STEEL MARKET ILLUSTRATES CHALLENGES IN REALIZING

C O N F I D E N T I A L SECTION 01 OF 04 RIYADH 001151

SIPDIS

DEPT FOR EEB, ARP

E.O. 12958: DECL: 07/26/2018
TAGS: ECON EFIN EINV EMIN ENRG EPET ETRD SA
SUBJECT: STEEL MARKET ILLUSTRATES CHALLENGES IN REALIZING
THE GULF DEVELOPMENTAL BOOM

Classified By: CG JOHN KINCANNON FOR REASONS 1.4 (B) AND (D)


1. (C) SUMMARY: With Gulf countries eager to translate
windfall oil profits into global commercial leadership, the
GCC project market has boomed, recently surpassing two
trillion USD - more than double the combined GDP of the GCC
economies. With massive industrial, utility, and real estate
projects comprising the bulk of planned construction, the
regional demand for steel and other raw materials has soared.
A tight global steel market, along with record oil prices
and a weak U.S. dollar, has caused steel prices to double
within the last ten months. Though steel demand has proved
surprisingly inelastic, increased prices and supply shortages
have created important challenges for local development,
including project delays, shaken investor confidence, and
rising inflation. Saudi Arabia and other Gulf countries have
sought to counter the overheating market by increasing
regulation, but with little success. GCC countries hope that
long-term investment in new steel manufacturing plants will
alleviate constraints by expanding production capacity. The
ability to meet and subsequently manage steel market
pressures will prove telling in the region's attempts to
create sustainable growth. END SUMMARY.

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Oil Wealth Creates Booming Project Market
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2. (U) With the price of oil at all-time highs, Gulf
economies are enjoying windfall profits and unprecedented
liquidity. Saudi Arabia, along with the rest of the GCC, has
moved to focus investment of these funds on further
developing hydrocarbon resources, resolving pressing societal
needs - for example housing and utilities, and placing the
Gulf at the vanguard of commerce and culture.


3. (U) Comprising a significant portion of the more than two
trillion USD in planned projects are integrated economic
development projects that Gulf countries are hoping will
satisfy growing housing demand and provide needed jobs for
the region's fast-growing population. Not content to simply
meet population needs, these projects often aim for
unprecedented technological or architectural feats. Saudi
Arabia's economic cities - with projects at Rabigh, Hail,
Madinah, Jizan, Tabuk and the Eastern Province (EP) - hope to
create more than one million jobs and become home to between
four and five million people by 2020. Reliable cost
estimates for the Economic Cities projects seem not to exist;
a June Arab News article estimated Rabigh, Hail, Madinah and
Jizan at more than 300 billion SAR, while a July Bloomberg
News article estimated the King Abdullah Economic City at
Rabigh as being 120 billion USD itself. Virtually every
other Gulf country has grand visions of their own, whether it
be Kuwait's 77 billion USD City of Silk or any one of the
myriad UAE projects.

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Steel Demand Grows, Prices Spike
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4. (U) Monumental in imagination, size, and number, projects
such as these have created an unprecedented demand for raw
materials, chief among them cement and steel. In 2006, the
Middle East produced 21.1 million tons and consumed 41.6
million tons of raw steel. The Middle East Economic Digest
(MEED) forecasts that by 2010, these numbers will reach 35
million and 60 million, respectively. Growing local demand
for steel dovetails with a tight global market created in
large part due to Chinese steel producers transitioning away
from export and instead focusing on the domestic market. The
world's three largest iron ore producers - Brazilian Vale and
Australian Rio Tinto and BHP Billiton - have responded to
this global demand by increasing 2008 prices between 65 and
96.5 percent, depending on region and iron ore quality.


5. (C) According to Abdullah al-Zamil, COO of Zamil
Industrial, increased demand and rising iron ore prices are
only part of the reason for spiking steel costs. In a July
14 meeting with EconOff, al-Zamil explained that the cost of
oil, used in producing and transporting steel, and the
weakness of the U.S. dollar are also important factors.
Al-Zamil estimated that the drop in value of the U.S. dollar
was responsible for some 20 to 25 percent of the rise in the
price of steel. President of Zamil Steel Industries Adnan
al-Mansour added that while his company paid some 300 USD for
a metric ton of steel plate in 2003, and 750 USD in October
2007, in June 2008 the cost was 1,400 USD. The price stated

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by al-Mansour is slightly lower than publicly reported
figures in the region, which continue to rise. On July 21,
Arabian Business website reported that in the past two weeks
alone regional steel prices had increased another ten percent.

