Rising costs threaten Aramco's expansion plans

27 June 2008
The world’s largest oil and gas company is confident it can mitigate the effects of spiralling costs and labour shortages that have delayed projects key to hitting its ambitious 2009 production targets.

Despite spiralling construction and raw material prices, and a dearth of skilled labour, Saudi Aramco remains confident that it will meet its challenging production target of 12.5 million barrels a day (b/d) by 2009. “All of our planning is based on maximum sustained capacity,” one Aramco executive tells MEED. “Our whole system is ready for that.”

Aramco’s current capacity is 11.3 million b/d. Production increases are expected to come from several fields over the next three years, including 1.2 million b/d from Khurais, 900,000 b/d from Manifa, 500,000 b/d from Khursaniyah, 250,000 b/d from Shaybah and 100,000 b/d from Nuayyim.

But even Aramco, which is known for delivering its projects on time, has been hit by delays to its programme caused by the tight construction market.

“There are limited resources and that means high prices for materials and engineered equipment,” says the executive. “There is a strain on the market and long lead times. We have made some adjustment but we are also suffering from the issues of cost escalation and delay. Producing a barrel of oil today costs a lot more than it did five years ago.”

Deadline delays

Delays have meant that the 500,000-b/d production increase at Khursaniyah missed its planned end of 2007 deadline.

Contracting issues including a lack of welders to join sections of the 500 kilometres of pipelines are understood to be the key reasons for the delay. But officially Aramco is reluctant to admit the dates have slipped. The firm will not say when in 2008 production will come on line, abiding by the premise that the only thing worse than missing a deadline is missing two.

Aramco is doing all it can to improve cost certainty. In a bid to better control costs, it moved to convertible fixed-price contracts several years ago, so the final price is set after the detailed design is complete. However, Aramco is keen to move back to non-convertible fixed-price deals. “It gives our engineering, procurement and construction [EPC] contractors little motivation to seal the deal,” says the executive. “The risk [of cost overrun] is lowered but the contractor does not want to then move to lump sum, and will keep finding reasons not to.”

Until a lump sum is fixed, EPC contractors are paid on a cost-reimbursable basis and Aramco carries all the risk. “We are seeking to return to non-convertible fixed-price contracts, where the price is bid up front, but we will add provisions for escalation,” says the executive.

Another step being taken by the firm is to set up direct supply agreements with large manufacturers. These will be written into EPC contracts and again mitigate the risk of non-delivery. Saudi Arabia’s expanding domestic gas demand is also putting pressure on the firm to find and exploit more natural reserves.

Total gas production was 8 billion cubic feet a day (cf/d) on average at the end of 2007, and the plan is to increase this to 13 billion cf/d by the end of 2011. Two fresh gas finds at the Karan and Jana fields in 2007 will help meet this but exploration of the Rub al-Khali (Empty Quarter) has been less successful, with a small number of finds to date but nothing like the volume required to go into production.

Domestic demand

As a result, uncertainty surrounds the future of the four concessions exploring the field. These are a series of Aramco joint ventures with the UK/Dutch Shell Group, Russia’s Lukoil, Italy’s Eni and Spain’s Repsol, and China’s Sinopec.

On the infrastructure side, gas projects are also experiencing some of the delays that are hitting oil projects, with the Hawiyah natural gas liquids (NGL) recovery plant, which will process 4 billion cf/d of sales gas and yield 310,000 barrels of natural gas liquids, expected to miss its July 2008 deadline. Delays with the commissioning of the Khursaniyah gas-oil separation plant have led to gas from the field being diverted to the Berri plant until it is ready at the end of 2008.

Another commitment that singles Aramco out from its peers, and should ensure that it continues to boost production, is its investment in research and development of new technologies. The Ghawar Integrated Assessment & New Technology team has found passages in the matrix of carbonate rock, where a significant amount of unrecovered oil resides.

“The discovery indicates that worldwide, there is about twice as much oil left in the ground following production of a field as was obtained during pro-duction” says Aramco’s 2007 review. “Understanding the newly discovered carbonate micro-pore system behaviour has great potential for fully optimising existing resources.”

Efforts are also under way to better understand the kingdom’s resources and more efficiently extract its reserves.

It is little wonder, then, that there is a sense of frustration within Aramco that it must continue to meet soaring domestic demand, at subsidised rates compared with world markets. Saudi Electricity Company (SEC) predicts the kingdom will require a further 35GW of generation capacity over the next 10 years.

Industrial and private users have no incentive to reduce consumption while energy prices remain low. “The rise in domestic consumption for all types of power is a major concern, we control very little of this,” says the Aramco executive.

“We feed fuel to the utilities who feed it to the consumers and there are a lot of inefficiencies. All natural gas is used domestically. The minister can say we will go to maximum production but if much of this is used domestically, it won’t help.”

The utilities themselves are undergoing a period of reform and are working to improve efficiency. However, the ultimate motivator for using fuel more sparsely is to introduce tariffs that reflect market prices for electricity - something Saudi Arabia is not quite ready for.

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