Around the world, the construction sector is typically characterised by its adversarial contracting culture, with low barriers to entry and a lowest-price-wins tendering model. It is hardly surprising therefore that such a business environment has led to low margins, as well as a questionable safety record and contract disputes, as both clients and contractors seek to maximise their positions.
It does not have to be like this. As the oil and gas projects market shows, there are alternative approaches to project contracting that can reduce delays, limit disputes, and improve quality and safety. This sector is viewed much more positively. Oil and gas project clients and contractors have proven their ability to successfully deliver on plans, typically on a much bigger scale than in the construction sector. And the industry has become synonymous with world-scale projects, cutting-edge technology and overcoming massive engineering problems.
So what, if anything, is the construction sector doing wrong? And is there anything it can learn from the oil and gas sector?
The two industries share plenty in common. Both develop large-scale projects with heavy engineering and fabrication requirements, while also facing similar boom-and-bust cycles. In the GCC, the cycles of the two sectors often overlap. With economies that are highly dependent on oil export revenues, periods of low oil prices often cause a shock to governments’ ability to pay for projects.
The outlook for oil prices has a significant bearing on the region’s oil and gas projects market as governments weigh up whether or not to push ahead with major spending plans at a time of lower revenues.
Spending on oil and gas projects in the region contracted abruptly in 2016, as a result of the collapse of oil prices that saw Brent crude fall from over $114 a barrel in June 2014 to below $27 a barrel in January 2016. The consequent fall in oil export revenues put significant pressure on government finances, leading to a review of spending priorities by the region’s oil exporters, with project spending slowing sharply as a result.
The GCC currently has $1.6tn-worth of construction projects planned or underway, ranging from housing to railway projects. By comparison, the value of projects planned or underway in the oil and gas sector is about $168bn.
The construction industry is much bigger and more fragmented than the oil and gas projects market, with 13 times the number of projects planned or underway, but with the majority being much smaller standalone developments.
Oil and gas projects have been driven by the need to meet rising local and international energy demand, from motor fuels to powering electricity generation. More recently, large-scale integrated downstream projects have become strategically important as the GCC producers aim to produce higher-value products, insulating their revenues from oil price cycles and opening up new avenues for job creation.
In fact, the dramatic escalation in the size, scope and cost of its projects, with multiple facilities being installed on a single site, means the oil and gas industry faces a conundrum. Delivering these schemes has become a major challenge, especially in a low oil price environment, where many projects must significantly reduce costs to meet the requirements of their final investment decisions.
One of the most significant differentiators between the construction and oil and gas projects markets is the type of organisation sponsoring a project: the client.
The GCC oil and gas projects market is centred on a handful of national oil companies (NOCs) such as Saudi Aramco, Abu Dhabi National Oil Company (Adnoc) and Kuwait Petroleum Corporation (KPC), along with their subsidiaries. There are also a number of smaller operators and international oil companies, particularly in Oman, but these tend to operate in joint venture with the host NOCs. A total of 86 companies have been behind all oil and gas projects in the GCC over the past five years, according to MEED data. By contrast, there have been about 2,035 construction project clients in the GCC over the same period.
The result is that oil and gas project sponsors tend to be repeat project clients tendering dozens of projects over the course of a year, often restricted to a core group of prequalified contractors. Although disputes between clients and contractors occur frequently, since both parties appear to realise they cannot operate without each other, they tend to be resolved quickly and relatively amicably.
It is also fair to say that many of the projects are better funded from the oil companies’ own budgets, or externally through project financing provided by banks and export-credit agencies. Oil and gas projects are revenue-generating assets, in contrast with many construction and infrastructure projects.
The construction sector, on the other hand, is much more fragmented and diverse, with a multitude of different project sponsors ranging from large state-run entities or quasi-privatised developers to numerous small clients offering one-off tenders.
The two sectors also diverge in their approaches to tendering and contracting. The one-off nature of construction projects, or sometimes public procurement regulations, has meant that construction clients tend to focus on a lowest-price-wins tendering, which in a downturn leaves contractors facing paper-thin profit margins, forcing them to cut as close as possible to the requirements, and seek to recover any additional costs through claims made against design variations made by the client after the contract has been awarded.
Contrast this with the oil and gas sector, where the lowest-priced bids still often win out, but where greater adoption of innovative designs, standardised equipment and other approaches to driving efficiency regulate savings.
“If you are a smaller oil and gas contractor without the [right] experience, you would never be allowed to bid. You have to take your responsibility seriously on these types of contracts without a doubt,” explains one contractor.
The relationship between the client, designers and construction contractors is key. Major oil and gas contracts are traditionally awarded on the basis of detailed front-end engineering and design (feed) work carried out by a separate consultant. The process can take upwards of a year, and there is little the client can do to speed up the process of tendering the construction contracts without compromising the engineering.
“You could be on a contract that spends well over a year, two years, three years in the engineering phase modularising building things before you even get onto site,” says the contractor source.
On construction projects, particularly in the commercial real estate sector, designs are often not completed by the time construction begins. While this enables work to begin earlier, it frequently results in major changes to the design during construction.
As the GCC’s NOCs have built a more global presence working overseas and alongside major international oil companies, their focus on safety at their facilities has increased.
“To get on an oil and gas job, your statistics need to be five times better. Your LTIFR (Lost Time Injury Frequency Ratio) needs to be world class. Nobody takes a local view on this and nobody turns a blind eye because the statistics generally play into the reputation of the operator or client,” says a source.
The construction sector generally has fallen far behind on this, and many say that the lowest-price-wins culture can result in corner-cutting to save costs, at the expense of safety.
The construction industry could gain from moving away from fixation on lowest-price-wins as the best path to reducing costs and focus on leading projects through engineering before construction even begins.
But it is not a one-way process. There are also opportunities for the oil and gas sector to learn. Even here, the sector has been slow to adopt new technologies such as interactive 3D engineering environments that allow users to virtually navigate sites and operating facilities before procurement and major construction even begins.
Such technology would allow design issues to be spotted and addressed much more quickly, reducing the man-hours spent on engineering and helping speed up project delivery.
As both industries grapple with the challenges of delivering capital projects, there are no easy solutions to transform performance, but new technologies have the potential of significant efficiency gains. Perhaps the most significant difference is the relationship between clients and contractors. While construction is characterised by an adversial relationship, oil and gas sees it as a strategic partnership.
This article is extracted from a report produced by MEED and Mashreq titled Transforming Construction: Lessons from Oil & Gas. Click here to download the report