Public spending cuts contribute to a slowing of growth in Saudi Arabia's construction sector

From 2003 to 2013 Saudi Arabia’s second oil boom brought a decade of prosperity for its construction and engineering sectors, but with the brakes applied to public spending, many businesses face a more challenging landscape in 2016. Work is continuing apace on some of the most prestigious projects, such as the Riyadh Metro and King Abdullah Economic City on the Red Sea, but progress has slowed or stalled on many other schemes, and contractors, developers and suppliers face delays on new developments and payments for work they have already completed. Yet, there may be increased opportunities to work for a broader range of clients as the government considers ways to stimulate private sector growth in order to meet the needs of an expanding population.

Modest Growth

According to the investment and research firm Jadwa Investment, the Kingdom’s non-oil sector grew by 3.6% in 2015, posting its lowest growth rate since 2003. The company expects that non-oil sector growth will slow to 2.6% in 2016, compared to an average of 6.6% per annum over the previous five years. The construction sector, meanwhile, is projected to grow by just 2% in 2016, down from an estimated 5.6% in 2015. Although cement sales were up year-on-year in 2015, indicating increased sector activity, after the government’s 2016 budget announcement, Jadwa Investment now anticipates that government expenditure will fall to 48% of non-oil GDP in 2016, down from an average of 65% over the previous five years.

While the construction sector benefits from a wide range of expenditure and programmes across all government departments, many mega-projects have fallen under the infrastructure and transport budget in the past, and the 2016 the allocation for this section of the budget fell from SR63bn ($16.7bn) in 2015 to SR23.9bn ($6.4bn). In its 2016 budget the Ministry of Finance told the media that all government capital expenditure projects would be reviewed and reassessed to ensure they were implemented efficiently, and that projects remained consistent with “development priorities, orientations and needs”.

Employment

As the flow of new schemes from the government-financed construction pipeline slowed to a trickle ahead of the budget announcement itself, there was potential for a significant impact on In 2015 the construction sector employed 17% of people working in the private sector in the Kingdom. According to a December 2015 report by the McKinsey Global Institute, the industry generated more than 1m jobs between 2003 and 2013, with 60% of them created between 2010 and 2013. However, foreign labourers occupied more than 90% of these posts. The sector has traditionally relied on low-cost labour provided by South Asian workers and has attracted relatively few Saudi nationals.

As part of the government’s drive to develop the private sector and provide employment opportunities for both citizens and foreign workers, construction firms have faced pressure to reform. In 2011 the Nitaqat quota system was introduced for all companies with more than 10 employees, using a combination of penalties and rewards to encourage firms to hire more Saudis. As a result, the cost of work visas for foreign workers rose sharply. In November 2012 the foreign worker levy was increased from SR100 ($26.70) per worker per year to SR2400 ($640).

According to employment data collected by the General Authority for Statistics (GaStat), based on visits to firms, the Saudiisation rate across the entire private sector rose from 21.2% to 22.1% between 2013 and 2014, but dropped to 20.7% in 2015, the first decline since the new regulations were introduced. According to data from the Ministry of Labour (MoL), the department that issues work permits, suggests a Saudiisation rate of just 15.5%. There are also significant differences between the data from the two agencies regarding the total number of non-Saudis in the workforce, with GaStat reporting 5.8m in 2014 and the MoL estimating 8.2m. The discrepancy is most extreme in construction, with MoL figures showing 4.4m non-Saudis to GaStat’s 1.3m. Labour market analysts have suggested that one reason for this might be that private firms were describing their line of work as construction on visa applications, knowing the sector had more generous quotas than some other industries.

Saudi Builders

By GaStat figures, the proportion of Saudis working in the construction industry increased between 2012 and the second half of 2015, though it still falls short of the 10% target. In 2012, 8.3% of workers in the sector were Saudis, and three years later this had risen to 9.3%. GaStat figures showed there were 141,250 Saudi nationals working in construction in 2012. However, by the second half of 2015 – three years after the new quotas and foreign worker levies were introduced – this had fallen to 125,802. In the first half of 2016 this had risen to 134,601. Over the same period, total employment in construction, including both foreign workers and Saudi nationals, dropped from 1.7m to 1.36m.

In 2015 there were just under 11.5m people employed in Saudi Arabia, with close to 8m in the private sector, including 1.6m Saudis. According to a Jadwa Investment report released in February 2016, construction firms shed 5000 Saudi jobs and 56,000 non-Saudi positions in 2015 alone, with more pressure predicted to come in 2016.

