Expansion and diversification: Using existing advantages to overcome shortfalls

As in many other countries, the construction industry in Kuwait was one of the first areas of the economy to suffer as a result of the global recession. However, the sector is now poised to become one of the immediate beneficiaries of Vision 2035, an ambitious blueprint for economic growth and diversification that will see hundreds of billions of dollars in infrastructure spending over the next 20-25 years. From transport to housing, to health and education, the plan has slated major projects for nearly every segment of the economy, many of which represent promising opportunities for private developers and investors.

THE NDP: Vision 2035 will include five successive fiveyear plans, the first of which is the 2010-14 National Development Plan (NDP). The government has budgeted KD30bn-35bn ($108.2bn-126.18bn) for more than 1000 infrastructure and development projects under the NDP, including some projects already under way that have been integrated into the plan.

According to official data, the first fiscal year under the NDP (2010/11) witnessed an estimated KD1.4bn ($5.2bn) in spending on the launch of 884 projects, 493 of which are related to infrastructure. As noted in a Kuwait Financial Centre report, infrastructure development is likely to be a major point of emphasis among NDP policymakers in the coming years: “We would expect the first few plans to be heavy on infrastructure as it is a sector which is in a very nascent stage.”

A key objective of the NDP is to address nearly two decades of underinvestment in infrastructure, which is especially important given the country’s young and growing population. Through the construction of new airports, roads and maritime facilities, new tourism areas, universities and private hospitals, the NDP aims to create a diversified economy and transform the country into a regional commercial centre. By 2015 the plan hopes to boost the GDP contribution of commercial activities to 3%, up from the present 0.8%.

HELPING HANDS: Several government bodies will oversee and execute construction ventures during the NDP.

Central is the Ministry of Public Works (MPW), an office that has played an essential role in infrastructure development since the country’s formal independence in 1961. Under the NDP, the MPW and its engineering divisions will execute small- to large-scale works on roads, water systems and municipal buildings, as well as a number of “mega-projects” such as the KD25bn ($90.13bn) Madinat Al Hareer (“Silk City”) housing scheme, which will see the construction of an urban centre in northern Kuwait housing 750,000 people in over 175,000 residential units. The MPW has been allocated a budget of KD3.1bn ($11.18bn) for the projects it will undertake in the period covering 2009 to 2013.

PARTNERSHIPS: Established in 2008, the Partnerships Technical Bureau (PTB) is the newest sector agency. The mandate of the PTB is to help enforce the regulations governing public-private partnership (PPP) as specified under Law 7 of 2008, including provisions for the issuance of PPP tenders. Although PPP construction works in Kuwait have traditionally followed a build-operate-transfer model, the PTB is now exploring alternatives to capitalise on new sources of funding and expertise. According to local reports, the PTB plans to structure 24 private sector infrastructure and construction projects worth $21bn.

Other key bodies include the Mega Projects Agency, which was established in 2005 to manage large construction initiatives for the MPW, and the Central Tendering Committee (CTC), which oversees the design and distribution of tenders. Although the CTC plays an important role in the sector, some players within the industry have argued that the committee needs to adjust its current criteria for evaluating bids.

According to Osama Refaei, the general manager for construction and engineering at Kuwait Dynamics, “Tendering authorities in Kuwait are required to select the lowest bids rather than those which are the most feasible or the highest quality. By allowing corner-cutting contractors into the market, this approach has led to a deterioration in the quality of the building standards.”

RAIL PROJECTS: Many NDP construction works target the transport sector, which, as a result of increased spending, is expected to grow by 15.5% per annum over the next five years. One major project is the new metro system planned for Kuwait City. Once completed in 2016, the $7bn metro will extend 171 km and have an annual capacity of 69.1m passengers. This will ease congestion in the capital, reduce commuting costs for residents and increase the efficiency of the economy.

The metro project is noteworthy because it represents one of the first major PPP projects under the NDP and the new legal framework for PPPs created in 2008. According to local reports, the PTB will offer invitations to bid on the metro in 2012, with construction to begin in 2013. Under one of several proposed ownership deals, the successful private investor and the government will own 40% and 10% stakes, respectively, with a 50% stake sold through an initial public offering (IPO).

