These are uncertain times for the energy sector. Less than six months ago, oil was trading at $147 a barrel, and while consumers were worrying about a seemingly unstoppable rise in prices, the main problem for producing nations was finding enough materials and contracting expertise to keep up with the acceleration in project activity that accompanied the upturn.

But in early December 2008, the price of a barrel of Brent, the European benchmark crude, fell below $40 on the announcement from Washington that unemployment in the US had reached a 15-year high. Today, the problem is not so much the difficulty of finding contractors to do the work, but rather the task of agreeing a price for the work that accurately reflects the changed global environment.

The short-term outlook for global oil demand is gloomy. The International Energy Agency (IEA), which acts as an energy adviser to 27 of the largest oil-consuming nations, says demand for oil declined in 2008 for the first time since 1983.

In its latest Oil Market Report, published in December 2008, it estimates that there was a drop in demand of 200,000 barrels a day (b/d) last year, compared with 2007, and predicts a further 300,000-b/d fall in 2009. Meanwhile, in its Short-Term Energy Outlook, published the same month, the US Energy Information Administration estimates there was a fall in demand of 50,000 b/d in 2008, and forecasts a further fall of 450,000 b/d in 2009.

Cutting production

Opec has tried three times in recent months to prop up oil prices. In September 2008, it exhorted its members to adhere to their existing quotas, in an effort to reduce overall output by about 500,000 b/d. The following month, the organisation agreed a cut of 1.5 million b/d, and following a meeting in Algeria in December, a further 2.2 million b/d cut was announced. But strong sentiment in the market and uncertainty over whether the cuts would actually be made means that despite these efforts, the oil price has continued to fall. When the latest cut was announced, prices again dropped below $40 a barrel.

Opec “is able to impose no or almost no influence” on the fluctuation of crude oil prices, said Hasan Qabazard, director of the research division at Opec, in early December. The global economic downturn is creating great uncertainty in the upstream projects market. As equity markets have collapsed around the world and oil prices have fallen, so too has the cost of basic materials.

Prices for aluminium, copper, nickel, lead and tin all fell by 20-35 per cent in the year to 3 December 2008, according to figures compiled by UK finance house Standard Chartered Bank. The price of hot-rolled coil steel fell by more than a fifth over the same period in all the world’s major markets, with the exception of Japan. And in early December, the Dow Jones index of commodity prices fell to just over 105 points, from a high of 238 points in July. There has also been a sharp fall in freight rates: the Baltic Dry Index, a benchmark measure of traffic, dropped to a 22-year low at the end of November 2008, 93 per cent down on its May peak.

With commodities prices falling so rapidly, national oil companies (NOCs) are anxious that they do not pay over the odds for engineering and construction services. Saudi Aramco is asking for new prices for the main contracts on the Manifa field development, despite the fact they have already been awarded, and is also asking bidders to submit revised bids for the Karan gas field development project. Similarly in Abu Dhabi, international firms have been asked to submit adjusted prices for the Sahil, Asab and Shah (Sas) field development programme.

The problem for contractors is that costs are not falling as fast as developers would like. Most either procured long lead items for current projects before the downturn in prices and are therefore locked into contracts, or are buying from materials providers that need to run down their expensively procured inventories before they can lower their prices.

In its December report on upstream capital costs, US-based international energy analyst Cambridge Energy Research Associates says that despite falling oil prices, the high level of activity and tightness in the upstream services and equipment markets led to a 9.2 per cent rise in upstream capital costs over the previous six months. According to the study, steel costs increased by 14 per cent over that period, and there was no change in procurement lead times after the first quarter of the year.

Contractors throughout the region tell MEED that continued high costs mean they cannot meet the 25-30 per cent price cuts that NOCs are understood to be seeking. One contractor in Abu Dhabi says the combination of a small reduction in materials prices, the remodelling of contract terms and the introduction of other efficiencies might enable the company to cut costs by a little over 10 per cent.

In Saudi Arabia, another service contractor says there is “no reason on earth” why service companies would be able to cut their costs by 30 per cent, while the country manager of an international oil company (IOC) working in North Africa says that tightness in the market means his company is still being forced to procure offshore rigs at inflated prices.

