Buoyed by demographic and economic growth, Nigeria’s construction sector has the potential to become the largest and most competitive on the continent. In all areas of the sector, from basic infrastructure to privately developed real estate, pressure from demand is rising. This has already attracted several players to the market, and the number of contracts on offer is set to dramatically increase in the coming decade. However, if the country is to realise its full potential, there are a number of problems that must first be ironed out. While many processes have improved for construction contractors over the past five years, there are still concerns over project bottlenecks, particularly concerning public sector contracts.
POSITIVE GROWTH: Strong GDP growth of 7.63% in 2011 driven by hydrocarbons production has certainly facilitated the construction sector’s expansion in recent years. The industry grew at a rate of 12.58% between 2006 and 2010, according to the National Bureau of Statistics (NBS), and maintained a level above 12% in 2011. Continued growth of the economy, forecast by the NBS to remain above 7% until 2015, indicates good news for the sector.
The country’s growing population is also supporting sector expansion, stimulating increasing demand for housing, services and improved infrastructure. According to the World Bank, in 2011 Nigeria’s population grew at a rate of 2.5%. Moreover, the UN has projected that Nigeria will experience the fastest urban population growth over the next 40 years, adding more than 200m people to the country’s cities and pushing the overall population beyond 367m. This will place significant pressure on housing and infrastructure, but it will also create many opportunities for the private sector. The World Bank estimates that the housing gap is around 12m-16m units and projects the potential value to be about $200bn.
INFRASTRUCTURE: Although the government plans to address this demand (see analysis), it has decided to focus on infrastructure roll-out in the short term.
According to the World Bank, infrastructure improvements have contributed one percentage point to per capita growth in Nigeria in the past few years and raising infrastructure provision to middle-income country levels could boost annual growth by a further four percentage points. The government has already committed significant resources to infrastructure development, averaging $5.9bn in annual expenditure on federal infrastructure – the equivalent of some 5% of GDP – according to World Bank data. However, the global body suggests that Abuja must spend $14.2bn a year, or 12% of GDP, on infrastructure over the next decade to meet the country’s requirements. The infrastructure funding gap is currently estimated to be $3.6bn per year, around 3% of GDP.
Given the strong hydrocarbons revenues, accounting for over 80% of government revenue and 95% of exports, according to the Federal Ministry of Finance, the government should be well placed to meet this challenge. The 2012 budget provides substantial expenditure for infrastructure needs. While the N4.88trn ($31.23bn) budget is relatively fiscally conservative, the government has set aside N1.34trn ($8.58bn) for capital expenditure, up 32.7% on 2011.
At the 2012 budget signing in April, President Goodluck Jonathan told local press that the focus of the budget was on completing viable ongoing projects and funding the development of critical infrastructure by involving the private sector. This is line with the federal government’s transformation agenda, a five-year plan running from 2011-15, which lists infrastructure expansion as one of the main priorities for economic development in the medium term. The strategy highlights 1613 key priority programmes, 28% of which are physical infrastructure projects. Most focus is put on the transport sector, which will be allocated some N4.47trn ($28.61bn) for the development of roads, railways, inland waterways, ports and airports.
A number of transport projects are already in progress, and have offered substantial contracts to the construction industry. Some of the biggest are in the rail segment, with two large-scale projects now under way. In July 2012 the government announced the go-ahead for the construction of the standard-gauge Lagos-Ibadan railway, awarding a contract worth $1.49bn to the China Civil Engineering Construction Company. The project is expected to be finished in 36 months. The Chinese company has also won the contract for the $874m Abuja-Kaduna railway, slated for completion by February 2015.
POWERING UP: The power sector is also a key priority area in the transformation agenda. With only enough electricity to power a mid-sized European city (roughly 4000 MW), investment in this sector is crucial. The government has allocated approximately N1.9trn ($12.16bn) to enhance power generation, transmission and distribution, as well as to research alternative energies. It aims to add 10 GW to the power generating capacity over the next decade, although a significant challenge to this is the funding gap.