Another major construction project is the National Rail Network, which will link to the new metro and the $30bn GCC railway line, a proposed network measuring 2200 km that is expected to connect all six GCC countries by 2017. Kuwait’s portion of the line will run 518 km and will be developed by a new shareholding company at a cost of KD1.8bn ($6.49bn). Half of the railway company’s shares will be floated in an IPO, and the government and the Kuwait Overland Transport Union will retain shares of 40% and 10%, respectively.

AIR & ROAD EXPANSION: Other transport projects to be executed during the NDP include the expansion of the Kuwait International Airport, which will see the extension of two runways up to 600 metres, as well as the design of a new KD212m ($764.26m) terminal building by Foster & Partners, an architectural firm based in the UK. Moreover, government planners have prioritised road development, with several tenders for new bridges and motorways going to foreign companies. According to Aysha A Bu Dastour, the chairman of Kuwait Bruckner Construction Contracting, “The NDP has witnessed some progress in the past year and a half, with several tenders for major projects have been awarded.” In February 2011 South Korea’s Hyundai Engineering and Construction won a KD738.7m ($2.66bn) tender from the CTC for the Jaber Bridge, which will run 28.5 km from Kuwait City to the northern city of Subiya. Over the last two years contracts have also been awarded to the US-based consultancy Louis Berger Group and the Egypt-based Arab Contractors Company for works on the KD264.7m ($954.24m) Jahra Road project.

DIVERSIFICATION PROJECTS: A chief objective of the NDP is to diversify the economy beyond the production and export of petroleum resources. This has led to new contracting opportunities for the construction sector, such as the KD345m ($1.24bn) Boubyan Island development, which aims to help Kuwait become a centre for regional business activities. In January 2010 South Korea’s Hyundai Engineering and Construction and Kuwait’s Kharafi Group received contracts worth $1.4bn to build a commercial port on the island with 60 berths and an expected capacity of 2.5m twenty-foot equivalent units. US-based URS/Scott Wilson won a four-year $1.2bn contract from the MPW for design, audit and construction supervision at the facilities.

Another NDP venture linked to economic diversification is the proposed Failaka Island Development, which aims to create a tourism resort featuring a water park, a golf course, four marinas, hotels and upscale chalets. In May 2011 the PTB identified the Failaka Island initiative as one of the agency’s nine “priority projects” for the next five years. According to government estimates, the 43-sq-km island will require a total investment of more than KD120m ($432.6m).

HUMAN DEVELOPMENT PROJECTS: Construction works under the NDP will also promote human development, especially in the areas of health and education. To help accommodate increased demand for school facilities, Kuwait University has commissioned the Dubai-based developer Arabtec Construction to build two colleges at the Sabah Al Salem University Complex in a joint venture with Combined Group Contracting, a Kuwait-listed firm. Valued at $408m, the project will take roughly 42 months to complete. In addition, the university has signed contracts with the Gulf Dredging and General Contracting Company and the Riyadh-based Dar Engineering for works at its complex which, once completed in 2015, will have capacity for 40,000 students across three campuses.

For the health care sector, government officials have appointed a consortium of the Egypt-based Arab Contractors and the local Kuwait Arab Contractors to build the KD304m ($1.09bn) Jaber Al Ahmed Hospital. Containing five buildings holding an aggregate capacity of 1268 beds, the facility will become the largest hospital in Kuwait when finished in early 2013. In addition, the proposed Kuwait Health Assurance Company, a public-private enterprise that will provide health insurance to expatriates, is expected to oversee the construction of three new hospitals and 15 health centres nationwide over the next three years.

OIL AND GAS: Given the importance of hydrocarbons to the economy, about 25% of NDP projects have been scheduled for domestic exploration and production, according to estimates from Meed Projects, a business intelligence company. Through extensive building and modernisation efforts, officials plan to achieve 1bn cu feet of gas production per day by 2015, and a daily crude oil production capacity of 3.5m barrels per day (bpd), up from 3m bpd as of early 2011.

In July 2011 the Kuwait National Petroleum Company (KNPC) made headlines when it received approval from the Supreme Petroleum Council to begin downstream projects worth $30.5bn. This includes $16.25bn for upgrading two existing refineries, along with $13.9bn for building the Al Zour Refinery, which will be developed over five years in two phases. Whereas phase one will see the facility begin processing 300,000 bpd phase two will witness an increase to 615,000 bpd.

