“To analyze the impact of constant changes in prices of crude oil and foreign

exchange on the cost of material used in construction sector.”

A report submitted
By
Muhammad Taimoor Khanzada (2914)
Amin Saleem Saghani (2899)
Aziz Ahmed Khan (2867)
Wasi Ahmed (2960)
To
Dr. ABDUL WAHEED

Department of Business Administration

In partial fulfillment of
the requirement for the
course

MASTER OF BUSINESS ADMINISTRATION

This report has been

accepted for the faculty of

FACULTY OF BUSINESS ADMINISTRATION

by:
___________________________
Dr. ABDUL WAHEED

1
ABSTRACT:

In this research paper, the cost of some of the basic material that is Cement and Steel has
been taken to compare costs and to analyze that how much it get affected with the rise
and fall in price of crude oil and foreign exchange. And on the basis of these costs
comparison it can be analyzed that how much inflation and cost raise percentage should
be kept in mind before preparing the feasibility of this business as these days we cannot
rely on our cost forecasting in construction sector as we cannot analyze 100%, whether
and how much will the cost rise in future. And with the help of this research it could also
be analyzed whether and how much is the growth in this business in the industry.

The purpose of this report is to analyze the effect of cost of crude oil as well as changes
in the currency rate on the purchase of material related to the construction sector in
Pakistan. Over the past few years, this sector has enjoyed exponential growth and a lot of
investors have given good attention to this sector. The material, however, due to vast
amount of it being provided through exports, is a major stumbling block in predicting
future expenses for the builders. This is because of so many fluctuations in the prices of
crude oil in international markets and further more, due to the instability of our currency
which leads to even more variety. This report draws a line towards a safety barrier a
builder must consider when stepping into this sector. It would help the user predict what
sort of market he can expect nowadays in this sector. There are a lot of other factors too
which impact the construction business as a whole. The sector has potential for success
particularly in Pakistan because of the growing population and need for infrastructure
thereby opening more grounds for research as well.

2
INTRODUCTION:

In the start of 2003, Pakistan’s economy started growing at a great pace and people
started to invest in different business in the country. Construction was one of those
businesses that got a big boost. Local as well as foreign investors invested in construction
business and by the end of year 2007, this sector was so much established in the country
that it has also became an immense reason for the growth of other businesses like real
state which also has grown so much during last decade, and one of the business which
has now become so popular within last 10 years is marketing. Marketing is one of those
sectors which expanded so much due to growth in construction sector in last 3 years.

But then all over in Pakistan, the costs went high due to inflation, recession, change of
government, taxes or duties imposed by the government and many other factors. And
now the owners in construction business are suffering heavy losses and charging their
clients the amount of escalation as the projected cost didn’t prove to be sufficient enough
to complete their projects. And at present construction sector is one of the most neglected
sectors in Pakistan, which can be judged from the fact that per capita consumption of
cement in Pakistan is one of the lowest among the developing countries i.e. 72 kgs.

This report is all about the raise of cost of the basic material used in construction sector.
The data that has been used in this report for comparison of costs has been taken from
material purchased by “Arsalan Construction Company” at different time scale. They
are having their project in Scheme-33, Karachi named “Gulzar-e-Erum” and “Noor-e-
Karim”.

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 LITERATURE RIVEW:

THEORETICAL BACKGROUND:

Dates back to the early days of civilization, when people trade their strength and ability to
build simple and crude structures with the help of soil and woods to live but as time went
on, skilled workers introduced innovative and better ways in construction sector.

The history of the construction industry over the past 200 years has been rapidly
changing due to the technological advancement with the Industrial Revolution and
extensive growth in population. History of construction industry was changed with the
creation of factories and improvements in metal working in the late 18th and early 19th
centuries. These improvements also converted the manual work that had to be done by
hand into more usage of machines and technology. Architectural advancements also
played a massive role in this development. And with the creation of new materials like
steel and cement, the history of construction industry changed once again.

