GCC rail market – a high-level analysis

There are many differences between the countries forming this region, with a variety of political, social and economic factors at play. 

Historically, this has meant different attitudes to public spending across the region, including on major infrastructure such as rail projects.  Oil producing countries have tended to ride a wave of high oil prices, often looking for fast procurements of eye catching projects while other countries have struggled to find a means of getting projects off the ground in the absence of significant multilateral and development finance institutional support. As we explore below, recent changes in the socio-economic fabric of the region will have long lasting impacts on the way that major capital infrastructure such as railways is procured across the region.

The past

For decades, the GCC countries' economies have relied on oil and gas as the main source of export and fiscal revenues. The spectacular collapse of the global oil price since 2014 therefore led to a significant deterioration in the fiscal balances of all GCC countries. The direct correlation between oil prices and infrastructure spending in the GCC means that this has had a resounding impact on the delivery and growth of current and future infrastructure projects, including in the rail sector. 

The record lows seen in the oil market during 2014 have since resulted in substantial budget deficits for many previously cash-rich regional governments and this, in turn, caused a widespread halt to many projects, especially non-profit-producing infrastructure schemes, including those in the transportation sector. 

These so-called "social" infrastructure projects are procured by governments based on the socio-economic needs of their people, despite the often inherent lack of profitability of the projects themselves. This type of project requires a different level and nature of government support compared to pure concession projects in profit-generating sectors such as ports, airports, resources and utilities. This and the fact that these types of deals are often considered less immediately imperative than projects in, say, the power sector means that they have often been the first to be cut when times have been tough. That, however, is now beginning to change.  

The present

The initial shock of the oil crash has now been absorbed. This led to a period of introspection and transition during which many projects were "value engineered" (i.e. reduced in scope), delayed or even cancelled altogether. During this time the number of regional rail projects in active procurement slowly dwindled as deals were either completed or quietly shelved. As a result, the market is presently at a historically low ebb in terms of active rail projects:

• Riyadh Metro nears construction completion, and is about to appoint O&M contractors and, potentially, a PMC;
• Doha Metro/Lusail Tram has reached a similar position with O&M appointments understood to be imminent;
• Haramain High Speed Railway is about to enter service and the Al Mashaaer Al Mugadassah line in Makkah has been operational for some years;
• Etihad Rail stage 2 is still awaited by the market without formal announcements on timing;
• Abu Dhabi Metro/LRT has seen multiple feasibility studies and many delays. It has been value engineered to a more manageable proposition than originally proposed, but no budgetary approval to go through to procurement has yet been announced;
• Kuwait Metro PPP was cancelled as a public-private partnership (PPP) in 2017 and kicked into the long grass with the newly formed public transport authority of Kuwait;
• Despite early promise, few of the constituent elements of the GCC railway have materialised – in particular Kuwait National Rail Road, Oman Railway and Qatar Heavy network have failed to make an appearance so far;
• The many-coloured additional lines to Dubai Metro (pink, blue, black and gold) have not appeared in the market; and
• Despite having gone into procurement some years ago, Makkah Metro grounded to a halt when the oil crisis hit and none of Dammam, Jeddah nor Medina Metros have progressed beyond (or even as far as) the feasibility stage.

There is therefore a danger that the GCC, having once been the world's busiest rail market, will shortly have no active major rail procurements. Industry professionals, expressing a private view, often speak of there being a sense that this has led to a slow dissipation of the region's industry sector expertise. Major players in the industry (whether in consultancy, operations, maintenance, systems, signalling or rolling stock) have begun to recalibrate what resources they have and where so as to best address the opportunities offered to them by a global market.

From having been indisputably one of the busiest rail markets in the world, in the past few years the MENA region has somewhat slid back and been overtaken by Asia, Australia and the Americas as the "hottest" rail markets in the world and the private sector has begun to respond accordingly.

There is, however, every reason to believe that this trend is on the cusp of reversal.

The future

If the above analysis paints a gloomy picture, we suggest that while the immediate position is slow, there is also a strong sense of renewed urgency under the surface and a growing pipeline of rail projects. There is every reason to believe that the region's rail market is, once again, on the verge of entering a new busy period that will rival any market in the world.

Behind this renewal is the acceptance by many GCC governments over the past couple of years that the oil price is now broadly at a "new normal" level and, therefore, is unlikely to undergo a fundamental change for the better in the foreseeable future. The initial natural reaction to this new fiscal reality was to focus on wholesale budget cuts and the extensive "value engineering" of projects. However, these kind of measures only go so far and, in particular, cannot address a series of increasingly pressing fundamental drivers of government policy across the region. All of this is now encouraging governments across the GCC to bring their infrastructure procurement plans back to life and to explore new delivery models and alternative sources of funding for such projects.

While some infrastructure spending is purely discretionary (and, therefore, may be budgeted down when times are hard), some can be very hard to avoid. Historically, transportation spending – especially in rail – would have been placed firmly in the discretionary category. This is increasingly not the case, however. Many regional governments are facing enormous social pressures that are being generated by overwhelming demographic change and also by an associated wave of grass roots desire for change, going back to the "Arab Spring" of 2011 and beyond. The populations of the GCC countries are growing rapidly (for example, since 1970 the population of the Kingdom of Saudi Arabia (KSA) has grown sixfold – a faster rate than China).

