Where does the construction sector go from here?

Ian Ingram-Johnson, a partner of Allen & Overy's projects team.

The days of construction boom are in the past, so where can we go from here? Allen & Overy partner Ian Ingram-Johnson lists some possible future trends.

Memories of the GCC, being an island of opportunity for contractors to shelter from worldwide economic storms, are now distant in most people’s minds. The contracting landscape is so changed from a year ago that it is barely recognisable. Simply put, there is less money for clients, less business for contractors and the fear of insolvency for certain key players.

Clear trends and themes for the GCC contracting market over the next few years have started to emerge.
First, there will be a real testing of existing contracts. As we all know, in boom times, time is often better spent chasing new work than picking over the bones of current and historic contracts.

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With fewer opportunities around and spare headcount, there is already an increase in the number of claims from contractors and clients alike. From the client’s side, the drop in construction commodity prices is leading to pressure for renegotiation of pricing agreed at the top of the market.

Second, the speed of the economic downturn combined with the ambition of regional projects and the ‘dash for cash’ will leave a number of local clients, contractors and sub-contractors with stressed cash-flow positions. This is already showing itself in late payment practices and is likely to lead to a significant increase in insolvency-related problems.

Third, formal bid processes will become more demanding. Whether it is the value of the bid bond required or the number of bidders permitted, clients will not have to work so hard to create interest in their projects. With hungrier contractors, recent blunt pencils will be sharpened and margins affected.

Fourth, the risk profile of contracts will change. Whether through more demanding financiers in project finance, or clients simply taking advantage of the new market conditions, the market is already seeing a move towards more ‘client-friendly’ contractual terms.

In particular, apart from large undefined projects, which cannot be priced, there is likely to be a significant reduction in the number of cost-reimbursable and construction management
contracts and a move back towards lump sum turnkey contracts. Similarly, the market has recently tested new lows for caps on liability for contractors. The level of these caps is likely to increase.

Fifth, the credit (and credit support) requirements of both clients and contractors will be more exacting. With cash-flow being all important (and memories scarred from recent experience), expect to see much more negotiation on the payment profile, with clients and contractors more keen than ever to be cash-positive throughout a project.
With recent calls on performance bonds, issuers of performance bonds are demanding higher levels of collateral, putting further pressure on balance sheets.

Finally, with some hard lessons being learned by clients and contractors alike, as they look back at their previous contracts and count the cost of glossing over important issues, there is likely to be a renewed focus on the importance of the terms of the contracts. As ever, clarity in the contracts will be important.

To conclude, none of the themes and trends mentioned above will be unique to the GCC. In fact, they are not even unique to this downturn or construction contracts. In a notoriously cyclical industry, we see these trends during every slowdown.

What sets this downturn and the GCC apart is the combination of the dizzy heights the boom years reached, together with the abruptness and breadth of the slowdown. If and when the upturn comes, hopefully the lessons of the last few years will not have been forgotten. But don’t count on it.

Who is Ian Ingram-Johnson
Ian Ingram-Johnson is a partner in Allen & Overy’s projects team in Dubai. He has worked extensively on a wide range of projects throughout the Middle East, including transportation, petrochemical, power, water and energy projects.