Boom puts contractors under pressure in Qatar

03 November 2009

Contractors involved in Qatar’s LNG programme have learned difficult lessons from negotiating during a construction boom, but there is little evidence clients will take on more risk as the project market picks up

Qatar has become one of the world’s most active energy project markets in recent years, as the country invests in an aggressive programme to lift its liquefied natural gas (LNG) production capacity. Doha’s plan is to more than double capacity from its April 2009 level of 43 million tonnes a year (t/y) to 77 million t/y by 2010-11.

Since 2005, the value of gas-processing projects awarded has been more than $6.4bn. But for the contracting groups that have committed to help Qatar roll out these new schemes, the large workload has not always translated into massive earnings. Indeed, for the companies most involved in the country’s energy expansion, Qatar has proved to be a financial burden over the past couple of years. Its billion-dollar energy programme helped create a congested projects market, with high materials and construction costs, and this has squeezed contractors’ profit margins.

On 23 October 2009, for example, Japan’s Chiyoda Corporation announced a revision to its financial results forecasts, anticipating an 85 per cent decline in operating income for the financial year to 31 March 2010, down to ¥1bn ($11m). It says this is mainly related to problems associated with its Qatargas 3 and 4, trains 6-7, LNG commitments.

The company, which formed a Qatar-focused joint venture with France’s Technip in 2000, also expects lower-than-forecast income this year because it has had to hire new construction subcontractors in an attempt to catch up with schedules delayed by lower-than-expected productivity on the part of its subcontractors.

“The subcontractors were not sufficient for our expectations, so we decided to change the labour force and put in new subcontractors in order to keep to the agreed schedule,” says a spokesman for Chiyoda. “This means we have had to spend more money.”

The roots of the problem lie in the dynamics of the Gulf construction sector over the past four years. Doha’s strategy of building several LNG megaprojects simultaneously pushed up construction costs, and the situation was aggravated by its preference for striking lump-sum turnkey contracts, placing the bulk of the risk on the contractor rather than the sponsor.

Key facts

  • $700m - Value of additional payments requested by Technip and Chiyoda for Qatargas II
  • $71m - Chiyoda’s forecast drop in 2009-10 profits compared with last year

Source: MEED

Chiyoda is not the only group feeling the pain. France’s Technip was forced into a substantial write-down in February 2008 related to its four LNG plant projects in Qatar. The bulk of the exceptional charge related to Qatargas II, a joint venture with Qatar Petroleum (QP), the US’ ExxonMobil Corporation and France’s Total. Technip recorded a charge of E200m ($295m) related to its Qatar projects for the 2007 financial year.

Both Chiyoda and Technip had originally submitted claims for more than $700m in additional payments in late 2007, linked to Qatargas II. Though initially rebuffed, Qatargas subsequently reached an agreement for an undisclosed compensation sum. The French company is confident this will cover all further related expenses on its projects.

“We are still comfortable with the charges taken in 2008 and that we won’t announce any more provisions,” says a spokesman for Technip.

This reflects a wider hope among contractors that their problems in Qatar will now be contained.

Clearly, the construction market in late 2009 is in a different shape to how it was during the 2006-08 boom. Companies then were bidding in a contracting environment that rapidly overheated, and took on commitments on a lump-sum basis to deliver some large projects.

“They underestimated the scope of work and then the contracting environment worsened,” says one analyst. “The construction of Ras Laffan Industrial City was going ahead at the same time that other major construction projects, such as Pearl GTL [gas to liquids] and a new petrochemicals plant, were starting up.” 

Labour demands

The demands on the local labour force, as well as on raw materials, proved to be much heavier than anyone anticipated and contracting groups like Technip and Chiyoda were unable to extract the full cost of overruns on the projects from the clients. A particular issue arose over the subcontractors.

“Everyone went for firm, fixed-price contracts, for which we took on high risk, and part of that risk was the assumption that you would be able to get good subcontracting,” says one Doha-based international contractor. “But the lesson of the past two years is that good subcontractors don’t exist.”

The same factors that hit the contractors have undermined the subcontractors. For example, fabrication subcontractors have been working less efficiently because the sheer volume of work in Qatar has made it difficult to find skilled labour. And the absence of sufficiently skilled contractors has been compounded by the lack of raw materials.

But construction materials prices have dropped dramatically over the past year. The price of steel, for example, has fallen from a high of $1,900 a tonne in July last year to about $530 a tonne in October, leading analysts to suggest the worst of the contractors’ supply-side problems might now be behind them.

“There is a lot of excess capacity, and they are not having to outbid each other or suffer from failures of delivery, as in the past,” says Christyan Malek, an equities analyst at Deutsche Bank.

Neither Technip nor Chiyoda would be likely to sign the same type of lump-sum turnkey contract they did in the height of the Gulf boom. “They are far more selective,” says Malek.

LNG producers Qatargas Liquefied Gas Company (Qatargas) and Ras Laffan Liquefied Natural Gas Company (RasGas) are clearly sympathetic to the contractors’ plight. “There has been a lot of risk-sharing [on the part of the clients],” says one analyst. “If QP had stuck to the letter of its contracts with Technip and Chiyoda, it could have bankrupted them.”

Whether this sympathy will lead to a substantive revision of contract terms from lump-sum turnkey to cost-plus or a similar type of flexible structure remains to be seen.

Yet there are signs that Qatargas is becoming more flexible with contractors. In March this year, it said it would guarantee payments for preparatory work undertaken by prequalified contractors on its $1.2bn plateau maintenance project, designed to maintain output at the Qatargas I LNG plant at 10 million t/y until 2030. Qatargas informed competing firms it would include a ‘paid-bid’ clause in the contract, meaning it will reimburse all contractors for the time spent preparing their bids.

QP is also rethinking the contracting strategy for some of its ambitious downstream projects. It plans to break up the construction packages for the 250,000-barrel-a-day Al-Shaheen refinery, costed at $10bn, into smaller sections to spread the project risk between contractors.

“If Qatar Petroleum had stuck to the letter of its contracts with Technip and Chiyoda, it would have bankrupted them”

Market analyst

Some contractors are optimistic. “I think you will see a transition from the firm, fixed-price contract to one where you have a target price,” says one contractor.

Yet there is still much for contractors to bid for. The decline of up to 45 per cent in engineering, procurement and construction (EPC) costs since July last year has led Doha to reconsider some large energy projects that barely 18 months ago would have been unfeasible. For example, QP is expected to invite contractors to bid for the main EPC contracts for the Al-Shaheen refinery and Barzan gas project – designed to provide gas for the domestic market – by January 2010.

Contractors hope that the importance of these and new petrochemicals and other downstream gas-based industries will compel QP to revisit its contracting model. 

While contractors would welcome such a move, their margins are still being squeezed, despite the dip in EPC costs, as Doha seeks to obtain 20-30 per cent reductions in contract pricing to justify the economics of the major new gas-based developments. The glut of materials that has emerged in the economic downturn is also likely to disappear as some big new projects come onto the market, taking advantage of the lower EPC costs. “There will never be a cheaper time to build than now,” says the contractor.

But clients are unlikely to change their contracting practices dramatically in the short term, and major energy contracts will still be signed with as much risk outsourcing as the client can get away with.

“We are not seeing a structural move towards improved terms and conditions,” says Malek. “Rather, you will see contractors take on more risk in the belief that we won’t revert back to the extreme conditions of the past couple of years.”

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