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The impact of falling oil prices on the UAE cement industry: Harpreet Duggal, Black Rock Cement (UAE)

Filmed at Cemtech MEA 2015, 8-11 February, Grand Hyatt Dubai, UAE

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It looks like oil is the flavor of the season and I'll continue with the flavor. While Yuri talked about the impact on the global level then Hitesh trickle down to, narrow down to GCC. Now, I will further narrow down closer home which is the UAE market. We will look at what is the impact of the falling oil prices in UAE cement sector, but before that, I'll give you very quick round about of what has exactly happened.

Why are we seeing the falling oil prices as we do. What has been the impact of these oil prices in the global economy and then we would look at what has been an impact in the UAE economy and then finally, we'll come down to look at what is the impact at the bottom line in our factories in UAE. So what really happened?

So, actually if you look at this last about 10 years has seen very good oil prices and the oil exporting companies, especially the countries we come from here did very well. And with high oil prices going up, the revenue is improved, but what we see happen here is a sharp fall. Now, what did happen. Like we saw in the last decade year thanks to increased demand from China, thanks to growth emerging markets and demand went up whereas the supply were issues in Iraq, Arab springs, they were uncertainties. And all this led to US and Canada who were not looking at expensive sources of oil which is sale or oil sands.

Now, this suddenly became more attractive, they started looking at it and the supplies at the same time continued growing. US showed record production and in shale oil deal capacities increased to almost the same capacity to put it in perspective in last three years what US had increased in shale capacity is the same as the capacity for UAE as a whole.

So, huge capacities came in. Libya, Iraq, We were expecting it would kind of continue to be in problems but their capacities came on board. At the same time, the demand in China, Eurozone kind of started bittering off. So, we had a huge kind of stack pile of oil available, demands not picking up, supply side increasing tremendously, and prices slightly started to kind of fall. And it was expected that somewhere in November during the OPEC meetings, OPEC would take into account of the falling revenues and then they would shoot up the prices, reduce production which normally Saudi leads and it acts as it's free producer, but, in this case Saudi stayed back.

It did not kind of reduce prices and what has been the reason for Saudi? Was it a gamble which they had played? And whether it did work? Saudi saw that last time in '86 when there was a price fall, and they had kind of reduced production, it kind of impacted the market share, impacted the revenues, because their volumes came down, so sorry their prices, volumes came down.

So, this time they said we are kind of staying put and they were backed by the huge foreign exchange reserves which they had. So, they have reserves to last for another 10 years, so they're not worried that with reduced oil prices they put them back them. But at the same time they wanted to retain the market share, they want these new capacities which had come in here with shale oil, et cetera to price them out, get them out of production. And in the meanwhile in the next 4-5 years when these would be out, Saudi would again remain strong. Again, there is a Geo-political aspect also into this Saudi, the oil prices of Saudi has large reserves as I mentioned but the same is not true for Iran or Russia. And Saudi also at the same time was seeing that with US going to Iran for talks, et cetera and Saudi was gradually, because was no longer as importance for US because their proportion of oil dependence on US dependence on Saudi oil had come down.

They wanted to kind of show that they are still a force, and they have taken the stand that in the next two, three years when the shale oil, et cetera would be forced to come down, those expensive oil fields would no longer be available to produce. Saudi would again come back, the market share would again remain strong, and it would be much buoyant compared to what the scene is.

So that is how Saudi has come out and they're expecting. They're betting that shale oil production, the US capacities would be coming down and they would pick up from the next, after two, three years, they pick up. UAE's stands is also very much in line with what Saudi is thinking. So what we expect is, and what whether it's IMF or Goldman Sachs or Morganstein, they expect that the price of oil in the coming years, it would continue to, in the coming months will may see a slight fall but averaging around 60 for 2015.

And in the coming years with more capacities from shale, coming out of stream, the prices are again going to inch back to 65 next year and 80 a year after that but going to 800 or a period of time. So, and again it is good news for the oil exporting companies like UAE. Now, what happens when the oil prices come down?