As a result, these countries are overwhelmingly youthful and this, in turn, has created a huge challenge to regional leadership: these young people require healthcare, education and employment and in most cases the existing infrastructure is incapable of delivering this to the required level.

That adds up to an urgent need to upgrade schools, universities, hospitals, entertainment facilities, airports, ports, roads and railways precisely at the time when the fiscal squeeze is making this extremely hard to do. As a result some key themes have emerged on the agendas of many of the region's governments:

• reform of government institutions and legal frameworks;
• a realisation that improved infrastructure is a necessity and not a luxury (in both social and economic terms);
• the desire to access private sector intellectual and financial capital through PPP/partnership programmes; and
  above all, the diversification of sources of GDP away from an over-reliance on hydrocarbons.

These drivers have now manifested themselves into actual government policy. In particular, the new youthful leadership in the KSA has publically tied itself to an agenda not just of public sector reform but also one of massive infrastructure development. At around USD 261bn, KSA's 2018 budget is its largest ever, with the bulk of the investment going towards new infrastructure spending and encouraging greater involvement of the private sector in that spending through the use of PPP schemes.

The development of new railway infrastructure lies at the heart of these plans, as regional governments have finally recognised the transformative effects these projects can have, both socially and economically. As a result, huge rail projects are now back on the public agenda for the first time in years: Dammam Metro, Jeddah Metro, Jeddah Corniche Tram, Madinah Metro, Makkah Metro, Yanbu-Riyadh Freight Railway, Riyadh to Riyadh heavy haul link, Saudi Landbridge and the concession for the operation and maintenance of all existing railway (excluding the above and metros) nationwide are all publically announced as being on the slate for delivery. This represents billions of dollars of investment and a huge opportunity for the rail market.

Project funding - a breakeven crisis

Governments were impacted differently across the GCC by the oil crash and this is reflected in each of the GCC government's public spending and the number of social infrastructure projects that each has delivered and is capable of delivering. A report last year by Standard & Poor's Rating Services estimated GCC governments "need" USD 604bn to fund projects through to 2019, including USD 100bn on infrastructure and, if anything, this figure has only grown since then. How, therefore, is this investment to be funded? It is important to consider each of the GCC countries' breakeven requirements in order to assess the impact the low oil price has had on each country's ability to spend on infrastructure projects and their consequent need to reconsider project funding.

Kuwait has the lowest breakeven oil price of all the GCC countries;¹ it is therefore not surprising that, compared with other regions in the Middle East, Kuwait's robust infrastructure projects' market expanded in 2016 and is expected to grow by 15-20 per cent as a result of the government’s current five-year plan (2015-2020).² The country is planning to spend around USD 15.6bn on infrastructure projects in the fiscal year 2017-18 alone.³

Other governments, such as Saudi Arabia, the UAE, and Qatar, have drawn down on reserves and taken on additional sovereign debt on the one hand, while also imposing spending cuts on the other. As noted above, this meant that progress on infrastructure projects slowed during that period, and contractors, developers and suppliers are faced with delays on new developments and payments for work already completed. However, with the arrival of a new political force in the form of "MBS" (the Crown Prince of KSA, Mohammad bin Salman) and the associated publication of Saudi's vision for its future in "Plan 2030", times are now quickly changing.

It is worth noting that Dubai has already taken progressive and successful steps to diversify its economy. Oil accounts for only 5 per cent of revenues due to a prolonged, concentrated and successful drive to diversify into tourism, other services industries, and the country's focus on infrastructure; it is expected that other GCC countries, left with little choice, will now follow Dubai's example.

Some of the other GCC countries have not been as fortunate as Kuwait, Saudi Arabia, UAE and Qatar and have had no option but to raise debt or cut funding, as they hold relatively low oil reserves. Oman, for example, posted a larger than expected budget deficit in 2015 at almost 16 per cent of GDP which increased to 17.2 per cent in 2016.⁴ However, in its recently issued budget for 2018, Oman is projecting a reduced fiscal deficit of 10 per cent of GDP for 2018. Bahrain's debt was expected to reach 65 per cent of GDP by the end of 2017 as it was classified as one of the most vulnerable countries affected by the plunge in oil prices in a report published by Bank of America Merrill Lynch in June 2017.⁵ With Bahrain requiring an oil price of USD 120 to break even, it is more exposed than most GCC countries to low oil and gas revenues.⁶

While signs of improvement are evident, it is likely to be some time before the situation in Bahrain and Oman improves markedly, particularly as these governments have suspended, and in some cases cancelled, local infrastructure projects in a bid to rein in public spending.⁷

