Building for growth: Effecting change for the benefit of all

With a range of big-ticket projects coming on-stream as the country gears up its economic diversification strategy, Oman’s construction sector is seeing something of a resurgence. The market is highly competitive, thanks in no small part to the government’s encouragement of foreign and private sector participation. This is in turn squeezing margins, and there has been some controversy over public tenders being won by companies that then have difficulties implementing projects. But with so many investments being made, and private sector demand picking up as well, there are considerable opportunities for contractors with expertise, capacity and scalability.

Current Drivers Of Growth

The Omani construction industry is expected to clock a growth rate of 5.5% in 2013, reaching a total industry value of $4.3bn, according to MEED, a Middle East focused business intelligence firm. An estimated $116bn worth of construction projects were planned or under way in Oman during 2013 – with 45% of the total earmarked for domestic and international railway development (see analysis), a major driver is government investment in infrastructure.

According to the sultanate’s current five-year economic development plan, running from 2011 to 2015, the government intends to invest some $10.7bn, nearly 10% of the total budget, in the construction of transport infrastructure and other related projects, including $6.2bn for airports and $3.2bn on roads. An additional $1.3bn has been allocated to the construction of water supply systems and dams. “Oman is investing heavily in advancing its road network. There are approximately 800 km of highway projects alone,” Stefan Altziebler, country manager for construction company Strabag Oman, told OBG. “The national budget increases are a pillar for the major projects in roads, ports and airports. Between 2012 to 2013 alone there was a rise of 15-20% in construction and infrastructure spending. Sustaining this type of growth has become the state’s priority.”

Investments have been incrementally growing over the past few years thanks to increasing oil revenues and as projects moved off the drawing board into implementation. Rising incomes have also been a factor in the ramping up of spending.

In Focus

Priorities of the investment programme include alleviating pressure on Muscat’s port and airports, and improving connectivity with the rest of the region, especially by supporting growth in the industry and tourism sectors. Transport is the primary focus of construction investment, accounting for 66% of the total, followed by energy and resources, with 25%. Important transportation investments include the Batinah Highway, the new Muscat Inter-national Airport terminal, airports at Duqm and Salalah, and the Gulf Railway. Projects in energy include independent power plants and independent water and power plants, which allow private ownership of utility assets, and $2bn of planned renewable energy investments, such as green power and a 400-MW solar plant, amongst other stations.

Funding Expansion

The government’s diversification strategy foresees crude oil’s share of GDP falling to 9% in 2020 from 41% in 1996, which should encourage growth in sectors like logistics, tourism and industry, all of which require substantial capital investment in construction. There is also considerable demand from private sector investments and revival of the property market, which cuts across all segments – residential, office, retail, tourism and industrial.

The strength of the recovery is clear from the 36% growth in loans to the construction sector in 2012, which reached OR930m ($2.41bn). While this followed a sluggish period in the wake of the global economic crisis, it is clear that financial institutions are keen to back the industry. The outlook of sustained growth means that the sector will be worth upwards of $5bn annually within a few years, according to Global Research, part of Kuwait-based Global Investment House. “We expect demand to be sustained for at least another five years,” Ghassan Shammas, deputy general manager of UAE-based construction firm Target, told OBG. “However, we should keep in mind that competition is rising, and there are a lot more companies bidding for contracts.”

Regional Perspective

Oman accounts for a relatively small proportion of construction activity throughout the Gulf, which is not surprising given the country’s population size and national GDP levels. As of early 2013, Oman accounted for roughly 6% of the projects planned or under way in the GCC member states, according to MEED. The resurgence of Oman’s construction sector reflects developments in the broader region, where a combination of public investment and increasing private interest (including from foreign investors) is driving growth. Muscat’s property sector is regarded as being loosely linked to that of Dubai, albeit with less pronounced peaks and troughs and a time lag behind its northern neighbour.

The region’s construction industry took a hit in 2012, when the number of contracts awarded ( including infrastructure projects) fell by nearly 18% to $51.9bn from $63.4bn in 2011. The dip reflected continued uncertainties in the global economic outlook, particularly regarding the eurozone crisis, the debt issues in the US and a slowdown in major emerging markets, including China.

Things have been looking up in 2013. Taken as a whole, the GCC construction industry’s top line grew by a striking 24.7% year-on-year in the second quarter of the year, as a number of projects entered the implementation phase and execution accelerated, according to Global Research. Much of this can be attributed to two UAE-based giants, DSI and Arabtec, both of which are active in Oman. “We expect the sector to sustain this trend in the coming quarters, aided by strong growth in the order of receipts as seen in the second quarter of 2013,” the report said. Region-wide, the sector’s net profit came in at $61m in the second quarter of the year, a return to profitability as a year earlier, it had run a net loss of $5m.