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As Steel Price Soars, Problems Arise and Projects Stall
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6. (C) Despite the unprecedented rise in steel prices, demand
has remained surprisingly inelastic, in turn only further
driving up prices. But, though the industry has continued to
grow, problems have begun to arise. Market confidence has
eroded as long-term planning has become extremely difficult.
With prices increasing so rapidly, Zamil Steel President
al-Mansour reports that many contract bids will often now
have only a 24-hour validity as any greater time period
creates too much risk of price fluctuation. In addition to
eroding investor and consumer confidence, such risk has
created a severe disadvantage for smaller contractors, as
they do not have the same ability as larger contractors to
hedge, negotiate favorable terms with suppliers, and
generally benefit from economies of scale. If the number of
contractors shrinks, the resulting oligarchic market will
likely create even higher prices.


7. (U) Government contracting has also suffered, as
governments continue to underestimate the cost of projects.
According to an anonymous EP contractor speaking to the MEED
in April, 55 percent of the Saudi Transport Ministry's 2008
budget is being spent on projects originally scheduled to be
completed in 2007. Government infrastructure projects are
now being completed in stages, with completion packages
following the original contract. While this creates shorter
timelines and mitigates price inflation, the lack of
continuity has created concerns of decreased project quality.
Articles in economic journals indicate that contractors are
beginning to avoid the Saudi and Kuwaiti markets where
lump-sum turnkey contracts are common and instead prefer
markets such as Abu Dhabi, where risk-sharing through "cost
plus" contracts is more common.


8. (C) Market conditions have caused extreme fluctuations in
project estimates. The Saudi Aramco and Total joint venture
refinery at Jubail, originally estimated at 6 billion SAR in
2006, was re-estimated at between 11 and 12 billion SAR when
the agreement was signed in June 2008. COO al-Zamil of Zamil
Industrial told EconOff that a large Saudi Consolidated
Electricity Company (SCECO) project estimated at between five
and six billion SAR 12 months ago is now estimated to cost 11
billion SAR. Demand for refined oil and electricity made
these cost considerations secondary for the SAG, however.
Project delays have become commonplace throughout Saudi
Arabia and the region. Aramco's Khursaniyah oil and gas
project is currently eight months behind schedule due to
labor and raw material shortages. Shareef Abu Auf, CEO of
Al-Haramain Co. for Contracting reported to Arab News in May
that steel shortages have not allowed for completion of the
Hajj Terminal lounge at the King Abdul Aziz International
Airport in Jeddah. Likewise, Abu Auf added that the
completion of public works in the Jeddah area, converting
major roads to under- and overpasses, has been hampered by
steel shortages. In addition to projects being delayed and
over budget, other regional plans have been cancelled. In
2007, Dow Chemicals and ConocoPhillips pulled out of projects
in Oman and the UAE, respectively, and local contacts report
that Saudi Aramco has mothballed two projects, one industrial
and one petrochemical, due to rising costs.

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Attempts to Respond to Market Challenges
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9. (C) The SAG has attempted to respond to these severe
market pressures. In response to the current steel crisis,
in early June, the Ministry of Commerce and Industry moved to
limit steel exports. According to Zamil Steel President
al-Mansour, the Ministry originally threatened to prohibit
all steel exports, including items such as pre-fabricated
steel structures produced from previously imported steel.
After negotiations with steel industry leaders, the Ministry
instituted a more reasonable requirement of obtaining an
export certificate from the Ministry. According to a June 11
Arab News article, the Ministry requires exporters to give
details regarding the source of the goods, destination of the
goods, and the contract with the buyers. Permission to
export is only granted after ensuring local steel

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requirements have been met. Export restrictions have also
been instituted for iron and cement.


