The task begins for low bidders in Abu Dhabi energy sector

17 February 2010

The winners of last year’s glut of oil and gas construction contract awards in Abu Dhabi now face the challenge of bringing those projects in on time and on budget

The contrast in the rate of contract awards in Abu Dhabi’s oil and gas construction market in 2009 compared with 2008 was remarkable. After years of delays, cancellations and shelved projects, Abu Dhabi National Oil Company (Adnoc) and its subsidiaries awarded $30bn-worth of engineering, procurement and construction (EPC) deals in the 12 months to 31 December 2009, an unprecedented feat in the small, oil-rich emirate and one that is unlikely to be repeated soon.

If Abu Dhabi Gas Industries Company (Gasco) had been able to award contracts on the delayed $10bn Shah sour gas development, the total value of that year’s energy contracts would have topped $40bn – the biggest volume of awards ever made in the region and five times the $8bn-worth of deals Adnoc struck between 2003 and 2008.

With its flurry of contract awards in 2009, Adnoc has captured cost savings of up to 20 per cent and made significant in-roads towards reaching its target of producing 3.5 million barrels a day (b/d) of oil before the end of the next decade.

“Abu Dhabi hasn’t raised oil and gas production for a long time,” says Samuel Ciszuk, -Middle East specialist at US-headquartered market analyst IHS Global Insight.

“The industry has had a history of deferments. They haven’t made any new discoveries and they are now spending to raise capacity. Gas, -especially, is a priority and a lot of this is -associated gas, which obviously involves their oil production.”

Cost pressures

But with the New Year came new challenges. The contractors that won billions of dollars’ worth of deals with bids submitted when the industry was in the doldrums now face the daunting prospect of building the new oil and gas infrastructure on schedule and on budget at a time when materials and employment costs are starting to rise.

Last year started inauspiciously, with contractors expressing concern over the number of projects being delayed and put on hold, not just in Abu Dhabi but around the world. As oil prices fell below $35 a barrel in January and February 2009 from record levels in excess of $147 a barrel in June 2008 amid weakened demand, international and national oil firms started re-evaluating the schemes they had been developing during the boom years.

“With oil at $100-plus a barrel, you can build what you want and it will still make money,” says a senior London-based oil and gas consultant. “If the cost of extraction is $20 a barrel you still turn a profit.

“But if [the sale price] falls below $40 a barrel and you have spent billions on infrastructure, it simply doesn’t offer the kind of return on investment you need for these big schemes.”

However, Abu Dhabi has historically been a counter-cyclical investor, using revenues raised during periods of boom to finance new developments during downturns, when construction costs are lower.

Contractors and oil executives point to the award of contracts on the Sahil, Asab and Shah oil field developments in January 2009 as the trend-setting award for the rest of the year.

Abu Dhabi Company for Onshore Operations (Adco), the Adnoc subsidiary overseeing the project, had originally tendered a single EPC deal in August 2008 but put the scheme on hold after receiving a bid of about $4.5bn.

Major savings

When the company retendered the project as two contracts in January 2009, bids came in at a combined total of $3.5bn – representing a $1bn, or 22 per cent, saving. In the intervening period, US bank Lehman Brothers had filed for Chapter 11 bankruptcy protection after suffering $2.8bn of losses related to sub-prime mortgages in the second quarter of 2008, precipitating the global financial crisis of the following year.

In February 2009, the UAE’s Energy Minister, Mohamed bin Dhaen al-Hamli, made it clear there was another spoke to Abu Dhabi’s strategy. Investing while other oil companies were not would leave the emirate in a better position to capitalise on higher demand and prices in later years, he said at a London conference in March 2009 organised by UK thinktank Chatham House.

“A growing number of projects are being scaled back or abandoned completely,” he said. “Crude oil prices have now fallen to around half the levels that would ensure investment levels would be sufficient to develop infrastructure for when the downturn ends.”

By March 2009, South Korean contractor SK Engineering & Construction had won an $818m deal to build a new compressor unit at Abu Dhabi’s Bab oil field after submitting a bid $100m lower than its nearest competitor. This foreshadowed another trend for the year – the dominance of the low-cost South Korean firms in the emirate’s oil and gas market.

In June, MEED research showed the cost of oil and gas projects had dropped by 19 per cent over a year, as falling material costs and an oversupply of skilled labour reversed what had been a contractors’ market. “It’s a buyer’s market now,” said the business development manager of one major US firm at the time.

This has brought down the cost of Adnoc projects. “Prices were escalating at a terrific speed in 2007-08, but they fell last year,” says Ciszuk.

During the final six months of 2009, Adnoc awarded deals on Gasco’s $10bn integrated gas development and a further $10bn of deals on the new Abu Dhabi Oil Refining Company (Takreer) refinery at Ruwais.

Further deals were awarded on Adco’s major Asab, Bab, Bu Hasa and Ruwais (ABBR) programme and the ‘1.8 million’ project, to expand onshore -production by more than 400,000 b/d.

In total, MEED estimates that $30bn of oil and gas deals were tendered in the emirate in the 12 months to 31 December 2009.

