Many UK contractors have been involved in the Middle East over the last few years – but what can they expect in 2017?
For the past two years, the Middle East construction sector has been battling against reduced liquidity as result of the low oil price.
With pressure on the bottom line, governments and government entities in the region have understandably taken a more detailed look at the various means by which cost savings could be made and operational efficiencies gained, consequently reducing expenditure on non-critical projects. This has had a direct impact on the operations of UK contractors in the Middle East, which witnessed a number of large, high-profile projects such as the GCC Rail Network being cancelled.
However, with the oil price stabilising (it’s currently hovering around the US$50 a barrel mark) and significant restructuring in the region either completed or well progressed, 2017 is already shaping up as a foundational year for Middle Eastern construction in the medium term.
A snapshot of 2016
In 2016, the construction market in the Middle East revolved around the consequences of downward pressures on oil prices.
Lower government revenues forced the re-prioritisation of spending commitments and the diversion of public funds to other priority areas such as security in the face of the increased geopolitical tensions. These factors directly impacted the construction industry, with non-critical projects being modified, terminated or put on hold.
The lower oil price also resulted in a tension between budget pressure and schedule-driven projects, such that procurers were prepared to accept more risk in an effort to reduce bid prices and relieve budget pressures.
“The construction industry experienced a tough market in 2016 and was characterised by restructuring, downsizing and an increase in disputes”
Notwithstanding the critical nature of projects, budget pressures also caused delays in the release of payments due under contracts as more scrutiny was placed on compliance with the requirements (both internal and external) for the release of funds. Consequently, the cashflow of contractors came under substantial pressure.
Last year also saw a continuation of the trend to leverage private sector finance for project development in the region, with a particular focus on PPP models.
Overall, the industry experienced a tough market and was characterised by restructuring, downsizing and an increase in disputes.
The outlook for 2017
Though the Middle Eastern economy ended 2016 on a stronger footing as global growth picked up and oil prices stabilised, many experts still predict the region will face a low-price environment in the near term.
Accordingly, in line with the 2016 objective of raising non-oil-sector revenues to fund spending programmes and reinforce regional economic growth, governments in the Middle East are expected to continue to seek to diversify revenue streams, review their current spending commitments and prioritise essential infrastructure projects.
It is therefore unlikely that 2017 will see substantial appetite for non-critical projects return, or reduced pressures on government organisations to cut costs and capture efficiencies. However, there is still much for contractors, including UK firms, to be positive about.
“It is unlikely that 2017 will see substantial appetite for non-critical projects return, or reduced pressures on government organisations to cut costs and capture efficiencies”
First, despite the expectation that the negative consequences of the low oil price on the ‘non-essential’ construction sector will endure, the appetite for ‘critical’ projects – particularly those tied to major events such as Dubai Expo 2020 and the 2022 World Cup – is expected to continue apace.
As we get closer to such events, the tension between scheduling and budgetary pressures is expected to intensify, with the outcome favouring contractors. The leverage in respect of payment claims is expected to shift further towards contractors, in part due to the risk to government organisations of contractors suspending operation, with the willingness of government organisations to terminate projects likely to reduce.
More clarity ahead
Secondly, with the new interest across the Middle East in PPPs as a form of procurement, opportunities may be created for UK contractors – many of whom have almost two decades of experience in the PFI/PPP market – as well as for private investors in infrastructure.
Although the trends of 2016 have carried through into Q1 2017, Q2 is expected to bring with it a clearer picture of the state of construction in the Middle East for the medium term.
Accordingly, UK firms will get a better understanding of prioritisation around certain projects, of any shift in the traditional approaches to risk allocation in the region, and of any change in the traditional approach to payment claims under various contracts.
Private investor confidence is expected to increase as oil prices stabilise, setting 2017 on course to be a significant year for the Middle East construction sector.
Michael Turrini, Julian Bailey and Luke Robottom are partners, and Nirmeen Gul is an associate, at White & Case