10. (C) The Saudi Ministry instituted these policies due to
suspicion of foul play by local steel distributors who buy
from steel producers such as Hadeed, the steel arm of Saudi
Basic Industries corporation (SABIC),and sell to local
contractors. Accusations, denied by local steel
distributors, allege that the companies hoarded steel in an
attempt to drive up prices, and additionally sought first to
sell steel to other markets, such as Dubai, where prices were
slightly higher. In a July 20 meeting with EconOff, SABIC
Strategic Purchasing Manager, Mansour al-Harbi - responsible
for obtaining iron ore among other inputs - said that this
black market had become a reality and praised the SAG for its
regulatory efforts. Al-Harbi claimed that the SAG did not
harshly impose these rules, but rather worked with industry
experts. Al-Harbi added that Hadeed had also begun directly
supplying to contractors in an attempt to remove the
middle-men. At this time, however, ninety percent of Hadeed
steel is still supplied to local steel distributors. The
long-term effects of Saudi and other GCC governments' efforts
is unclear, though price growth has not slowed in the
short-term.


11. (C) Understanding that short-term government regulation
is a temporary solution at best, and that the regional boom
will require massive amounts of steel, GCC countries have
realized that only by boosting steel production will they be
better able narrow the gap between regional supply and demand
and perhaps cool the overheating market. According to a June
10 article in Arab News, 18 billion USD has already begun to
be invested in 46 new steel manufacturing plants in the Gulf.
Of these 46, 17 will be in Saudi, 16 in the UAE, 13 in Oman,
four in Bahrain, and three in Qatar. According to industry
association Arab Steel, as of early 2008, Saudi Arabia -
which currently consumes an estimated 11 million tons of
steel annually - had the ability to domestically produce 8.43
million tons of steel, of which Hadeed accounted for 5.5
million. SABIC's al-Harbi told EconOff that Hadeed intends
to triple capacity to between 15 and 16 million tons by 2020.
Hadeed announced the beginning of such efforts on July 13,
2008 by signing a deal with Saudi Arabia Fertilizers Co
(SAFCO) to set up a new Jubail steel factory of 1.7 million
metric tones. Hadeed also recently announced plans for a new
facility capable of producing 500,000 metric tons of rebar
and wire rod annually.


12. (U) In addition to increasing output, industry analysts
predict that Middle Eastern steel producers, and particularly
those in the GCC, must consolidate if they are to remain
globally competitive. The regional market is currently
highly fragmented, comprised primarily of small producers who
will struggle to remain competitive with global industry
leaders. Meanwhile, Saudi Arabia's largest steel producer
has hinted it might not stop at simply increasing steel
production. SABIC has also indicated that it has interest in
vertically integrating by making large investments in the
global iron ore sector. Though SABIC cancelled 2007
arrangements to acquire iron ore mines in Mauritania
(instead, Qatar Steel Company assumed SABIC's stake in the
project),several SABIC officials have anonymously reported
to investment publications in 2008 that the company is
organizing a mining acquisition portfolio to aggressively
enter the iron ore market.

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Questions on the Future of the Boom
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13. COMMENT: (C) With a large percentage of the two trillion
USD in announced projects comprised of hydrocarbon-related
investment and integral population needs, such as expanded
utilities, it is probable that most projects will be
completed in the final tally - governments will simply be too
committed to let them fail. But while the future of oil and
gas investments looks clear, some suggest that the Gulf is
experiencing a market bubble, particularly in the real estate
sector. These concerned voices caution that the pace and
magnitude of projects are grander than the market will
support. With only one quarter of the more than two trillion
USD in projects currently under construction, there is still
much unclear about the fate of the boom economy.


14. (C) Thus far, the market has allowed each level of vendor
to pass the increased cost of inputs on to customers, but
fear exists regarding what happens when end-consumers finally

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reach their price limit. In the event of a hard landing,
investors in unrealized projects will be left in a lurch.
Likewise, completed projects might find tepid demand for
luxury condos, offices, and kilometer-tall buildings. Even
if the booming market continues along with only minor
hiccups, how governments manage consumer and investor
confidence, as well as rapidly growing inflation, will play a
significant role in regional political stability and civil
society development. This cable investigates the place of
steel in the Gulf boom, but factors such as other raw
materials and human capital will also play a key role in the
Gulf's development. The Gulf has become the cutting edge of
investment and development due to what many see as a
fundamental shift in global economics. Windfall oil profits
and massive projects, however, must be effectively managed if
they are to bring sustainable success. END COMMENT.

(APPROVED:JKINCANNON)
GFOELLER