Saudi construction sector consolidates gains ahead of anticipated bumper year in 2019

In 2018 consolidation marked Saudi Arabia’s construction sector, following a difficult 2017 when the government shelved or paused many unfinished projects. Growth in 2018 was modest at around 4% and the value of contracts awarded was still well below the record years of 2013 and 2014. The year also saw the fall of one of the country’s largest and most successful construction companies, Saudi Binladin Group. In addition, the sector is increasingly being opened up to further competition. Overseeing the Saudi Public Investment Fund (PIF), the largest project developer in the country, Crown Prince Mohammed bin Salman bin Abdulaziz Al Saud has continued to play a major role in sector reform in 2018, announcing privatisation plans and bold development projects. Backed by increased development and infrastructure spending, the construction pipeline for 2019 and beyond is extremely positive with 700 new projects set to come on-line in 2019.

Sector Size

As of October 2018 the total value of the Kingdom’s ongoing construction projects had reached $284bn. In terms of combined value across the GCC, Saudi Arabia accounts for 45% of construction projects in the region. Overall, growth in the construction sector as of October 2018 stood at 4.1% year-on-year, likely boosted by the $14bn in infrastructure spending set aside in the 2018 state budget. The total value of construction contracts awarded in 2018 is forecast to hit $26.3bn, and then climb significantly to $44.1bn in 2019. The construction sector’s contribution to total GDP, which in 2017 sat at around 4.6%, is expected to increase to as much as 10% of GDP by 2030.

Although a strong pipeline bodes well for the coming years, the sector’s current performance is still well below the record $78.1bn of contracts that was awarded in 2013. The value of Saudi contract awards has varied widely over the past decade as state spending fluctuated. A recent low point in terms of contracts awarded was reached in 2016, with just $20bn awarded. In 2017 this figure rose to $27bn and this was expected to remain fairly consistent in 2018. The government continues to be the principal source of the vast majority of new construction project tenders in the country.

Performance

In recent years, the government has had to cancel several planned construction projects as part of efforts to reign in the widening fiscal deficit amid decreased oil revenues. In 2017 the government announced it would shelve billions of dollars’ worth of construction projects, many of which had advanced by less than 25%. Fiscal pressures and changing government priorities have had a significant knock-on effect for the construction sector’s performance. Few new projects outside of oil and gas have been started in recent years, and most others have been concentrated in the capital Riyadh. “Everything was put on hold,” Nagib El Alam, vice-president of Construction at Saudi Arabian Trading and Construction Company (SATCO), a Saudi civil construction contractor, told OBG. “Projects were re-evaluated and restudied and reprioritised in line with Vision 2030,” El Alam added.

Going forward, the government is set to prioritise several construction segments for investment, including hospitals, schools and housing. In addition, traditional economic sectors – such as hydrocarbons – as well as relatively new segments, such as technology, entertainment and tourism, are also being prioritised. Housing construction is set to be a major focus for the government as it seeks to meet its development targets laid out in Vision 2030. Notably, this includes a target of 70% home ownership in the country, up from its current level as of 2018 at 47%.

Despite recent project cuts, the construction sector is still expected to achieve a compound annual growth rate of 3.1% between 2017 and 2022. This growth is in part supported by the government’s $3.5bn allocation for road and bridge construction projects as well as investment in gas infrastructure, including a $590m gas pipeline construction project. Multibillion-dollar projects focused on tourism, including the NEOM and Qiddiya mega-projects, are also buffering the construction pipeline. NEOM, a bold cross-border smart city, is expected to bring in around $500bn worth of total investment alone.

Structure & Oversight

Saudi Contractors Authority (SCA), a newly formed government authority, is the primary institution responsible for regulating Saudi Arabia’s construction industry. Formed in 2017, the SCA has been tasked with increasing mergers and acquisitions, addressing labour issues, drafting rules for the industry, and publishing industry data and supply statistics on behalf of the government.

The PIF, the Kingdom’s sovereign wealth fund, invests across numerous sectors including infrastructure and housing development. Under its 2018-20 development programme, the PIF expects to create around 260,000 construction jobs. Crown Prince Mohammed bin Salman is also a prominent figure in the country’s construction sector and has played a key role in reform efforts. He leads the PIF and has been credited with shaking up the construction sector through opening it up to more competition and breaking up the historically dominant construction conglomerates in the country. Additionally, he has been instrumental in bringing about a number of recent reforms to foreign ownership laws which now allow foreign companies to own 100% of projects in most industries, including construction.

