With oil regularly trading above $100 a barrel and the bank balances of national oil companies (NOCs) at record levels, it may come as a surprise that the number and value of energy projects in the Gulf has fallen by two-thirds over the past year (see feature, pages 36-40).
Putting record crude prices to one side, a dearth of contractor capacity and spiralling costs caused by a spike in materials prices has forced clients to reduce, postpone or even cancel projects. Abu Dhabi’s International Petroleum Investment Company (Ipic) is thought to have cut the capacity of its planned Fujairah refinery to just 200,000 barrels a day (b/d) from an initial 500,000 b/d because of cost concerns. In Saudi Arabia, the proposed Jizan export refinery is also likely to be reduced to about half its original capacity, due in part to price inflation on materials and parts.
In neighbouring Qatar, supply bottlenecks have pushed back delivery on long-lead items for the construction of the state’s liquefied natural gas (LNG) trains, and severely eroded profits for two of the main contractors: Japan’s Chiyoda Corporation and France’s Technip.
In Oman, the $10bn, 300,000-b/d refinery being evaluated by the government may be downsized to less than half that size, as concerns mount over the feasibility of the project in its current form.
While much of the cost inflation has historically been blamed on deficiencies within the labour market, contractors are having difficulty securing the basic building materials needed for construction.
US oil and gas analyst Cambridge Energy Research Associates (Cera) says basic commodities such as cement, copper and diesel fuel have become limited, especially in the Middle East. This is partly because of the unexpectedly rapid expansion of the Asian economies. “Projects that were economically viable a year ago may no longer be attractive,” said Cera in a recent note to clients.
The consultant describes the sharpest increases in the last six months of 2007 as those requiring machining, skilled labour and high-priced raw materials such as nickel, steel and copper.
Cera says the price of upstream oil field equipment – such as major power facilities, steel, onshore and offshore rigs and sub-sea equipment – increased by 5-20 per cent in the second half of 2007. Specialised equipment required for sub-sea installations rose by 15 per cent over the same period.
Much of the core cost increases for these parts can be traced to higher raw material prices for commodities such as steel, which cost 8-23 per cent more in the last six months of 2007, depending on quality and the country of manufacture. Other vital materials are also in short supply, with the most acute shortages found in titanium, nickel, molybdenum, iron ore, coal and alloy materials.
While the cost of ready-mixed concrete and cement has increased significantly, the highest escalation has been in the price of carbon and galvanised steel piping, a basic raw material for the oil and gas industry.
Structural steel, heavy vessel, air cooler, pump and seamless pipe manufacturers across the region are overloaded by as much as 200 per cent, according to one industry analyst.
Delivery times for seamless pipes have doubled from four to eight months for large vessels, and increased from 12 to 18 months for compressors and 12 to 16 months for boilers.
Crucially, it appears that the steel market, which is vital for the pipeline and refinery industries in particular, may face even leaner times ahead in terms of expense. A recent deal between Middle East steel makers and Brazilian iron ore producers could result in the price of feedstock for steel mills in the region rising by nearly 90 per cent compared with 2007 prices.
Brazilian mining company Vale lifted the price of direct-reduction pellets sold to four of the region’s biggest steel producers by 86.7 per cent in early April. The rise was the outcome of negotiations between Vale and Egypt’s Ezz Steel, the Libyan Iron & Steel Company (Lisco), Qatar Steel Company and Saudi Basic Industries Corporation (Sabic).
As a result of price negotiations between global suppliers and major steel producers, prices for iron ore are used as an indicator of overall cost increases across the industry.
London-based Corus Group, one of the world’s largest steel producers, says the Middle East is in a difficult position because of its lack of producing capacity.
Cera estimates the cost of the special mill runs required for oil industry-grade steels has increased by about 150 per cent over the past seven years.
David Rodgers, senior sales manager for Corus International, says prices for welded pipe and coil have been highly volatile, with increases of up to 20 per cent for some products over the past 12 months alone. He says there has been a notable change for energy producers from dealing with high prices to struggling to even source products such as steel.
