Korea Construction Giants Ride Oil Boom

Oil prices are fueling the Middle East's building surge, which in turn is fueling South Korean builders. Next to benefit: construction company investors

by Vaughan Scully From Standard & Poor's Equity Research

Market players seeking innovative ways to benefit from higher oil prices might consider exposure to South Korea, whose construction companies are being hired to build the refineries, petrochemical plants, offices, and infrastructure springing up around the Middle East.

Oil prices have been hovering near record levels. In September alone, the price of oil shot past the previously unimaginable $80-a-barrel mark, and the chance it will reach $100 a barrel in the near future is being discussed.

As economists worry about the impact on the economy, investors have responded by bidding up the shares of oil producers and other energy companies. But it's a double-edged sword. While the revenue side of these companies benefits from higher oil prices, there's substantial cost effect as well. New properties—both proven and prospective—have become increasingly expensive, as have manpower, equipment, and services. In addition, many producers were running at top speed already, and thus have been unable to boost their output much to take full advantage of the higher price environment.

But for the oil-producing nations of the Middle East, where there's no real distinction between the oil companies and the state, higher prices have created an economic boom, leading to a surge in construction activity. In Dubai, United Arab Emirates, the world's largest building—the Burj Dubai Tower—is currently under construction, as are the Dubailand entertainment complex, featuring the world's largest indoor ski slope, and the Palm Islands development, which will create three enormous artificial islands shaped like palm trees. In Saudi Arabia, construction is under way on an entirely new city—the King Abdullah Economic City—at a cost of $27 billion, which will include a new international airport, a container port, and rail links to other cities.

Record OPEC Earnings

Enter the Korean construction outfits. "We see continued profit growth driven by the global oil, gas, and petrochemical plant buildout centered in the Middle East," says Keith Nam, who follows the Korean construction industry for Nomura International in Seoul. He has been upbeat on Korean EPC (engineering/procurement/construction) players—whose key longer-term focus areas are overseas construction and domestic homebuilding—since August, 2005.

The surging price of oil helped members of the Organization for Petroleum Exporting Countries, most of which are located in the Middle East, earn a record $650 billion in petroleum export revenues during 2006, according to the group, a 22% jump from 2005 and almost twice the level of 2004. Revenues in 2007 will almost certainly be even larger as OPEC output levels have risen since then. Economic consultancy Global Insight predicts the Middle East together with Northern Africa will show economic growth of about 5.4% in 2007 and 5.7% in 2009, far more than North America or Western Europe and about the same as Asia Pacific (including Japan).

Much of that money is being invested in new refineries, petrochemical plants, and other energy infrastructure projects, as well as new hotels, highways, and water desalinization plants, a specialty of Korean contractors. Currently, there are about $1.7 trillion worth of new construction projects going on in the Middle East, according to construction data publisher MEED Group, up from $1 trillion in April, 2006.

Overseas Orders Rise Dramatically

Korea's construction industry has been winning a lot of that new business. In September, the Korean government announced that South Korean construction companies landed about $21 billion in new orders from overseas customers during the first eight months of the year and would probably top $24 billion for the full year, compared with $16.4 billion in overseas orders won in 2006. Most of those orders are coming from the Middle East: The United Arab Emirates was the largest market, with $4.95 billion in orders, followed by Saudi Arabia with $2.74 billion, Egypt with $1.84 billion, and Kuwait with $1.67 billion.