Overcapacity to reduce cement prices in Saudi

Overcapacity will push down cement price in Saudi Arabia from SAR255 (Dh250) to SAR200 per tonne in the next five years, according to a recent HSBC Saudi cement sector report.

The eight Saudi incumbent cement operators are ramping up capacity just as six new players enter the market – and the government has banned exports, as well as setting a ceiling on prices in Saudi Arabia.

Between 2002 and 2007, cement consumption rose to 6.5 million tonnes per annum (mtpa). By 2010, there will be an additional 13.5mtpa of capacity, said the report. The report estimates the capacity of the market will rise from 35mtpa of clinker at end-2007 to 48.5mtpa in 2010. The regions with the highest demand – western, central and eastern regions – have two incumbent players apiece, while the northern and southern regions have one each. Saudi has 13 provinces, but the report has subdivided it into five regions.

The six newcomers were mostly licensed in 2005. Four have already started production, one is expected to launch production in 2009 and the last in 2010.

The newcomers are, for the most part, based in similar locations to the existing players. Combining with the expansion plans of the incumbents, means that a substantial increase in supply is coming on line in KSA.

The report said the government wishes to issue seven new licences with access to quarries. It moots whether these are likely to be acquired, and if so, are unlikely to materialise in the form of a functional plant. "Since in summary the deluge in capacity will lead to price reductions, making the newcomer model unsustainable. Given the amount of capacity coming on line, we believe prices will fall to around SAR200 per tonne. At this level, the new entrant model does not work," said the report.

PROMPTING A BAN 

Growth in construction activity in the past few years has been accompanied by rising demand, causing prices to increase by 20 per cent between 2002 and 2007 – and this has been kept in check with a price cap. "The price cap only served to encourage producers to export their cement to obtain higher prices, leaving local demand unsatisfied – and prompting the export ban in July of this year," said the report.

Prices are regulated in KSA, currently at under $70 per tonne, so transport costs play an important role there. It costs about SAR60 per tonne to transport cement for 300km. As a result of this and locally centralised demand, the incumbents tend to focus cement sales on their home regions or on exports [which have recently been banned].

The export ban is a key factor – five of the incumbents and four of the new operators rely on exports to bolster their sales. "As local sales remain strong, there is no real need to lift the ban yet, but the local newspaper, Al-Riyadh, has reported the government is considering proposals, whereby the ban would be lifted but a price cap of SAR200/tonne would be placed on exports. Our models assume the ban will not be lifted," said the report.

"The incumbents, which have been established for some time – decades in some cases – have been increasing capacity to meet growing demand in KSA, but primarily to cater for demand outside the country. The producers only started to look at the export market in earnest when the price cap started, causing a large differential between local and export prices."

"In July, however, the government decided to introduce an export ban (with a small concession for Bahrain) and recently decided to auction off a further seven licences, in a process that is still ongoing. The cement producers, therefore, find themselves in an unfortunate position. They have a built-up capacity for the export market, but are not allowed to export," said the report. The credit crunch could lead to a delay in the materialisation of a number of projects and hence reduce demand in Saudi. It will also lead to a reduction in demand from the export market, once it is opened up.

"Many countries outside Saudi have been increasing their own cement production facilities. As we mentioned earlier, substantial supply is coming on line and many operators have recently upgraded their capacity. Consequently, the operators are generally reluctant to reduce prices owing to the fixed costs associated with operating plants. This is especially true of the companies with relatively low capacity," said the report. "Without the export market, producers are heavily reliant on domestic market. However, it is expensive to transport cement on the roads and inevitable that there will be price decreases.

PROPORTION TO BUILDING COSTS 

"In order to gauge the future consumption of cement in KSA, we look at our expectations for gross capital formation (GCF). This analysis also considers the historical relationships between residential and commercial building costs and cement consumption. We note that these costs have been falling, from 47.8 per cent of total GCF in 2002 to 41 per cent in 2007," said the report of the two main segments of cement usage. "Cement costs as a proportion of residential and commercial building costs have also been diminishing, from 7.2 per cent in 2003 to 5.8 per cent in 2007. We would expect that percentage to fall further, as commercial building has been increasing and the focus has increasingly been on petchem projects, which have lower cement needs than other constructions. Similarly [excluding commercial building costs], as cement price increases have outpaced realty price rises from 16.2 per cent in 2003 to 18.1 per cent in 2007."