So, in effect for the world, for the global economy, it is good for the economy, for the global economy. The reason being it benefits the oil importing companies, who have reduced costs improved budgets, people have more money in their pockets and most of these oil importing companies especially the one not as developed for example India, China, etc.

This money goes into disposable income of the people there who have extra money, [xx] extra money to spend on other things consumption increases. Whereas if the price increases, their impact is not as much beneficial for people in the oil exporting countries because these people already have a lot of money so oil is a very small part of their overall monthly budget. So, and since the population of oil importing companies is much more the impact of oil prices coming down, benefits globally much more significantly.

They say that with every drop of price by $10 you reduce the global GDP increases by 0.2%. But interestingly, this increase is not coming about, at least what IMF thinks. They feel this is kind of offset by weakening in investments in Euro zone, in China. The strengthening of the dollar and the last outlook which IMF came up with, there were slightly not as kind of a about the global economy compared what they were about in October when they had a previous outlook. They have significantly revised GDP growth in Russia, China.

It's only US which stands out as kind of which is withering the strength. So, as mentioned money is flowing from oil exporting countries to oil importing countries, so consumers from here are coming, paying and consumers in the importing countries are benefiting. Again US is seeing a mixed kind of an advantage, whereas people who are affected most are the oil exporting companies, countries here in the Middle East, Angola, Venezuela, Iraq, Iran, Russia. But again in each of these countries the impact is not in the same manner for example oil exporting countries.

Oil exporting countries who have enough reserves like Saudi and UAE are not seeing that much of an impact in their economies, but the program is for countries who don't have as much reserves, countries like Iran or to a smaller extent like Oman. They are seeing the problem, Russia is seeing a problem, Venezuela is in huge problem, Nigeria is having a huge problem, but luckily thanks to the strong oil prices in the last 10 years UAE has enough reserves to take it on for the future.

So which is, as you would see in their spending it's not kind of making much impact. So, now coming to the the UAE economy. Yes, on the GDP side, yes the GDP is going down compared to what was projected. In October, IMF projected 4.5% growth, now they have got the figures down in January 24th January they had got the figure down by 1% to 3.5%. So, yes it is expected that the GDP growth would fall or would not be as good as what was read earlier and thanks to the impact of the oil prices. An impact is going to be more on Abu Dhabi where it is more dependant on oil compared to Dubai which is more diversified. Non oil economies is expected to grow by 5.5%, but UAE this year has been a slight deficit and is expected to be a deficit budget next year as well going by the fact that they are planning to keep spending and to be back in surplus in 2016.

So, while the GDP numbers are down, UAE has the buffer to cushion the fault. It's break even prices are still quite good, it has enough reserves in it's pocket to take on for the coming years and with the expectation that this price kind of impact is going to be there only for the next two, three years.

So, it is again going by the same gamble that, let us kind of keep spending. Let the economic sentiment keep being strong and we will recover again once the prices go up to the normal level. So, that's why the drop in GDP has not affected government spending. So that's good news for cement triple A, sitting here.

So, government budget which was released has a about nine percent increase this year. So, and interestingly historically, oil prices have not had direct impact on the construction sector here. So, we don't need to get too much worried about what is going to happen. Yes, sentiments may be different which might affect people coming and buying more kind of property here. But there would be going to be a kind of a slight fall, but it's not going to be very significant. Now, coming to the construction sector, now on the positive side with the way UAE is, they've got strong government reserves which can afford to continue spending on infrastructure project.

Demographic growth is going on strength, population is increasing at a healthy pace, political commitment is there on infrastructure. So, the government wants to keep spending it, spending money on building infrastructure and thanks to the economic diversification and less reliance on oil compared to other JCC countries. UEA has the wherewithal to continue with spending on the construction sector.

