Government projects promote construction sector growth in PNG

Although Papua New Guinea’s construction sector contracted in 2014 after a four-year boom from the massive PNG liquefied natural gas (LNG) project, industry growth is expected to pick up again in 2015. New petroleum revenues are set to support the government’s sizeable infrastructure investment programme, which will see major improvements to roads, ports and airports, part of the country’s preparations to host the 2015 Pacific Games and the 2018 APEC summit.

The business environment remains challenging for private contractors, particularly in terms of obtaining construction permits; however, a growing emphasis on public-private partnerships (PPPs) and rising foreign financing has improved the near-term outlook, and new efforts to supply affordable housing and expand home ownership will underpin steady, long-term growth.

Boom Years

PNG’s construction industry experienced a marked expansion in 2010 thanks to the start of construction on the ExxonMobil-led PNG LNG project, with the sector contributing 16% of GDP by 2011, according to the Department of Treasury (DoT). The industry recorded five consecutive years of double-digit growth through to 2012, growing at an average rate of 20.38%. Meanwhile, the real value of construction activity rose from PGK1.83bn ($692.5m) in 2010 to reach an estimated PGK3.4bn ($1.29bn) by 2013.

The PNG LNG project began commercial operations ahead of schedule in April 2014, with the country delivering its first LNG cargo the following month. While this has had a positive impact on state revenues, with mining, petroleum and gas dividends hitting PGK513.8m ($194.4m) in 2014, ahead of earlier projections of PGK133m ($50.3m), the booming construction industry has slowed in the wake of the project’s completion.

Slowdown

In a 2014 economic forecast, the DoT projected an 8% contraction in the sector due to completion of the project, and the Asian Development Bank (ADB) reported a 6.4% decline for the year. Contractors reported disappointing growth in mining and petroleum construction, although the worst of the shocks were cushioned by state investment in infrastructure projects, while long-term plans to upgrade the national power grid and planned development of the Konebada Petroleum Park and Elk-Antelope LNG project could see the industry return to double-digit growth in the medium term (see Energy chapter).

Public infrastructure spending rose to PGK2.7bn ($1bn) in 2014, with funding for major upgrades of the Lae and Port Moresby city roads, the Lae Port tidal basin and various provincial hospitals, as well as projects ahead of the 2015 Pacific Games (see analysis).

Spending in 2015

Although public spending on infrastructure is forecast to decline slightly in 2015, government investment in the sector remains high, with PGK2.3bn ($870.3m) in infrastructure funding earmarked in the 2015 national budget. Transportation in particular is set to benefit, with some PGK151m ($57.1m) in planned investment in airport upgrades, PGK50.8m ($19.2m) for port upgrades, and over PGK680m ($257.3m) for road and highway projects.

Social infrastructure will also receive a boost, with plans to invest PGK216m ($81.7m) on major works at the Angau Memorial Hospital and the New Enga Provincial Hospital, as well as PGK93m ($35.2m) for capital works at the remaining provincial hospitals. The budget also includes PGK62.5m ($23.7m) for rehabilitation works at seven universities, PGK40m ($15.1m) for upgrades to 13 technical colleges, and PGK80m ($30.3m) for works at eight teachers’ colleges and eight nursing colleges. With a raft of upcoming projects, the ADB forecasts 3.8% growth in the sector in 2015.

Policy Progress

Recent policy developments have supported the roll-out of state-supported infrastructure projects. The new National Transport Strategy, launched in 2013, clarified and delineated responsibilities for various infrastructure assets, and was characterised by Australia’s Development Policy Centre (DPC) as “a big step in the right direction,” in a September 2014 report. The government also established the Infrastructure Development Authority (IDA) in a 2014 draft bill that originally targeted rehabilitating and maintaining the nation’s infrastructure using LNG revenues.

The IDA will oversee procurement and implementation of projects with capital investment of over PGK50m ($18.9m), with 50 projects worth a combined PGK4.1bn ($1.55bn) already identified that could fall under its purview, including PGK359.2m ($135.9m) in Pacific Games-related infrastructure, the PGK53.8m ($20.4m) Pacific Marine Industrial Zone and PGK170.5m ($64.5m) to build 116 classrooms and supporting infrastructure.

Funding

However, recent developments have given stakeholders cause for concern; while the IDA was originally expected to receive secure funding from PNG’s sovereign wealth fund (SWF), the government’s draft Organic Law on the SWF did not include plans for this, with the IDA instead to be funded by budget allocations. “In our view, this does not bode well for the establishment of the IDA. We consider reliance on annual budget allocations to fund IDA activities to be inadequate. The binding constraint for infrastructure development in PNG, particularly maintenance activities, is the availability of resources,” the DPC wrote.