Major Construction Companies

Saudi Arabia’s construction sector is dominated by several large government-owned funds and around a dozen or so prominent contractors. The PIF is the country’s and the GCC’s largest project developer, with pre-execution pipeline investments worth $534bn, a number of which are in construction. The PIF is one of the seven Saudi entities in the GCC’s top-10 largest project owners. Others include the King Abdullah City for Atomic and Renewable Energy (KA-CARE) investment fund and Saudi Aramco. As of 2018, KA-CARE’s developments were valued at $70bn and Aramco’s at $36bn. Beyond these large multibillion-dollar players, smaller funds such as the Al Akaria Saudi Real Estate Company (SRECO) and Alinma Investment Company (AIC) are also very active in the construction sector. In October 2018, SRECO and AIC established a joint $400m fund to build hotels and commercial premises in Riyadh. Most construction contractors operating in the Kingdom are local and depend almost entirely on government contracts. According to SATCO’s El Alam, “Around 98-99% of contracts still come from the government as the private sector remains wary due to the current economic situation.” Construction permits are typically issued by the corresponding municipal authority and can cost around SAR7800 ($2080) in Riyadh, for example. The family-owned Saudi Binladin Group, which has been the preferred government contractor for decades, is the dominant player in the market and was formerly worth approximately $7bn. Saudi Binladin Group’s largest contracts include the ongoing $26.6bn expansion project at the Grand Mosque in Makkah. However, the company appears to have fallen out of favour with the government. Saudi Binladin Group is currently in the process of being slimmed down, restructured and renamed after members of its management were swept up in an anti-graft drive. Nevertheless, it remains the largest construction contractor in the country.

Other major local construction contractors include Al Rashid Trading & Contracting Company, Al Arrab Trading & Contracting, Al Bawani, El Seif Engineering Contracting Company, and Al Fouzan Trading & General Construction Company. There has also been an uptick of involvement by large foreign contractors, including from Russia and China. In October 2018 Russian Railways announced that it would submit an application to build a high-speed rail link between the holy cities of Makkah and Medina. Various companies from Japan, the US and China are also being contracted to build housing and to improve the efficiency and technology of construction methods in Saudi Arabia.

Public Procurement

There are three government procurement methods: public procurement competitions, direct purchases and specific purchases. The majority of the acquired purchases are under the category of public procurement competitions. In the past, the Kingdom has faced issues in delivering mega-construction projects, including delays, high costs and low customer satisfaction. Some studies have shown that around 70% of public projects in Saudi Arabia are delayed. One factor that might be causing these performance issues is the traditional low bid contracting system in Saudi Arabia, or the Saudi procurement system. In Saudi Arabia owners often select contractors mainly based on the lowest price.

To address these shortcomings, in 2017 the Saudi Arabian General Investment Authority (SAGIA) partnered with the US Department of Commerce to assess its public procurement system, with the aim of aligning it with international standards. As of November 2018, planned reforms to the public procurement system were still under discussion.

Although Saudi’s 2006 Government Tenders and Procurement Law sets a level playing field for local and foreign companies to tender for projects, Article 5 of the same law states that priority will be given to locally manufactured goods, products and services. As such, local construction contractors are typically given priority throughout the tendering process whenever there is no difference between their offers and the foreign company’s offers. There is no central tender board in Saudi Arabia, and each government department has its own contracting authority. Pre-qualification is used to identify contractors who have the necessary experience, know-how and resources to successfully carry out a particular scope of work or project.

The specific requirements for pre-qualification for government tenders vary between different government agencies and also from project to project. One of the major requirements is that companies bidding for public tenders have a commercial registration; foreign contractors require a licence from SAGIA. Regulations are generally flexible for foreign contractors, particularly in relation to infrastructure tenders. In these cases, foreign companies can secure a temporary licence from SAGIA without having a physical presence in the country. Apart from the major tender for the high-speed rail link, the government is also looking to international companies to bid on other major infrastructure development projects. In June 2018 the government invited five international companies to bid for a $745m contract to build a 60-km canal along the Qatari and Saudi border. Other current tenders targeting foreign companies include upgrade projects for power stations.

