Major public construction projects will drive sector expanion in Oman

With a wave of major public projects being implemented in sectors including energy, manufacturing, transportation and utilities, Oman’s construction industry is growing strongly. Demand also comes from the private real estate sector, where developers are delivering projects in thriving segments from grade-A office buildings to shopping malls and a growing number of Oman’s unique integrated tourism complexes (ITCs).

With a strong pipeline of projects underway, and the government committed to pushing forward infrastructure projects that will help long-term economic diversification, the sector has thus far ridden out the challenges created by lower oil prices.

Indeed, the situation may catalyse a new broadening of public-private partnerships (PPPs) that encourage the private sector to take the lead in construction, financing, management and ownership of infrastructure, a model that has already proved successful in the utilities sector.

“PPP and export finance are both great opportunities for the construction sector in Oman now. The country currently lacks the required legalisation, but the government understands the importance of changing the model to sustain the pace of development,” Andy Jones, the regional managing director of Carillion Alawi, told OBG.

Rapid Growth

The building and construction sector contributed OR2.05bn ($5.3bn) to the economy in 2014, according to the National Centre for Statistics and Information (NCSI), up from OR1.89bn ($4.9bn) in 2013 and OR1.75bn ($4.5bn) in 2012. It thus accounted for 8.2% of GDP in 2014, up from 7.5% and 7.1% in 2013 and 2012, respectively, at constant prices. In real terms, the sector has grown very strongly in recent years, outstripping broader economic growth. It expanded by 12.9% in 2014, following 8.6% growth in 2013 and 23.6% in 2012. Rapid levels of growth should be sustained by new projects.

In a June 2015 report on the GCC construction industry, Alpen Capital, a regional investment bank, estimated that Oman’s construction sector was worth $5.2bn in 2014, up from $4.9bn in 2013, and forecast that it would continue to grow rapidly, to $5.6bn in 2015 and $6.0bn in 2016. Alpen calculates that, of the top 100 projects being carried out in the GCC member states in 2014, 2.4% were in Oman, with a total value of $29.6bn.

The firm sees continued strong growth across the region, with the sector expected to clock up a compound annual growth rate (CAGR) of 11.3% between 2013 and 2016. Between 2014 and 2019, Alpen forecasts that Oman’s construction industry will grow at a CAGR of 7.6%. Again, this is considerably higher than forecast GDP growth for that period, indicating that construction will be one of the most dynamic parts of the economy and play an important role in the sultanate’s growing diversification.

“The construction industry in Oman is expected to remain robust, driven by a significant increase in infrastructure projects planned by the government along with many tourism projects, as well as the construction of private and commercial buildings,” the Alpen report stated.

Downside Risks

Downside risks to the sector include falling oil prices, which trim broader economic growth and may restrict government spending over the longer term; high dependency on expatriate staff; rising prices and increasing regional competition from major market countries such as Saudi Arabia and the UAE for construction materials such as cement; and competition on the market between contractors, both domestic and international.

Competition region-wide has increased, as rising local companies compete with foreign players looking to tap into the growing construction boom, including firms from emerging markets such as China and Malaysia looking to widen their global footprint, and those from developed markets aiming to offset slowing growth in their home markets.

Project Pipeline

The total value of projects planned and under construction in Oman stands at $163.5bn, professional services company Deloitte reported in its “GCC Powers of Construction 2015” report – equivalent to twice Oman’s annual GDP. These investments are spread across a wide range of segments, indicative of the sultanate’s efforts to develop utilities, transport and industrial sectors to support broad-based economic growth. Of the total investment, $43.2bn was allocated to general construction, $36.5bn to transportation projects, $25.7bn to gas projects (with the huge Khazzan gas field development in full swing), $14.7bn to the oil sector, $12.2bn to industry, $9bn to the power segment and $6.9bn to water. Major projects include a national railway network built from scratch, new privately developed power and water plants, hospital complexes and affordable housing (see analysis).

Growth Drivers

There are a number of factors driving construction industry growth in the sultanate and which are expected to continue to play into the sector’s expansion and diversification over the remainder of the decade and beyond.

Population growth is particularly important. The sultanate’s population is expected to achieve a CAGR of 3.7% between 2014 and 2019, according to Alpen, which is likely to make it one of the fastest-growing countries in the world. Nearly 1m new residents will need homes, as will the increasing number of young Omanis reaching adult age, getting married and starting families of their own. Nearly a quarter of Omanis are under the age of 15, indicating that the demand for housing will continue well into the next decade. The growing population will also necessitate ongoing investment in infrastructure projects, from schools and hospitals to an increased emphasis on roads and public transportation across all parts of the country.

