Like all good things, the boom in the Middle East project market has to come to an end at some point, and the evidence suggests it is already slowing. According to Gulf projects tracker MEED Projects, in the 12 months to the beginning of June 2008, just over $7bn worth of engineering, procurement and construction (EPC) contracts were awarded in the GCC petrochemicals sector, less than half the $16.3bn worth awarded the previous year, and lower still than the $17.5bn worth awarded the year before that.
However, the slowdown has not been unexpected. There have been far fewer projects coming to the market in the past 12 months. A shortage of available ethane feedstock in Saudi Arabia, the main driver of chemical growth in the region, has meant that the flow of the kingdom’s production projects is close to drying up.
Across the GCC, there were only two notable projects awarded in the whole 12-month period. The larger of the two was the $4bn National ChevronPhillips (NCP) olefins complex at Jubail, developed jointly by Saudi Industrial Investment Group and the US’ ChevronPhillips Chemical Company.
The only other major scheme awarded was the $3.2bn fifth-phase ammonia and urea expansion planned by Qatar Fertiliser Company (Qafco) at Mesaieed – a rollover of contracts awarded the previous year that were effectively re-bid. Apart from smaller scale facilities awarded such as the Arabian Amines complex at Jubail, tendering activity in the regional sector has virtually ground to a halt.
The contracting slowdown is not unique to petrochemicals. The oil and gas sector has also experienced a halving in contracting activity over the past year, just $15bn in the year to March, down from $35bn the year before. What has become apparent is that the market in both sectors is taking a breather after a hectic two years in which more than $110bn worth of EPC contracts were awarded in the Gulf alone.
Quite simply, project sponsors and the contracting community hit a natural limit to their capacities. The market could not absorb any more activity.
The good news is that, just like hydrocarbons, the petrochemicals slowdown is likely to be temporary. More than $84bn worth of contracts in the Gulf petrochemicals sector are expected to be awarded over the coming five years, more than $7bn of which are under bidding and due to be awarded in the next few months.
These include the Saudi International Petrochemical Company (Sipchem) cracker in Jubail, and the Honam Petrochemical Corporation/Qatar Holding Intermediate Industries olefins and aromatics complex at Mesaieed, as well as the Jubail ethylene dichloride facility, planned by a joint venture of Sahara Petrochemical Company and Saudi Arabian Mining Company (Maaden).
The longer-term outlook is even more promising, as the two largest chemical production projects in history go head to head.
Tendering for the main process packages at the giant Ras Tanura refinery and integrated petrochemicals complex and the first-phase Chemaweyaat aromatics, olefins and fertiliser complex at Taweelah should start in the summer of 2009. Each scheme will have a total cost of at least $20bn and should keep contractors busy for some time.
Indeed, some observers are already questioning whether the market will be able cope with the large amount of resources such projects will require. “On the Chemaweyaat project in particular, it is very doubtful that there will be the manpower, equipment and material available to develop the complex in the timeframe they are looking at,” says one Abu Dhabi-based contractor.
Equipment and labour remain a major headache for contractors. Costs for materials such as steel and cement keep rising, and contractors find it hard to get firm prices for equipment beyond a few weeks.
As contractors seek to hedge themselves against being caught out by sudden increases in their cost base, so EPC costs have gone up. The general consensus is that it now costs roughly twice as much to build a complex as it did five years ago.
“Compared with last year, the material situation is a little better,” says Nobuhiro Kobayashi, senior vice-president of Japan’s JGC Gulf International, which came top of this year’s contractor survey (see table, page 44). “But still material prices are a big worry, especially steel. We expect fluctuations to continue.”
But rising EPC costs have not necessarily resulted in better bottom-line figures for contractors. Profit margins remain more or less the same, and in some cases have decreased. Some firms that signed lump-sum deals in 2003-04 before the boom became apparent have lost hundreds of millions of dollars as the cost of materials has soared.
“Margins have not increased,” says Jay Choi, general manager, business development and marketing at South Korea’s Samsung Engineering Company.
“They are stable or are even lower than before because even if we get better margins from the client, the suppliers and construction subcontractors absorb most of them.”
The other major issue for contractors is labour, both manual and skilled. With hundreds of thousands of labourers now working in the Gulf, the manpower pool of the traditional workforce supply in Asia is substantially thinner. More worrying still is a lack of suitably experienced engineering talent required to design the complex projects.
“Faced with a shortage, EPC contractors are putting inexperienced engineers, straight out of university, on intensive courses to get them up to speed,” says Euisuk Rah, part of the plant business team at South Korea’s Hanwha Engineering & Construction.
Clients have reacted to the contractor squeeze and heightened EPC risk by adopting convertible lump-sum contracts to enable both parties to get a better final cost estimate. This has allowed for more competitive bidding for tenders but has not really had much of an impact on overall EPC prices.
In fact, far from being the panacea, convertible lump-sum deals have become a bone of contention with delays and disagreements between contractor and client over the conversion and final lump sum. The Qafco V project is perhaps the best example.
After being awarded on a cost-reimbursable basis initially, the two original contractors left the project and the scheme was re-awarded to Italy’s Snamprogetti and South Korea’s Hyundai Engineering & Construction Company on a lump-sum basis.
“A lot of clients, we think, will be looking to go back to the lump-sum model because of the difficulties with the convertible lump-sum contracts,” says Choi.
“They don’t get any benefit from convertible lump-sum like shorter tender schedules and cost savings.”
But for all the undoubted issues facing the contracting strategy, the sheer amount of work available should ensure that contractors will be busy for years to come. The challenge for firms will not be finding work, but making sure they make a good profit from it.