Current Financial Situation and Its Impact on Projects in the Region

The US sub-prime crisis has led to plunging property prices, a slowdown in the US economy and billions in losses by banks. In brief, the sub-prime crisis was initiated when banks moved to a new model whereby rather than banks lending mortgages through deposits received from their customers, banks began to sell on mortgages to the bond markets. This made additional borrowing much easier, but also created a platform whereby banks no longer had the incentive to carefully check the mortgages they were issuing. As a result, a wave of house repossessions has begun, which has had a dramatic impact on the US housing boom of the last few years. House prices in the US have been and are continuing to fall, and millions of unsold homes are forcing builders to lower prices in order to sell properties.

The property crash is having a knock-on effect on the broader economy. The building industry is being forced to cut output, resulting in job losses. In addition, the banking industry is facing huge losses, and it is estimated that banks and other financial institutions could lose $1 trillion from the credit crisis as mortgage-backed assets have lost most of their face value. Over the past few weeks, the worldwide banking sector has been thrown into disarray. Nationalisation, bankruptcy and acquisition of leading banks have been observed – failure of Lehman, government takeover of AIG, the sale of Merrill Lynch to Bank of America, etc. In addition, panic in world financial markets has led to sharp falls in share prices. The crisis is spreading into many other sectors of the economy and is now affecting people’s overall confidence. When confidence declines, people often become more careful about their spending, causing further economic slowdown. With plunging stock markets around the world, contraction of credit markets and the world apparently being driven into economic slowdown, we ask what impact the current financial situation will have on projects in the Middle East region.

Current impact in the region

By examining various indicators, some of these suggest that the credit crunch is yet to make a significant impact in the region. For example, in the IPO market, the Middle East is strong relative to the global downturn that has been observed. In the third quarter of 2008, capital raised in the Middle East from 12 initial public offerings (IPOs) was US$3.61 bn. Although this capital was down 23% than in the previous quarter, regional markets fared better than global markets which were down 66% in the lowest activity level seen since 2003 (Ernst & Young quarterly global IPO update). Saudi Arabia was placed second globally in terms of funds raised by any country with US$3 billion, equalling 23 per cent of the global IPO market, whilst the UAE came in second in the MENA region with US$600 million, equivalent to 5 percent of global capital raised.

In addition to the IPO market suggesting that the region is dealing with the global downturn relatively well, a second indicator, willingness of GCC to invest windfall oil revenues in massive infrastructure, industry projects and international assets, also paints a relatively positive picture. For example, Qatar, the world’s biggest exporter of liquefied natural gas, confirmed in October 2008 that the Gulf state would push ahead with investment plans despite global economic turmoil. In addition, Qatar’s Prime Minister, Sheikh Hamad bin Jassim Al-Thani, was quoted as saying “Qatar will not stop or slow down its various projects due to the global crisis. Qatar will continue its infrastructure and investment projects in spite of the global turmoil in the markets.”

In addition to these indicators, project costs, salary demands and housing expenses, all continue their general upward trend across the Gulf, further reinforcing that the global credit crunch has yet to significantly impact the Middle East. With the recent slide in oil prices however, worries are understandably mounting that the financial crisis could cause a slowdown in the region’s economic growth in the coming months. Oil has slumped more than 50 percent since hitting an all-time high of $147 per barrel, and the question that this raises is what impact a much lower price will have on projects in the region.

Potential impact on planned projects in the region

In the GCC, Energy projects currently in plan or study phase equate to $133 bn USD, whilst such projects in infrastructure equate to $285 bn USD and in Construction, $70 bn USD (Contax, November 2008, Figure 1). After several months of oil prices being above $100 a barrel, new projects across the region, based upon feasibility studies, have been given the green light. The viability of many such projects will now be challenged as shareholders review their market assumptions which underpinned their feasibility studies. Middle East oil producers for example may shelve projects to boost output if crude prices remain below $80 a barrel. Other energy projects may also face cancellation or postponement, and potentially $133 bn worth of energy projects may be impacted. This will have a knock-on effect on other investments and developments, potentially impacting an additional $355 bn worth of projects.

In addition, projects requiring project finance will find that the appetite of the financial markets has significantly changed and that financing will be extremely selective. If credit becomes harder to find, new projects in the region may have to be put on-hold, or cancelled altogether. For international banks which are heavily involved in project financing in the Middle East (for example, RBS which has the mandate to arrange financing for the $26bn Ras Tanura refinery for Saudi Aramco), they will be forced to focus on credit expansion in their home market, so lending in areas like the Middle East region may be further curtailed. In summary, Contax forecasts that the global financial situation will result in a dramatic decrease of projects requiring finance across most of the Gulf.

