PROJECT RISK: Spanners in the works

18 August 2006
It started with a bang, but the construction boom could end with a whimper. In late July, Peter Voser, chief financial officer (CFO) of the Royal Dutch/Shell Group, publicly admitted his concerns over major cost overruns on the Pearl GTL project in Qatar. In mid-2004, capital expenditure on the scheme was projected at about $6,000 million. By the time the final investment decision was taken on 26 July, the cost of the integrated gas development had risen to an estimated $12,000 million.

'Shell would no longer be in the business of providing cost estimates for individual projects, as they are frequently rendered irrelevant,' he told reporters in London. 'When you start work on a project, the scope, the sequence and timing of the investments are often not clear. If I had been the CFO then [at the time of project announcement], I would probably not have included a cost estimate in the initial public communications.'

The pioneering 140,000-barrel-a-day

(b/d) Pearl gas-to-liquids (GTL) project is not the first massive project to fall victim of growing uncertainty and project execution risk in the Gulf's oil and gas market, and it will not be the last. The Rabigh refinery scheme in Saudi Arabia, which was launched at the same time as Pearl GTL, has also seen its costs double, to $9,900 million.

Contractor prices for the ambitious flowlines replacement scheme of Kuwait Oil Company (KOC) came in at about $1,200 million, nearly twice the estimated budget. More recently, a similar story was repeated with the Qarn Alam enhanced oil recovery (EOR) project in Oman.

A number of factors have contributed to the major increase in project costs: a relentless hike in the price of construction materials over the past two years; the growing shortage of qualified engineers; the availability of manpower; and a rapidly shrinking engineering, procurement and construction (EPC)

contractor base, to name a few.

But an equally important issue for clients is the increasing delays on projects awarded over the past three years. On the Dolphin pipeline project, delays have been encountered as contractors struggle with price increases. The first flush of Qatari gas is now not expected to arrive at the Taweelah receiving station in the UAE until the summer of 2007. At Habshan, work on one of the packages on phase 3 of the onshore gas development and phase 2 of the Asab gas development (OGD-3/AGD-2) programme has been delayed by some five months due to the non-availability of equipment. 'This is a global malaise now,' says an official of Germany's original equipment manufacturer ManTurbo. 'Delivery of long-lead items now takes an additional eight-12 months, as price and materials have gone haywire.'

The delays and heavy workloads are compounding the costs incurred by EPC

contractors bidding for new work. In Oman, the Qarn Alam and Mukhaizna projects,

both of which are out to tender, are cases in point.

As contractors' margins are threatened,

liquidated damages are becoming a real issue. 'They [delays] will eat into our profits,' says an

Al-Khobar-based EPC contractor. 'Clients have nominated subcontractors and vendors and we cannot control their delivery schedules. Unless we deliver on time, we will not maintain credibility with clients and lose standing in the industry.'

The upshot is a sharp increase in project risk for contractors and clients alike. 'It is at an unprecedented level and is getting bigger,' says an official of a leading Asian EPC company. 'On a scale of one to 10, risk levels are now peaking at eight. The Gulf may be free of political risks that oil and gas projects are vulnerable to in Africa, South America and Asia. But we see a new form of risk gaining ground the Gulf is becoming a victim of its own success.'

In the recent past, Gulf national oil companies (NOCs) have successfully implemented a number of multi-billion-dollar hydrocarbon developme

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