The consensus among contractors and industry analysts talking to MEED in recent weeks is that delays are likely to prove the best way to bridge the gap between the expectations of NOCs and international contractors. As a result, while construction contracts that are already under way are expected to go ahead as planned, those on which work is yet to begin are likely to be put back.

Lengthy delays

The length of the delays is difficult to predict. Early in the fourth quarter of 2008, senior energy industry executives told MEED they would have a better idea of the market by the end of the first quarter of 2009. But by the end of the year, with the continued fall in oil prices perpetuating the uncertainty of the market, many were saying that projects could be delayed by up to 12 months. The majority now say they will wait and see.

The fall in oil prices is also having an impact on the willingness of IOCs to take on upstream exploration and development contracts. When oil prices were high, state oil firms were keen to ensure that IOCs were not benefiting disproportionately. As a result, the terms of exploration contracts in markets such as Libya and Algeria became increasingly severe. But now that oil prices are falling, overseas companies are thinking twice before entering into such contracts.

Such was the discrepancy in the valuation of upstream contracts between the state and foreign oil firms in Algeria’s last exploration licensing round in December that only four of the 15 concessions on offer received bids. State energy company Sonatrach withdrew the most attractive prospect from the round, having established that any prospective bids were likely to be well below its initial expectations.

In Libya, senior IOC executives working in the country tell MEED that another upstream exploration round on similar terms to those offered by the recent exploration and production-sharing agreements would not be viable in the current oil price environment. Meanwhile, if oil prices do not return quickly, at least to the range of $50-70 a barrel, then the country’s oil field development programme could be delayed by 12-24 months.

NOCs also claim that low oil prices will hit their investment plans. In late November, Saudi Oil Minister Ali al-Naimi took the unusual step of announcing that “the fair price of oil is $75 a barrel”. Qatar’s Energy Minister Abdullah al-Attiyah, also speaking in late November, said that prices were too low to sustain investments in the oil industry, and that it would be difficult to boost output. And Opec president Chakib Khelil said in December that although “normally Opec has no price target - the bottom cost below which we cannot step down is between $70 and $90 a barrel”.

Yet despite unease about the market’s short-term prospects, oil companies already working on exploration and development projects in the region remain bullish about the longer term. “We do not make decisions on day-to-day prices,” says the country manager of one IOC working in Libya. “These are long-term projects that are going to deliver over decades, so the current oil price is neither here nor there,” says another senior IOC executive working in Oman.

Even in Jordan, where the development of oil shale - a technology that is unlikely to be viable at an oil price of less than $80 a barrel - is a cru-cial part of the country’s strategy to reduce its dependence on hydrocarbons imports, there is confidence about the future. “There is no effect on these projects,” says Maher Hijazin, head of the country’s Natural Resources Authority. “Oil shale projects are 40-year projects; we are not working on the oil price of today.” The contrast between the industry’s uncertainty about the next few months and its confidence about the longer term is explained by the fact that despite the unexpected scale of the current downturn, it is still regarded as cyclical rather than structural, and the fundamentals of the market are unchanged.

According to the IEA’s latest annual report, published in November 2008, conventional crude oil production will peak in 2020, while overall crude production will peak in 2030. The IEA has revised its estimated rate of decline from existing oil fields to 6.7 per cent, from 3.7 per cent the previous year, meaning that additional supply will have to increase just to maintain current production. Meanwhile, demand is set to increase strongly over the longer term. Opec’s Qabazard said in early December that he expects global crude consumption to increase to 92.3 million b/d by 2012, from 84.7 million b/d in 2006.

Most market analysts predict an average oil price of $55-60 for 2009, based on a modest rally in the first half of the year and a stronger recovery in the second half as the world begins to emerge from recession. But they are more bullish about the next decade. By 2010, prices are expected to have returned to the levels currently targeted by Opec, and beyond that most analysts are more concerned about a lack of supply rather than a lack of demand. In its Commodity Investor report, published on 11 December, UK-based investment bank Barclays Capital says a sustained period of low prices would prepare the ground for “potentially catastrophic supply problems in the next few years”.

After an uninterrupted five-year oil boom, producers and contractors in the Middle East are likely to find the next few months difficult. But over the longer term, they can expect the good times to return.