“The industry as a whole is suffering quite heavily with raw material increases and availability,” says Rodgers. “It is not a question of price or delivery. If you can get hold of it [steel] these days, then you take it.”
Rodgers says little will change while production facil-ities are outside the region’s reach. “There is only a small [producing] market in the Middle East so it [steel] is all imported from Asia or Europe. If a producer in the Far East sees his raw supply increase by $100 a tonne, he has no option [but to put up his prices]. What can he do? He is open to the market volatility and the situation is becoming critical.”
Rodgers notes that more Middle East sup-pliers are, however, looking to put seamless pipe facilities in place, which could help to ease bottle-necks.
In December, one of Saudi Arabia’s largest industrial companies, Zamil Group, signed a deal with Canada’s Brandt Engineered Products for the development of a new seamless-pipe processing facility in Dammam.
Construction of the plant is expected to be completed in 2009. It will have an initial capacity of 170,000 tonnes a year of seamless pipes for use in oil and gas wells, including a supply deal with Aramco.
Other facilities coming on stream have also helped alleviate price rises. Cement and ready-mixed concrete prices in Saudi Arabia fell marginally in 2007 because of an expansion in domestic production capacity.
Pritesh Patel, lead researcher for the capital costs analysis forum for Cera’s upstream unit, says limited manufacturing capacity has added to longer lead times for the machining of large equipment such as pumps and compressors.
“Our survey of manufacturers indicates that over the past six months, lead times have increased by 30-50 per cent for specialised oil and gas equipment such as the flexible flow lines used in offshore projects,” says Patel.
In terms of downstream activity, Cera estimates that lead times for engineered equipment have increased by up to 50 per cent over the past 6-12 months, for items including electrical and instrumentation bulk materials.
“Further compounding the problem is the raw materials and shipping situation,” Cera said in the note to clients. “Both of these sectors have experienced recent increases, ultimately passing through costs to projects.”
Even when materials and items are sourced, shortfalls in the availability of shipping and key item manufacturers ensure that delivery times are increasing. “There is a severe lack of ocean-going vessels and freight rates to move steel have become more prohibitive,” says Rodgers.
While some would expect a company like Corus to be profiting from such a tight steel market, Rodgers says much of the profit is being made by those sourcing the material.
“We [Corus] are not working at full capacity because of the availability of raw materials,” he says. “This started in 2002 when the China impact kicked in, and it has continued to surge recently as well.”
One commodities analyst says that while previous rises in steel and rebar (reinforcement steel bar) prices were due to increasing demand in China, local suppliers have since been taking advantage of record regional demand and ramping up prices.
Bahrain was hit by an almost 30 per cent rise in rebar prices in the final quarter of 2007, while prices rose by up to 50 per cent in many parts of the Gulf over the full year.
“The issue is that many of the firms that need this supply have absolutely no determination over price, so they are held ransom to local players in the market as well,” says one London-based commodities analyst.
While the market is tight for long-lead-time oil and gas equipment, which includes generators, compressors and vessels, vendors have not signalled any intention to boost their facilities. One procurement manager working for an engineering, procurement and construction (EPC) company based in Abu Dhabi says that while several projects are either being curtailed or downsized, the Middle East is still moving forward with the bulk of projects.
“Yes, we are seeing tremendous cost pressure mount up in energy projects here in the Gulf,” he says. “But it is a global problem affecting every sector. We need to keep pressing on with these important megaprojects where we can, as this cycle will not be with us forever.”
While the larger NOCs and international oil majors are able to shoulder the burden, smaller players and sub-contractors are arguably being squeezed more tightly by the cost ramp-up.
“It is putting pressure on our whole operation,” says one business development manager for a local Saudi company. “We are hoping the cycle turns again because at the current rate of inflation, projects are simply not stacking up.”
Whether client or customer, the next few years will provide a true test for the energy industry’s ability to deal with an unpredictable inflationary environment.
Lead times for specialist oil and gas equipment have increased by 50 per cent over the past six months.