The troubled history of the Al Zour development reflects the risks national and foreign investors sometimes face in Kuwait. After receiving permission to begin work on the refinery in 2009, the KNPC had its contract terminated by the State Audit Bureau after several lawmakers argued that the company had bypassed CTC regulations. This resulted in the cancellation of all foreign contracts, which were valued in excess of $10bn.

The lesson for investors is that political opposition must be monitored on each project to determine the risk environment. As noted by Mansour Al Saed, the general manager of local engineering services firm ASAS Engineering Documents, “Political obstructionism is a red flag for developers and investors. Whenever the government proposes an ambitious venture, there is a chance that certain parliamentarians will run interference – a problem likely to affect projects under the NDP.”

ROAD BLOCKS: These sentiments have been echoed by independent observers such as Business Monitor International, which argued in a 2011 report that development works in Kuwait have traditionally experienced delays due to “the transitory and erratic nature of the political landscape”. Indeed, there have been seven cabinets in the past five years. As the NDP is the first major plan since 1985-86, there are questions of whether capacity exists to execute the programme.

First, there is the issue of logistics, or how companies will acquire and transport all of the raw materials, heavy equipment and foreign workers needed for such a project. Second, there is the question of whether local firms have the technical expertise to carry out works in every sector. “Aside from major developers such as the Kharafi Group, which carried out building works for the South African World Cup, there are relatively few firms in Kuwait that have broad expertise,” Al Saed said. “Thus, if foreign developers are unable to contribute as expected, several specialised or large-scale projects may be cancelled or delayed.”

Given the current reluctance of local banks to offer project financing, others have expressed concerns that private sector ventures will experience difficulties acquiring funding. This is crucial considering private investors are expected to cover 50% of all NDP costs. “Since the global financial crisis Kuwaiti banks have become far more risk-averse,” Kuwait Dynamics’s Refaei told OBG. “If this continues, local firms may find themselves unable to finance major NDP projects unless they secure loans from foreign lenders.”

SUPPORT FOR FINANCE: Nevertheless, the authorities are taking steps to encourage bank participation in the projects market. In August 2010 the government indicated that it was prepared to guarantee bank loans serviced under the NDP with state deposits worth KD10bn ($36.05bn), a proposal that led to an immediate rise in the share value of local lending institutions. According to some, this pledge has already stimulated lending activity among key players such as Burgan Bank, which structured several loans for NDP projects through to the first half of 2011. “Burgan Bank’s Corporate Banking Group has completed a range of finance deals with its corporate clients to support the execution of their major projects with a total value of KD741m ($2.67bn),” Raed Al Haqhaq, the chief banking officer at Burgan Bank told the local press. “These projects cover different industry sectors ranging from construction, infrastructure, oil and gas, trading, and services.”

BUILDING MATERIALS: Another issue for the sector’s progress will be the price of building materials. According to one estimate, to complete all of the remaining NDP projects over the next four years, the local construction industry will need about 26m tonnes of iron, 26m cu metres of sand and 72m sacks of cement. This may lead to a surge in demand and a spike in prices, especially if several large-scale projects come on-line simultaneously. Consequently, the Kuwait Financial Centre has argued “the government can help mitigate this risk by spacing out its mega-projects onto a definitive, pre-ordained timeline giving priority to those projects which are of more immediate need to the country.”

At present, however, the local cost for cement is at a three-year low, with more supply is coming on-stream.

Moreover, according to projections from Global Investment House, cement supply in the GCC region will be 123m tonnes per year from 2010 to 2017.

In terms of steel consumption, it is estimated that Kuwait currently uses 800,000 tonnes of rebar per annum — a figure expected to reach some 1.1m tonnes per annum in the coming years. Despite rising prices, officials from the United Steel Industrial Company have stated they do not expect per-tonne costs to exceed the current price of KD240 ($865) in the medium term.

OUTLOOK: Forecasts from BMI indicate the construction industry will rise in value from an estimated $2.4bn in 2011 to $3.2bn by 2015. This modest growth projection reflects perceived obstacles, such as red tape, potential land shortages and uncertain bank financing. However, given the government’s massive surplus from oil revenues and the relatively low cost of building materials, it seems an opportune time to start the major public and private works that form the backbone of Kuwait’s development and diversification plans.

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The Report: Kuwait 2012

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