Timely strategies

16 May 2005 00:01  [Source: ICB Americas]

The current boom may be great news for the chemical industry, but there is a flip side. High demand means tight supply and very much extended lead times, as Michael Gordon explains from our European bureau

The wave of new chemical projects, in the Middle East and China especially, is putting severe strains on equipment supply and lead times at many sites. This situation is compounded by the rise in prices of metals such as iron, steel and titanium, and the availability of contracting capacity.

Lead times for fabricated products such as columns, pressure vessels and heat exchangers are now three to four months longer than a year ago. Fired heaters, boilers and cooling towers are generally on one to two months longer delivery, and bulk piping materials are taking an extra four to six weeks.

Careful attention

Clients are having to pay careful attention to their project procurement strategies. They are giving more consideration to identifying and qualifying new suppliers, and taking carefully considered views of currency exchange rates and political risks.

One leading German contractor bemoans the situation. “The scenario of high demand and tight supply, particularly with obtaining steel, is affecting us greatly. Many suppliers are unable to meet their contractual agreements and are keen to pass on their increased costs. Some materials, like titanium, are simply not available.”

The phenomenon of increased prices and tight supply is something that has arisen over the past 18 months, it adds. At the moment there is no sign of costs reducing or the supply/demand ratio equaling out. “This is not just for materials and equipment, but also energy,” the contractor explains. “To avoid alerting our customers we try to avoid the issue of price increases in key critical equipment as long as possible.”

The German company believes that contractors have to make themselves more cost-effective. In the short term it is impossible to change technology requirements, “but we can reduce the amount of excess material we order.”

In Italy, an official for leading contractor Tecnimont agrees. “For sure there is an increase in the lead time for delivery of critical equipment, as well as cost increases for materials, equipment and construction.” This is due to a number of reasons, mainly the increased cost of raw materials such as steel, concrete and energy; increased demand for certain equipment in respect of workshops capacity; and increased transportation and insurance costs. The situation, Tecnimont’s official says, “is expected to last at least for the next couple of years.”

These views are echoed by other leading contractors. At Foster Wheeler, for instance, there is the recognition that the Middle East is seeing an unprecedented level of activity. Says Ray Bignell, director of strategic planning: “After approximately two years of relatively low activity in the petrochemicals process industry, there has been a rapid upturn during 2004–2005 and contractors are now becoming heavily loaded.”

All this petrochemical investment, he adds, is taking place at the same time as investment in infrastructure for roads, airports, hotels—all of which require manpower, materials and equipment. “With the current state of the oil market, there is pressure on Saudi Arabia to increase oil production, again adding to construction pressures.”

Andy Allen, global business director at Foster Wheeler, adds that Qatar has a particularly severe restraint. “It has huge hydrocarbon resources, but the country is much smaller than Saudi Arabia and has a lower population. There will be severe issues over the construction of its planned plants.”

Pricing for materials

In terms of pricing for materials and equipment, for example, compressors, control systems and electrical systems, Allen says the early indications are that increases are coming through, yet at around 10 percent price inflation they are perhaps more modest than expected. “But we have not got into the core of construction activity. The cost for alloy and stainless steel pipe is up about 40 percent.”

Allen adds that specialist equipment like reactors are particularly in demand. Lead times here are six months above what they would have been a few years ago. Some projects are ordering reactors before they appoint a contractor. “We are being asked to help source these kinds of items prior to a project being awarded. And the list of non-lead items is growing—it’s not just compressors, reactors and pressure vessels that are affected.”

One particular tight spot is titanium. This is proving difficult to source for fabricationpurposes, so it is not just a price issue, but also one of availability. Issues about the avail-ability are being factored into the design ofprojects. Sea water cooling using titaniumexchangers is being switched to standard close water cooling systems, for instance. “There are stresses in the marketplace around metallurgy that can significantly affect the project,” says Allen.

A US perspective is provided by Mike Pears, senior vice president of sales at Fluor. He notes that the time to deliver critical equipment—such as large rotating equipment, reactors, heavy-wall vessels and extruders—has definitely increased. Many suppliers are busy and shops are becoming full. “All critical equipment supply dates are running quite a bit longer than even a year ago; some by as much as two to four months, or even longer.”