Varied Sector

There are tens of thousands of construction and engineering companies in Saudi Arabia. The latest GaStat figures show there were 19,185 companies involved in the construction of buildings, plus 11,084 specialist builders, 2114 architectural and engineering practices, and 1135 civil engineering businesses. These firms vary in size, with some employing less than five people and others with more than 20 employees. According to data released as the Nitaqat programme was being first rolled out in 2011, some 40,147 firms with 10 or more staff were classified as being in the building and construction sector. The data showed that 39 firms in the sector employed more than 3000 staff each.

The largest construction firm in Saudi Arabia is Saudi Binladin Group (SBG), which employs some 180,000 staff in Saudi Arabia and 20,000 abroad, according to the company, equivalent to 2.3% of all 7.9m private sector workers in the Kingdom. According to Mubasher Financial Services, three private firms – SBG, Saudi Oger and Al Arrab Contracting Company – share 40% of the construction market.

There were 18 construction firms listed on the Saudi Stock Exchange in 2016, and their year-end reports for 2015 showed a mixed picture. A number of these companies posted profits in 2015: Zamil, Saudi Vitrified Clay Pipes, Saudi Steel Pipe Company, and Al Babtain Power and Telecommunication. Several listed firms remained in the black but saw profits ease, while five reported a net loss for the year. Issues faced by construction firms in Saudi Arabia can be seen in the results of one of the companies that remained profitable despite challenging market conditions. Abdullah A M Al Khodari Sons’ net profit fell by 67% in 2015 from SR101m ($26.9m) to SR34m ($9.1m). The company cited tighter gross margins due to increased project costs, including the government’s decision to adjust the prices of energy and electricity, as well as a drop in the used equipment sales. The company announced that it had seen a 48% decline in the value of new contracts from SR2.9bn ($773m) in 2014 to SR1.5bn ($400m) in 2015, as government entities waited for the 2016 budget statement before proceeding with awards.

SBG

SBG faced a unique set of challenges in 2015 and early 2016 following an accident on one of the country’s most prestigious construction projects, the $21bn expansion of the Grand Mosque in Makkah. On September 11, 2015 one of the company’s cranes fell onto the roof of the mosque in a thunderstorm. The accident caused 111 deaths, and an immediate investigation into the cause was launched by the Saudi authorities. The company, which had worked on a substantial number of projects for the ruling family since the 1950s, including the original extension of the Grand Mosque, was ordered to review work on all its existing projects and was barred from tendering for any new contracts. Its directors were barred from travelling abroad, and some of the company’s engineers, managers and other staff working on the Grand Mosque site were among 40 people whose files were passed to the public prosecutor.

According to Reuters, an initial investigation found the crane had not been properly secured. While aspects of the investigation were still ongoing, SBG’s suspension from bidding for new work was lifted in May 2016. In November 2015 SBG, which employed around 200,000 people, laid off 15,000 of its workers, followed by an additional 50,000 foreign workers in April 2016, citing the wider downturn in the economy.

Infrastructure Projects

Although there is concern about the prospects of major contracting firms in Saudi Arabia that have built their fortunes on government-led spending on infrastructure, the construction sector has not ground to a halt. “There are plenty of infrastructure mega-projects in the pipeline, from the expansions of the two holy mosques at Makkah and Medina to the new airports in Jeddah and Riyadh, which will provide opportunities for construction development,” Yousof Al Hammouri, operations director at Mechanical and Chemical Supplies, told OBG. Indeed, the 6m inhabitants of the capital, Riyadh, face daily reminders that the city’s huge metro construction project is taking place as they negotiate traffic jams, road closures and diversions. In June 2015 Alpen Capital reported that Saudi Arabia had $180bn worth of transport infrastructure projects planned up to 2019, $85bn of which were already under way. The largest is the Riyadh Public Transport Project – a six-line metro system. All six lines are being built simultaneously, and there will be 178 km of track, much of it above ground, and 85 stations. Work on the $23bn scheme began in April 2014, with tunnelling for line 1 commencing in July 2015. Commissioned by the Arriyadh Development Authority, the entire project, together with a complementary 85-km, three-line rapid bus network, is due to be completed in 2018.

At the heart of the network will be three landmark stations serving major intersections on the grid; these are being built by a number of leading architecture firms from the UK, Norway and Germany. King Abdullah Financial District Metro Station, designed by the late Zaha Hadid, will serve lines 1, 4 and 6 at the heart of the capital’s new commercial centre. Snøhetta is designing the downtown station, which will be located between Al Madinah Al Munawarah Street and King Faisal Street at the intersection of lines 1 and 3, which are 44 km and 45 km long, respectively. Gerber Architekten has been commissioned to design Olaya Metro Station, which will be at the intersection of lines 1 and 2 in the centre of one of the capital’s most prestigious commercial districts.