Notwithstanding the breakeven requirements and their impact on infrastructure spending, a number of the GCC country's 2017 budget allocations for infrastructure increased on previous years. This positive momentum continued through to the recently released 2018 budget which provided in Dubai for example, for a 46.5 per cent increase in infrastructure spending from 2017, such spending representing 21 per cent of the Dubai government's total expenditure.⁸ Saudi Arabia has allocated nearly USD 14.4bn in its 2018 budget to infrastructure and transport (an increase of 5.5 per cent on the 2017 figure).⁹ It is not all good news in 2018, however, as Bahrain and Oman's 2017-2018 budgets both still focus on austerity measures which is not surprising given their breakeven requirements. Bahrain has been forced to scale back 22 municipal projects due to be completed by the end of 2017, as a result of budget cuts,¹⁰ while Oman was handed one of the hardest hitting budget statements in recent years with a deficit of nearly USD 8bn in 2017. On a more positive note, the 2018 budget projects Oman's GDP to expand by at least 3 per cent during 2018,¹¹ supported by the recovery in oil prices and its diversification drive and it also envisages a major role for the private sector in supporting the nation's infrastructure and economic development.

In light of the reduced access for liquid funding, it has become vital for governments to assess their financial models to ensure that:

• they are not hindered by a long-term fiscal deficit; and
• the ambitious social infrastructure projects needed to promote social harmony and diversified GDP growth are able to progress under a workable financial structure.

It is not surprising, therefore, that the GCC governments are now exploring alternative funding and procurement options as a priority. To boost income, a number of GCC countries announced the introduction of value added tax (VAT) in 2018 with this coming into effect in KSA and the UAE as planned on 1 January this year. This is, however, unlikely to sufficiently recompense the GCC governments' coffers in the short term following such significant drops in oil revenues. Therefore, the money for social infrastructure will need to be found elsewhere.

The rise of PPP?

Most prominent of the new trends that have been notable as the market has evolved to deal with the effects of the oil crash is the re-emergence of PPPs as a funding model. In these structures a public project is funded, constructed and operated through a partnership of government and one or more private sector companies, usually accessing private sector funding. This is the prime alternative project delivery structure candidate for the GCC governments to consider in the current climate. The attractiveness to government is that the initial capex to create the asset is funded by the private sector thus reducing the fiscal strain on already stretched budgets. In addition, it allows governments to reduce their technical and operational risk exposure by transferring this risk to the private sector, which is generally considered better for delivering major infrastructure on time and on budget.

To enable this switch to PPP, Dubai and Kuwait introduced new PPP laws in 2015. KSA, Qatar and Oman's PPP and private investment frameworks are currently also being put in place. This is a highly desirable development – although despite the underdevelopment and absence of a formal PPP regulatory framework in all GCC countries, infrastructure projects have used PPP structures (or some variant thereof) in social infrastructure regionally in the past, including for the Prince Mohammad Bin Abdulaziz Airport in Madinah, Saudi Arabia, and the Queen Alia International Airport in Amman, Jordan. There has always been the appetite for considering alternative project delivery methodologies, but now there is a material financial driver (and, increasingly, a suitable regulatory framework) for governments to start proceeding at pace with these alternatives.

It can be expected, therefore, that more PPP structures will increasingly be a feature of the market as the process of change takes effect: acceptance of changed circumstance, through value engineering, through project re-prioritisation, through legal, regulatory and institutional reform and finally through to project implementation utilising PPP. In our assessment, much of this process has now been completed and the market is now gearing itself up for delivery.
It is notable, in particular, that a large preponderance of the new rail projects currently being touted in KSA (see above) are slated for delivery as some form of PPP. This also goes for many other deals in the region including the King Hamad Causeway, the Kuwait National Rail Road and the Oman Mineral Railway.

Conclusion

Once again, the Middle East rail market stands on the brink of a major period of expansion. Likewise, PPP structures are being touted as the means by which a huge array of major rail infrastructure is going to be delivered across the GCC over the next few years. What is different this time, is that huge macro socio-economic forces are combining with a subdued oil price to create a fertile environment for this sort of development. It remains to be seen whether this will finally prove to be the breakthrough in access to private funding for the rail infrastructure market that the region has been waiting for, or another false dawn, with projects and procuring authorities reverting to government funding as soon as the oil price recovers.

1. See UAE least vulnerable among GCC countries to oil price, gulfnews,com, June 2014

2. See Kuwait – Infrastructure, export.gov, July 2017

3. See About Kuwait Infrastructure Week, kuwaitinfrastructureweek.com

4. See Fitch Publishes Oman's 'BBB' IDRs; Outlook Stable, fitchratings.com

5. See Bahrain, Oman among most ‘vulnerable’ oil exporters – report, gulfbusiness.com, June 2017

6. See Bahrain Macro 2016 report, Kuwait.nbk.com

7. See Gulf Cooperation Council Countries Continue to Offer Favourable Environments for Foreign Investment, tamimi.com, January 2016

8. See Infrastructure to comprise 21% of Dubai's largest budget in 2018, constructionweekonline.com, December 2017

9. See Saudi Arabia's expansionary budget positively received by economists, thenational.ae, December 2017

10. See Bahrain scales down 22 projects due to budget cuts, constructionweekonline.com, January 2017

11. See Oman unveils expansionary budget for 2018 with similar deficit to 2017, thenational.ae, January 2018