Emirates press ahead with energy sector expansion

20 March 2009

The Petroleum & Mineral Resources Ministry has signalled its determination to continue investing in energy sector infrastructure despite the global downturn, with $28bn worth of projects planned.

The UAE may be suffering as badly as any country in the region from the global downturn, but it is committed to an expansion of its oil and gas infrastructure. The country has more than $28bn worth of oil and gas projects planned between now and March 2010, according to Gulf project tracker MEED Projects, and the Petroleum & Mineral Resources Ministry has repeatedly insisted that, regardless of the economic turmoil, work will continue.

Speaking in London in February, UAE Energy Minister Mohamed bin Dhaen al-Hamli warned of the dangers of not continuing with expansion. He said the global economic turmoil was leading to a lack of investment in production capacity, which he forecast would have catastrophic consequences for the region’s ability to meet future increases in demand.

Expanding capacity

Al-Hamli is in good company, as both the secretary general of Opec, Abdalla el-Badri, and the chief economist for the Paris-based International Energy Agency (IEA), Fatih Birol, have recently warned of a supply crunch in the coming years.

However, contractors, analysts and international oil company (IOC) executives do not expect the UAE to escape from the difficulties, and many say they do not believe the coming years will bring the level of development that has been promised.

While many contractors think the country will eventually accomplish its ambitious plans to expand oil and gas production, they do not expect it to reach its target of increasing oil production capacity from 2.5 million barrels a day (b/d) today to 3.5 million b/d by 2015.

“They have a lot of projects planned, and every intention of seeing them through,” says a senior source at one large international contractor. “But they also have an eye on commodity prices and demand, and the cost of projects.”

One senior government source told MEED in February that while there was no intention of cancelling any of the country’s projects, there was a caveat that the deadline for 3.5 million b/d might not be reached on time.

Much of the UAE’s planned capacity increases will come from expanding production at existing onshore and offshore fields, rather than developing major new acreage.

These developments are being overseen by the exploration and production arms of the Abu Dhabi National Oil Company (Adnoc), including the Abu Dhabi Company for Onshore Operations (Adco), the Abu Dhabi Marine Operating Company (Adma-Opco) and the Zakum Development Company (Zadco).

These companies in turn work in association with government-owned oil and gas processing companies such as Abu Dhabi Gas Industries (Gasco), Abu Dhabi Gas Liquefaction Company (Adgas), and Abu Dhabi Oil Refining Company (Takreer). Between them, these companies have plans to expand capacity in the state but, according to one local contractor, much of the work is likely to be delayed.

According to data from MEED Projects, over the past 12 months, $4.9bn worth of engineering, procurement and construction (EPC) contracts have been awarded for oil projects in the UAE, a large proportion of which came from the award of two packages for work on the Sahil, Asab and Shah (Sas) fields by Adco in January 2009, worth a combined $3.5bn.

More contracts are due to be awarded over the coming year but, given the amount of deals that went through in the past 12 months, one analyst describes the plans to award $28bn worth of contracts in the year to March 2010 as “unrealistic”.

Of the projects that are due to move ahead in the coming year, one of the most ambitious is Gasco’s Integrated Gas Development (IGD). The project incorporates the production and transfer of more than 700 million cubic feet a day (cf/d) of high-pressure gas from the offshore Umm Shaif and Khuff reservoirs to new onshore processing facilities at Habshan and Ruwais. The project is due to be completed by 2012.

A project management consultancy contract for the onshore portion of the scheme is due to be awarded before the end of March 2009, along with five onshore EPC packages worth about $5bn in total, and associated works worth an additional $300m.

The offshore development package for the IGD is due to be tendered this year, and is valued at less than $400m. The project is due to be completed by the fourth quarter of 2013.

Adco’s ‘1.8 million’ project, to increase oil production at the Qusahwira, Bida al-Qemzam, Ruwais and Bab fields by 400,000 b/d, is due to have EPC contracts tendered in 2009, at an estimated value of $3bn, with completion set for the fourth quarter of 2013.

EPC contracts for Zadco’s ‘750’ project, to increase production from the field from 500,000 b/d to 750,000 b/d while increasing the processing capacity at the company’s Zirku island facility, are also due to be awarded in 2009 and 2010. The project is valued at a total of up to $3.8bn and it is slated to be completed in 2015.

However, the standout project, in terms of value, is Adnoc’s Shah Gas Development, which is valued at more than $10bn. A final investment decision on the project is due to be made this year by Adnoc’s joint venture partner, the US’ ConocoPhillips.