But there are issues. Again with oil nobody can be sure. So yes, it is expected [xx] after two, three years things would go back to normal but still there is an uncertainty. Real estate, we are actually seeing an impact of oil prices on real estate. Again, the prices in Dubai in the last quarter have come down and expected to continue going down from 0-10% in next year.

So it has made an impact, and many of the investors in real estate in Dubai are from say Russia, Iran who have been affected, and it is kind of having a trickle down effect here. So we see, while on the infrastructure spending, we don't see much change but on the real estate site, on the residential company to commercial, we are seeing an impact in construction for real estate.

Many of the offline project by smaller developers are being kind of postponed whereas the larger master developers are so far continuing, they've not made any changes. But we see an impact on the residential sector which could have again trickled down impact on the cement manufacturers in the region. Interesting to see like historically oil prices and project market there is not a direct correlation.

We can see that in 2008 also, whereas when the oil prices shot up, contracts were not as kind of high and here when you see the oil prices coming down contracts are high. So, there's no direct relationship between the oil prices and the construction sector in the UAE. Again, it's very different from what a normal economic student would feel that oil prices coming down, revenue is coming down, the construction would be affected.

It's not so and thankfully for us here. So construction continues to grow and is expected to grow primarily at the infrastructure side but on the real estate side I would say its slightly unfavorable, especially in the next two years. But after two years with Expo 2020 project actually coming in to shape, government is committed towards Expo 2020. And these would actually, today in your cement plant you'd see not much activity or not much off take because of what was promised but it would only 2017 onwards you would see that projects actually takes shape and cement demand actually increasing over that period of time.

So, it's another two years down the line and for the cement sector, on the sales side, we expect a slight dip in infrastructure projects in 2015 to 2016. But again this would be more of sentimental reason whereas some projects would be postponed or would be kept on hold until uncertainty on the oil prices gets clearer. But definitely that would impact the cement demand but after 2017 things are expected to go back to normal.

Again compared to earlier projections we would see cement demand in UAE, reduced compared to what we were projecting earlier. And it is also expected that other countries who, other countries would gain on the cost of UAE where their cost of production reduces. Here, I'm talking about the oil, the cement producers in countries like Turkey or India, they would benefit at the cost of UAE as far as exports is concerned.

So overall, the blue graph here you see is what was the projection which was about four months back and the new projection the orange one, you will see definitely there has been an impact of oil prices on cement demand in UAE. But the good thing is it is expected to kind of get better as prices come back to normal after 2017.

On the production side, there has been an increase in electricity tariff primarily in, this was announced much earlier. But the direction is still going in the same line and it is expected that electricity tarrif for industry and the way also may follow suit. Prices of diesel have come down including in the pump prices and this is helping the industry to reduce their distribution cost. On the trade side bunkering cost, though the trickle down effect is not kind of completely come down and bunkerage cost but it is expected to come if the oil levels remain low, it is expected to come down in the coming months. As far as container freight rates are concerned, we don't see much impact of oil prices and container freight in that business and I don't see any impact the freight still remain strong. Again it's more of the demand supply situation in the shipping industry and the shipping industry over the last few years have been making lot of losses.

So, this is the time where they are recouping loses are not passing to on the benefits of the customers. So, overall production cost would be a slight for the cement industry, and when we look at the capacities, we are not expecting major capacity additions in the coming year. ccapacity utilization in the country is getting better at the same time to prices are slightly getting better. this figure about four months back looked a little more positive, but now it is kind of mellow down a bit.

So finally, construction spending is expected to kind of go down, but not that big in impact. Cement sales will kind of bitter down slightly and then recover from 2017 onward. Cement industry will benefit from lower input cost and then capacities are expected to,capacity utilization is expected to improve and profitability as a result to margins as a results are also expected to increase.

So, what we are seeing is, in the next two years, it might not be as good for the cement industry from the top line part of things where the sales would see a slight decline. But this decline is not something very major to be concerned about, it could be partly be offset by reduction in input cost and what we see is after 2017 things would again go back to normal and cement industry in UAE would get stronger after 2017.

Thank you very much.

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