Building Materials

Cement sales in Saudi in 2018 were some of the lowest compared to the last five years, largely due to oversupply. Most cement companies recorded a 6% year-on-year decrease in revenues in the second quarter of 2018 and an average earnings decrease of approximately 10%. This followed a sharp contraction of 57% in earnings and fall in dividend yields to 4.7% in 2017 against a three-year average of 6.1%. Conversely, steel prices recorded a 12% year-on-year increase in the first quarter of 2018, while cables rose by 19% and wood by 5% over the same period, amid increased demand across the globe.

According to a report by Trade Arabia, 15 cement companies recorded a decline in sales volume in the second quarter of 2018, led by Riyadh Cement (-44.1%) and Cement City (-37.5%). However, Tabuk Cement (+82.4%) and Hail Cement (+28.7%) recorded major sales boosts off the back of increased production of 20% and 55%, respectively, in the first half of 2018, reportedly linked to the NEOM mega-project. In 2017 the residential segment held the largest cement market share in Saudi Arabia, accounting for over 62% of the market. Riyadh Capital, a local investment bank, has said that the cement segment is on a modest path to recovery but that companies are likely to see flat or modest improvements in margins and earnings in the next 12 months. According to Riyadh Capital, most production will feed local demand in the short term, as the export market remains challenging due to stiff price competition in neighbouring countries and oversupply in the region in general.

Despite weakening demand for cement in 2018, the outlook for the short to medium term is positive. Technavio, a global technology research and advisory firm, has forecast a compound annual growth rate for cement demand of over 5% for the period 2018-22, with the key driver of growth being the Vision 2030 development programme. Infrastructure developments associated with religious tourism, health care and real estate, in addition to the development of the NEOM and Qiddiya mega-projects, are set to underpin this.

Staffing 

As of end 2018 the construction sector employed around 150,000 private sector workers. Construction in Saudi has been one of the sectors hardest hit by the recent exodus of expatriate workers. In 2017 the government introduced expat dependent fees and then in early 2018 implemented a series of expat levies. These reforms are part of the government’s broad policy of Saudiisation, which aims to increase the number of local employees in key sectors.

As part of this policy, the government is increasing the costs of hiring expats in an effort to incentivise local firms to hire locally. Around 221,000 expats left the country in the first quarter of 2018 alone, 126,000 of which were formerly employed in the construction sector. At the time, the total number of foreigners who had left the market since the start of 2017 stood at around 796,000. In February 2018 several heads of chambers of commerce and industry called on the government to exempt the private sector from full Saudiisation, citing concerns that many businesses in construction and other sectors may be forced to close down as a result. A July 2018 report by BMI Research warned that labour shortages and strict implementation of a 100% Saudiisation policy threaten the construction sector’s growth potential. Although the sector is forecast to grow at an annual average of 6.1% between 2018 and 2022, this could be revised downwards given current labour law trends.

Major Projects & Demand Drivers

With 700 new projects set to launch in 2019, the Saudi construction industry is poised for medium to long-term growth. Apart from tourism and residential-focused mega-projects like NEOM and Qiddiya, demand from the petrochemicals and minerals sectors is also driving a promising pipeline of construction work.

In October 2018 the PIF inked $50bn in agreements and memoranda of understanding (MoUs) with local and foreign firms during the Future Investment Initiative summit in Riyadh. Construction contracts to build a copper and zinc smelter, a petrochemical complex in Jazan, and a refinery at King Salman Global Maritime Industries Complex, were among the largest projects agreed upon. Transport infrastructure, including $3.5bn in government allocation for roads and bridges, as well as separate contracts for a rail network, are among the other main drivers of demand.

Outlook

The Kingdom’s construction sector is on a steady road to recovery following several challenging years amid a scaling back of government investment. With a rebound in global oil prices strengthening state revenues, the government is once again upping its investments in a pipeline of mega projects related to infrastructure, petrochemicals, transport and housing projects. More than $44bn in construction contracts are expected to be awarded in 2019 and foreign companies with technical knowledge and skills are well positioned to win bids for complex projects related to petrochemicals, power and canal construction.

Although potential labour shortages driven by visa requirement changes and Saudiisation pose operational challenges, the government is likely to address this problem. Under Crown Prince Mohammed bin Salman’s lead, positive changes to foreign ownership laws and ongoing privatisation plans have set the stage for promising sector growth in the coming years as the country looks to meet its ambitious Vision 2030 targets.