High energy costs crush cement producers' profits

A report says producers are struggling to gain access to essential natural gas resources.

Producers were once at liberty to increase prices to offset energy costs, but the Ministry of Economy began capping prices last year.

Soaring energy costs are squeezing the profits of cement producers as they struggle to gain access to natural gas resources, according to a report by The National Investor investment group. Energy makes up about 60 per cent of the cost of manufacturing cement. So a shortage in the supply of natural gas, combined with pressures to keep up with strong demand, has forced some producers to either switch to more expensive fuels, such as diesel, or temporarily rely on power generators.

For the third quarter in a row, the Ras al Khaimah-based Union Cement Company (UCC) - with a market share of 15 per cent - recorded a slide in its profit margin to less than 20 per cent, compared with an historical average of 35 per cent, according to the report by the group. UCC's net income in the second quarter of this year fell to Dh38.22 million (US$10.41m) comparedwith Dh96.06m in the same period last year. Its gross profit margin for the full year is expected to be 18.6 per cent.

UCC has been using diesel and hired power generators to make up for power supply shortages. RAK White Cement, another major producer in Ras al Khaimah, recorded a net loss of Dh1.35m in the second quarter. Gross profit margins for cement producers across the board were averaging 15.7 per cent, according to Hassan Awan, an analyst at The National Investor and one of the report's authors. "This has been going on for a long time now and margins across the board have been affected," he said. "It's because there's a shortage of natural gas. Some companies are using more expensive liquid fuels. As long as they continue to do this, then margins will be squeezed."

Mr Awan added that a move towards using imported coal should help improve profits in the long-term. "For example, UCC started to use coal at the end of June, which wasn't recorded in the second quarter results, but this will improve margins," he said. Producers were once at liberty to increase their prices to offset high energy costs but, to control prices, the Ministry of Economy stepped in last year and capped the price of cement.

Last year's cap was set at Dh295 per tonne, and it has since gone up by about 15 per cent to Dh340 per tonne. While the cap has helped producers, the rising cost of transport raw materials and labour continues to eat into profit margins. "With the price of crude and transportation costs going up, I speculate that the Government might increase the cap again in the future," said Mr Awan. Meanwhile, the profit margin for Arkan Cement, the Abu Dhabi cement producer, remains at a robust 30 per cent due to a steady flow of natural gas. "We as a company don't suffer as badly as other companies as we have a long-term supply contract for gas with the Abu Dhabi Government," said Jeremy Rowson, its chief operating officer.

The region's major cement manufacturers are investing heavily in expanding their production capacity to keep up with demand, which is expected to be further fuelled by the multi-billion construction projects either already underway or planned in the northern emirates. Arkan alone is building a Dh1.3 billion factory in Al Ain, which will be operational by end-2009. The factory will produce 3.1 million tonnes of clinker, a type of brick, and will have a grinding capacity for 4.5 million tonnes of cement.

Fujairah Cement is also expanding its capacity. Cement consumption in the UAE has grown by 25 per cent in each of the past four years. But Mr Awan said there remained "a lot of ambiguity" as to how much pent-up demand remained. "The general consensus is that there is Dh4.7 trillion worth of projects in the GCC, but there's no absolute statistic on what the actual proportion of projects under construction is worth, so demand could actually be higher," he said.

"The smaller emirates have just started to position themselves with their own multi-billion dollar projects. Because of this, we now feel that the situation might not necessarily level itself out in the near future." @Email:[e-mail]