Ever since civilizations first started to build, we required a material that would bind
stones into a solid, formed mass. The Assyrians and Babylonians used clay for this
purpose, and the Egyptians advanced to the discovery of lime and gypsum mortar as a
binding agent for building such structures as the Pyramids. Then in 1818, a year after the
Erie Canal was started, Canvass White, an engineer, discovered rock deposits in
Madison County, NY, from which natural hydraulic cement could be made with little
additional processing. He produced large amounts of this cement for use in the Erie
Canal.

The iron we use today is much better than the iron that the Hittites made. Today most of
our iron is made into steel. Steel is iron with more carbon in it than regular iron. It is
much stronger and more flexible (it doesn’t break as easily). People first began making a
kind of steel in India, around 250 BC. Men living in the Fatimid Empire, around 1000
AD in Damascus, added some new elements to make a very high quality steel called
Damascus steel. But by 1300 AD, people lost the secret of making Damascus steel.

4
Nobody knows why or how this happened. Even now, although people claim to be
making Damascus steel, we are not sure that they are using the same method as before.
Though steel had been produced by various inefficient methods long ago but its use
became more common after more efficient production methods were introduced in the
17th century. With the invention of the Bessemer process in the mid-19th century, steel
became a relatively inexpensive mass-produced good. Further refinements in the process,
such as basic oxygen steelmaking, further lowered the cost of production while
increasing the quality of the metal. Today, steel is one of the most common materials in
the world and is a major component in buildings, tools, automobiles, and appliances.

Cement is a material to be used for almost any type of project which is strong and durable
while steel provides the strength needed for the base of large scale building projects. As
almost all materials are imported from other countries either in form of raw material or
finished goods, and if it’s in the form of raw material then it’s being finished with the
help of electricity and the main source of electricity is crude oil in our country. As far as
this report is concerned the best example is of steel that steel isn’t much produced in our
country if we compare it from imports of the same. And then that iron which is being
imported from foreign is then converted into finished steel which requires electricity.
Steel bars are prepared from ship plates, which were available at PKR 45,000 per tonne
in January 2010, have now crossed PKR 60,000 per tone. Same goes for the foreign
exchange rates.

In our country, we don’t have many industries to produce items like steel, tiles. And even
if we have all the raw material available for production, it is not up to the quality
standards of the consumer. Therefore importing items whether raw material, semi-
finished, or finished goods, it does effect on the final cost. Our currency has seen
depreciation over the years and that has contributed to a great extent on price hikes. I
have tried to reflect this change in my report.

Arsalan Construction Company was founded in 2004 with the project of Gulzar-e-Erum
which is now in its final stage. All the materials that are being purchased for construction

5
purpose are affected by the change of rates in foreign exchange and crude oil. The costs
used for analysis has been taken in accordance with invoices of the material purchased.

SOME PAST STUDIES

There are many researches done in construction sector as well as the impact of foreign
exchange and crude oil on economy but there is no research done in the joint venture. I
am the first one who is conducting this research. But some of the individual research
papers are as follows:

Topic: Role of Construction Sector in Economic Growth: Empirical Evidence from

Pakistan Economy.
Researcher: Raza Ali Khan, Associate Professor, Dept of Civil Engineering, NED.
Reference: http://www.neduet.edu.pk/ICCIDC-I/Conference%20Proceedings/
Papers/030.pdf
Year & Place of Study: August 2008, Karachi, Pakistan

In this research, researcher investigated the relationship of total economy and

construction sector of Pakistan. The findings of this research shows that there is a uni-
directional causal relationship between the two variables real growth rate of GDP and
construction flows and aggregate economy of Pakistan is greatly influenced by the construction
industry.

Topic: Evaluation of the Competitiveness of Construction Company Overhead Costs.

Researcher: Ala Šiškina1, Arvydas Juodis, Rasa Apanavicien_2, Dept of Civil
Engineering Technologies, Kaunas University of Technology.
Reference: http://pdfcast.org/pdf/evaluation-of-the-competitiveness-of-construction-com
pany-overhead-costs
Year & Place of Study: February 2009, Lithuania

In this research, researcher presents the relevant and innovative methodologies to forecast
overhead expenses of a construction company’s management system, administration and
facilities management and to select the appropriate overhead costs structure and to form

6
the overhead costs optimization strategies for evaluating the competitiveness of
construction company overhead costs.

