When the rest of region is trying to get back on its feet in the post-global economic slowdown scenario, Saudi Arabia stands tall with an expected growth rate of about 10% this year and the next. As government-backed mega infrastructure projects and real estate initiatives to meet the housing and commercial needs of the kingdom’s burgeoning young population as part of a $130 billion package of handouts, goes into full swing, the HVACR sector is poised to tap the gold mine. The Kingdom is the new Eldorado where major players are rushing. By Pratibha Umashankar
Buoyed by high oil revenues and rising non-hydrocarbons exports, the Kingdom of Saudi Arabia is riding on the crest of success. According to research by Standard Chartered, the economy is expected to expand by 4.7% in 2012, well above the 2.9% projected earlier this year. It is, indeed, enjoying a period of sustained growth with the country’s robust economy set to touch the 10% mark in 2012 and 2013, backed by the government’s massive investment programmes.
The government has reportedly approved an SAR690 billion-budget for 2012, with a huge chunk of it earmarked for mega housing and infrastructure development projects. SAR250 billion has been allocated by the Saudi Arabian Monetary Agency to finance 500,000 housing units.
Despite this, with a 26 million-strong population at an annual growth rate of 3.2% (2004- 2010), Saudi Arabia is facing a huge housing shortage in the residential sector, pushing property prices high, as demand continues to outstrip supply, bucking the regional real estate trend. The government is vigorously encouraging non-oil industries and small and medium enterprises to generate new jobs for the country’s young population.
This is corroborated by a Standard Chartered report, which affirms: “Investments in transport, industry, health, housing and education should serve to strengthen GDP, as the boost in the construction industry will generate more employment opportunities and increase the flow of cash into the economy.” (Oxford Business Group, May 1, 2012)
Tawfiq M Attari, Technical and Sales Director for the MENA Market, DuctSox, a ducting system manufacturer with a major presence in the Kingdom, seconds this view: “KSA was one of the few countries which didn’t face a noticeable slowdown in most of the sectors, in the number of projects or in growth. But a few of the sectors and investors were hesitant to invest in new projects in 2009 owing to the global economic crisis. However, the government’s heavy investment has encouraged private investment.”
Regional players, too, are willing to invest in projects where they can secure guaranteed off-take to minimise investment risks. Despite the global financial crisis, Saudi Arabia enjoys high credit worthiness to raise the required finance, which has helped implement new projects. The growing confidence of the financial institutions in new developments has had a positive spillover effect on the HVACR sector. “We can see the appetite of Saudi banks and investors to fund new projects in the KSA with higher gearing than other markets,” says Ahmad Abushama, Director, Business Development, Dalkia Utilities Co, Dubai. “In the last few years, many district cooling plants have been implemented in the KSA. We have witnessed the banking sector’s willingness and support to meet the required fund/debt.” He cites Hadeed, Aramco, Jebel Omar and KAFD DC plants as examples. “We are sure that we are going to see more similar projects to come in the near future,” he adds.
All this spells good news for the HVACR industry, as new real estate and infrastructure developments translate into greater demand for the sector’s products and services. Quoting Khaled Daou, Project Manager, Saudi Energy, a recent report said that the Saudi Arabian HVAC sector is expected to achieve between 30% and 50% growth over the next two years. With the Kingdom remaining a major market for air conditioning due to its hot climate and high individual purchasing power, growth is expected to hit $1.19 billion by 2014. “HVAC is not just a luxury in the Kingdom of Saudi Arabia; it is a necessity for key sectors, such as hospitality and food,” Daou said. “Given its geography, vibrant business environment and growing population, the Kingdom is constantly in search for advanced air conditioning systems that can provide comfort while supporting economic growth.”
Daou explained that the domestic market for air conditioners continued to boom due to four major factors: a growing population; the establishment of new businesses; continuous decline in equipment prices due to technological advancements; and a year-round hot climate. “These all combine to make Saudi Arabia the world’s biggest air conditioning market,” he added. “Individual and corporate purchasers are currently on the lookout for products that are more energy efficient and eco-friendly.”
This implies that central units, split and window units, ducting and ventilation systems, refrigeration and cooling and industrial fans, vents and grills, instruments and controls, as well as district cooling, in fact, the entire range of HVACR equipment and services will continue to be in demand.
“No doubt, that the cooling system will experience a significant positive impact to meet the cooling expectation of the new developments,” agrees Abushama. “Due to the willingness of the KSA government to allocate a significant budget on new projects, HVAC suppliers, contractors, consultant and developers should expect a good post. We are seeing many companies in the region positioning themselves in the Saudi market, looking for further potential growth.”