The growing population is also contributing to economic growth, which is an important factor in maintaining momentum in the construction sector. Indeed, construction is widely seen as a barometer of broader economic performance in the Gulf.

The IMF in its October 2015 “World Economic Outlook” forecasts that Oman’s GDP growth will dip from 4.4% in 2015 to 2.8% in 2016, due partly to the fall in oil prices. But ongoing efforts to diversify the economy, including development of tourism, manufacturing and transport and logistics, should help broaden growth over the medium to long term, making the country less vulnerable and more adaptable to fluctuations in the oil price.

The price is expected to stabilise in 2016 – though it is notoriously difficult to predict – which is likely to mean a steady expansion of the construction sector, with government and private sector demand both playing a role in creating new opportunities.

Diversification of tourism, in particular, is an important factor for construction. The government is aiming to attract 12m visitors a year by 2020, from a forecast 1.1m in 2015. While this target, set in 2012, is unlikely to be met, tourism continues to grow, increasing demand for hotels, resorts and other leisure facilities such as marinas, golf courses and theme parks. Oman’s focus on high-end rather than mass tourism will require an expansion of luxury hotel capacity across the country, one that is already starting to take shape with projects like the ITCs.

Finally, the government’s commitment to infrastructure development is at the centre of its medium- to long-term strategy. Enhancing Oman’s transportation and utilities is not only a necessity to ensure that it keeps pace with rapid population growth, it is also a means through which to drive economic diversification. Through working to develop ports, roads, airports and railways, Oman will be able to strengthen its position as a tourist destination, a manufacturing base and a transportation centre for the region. In doing so, it can take advantage of its position on the Arabian Sea, with wealthy neighbours to the north and fast-growing emerging markets in Asia and Africa to its east and west.

The government has continued its plans for infrastructure development in 2015, which has been a major factor in keeping the economy and the construction sector moving forward. Aside from their direct impact on construction, major projects stimulate demand for other forms of construction, including the sort of grade-A office space that major international contractors seek. It also tends to lead to a growth in housing for expatriate workers.

“[2015] has been one of the best years for us in terms of volume of projects,” Ghassan Shammas, general manager of Omani construction company Target, told OBG. “The government is committed to projects of national importance, so we do not predict a slowdown any time soon.”

Region-wide, Alpen identifies a number of trends in the construction industry. These include growing demand from the tourism sector; better implementation of affordable housing schemes; greater use of pre-cast concrete; increasing participation of international players in partnerships and joint ventures; and increasing economic diversification driving expansion and initial public offerings (IPOs) of companies that use construction services.

Oil Price

The fall in the global oil price is widely perceived as the biggest downside risk to the construction sector. The sultanate can continue with government investment at its current pace for some time without putting its fiscal position under severe strain. However, this level of government support would not be sustainable over the longer term if subdued prices continue, or if they were to drop further.

Oman has a fiscal break-even oil price – that is, the oil price needed to cover its budgetary spending plans, taking into account other sources of income – of $108, according to Deloitte, which will push the budget into deficit in 2015 and 2016. The IMF expects Oman to run a deficit of 17.7% in 2015 and 20.0% in 2016. These levels would be alarming in a country without large fiscal buffers, but Oman’s external debt is very low, and its foreign reserves substantial, which allows the sultanate a degree of flexibility in its ability to plan and develop for the future.

The price of a barrel of Brent crude oil was around $45 in late November 2015, having fallen from $65-70 in the middle of the year. A Reuters survey that month forecast an average of $58 for 2016, while the US government Energy Information Administration (EIA) forecasts $56, rising to $71 in 2016. Deloitte Market-Point, earlier in the year, forecast the price rising to a “steady range” of $75-80 by 2018, which would ease some pressure on the sultanate’s finances, and certainly aid in boosting economic growth.

Thus far, Oman has continued to push forward with major public projects, in the understanding that the lower oil price is a reason to persevere in its policies, rather than to cut back; the investments made now are intended to support diversification over the medium to long term.

