E&C firms report growth in chemical capital spending

26 August 2011 14:37  [Source: ICB]

 Global E&C firms forge ahead, undeterred by troubled economies
E&C firms forge ahead, undeterred by troubled economies
Global engineering and construction companies say chemical sector business is reviving; margins may be tight, but capital spending is back and the outlook upbeat

Global engineering and construction (E&C) companies say capital spending by the chemical industry is on the rebound. Competition for contracts is intense, but projects are moving forward; not only in Asia and the Middle East, but in the US, where shale-gas exploitation has changed the economics of production.

However, global political and economic uncertainty are amplifying risk, and projects are proceeding with greater deliberation.

The recession had the greatest effect on capital spending in Europe, the US and Japan. In Western Europe, chemical capital spending slipped from $54.9bn in 2008 to $45.1bn in 2009. Figures from the American Chemistry Council (ACC) show it did not recover fully in 2010, reaching just $46.3bn (see graph).

In North America, chemical capital spending fell from $33bn in 2008 to $29.1bn in 2009 before increasing to $31.6bn in 2010, according to ACC. In Japan, it fell from $8.6bn in 2008 to $7.9bn in 2009 and increased to $8.3bn in 2010.

"Like many companies, our chemicals business took a hit during the global recession," says Pete Primm, global chemicals business vice president at US-based privately owned E&C company CH2M HILL. "Many projects were either postponed or canceled."

He agrees the market is better: "We have seen, over the past few quarters, a strong turnaround in the chemicals industry. CH2M HILL's chemicals business is now experiencing substantial growth throughout the globe as demand and production increase. We are expanding our work in North America, Brazil, Mexico, Argentina and Asia and we are making solid inroads in the Middle East."

Other major players such as Jacobs Engineering, Fluor, Foster Wheeler and Shaw ­offered a similar picture during quarterly earnings calls in late July and early August.

"The chemicals market is very robust," Craig Martin, CEO of US-based Jacobs Engineering, maintains. "It's every bit as good as we thought it was going to be, maybe even a little better." He is optimistic about the related oil and gas market, but more circumspect about refining, which is improving, but "not robust by any means yet."

Two factors are driving chemicals segment's demand growth, Martin notes - low-cost abundant feedstock and the desire to convert lower value products into higher value goods.

"Activities are very high on the Gulf Coast, in the Middle East and in Asia, and the focus seems to be on what I'll characterize as high-value chemicals," he says.

There is broad agreement among E&C companies that excess capacity is being taken up in all business segments.

"We have reached a bottom," says Umberto della Sala, interim CEO, president and COO of US-based Foster Wheeler. "I don't see the margin going further down."

With prospects better, E&C firms are hiring again. Jacobs Engineering added employees in 28 of the past 30 weeks as of July 26.

"What we saw in this quarter is that unit margins improved very, very slightly," Martin says. "It's the first time in several quarters where that was true, and my optimism comes from coupling that with [the] steady increase in staffing and a billable hours trend, which is also positive."

US-based Fluor cut its US staff by about 15% during the recession, but the company is bulking up again, CEO David Seaton, says. "I think we've stabilized to where we're probably 5% down from where we were before," he says.

Positive indicators aside, the industry is not yet out of the wilderness. Most agree that this year will be transitional.

"From a margin perspective, we are kind of rattling along the bottom and probably will start to see improvement as we start into 2012," Seaton says.

According to Jim Bernhard, chairman, president and CEO of The Shaw Group, the latest quarter was particularly challenging for the energy and chemicals segment, but he sees a harbinger of renewed capital investment in the steady demand growth and strong earnings reported by major producers.

"This has yet to transfer to major project expansions, but we believe that in 2012, these awards will begin to occur, in particular in the energy and chemicals segment," he says.

Indeed, competition among E&C companies has not let up. "Many competitors are not full," Martin says. "Prices are still a factor."

Della Sala agrees: "Some clients are trying to impose tough contract conditions, which is an indication that, in many areas, it is a buyers' market still."

Della Sala counsels discipline. "When you bid for projects in a competitive environment you need to take a cold approach because you measure the success of a project not when you book it, but when you deliver it, and typically [that is] two or three years later," he says. "We can change our approach to margins, but not risk."

Competitive pressures are particularly high in the Middle East, the site for many of the largest E&C opportunities. Countries there are increasingly eager to access the higher margins available downstream in value-added petrochemical markets.

Chemical capital spending in the region (including Africa) has consequently doubled since 2005. In 2008, it totaled $18.8bn, barely dipped to $18.7bn during 2009, and rebounded to $20.6bn in 2010.

The Al Jubail petrochemical complex, a joint venture between Saudi Aramco and Dow Chemical, illustrates the trend.

The $20bn project will have a world-scale cracker and 25 other units for manufacturing isocyanates, polyether polyols, propylene oxide (PO), propylene glycol, elastomers, linear low-density polyethylene (LLDPE), low-density polyethylene (LDPE), glycol ethers, amines and other products.

"The kingdom, through Aramco, is spending a lot of money, and the continued spending seems to be there as far as the eye can see," says Noel Watson, chairman of Jacobs Engineering. "There will be a lot of Middle East work in the Jacobs' house as we look out towards the end of the year."

Projects such as Al Jubail contribute to the continuing shift of chemical production away from the US, Europe and Japan.

"What we are seeing is that a lot of the commodity chemicals continue to move to developing markets, where capital and production costs are lower," Primm observes.

Asia, particularly China, has been the primary beneficiary. Chemical capital spending in the region (excluding Japan) has risen every year in the past decade - even during the recession - from $249bn in 2008 to $291bn in 2009, and $338bn in 2010 - more than three quarters of the global total of $464bn.

"The chemicals market in China is growing at a phenomenal rate," Primm says. "Vietnam is seen as a future market, but not at the growth rate of China. When we look at the sheer size and scope of China, with the continued rising middle class population, that market will grow for years to come."

China does have its own well-developed E&C base and the market is extremely competitive. "Bidding against Chinese competition inside of China doesn't carry the same margins we'd get elsewhere," observes Gary Nedelka, CEO of Foster Wheeler's global power group and president, North America.

However, sophisticated projects involving differentiated technologies put the company in a more advantageous position, he adds.

World Chemical Capital Spending

Motivation for US Capital Spending

Chemical companies are still making capital investments in the developed economies.

Much of the work is focused on upgrading facilities, debottlenecking, meeting regulatory requirements and increasing efficiency, but opportunities are also opening up in green chemistry and sustainability, Primm says.

"We are one of the only E&C companies in the business that has a sustainability development group," he notes. "We saw a healthy up-tick in demand around these solutions."

The development of shale gas could dramatically affect the E&C outlook in North America..

"For the first time in a decade, we see major activity in the US olefins market," says Bernhard. "We expect to have two to four of these domestic ethylene plants in the next 24 months to be active in the United States for major expansions or grassroots plants."

However, uncertainty is suppressing growth, and decision-making has become more protracted worldwide. "We are still seeing delays in clients awarding contracts or in releasing the next stages of work," della Sala notes. "Also adding to delays are client concerns about the macro environment, specifically political and economic uncertainties."

Seaton points to the issue of the scale of large projects and the problems with getting approvals. "Projects have gotten so big that many companies are having to go back to their boards multiple times to get these approvals," he says.

Chemical capital spending is nonetheless moving forward, della Sala remarks. "Client determination to proceed with prospects is definitely showing momentum, especially with projects that have been dormant and that are now starting to resurface."

Global E&C firms forge ahead, undeterred by troubled economies

By: Clay Boswell
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