Challenges ahead: A slowdown in construction projects and higher production costs prove short-term hurdles for cement producers

Saudi Arabia was the eighth-largest producer of cement in the world in 2014; however, the slowdown of the economy and the energy price hikes of December 2015 have impacted the sector. While major government-led infrastructure projects are still going ahead – though some are delayed and others may be downsized or cancelled at a later date – the Kingdom’s cement sector is under pressure from a combination of the decline in overall infrastructure investment, lower fuel subsidies, increased competition and a growing inventory stockpile.

However, the government decision in April 2016 to lift a ban on exporting cement and other building materials could help the sector weather the storm, with the move broadly welcomed by the cement industry. Indeed, local stakeholders have underscored the growth opportunities of an easing of the ban on cements exports. “Lifting the export ban will allow us to monetise the surplus of clinker we currently have,” Safar Dhufayer, CEO of Southern Province Cement Company, told OBG. “It will reduce price competition and help alleviate a great deal of pressure on cement companies.”

Supply Side

Cement producers in Saudi Arabia have reported falling profits as well as rising stockpiles in the face of lower government infrastructure spending linked to the drop in energy prices – the key source of government revenue for the Kingdom. In June 2016 Saudi Arabia’s total cement inventory amounted to 21.4m tonnes, according to data released by Yamama Cement, having grown by 7% year-on-year and 5% month-on-month. The number was the equivalent of 36% of sales from the previous 12 months. Monthly cement production was calculated at 3.66m tonnes in June 2016, down 25% from June 2015 and 34.6% from May 2016.

According to Yamama Cement, every major cement producer in the Kingdom reported a decline in sales that month, with Al Jouf Cement, Saudi Cement and City Cement seeing declines of 5%, 7% and 8% year-on-year, respectively, and Najran Cement, Yanbu Cement and Arabian Cement seeing respective declines of 53.5%, 39% and 36%.

In August 2016 total cement sales were down 10.3% year-on-year, despite the earlier lifting of the export ban. Meanwhile, total inventory reached a new high of 26.35m tonnes – 45% of the previous 12 months’ sales – with total inventory rising by 11.7% year-on-year and 5% month-on-month, according to a report by Al Rajhi Capital. In the first eight months of 2016 total cement dispatches dropped by 4% year-on-year to reach 38.7m tonnes. These numbers point to a continuing difficult landscape for those operating within the sector.

Despite this slowdown, the industry remains a profitable one. “There won’t be any consolidation in the foreseeable future. The industry is indeed competitive, but it remains profitable, so there would be no economic reason to do so,” Jehad Al Rasheed, CEO at Yamama Cement, told OBG. “There is currently a significant amount of oversupply in the market, meaning companies are competing under the price cap, making pricing low. Still, margins do remain healthy,” he added.

Others see opportunities in the cement situation. According to Muhammad Abusamak, general manager of the Arabian Tile Company, the changing environment offers prospects for investment. “The currently low prices of building supplies, caused by the market slowdown, present an area of opportunity for those in a position to buy,” he told OBG.

Government Spending

The decline in global oil prices left many bracing for a sharp decline in the overall funding and volume of government infrastructure projects, but according to some industry insiders, this has not been the case so far, with only a few projects having been delayed and the government continuing to fund others. “Nonetheless, this has caused a psychological effect on people, especially the private sector projects that stopped for a few months,” Gasem Al Maimani, president and CEO of Arabian Cement Company, told OBG. Al Maimani estimates that 60% of cement volume is chanelled into big-ticket infrastructure projects, with the remaining 40% going towards private projects and housing projects. Arabian Cement is currently looking to increase its capacity, adding a total of 10,000 tonnes per day in 2020, and while Al Maimani estimates that there is an oversupply of around 25m tonnes on the market, he forecasts domestic demand of 60m tonnes for 2016.

Other sources paint a somewhat less optimistic picture. According to MEED, Saudi Arabia was among the worst-performing construction markets in the region in the first six months of 2016, awarding just $4.5bn worth of contracts in the period, down from $19.9bn during the same period the year before.

Cutting Production

The Kingdom’s growing inventory for cement and clinker, estimated to be more than 20m tonnes, has led some companies to shut production lines to avoid further increases in inventory. In November 2015 local media reports suggested that some steel factories had cut production by 50% and shut down smelters entirely. In February 2016 Saudi Cement announced that it was halting production at one of its clinker kilns that manufactures 3500 tonnes a day and was scrapping plans to install two new cement mills. The company cited market conditions as well as the export ban as its reasons for doing so.