Hamed Hashim Al Dhahab, CEO of Al Watanyiah United Engineering and Contracting, told OBG that 80% of sector activity is dependent on government spending. He said that the industry is central to Oman’s economic well-being, as one of the largest employers, with 800,000 people dependent on construction for jobs, making it one of the most important employers of Omanis. Furthermore, he emphasised the importance of the sector to broader economic growth, with strong long-term economic and social multiplier effects from investment in construction. These factors are regarded as making it less likely that the government will make severe cut backs on its investment in the industry. The government order book for 2016 is already solid, and so current momentum looks set to be sustained for the following year at least. However, the state may be forced to trim investment by 2017 if oil prices persist at low levels, which would, in turn, have an impact on the construction sector, which has grown strongly on the back of public projects; private demand for real estate has also been stoked by government outlays boosting incomes directly and indirectly, and drawing expatriates in to work on major developments. Lower oil prices may also affect tourist arrivals and investments in real estate from other oil-rich countries, including the neighbouring Gulf states, Russia, and South-east Asian countries.

Managing The DIP

However, trimming government spending on infrastructure projects need not necessarily see them put on hold altogether. PPPs have already been enthusiastically embraced by the sultanate, which is not as cash rich as some of its neighbours and has pursued an open-doors policy to investment, much to its benefit.

Expanding the use of financing structures such as build-operate-transfer (BOT) and build-own-operate (BOO) would allow infrastructure to be delivered by private partners, at lower immediate cost to the exchequer, a change which would benefit most participants in the industry.

As well as lowering the burden on the budget by harnessing private financing, PPPs can bring in expertise and management skills, easing the burden on Oman’s public administration in the short term, and supporting knowledge and technology transfer in the longer term. Some contractors see other upsides from the situation, if managed well, including a catalyst for creating leaner, more efficient, and thus more competitive companies.

“What we as construction companies need to do now is to implement cost reduction across the value chain,” Steve Scott, CEO of Al Hassan Engineering, told OBG. “We all became complacent when the oil prices where high; now that they are low, the strong companies just need to tighten their belts.”

Combined with regulatory moves and a change in the government’s priorities in public project tenders to focus on delivery and value – rather than merely lowest price – others in the engineering sphere also expect a necessary shakedown of the sector, to the long-term benefit of the better contractors. PPPs: In November 2015, Ali Massoud Al Sunaidy, Minister of Commerce and Industry, told a conference that the sultanate would follow up the liberalisation of power and water supply with PPPs in other sectors, including wastewater, health and housing.

He went on to say that the government was in the process of drawing up a five-year investment plan running from 2016 to 2020 to encourage private investment in sectors including transport and logistics, minerals and tourism, all of which require extensive inputs from the construction industry. The strategy is expected to prioritise private investment and management, with the government stepping in only where private investors are less interested in delivering strategic projects.

“In the future, our experience in liberalising power generation, water production and communications will pave the way for the privatisation of other service and utilities,” Al Sunaidy said.

“In the discussions of the five-year plan, there is no better time to drive privatisation further, and provide the foundation for a new era of PPP experience,” the minister continued.

Oman has a pioneer in the use of PPPs in the region, encouraging investors not only to construct public infrastructure, but to take a stake in ownership and management, easing the burden on the state and boosting technology and knowledge transfer.

Perhaps the most obvious examples of these are the independent water and power plants (IWPPs) and independent power plants (IPPs), which are at least part privately owned (usually majority privately owned now), and sell their output onto a state-owned grid at an agreed price. As early as the 1970s, the Al Ghubrah IWPP was launched. Then in 1996, Oman became the first GCC member state to formally liberalise its utilities sector, with the Manah power project developed by the United Power Company on a build-own-operate-transfer (BOOT) model. In 2002, private companies were encouraged to invest in the Salalah Power System, now the Dhofar Power System, and the Oman Power and Water Procurement Company (OPWP) was established as the state’s sole off-taker of power and electricity.

In 2004 the Law for the Regulation and Privatisation of the Electricity and Related Water Sector, also known as the Sector Law, was promulgated. The law set the parameters for the transfer of utilities into private hands, overseen by an independent regulator, following a model used in many developed markets.

The independent utility model is widely seen as highly attractive to investors, offering majority ownership, favourable off-taking fees and long-term purchasing contracts. Meanwhile, it has continued to deliver a reliable supply of power and water to Oman’s rapidly growing population.

Challenges

Writing in the foreword to Alpen’s 2015 report on the GCC region construction sector, Yusuf Nalwala, managing director of Al Ansari Group, noted a number of trends presenting challenges to contractors and the broader construction sector in the region, and Oman in particular. These include the increased complexity of projects, as major developments are rolled out. For example, the development of the Khazzan field and the proposed railway network are projects of unprecedented scale for the sultanate, requiring best-in-class engineering, procurement and construction (EPC). This becomes more of a challenge at a time when other countries in the region are also implementing similar projects, putting a strain on the talent pool, even with expatriate workers available. Nalwala also noted that clients are becoming more stringent on both cost and pre-qualification, while also demanding shorter planning and completion periods. He sees tougher pre-qualification as a positive move, ensuring that only companies with sufficient technical capacity win contracts. Nalwala also urged closer adherence to payment schedules to better encourage timely delivery of projects, with an improved understanding of payment cycles by contractor and client alike. Finally, a focus on vocational education from the government to broaden the skill sets of Omanis and encourage them to enter the construction workforce would “qualitatively benefit the construction sector in Oman”, Nalwala wrote.