Other Projects

Metro systems are also being planned in Makkah, Jeddah, Dammam and Medina, with the initial phase of each project expected to cost $8bn, $9.5bn, $9bn and $8bn, respectively. These rapid transit networks have planned construction periods of between four and five years. Tenders to construct the various packages of Makkah and Jeddah metros were submitted in 2015, but any awards have been delayed until further notice by the Ministry of Finance. Dammam Metro and Medina Metro are still under study, but there has been no indication that either would be tendered any time soon.

Rail networks that will enable goods and passengers to move more easily are also being built. For example, the Haramain High-Speed Rail network between Makkah and Medina is due to be operational by 2017 at a cost of $13.8bn. Meanwhile, in October 2015 the Public Investment Fund gave an extension to the design contract for the Saudi Landbridge, a $7bn infrastructure project that could have fundamental and lasting benefits for the Kingdom’s economy if completed as planned in 2022. In addition, Italferr, the engineering consultancy arm of Italy’s national rail group FS, is working with a Saudi partner, Arabian Consulting Engineering Centre, on the design phase for a 950-km double-track line running from the Port of Jeddah to Riyadh, where it will connect with an existing line to complete a 1300-km rail corridor enabling freight to be transported between the Red Sea and the Gulf in a fraction of the time and at a fraction of the cost of sea cargo. Italferr says that once the line has been electrified, passenger trains will travel at up to 350 km per hour, allowing train users to complete a 12- to 14-hour journey in less than four hours, plus time for station stops.

Major Contractors

Public sector investment has driven much of the private sector growth in Saudi Arabia. This has created a construction ecosystem dominated by major contracting firms with the capacity to employ tens of thousands of workers at concurrent schemes across the country, while also supporting many smaller subcontracting firms and suppliers. When the pipeline of new prestige projects was relatively constant, these major contractors were able to insulate themselves against the risk of working for private sector clients with smaller budgets and a greater tendency not to honour payments. “In Saudi Arabia, the larger contractors prefer not to work with the private sector unless it is a big name, as they know there is a risk they will complete the work, but they may not receive the final 5-10% of their payment, and for this reason they have preferred to work for the government,” Nagib El Alam, vice-president for construction at the Saudi Arabian Trading and Construction Company (SATCO), told OBG.

Existing Projects

As it waits for new government projects to be commissioned, another of the Kingdom’s major contractors, Saudi Oger, is deploying its 42,000 staff on a raft of existing state-funded projects. These include the King Abdullah International Conference Centre and the Haramain High-Speed Rail Station, both in Jeddah, as well as the King Abdulaziz Centre for World Culture for Saudi Aramco in Dammam. It is also continuing work on Riyadh’s $7bn King Abdullah Financial District and its monorail, which is due for completion in 2017.

In addition, the company is working on a new headquarters for the Ministry of Education and a large housing complex for the Saudi Arabian National Guard. “These are mega-projects that were signed before 2016 and we are continuing the execution phase. I do not believe that commissioning of new major construction projects will be stopped, but clients are being more selective and prioritising which schemes to authorise,” Mazen Fayed, director of corporate communications at Saudi Oger, told OBG. The company said in February 2016 that is bidding on four or five new projects. Al Arrab Contracting Company was also busy at the start of 2016, working on projects for several government agencies.

Transport works included a SR13bn ($3.5bn) contract for the civil engineering and groundwork on the high-speed rail link between Makkah and Medina and a SR3bn ($800m) project to build 12 aircraft maintenance hangars in Jeddah. Meanwhile, a total of 900 villas are being built for faculty members at Jeddah’s King Abdulaziz University, as well as a range of buildings around the country, as part of a SR5.7bn ($1.5bn) project with the Ministry of Interior. The company also recently completed two large-scale projects: the SR3.75bn ($1bn) new airport at Medina and the fifth terminal at King Khalid International Airport in Riyadh.

SATCO said it is working hard to retain its best staff in the face of delays from government entities, which have slowed the process for granting final approval for projects. “We are in wait-and-see mode at the moment, and we have just sent 200 staff on long vacations,” El Alam told OBG. “We don’t want to lose them because we have already been awarded two big projects and we need the people.”

