Volatile oil prices and the impact on the GCC construction sector

Dramatic drop in oil prices focuses GCC Governments project spending

The dramatic drop in oil prices around the world in 2015 is causing GCC Governments to review spending to ensure public projects are necessary, affordable, and efficient and to continue to diversify their economies.

Oil prices have fallen by over 70% in the past 18 months, from a peak of US$115 per barrel in June 2014 to less than US$30 per barrel, as supply has surpassed demand. The USA, which is thought to have among the largest oil reserves in the world, with the capacity to hold up to 713.5 million barrels, is now having difficulties with storage. The shale boom has led to production nearly doubling since 2010.

The slowdown in the Chinese economy has also had a significant effect on the price of oil. China’s National Bureau of Statistics reported in December 2015 that the country's industrial profits fell by $103.8bn in November compared to the same period in 2014. It was the sixth straight month of decline, signaling a continued Chinese economic slowdown in 2016.

The historic nuclear agreement between Iran and world powers last July brought an end to trading sanctions from mid-January 2016 and with it a surplus to the market, further reducing the global price of oil. Iran is expected to add another 600k to 800k barrels a day to the market over the course of 2016.

In addition, the world's largest exporter of oil, The Kingdom of Saudi Arabia (KSA), has refused to cut production, something it has done previously to control oil prices. Analysts estimate that, at present, about one million barrels of oil are being produced over and above daily requirements. Since the middle of 2014, the world has been producing far more oil than required. With supply remaining much higher than demand, prices have plummeted.

Impact of falling oil prices on the construction market

History has shown that there is a direct relationship between oil prices and project spending in the GCC. In 2002 US$9.7bn of construction contracts were awarded per annum, increasing to US$126bn by 2008Oil prices increased from US$20-$100 over the same period.

With this latest drop in oil prices Governments are delaying making decisions and have reduced the number of construction project contracts awarded. This has been evident across the industry for 2015, with fewer contract awards and tightening cash flow, as organisations adjust their capital expenditure plans.

In 2016, the GCC has predicted that contracts will be awarded in excess of value of $140bn – approximately a 15% drop on last year. KSA, UAE, Qatar and Kuwait are expected to award a total of US$123.7bn worth of projects, whilst Oman and Bahrain are anticipated to maintain their 2015 spending with a combined forecast of US$16.3bn. It should be noted that in 2015 projects awarded in the GCC were a little short of the US$165bn prediction.

In 2016, the GCC has predicted that contracts will be awarded in excess of value of $140bn – approximately a 15% drop on last year.

The outlook in Dubai for 2016 is cautiously optimistic. The government has increased its expenditure by 12%, compared with its 2015 figure of US$12bn. It is planning to maintain the size of its investments in infrastructure over the next five years. 37% of spending, or US$4.6bn, will go towards health, education, housing, and community development, compared with US$3.8bn in 2015. The increase in this year’s budget shows the diversified nature of the Dubai economy, with oil only providing 6% of its revenue.

There are signs that large government backed projects are being driven ahead, such as the Metro Link connecting Dubai to Expo 2020. Other projects such as the Wasl Tower, Burj 2020, the Museum of the Future, and Zabeel One are all set to be tendered in 2016. In Abu Dhabi, detailed planning has been approved for the $1bn Reem Mall, scheduled for completion in 2018.

An area that is seeing a decline is the UAE property market, which recorded a 2.3% drop in average rents during Q2 2015. This is the first time this has occurred since the property crash of 2008.

The Saudi government budgetary performance in 2015 saw a deficit of US$98bn, or 15% of GDP. Total revenue fell by 41.5 % compared to 2014, reaching its lowest level since 2009 at US$162bn. The construction infrastructure budget has been reduced by 60% compared with 2015. The Government has reduced advanced payments from 20% of the contract value to 5%.

There are a large number of construction schemes which are at the tender and pre-qualification stage as well as a number of large-scale projects like the Riyadh Metro currently under way. Interestingly the Saudi regulator has said that foreign companies will be allowed to invest in Saudi Arabian airports, without the need for local partners. This approach may become more commonplace in other infrastructure projects in the future, if oil prices remain depressed during 2016.