Gains

The region benefitted from rising international investment – some of it linked to the US Federal Reserve’s quantitative easing programme, strong oil prices and resurgent domestic demand.

Regional sector margins averaged 11.3%, with operating margins at 6.1%, both considerably improved from 6.9% and -3.0%, respectively, in the same period of 2012. However, Global Research forecasts that margins will decline again as competition and rising costs erode profitability.

“The overall amounts of mega-projects are increasing, however, and so is the competition. Companies’ margins have been squeezed due to the aggressive nature of the business,” Shammas told OBG.

In a 2013 report on construction in the GCC, professional services firm Deloitte published an analysis for the sector in Oman. It listed the government’s diversification strategy – “well under way and … helping to drive infrastructure and tourism development” – and its enthusiasm for private sector involvement, “including foreign companies” and “strong market orientation” as key market strengths. The report noted that opportunities lay in, “Diversification of the economy will lead to a number of construction contracts and investment into accompanying infrastructure,” particularly in tourism and transport.

Challenges

The current lack of a rail network constrains Oman’s ability to reach its economic potential, particularly in terms of medium and heavy industry and as an import and export centre for the region, capitalising on its location. However, progress is now being made on the long-awaited Gulf Railway – few doubt that the project will be executed in the coming years. Thus rail infrastructure, while still a short-term weakness, is on balance regarded as an opportunity and a future strength for the sultanate.

The threat of “spillover” of dissent and disturbances is bordering countries is also exaggerated. Deloitte singles out Yemen as the most likely contagion, and indeed the neighbouring country faces serious security challenges from a number of groups, and clashes have occasionally spread across the border into Saudi Arabia. However, Christopher Steel, managing partner at Savills Oman, an estate agency, said that he saw the risk as minimal, thanks in large part to the border being well policed. Furthermore, Yemeni militants have no real cause to create problems in Oman.

Arguably there are greater risks from elsewhere in the Middle East, including international tensions over Iran, and an escalation of the conflict in Syria. But overall, Oman is one of the more stable countries in a generally calm part of the Middle East. “In terms of political risk, we can’t really feel the effects of problems in Yemen, or the Arab Spring,” Peter Fischer, head of operations at Doka Muscat, an Austrian-owned construction firm, told OBG.

Projects

Transportation infrastructure is a major focus of government spending, including roads, ports, airports and the regional railway project (see analysis). The Batinah Expressway, due for completion in 2016, is Oman’s most prominent ongoing road construction project. It will run 260 km from Muscat to the Sohar Industrial Port and on to the UAE border, and is seen as vital to boosting the growth of the Sohar region as an industrial and transportation centre. The total cost is estimated at OR1bn ($2.6bn), and the construction contracts are being awarded in six separate packages, for which there are a range of subcontracts for operations like drilling and blasting.

Oman expects to implement road projects worth over OR550m ($1.42bn) in 2013, according to the state budget. “The road network is more congested than ever and main transport roads are going to need significant maintenance work,” Surendra Kumar, managing director of Oman-based KAS Construction, told OBG. “Over the next few years, there will be a growing demand for repair works on the country’s roads, which will lead to new opportunities for contractors.”

Greenfield Development

In September 2013, after a two-year hiatus, the government relaunched tenders for the greenfield airport developments at the port cities of Sohar and Ras Al Hadd, worth $400m and $300m, respectively. The airports are an integral part of Oman’s transport development strategy, but the plans have been scaled down to lower costs and improve efficiency. Technical and design factors have been reappraised to reduce terminal size without lowering passenger throughput capacity, and with the proviso of scalability so that the buildings could be expanded at a later date if needed.

By freeing up space on the airport sites, the government also hopes to create room for tourism and other aviation-related businesses, capitalising on synergies created by the proximity of the airport. Sohar Airport will have an air cargo terminal with capacity of 25,000 tonnes, reinforcing the city’s potential as a logistic centre. The Sohar and Ras Al Hadd airports will follow a uniform layout that is also being used for Duqm Airport, with a terminal of around 5000 sq metres and standard services and equipment.