It is evident, therefore, that Saudi Arabia being the biggest market in the region, this boom period will not only boost the HVACR sector in the country but will also act as a buffer for contractors, suppliers and developers in the region. The recent migration of many companies in the sector to the Kingdom, seeking secure and long-term operations is a testimony to this. Diversification is another strategy companies are adopting to remain ahead of the game and make inroads into the country’s expanding, but highly competitive market.
Abushama’s company, which has a registered office in the Kingdom, is targeting upcoming district cooling projects there. “We are looking for opportunities in industrial utilities,” he reveals. “We got awarded Saadiyat DCP 1, 2 and 3 in Abu Dhabi last year, to provide 50,000TR capacity. Our international experience, along with our local/GCC presence has given us the thrust to look genuinely at new projects, and we hope to become a key player in Saudi market soon.”
THE DC DEBATE
The general consensus is that the district cooling market in the Middle East is projected to achieve an annual revenue of US $2 billion during 2013, and Saudi Arabia is considered to be the strongest district cooling market in the region with over US $100 billion being awarded for construction and infrastructure projects. By 2013, the Middle East district cooling market is expected to have an additional capacity of 4.5 million tonnes of refrigeration, mainly owing to demand from Saudi Arabia and Qatar. The urgently felt need to optimise energy-efficient air conditioning has resulted in the need to implement district cooling systems over traditional methods. This assertion brings into sharp focus, the significance of district cooling, which appeared to have lost its edge, after the initial euphoric welcome the technology received in the region. It also highlights the debate regarding the efficacy of district cooling in real, measurable/calculable terms, as opposed to theoretical claims of its many advantages.
“The current market penetration share of DC in the Kingdom is minor, but there is significant development expected in the coming few years, which will attract new DC plants. However, the main challenge for the DC sector now is to restore trust from all stakeholders and specially from banks,” says Abushama, highlighting the DC dilemma. He presents both sides of the argument: “District cooling will be a key solution for the increased cooling demand in light of general power shortage across the kingdom. We believe that it stands a good chance to acquire more market share over the conventional system in the coming years. DC utilises up to 50% less power compared to the conventional one. Thus, a significant saving will be made from the government side in reducing the capital investment on power stations. On the other hand, significant amount of green gas emissions will be eliminated, which will reduce the carbon footprint per capita and achieve better environment targets.”
However, Abushama, while arguing that the faith the region reposed in district cooling has been justified, concedes that over-sizing and building redundant capacity is a widely accepted problem that the sector is facing. “The key mistake many DC plants made was, indeed, building a large capacity for no sufficient off-takers, which has affected many DC projects,” he says. “But having said that, DC still has a clear edge over conventional systems, when we apply correct and genuine measures. There are many DC success stories when you see master developers work closely with DC providers to generate a cooling capacity based on genuine phased demand. We cannot keep building for the ultimate capacity phase. This has to stop. We need to build to match the consumption and gradually increase the capacity as per the real requirement. If we do so, the end users will get a competitive tariff, the utility providers will get their return on investment and the banks will get the right cash flow to cover their loans.”
Speaking for Dalkia, he adds: “We are a utility provider. We develop projects under Build Operate Transfer (BOT) scheme. We operate projects for long-term duration – for 20 to 25 years. We also undertake DBO and O&M projects. We work closely with master developers and appoint qualified contractors to undertake the construction side of the project. Our engineering department conducts a vigilant study at the construction site and for equipment selection to assure that we meet our obligation during the concession term. We operate our plants under stringent KPIs to provide the optimum designed efficiency, which directly reflects on electricity and water consumption.”
While this might be a utopian model, there is room for both district cooling services and conventional air conditioning systems in a vast and rapidly growing HVACR market like Saudi Arabia. Abdullah M Abdul-Kareem, Managing Director of Alessa, a big player in the Saudi HVAC equipment sector, gives credence to this view when he says that District cooling does not pose a notable threat to the traditional HVAC segment in the region. Given the rate of growth and the introduction of new energy-saving HVAC technologies, Abdul-Kareem said that he remained unconcerned about the challenge district cooling represented to his industry.
“The (district cooling) technology itself requires heavy investment at the start; the savings come through better usage of this type of air conditioning,” Abdul-Kareem points out, referring to the weak link in the DC chain. “The savings will only happen for the contractors who are building the houses, skyscrapers, malls and large commercial buildings, so they don’t have to worry about installing central units or local split units. As a result, it is unlikely that end users will see the benefits of these savings due to the fact that they will have to bear the cost of the initial investment through high utility bills and uneven payment schemes, which charge users a fixed rate divided among the users in a building, a practice that is flawed in principal,” Abdul-Kareem argues.
