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Facing New Challenges
The industry should be more competitive by further heightening the added value and diversifying the market
Facing New Challenges
  • By matthew
  • June 29, 2011, 16:13
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In 2010, the total value of orders that Korea received for overseas plant construction reached US$64.5 billion, increasing approximately 10-fold in just seven years. At present, there is no doubt that Korea is one of the global top players in plant construction. It has positioned itself, along with shipbuilding, semiconductors and automobiles, as one of the country's leading export industries in the recent years.

Plant construction is a knowledge-intensive and high value-added industry which has contributed significantly to the economic development of Korea. It comprises a number of fields, from the manufacturing of hardware such as machinery to the development of software elements, e.g., engineering design.

Although Korea has fared exceptionally well in the sector up until now, it cannot be denied that there are still some tasks to overcome in order to make the industry even more competitive. For example, the orders recently won are rather lopsided towards Middle East markets, which could harm profitability in the long-term as competition becomes fiercer. Furthermore, some say that the added value of the sector needs to be further heightened for the sake of sustainability.

First-half Performance and Future Prospects

During the first half of 2011, Korean plant constructors have slow down overseas. However, experts are claiming that this retrogression has not been excessive despite political unrest in the Middle East earlier this year and the recent earthquake in Japan. “It had been forecast that the volume of orders would shrink considerably in the first half of the year, but this did not happen”, said Lee Sang-ho, director of the economic research institute at GS Construction. He added, “Although Korean builders have failed to win mega-scale projects overseas during this period, they have focused on their global business and it seems that such efforts have been rewarded.”

Nevertheless, some are putting more weight on the fact that the total value has shown a remarkable decrease, making the problem of market concentration conspicuous yet again. “The sum of this year up until now is less than 50% of that of 2009, when no nuclear power plant projects were won by Korea”, said Construction Economy Research Institute of Korea (CERIK) researcher Kim Min-hyeong, adding that it shows how severe the lopsidedness is. “This year's projects were launched last year in fact, and it is a stretch to say Korean construction companies have not been affected at all by the Middle East's political turmoil,” remarked director Lee Sang-ho, adding, “It is worrying that the aftereffect of the crisis could emerge from now.”

Experts are also citing the Middle East situation as the No. 1 factor influencing the track record of the industry in the latter half of 2011. “Once the unrest subsides, there will be a series of projects, including those for restoration”, said General Manager Kim Tae-yeop of the International Contractors Association of Korea (ICAK) and echoed, “Luckily, the crisis has not spread to our major markets there, including the member nations of the Gulf Cooperation Council, and the aftermath is seen to be rather limited until the region comes up with a lot of new projects in the second half.”

Director Lee Sang-ho, however, refrained to be entirely positive about future prospect, saying, “Winning new orders before the end of this year in markets where democratization rallies took place, such as Libya and Egypt, will be quite tough, with the global economy feared to lose its steam again and our dependence on GCC nations likely to rise with time.”

In the meantime, the ICAK predicted that Korean constructors' performance will improve overseas as the number of overseas projects increases and the nationalities of ordering organizations diversify. Within this year, the project for a second petrochemical plant in Jubail, Saudi Arabia is predicted to be launched on a package-by-package basis ahead of that for another one in the Rabigh region. Kuwait is also planning to kick off construction of a large-scale oil refinery this year. According to MEED Projects, a magazine specializing in the local construction industry, Middle East plant construction orders are estimated to be worth US$2 billion in 2011. In addition, many new oil refineries and power generation plants are scheduled to be built in Asia during the period.

“On the back of high oil prices, petroleum-producing countries affiliated with the GCC are now seeing a lot more budgetary leeway, which is tempting them to place more orders”, said analyst Kim Yeol-mae of Hyundai Securities, continuing, “It seems likely that large petrochemical plant projects will begin continuously down the road.” According to her forecast, chances are that the electricity demands of these nations will rise consistently given the order placement and pace of GDP growth. “Major Mideast countries' power reserves have already reached their thresholds and investments in power generation facilities are pressing there”, she added.

Meanwhile, some industry insiders are voicing that this lopsidedness for the Middle East should be addressed in the long-term, if not immediately. “We should watch closely the possibility of alternative energies’ and green infrastructure’s fast emergence while, in an effort to diversify our markets, paying attention to Africa’s water resources development”, said Korea Institute of Science & Technology (KIST) researcher Kim Seong-il. “We need to take note of those less-developed but resources-rich countries, that is, the Commonwealth of Independent States (CIS) nations around the Caspian Sea and Australia”, added analyst Kim Yeol-mae. Mentioning Kazakhstan being home to some 48 billion barrels of oil deposits and Turkmenistan’s and Uzbekistan’s gas on market and experts are claiming that now is the time the government needs to take care of it, while providing overall support to the segment. “In terms of market size, civil engineering is larger than plant construction”, said Kim Tae-yeop, adding, “In subcontract-based projects, we cannot beat our Chinese competitors, whose price competitiveness is much higher than ours, therefore we should find a breakthrough by means of project financing-based ones.”

Researcher Kim Min-hyeong, in the meantime, stressed the importance of follow-up measures as much as the financial backup, including system reorganization and risk management. He also remarked that market exploration, business feasibility examination, order data management etc, currently handled by different ministries and agencies, need to be managed under a single framework.

“Japan, in the wake of the recent disaster, is not in a position to spend much on official development aid and so this can be an opportunity for the Korean government to increase its ODA to Asia, leading to engineering service contracts and orders”, commented the director of GS Construction’s research institute.

Evolution of the Industry

Currently, domestic plant engineers and builders are diversifying their business scope. Large Korean construction companies are reinventing themselves from constructors to providers of comprehensive design, engineering and construction services. Under such circumstances, it is expected that they will soon become project-proposing developers with financing capabilities.

Samsung Engineering is standing out nowadays in the petrochemical plant markets of the Middle East. It has worked successfully on orders awarded by Dow Chemical and the International Oil Company (IOC) since last year. Hyundai E&C is finding its competitiveness increasing overseas along with the growth potential of Hyundai Engineering, its daughter firm. GS Construction is anticipating that its overseas profit ratio will go up with the passage of time, while Daewoo E&C swelling the list of leading overseas players by dint of the financial assistance from the Korea Development Bank (KDB), its new largest shareholder.

Back in 2010, Korean companies won plant construction orders worth US$38.1 billion in the Middle East, with the figure accounting for approximately 60% of that year’s total value of US$64.5 billion. The situation was not that different in 2009, when the percentage reached 67%. In this context, market diversification is considered one of the most pressing assignments.

“Though Korean plant builders have done pretty well both quantitatively and qualitatively, the regional concentration has begun to result in price competition among themselves and thus lowered profitability”, said the National Information and Credit Evaluation (NICE) Investors Service. It advised that they would find it wiser to focus more on Latin America and Africa and diversify products to cover upstream petrochemical ones.

Another task for them to cope with is the evolution to move up the industrial value chain. Until now, Korean players have been engaged mostly in engineering, procurement & construction (EPC), where the level of added value is relatively low compared with competition intensity. In the meantime, global leaders have monopolized high value-added technologies, e.g., project management consultancy (PMC) and front-end engineering & design (FEED). Korean companies are now required to clear such a hurdle in order to become even more competitive and sustainable.