Impact of Higher Oil Prices on the Saudi Construction Sector

JEDDAH, 27 October 2003 — Given that oil revenue remains the dominant source of income to Saudi Arabia, oil prices tend to dictate government expenditure, which includes budgetary allocation to public projects. Therefore, oil prices have a strong correlation with the Saudi economy in general and the local construction activity in particular. Brent crude averaged $25.13 per barrel last year compared to $24.20 per barrel in 2001, registering relatively strong levels that have provided a major catalyst to the booming construction sector.

Moreover, Brent crude is expected to average around $27 per barrel in 2003, giving a 65 percent increase in total government revenues or SR110 billion over the original budgetary revenues. Year-to-date, Brent has averaged $28.65 per barrel, mainly due to the disruptions in oil supply from Venezuela, Nigeria and Iraq. In addition, OPEC has maintained its supply policy that targets oil prices in a range of $22-$28 per barrel, as seen in their last meeting when total OPEC production, excluding Iraq, was cut by 0.9 million barrels per day to 24.5 million barrels a day, effective Nov, 1, 2003. While OPEC’s decision was intended to accommodate Iraqi oil supply, Brent jumped above the $30 per barrel level. Moreover, the price of Brent is forecast at $25 per barrel in 2004 on the expectation that the global economy would recover and register a 3.5 percent growth.

This is predicted to have a ripple effect on the Saudi economy and maintain the momentum of the local construction activities, particularly those commissioned by government.

The Saudi construction activity continues to be in good health following an excellent performance in 2002. The strong investment in the construction sector, as measured by the gross fixed capital formation (GFCF) is estimated to have jumped by 8.8 percent to SR61.5 billion in 2002 compared to SR56.5 billion in 2001. Residential buildings, which accounted for about half of GFCF, grew by 2.7 percent to an estimated SR30.3 billion, partially attributed to Saudi investors repatriating their investments from abroad and re-investing into the local real estate market. Also, the residential sector is generally expected to rise on the back of a rapidly growing Saudi population of around 3 percent per annum. Meanwhile, the other construction projects, which include government contracts, were put at SR31.2 billion in 2002. This was reflected by the publicly announced construction projects that were mostly government contracts for road, urban development and social sectors.

The publicly announced projects rose sharply by 32 percent to SR15.56 billion in 2002 compared to SR11.81 billion the year before. However, during January-September 2003, the construction contracts awards fell by 2.8 percent to SR12.36 billion compared to SR12.71 billion over a year ago, suggesting that the boom in the Saudi construction may be cooling off. Noteworthy, due to the build-up and subsequent invasion of Iraq earlier this year, the value of contract awards amounted to SR2.9 billion during the first quarter of this year, compared to SR9.5 billion during the second and third quarters of 2003.

Total commercial bank lending to the building and construction sector gives another indication of construction activities going forward. Local banks’ lending to the construction sector demonstrated an upward trend during 2002, increasing steadily to SR20.98 billion by the end of that year compared to SR16.75 billion reached at the end of 2001. This growing level of borrowing by local contractors supports the surge in construction activity, which was evident in 2002. However, by the end of the first quarter 2003, total lending to contractors fell back to SR18.74 billion, indicating that repayments exceeded the level of fresh loans. Conversely, commercial banking exposure to the building and construction sector rose to its highest level ever of SR21.3 billion during the second quarter of 2003, a surge of 13.7 percent over the previous quarter, implying a SR2.56 billion worth of new loans. This suggests that major construction projects may have been delayed due to the geopolitical tensions earlier this year. Nevertheless, the construction activity rebounded in the second and third quarters of 2003 as reflected by the value of construction contract awards.

The top sub-sector was Social, Health and Philanthropic projects that reached SR3.30 billion and accounted for 26.7 percent share of the total announced construction contracts during the first nine months of 2003. The largest project of this sector was a contract for the construction of 195 schools for boys, which was issued by the Education Ministry to be built by Al Zekri Est. and Samama Co. for Operation & Management, at a total cost of SR1.44 billion. The financing will be provided through the private sector on a Build-Operate-Transfer (BOT) basis through an agreement with the government. The other major contract was the construction of academics buildings for girls colleges in Riyadh, which was issued by Ministry of Education and the contract was won by South Star Est., Al Mashrik Contracting Co. and Al Oraini Est., with a total cost of SR137 million.

The other major sub-sectors were roads (SR3.56 billion) and urban development projects (SR2.65 billion), which accounted for 28.8 percent and 21.5 percent, respectively, of total construction contracts awarded during January-September 2003. Jeddah and Makkah region accounted for SR1.25 billion or one-third of the total road projects, while road projects in Riyadh (SR752 million) and Dammam area (SR527 million) where relatively lower. Moreover, urban development contracts which include water and sewage projects, were largely allocated to the Jeddah and Makkah region, reaching SR1.83 billion during January-September 2003, whereas urban development projects in Riyadh and Dammam area were significantly lower at SR332 million and SR48 million, respectively, during the same period. However, construction contract awards related to industrial projects fell steeply by 86 percent to SR726 million (or 6 percent share) during the January-September 2003 period compared to SR5.1 billion over the same period the year before. This was mostly attributed to large projects issued by Saudi Aramco and the petrochemical giant SABIC in 2002, which provided lucrative contracts to international construction companies.

The Monthly Construction Contracts Awards (MCCA) index, which was prepared by NCB’s Economics Department, depicts a forward looking direction of construction activity in Saudi Arabia. The MCCA index, based on a six-month moving average of publicly awarded construction contracts, is estimated to capture about 25 percent of total construction investment in the Kingdom. The majority of the construction contracts announced are government projects that include industrial, urban development, roads and power projects. Setting the benchmark at 100 points in June 1994, the construction index moved in response to changes in oil prices. Therefore, on the back of higher oil prices, the Saudi construction sector has been gaining momentum since 2000, and the construction contracts awarded reached a five-year high of SR15.6 billion in 2002. This was depicted in the MCCA index that spent all of last year above the benchmark and peaked in July 2002 to 200.49 points, the highest level seen in five years. However, by the end of 2002, the index dropped to its lowest level in ten months, causing the MCCA index to fall back near the benchmark and remained subdued for the first quarter of 2003, largely attributed to the uncertainty from the war on Iraq. After the end of the war in Iraq, the value of construction projects picked up substantially in April and the MCCA index moved steeply higher, reaching 175.53 points in September 2003. This six-month upward trend suggests another strong performance for the Saudi construction sector in 2003. Moreover, given that the average duration of such projects is two-three years, then the value of contracts awarded during the last couple of years is expected to demonstrate a vibrant construction activity in 2004.

(Said Al-Shaikh is chief economist at the National Commercial Bank in Jeddah.)