The dynamic EPC landscape remains a fertile ground for contracts as key players adapt to change, reports David Manuel
FOLLOWING a period of skyrocketing costs, overheating demand and strained resources, the significant drop in EPC costs during the 2008 downturn has turned the tables from a contractor-dominated market to one largely controlled by project owners.
Operators call contractors for bids that offer the lowest cost while EPC contractors, hungry for work after the slowdown, have used this scheme to win lucrative awards, especially during the tightening market conditions that began two years ago.
“Pre-2008 the large number of projects made it a contractors market,” says Charles Ellinas, managing director - oil, gas & petrochemicals at Mott MacDonald, a key regional player particularly in Oman and the UAE. “With the credit squeeze that followed 2008, it all changed, turning it into a buyers’ market.”
The shifting landscape has also given regional governments an incentive to spend and push forward high-value projects by taking advantage of the considerably lower-cost environment.
“It’s a client’s market,” says Günther Pergher, general manager, Samsung Engineering Middle East, the biggest South Korean EPC contractor. “Project owners are in a position to say that it’s a good time to build.”
Given the attractive construction price tags, clients have re-tendered projects in the hope of attracting lower bids, drawing a long list of prequalified bidders to choose the most competitive price.
On the other side of the deals, EPC contractors say they are driven by their ability to execute projects on tough timelines and tight budget from the owners/operators.
“Our strategy is to carry out these projects with a high amount of due diligence and remain competitive enough to allocate the necessary resources,” claims Pergher, the UAE-based general manager of the South Korean engineering giant.
Ellinas of Mott MacDonald thinks EPC is still the predominant contracting route, but other options are now being pursued, such as engineering and procurement separate from other processes such as construction management.
The big picture
In the post-downturn environment, the outlook for energy projects in the Middle East and North Africa has remained bright, with the Arab Gulf countries proving a fertile ground for the biggest, most ambitious tenders and the best prospects in energy.
“The EPC market is stronger than ever in the region,” says the Mott MacDonald executive, with the contractor currently involved in projects with a capital value of over US$8 billion in the region. “With instability and the world economic problems, which are affecting businesses worldwide, the Middle East oil industry is on a good footing.”
One of its most prestigious projects, which is almost complete, is the US$1.2 billion Qarn Alam Steam Project in Oman to enhance heavy crude oil production for Petroleum Development Oman.
“The market is extremely competitive,” says Samsung’s Pergher, with the business having expanded its footprint across Saudi Arabia to Abu Dhabi. “It has become very crowded and tight wherein contractors have to be very aggressive in bidding competitively.”
Sudeep Sam Alex, energy syndicated researcher at Ventures Middle East, a leading energy projects consultancy, saw a considerable drop in the EPC hydrocarbon awards in 2008 but observed projects picking up from 2009.
“The current EPC sector looks like it is going to maintain a steady market in the coming years throughout the GCC,” Sudeep tells Pipeline.
Around US$400 billion worth of hydrocarbon projects were executed in the Gulf around 2008 and 2009, according to an independent study carried out by Ventures Middle East, which tracks oil, gas, petrochemicals and utility projects in the region.
“Tendering is expected to pick up pace, as stalled projects are gradually released and as new projects become necessary,” Sudeep adds, estimating over US$150 billion worth of energy projects currently under execution in the region.
In 2010 alone, over US$26 billion worth of contracts have already been laid on the table for execution. Most of these projects came from Saudi Arabia which covers key upstream and downstream developments.
Following Saudi’s lead is the UAE and Kuwait as Gulf OPEC countries push forward capacity expansion plans.
The contractors see an influx of new activities both upstream and downstream projects during the first half of 2012 in areas such as Iraq and Saudi Arabia.
Downstream rise
In the last two years, potential downstream projects across the world have not moved ahead due to unhealthy margins and a weak global picture. Slow demand has led to downstream projects being scrapped or shelved during that time.
As the cost economics gradually improved in the following years, capital intensive downstream projects were back on track and petrochemical or refinery jobs have grown significantly since then.
In 2011, contract awards for petrochemicals alone have quadrupled to more than US$8 billion as compared to only US$2 billion in 2008, according to data from Ventures Middle East.
“Definitely, downstream projects have finally taken off,” says Sudeep. “There’s a rapid development in the petrochemical sector and investing is on a steep rise.”
Earlier this year, the industry marked the biggest petrochemicals complex to date. Heavyweights Dow Chemicals and Saudi Aramco have teamed up to launch their flagship petrochemicals megaproject under their joint operating venture Sadara Chemical Company.
The US$20 billion Jubail-based petrochemical unit, which has been the subject of an extensive project feasibility study and FEED since 2007, will have the capacity to produce in excess of 3 million metric tonnes of chemicals a year from its 26 manufacturing units.
The complex, slated for a 2016 start up, will be the first large-scale project to be constructed in a single phase. Sadara Chemical is expected to hand out all EPC contracts by Q2 2012.
Earlier this year, US engineering Fluor and South Korea’s Daelim were already primed to do the first part of the job.
About 50 per cent of the capital investment amount is already under contract and the rest are being tendered. Due to the scale of the project, the Sadara may tap debt markets to help finance the project.
Value chain integration
On the other hand, the recent downward trend in midstream and downstream sectors demonstrated the importance of EPC companies in focusing upstream and diversifying in capitalising on other opportunities in the value chain.
This trend has allowed predominantly downstream-focused players to enter the upstream space, going head-to-head with traditional upstream EPC giants such as Italy’s Saipem and UK’s Petrofac in building production units and associated oil and gas handling facilities.