Topic: Distributional Effects of Oil Price Changes on Household Expenditures: Evidence

from Mali
Researcher: Kangni Kpodar’
Reference: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=901882
Year & Place of Study: March 2006, Mali, Africa

It has been analyzed that changes in prices of different bi-products of crude oil effect
demand and average consumption of household items for about 1.67 percent in rural
areas and 1.76 percent in urban areas directly. And the same effect the average
consumption almost 50 percent indirectly.

Topic: Oil Prices and the Swiss Economy

Researcher: Erdal Atukeren
Reference: http://www.ecomod.net/conferences/ecomod2003/ecomod2003_papers/Atuk
eren.pdf
Year & Place of Study: May 2003, Zurich, Switzerland

In this research, it has been investigated that increase in oil prices affects the decrease in
Swiss GDP but at the same time, decrease in oil prices does not lead to increase in their
GDP.

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 STATEMENT OF PROBLEM

OBJECTIVE:

The objective of this study is to determine how much the cost is dependent over the
increase or decrease in rate of crude oil and foreign exchange.
HYPOTHESIS:

Ho : Cost is independent of prices of crude oil and foreign exchange.

H1 : Cost is dependent of prices of crude oil and foreign exchange.

METHODOLOGY:

i) Source and Type of Data:

The type of data in my research is secondary and it has been taken in accordance
with invoices of the material purchased in Arsalan Construction Company.Prices
of crude oil has been taken from http://www.nyse.tv/crude-oil-price-history.htm
Prices of Foreign exchange has been taken from http://www.forex.pk/foreign-
exchange-rate.htm

ii) Recommendation of data its Sample size and Justification:

Sample size has been taken only 36 that are of past 3 years. The “Multiple
Regression” technique is used for analyzing the dependency of cost over the rate
of crude oil and foreign exchange.
As per standard, the number of observations for regression must be

(8 * # of variables) + 50

And for my data it will be

(8 * 3) + 50 = 74

But statistics allows the parametric tests in other conditions as well that is sample
size must be greater then 30 or data should be normal. And the observations that I
have used is this data are 36 as well as normal.

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 ANALYSIS

The first table shows the list of independent variables on which the cost (expenses)
depends on.

Model Summary(b)

Adjusted R Std. Error of

Model R R Square Square the Estimate Durbin-Watson
1 .730(a) .532 .504 3911.05879 1.048
a Predictors: (Constant), Currency, Crude_Oil
b Dependent Variable: Expenses

R stands for coefficient of multiple correlations and in the above table it shows that there
is 73% strong relationship between dependent (cost) and independent variables (foreign
exchange and crude oil). While R-Square shows that there is 53.2% accuracy in this
regression model.

Next table of ANOVA is showing that the p-value is .000 which is less then 0.05 that
means we must reject Ho and accept H1 which states that cost is dependent upon the
prices of crude oil and foreign exchange.

Coefficients(a)

Unstandardized Standardized
Coefficients Coefficients t Sig. Collinearity Statistics

Model B Std. Error Beta Tolerance VIF B Std. Error

1 (Constant) -5191.709 7239.449 -.717 .478
Crude_Oil 183.878 30.271 .809 6.074 .000 .799 1.251
Currency 266.755 77.122 .460 3.459 .002 .799 1.251
a Dependent Variable: Expenses

By the help of this table, regression model could be defined easily at it states the values
of constant, crude oil and currency. The regression model is:

Cost = -5191.709 + 183.878 (Crude oil) + 266.755 (Foreign Exchange)

The above regression model defines that with raise of every $ 1 of crude oil prices in the
international market will increase the cost by PKR.183.878 and with the depreciation in
value of PKR against USD by Rs.1 will result the increase in cost with Rs. 266.755/= and

9
vice versa. And this shows that both variables (Crude oil and Foreign exchange) have
direct relationship with the cost.

