Viability of petrochemical projects in the region could be eroded

BY LUCIA DORE - Khaleej Times

DUBAI — The energy industry in the GCC is expanding rapidly with projects worth about $260 billion under development, according to figures from Taylor-DeJongh, a merchant-banking firm specialising in the energy and infrastructure industries.


One of the main reasons for this surge in development is the simultaneous peaking of all three sectors of the energy industry- upstream, midstream and downstream.

In an article for the Project Finance Yearbook 2006/2007, the firm states: "This euphoria has contributed to a glut of projects, amounting to 3 million bbl/day of refining capacity and 32 million tpa of petrochemical plants, under development in the region." The number of projects coming on stream is such that the capital requirement for the petrochemical industry alone in the GCC and Iran is huge.

Speaking at a recent conference in Dubai, Taylor De-Jongh banker, David Ghighi, commented that the total estimated investment requirement for new projects in the region through to 2010 is over $50 billion, of which about $30 billion is concentrated in Saudi Arabia.

In 2005 there was just under 2 million metric tonnes of capacity additions in the region (calculated for styrenics, polyolefins and olefins). This figure is projected to increase to 17.5 metric tonnes in 2009, with another 10 million metric tonnes of capacity estimated to be built in 2010.

However, the large number of projects under construction, in other parts of the oil and gas sectors as well as large infrastructure projects such as water and power, is stretching demand for capital in the region. MEED has estimated that over $1 trillion worth of construction projects are in the pipeline in the Middle East.

Writing in the Yearbook, Taylor De-Jongh points out that the rapid expansion of the petrochemical sector has resulted in soaring engineering, procurement and construction (EPC) costs and the possible risk that the industry might overbuild and overpay for its projects, "which could potentially nullify the GCC's low cost feedstock advantage."

Moreover, the fact that the viability of many projects is predicated on the assumption that "the industry has undergone a permanent structural shift and has entered a new era characterised by high oil prices and high refining margins," is cause for concern said the bank. It says that the viability of a project's investment is whether it would still be viable if oil were priced at $35 a barrel. The reasons behind the surge in EPC costs are a shortage of engineering service personnel, a sharp increase in demand for major equipment, a shortage of construction labour and cost inflation of bulk materials. "It has been estimated that on average aggregate EPC costs have gone up 30 per cent in about 18 months in the Middle East. Qatar, the second largest construction market in the GCC, saw a 95 per cent increase in aggregate prices in 2005. Such an environment has forced Shell to consider delaying its $6 billion gas-to-liquids (GTL) project in Qatar," the bank writes.

It also states that while the increase in EPC cost has been a worldwide phenomenon, "its dimensions seem to be more acute in the GCC. And there is the question of whether the EPC premium erodes the GCC projects' location-specific competitive advantage". In this respect, Ghighi mentioned that project sponsors could reduce risk (or add value) significantly in the early stages.

"Involving a financial advisor early on can protect $100s of millions of profits 'at risk'," he said, adding that most projects incur delays in late stages, due to changes required by lenders.

Using data to analyse the relationship between ethane price, EPC cost and internal rate of return (IRR), the bank writes: "It appears that the low cost feedstock advantage, typical of a GCC project, is nullified at the marginal increase in EPC cost levels of 12 per cent. Given the current construction industry environment in the Middle East, such marginal EPC cost increases are highly likely."