Social Benefits

The government has also committed to a number of infrastructure projects aimed at improving the health and welfare of its citizens. Tens of billions of dollars have already been committed to the construction of new hospitals, according to Alpen Capital. In Makkah, Ajyad General Hospital is due to be completed in 2016 at a cost of $600m, and two years later the $2bn King Abdullah Medical City will open. The $1.2bn King Khalid Medical City in Dammam is also due to be delivered in 2018.

Meanwhile, King Abdullah Project Security Forces Medical Complexes are being built in Riyadh and Jeddah, each costing $3.5bn, and are due to be completed in 2017 and 2018, respectively. A $3.4bn centre for the rehabilitation of prisoners is likewise scheduled to open in Riyadh in 2017.

Demographic Drivers

Although the Kingdom’s major contractors may prefer to work on prestige projects for government entities, the country’s growing population, many of whom are young and affluent, is driving a broader range of future commercial opportunities. The potential housing crisis in Saudi Arabia is becoming a growing area of concern, as young Saudis – even those with good salaries – are often unable to afford to buy their own houses.

On the Red Sea, King Abdullah Economic City, a $93bn mega-project, is being built by Emaar, The Economic City, which is a subsidiary of Dubai’s partially government-owned developer Emaar, which is scheduled to be completed in 2019.

A substantial number of master-planned mixed developments such as this are being complemented by smaller commercial developments in major cities. “There are many smaller builders who may be working on schemes of five or 10 homes, and I would say that 80% of developments are in that category, while perhaps 20% of residential development is master-planned communities,” Fayyaz Ahmed, Riyadh director of property consultancy JLL, told OBG. “Financing, execution, control and delivery are all easier on a small scale. Speed matters more than anything in this market, and if you are working on a larger project, you have to spend more on infrastructure and proportionally less on the development itself.”

Saudi Arabia’s population grew by 2.4% in 2015 to 31m, and GaStat estimates that this figure will grow by almost 20% over the next decade to reach 37.6m by 2025, driving demand for housing and retail. The Kingdom had an estimated shortfall of 1.5m affordable homes in 2015, and a new law came into effect in June 2016 that taxes owners of undeveloped land – known as white land – in order to incentivise more building in urban areas (see analysis). “A tax on white land is a positive development that will hopefully accelerate housing development at a time when the Kingdom faces a massive shortage,” Khalid Al Amoudi, CEO of Saudi Red Bricks, told OBG.

Tourism

A number of major new retail and hospitality developments are planned, that will meet the demands of a growing population, while also creating more amenities that can be used by the millions of religious tourists who visit Saudi Arabia every year for the Hajj and Umrah pilgrimages.

According to Alpen Capital, Makkah will see two significant mixed-use developments open by 2018: the $9.3bn Al Shamiyah Urban Development and the $5.6bn Tareeq Al Mawazee development, which will be built on either side of a major route into the city. Makkah will also see the $3.5bn Abraj Kudai, billed as the world’s largest hotel, with 10,000 bedrooms and 70 restaurants, completed in 2018.

Contracts Awarded

According to data from National Commercial Bank, the value of construction contracts awarded in 2015 rose marginally, finishing the year up 1.2% at SR223.4bn ($59.6bn). Another SR27.9bn ($7.4bn) worth of contracts were awarded in the first three months of 2016; however, this represented a 51% year-on-year decline. The private sector accounted for the bulk of contracts awarded in early 2016, and with a 14% drop in government capital expenditure projected over the course of the year, this trend is expected to continue. Some 47% of the first quarter contracts were for oil and gas projects, while 21% went towards hospitality and 16% were for residential property development.

Outlook

Although those working in the construction sector are accustomed to cyclical rises and falls in market conditions, structural changes in the labour market over the past five years have imposed additional costs on many Saudi construction firms.

Labour costs have been estimated to constitute some 60% of construction firm costs, and companies in the sector have come to accept that no area of the economy can be exempt from Saudiisation quotas. As a result, a sector that has traditionally relied heavily on inexpensive imported labour has had to find ways to attract, and in many cases train, Saudi nationals. With the latest downturn in the industry, however, thousands of Saudis, along with tens of thousands of foreign workers, have lost or left their jobs.

Nonetheless, the sector could be facing a healthier medium-term future if it continues to modernise, while maintaining a focus on increasing productivity and efficiency. In particular, investment in more modern building equipment and the training of highly skilled construction staff, ranging from apprentices to managers, are expected to yield dividends for the industry as a whole. In this way the sector can also play a key role in preventing growing unemployment among young Saudis over the next decade.