGNS: As Karim Ibrahim, managing director of real estate developer Dream Realty said, “If you want to see the demand for construction in the market, just look at cement.” With double-digit growth, there is little better indication of the health of the sector.

Fuelled by public infrastructure maintenance and expansion, private real estate development, and individual residential construction, the few established contractors in the country are becoming of inundated. Indeed, the Ghanaian construction sector has been witnessing steady growth for some time. According to the Bank of Ghana, construction output grew by 91.8% between 2006 and 2010, reaching GHS1.95bn ($1.2bn) in the latter year, accounting for 8.1% of real GDP. According to Morten Gade, the managing director of Ghacem, Ghana’s biggest cement firm, which is 93.1% owned by Heidelberg Cement Group, this growth “was mainly led by infrastructure projects, but there are also a lot of office, merchant building and housing projects going on, particularly in the Western Region”.

INFRASTRUCTURE ROLL-OUT: While infrastructure maintenance has always been a key priority for the government, recent policy, supported by the first full year of oil production in 2011, has focused on substantial infrastructural expansion as a means of facilitating economic growth. Indeed, the 2012 budget emphasises the importance of infrastructure spending for growth and job creation. Ghana’s production of 24.7m barrels of oil in 2011 at a value of $2.78bn, according to the Bank of Ghana, has given the government increased confidence in its ability to deliver infrastructure projects. The output of the mining and quarrying industry, which includes oil and gas, grew at an annual rate of 225.4% by September 2011, compared to the same period of 2010, according to global consultancy PwC, bolstering government revenues.

Indeed, the 2012 budget projects government oil and gas revenues of GHS1.24bn ($735.2m), representing 8.6% of total anticipated budget revenues in the year. The government proposes to set aside 70% of benchmark oil revenues for the annual budget financing amount, and under the regulations of the Petroleum Revenue Management Act this must be spent in four key areas including roads and other infrastructure. As such, the government has highlighted several road projects, including the Eastern Roads Corridor project, as well as improvements to the efficiency of the electricity network, including the Transmission Improvement Project and the Distribution System Improvement Project, as key areas of spending (see analysis).

However, given that it will cost an estimated $1.5bn per year to meet Ghana’s infrastructure needs over the next decade, according to the Africa Infrastructure Country Diagnostic Report 2010 (AICD), produced by the World Bank, the government is also looking at other means of financing infrastructure construction. This includes a $3bn loan facility from the China Development Bank (CDB), which will be used for rail and port upgrades, as well as plans to improve the environment for, and confidence in, public-private partnership agreements within the country (see analysis). According to AICD, Ghana lags behind its regional counterparts when it comes to private sector investment in infrastructure development, with the country capturing less than 1% of GDP for infrastructure investment in 2010.

This all suggests that if the government can get the framework in place for private sector involvement in infrastructure development, and make efficient use of both its foreign donor and loan facilities and domestically generated revenues, the scale of public sector contracts on offer should increase dramatically in the next 12 months and beyond. While foreign loan agreements, such as the CDB facility, may be tied to contracts for companies and contractors from that country of origin, there should be plenty of work to keep both local and foreign entrants busy.

LOW-INCOME HOUSING: The continued growth of the real estate sector should provide plenty of contract opportunities over the coming years. The most pressing demand here is for the volume-driven low-income segment of the housing spectrum. The next decade will see rapid growth in the working age population and, thus, further pressure for new housing units, with the Ghana Housing Profile, authored by the United Nations Human Settlement Programme (UN-Habitat) in conjunction with the Ministry of Water Resources, Works and Housing, estimating that the country will need another 2m housing units by 2020 (see Real Estate overview).

Thus far, the ability of the government and the private sector to meet this shortfall has been limited. However, the government has stated its intent to incentivise the private sector to deliver low-income housing through a number of measures including land allocations and low-interest loans (see Real Estate overview). Such a massive construction drive would provide a significant amount of work for contractors in the country.

With the now defunct Ghana National Housing Project, which was to be undertaken by the South Korean firm STX, scheduled to produce 200,000 units at a cost of $10bn, the potential value of contracts for a decade-long programme to build 2m houses is enormous. Part of the STX deal has recently been awarded to South Africa’s Guma Holding.

REGIONAL CITIES: Some of these houses are likely to be constructed as part of broader development programmes. For example, the government, energised by the impact of oil and gas in the Western Region, has nascent plans for the development of new cities in that part of the country. Although detailed plans are yet to be released, the first city would be at Cape Three Points, one of the closest towns to the offshore oil and gas fields, and would include higher-end residential and business properties, manufacturing zones and sport and tourism facilities. The Western Region is seeing the highest construction demand in the country, with cement consumption up 25% in 2011, compared to a national average of 22%, according to Ghacem.