Cost Increases

Cement producers in Saudi Arabia are also dealing with the rise in energy prices after the authorities cut energy subsidies in December 2015 in an attempt to reduce government expenditure. Saudi Cement, the Kingdom’s largest cement company by market value, estimates that the price increases will effectively raise its production costs by SR68m ($18.1m) in 2016, after the prices of methane and ethane rose from $0.75 per million British thermal units (Btu) to $1.25 and $1.75, respectively. This could force many producers to further trim production volumes.

At the same time, some companies are set to prosper in the new environment of higher energy costs. In November 2015 Yamama Cement, one of Saudi Arabia’s largest cement producers, signed a SR4.2bn ($1.1bn) contract with Germany’s ThyssenKrupp Industrial Solutions to build two new cement plants 80 km east of Riyadh, with a combined capacity of 20,000 tonnes of clinker per day. The new plants will feature low-power consumption technology which consumes less than 800 Btu per tonne of clinker and under 100 KWh per tonne of cement. The plants are expected to be up and running in early 2019.

New Capacity

While this project is not expected to add new capacity to the local market, as it will be replacing an old plant mandated to be relocated outside of Riyadh to avoid congestion and pollution, the challenging environment for cement producers has not been helped by the number of new cement production facilities that have come on-line over the last few years, built to cater to Saudi Arabia’s previously substantial domestic construction needs. However, with the export of cement returning as a possibility for domestic players, foreign demand could help counter the drop in Saudi domestic sales while oil prices remain low.

Export Ban Lifted

For many months in late 2015 and early 2016 rumours swirled that the government was considering lifting the partial export ban that had been in place for cement, as well as steel, since 2008, thus enabling domestic cement producers to once again sell their products abroad. The ban was initially put in place at a time when Saudi infrastructure projects required an abundance of building materials, but producers were often able to get a better price for their products abroad. However, with the current oversupply of cement on the domestic market, this is no longer the case.

The ban was lifted in April 2016 for both cement and steel rebar and could open up plenty of opportunities for the export of excess supply of cement from local producers. There is a hope that the lifting of the ban will help to mitigate lost earnings that have accompanied decreased public spending on infrastructure projects and real estate developments within the Kingdom.

On news that the export ban had been lifted, domestic cement producers saw a jump in their share values. Najran Cement Company’s stock rose by 10%, while Al Jouf Cement Company saw an increase of 9.7%, Southern Province Cement Company 5.5%, Saudi Cement 5.3% and Yamama Cement 4%. This highlights the importance many investors place on the decision to allow producers to begin exporting again. However, some within the industry are concerned that some of the conditions imposed on producers who wish to export, which include paying back the fuel subsidy for exported cement, coupled with current oversupply on the international markets, make exporting less of a viable option.

Other Markets

Demand in countries like Qatar, which is undergoing significant infrastructure investment in the lead up to the 2022 FIFA World Cup, could help offset some of the reduced demand from government-backed infrastructure projects in the Kingdom. Peak demand for cement in Qatar is expected to reach an estimated 57m tonnes in 2017, according to official data, with the average demand for cement in the period 2013-15 hitting around 5.5m tonnes a year and expected to increase to reach 10m tonnes per year.

When it comes to the cement sector, recent demand has been largely based on private sector growth, with regions where a large number of private projects are taking place, such as the southern region, continuing to perform well. Some are optimistic that despite the challenges the Kingdom’s cement market will grow in the coming years. According to a 2016 report on the Saudi cement market by Zion Research, demand for cement in the Kingdom reached $3.9bn in 2014 and is expected to total $5.27bn in 2020, growing at a compound annual growth rate of more than 5.1%.

Challenges Ahead

While oil prices remain low, it is likely that government-funded infrastructure projects in Saudi Arabia will be reevaluated, though many will likely go ahead as planned. Even so, cement producers face a challenging landscape of oversupply and weaker demand in the short term. Questions are also being raised about the industry’s future supply of fuel, which has at times been subject to restrictions imposed on it by the industry’s supplier, Saudi Aramco. This has led some to speculate about a possible switch to coal as a fuel source if the construction sector rebounds in the short term, which seems to be a likely prospect. As government revenue rises and confidence returns, large building projects should once more dominate the headlines, helping the cement industry thrive again.