Two years ago, he explains, it was very mucha buyers’ market in the engineering and construction industry. “That has changed signifi-cantly. Now it is a more balanced market.Some would even say it is a sellers’ market. Also, in comparison to two years ago, there was little project work being done in the chemicals/petrochemicals industry globally. This business line has heated up significantly, particularly in the Middle East, and to a lesser extent China. We are also seeing opportunities in North and South America, and in Europe.”

Raw materials

Pears notes also that the cost of equipment and materials is being driven up by the demand for basic raw materials, such as iron ore, which has risen in price significantly. Manufactured steel products pricing has increased by as much as 40 to 50 percent, he says.

“Currently, the market is very hot. There are numerous projects being carried out in many industries globally that Fluor operates in, including energy and chemicals, infrastructure, mining and metals. These industries are experiencing above-average growth. Similarly, construction costs are escalating, but to a lesser degree. We feel the extent of that pressure will be seen one or two years from now.”

And there is a similar picture in Asia. Taiwanese engineering and construction company CTCI expects steel prices will rise by more than 5 percent this year. But, it adds, it will depend on how successful the Chinese government is in controlling its economy, and on whether projects are bunched together.

To reduce exposure to price hikes, CTCI tries to include a clause in its client agreements that allows it to seek compensation if the cost of key raw materials rises by over 10 percent during the construction period. But clients would like contractors to absorb such increases on a turnkey contract.

The company is carrying out two projects with CSPC (the CNOOC/Shell cracker joint venture) and has tried negotiating for compensation, but CSPC wants CTCI to finish the projects first.

A South Korean contractor says that althoughsteel prices dipped in the first quarter of this year, they have started rising again, and are likely to remain firm if the Chinese economy maintains its current pace of growth. And it is not only the cost of steel that is hurting contractors, but also the rising freight costs.

A third contractor says the increase in the price of steel has pushed up project cost by 25 to 30 percent. Others say that in some cases, the cost-push is so severe that some contracts may have to be terminated. Petrochemical projects face a higher cost burden because they need more steel than other projects. The worst hit are the lump-sum, turnkey contractors.

Some contractors are using steel futures to hedge their risks, reduce construction times and cut other costs. While quoting for new projects, some contractors are cutting the validity period—in some cases, to just 24 hours.

A source at an Indian engineering company agrees, saying lump-sum, turnkey contractors have been the worst hit. There have been cases where contractors have signed a MoU for a project but are unable to hold to the price when signing the contract.

The South Korean contractor adds that longer delivery times on equipment mean that it is sometimes difficult to meet project schedules. Two years ago, the delivery time for large columns and extruders was 12 months but now it is 15 to 18 months. “Before preparing the schedule, we closely examine the situation and then negotiate with the client and the vendor. We are concerned about this issue, but as we have experience we think we can overcome the problem.”

A better relationship

But what else can be done about the situation? Daniel Valot, chairman and CEO of France’s Technip believes that a better, more lasting relationship is needed between owners and contractors to deal with these bigger challenges. Some progress has already taken place, he explains, illustrated by a few new contracts with major chemical and oil companies which have a better-balanced risk/reward sharing between owners and contractors.

This includes, he says: indexation mechanisms against fluctuations of raw material costs; multicurrency contracts, reflecting the multicurrency structure of contractors’ costs; less-extravagant penalties which lead contractors to increase contingencies on their prices and, thereby, lead to increased project costs; and contracts starting on a cost-plus-fee basis that can be converted into lump-sum contracts once visibility improves.

But there are still a few nuts to crack, in particular the short-term focus of the companies versus long-term stakes. As the size of projects is growing and they become more complex, costs are rising and contractors are facing a “double squeeze” by owners, on the one hand, and suppliers and subcontractors, on the other. This is due to the turmoil in raw material prices and freight rates.

“Contractors, asked to invest in R&D and new assets, badly need long-term visibility while most owners are not ready to give any commitment longer than the current contract under execution. Excessive focus on short-term goals is jeopardizing the overall development of oil and gas projects,” Valot concludes.

Additional reporting by CMR’s Robert Brown and ACN’s Malini Hariharan

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