Omanisation

Omanisation – the principle of increasing the proportion of the workforce that are Omani nationals – is seen as essential for long-term economic sustainability, but has presented employers with short-term challenges.

“Omani engineers are hard to come by, mainly because the private sector cannot keep up with public sector salaries,” Milan Maksimovic, general manager of Energoprojekt Entel, a Serbian company specialising in energy project construction in Oman, told OBG. “There have been some improvements, but the pool to pull from is small to begin with.”

The construction sector has an Omanisation target of 30%, which may seem modest given Oman’s relatively low proportion of expatriate workers compared to some of its Gulf neighbours, but is still a challenge in an industry perceived by many Omanis as low-wage and unfashionable. The government seems to recognise the extent of the problem and is seeking to implement effective solutions.

The sector faces the twin issues of a shortage of qualified local graduates for managerial positions, and that few Omanis desire to be construction labourers – the segment of the workforce which accounts for most jobs. The CEO of the Oman Society of Contractors, speaking in April 2015, said that the sector’s Omanisation rate stood at 9%.

However, increased investment in education and training, and a broadening of courses tailored for the all-important construction industry, including surveying and engineering, are helping to ease the bottleneck on skilled labour in the sultanate’s population. At the lower-skilled end of the spectrum, the authorities are flexible, given the critical importance of construction to the sultanate’s economy – and the creation of jobs for Omanis in the medium and longer term. It’s a situation that continues to evolve as time goes on.

“The government understands that you need labour clearances to build the country’s infrastructure,” Arif Modaberi, director of Deebaj National Enterprises, told OBG. “If you have projects and paperwork the government will give you the visas you need [to complete the work].”

EPC

As the sultanate rolls out big-ticket projects over the coming years, some in the sector see an increasing need for EPC contracts to be deployed. EPC contracts generally entail a completed project being delivered from design, usually for a piece of operating infrastructure, such as energy utilities, rather than buildings. EPC contracts thus tend to have performance standards built in, putting the onus on the contractor to ensure that an efficiently operating system is delivered, functioning and on time.

An EPC contractor becomes a single point of contact for the client – often in this case a government – managing engineering, design, contracts with suppliers, and overseeing the construction until the point of operation. EPCs are often seen as delivering projects more efficiently and in timely fashion, and with better price control, than other models.

“Oman’s mega projects require strong EPC contractors,” Steve Scott, CEO of Al Hassan Engineering Co, told OBG. “If the engineering element is missing or weak, the rest of the value chain is affected and procurement and construction suffer.” Al Hassan itself is already active in EPC contracts, first as a subcontractor on projects including the Musandam Gas Plant being built by Hyundai Engineering & Construction, as well as in the UAE. The company is now shifting towards pitching as the lead contractor on EPC contracts itself, taking on more risk, but with higher margin business as a reward.

EPC contracts are already being awarded for big-ticket projects in the sultanate, but the bidding tends to be dominated by foreign players; Al Hassan aims to be Oman’s first homegrown true EPC company.

In November 2015, Oman Oil Refineries and Petroleum Industries Co (ORPIC) announced that it had finalised negotiations with the preferred bidders for contracts worth $4.5bn for the construction of the Liwa Plastics Project. This included a $2.8bn EPC contract for a steam cracker and associated utilities awarded to a consortium of Chicago Bridge and Iron of the US and Taiwan’s CTCI. Italy’s Technimont won the EPC contract for plastics units; a third EPC contract for natural gas liquids extraction facilities went to a consortium of South Korea’s GS Engineering and Construction and Japan’s Mitsui & Co; and a fourth, for a pipeline, went to India’s Punj Lloyd.

Outlook

The outlook for the Omani construction industry in 2016 remains robust, despite the downside risk created by lower oil prices. A strong pipeline of public projects, and sustained private demand for high-quality real estate projects, are likely to help sustain momentum. If oil prices remain low, or drop further, the government may reassess some projects, but priority development should continue, while tighter resources could drive further use of PPPs.