As part of the government’s efforts to attract foreign investment to fill this gap, the National Electric Power Policy was created in 2001 to improve the regulatory framework and promote competition, among other things. The policy was consolidated in 2005 with the Electric Power Sector Reform Act. Progress has been slow, however, and as of 2012 moves to fully privatise the generation and distribution networks, as well as outsource the transmission network were still far from being realised. Concerns over risk guarantees and gas supply are hampering the roll-out of independent power producers, for example. Nonetheless, some steps forward have been made, which include the signing of a three-year contract in July 2012 by Canadian firm Manitoba Hydro International to manage and reorganise the Transmission Company of Nigeria. Moreover, in March 2012 the US’s General Electric signed a memorandum of understanding with the government to supply equipment for power generation and services to new electricity projects. While the firm was initially reported to have signed a $10bn investment deal to build new plants, it later released a statement explaining it only had plans to invest 10-15% in individual power projects.
PROBLEM PARTNERSHIPS: Other infrastructure projects have also presented opportunities for the private sector, and several public-private partnerships (PPPs) have been established, including the Lekki-Epe Expressway, the Murtala Mohammed Airport 2 and the Lagos-Badagry Light Rail Project.
However, there have been very few PPP approaches so far, according to Joerg Adelt, the financial director of Dantata & Sawoe Construction Company. Doubts surrounding the effectiveness of the PPP model in Nigeria have arisen in part due to a lack of security of revenue. The Lagos State government froze road tolls implemented by investors on the Victoria Island-Lekki Expressway in 2011, for example. The stalled Lagos-Ibadan Expressway project is likewise one example of a problematic PPP. After receiving numerous complaints about the slow progress of the project, which was concessioned to Bi-Courtney Highway Services in 2009 under a 25-year PPP, the government has been moving to re-take control of the project, and as of August 2012 was in the process of reviewing the concession agreement.
In the absence of well-established practices and principles for raising private funds for infrastructure development, the construction industry is likely to be largely dependent on government tenders and contracts in the short term. While the federal government is committing a significant portion of the annual budget to this task, there is still the issue of delivering the requisite funds to meet the backlog of projects. “The main problem is that thousands of contracts have been awarded but not completed yet. A study by the presidency says that Nigeria needs over N7trn ($44.8bn) to complete all these projects that have been awarded, but the annual federal capital budget is N1.3trn-1.5trn ($8.32bn-9.6bn). So there is a tendency not to award any more contracts,” Adelt told OBG.
RAISING FUNDS: One measure the government has taken to raise funds to meet the infrastructural shortfall is to set up the Subsidy Reinvestment and Empowerment (SURE) Programme. Established in January 2012 following the removal of the fuel subsidy, the programme is aimed at using the cost savings to foster further development. Though the fuel subsidy was partially reinstated in response to popular protests, the federal government has saved N180bn ($1.15bn), which will go to capital expenditure programmes.
This should create more opportunities for contractors in the sector, and according to Christopher Kolade, the chairman of the SURE Programme Committee, the impact of the project on the construction sector should be felt in the second half of 2012. In a statement following an April 2012 meeting, he announced that a number of projects had already received investments, including road construction, public transport expansion, maternal and child health care provision, and vocational training centres.
GOVERNMENT ROLE: The release of funds for such projects will be welcome news for a sector that is reliant on government contracts for much of its work. Adelt from Dantata & Sawoe, which focuses on road and bridge construction, said as much as 99% of Dantata’s projects are contracted by the federal and state governments. Given the prominence of the federal government, moves to bring its procurement process in line with international best practice have been welcomed. For example, the federal government has begun categorising contractors. Using turnover and equipment provision as the main metrics, the Bureau of Public Procurement is in the process of ranking contractors, which should make the bidding process for future tenders more transparent and efficient.