Fresh water scarcity is another issue which affects the viability of district cooling projects. Though the use of treated Sewage Effluent (TSE) as make-up water does offer a solution, the question that George Berbari, the CEO of DC PRO Engineering, asked during The Climate Control Conference (C3) held on October 16 and 17 in Al Khobar, Saudi Arabia, remains to be answered: “Potable water is 10 times more expensive than TSE. Yet, we need a law for people to use it (TSE). So, is it complexity that is driving us away (from using any technology)?”
However, Abushama affirmed his allegiance to district cooling. “I am optimistic about the future for DC market in the KSA,” he says. “The commitment of the government to allocate high budget for large development, beside having robust and healthy banks which can fund new DC projects provide us with clear positive signals. I believe the DC sector still possesses a strong edge over standalone solutions. Having said that, many criteria should be met to achieve this edge, such as:
- Proper construction phasing of the DC plant, which meets effective cooling demand
- Master developers to build the DC network as part of infrastructure works
- Proper equity/debt gearing
- The ability to raise funds
- Secure, guaranteed off-take
Without these, a DC project will never meet viability parameters.”
Abdul-Kareem highlighting another obstacle, says that investment in district cooling is likely to remain high due to lack of local manufacturers, with the sector having to import the equipment from overseas, which adds to the costs. His verdict, which is echoed by others in the sector in the Kingdom is that the benefits of district cooling warrant a more rigorous scrutiny.
THE RETROFIT SEGMENT
Interrogating the general perception that the practice of retrofitting has not taken roots in the region, as the construction sector is relatively new, Attari believes that there is a lucrative retrofit market in the GCC and in Saudi Arabia. “We have a special department following the retrofit market, as there are a lot of supermarkets and shops which have approached us for our services,” he says. “And they usually change the entire establishment from inside. This gives us an opportunity to give the fastest and cheapest solution by using our ducting system.”
Abushama agrees, and says: “The retrofit segment has a good potential for major industrial players, such as Aramco and SABIC and others. We see more interest from those clients to outsource the utility services to specialised companies, while focusing on their core business. Energy performance contract is one area that starts to attract more attention from major industrial players. Dalkia has extensive experience in this field, and we have a lot of success stories, where we have managed to save significant amount of energy.”
Abushama believes that the rental services is a good solution for small cooling capacity, and can be used as an intermediate solution till a permanent cooling plant becomes ready. “The challenge we face today with rental solution is to get a good diesel fuel price when power is not available,” he says.
Attari thinks that rentals have a limited scope in the country. “It can be used only in some applications like wedding and exhibition tents,” he said.
This coincides with the general opinion of experts. The participants at The Climate Control Conference (C3), on October 16 and 17 in Al Khobar were of the opinion that long-term rental solution was not viable as it was not feasible to develop a mobile heat-recovery system.
The Saudi HVACR market looks upbeat, riding as it is, on the promise of an ever-growing property and infrastructure sector. But there are a few niggling worries which might threaten to metamorphose into a full-blown crisis, as it did in the UAE on the eve of the global economic meltdown.
The country is facing a huge shortage in the residential sector that might keep prices high, despite increased government spending on infrastructure and housing schemes. An Oxford Business Group report pegs it at 8.9% for the 12-month term. Concurrently, there is a steep increase in fuel and other real estate-related services. This, along with rising food costs could contribute to further upward pressure as demand fuelled by higher incomes and stronger spending power continues to rise, warns the report. (Oxford Business Group, May 1, 2012) This will adversely affect the HVACR sector.
According to the Saudi Economic Survey, there is a demand-supply mismatch in the residential sector, with only 35% of locals reportedly owning homes, of which, low and middle-income households make up 80% of the current unmet demand. (“Saudi property prices to rise as ‘demand grows’”, Saudi Economic Survey, http://saudieconomicsurvey.com/2012/01/saudi-property-prices-to-rise-as-demand-grows/) This, too, will have a ripple effect on the HVACR sector.
Lending a different perspective to the scenario, Dubai-based contracting company, Arabtec Holding, which operates in Saudi Arabia, has said that the Kingdom’s real estate market would be the growth story of the region, but has sounded a caveat that prices will not rise too much, “as supply will increase greatly” in the country. (“Saudi property prices to rise as ‘demand grows’”, Saudi Economic Survey) If this prediction comes true, Saudi Arabia might find itself in the same predicament Dubai is in – being a victim of the reversal of the supply-demand mismatch. This will, once again, have a spillover effect on the Saudi HVACR sector.