In the seventh column, the p-value of individual variables has been shown and according
to that it can be analyzed that the constant is insignificant in this model as it has the value
of 0.478 which is greater than 0.05 but the other 2 variables that is crude oil and currency
has the value of 0.000 and 0.002 respectively and they both are significant to determine
cost.

The columns of tolerance and VIF are used to determine the interdependency or the
relationship amongst independent variables which is also called as multicollinearity. As
we can see that the t-value of Crude oil is 6.074 and of currency are 3.459 that are greater
than 0.2 which indicates that there is no multicollinearity. It can also be checked through
VIF and it shows the same result as the VIF value of Crude oil is 0.000 and of currency is
0.002 which is less than 5.
Normal P-P Plot of Regression Standardized Residual

Histogram Scatterplot
Dependent Variable: Expenses

Dependent Variable: Expenses Dependent Variable: Expenses

1.0

10 45000.00
Expected Cum Prob

0.8
8 40000.00

0.6
Frequency

Expenses

6 35000.00

0.4
30000.00
4

0.2
25000.00
2

Mean =-1.62E-15
Std. Dev. =0.971 0.0 20000.00
0 N =36 0.0 0.2 0.4 0.6 0.8 1.0
-3 -2 -1 0 1 2 3 -3 -2 -1 0 1 2 3
Observed Cum Prob
Regression Standardized Residual Regression Studentized Deleted (Press) Residual

The above histogram shows that the data that has been used is symmetrical in nature and
shows the normal behavior. And further, the P-P plot and scatter plot also shows the
same.

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CONCLUSION & RECOMMENDATION:

From the above analysis, it has been concluded that there is a positive impact of changes
in prices of crude oil and foreign exchange on the cost of material used in construction
sector.

Further it was analyzed that with raise of every $ 1 of crude oil prices in the international
market will increase the cost by PKR.183.878 and with the depreciation in value of PKR
against USD by Rs.1 will result the increase in cost with Rs.266.755/= and vice versa.

By the above analysis it has been recommended that as the prices of the material are
constantly increasing so it can be bought in bulk to avoid future inflated costs or we can
engage our suppliers in long term contracts with a periodically step raise. Also as our cost
is directly related to crude oil so the decrease in demand may result in decrease in the
prices of crude oil.

The purpose of this report is to analyze the effect of cost of crude oil as well as changes
in the currency rate on the purchase of material related to the construction sector in
Pakistan. Over the past few years, this sector has enjoyed exponential growth and a lot of
investors have given good attention to this sector. The material, however, due to vast
amount of it being provided through exports, is a major stumbling block in predicting
future expenses for the builders. This is because of so many fluctuations in the prices of
crude oil in international markets and further more, due to the instability of our currency
which leads to even more variety. This report draws a line towards a safety barrier a
builder must consider when stepping into this sector. It would help the user predict what
sort of market he can expect nowadays in this sector. There are a lot of other factors too
which impact the construction business as a whole. The sector has potential for success
particularly in Pakistan because of the growing population and need for infrastructure
thereby opening more grounds for research as well.

11
REFRENCES:

Raza Ali Khan, “Role of Construction Sector in Economic Growth: Empirical Evidence
from Pakistan Economy”, Dept of Civil Engineering, NED, August 2008,
Karachi,http://www.neduet.edu.pk/ICCIDCI/Conference
%20Proceedings/Papers/030.pdf

Ala Šiškina1 et al, “Evaluation of the Competitiveness of Construction Company

Overhead Costs”, Dept of Civil Engineering Technologies, Kaunas University of
Technology, February 2009, Lithuania, http://pdfcast.org/pdf/evaluation-of-the-
competitiveness-of-construction-company-overhead-costs

Kangni Kpodar’, ”Distributional Effects of Oil Price Changes on Household

Expenditures: Evidence from Mali”, March 2006, Mali, Africa,
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=901882

Erdal Atukeren, “Oil Prices and the Swiss Economy“, May 2003, Zurich, Switzerland,
http://www.ecomod.net/conferences/ecomod2003/ecomod2003_papers/Atukeren.
pdf.

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