While the bill grants the IDA the power to invest in maintenance, according to the DPC, the authority is likely to maintain its focus on new projects, as it was modelled on the infrastructure development authority in New South Wales, Australia, which does not have the same maintenance challenges as PNG.

With infrastructure funding under the public investment programme forecast to decline from PGK1.54bn ($582.7m) in 2015 to PGK3m ($1.14m) by 2019, the government will need to develop new sources of capital to complete and maintain major projects.

Reforms

According to the ADB, the PNG government is in the early phases of a reform strategy that is expected to lead to large gains and significantly reduce the challenges faced by private construction players. The strategy targets expansion and restoration of the road network, including user-funded maintenance activities, with the goal of delivering all-weather transportation access to 95% of the population and access to 95% of developable agricultural land, in addition to upgrades to urban traffic networks and public transit systems. Reforms will hinge on new inflows of private investment in roads, ports and airports, with a PPP-based model representing the best way forward, the ADB noted.

The government has been working towards a more business-friendly framework, with the National Executive Council (NEC) launching a comprehensive review of the existing PPP framework in 2012 with the goal of reducing barriers to market access and improving foreign inflows. These reforms got a shot in the arm with the promulgation of the long-awaited PPP Act in September 2014, which builds on PNG’s National PPP Policy, first established by the NEC in 2008.

Although the original policy attempted to establish a transparent and predictable process for the PPP project cycle in an effort to mitigate project development risks, prior PPPs have nonetheless been marred by delays and budgeting problems, and this has slowed the development of critical infrastructure projects.

Private Sector

PNG fell two places in the World Bank’s 2015 “Doing Business” report, and now ranks 133th out of 189 countries. It also fell two spots in the “dealing with construction permits” category to 141st place, with investors required to complete 17 procedures, taking an average of 217 days, before obtaining a permit, compared to the East Asia and Pacific average of 14.6 procedures and 134 days.

Deficiencies in the country’s institutional framework have also posed significant problems for contractors who have successfully entered and bid on new government projects, including PPPs. In a 2011 report, the ADB noted the sector’s poor record of completing contracts on time and within budget due to various structural factors, including flaws in the procurement and large-scale contracting processes, insufficient community compensation and the small size of the market.

At the time, there were fewer than 15 national contractors and less than five international players operating in the country, which limited the government’s ability to carry out competitive tendering. Furthermore, many companies were over-committed as a result of PNG LNG, which in turn created some development delays on key infrastructure.

Opportunities Abound

The PPP Act will help to address these challenges, primarily by creating a PPP Centre to assist the government in tendering and implementing PPPs, as well as creating a PPP project pipeline. The undertaking is being supported by the ADB, with stakeholders welcoming the move, which is set to significantly reduce both the barriers to market entry and the development risks of large-scale builds.

At the same time, PNG’s portfolio of private contractors has expanded considerably since 2011, creating a healthier and more robust private construction sector ecosystem that should allow for more efficient delivery of new projects. According to the Commonwealth Network, there are now 41 private construction and engineering companies active in PNG, and several major multinational firms have flourished as a result of the country’s rapid economic development.

Major private firms include Avenell Engineering Systems (AES), Hebou Constructions, Lamana Development, Kramer Ausenco, Monier and Hornibrook, with Business Advantage PNG reporting in February 2014 that several recent market entrants have decided to stay on despite the completion of construction on the PNG LNG project, attracted by ongoing opportunities in terms of public infrastructure and growth in the housing sector. Although this has created an increasingly competitive environment for private contractors, many firms remained busy and profitable in 2014.

Real Estate

For its part, AES reported several projects that were finished or near completion in early 2014, many of which were in the real estate sector, including the second stage of the Windward Apartments complex at Ela Beach and a new harbourside office building for Steamships, which was completed in early 2014. The group’s upcoming project portfolio is sizeable and includes the PGK250m ($94.6m), 300-bed Enga Hospital; a PGK85m ($32.2m) refurbishment of the Marea House office building in Waigani; a PGK100m ($37.8m) office complex for the Western Highlands Development Corporation; and millions in road and bridges for the Ok Tedi Development Foundation.

Indeed, stakeholders report that as projects in the resources sector decline, construction companies are now looking to the housing sector to maintain momentum. The boom years saw housing prices skyrocket, and the government launched a national affordable housing programme in August 2014, announcing plans to allocate over PGK41m ($15.5m) in funding for institutional housing in 41 districts.