Given the current drive to cut costs in the wake of the fall in oil prices over the past year, many contractors say the scope of these and other projects may well be reduced, and some would be put back entirely.

Project delays

Already, Abu Dhabi has had some success in cutting costs by reducing the scale of some projects. Adco managed to cut the cost of the Sas scheme by $1bn to $3.5bn, after retendering it as two contracts with a smaller scope of works. It asked the firms that had competed for the contract previously, when it had been just one package, to reduce their bids and, in return, offered improved terms, such as a larger downpayment and lower fines in the event of construction work overrunning.

Contractors in the UAE also tell MEED that they believe forthcoming EPC contracts for the ‘1.8 million’ project will only cover two of the four fields originally discussed, which again will help to reduce the initial cost of the project significantly.

Ismail al-Ramahi, manager of Adnoc’s gas process division, told the Gas Arabia conference organised by energy investment company Energy Exchange in Abu Dhabi in February, that costs on the Shah gas development could also be cut by up to 30 per cent. However, the entire project is increasingly in doubt. Questions have been raised by contractors over ConocoPhillips’ ability to justify the financing for the project in the current financial climate.

ConocoPhillips has said it will make a final investment decision once the front-end engineering and design (FEED) process has been completed, but this has been delayed from February to the second quarter of this year and Adnoc is expected to ask for changes to the FEED before then.

A completion date of 2013 was originally set for the project, but Ismail al-Rumhi, director of the gas treatment section at Adnoc, recently told the Arabic language daily Al-Hayat that the EPC contracts on the scheme will now be awarded “in the next two years” instead of 2009 as originally planned.

One UAE-based contractor says the government-owned energy companies are showing different levels of commitment to their projects. “Gasco seems very keen to get things done,” he says. “But with Adnoc, we don’t hear a lot, and I am never really sure what is happening [with] Zadco.”

But a slowing of the pace of investment will not necessarily be to the country’s detriment. Project costs, which peaked in 2008, when there was a shortage of contractor resources and commodity prices were high, are now tumbling back down. Projected capital expenditure across the industry is down as by much as 20 per cent for 2009, compared with 2008.

“It is an obvious choice, a pragmatic stance, when you consider the collapse in oil prices and the effects on global oil demand from the current economic downturn,” says Colin Lothian, Middle East analyst at UK-based consultant Wood MacKenzie. “Development capital expenditure has reduced in the order of 10-20 per cent on some of the larger EPC contracts from the mid-2008 highs.”

In this environment, especially given crude oil trading at less that $40 a barrel through most of the early months of 2009 and the global recession, the UAE has nothing to lose if projects are delayed by one or two years.

The UAE is also committed to reducing its oil production as part of a co-ordinated series of cuts by Opec members. The international oil cartel hopes to have cut its members’ production by more than 4 million b/d between September 2008 and February 2009. At Opec’s meeting in October 2008, for example, the UAE was asked to cut production by 134,000 b/d, or 8.9 per cent of the total 1.5 million b/d of cuts implemented at that meeting alone.

The decisions the UAE makes on its energy projects in the coming years depend largely on global demand for crude oil and gas, and how long or deep the recession is in major consuming nations in Europe, the US and Asia.

According to Paul Hodges, chairman of consultant International Echem, there are three possible economic scenarios, which he categorises as V, U, and L-shaped recessions.

A V-shaped scenario will lead to a quick recovery, as happened in 1997-98 or 2001-02, whereas a U-shaped recession would be more like the early 1980s or 1990s, when demand took up to five years to recover.

The worst-case scenario is an L-shaped downturn, which would mean economies remain at their depressed level for even longer, leading to a “lost decade”, similar to the one that Japan suffered in the 1990s.

Hodges’ current expectation is still a U-shaped recession, although he fears that an L-shaped one is becoming more likely.

International Monetary Fund (IMF) managing director Dominique Strauss-Kahn recently suggested that demand from Asian countries could return by 2010-11, but Hodges says it is likely to take a lot longer before demand returns to 2007 or 2008 levels.

Regardless of the dynamics of the oil market, however, Lothian, who describes the UAE as a “countercyclical” investor, says the country will continue to invest in its infrastructure, albeit at a slower pace. He adds that a target date of 2017-18 for the country to increase its production capacity to 3.5 million b/d is more realistic.

While it is impossible to say how the global economy, and hence demand for oil and gas, will fare in the coming years, if the UAE can push ahead with investments during the downturn, it should be well placed to benefit once recovery does happen.

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