Logistics

Related to the large sums being spent on transportation, investments in logistics infrastructure are also gaining pace. Hong Kong’s Hutchinson Whampoa is developing a 70-ha terminal at the Port of Sohar, boosting the port’s capacity to 1.5m twenty-foot equivalent units (TEUs) per year from the current 800,000 TEUs, and also allowing the port to take larger ships with 10,000 to 11,000 TEUs of cargo. The project is due to be completed in 2014 and should help boost the ongoing shift of freight traffic towards Sohar from the crowded Mina Sultan Qaboos in Muscat, with logistics infrastructure likely to follow.

In November 2012 Al Siraj Investment Holding signed a deal to develop standard warehousing units on a 40,000-sq-metre site in Freezone Sohar. This followed a November 2012 deal by Suhail Bahwan Automotive and Oman Trading Establishment, which signed a lease for a 50,000-sq-metre site in the free zone to develop a distribution centre for the automotive industry. “While the logistics sector still has plenty of room to grow, and could benefit from altered regulations, the economy has shown an increasing demand for logistics providers,” Fawzi Al Harrassy, executive director of the Teejan Group, an Omani conglomerate with interests in the construction and engineering sectors, told OBG. “One reason for this growing demand is the amount of infrastructure and construction projects coming on-line in the sultanate, which has also created a market for the construction and renting of storage warehouses.”

SEZAD

Along with Sohar, Duqm, 450 km south of Muscat, is set to become one of the major focus areas for investment – and thus, construction activity – in the sultanate (see Regions chapter). The Special Economic Zone Authority Duqm (SEZAD) covers a massive area of 1777 sq km, and with 80 km of coastline along the Arabian Sea, it is seen as central to Oman’s efforts to diversify the economy and boost employment for Omanis. SEZAD is expected to attract as much as $20bn in investment over the long term and create 15,000 to 20,000 jobs by 2020.

SEZAD includes a seaport, industrial area, new town, tourism zone, a logistics hub, an education and training zone, and a fishing harbour, all linked and supported by a multi-modal transport system that will include Oman’s national railway, due to commence operations in 2018. At the heart of SEZAD is the Port of Duqm, which has an inner basin draught of 18 metres (allowing it to accommodate all but the very largest of supertankers), a 2.25-km commercial quay with eight berths, and a 1-km government quay for the Omani Royal Navy, Coast Guard and fast ferries. A second phase will develop the port into a 6.5-sq-km basin adding 13,500 metres of commercial quays, with space for more than 36 additional berths.

The government has already spent some OR1.75bn ($4.53bn) in developing SEZAD, and more investment from the public and private sectors is expected as the project approaches its completion date of 2020. Work on a $4bn oil refinery is due to start in 2015 (and finish by 2018), 200 km of primary and secondary roads are planned, and 19 km of coastline has been marked for tourism development projects.

Furthermore, Duqm’s population is expected to reach 70,000 within years, according to Yahya Al Jabri, chairman of SEZAD, requiring considerable investments in housing and services, including health care facilities, education and retail. Anticipating growth, SEZAD’s residential zones can be scaled up to accommodate 110,000 residents in the longer term.

Contracts & Tenders

The government’s considerable uptick in its infrastructure investment drive is putting Oman’s system of tendering and contract structures under greater scrutiny. The sultanate is widely admired for its efforts to encourage private participation in public projects and has been a leader in encouraging and facilitating in private participation in the utilities sector in particular.

Almost all tenders are competitive, and the larger ones tend to attract a range of international players, often in partnership with local firms. The level of competition helps ensure that costs to the exchequer are reduced. However, the system of tendering is not without its critics. Many sector leaders told OBG that the process takes too long, partly due to the limited capacity of the Tender Board, and partly because the low barrier to prequalification means that each tender often receives many bids.

There are also concerns that poorly qualified companies are able to enter the process, dragging down contract prices, and in some cases leading to the award of contracts to firms that are unable to execute projects entirely satisfactorily. The government is now working with industry representatives to reform the tendering system, which may also include eliminating contradictory legislation and the introduction of escalation clauses that allow contract fees to rise, within limits, if costs increase (see analysis).

Properties

Along with wage increases, one of the government’s responses to the Arab Spring, was to pledge OR80m ($207.2m) a year to provide affordable housing for Omanis. A 2011 report by Jones Lang LaSalle (JLL), a global property company, suggested that the sultanate had a shortfall of 15,000 affordable homes – small by regional standards, but significant, particularly with population growth at over 2% per year. The government already has a number of schemes available providing low-cost financing to Omanis looking to purchase a home.