Potential impact on existing projects in the region

In the GCC, Energy projects currently in design, EPC bid or execution equate to $296 bn USD, whilst the same projects in infrastructure equate to $667 bn USD and in Construction, $798 bn USD (Contax, November 2008, Figure 2). There are many Energy Companies in the Middle East that are executing such projects, and either have cash in the bank to help them through this period or a good enough reputation in order to continue getting credit required to finance existing requirements. For such companies, their projects can still be impacted by the current financial situation. For example, they may have customers, suppliers or partners, who are facing more difficulties in getting credit (especially if they have large existing debt), and who subsequently are unable to pay for services received, supply services expected, or even face bankruptcy. In such situations, the current financial climate will have a domino effect on even financially prudent companies.

In the infrastructure and construction sectors, however, there is a totally different picture – government projects are secure but private developers are coming under increased scrutiny. Many such developers are unable to complete existing projects due to soaring costs and other challenges, and in order to fund completion, are in some cases using funds secured from customers for already sold, off-plan future developments. In Dubai for example, authorities are now beginning to step up efforts to regulate the real estate market with a series of ongoing police probes into firms, including property companies. Private developers are already feeling the impact of the current financial situation, as property shares in the UAE, for example, fall sharply as fears of an economic slowdown sweep the Gulf. In Dubai, shares of Emaar Properties have fallen almost 30 percent since the beginning of August, whilst in Abu Dhabi, Aldar Properties has slumped nearly 40 percent and Sorouh by almost 36 percent. Increased regulation is therefore a necessity in order to lessen the impacts of the financial crisis felt by this sector in the coming months.

In addition, EPC contractors of many projects in the Middle East are also facing spiralling costs, lack of resource availability, declining productivity and delays in material availability. Again, it is likely that the current situation will exacerbate existing project challenges. Contax forecasts that suppliers throughout the value chain will face difficulty in financing their business, with lines of credit being either withdrawn or cut back at a time of peak activity and significant swings in their requirements for working capital. In addition, we have already seen debtor days within the Middle East increase over the past few months. Other impacts that organisations may face are performance issues and lack of focus as their leadership become distracted by personal wealth. In many cases leaderships within organisations are heavily leveraged and exposed to the equity and real estate markets in the Middle East, for example. Finally, existing projects may be impacted by many other aspects, including, to name just a few, the exchange rate of the dollar, other currencies fluctuations, and existing insurance policies etc. In summary, these are early days but one thing is likely, in the coming months, projects in the Middle East will have to deal with a tougher economic environment and even more challenges than those currently in place today.

The way forward

There are actions that can be taken by both project owners and contractors of projects in the Middle East in order to alleviate some of the effects of the current financial climate. For example, contractors can focus on cash flow earnings by achieving higher productivity, reducing debtor days and ensuring that claims are transparent so that project owners can settle them easily. In addition, contractors can focus on identifying those projects that are most likely to go ahead, and then prioritise them based on quality of owner. Meanwhile, owners should focus on gaining market knowledge of their EPC Contractors and Subcontractors in order to fully understand their strengths, weaknesses and drivers in this turbulent market. Owners should also revalidate and focus on the projects that are most likely to take place given the current market conditions. Finally, for those companies who survive this financial crisis, and who maintain liquidity, there could be extraordinary opportunities. For example, assets will be sold at attractive prices to keep less liquid parties in a solvent state. Both project owners and contractors in the Middle East may be able to capitalize on the current environment through rigorous and creative identification of opportunities and proactive mitigation of risk.

Authors:

Ann-Marie Carbery, Manager, Contax Risk Advisory Services and Tony Bury, Chairman, Contax Group

Based in Dubai, Ann-Marie is the Manager of Risk Advisory Services for Contax. She has over 7 years of Strategy Development and Implementation, Project Management, Corporate Transformation, Risk Management, EPC Contracting and Procurement experience within the Middle East and Europe. Ann-Marie has a strong background in the energy, utility and construction sectors. Former experience: Strategy consultant for Accenture working particularly with IOC and NOC clients in UK, Holland, Kuwait, Dubai, Oman, Syria and Qatar.

email: annmarie.carbery@contaxgroup.com

 

5 Responses to “Current Financial Situation and Its Impact on Projects in the Region”

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  5. Tony Bury Says:

    Susan, the blog was created internally within the company. Thanks for dropping by.

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