While the Western Region and the high-volume segment of the market may be expected to provide the greatest amount of work, there should also be increasing opportunities for contractors and developers in less volume-driven, higher-value projects in Accra and elsewhere. According to Gade, in the Western Region and elsewhere, Ghacem has seen a lot of private developments in which the company starts construction and hopes to sell the balance later. It is also seeing a lot of hotel construction.

While the formal private developer sector remains reasonably small, it offers many opportunities for large-scale contractors that have built a reputation in the country. According to Ibrahim, with so few significant players in the contracting industry, the experienced firms can get 30% to 40% profit above cost on buildings in the range of 50,000 sq metres and above. “They can price so highly because of a lack of competition. If you need a contractor, your choice is very limited. I think foreign contractors will start coming in and things will be very different in two years,” he told OBG.

CHALLENGES: However, the industry, is not without its challenges, especially for smaller contractors. For example, much work still needs to be done to build faith in government-issued contracts to the construction sector. The introduction of the Public Procurement Act in 2003, coming on the back of recommendations from the World Bank, has laid out new standards and regulations for the tendering process, as well as opening up the bidding process to international competition. Nonetheless, contractors, particularly smaller local players that have less capital, have complained about the tendering process, highlighting delays in payment for work completed as an issue.

While the Atta-Mills government pledged to address the issue during the National Democratic Congress 2008 election campaign, delayed payments remain a significant issue for the contracting industry.

DELAYS IN PROJECTS: According to a 2010 study by Frank Fugar and Adwoa Agyakwah, “Delays in Building Construction Projects in Ghana”, published in the Australasian Journal of Construction Economics and Building in 2010, the number one cause of construction project delays in the country was the inability of clients to honour payments. The study stated that this was a significant problem for government projects, a point supported by Rockson Dogbegah, the technical committee chairman of the Association of Building and Civil Engineering Contractors. In an interview with the local publication, Joy Business, Dogbegah stated, “We have instituted construction excellence awards just to position Ghanaian contractors to be able to compete and perform anywhere on the globe. So if the government does not support us by way of at least making prompt payment, then we may not have the capacity to live up to expectations.”

This issue, however, is just one part of a greater financial challenges that are currently faced by contractors and developers undertaking their own construction. The difficulty of financing and managing cash flows remains a key consideration in the Ghanaian market. This is a problem in both public and private sector contracts, with the reticence of banks to lend to the sector stifling supply in the market.

According to Kojo Addo-Kufuor, the chief operating officer at Ghana Home Loans, “The main problem now is lack of availability of construction financing to estate developers. What they really need is long-term structured financing like is done elsewhere. We are confident that this will eventually happen since the existence of mortgage finance companies should provide the certainty of a take out when the properties are built.” Ibrahim said the lack of financing could create pressure on cash flows for some and affect the ability to reach project completion, but “the investment size here is never that much, so you don’t need immediate income,”

FINANCING ISSUES: Financing is a particular issue for smaller local contractors that dominate the market. For larger players that have significant capital, or are able to access international funds, the situation is not so dire. Furthermore, while banks are still somewhat cautious about lending to a sector in which project delays, cancellations and contractor erosion are still factors, financing to the industry is certainly on the rise. According to the Bank of Ghana, outstanding credit to the construction sector grew by 24.9% to GHS751.64m ($445.6m) in 2011. This is a positive signal, representing 8% of total outstanding credit from commercial banks, in line with the sector’s contribution to GDP.

Nonetheless, given the high interest rates in the market, a product of factors including lack of confidence in the country’s macroeconomic and fiscal stability and high non-performing loan ratios among the banks (averaging 17.6% in December 2010), the cost of borrowing in the local market remains extremely burdensome. Bank of Ghana figures show that the average lending rate to the construction industry by commercial banks in December 2011 was 25.93%, although as Alexander Tweneboa, the president of the Ghana Real Estate Developers Association, said, “If you borrow locally, you are paying interest rates and fees of about 32%.” This not only makes it difficult for developers and contractors alike to maintain margins and remain profitable, but it also limits the scope of operations for many developers. Furthermore, Tweneboa told OBG that it is very difficult for developers to make any margin at the social housing level.

For contractors, such financing issues are compounded by the escalating cost of materials in the local market. “Residential price increases are a reflection of the material prices in dollar terms and particularly in local currency terms. In local terms,” Tweneboa told OBG. “We’ve seen a 48% increase in our basic material, cement, since January.” As of June 2012 a 25-kg bag of cement was selling at GHS23 ($13.60). While wholesale prices have increased less, rising by 10% to mid-June, this is still having a significant impact on the industry.

