The energy sector has been the engine of the Middle East economic boom over the past five years, with high oil prices providing governments with the funds to embark on a wave of major investments in upstream and downstream projects.

Although economic diversification away from the region’s dependence on oil sales remains the strategic priority for governments, crude exports still provide the vast majority of revenues for most Gulf states - at least $600bn worth of earnings in 2007 alone. With oil prices staying above $100 a barrel, the sector is more important than ever.

The value of projects announced or under way in the hydrocarbons field tends to reflect this. More than $260bn is being invested in upstream and downstream infrastructure as national oil companies seek to maintain and increase output capacity, a total second only to the $1.2 trillion being invested in the construction sector.

Yet the 12 months to March this year reveal a startling statistic. A mere $15bn worth of engineering, procurement and construction (EPC) contracts were awarded in the sector over this period, down from $45bn and $35bn in the two previous years respectively, according to Gulf projects tracker MEED Projects, which monitors EPC projects in the region over $50m. If oil and gas is so crucial for the region’s continued prosperity, why has the amount of work awarded in the sector shrunk by so much?

Stretched capabilities

There are several reason for this. On the one hand, it has become clear that both contractors and clients are working at the limit of their capabilities. The sheer amount of work awarded in previous years has drained manpower, engineering expertise, resources and logistical capability. The market was simply unable to continue taking on work at the same rate as before, and the slowdown is a natural reflection of this.

On the other hand, there has been a marked delaying effect caused by rapidly rising EPC costs and materials scarcity. EPC costs have increased by 50-100 per cent over the past three years as the price of essential construction components such as steel and concrete has soared (see feature, pages 42-43), and contractors, facing reduced competition, have sought to increase their profit margins.

Clients have reacted accordingly, either by postponing their projects to allow the market to cool down or, in some instances, scrapping them entirely.

Project delays

For example, Kuwait’s $15bn grassroots refinery at Al-Zour was originally due to have been awarded in the second quarter of 2008. However, when contractors’ prices to build the facility came in more than two and half times the initial budget, the client, Kuwait National Petroleum Company (KNPC), was forced to cancel the tender, delaying the scheme by a year.

Localised issues are another factor. The bulk of EPC contracts awarded in 2005 came as a result of Qatar’s drive to build up its liquefied natural gas (LNG) cap-acity, but with Doha placing a moratorium on further development of its giant North field, the pipeline of megaprojects from the peninsula has dried up.

The issue of existing resources is equally critical. With so much work awarded in 2005 and 2006, clients and contractors alike naturally focused on executing the work they had already won.

“Many people forget that executing pro- jects takes up a lot more attention than simply winning them,” says one London-based industry analyst. “Contractors have to implement their contracts, while clients have to monitor them. New schemes get pushed back as a natural consequence.”

“Rather than a dramatic slowdown, there appears to be a broad regional cyclicity to the GCC market, which shows no imminent sign of weakening,” says Stuart Lewis, Middle East regional manager at energy consultant IHS. “Contractual activity peaks and troughs due to the sheer scale and duration of many existing developments, an effect compounded in recent years by project moratoria and rescheduling.”

MEED’s EPC contractor survey for the period April 2007 to March 2008 is therefore not necessarily indicative of the state of the Gulf contracting sector. Many established contractors, such as Chiyoda Corporation and JGC Corporation, both of Japan, Spain’s TR and the US’ Bechtel, are notable absentees from the list as they undertake their already full workbooks.

“Nothing really happened last year,” says one Al-Khobar-based contractor. “But it will definitely jump this year.”

That said, the table does feature some big names, including Paris-based Technip, SK Engineering & Construction and Samsung Engineering Company, both of South Korea. But it is the US’ J Ray McDermott that has won most new work, thanks to two major offshore contract awards for state oil giant Saudi Aramco and a pipeline contract in Qatar.

Major awards

Its largest deal was the estimated $800m contract to install offshore platforms on the 900,000-barrel-a-day (b/d) Manifa oil field development project. It also scooped the estimated $375m long-term agreement on the offshore ‘maintain potential’ programme, as well as the pipeline job.

Seoul-based GS Engineering & Construction is second on the list after winning in January the $1.14bn green-diesel project for Abu Dhabi Oil Refining Company (Takreer) at Ruwais. “We successfully managed to enlarge our manpower and facilities base to put us in a better position to win more work,” says one GS executive.

The fact that just one contract could catapult a contractor close to the top of the survey demonstrates how small the market for new awards was in the 12 months to March 2008. In 2005-06, Technip topped the survey with $5.7bn worth of contracts. Even last year, Italy’s Snamprogetti headed the table only after winning more than $2bn worth of deals. Indeed, so small is the total this year that only six companies won work worth more than $500m, compared with 14 in 2005.

The presence of three Korean firms in the top six heralds the arrival of Seoul-based contractors in the region in force. GS’s green diesel deal is significant within the context of the Koreans’ success as it is one of the few contracts awarded to Korean firms in Abu Dhabi in recent years.