The Qatari economy is largely based on petroleum and liquefied natural gas, with it accounting for more than 70% of its revenue. The Government’s commitment to delivering a large number of infrastructure projects for the 2022 FIFA World Cup has not been affected by the drop in oil prices. The 2016 budget has an increased allocation for major projects and a significant outlay for infrastructure, health, and education sectors.

Oman and Bahrain are anticipated to maintain last year’s spending levels, recording US$13.5bn and US$2.8bn respectively. Oman has pledged to spend more than US$50 billion in infrastructure projects over the next 15 years with US$20bn set aside for the transport sector. The Al Batinah Expressway, one of the main transport projects , will serve as an eight-lane, 260 km long expressway linking capital Muscat to the new Sohar Port and Industrial Area and the border with the UAE.

Similarly Bahrain’s future expansions include the King Hamad Causeway and rail link, the second bridge that will connect the KSA and Bahrain. Estimated to cost US$10bn, it will form part of the 2,200km long GCC rail network, which will connect all six Gulf States by rail for the first time.

How GCC countries are continuing to diversify their economies 

In recent years the GCC countries have strived to diversify their economies, in order to reduce the effect of volatile oil prices.  

According to IMF figures GCC countries currently account for circa 30% of the world’s proven oil reserves, with KSA in the lead (15.7%), followed by Kuwait (6%), and the United Arab Emirates (UAE) (5.8%). Together the GCC countries produced 28.6 million barrels per day in 2014, equivalent to 32.3% of total global production.

The table below shows the reduction in GCC reliance on oil exports since 2011:

The UAE’s economy is one of the most diversified among the GCC countries, making it resilient to falling oil prices. Hydrocarbon revenues accounted for 25% of GDP and 19.8% of total export revenues in 2015. Dubai is a prime example of the UAE’s ability to diversify from oil based revenue. In 2015 Dubai International Airport surpassed Heathrow as the busiest airport for international passengers; by 2020 Dubai authorities expect to welcome 126 million passengers and its aviation industry is projected to account for 22% of the emirate’s employment.

Abu Dhabi’s Economic Vision 2030 objective is that the non-oil sector will contribute 64% of the Emirate’s GDP. Currently the manufacturing industry which is dominated by chemicals, plastics, and related products accounts for 13%. Although still in the early stages, the intention is to develop manufacturing clusters around basic metals, the aerospace industry, health, and pharmaceuticals.

The UAE’s economy is one of the most diversified among the GCC countries, making it resilient to falling oil prices.

The oil sector provides 80% of KSA export revenues and around 85% of its budget revenues, however, the Kingdom has put economic diversification as a priority for the approaching years. In December King Salman bin Abdulaziz Al Saud published economic reforms aimed at diversifying sources of revenue and decreasing dependence on oil amid the steep decline in crude prices. He also stated that KSA would 'maintain stability and balance between revenue and spending on big development projects in all sectors'. So it is turning to the renewable energy sector to help meet its growing energy demand, shift government energy subsidies, and provide jobs for its workforce. The Kingdom's energy demand is expected to grow by 45% from 69 gigawatts in 2014 to 100 gigawatts in 2040. Solar power and wind power in particular are seen as the most viable forms of renewable energy.

Qatar National Vision 2030 (QNV) identifies tourism as one of the main mechanisms for diversifying its economy. The QNV envisions seven million tourists visiting Qatar each year by 2030. The capital Doha is currently the sixth busiest city in the world in terms of new hotel development. The city has 37 projects under way featuring around 10,500 hotel rooms. Only Dubai (85 hotels) and Riyadh (42 hotels) have more projects in the region.

Bahrain and Oman are both at the early stages of economic diversification; both have set out strategies i.e. the Bahrain Vision 2030 and Oman Vision 2020. These strategies have targeted tourism, the development of small and medium enterprises and financial services as the foundation for a self-reliant industry and modernisation of the economy.

The dramatic drop in oil prices is having an adverse effect on the GCC construction markets nevertheless this would have been much greater only for the strong motivation by the GCC to diversify their economy and their ability to access a huge stock of net foreign assets.