If the expansionist mood continues and deals are awarded on the Abu Dhabi Polymers Company (Borouge) third phase expansion of its Ruwais petrochemicals complex and the joint venture Shah sour gas project being tendered by Adnoc and the US’ ConocoPhillips, both due to be awarded by the end of June 2010, the figure for 18 months could top $45bn.

And this is just the beginning of a surge of construction activity, says one senior South Korean executive working in the emirate.

“The challenge now is to actually build -everything,” he says. “These projects will need tens of thousands of people, hundreds of skilled engineers. They will need millions of tonnes of materials. The next problem is making it happen – getting the logistics right and watching out for costs.”

But contractors warn that, as the projects awarded in 2009 move into the construction phase in 2010, demand for skilled workers will begin to outstrip the available resources in the emirate, pushing the price of each project up and in some cases potentially delaying schemes.

“It will be even worse for guys who win projects in 2010,” says a senior executive at one European firm. “They will be pushed to submit lower bids on projects and at the same time will have to deal with this capacity crunch. And they will have to bid low, because it will be a tough year for winning jobs.”

Three challenges, the executive says, will face contractors working in the emirate: the presence in the market of low-cost and high-quality South Korean firms; a much smaller pool of projects; and the arrival of new players.

South Korean firms won $57.7bn of -engineering construction deals in the UAE in 2009 alone. While $40bn of this figure was accounted for by the consortium that won the deal to build and operate four nuclear power plants at Sila, in Abu Dhabi’s Western Region, $16.7bn of the remainder comprised oil and gas deals. South Korean companies won 18 per cent of all deals on offer in the sector last year.

Contractors say they did this by offering prices as much as 20 per cent lower than their competitors. Meanwhile, Adnoc is likely to adopt a slower pace in tendering new schemes over the next two years, according to a senior executive at the company. He says that with Abu Dhabi having bailed out neighbouring Dubai to the tune of $20bn, there will be a rationalisation of projects across the board in the emirate.

“It will not affect existing contracts, but we may see some things pushed back until 2012,” says the executive. “Things change and, of course, in the current market there are a lot of issues.”

Efficient strategy

Industry observers say the strategy being pursued by Abu Dhabi is smart but it creates challenges down the line. Ciszuk says: “[Adnoc’s] strategy looks very clever. They delayed things when project costs were rocketing and now they are pushing them through to take advantage of the slack market.”

The arrival of new contractors, such as -Italy’s Techint and Taiwan’s China Technical Consultants, on requalifier lists for deals such as the Shah gas development is also a cause for concern among established contractors.

“It is part of the Adnoc strategy for pushing prices down,” says the business development manager of a European energy firm.

The Adnoc executive says that after this -latest wave of projects, many of the major deals to be tendered in the emirate in future will be -offshore projects, limiting the number contractors that can bid on them. “From 2010 onwards the new fields Abu Dhabi develops will be underwater,” he says. “Not everyone can bid on these, so that cuts down the bid lists, but that means, if you don’t have experience [of offshore schemes], you are out of work.”

Among the major offshore contracts due to be tendered in the coming years is the $15bn development of the offshore Upper Zakum field by Zakum Development Company (Zadco). In 2009, Zadco awarded a $620m deal to the local National Marine Dredging -Company to build four artificial islands at the field, to be used as offshore -drilling platforms.

After Zakum, Adnoc is likely to look to smaller offshore fields for new production opportunities, having effectively exhausted its long-serving onshore reservoirs.

“There are a lot of untapped new oil deposits,” says the Adnoc executive. “The most recent geographical surveys of Abu Dhabi showed a lot of possibilities offshore as opposed to onshore. Zakum is one of the -biggest reservoirs in the world, but after that we will have to start looking at new, more -marginal fields.”

Using existing fields alone, Adnoc wants to increase its total oil production to 3.5 million b/d by 2018, up from 2.7 million b/d currently, using existing fields to hit the target.

Speaking at a conference in Abu Dhabi in February, Adco’s general manager, Abdul Munim Saif al-Kindy, said there could be another 230,000 b/d of production available at smaller fields.

The hectic award schedule of 2009 is unlikely to be repeated in Abu Dhabi, especially as oil prices climb back up to more than $70 a barrel and material costs follow suit. As a counter-cyclical investor, Adnoc is even more likely to retreat in the face of increasing construction activity elsewhere in the world.

Ciszuk says that with billions of dollars of new projects due to be tendered in Iraq and Saudi Arabia in the coming years, there is only one way for project costs to go – upwards. “We should see prices rising quite significantly over the next year,” he says.

Abu Dhabi’s next challenge will be to make sure that the contracts it has awarded are executed, and then plan for a new, more mature phase in which it focuses on maintaining existing assets and ensuring that production levels do not fall.

Even as the new infrastructure is being built, firms with operations and maintenance expertise are flooding into the emirate.

The next wave of contractors, it seems, will not be building new infrastructure, but tending to its upkeep.

“Making an award isn’t even half the battle,” says one senior engineering consultant. “The real struggle will be making all of this work.”

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