“Diversification has always been the name of the game,” says Pergher. “In line with that, we have managed to diversify our portfolio and grown to capture upstream EPC.”
As gas development becomes vital, the company, which largely covered jobs for Takreer and Borouge in Abu Dhabi, has fast-tracked its learning curve over the years in developing gas processing capabilities. Samsung is now actively pursuing projects in line with ZADCO's development of offshore projects.
Last year, the South Korean powerhouse won the US$1.5 billion plant package-4 from Abu Dhabi Gas Development Company to build an offsite and utilities facility for the 1 billion cfd Shah Sour Gas Development.
Samsung Engineering, which will head all EPC and pre-commissioning on a lump-sum turnkey (LSTK) basis, was the only Korean company selected for the project in the pool of European firms such as Italy’s Saipem and Spain’s Technicas Reunidas.
Recently, the company scored three new projects in Saudi Arabia worth about US$4.6 billion which include projects such as Shaybah NGL and Wasit power plant from Saudi Aramco, and an aluminum complex from Maaden ALCOA JV.
“These contracts mark the diversification of our traditional hydrocarbon business into the upstream, industrial and infrastructure sectors,” adds Pergher.
Seoul connection
In line with the stable expansion of the global engineering market, Korean engineering companies have shown impressive growth in edging ahead of their well established Western rivals.
Korea’s overseas plant orders surged to US$64.5 billion in 2010, nearly eight times the US$8.4 billion recorded in 2004, growing at an annual average rate of 40 per cent, according to a study by Korea’s Ministry of Knowledge and Economy.
Banking on their ability to execute projects with good quality standards, lower pricing and delivery without delays, South Korean EPCs gained prominence by scoring the biggest deals across the Gulf.
Companies such as Samsung, Daelim, Hyundai, GS, SK Engineering and Doosan have seen considerable success in bidding for energy projects especially those that include big, complex processes.
In 2010, ADNOC’s refining arm Takreer handed out EPC contracts worth US$9.6 billion to four Korean companies to expand its oil refining capacity in Ruwais. Agreements were awarded to SK E&S, GS Engineering, Samsung Engineering and Daewoo E&S for various packages.
In 2011, Sadara Chemical awarded the US$920 million EPC contract for the main mixed feed cracker to Daelim Industrial. The company was also tipped as the forerunner against compatriot Samsung Engineering for submitting the lowest bid for building parts of the other production units.
The business model adopted by these companies revolves around aggressively bidding for low prices for projects, carrying out a relatively large amount of basic engineering during the tender phase and forging close links to suppliers, according to Middle East Economic Digest, which estimates around US$50 billion-worth of projects under execution by South Korean firms here.
Although, dogged by criticisms by their Western counterparts, Korean firms are already considering strategies to sustain their significant lead here, especially with the entry of Chinese contractors that can aggressively match them with lower costs.
“Korean EPCs have gained a strong foothold in the hydrocarbon market,” says Samsung’s Pergher. “But now the question would be – how do we maintain that?”
For Western contractors, innovation is critical to the future EPC market. The lessons learnt from the advent of Korean EPC contractors are already seeing tighter bidding.
The more widespread opening up of the market to Asian vendors is also having an effect on lowering EPC contract prices.
“The entry of Asian and particularly Korean contractors has had an impact on the energy contracting market – even though this has always been very competitive – keeping western contractors out,” says Ellinas.
“However, the balance is now gradually being restored by western contractors learning from the Koreans,” he adds.
Supply story
A wave of construction activity across the board has driven up overall cost of construction in the region before the great recession in 2008. But since the property bubble burst, a lot of construction capacity was freed, easing the pressure on labour, steel and cement costs.
Baljit Heer, acting general manager of Brown McFarlane International, a specialist steel plate distributor for the oil and gas sector, believes that steel prices have fallen slightly recently but not as bad as reported.
“We have seen about 8 per cent fall, but the mills are reporting that an increase is expected in Q1 2012,” Heer says. “But we are in steel supply and the effects of price decreases will not really be evident for two to three months as the prices fell, but supply takes up to four months to arrive from order date.”
Brown McFarlane International, which provides steel plates for boiler and pressure vessels along with structural and offshore plates, saw steady demand this year.
“We had a period in August and September when it went very quiet, but it has picked up again in October and November is also proving fruitful,” the Dubai-based supplier says. “We have recently increased our product range and the quantity of sizes we supply, and hope to increase turnover in line with this investment.”
For contractors, the low-cost environment still dominates and price is a major factor in project development reflected in recent contract awards.
Mott MacDonald’s Ellinas says supply of qualified personnel, labour and basic materials are not major issues. However, he believes there is a shortage of experienced senior management staff.
“It is very favourable at the moment,” says Pergher, who pools supplies from local and South Korean suppliers. “It will be balanced in the long run.”
Looking forward
Contractors believe the EPC market in the coming years will continue to be driven by the oil demand fuelled by the growing energy appetite of countries like India and China, and its impact on keeping oil prices high.
“The main driving factor is obviously the ever increasing demand for petroleum and petrochemical products for fueling economic development all around the globe especially the developing Asian countries,” says Sudeep of Ventures Middle East.
However, pricing mechanisms for EPC contracts that adds value to a project will be a commercial challenge in the future, says Pergher of Samsung Engineering.
“I think the industry should look at putting competitive pricing on projects, especially in delivering quality projects at a considerably lower cost,” he adds.
Summing up, Ellinas says: “I believe that the oil and gas industry will remain buoyant in the longer term. I don’t see why we should not expect an increase in the number of projects in the coming years.”
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