PNG has also partnered with Bank South Pacific to launch its First Home Ownership Scheme (FHOS), offering low-cost loans to first-time buyers, and private contractors have been quick to capitalise on this opening. The PGK250m ($94.6m) Edai Town project is one such participant and its developer, Portion 11, expects the development will eventually house up to 2000 residents, many of whom will be FHOS beneficiaries.

More promising still, the National Housing Corporation has announced plans to build 40,000 new affordable units for PNG citizens, at a rate of around 2000 per year. Although land allocation poses a problem, the announcement bodes well for future growth in real estate construction (see analysis).

Infrastructure Support

With the government still hammering out the details of the IDA’s framework and its new PPP scheme, foreign assistance will likely remain a critical pillar for construction growth. The industry has already benefitted from foreign assistance in recent years; the World Bank’s total lending to PNG stood at $343.4m as of April 2015, with many of its 19 active projects targeting infrastructure, including the $157m second phase of the Road Maintenance and Rehabilitation Programme, which has already seen improvements to national and provincial road networks elsewhere in the country. The Australian Agency for International Development (AusAID), meanwhile, has committed up to $786m for infrastructure upgrades between 2007 and 2019.

ADB

PNG’s partnership with the ADB, however, is perhaps the most significant for the country’s construction portfolio. PNG joined the ADB in 1971, and today stands as the bank’s largest Pacific region borrower for public and private sector development, while the bank represents the nation’s second-largest development partner after AusAID. The ADB’s active portfolio in PNG comprises $1.1bn in funding, including 22 loans for 11 projects, eight grants, nine technical assistance projects, and two private sector loan and equity operations. Although the bank has been active in providing employment and finance programmes, it has focused much of its activity on transport and infrastructure.

In March 2015 the ADB announced it had approved a five-year country partnership strategy with PNG, from 2016 to 2020, which will support government efforts to remove infrastructure bottlenecks, as well as barriers to job and business creation. The country will receive $637m in funding in the first phase of the strategy to upgrade the national transportation networks and develop new renewable energy and power projects.

Sea & Air

Through its partnership with the ADB, PNG has made significant progress in updating major infrastructure, most notably the Lae Port tidal basin, in addition to improvements under way at its airports. With 15 of the country’s 20 provinces located in coastal areas, over 60% of the population widely dispersed across the country and land links in need of repair and expansion, sea transport represents a critical lifeline for the country, and upgrades at Lae Port have been a welcome development for the business community.

In progress since 2005, the Lae tidal basin project will greatly expand the port’s cargo handling capacity, which stood at 3.3m tonnes in 2011. Current construction is being carried out by the China Harbour Engineering Company (CHEC) under a contract awarded in March 2012. While the second phase is set to begin in the near term, the operating environment has added to costs. “We have spent anywhere from 5-10% on security for the completion of the Lae tidal basin project, and if you considered that this was a PGK800m ($302.7m) project, one gets a sense of the impact that law and order has on business developments in PNG,” Ma Jinhua, CHEC’s general manager, told OBG. The ADB’s second flagship project, the $640m Civil Aviation Development Investment Programme, will upgrade safety and security infrastructure at seven airports, including Jackson’s International Airport in Port Moresby.

Roads

PNG’s road infrastructure has been identified as one of the foremost impediments to conducting efficient business operations in the country. As such, road construction stands as the future opportunity with perhaps the most potential for private contractors. Infrastructure is set to receive a total of PSK2.3bn ($870.3m) in 2015, some PSK681.9m ($258m) of which will be allocated to roads. The government has also partnered with a host of foreign players in recent years to roll out major highway projects.

The World Bank has committed $126.5m to the Road Maintenance and Rehabilitation Programme’s second phase, approved in February 2014, while the ADB’s Highlands Region Road Improvement Programme launched its second phase, with $109m of new funding, in December 2013, which will see improvements to 118 km of priority national roads and maintenance work on 500 km of national highways.

Outlook

Despite facing headwinds in 2014, the construction industry is expected to return to growth as the government, private sector and foreign entities work to address PNG’s sizeable infrastructure backlog. Policy reforms aimed at transforming the country’s institutional framework have led to cautious optimism among stakeholders, with the new PPP Act and the IDA lending a brighter near-term outlook to construction growth. Plans to deliver thousands of new affordable housing units will further support long-term expansion, and although construction on the PNG LNG project has ended, considerable future opportunities exist in infrastructure, real estate and eventually new energy builds.

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The Report: Papua New Guinea 2015

Construction & Real Estate chapter from The Report: Papua New Guinea 2015

The Report: Papua New Guinea 2015

The Report

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