Continuing regional instability might prove to be a chink in the Saudi armour. A fertile “oasis” market amidst an arid regional desert could lead to overcrowding, unhealthy undercutting and ergo, fierce competition. The Kingdom cannot continue to be a low-hanging fruit which the regional players can help themselves to for long, without the market showing the strain.
But by far, the real and immediate challenge to the mega projects, and thereby to the HVACR sector, is the power crisis the Kingdom faces. This is, indeed, ironic because, the country has the world’s largest oil reserves, the 5th largest proven gas reserves and the world’s largest swing capacity for oil production. However, the country has an insatiable thirst for energy. It produces 11 million barrels of oil a day, of which, above three million barrels a day goes towards domestic consumption, mostly for generating power. By 2030, the country will use an estimated eight million barrels a day for domestic consumption. At the current rate of domestic consumption of fossil fuels, it is expected to nearly triple by 2030. As a corollary (at the current rate), energy peak demand is expected to exceed 120 GW by 2032, analysts say. Given the alarming forecast of energy demand growth, power security is very much on the government’s radar. Tapping alternative energy sources, especially solar and nuclear power, and increasing the Kingdom’s share of global oil production are seen as possible solutions. The country is, in fact, perusing an aggressive policy of moving towards alternative sources of energy, with an avowed plan to derive 10% of its electrical supply from the sun by 2020. (See Box: Looking to the sun)
Along with its commitment to sustainable energy, the country also needs to usher in tough policy reforms in areas, such as domestic pricing of energy.
In this context, the verdict of the industry insiders who participated in the C3 2011 at Al Khobar is instructive. Acknowledging the power challenges facing the Kingdom, the delegates and participants believed that electricity subsidy remained a barrier to district cooling and cogeneration. Fifteen years ago, it was 15 Halalas/kwh, they said. Today, it has come to five Halalas/kwh, which surely is not a normal pricing policy. Subsidy and over-sizing, they said, were two bad words in the region. The objection to cogeneration and district cooling, they thought, was the slab rate system and also subsidised power. Subsidies, they agreed, were not tenable, considering the substantial shortage of electricity.
Saudi Arabia is poised for growth. At least in the foreseeable future, the country’s mega projects and the HVACR sector will enjoy a healthy symbiotic relationship. The HVACR market has provided the much-needed lifeline for the region, and is expected to continue to play the leading role. This might encourage overconfidence and overspending. What it needs to be wary of is the possibility of sudden, steep rise or fall in real estate price, both of which could prove detrimental to the HVACR segment, with Dubai being the case in point.
There are too many players trying to elbow each other out in an overcrowded arena. While this could lead to better technology and an improved product range, cost considerations could dictate market trends, leading to substandard equipment and services.
Attari voices this worry when he says that one of the challenges is the poor quality of equipment from fake suppliers, which tarnishes the reputation of the industry in the market and adversely affects the prices. “But when it comes to mega projects, manufacturers of spurious or substandard products cannot compete, because government consultants and investors will not accept low-quality goods,” he assures. “In the final analysis, what developers demand in terms of energy efficiency, reliability and capital costs are as follows:
a) For commercial applications – price and energy efficiency
b) For industrial applications – energy efficiency, quality and price
c) For the government – quality, energy efficiency and then the price,” Attari says, listing customer priorities.
“End users – homeowners and facilities managers – have become quality conscious, and have an array of players to choose from. Consequently, they demand products with optimum efficiency at the lowest possible cost or tariffs,” Abushama adds, and explains that a company like his has to tick several items on a checklist: “As a developer, we look at the lifecycle assessment of our projects. We evaluate the CAPEX and OPEX along with applying stringent KPIs. Hence, we go through stringent criteria to evaluate which product and equipment we should use. At the end of the day, we have to make sure that we achieve a good return on investment to our shareholders while we deliver reliable and efficient services to our end users.”
The major worry, however, is the country’s looming power crisis. The Kingdom needs to earnestly and aggressively address the issue, and find sustainable solutions and effective energy management, as registering the world’s highest energy consumption per capita does not bode well for the economy and the market.
Despite the challenges, the general mood in the HVACR street is upbeat. Attari echoes this when he says: “I think the market is promising and has potential. All the reputed suppliers will get a good market share in Saudi Arabia. The government is strong and financially healthy. It has taken appropriate and well-considered steps to boost the economy. I think the HVACR sector should be optimistic about the market.”
Yes, indeed, the Saudi domestic market is booming, and it augurs well for the region. But it is still suffering from the after-shocks of the global and regional economic crisis.
No one wants to take the country’s robust growth for granted, as a lot of hope and faith is riding on it. Things, somehow, seem too good to be true. The unasked question in everybody’s minds is: How long will it last?