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Costs Slide Prompts Wave Of Project Delays
November 14, 2008 MEES/Zawya
The global financial crisis is poised to cut a swathe through projects throughout the Gulf. Plunging costs for raw materials and the expectation of further slides are prompting Gulf project sponsors with an eye to making major savings to reschedule bidding dates on lump sum turnkey (LSTK) projects. Even state-owned Saudi Aramco, with its strong track record on delivery times, has postponed bid dates on at least two of its flagship downstream projects.
Saudi Aramco has told short-listed engineering firms seeking construction contracts on its 400,000 b/d Jubail export refinery joint venture with Total that the bid date has been postponed from 10 November to February 2009. The decision was partly taken at the request of contractors, MEES understands. The bidding dates for the main process packages will now be on 23 February, with those for the smaller packages to be made a couple of weeks earlier, a source from one engineering company says. Saudi Aramco is hoping that a less fevered procurement and construction market, resulting from the global economic slowdown, will allow it to shorten its present 45-month construction timetable, enabling it to start up the project end-2012/early 2013, the source adds.
On 6 November Saudi Aramco and ConocoPhillips announced that they were postponing bidding on their 400,000 b/d joint venture Yanbu’ export refinery project from 13 December to the second quarter (MEES , 13 December). “The contracting sector also is going through many changes,” Saudi Aramco CEO-in-waiting Khalid al-Falih told Al-Arabiya TV . “Everyone knows that the costs of materials such as steel, copper and cement are falling and it was difficult for us to get realistic estimates for all these projects.” Mr Falih said Yanbu’ would be delayed by less than a year, but there have been lingering question marks over the project, which has still not received a gas allocation, despite getting a final investment decision (MEES , 21 July). “Everyone knows that Saudi Aramco‘s joint ventures will need to raise billions of dollars for projects of this scale and this will be more difficult given the current crisis than we anticipated when we first started the project,” Mr Falih added.
Saudi Aramco‘s downstream push aims to add at least 1.2mn b/d of net capacity, and includes major revamps to existing refineries such as its 400,000 b/d Samref joint venture with ExxonMobil and flagship petrochemicals initiatives at Rabigh and Ras Tanura. Coupled with overseas refinery expansion in China and the US, this downstream drive would have fundamentally transformed the firm’s character from that of a predominately upstream machine, albeit with an important downstream wing, to a fully fledged integrated international oil firm, noted one veteran observer of the Saudi oil industry. Given the global financial crisis some caution was probably well-placed, he noted.
The $1.5bn Samref expansion has not been delayed as a result of cost negotiations, MEES learns. And talks are still continuing on a proposed scope and configuration for Phase 2 expansion for PetroRabigh, one source tells MEES . But given the extremely bad short-to-medium term prospects for petrochemicals globally, no decision on PetroRabigh, where Phase 1 has already cost $10.1bn, is expected soon. The Ras Tanura petrochemical joint venture with Dow Chemical had been already delayed, and as such might be less impacted by current market conditions (MEES , 22 September). Outside the Saudi Aramco realm, bid dates have been postponed for Saudi Electricity Company ‘s Rabigh independent power project, and Marafiq’s Yanbu’ independent power and water project (MEES , 3 November). These delays are mostly aimed at giving developers more time to put together financing given the difficulties in the banking sector, although developers also noted that the fall in contractor and materials prices is throwing a new wrinkle into their estimates.
Manifa Costs Caution
Saudi Aramco is also seeking to reduce costs on its 900,000 b/d offshore Manifa increment, which is due to begin starting up at the end of 2011. Manifa, the last of the mega-projects in Saudi Aramco‘s current upstream expansion drive, is being widely touted as the most expensive increment in the company’s history, with current projections overshadowing the $10bn-plus estimated for the 1.2mn b/d Khurais project. The two largest onshore packages – the gas oil separation plant and the offsites and utilities – are thought to be worth around $3bn each – but the huge scope of the offshore work, which involves 41km of causeway, is thought to have pushed capital cost estimates up to nearer to $20bn than $10bn. One major engineering firm working on the project denies being sent any letter, but MEES learns that Saudi Aramco has told at least some of the contractors involved that they are to produce revised contract costs. This, given the LSTK nature of the contracts, is highly unusual and has produced fierce objections from the contractors, MEES understands.
What may have prompted the push to cut Manifa costs was Saudi Aramco‘s ability to bring down some costs at the Karan gas project. The cost of Karan, which is the first major offshore project and the most significant non-associated gas project to date, will give a gas production cost of $3.50-4/mn BTU, which is considerably higher than the standard Saudi internal sales gas price to petrochemical and utilities, at $0.70/mn BTU, MEES understands. Furthermore, the reductions that Saudi Aramco was able to negotiate apply only for the onshore portion of the project – the offshore part of the project, which is expected to cost around $1.9bn, has not enjoyed the same cost reduction, MEES understands. The reason behind the discrepancy is that offshore contractors’ order books remain fuller, and lead times are generally longer, and as a result prices for the specialist steels that are needed in difficult offshore environments have held up well. “Only a few companies can produce the thick-walled tube used offshore and many of those have full order books for the next two years,” explained a market expert in Saudi Arabia.
While all steel prices are falling, some product types are seeing much steeper declines than others. Notably, steels used in the energy sector, including power generation, are not seeing the same downwards pressures as mainstream flat and long steel products, according to London-based specialist publication Steel Business Briefing (SBB). The only sign of weakness in the oil country tubular goods (OCTG) sector is a suggestion from one of the major producers that prices will slip in the first half of next year as result of project cancellations, said SBB. The price for plate, which is used for large diameter pipeline consumed by the oil industry, has only been edging down since last month, while commodity grades of steel have been in a downtrend since July, said SBB. Furthermore, prices for special grade plate are faring even better than the regular product grades. However, SBB noted that destocking continues and the general consensus is that steel demand, and prices, will continue to weaken.
Saudi Aramco ‘s decisions appear to be prudent, given plummeting prices for most raw materials. “In general people are taking a wait-and-see attitude,” says one consultant. “Commodity prices are coming off. I
hear current prices for flat steel in Dubai are 60% down compared with just four months ago.rather like prices for polypropylene. A lot of people, who bought up inventory, are going to lose a lot of money,” he adds. “Everything is dropping dramatically – raw materials, but also the hydrocarbon product. People are going to have to recalculate their IRR [Internal Rates of Return] on projects. This is probably going to mean that Kuwait’s fourth refinery is toast – at least for the moment,” he added, referring to the emirate’s troubled 615,000 b/d flagship al-Zour refinery project (MEES , 1 September). “They will probably have to put it out to bid for a third time,” he said.
When a company like Saudi Aramco starts to delay project bids, it generally spells trouble for many others and a triple whammy of uncertainties – materials, financing, and oil price – suggests that negotiations on project pricing between sponsors and contractors will become tougher in the months ahead, and that further postponements are likely. While the bank market crisis and any further drops in the oil prices are not encouraging, the fall in materials prices could ultimately prove supportive to project sponsors. But over the short term, contractors that were hit with higher materials costs after signing LSTKs will be eager to hold onto to any benefit as prices come down.