Owners of downstream petroleum and petrochemical companies rank qualifications of key personnel as the most important consideration in choosing engineering contractors, says a recent industry study. Other important factors include project management, construction, and detailed engineering capabilities of the contractor.
These are some of the conclusions of a biennial survey of the global downstream engineering, procurement, and construction (EPC) industry by Transmar Consult Inc., Houston.
The study, sponsored by the senior management of most of the leading EPC contractors, is based on 120 interviews with key decision makers in refining and chemical companies. From August to November 2005, Transmar conducted interviews across North America, Europe, the Middle East, and Asia.
The interviewees’ areas of responsibility include:
• Engineering, 18%.
• Construction, 15%.
• Project management, 28%.
• Planning, 7%.
• Procurement, 8%.
• Senior management, 25%.
Global trends
The collective interviews with the senior-level experts provided many visions of future trends for the industry, according to the study. The five major trends are that companies are rethinking their view of the industry as a commodity business, long-term capital investment is flowing toward the Middle East and Asia, profitability will remain strong in the longer term, there are technical personnel shortages, and there are mixed views on the outlook for growth in global refining capacity.
Senior executives are rethinking the long-held perception of refining and petrochemicals as commodity businesses that led them to treat them as “cash cows” and extract as much cash from the plants possible. This attitude led companies to minimize investment in those facilities.
Currently, according to the study, senior executives are viewing global refining and petrochemical industries as long-term investment opportunities. More companies are upgrading and revamping refineries and petrochemical plants.
Much of the long-term capital investment for downstream operations is flowing towards the Middle East and Asia. The two regions represent growth regions-the Middle East for its feedstock advantages and Asia for its rapidly expanding consumer markets.
According to the study, there is a strong consensus that profitability will stay strong in the long term, which will support sustained capital investment.
“I think that there is no question that profitability will remain high in both the refining and chemical sectors in the decades to come,” according to one refinery manager. “Also, capital investment will center on the Middle East. In the decade to come there will be considerable expansion of the refining industry in the region.”
The fourth overall trend is the consensus that there are serious technical resource shortages.
These shortages of engineers and viable contractors could interfere with future capital-investment programs, according to the study.
The independent oil companies have the greatest concern, followed by the major oil and chemical companies, then the national oil companies (NOCs) have the least concern. There are also some concerns about finding contractors willing to complete projects on a lump-sum basis.
The study found mixed views on the outlook for growth in refining capacity. One group believes that demand will decrease due to higher product prices. They argue that there is a refinery-capacity surplus globally except in the US. Refinery investments, therefore, made financial sense only if initiated recently and companies that build hydrocrackers and deep conversion units in the near future will be increasing capacity in a declining market.
The other group argues that this deep conversion capacity is required because of heavier crude entering the market and the need for expansion.
EPC selection criteria
During the past 20 years, Transmar has tracked 18 principal factors that owners consider when evaluating a contractor’s bid proposal for a major project. And although the relative order of importance may vary, the top six factors have remained the same with minor shifts.
Table 1 shows the critical factors in order of importance as well as scores for 2001, 2003, and 2005. Project performance considerations top the buying factors list.
Many major capital projects are shifting geographically toward the Middle East and Asia, which affect owners’ weighting of selection criteria. Fewer viable firms capable of managing major NOC projects in the traditional lump sum turnkey mode further complicate the contractor selection process.
Quality of key personnel went to 8.52 in 2005 from 8.28 in 2001, and construction capability rose to 7.76 in 2005 from 7.25 in 2001. A difficult business climate tends to accentuate statistical shifts, according to the study.
The emergence of super oil company groupings and the streamlining of corporate staff sizes and resources are forcing owners to rely more heavily on EPC contractors. In addition, major projects are becoming larger in scope and magnitude; this requires that owners, in their selection of contractors, give more weight to a contractor’s depth of technical and financial resources.
While project performance factors are becoming increasingly more important, the number of viable and financially stable contractors with the depth of resources to meet project requirements continues to shrink. Several EPC companies merged with other companies to survive.
Strategic issues
Transmar, in conducting interviews, presented 12 strategic issues that are influencing the future of the downstream EPC industry:
1. Owner-contractor relationships.
2. Outsourcing of technical services.
3. Preferred contracting mode in the next 10 years.
4. Consolidation within the EPC industry.
5. Technical capabilities of NOC staffs.
6. Upstream and downstream capabilities.
7. Satisfaction with the quality and prices offered by EPC contractors.
8. Third-world engineering contractors.
9. Rising “stars” amongst engineering contractors.
10. Splitting projects into smaller parts to create more viable contractors.
11. Regional differences in engineering contractors.
12. Attitudes toward global execution centers.
More than 69% of the owners interviewed are concerned about the evolving owner-contractor relationships. The independent petroleum companies are most concerned about the evolving owner-contractor relationships, which are mainly due to contracting quickly becoming a seller’s market.
“The turn in the market is not a good thing for independents,” said a vice-president of an independent company. “We do not have the leverage of the major oil companies. Most of our projects are in the $15-20 million range. None of the big contractors are interested in this stuff at affordable prices.”
Many of the study interviewees suggested that they would do even more outsourcing; however, a significant number of them claim this is only a short-term policy.
About 44% of the interviewees claim that technical outsourcing will increase in their companies. Conversely, 23% claim that their companies will do less work on the outside. The other 33% claim that their amount of outsourced technical work will remain the same.
