A perfect storm for GCC steelmakers

Author Sara Warden, Reporter

The Covid-19 pandemic, combined with the timing of the oil price collapse, could have created one of the most hostile steel markets for the GCC region ever.

Even though governments in the region quickly imposed measures to curb the spread of the virus, the construction and steelmaking industries were categorized as essential and were not subject to closures, but operations needed to be scaled down.

Governments in the GCC are already aware of the dangers of a non-diversified economy. The Saudi Arabian budget for 2020 assumed an oil price of $65/bl, while the Omani budget envisioned a price of $58/bl. At its lowest level, Argus assessed the Dubai crude spot price at $13.61/bl on a fob basis on 22 April.

In 2019, non-oil GDP in Saudi Arabia rose by 3.3pc, a rapid increase spurred by high levels of investment in other sectors as a result of an ambitious diversification plan. But this effort is still in its infancy and the GCC region still overwhelmingly relies on oil revenues to subsidize newer industries. The collapse all but eliminated growth for non-oil sectors in the region for the year, with a risk of recession looming.

Steel demand: A downward curve

After East Asia and the Pacific, the Middle East and North Africa accounts for the largest infrastructure spend as a proportion of its GDP, according to the World Bank. About 6.9pc of the region’s GDP is spent on infrastructure development due to a rapid period of industrialization in North Africa and growth of the tourism industry in GCC regions.

But even prior to the Coronavirus and oil price fall, the UAE’s PMI numbers had begun to freefall. After a significant peak of 59.4 in May 2019, confidence steadily dropped and the country hovered around the 50 mark at the end of the year, indicating no growth. In 2020, the index promptly fell below 50 for the first time, reaching 45.2 in March, meaning a contraction in activity. Saudi Arabia similarly saw its index fall below 50 for the first time as it dipped from 52.5 in February to 42.4 in March. In Qatar, the PMI has frequently contracted, hitting its lowest ebb in July 2019 at 45.2 and never exceeding 50 in the months since.

Purchasing Managers Index
Source: IHS Markit

Construction activity was dropping in the GCC region as early as the third quarter of 2019. Not only is the number of projects announced dropping but so is the value invested. In the first quarter of 2019, the average project cost was $222 million, but this dropped by almost $100 million a year later. With the announcement from the UAE that all projects would be suspended until further notice, it is unlikely more will be announced from this country in the second quarter and this number is likely to fall further. A significant number of projects for 2020 were already completed in the first quarter and it is thought that the majority of procurement for megaproject Expo 2020 has already been carried out.

GCC construction projects announced
Source: BNC

A rising supply

Since a high of just over 1mn t in June 2016, the UAE’s steel product imports have steadily declined, with February 2020 registering imports of almost 190,000t for all steel products. In the last year, exports and imports have mostly balanced out, meaning the country’s net steel consumption averages around 370,000t/month. While demand was high during the country’s construction boom, consumption exceeded production levels but in March a dramatic drop in export and import activity is a warning sign for mills that are finding that their production levels now exceed total domestic demand.

UAE net steel consumption
Source: World Steel Association, Global Trade Tracker

The situation is similar for Saudi Arabia, although as a country that is much less prone to export, the issue could be much more exacerbated. One solution may be to ramp up exports and decrease imports, but the problem here is that there is not enough local semi-finished steel availability to feed the mills, meaning some imports are essential to keep mills running, especially given high iron ore prices. Additionally, Saudi Arabia traditionally does not export finished steel products because of its ability to command higher prices domestically, meaning if it were to try exporting in such a competitive market as exists today, it would have to slash prices dramatically. This raises questions about the production costs of these mills, especially given relatively low apparent capacity utilization rates.

KSA net steel consumption
Source: World Steel Association, Global Trade Tracker

Production according to the World Steel Association averages around 3.2mn t/yr in the UAE and roughly 5.3mn t/yr in Saudi Arabia. The OECD estimates production capacities of 4.8mn t/yr for the UAE and 13.7mn t/yr for Saudi Arabia, which means actual output dramatically underuses available capacity. With the current situation, the UAE may be able to reduce some capacities, but Saudi Arabia’s capacity utilization has already hovered around the 40pc mark since 2016, with some small peaks of about 60pc noted in March 2019 and 2020. Oman’s production capacity is estimated at 3mn t/yr but the country does not report actual production.

Estimated capacity utilization
Source: World Steel Association, OECD

Looking ahead

Overcapacity exists in the GCC region just as it does globally. In March, production figures show that the Middle East increased production by almost 10pc on the year, which although driven primarily by Iran, saw UAE increase production by 25pc to 264,000t and Saudi Arabia increase by almost 6pc to 675,000t. There are also new capacities coming online in the region, namely the 1.2mn t/yr MISCO EAF in Oman and the 600,000t/yr Gulf Tubing Co. EAF in Saudi Arabia.

Despite the non-oil economy in Saudi Arabia strengthening, there is still a lack of private sector investment, meaning the onus will be on the government to spur growth in a time of economic uncertainty. This will undoubtedly be constrained by the oil price drop, which will mean construction, steelmaking and infrastructure sectors are likely to suffer, with an 8pc cut in expenditures. The Institute of Chartered Accountants in England and Wales has revised its 2020 non-oil growth estimate for Saudi Arabia from 2.8pc to just 0.7pc.

While Saudi Arabia is likely to maintain a marginal growth level, the picture looks even worse for the UAE, with just 0.1pc growth for non-oil GDP for the entire year, down from original growth estimates of 2.5pc. Ramadan, coupled with hot summer months of June, July and August are likely to see weak construction activity, which is normal for the region but can normally be compensated by a strong performance at the beginning and end of the year. However, much of the construction activity in the UAE is driven by its tourism sector, which is unlikely to recover for the remainder of the year and even ongoing construction contracts are to be re-priced, adding to the burden for retailers, which will pass through the supply chain. One of the biggest concerns is over Expo 2020, which remains at risk of cancellation. Overall demand is likely to remain subdued and competition will be strong.

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