Since the Koreans were rebuffed for Adco’s Sahil, Asab and Shah (Sas) field upgrade last year, speculation in Abu Dhabi has mounted that Abu Dhabi National Oil Company (Adnoc) has requested its so-called ‘operating companies’ to ensure they are considered for prequalification for all future projects.

They are already on board for the multi- billion-dollar integrated gas development and look well set on Adco’s 1.8 million scheme. Having tied up the Kuwait market and now well-entrenched in Saudi Arabia, Korean contractors are targeting the region’s oil and gas sector.

The Koreans have been fully able to capitalise on the absence from the market of more established Western contractors. With costs rising by the day, they are consistently able to bid competitive prices and conform to project schedules that others cannot.

“We have not suddenly sprung onto the scene,” says another Korean contractor. “We have all been working in the region for some time, but we have [now] built up such a resume of experience from Oman, Qatar and Kuwait that clients in Abu Dhabi and Saudi Arabia can no longer ignore us. We have the confidence now to succeed.”

Local winners

Korean firms have not been the only companies able to take advantage of the conditions. With the bigger players busy, traditionally smaller contractors such as Oman’s Galfar, India’s Punj Lloyd and Dubai-based Dodsal have also won some big deals over the past 12 months, the largest of which was the latter’s $750m contract to implement the Qarn Alam enhanced oil recovery scheme in Oman.

As a result, these firms are doing more work than ever, and are seeing their names rise up the list. “These types of contractors have always been there, especially given that they take on much of the construction load on the big EPC contracts,” says a source at one medium-sized contractor. “In many cases, they have a better safety record and much better relationships with clients than the big boys.”

According to Naushad, business development director at Galfar, internationals will not need to worry, however. “Where the Technips and Snamprogettis are required, they will still get the work because of the engineering requirement,” he says.

Chinese competition

The Chinese are the next major entrants on the horizon. Firms such as China Harbour Engineering Company and China Huanqiu Contracting & Engineering Corporation have made significant inroads into the regional construction, industrial and power and water sectors, and are soon expected to figure in the hydrocarbons field.

BGP is already a leader in seismic processing in the Gulf, and exploration and production companies such as Sinopec and China National Petroleum Company are expected to bring in their compatriots as they increase their oil output in the region.

“While Chinese companies have come to take a significant market share in the upstream service sector, with the likes of ZPEB & Great Wall for land drilling rigs and BGP for land seismic, this trend has yet to manifest itself as dramatically in the mid and downstream sectors,” says Lewis.

The contracting market is becoming more crowded, but the signs are there will be more than enough work for everyone. Kuwait says it plans to invest more than $50bn over the coming five years in its oil and gas sector. Riyadh plans investment of more than $80bn over the same period, while similar amounts are estimated for Qatar and the UAE.

Of those investments, almost $60bn worth of EPC contracts are scheduled to be awarded in the coming 12 months, according to MEED Projects. One project - the new grassroots refinery at Al-Zour in Kuwait - will be worth more than the total value of contracts awarded last year alone.

Add to that the massive Manifa and Karan crude and gas increment schemes in Saudi Arabia, the Jubail and Yanbu export refineries, and the Sas field development in Abu Dhabi, and it is clear that in the short term at least, there will be plenty of contracting opportunities.

There are also signs that the main players are becoming hungry again. “It is inevitable that as the contracts reach a conclusion, all the large contractors that were so successful in 2005 and 2006 will start looking for work again,” says the London-based analyst. “They need to. They already have thousands of staff and millions of dollars worth of equipment mobilised that will stand idle unless more contracts are won.”

Over the coming two years, the big guns should re-emerge, and if clients adopt the right strategy, it should ensure enough contractor competition to stem the rampant inflation in EPC costs.

Contractors and clients will nonetheless have to adapt to the changing times. Contractors will need to continue the trend of establishing low-cost engineering centres in places such as India and China.

With the number of Western-educated engineers falling, greater efforts will need to be made to attract talent from diverse economies. The same goes for labour. Upwards of a million people are required in any one year to implement the region’s hydrocarbons plans and new sources of manpower, such as Vietnam and Laos, will be required.

For their part, clients will not be able to rest on their laurels. Contract terms will need to be continually re-evaluated to ensure there is an adequate sharing of risk and that diverse contracting strategies are adopted.

Balancing needs

It is becoming increasingly clear that the cost-reimbursable, convertible lump-sum approach is not the panacea to all contractual issues as clients struggle with the procurement complexities these contracts cause. Clients will need to settle on a strategy that adequately balances their needs with those of their contractors.

Despite the obvious challenges ahead, there is no room for pessimism. Such is the global thirst for oil that the region’s national oil companies will be required to invest in increment programmes for years to come. And with the oil price so high, there will be no lack of funds for them to do this.

Key Fact:

Just $15bn worth of new contracts have been awarded over the past 12 months, compared with $45bn on 2006/07.