Among the client segments, the majors lean toward increasing in-house staffs and decreasing outsourcing. The NOCs and independents lean the other way.
Generally, most major petroleum and chemical companies preferred the reimbursable approach for projects. In an era of partnership with NOCs, however, they were increasingly forced to accept lump-sum contracts. Overwhelmingly, NOCs wanted and demanded lump-sum, turnkey arrangements but were willing to accept hybrid approaches or even cost-plus for smaller projects.
About 31% of the owner interviewees preferred cost-reimbursable contracts. About 47% favored EPC lump sum contracts. Finally, 22% like a variety of hybrid-type contractual arrangements, according to the study.
Most of the interviewees believe there will be more consolidation in the global engineering contractor industry. Many see this consolidation in parallel with a similar consolidation in the refining and chemical industries.
Generally, most owners see consolidation as a positive force that provides a technically more complete and financially secure contracting industry. A minority of owners have no firm opinion on this issue. Those concerned about consolidation fret about the loss of competition.
About 75% of interviewees anticipate more consolidation among the engineering contractor companies. Only 11% of interviewees predict less consolidation in the future. And 14% are unsure what the future might hold regarding consolidation.
The vast majority of interviewees believe that the technical staffs of NOCs are improving. They see the NOCs as a positive factor in mitigating the worldwide problem of technical personnel shortages.
About 76% of interviewees believe that the NOCs have improved their technical capabilities in recent years. Only 10% of interviewees see no technical improvement within the NOCs, while another 14% are undecided about whether the NOCs have made any improvement.
The majority of owners (63%) perceived no advantage in having a contractor capable of doing both upstream and downstream engineering and project work. A few (21%) did, however, see some value in this capability for the engineering contractor. About 16% had no opinion whatsoever on the matter.
About 65% of interviewees are dissatisfied with the prices and quality of services they receive from engineering contractors. Complaints regarding declining quality are especially pronounced.
About 30% of owner interviewees are satisfied with prices and quality of services. Only 5% are undecided. Most owners link prices with quality to decide whether they are receiving value, according to the study.
Most owners (56%) claim that they have or will contract directly with third-world contractors from countries like China, India, and Thailand. They see it as a means to get more much-needed technical support. However, 33% said no and about 11% of owners are undecided.
Transmar asked the interviewees to name one or more “rising stars” in the global engineering contractor industry. More than 40% could not name a single “rising star.”
The company receiving the most mentions as a “rising star” was Chicago Bridge & Iron Co. NV, which received 27 “rising star” mentions. The number two company was Petrofac, which received 21 “rising star” mentions.
An overwhelming majority of owners said they would divide projects into smaller parts allowing them to use second and third-tier contractors on their mega-projects. Specifically, 82% of interviewees said they would split up their projects into smaller pieces. Only 19% were against the idea of splitting up a project and 11% were undecided.
Transmar asked owners to suggest key differences they perceived between the practices of European, US, and Asian contractors. Most of the differences mentioned center on contractual approaches and cultural comfort.
For example, most Asian and European contractors prefer lump-sum arrangements with owners. Conversely, many US contractors prefer reimbursable arrangements, as do many US oil and chemical companies.
Most interviewees like the concept of global execution centers especially if the center is near their places of operations. Specifically, 83% were positive to the concept and only 10% negative. About 7% had no opinion or believed that this trend was not applicable to their company.
Overall contractor trends
Transmar discovered some overall trends that emerged from interviewing the owner executives:
• The industry is at the beginning of an era of technical resource shortages. Transmar feels that the shortage situation will become measurably worse before it improves.
• Owners are clearly experimenting with long and short-term approaches to coping with the technical shortage problem. In the short term, some owners are bringing more engineers out of retirement and upgrading their recruiting activities. In certain sectors like LNG, there are “headhunting wars” to extract engineering talent from rivals.
In the longer term, many companies are developing long-range programs to make the petroleum and petrochemical industries more attractive to young engineers. These programs include more summer internships, more scholarships, and more company-university research programs.
A few oil companies are even developing “speakers programs” that would send eminent company scientists and senior executives to talk to groups of students. The idea is to show them that the hydrocarbon industry is an exciting environment.
• Most owners are trying to upgrade and expand their front-end technical staffs. In a shortage environment with declining contractor project performance, owners believe they need better staffs to manage lower-quality contractor teams.
• There is likely to be greater involvement by top management at chemical and petroleum companies in project-execution-related matters. Operations and project managers are now obliged to explain to senior management that they cannot find sufficient bidders for an authorized project or that an important capital projects cannot be completed in the time period desired.
• There is the possibility for more clashes between NOCs and their major oil or chemical company partners. This is because despite the technical shortages, NOCs seem adamant about staying with lump-sum, turnkey contractual arrangements. Most NOCs are only willing to use reimbursable contracts for small projects or for the front-end portion of a large project. The major oil companies, on the other hand, understand that many contractors will now insist on reimbursable terms or decline to bid on a project.
• Finally, Transmar finds that most refiners are more optimistic about their future prospects than petrochemical executives. Many petrochemical executives feel increasingly captive to the inexpensive feedstock, third-world countries for growth.
Refiners, on the other hand, seem convinced that they can maintain their independence. They do not see all capital investment going toward these producer countries. ✦