In terms of private sector demand, contractors are also benefitting from the growing success of Oman’s integrated tourism complexes (ITC), mixed-use developments in which non-GCC nationals can buy freehold property. Popular with expatriates and Omanis alike, both for investment and as places to live, these properties have become among the most desirable addresses in the country, particularly The Wave and Muscat Hills, which continue to expand.

Work on a new ITC, Saraya Bandar Jissah, began in the third quarter of 2012, and full construction should start in early 2014. The 220-ha site will have between 350 and 400 residential units and two five-star hotels, which will be a priority for the developers – a sign that this ITC will truly be pitched at the tourist market, a development that property surveying and consultancy firm Cluttons welcomes. The project is being developed by government-owned tourism company Omran and Saraya Oman.

“There are two main areas for growth in housing,” Benjamin Cullum, general manager at Hampton’s International in Oman, told OBG. “First, expatriates – while some industries are recruiting fewer due to Omanisation, others are employing many more thanks to investments, including the construction sector. Some will stay in labour camps, but also there are managers looking for mid- to high-end property. Second, young Omanis are looking to move away from their parents’ homes and are seeking residential units, and herein lies a problem of supply and demand. Many people want a villa on their own land.”

Financing

Cullum says that a small plot and building can be secured for OR40,000 ($103,600) – low by global standards, but still too high for many Omanis without financing. Though Omanis traditionally have not used loans to finance residential property acquisitions, this may change as banks and individuals alike look to tap into the growing property market. “We might see a further loosening of financing,” Matthew Wright, head of logistics and industrial at Cluttons Oman, told OBG. “Mortgages have become more attractive. There’s an emerging middle class, which in the long term gives a hint of potential.”

Currently, mortgage rates stand at around 7%, while the central bank has a cap of 80% loan-to-value ratio, fairly attractive terms by international measures. Rising incomes are also driving demand for retail property. According to Wright, there are around 60,000 sq metres of mall space alone that are being planned or constructed throughout Muscat, though he is sceptical about whether all of this will be realised, given the relatively small size of the capital’s market. Much will depend on how well these developments are targeted, with most analysts agreeing that smaller neighbourhood malls and shopping centres with lower-cost retailers present better opportunities than larger mid-range complexes in the local context.

Finally, the shift of office space towards the west of Muscat is expected to gather pace over the next five years, having been catalysed by the move of Bank Muscat out to Airport Heights from Ruwi. Supply of quality office space (particularly with parking) is tight, and the wave of infrastructure projects taking shape over the next few years is expected to see more international companies set up, expand and upgrade in Oman. The $1bn Oman Convention and Exhibition Centre – a large construction project in itself – should open in 2016, further stimulating the shift westwards for office and hotel properties.

Omanisation

The construction industry is somewhat affected by the policy of Omanisation, which sees the government favour firms that guarantee that a certain proportion of their workforce is Omani – in the contracting sector, the figure is 30%. This presents a challenge for many companies that rely on expatriate labourers and skilled technical staff. Shammas of Target told OBG that few companies have reached 20% Omanisation as of yet. Few Omanis wish to work on construction sites (where an average of two-thirds of construction sector employees work), and there is still a shortage of Omanis with the experience to take on senior technical roles (though the pool of young graduates is steadily expanding). With margins already being squeezed, smaller companies may find it more difficult to pay the premium wages that are needed to attract, train and retain local staff.

Nonetheless, Omanisation is widely accepted as a reality and a condition of operating in the sultanate. With the government offering so many lucrative contracts, and favouring companies that have made more progress in recruiting Omanis, the benefits of Omanisation are growing. The increase in the minimum wage for Omanis has actually been welcomed by many in the construction sector, as it obliges all companies to pay Omanis more, which should make attracting local workers easier.

Outlook

The Omani construction sector can anticipate healthy growth driven mainly by government investment in infrastructure, particularly transportation. Bigger firms did not suffer too badly during the slowdown, thanks to ongoing work, and can now look to secure lucrative new contracts. The environment is certainly a competitive one, and many of the tenders going out over the coming years will appeal to a wide range of international players. For local companies, partnerships as subcontractors should prove a promising source of revenue, as well as technology and knowledge transfer, over the longer term.

The government is receptive to the industry’s concerns about the tendering process and regulations governing public contracts, though change tends to take place incrementally, so radical amendments in the near future may not be possible. The experience of some poorly executed projects may encourage a tightening of prequalification, to the benefit of more experienced contractors. With public and private investment rising, opportunities should flourish.

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The Report: Oman 2014

Construction chapter from The Report: Oman 2014

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