While discrepancies between public tendering at the federal and state level remain, many contractors believe the process is becoming more professional and competitive. “A minimum of three firms are necessary for a tender process, although some state governments will use selective tendering that focuses on competent contractors. This has consolidated industry somewhat and creates more work for big firms,” said Joe Wahab Jr, managing director of Stateco.
While this is a positive step for the industry, the process involved in undertaking public sector contracts can still cause several issues for construction firms. The backlog of public sector projects and the government’s inability to pay for project completions is creating some challenges for both small- and large-scale players within the industry.
In August 2012 Augustine Etafo, the president of the Construction and Civil Engineering Senior Staff Association, one of the leading unions in the sector, told local press that a lack of payments on completed and certified jobs had led to the loss of 100,000 jobs among both local and international contractors in the last 12 months. Etafo also estimated that at least N100bn ($640m) is owed to contractors by federal and state governments.
WEIGHING THE RISKS: This has caused difficulties for many contractors as pressure on cash flow builds. “The problem for the contractor is to know how much to have going into a project and how much to have going into finance,” said Adelt.
This uncertainty has affected contract costs. Under the 2007 Public Procurement Act, the federal government allows for a 15% advanced payment or mobilisation fee on public contracts for domestic contractors (10% for foreign contractors), which may give contractors some breathing space. However, uncertainty over payments during the implementation of a project and upon its completion has led to contractors reassessing their bids. As Adelt told OBG, “Firms must consider all the additional risk factors that relatively affect the price of contracts.”
Though the government has stressed several times in the past two years that it is looking at ways to control the high construction costs, this is unlikely to change while payment delays persist. Delays on payment exacerbate the potential risks for contractors, including price escalation due to material price rises, interest rate payments and local currency fluctuation. Those last two considerations are seen as especially debilitating for contractors. With commercial financing costs reaching 17-20% a year for large-scale well-capitalised construction firms, any delay in contract payments leads to substantial additional costs in interest payments to commercial lenders.
“Theoretically, the Public Procurement Act contains a reimbursement clause for interest payment costs, but so far we have not been able to get any interest back,” Adelt said to OBG.
CURRENCY DEPRECIATION: Nigeria’s depreciating currency has had a similarly pernicious effect. With many contracts stalled for more than four years, the fall of the naira, from a rate of N117 to the dollar in August 2008 to N157 in August 2012, according to the central bank, has had a significant impact on contractors’ margins as the government does not implement variation clauses for currency fluctuation.
The weakness and volatility of the naira has also been felt in material cost inputs for contractors. Due to the level of construction material imports, the depreciating naira has affected domestic market costs. This is perhaps most evident in the steel sector.
According to Raj Gupta, the chairman of steel firm African Foundries, the market for steel products has reached 2.5m tonnes, of which 1.77m tonnes is for long steel products. Domestic output has reached 1.2m tonnes. While this has led to an overreliance on imports, the government is looking to bolster local production. As part of its Vision 2020, Nigeria aims to raise per capita steel consumption from less than 10 kg in 2009 to 100 kg by 2020, and to boost local production levels to around 12.2m tonnes a year. It also targets 70% self-sufficiency in industrial minerals production and consumption.
CEMENTING PRICES: This drive towards self-sufficiency is already well advanced in the cement sector. Expansion projects worth $7.7bn in the past seven years have brought production capacity to 22.5m tonnes, well above the total consumption of 17m tonnes in 2011, according to reports by local media.
This should mitigate exchange rate pressures on cement pricing, especially considering the only imported input in cement production in Nigeria is gypsum, a small component of the finished product. Nonetheless, the cement price is still of concern, largely as a result of minimal competition among producers and the high margins of traders. By the end of 2011 the price of cement had increased to N2200 ($14.08) per 50-kg bag, a 25% increase on the previous month.