The report estimates that cement costs as a proportion of both residential, and residential and commercial building costs, will decline in line with cement prices, stabilising at 15.5 per cent and 4.4, respectively. "This effectively means we do not see any relationship between volumes consumed and the pricing of cement," it said.

It notes the key drivers for residential construction are population distribution and growth, as well as household size. "The Saudi population has been growing apace, tripling in the space of 30 years to reach 22.7 million in 2004 and, we estimate, around 26 million today (of which around 15 per cent are expatriates). We expect the annual growth rate of 2.5 per cent to continue, especially as 46 per cent of the population is below 20 years old," the report said.

"On the commercial front, we examined projects that have been announced and those that have been awarded. The information we have on these projects is project type and value. Clearly, given the ongoing global financial crisis, it is uncertain whether announced but still unfunded projects will actually go ahead. However, we take the view that projects backed by government entities will materialise, especially given comments made at the G20 conference to the effect that KSA "will continue the programme for government investment in spending on basic projects and services. We expect this programme for the government and oil sectors to exceed $400bn (Dh1,469bn) over the next five years." Based on the above analysis, the report allocates cement consumption to the five regions giving a higher weighting to the residential segment than to commercial build as the government has, in the past, favoured projects that directly benefit the population. 

NEIGHBOURING DEFICIT 

Exports volumes had been picking up well before the ban. Growth momentum for Saudi cement exports has been increasing at a healthy pace over the past few years, recording annual growth rates of 56 per cent in 2007, before the export ban introduced in Q3 2008. Saudi exports totalled 3.5m tonnes in 2007; these were largely dominated by producers located in the eastern province, which accounted for 65 per cent of the total export market. Local capacity additions of 1.65m tonnes in 2005 and 4.65m tonnes in 2007 undoubtedly helped boost exports. "However, the main supporting factor, in our view, was a cement deficit in neighbouring countries, such as other GCC countries and Iraq, which grew 11 per cent pa over the past three years (See table). While the exports of most operators fell in 2008 as a result of the ban, Saudi Cement has been less affected as it has taken advantage of a concession that allows a small amount of exports to Bahrain. Looking ahead, we believe, other than the producers in the eastern regions, companies that have recently undergone major capacity expansions will be more focused on the export market," said the report.

How far will removal of the export ban actually help? "Based on our analysis, cement consumption in the first cluster should total 43.3m tonnes in 2008e, which would imply an aggregate cement/clinker deficit of 12m tonnes. Historically, Saudi Arabia has supplied as much as 26 per cent of the region's cement deficit, but we calculate this will have fallen to 12 per cent in 2008e, with the introduction of the export ban," said the report. "However, once the ban is lifted we believe the Saudi operators will be able to supply more than 50 per cent of the regional deficit as they are likely to price lower than competitors elsewhere."

WHO WILL BENEFIT

In a normal pricing environment, then, the lifting of the export ban will not provide immediate and significant relief to the Saudi producers. However, given their cost advantages, the Saudi operators can price lower to gain sales. They already price slightly lower than other GCC producers. Obviously KSA is not the only country that is increasing its cement capacity: all other countries in the Middle East are doing the same and, given the credit crunch, there is likely to be a tapering-off of demand in those countries as well.

"However, the KSA manufacturers do have lower cost bases, which could allow them to gain market share outside KSA with more aggressive prices.

"As mentioned, the incumbent operators benefit from low raw material and energy costs, which our benchmarking analysis of some international operators show to be the main causes for differences in margins," said the report.

The report said if Saudi producers decide to price at levels below SAR200, some of the new operators in the other GCC markets could be forced to exit.

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