The primary contributor to this price inflation is the depreciation of the cedi. Cement prices are more or less stable in dollar terms; Ghacem is selling at about $133 per tonne and that has been relatively steady over the past 12 months. This currency-led price inflation is having a particularly severe impact on smaller local contractors and traders who continue to work in the cedi, despite the increased dollarisation of the economy.

DEMAND PRESSURE: Gade argues that there is little in the supply-demand dynamics that is currently pushing prices upwards and that supply is capable of meeting demand at the moment. However, demand has been increasing significantly, with cement consumption rising by some 22% in 2011. In the Western Region, an area where oil- and gas-related developments are spurring construction, growth was 25%. Gade expects this demand pressure to continue, albeit at a lower level. “I think there’ll be growth in the high single digits,” he told OBG. “We’re talking around 5m tonnes consumption in the market for 2012, up from approximately 4.5m-4.6m tonnes in 2011.”

However, the industry should be able to absorb this demand without undue pressure on prices, given the significant additional supply that is in the pipeline. Ghacem alone will invest €18m to add new capacity of 1m tonnes per annum at a new mill in the port of Tema by November 2013. This will complement the 1.3m tonnes its four mills at that location currently produce. In 2013 the company will also be adding another 800,000 tonnes per annum at a second mill in the port city of Takoradi in the Western Region, bringing Ghacem’s total capacity there to 2.1m tonnes.

The market should thus be well placed for cement supply, a situation that could ease the price pressure on contractors in the market. However, not everybody is convinced that it is simply a supply and demand scenario that is influencing the comparatively high price of cement in the Ghanaian market – in Nigeria, for example, cement was selling for $100 per tonne in April 2012, according to Dangote, compared with Ghacem’s $133 in Ghana. In June 2012 a comment by World Bank economist Sebastien Dassus to journalists in Accra that the effective monopoly in the cement sector made no economic sense and that liberalising the sector would help to drive down prices led to a lively public debate in the media.

IMPORTING INPUTS: Ghacem currently has a 55% market share in the country, while Diamond Cement has 32%. However, local producers are keener to point out other factors that are affecting cement pricing. “We need to import clinker because there’s not limestone in sufficient quantity and quality. We are also importing gypsum. It would be a significant cost saving if you could produce clinker locally, rather than taking it from Europe or Asia, but this is not possible,” said Gade. Although Savannah Cement Company has plans to produce clinker at a site in the north of the country by the end of 2012, this may be used for local cement production in northern Ghana and have little impact on the industry as a whole, given that Ghacem alone requires 2m tonnes of clinker per year. Such import costs may have a substantial impact on pricing for end-users. “It squeezed our margins for a while, but it also squeezes our competitors’ margins, so sooner or later we can pass on the additional cost to the consumer,” Gade said.

As well as the currency issue, shipping charges, and specifically the demurrage, impact the import cost or waiting charge that producers incur as their goods sit waiting to be unloaded at port. In 2011 Ghacem paid GHS5m ($3m) in demurrage charges alone. There are not sufficient berths to handle port traffic, so congestion is an issue affecting the many firms’ operations and cost of production. Nonetheless, Gade sees this having little impact on demand, arguing, “we have to import in dollars but it’s not putting a ceiling on consumption.”

However, such charges do affect the sector and often the contractor. While there is a mix of fixed lump-sum and cost-plus contracts in the market, contractors often bear the brunt of material price escalation or currency depreciation, especially in the circumstances when escalation clauses are not applied or enforced. In late May 2012 Dogbegah told the local Luv Business, "Some contracts we have are fixed contracts, [under] which you cannot pass on [cost] increases to the client, so it becomes the burden of the contractor and that is where our worry is.”

OUTLOOK: The sector, therefore, faces several challenges as contractors and developers look to take advantage of the expected surge in construction contracts over the next decade. While significant regulations are in place to support a transparent process of tendering and contract agreement, local contractors still suffer, to some degree, from inflexible contracts and the lack of contract enforcement, particularly on issues of payment schedules and escalation clauses.

For the limited number of large class-one contractors – those at the top of the government classification system based on technical and managerial expertise, financial standing, equipment and plant holdings, and previous performance, with access to capital and foreign funds – there is significant potential in the Ghanaian market. Indeed, while the industry has grown robustly over the past five years, the prospects for the next five, driven by oil-led government spending and industrial diversification plans, look even better.