Prices had reached N2900 ($18.56) per bag in May 2011, leading to the president issuing a directive for producers to cut prices. A reduction of the wholesale price to N1350 ($8.64) by Dangote led in part to a final stabilisation of the retail price at approximately N1750-1800 ($11.20-11.52) per bag.
Such high prices have caused difficulties for contractors, particularly considering the cost-plus contract model is not used in the Nigerian market. For many input costs, a contractor must absorb price escalation. However, the government has tried to support contractors via the Public Procurement Act, allowing for variation or escalation clauses on diesel and imported steel. In addition, with such pronounced delays in payment, the government often has to renegotiate contracts to ensure their completion.
Wahab, however, said that there is a significant difference in contract specifics depending on the tier of government with which a construction firm is working. “One benefit of contracts from the federal ministry of works is that the federal government will pay the difference for diesel, cement, iron rods, bitumen and labour pricing fluctuations, whereas the state governments have fixed contracts.”
AN UPWARD TREND: However, it is not only in the public sector where construction costs remain an issue. While delayed payments undoubtedly lead to price escalation, the general trend for input costs across the board is upwards. This is unlikely to reduce in the short to mid-term given the expected surge in the sector and in demand for materials.
Contractors are also casting a wary glance at the labour market. According to Adelt, the power of trade unions has led to significant labour cost escalation. Under union agreements, there is an automatic 7.5% salary rise each year and there is a renegotiation process which takes place every two years.
The last negotiation in November 2011 resulted in a minimum salary increase of 30% from N24,300 ($155.5) to N31,500 ($201.6), excluding overtime. In February 2012 at a hearing on the high cost of road construction in the Federal Capital Territory, leading contractors told the Senate committee they pay their workers 60% above the minimum wage of N18,000 ($115.2). With input costs rising, overall construction costs have also been on an upward curve. According to Davis Langdon, a construction consultancy, Abuja has the highest construction costs of any capital in Africa – an average multi-unit high-rise residential building averages $1400 per sq metre.
The capital is also among the most expensive places in Africa to build luxury high-rise residential buildings ($2200 per sq metre) and high-rise office complexes ($2610 per sq metre). Indeed, the luxury end of the market is particularly expensive given the high import duties (which can reach up to 50%) on finishing products such as marble and ceramics.
Such trends should not affect contractors catering to private clients, as they are able factor in high costs and potential escalation when writing a contract. However, developers may be beginning to feel the rise in costs. Margins, particularly in the luxury segment, remain high, well above 20%, and are among the most lucrative in the world, according to some developers.
Nonetheless, with supply expected to increase and with both building and land costs rising, developers’ ability to maintain such margins may be challenged in the coming years. Land, in particular, is becoming an issue in terms of availability and pricing. While prices have not returned to the peak before the global crisis, when they could reach N300,000 ($1920) per sq metre in prime areas of Lagos, they have rebounded to N220,000-250,000 ($1408-$1600) per sq metre from a low of N150,000 ($960).
While this trend may be concerning for builders in the bigger cities, government attempts to improve land availability could stymie any potential overheating in the market. “Government land is generally easy and safe to access, and there is no risk of contract sanctity or title disputes, but it is still not at the level it should be. I would estimate that the government owns up to 80% of land in Lagos,” said Gboyega Fatimilehin, a partner of real estate firm Diya, Fatimilehin & Co.
OUTLOOK: This is just one of a number of obstacles facing Nigeria’s construction industry. While there is much potential to ramp up growth in the sector, a number of challenges still pose difficulties for contractors. In the public sector segment, where much of the short- and mid-term growth should occur, the problem of cost control is persistent.
Not only is the weak naira and the sector’s reliance on imports fuelling cost increases, but also the demand for materials and the pressure on labour prices are adding to contract price pressures.
However, the biggest issue over the coming years is likely to be the government’s ability to clear the backlog of infrastructure projects and improve payment efficiencies. The government has already taken steps to improve the tendering process, and if it can address payment delays, confidence should continue to rise.