The UAE cement industry must to restructure rapidly or face long-term financial distress
The massive bull-run of cement demand in the UAE finally reached its peak in 2008, when demand reached 21.7Mt, up three-fold on the 6.9Mt consumed in 2003. This extraordinary growth is even more startling when one considers per capita consumption reached 4,345kg at this time – over ten times the global average.
Throughout these boom years, supply shortages became common-place, resulting in rapid price inflation as producers sought to capitalise on the scarcity of cement (often funnelling their vast profits into the stock market), while cement and clinker trade increased exponentially. All of this activity was accompanied by a frenzy of new capacity additions as ement capacity reached 32.5Mt, up from just 11Mt in 2003 leaving the UAE littered with grinding plants. Annual clinker production is now in the region of 18.6Mt.
Suddenly, at the end of 2008, amidst the global financial crisis and the bursting of Dubai's self-inflicted real estate bubble, the market turned – sharply. Cement demand fell 16% in 2009 to 18.25Mt as half of all construction projects in the UAE ground to a halt. A further double-digit decline forecast for 2010. Prices have plummeted, from Dhs500/t to just under 200/t in January, while imports, which reached 3.6Mt in 2008, have all but vanished.
Like a supertanker drifting in the sea, capacity in the UAE will continue to rise inexorably, reaching a massive 40.7Mt by 2011, as projects conceived in happier days are completed. This will leave a demand-supply gap of around 25Mt, assuming demand stabilises at around 15.5Mt by 2011. In terms of clinker, the gap could reach 16Mt by 2011.
Who's to blame?
Now saddled with a massive capacity surplus, lowering utilization rates and low prices, one might ask, "who's to blame?". During the boom years, construction companies found themselves facing repeated supply shortage as local cement supply failed to meet demand, while prices swiftly exceeded pricing caps supposedly agreed with the government. For some construction companies, whose operations were continually held back by supply uncertainties, one answer was to build their own grinding plant to ensure guaranteed supply at reasonable prices. Grinding plants are relatively easy to build and require only a limited capital expenditure that could quickly be paid off.
Others speculators from outside the industry saw the potential for windfall profits. To the dismay of many industry observers, new entrants kept coming, even when it was obvious the market was heading for severe overcapacity.
But ultimately, the industry itself must take some responsibility for the pricing environment which attracted speculators with limited understanding of the longer-term cement market cycles, and those simply focused on short-term profiteering and with the support of financiers ill-equipped to carry out proper due diligence.
Perhaps an even deeper problem is the issue of industrial regulation. The absence of any industry co-ordination by the government, including an effective licensing system designed to phase in new capacity at a rational pace in order to protect the long-term viability of the industry.
Even regulation is no protection of overcapacity if the law-makers, financiers and speculators are operating under the collective delusion of a market with infinite growth potential.
The current industry response to this situation of overcapacity over the next year will be crucial. In a rational market, all existing players would reach for their nearest economic textbook, and remind themselves of the damage to profitability that a price war will cause to all involved. Instead the industry must take proactive steps to start a process of restructuring, whereby surplus grinding capacity is whittled out. A degree of price discipline should be adopted, with price levels adjusted to levels at which efficiently run operations can survive, and which correspond to an international price level (and therefore limit unnecessary imports). Finally, production volumes need be adjusted to the demand of the market.
In this way the industry will not be plunged into needless long-term financial distress, while ensuring a sustainable course for the industry in the years ahead. Alternatively, the price war can continue, leaving only the strongest – or those with the deepest pockets – to survive. But at what cost?
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