ENGINEERING/CONSTRUCTION FIRMS ADJUST TO DOWNSIZED PROCESS SECTOR

Contractors' worldwide backlogs are increasing, and grassroots construction of refineries and petrochemical plants is common in many parts of the globe.

The U.S. is absent from the list of world grassroots refinery construction projects. Plans to build the first such project in the U.S. in the past 20 years collapsed early this year, largely because of high costs (OGJ, Jan. 23, p. 67).

Elsewhere, E&C companies are winning contracts for new plants and expansion projects, particularly in Southeast Asia, Latin America, China, and Russia.

Underscoring the current upswing in E&C operations are contractors' project backlogs.

At the end of last December, Foster Wheeler Corp., Clinton, N.J., had a backlog of more than $5.1 billion, the highest in the company's history.

John Brown's backlog for the southern U.S. is close to 1 year.

And Stone & Webster Engineering Corp.'s petrochemical backlog is about 600,000 man-hr. This could double in the next month or so, depending on how a number of negotiations go, said Colin Bowen, vice-president of olefins technology for Stone & Webster, Houston.

Doy Cole said Kellogg's backlog at the end of February was $1.55 billion, and it may reach $2 billion or more by October. "In general, Kellogg's business right now is healthy," Cole said. "But for the E&C industry in general, there is still more engineering capacity available than there is work."

PETROCHEMICALS

Contractors have seen an increase in chemical/petrochemical activity during 6-12 months. Jerry Oliver, vice-president and manager of technology for Bechtel Corp., Houston, said the petrochemical industry moves in cycles of about 10 years and is about 1 1/2 years into the current upturn.

"We're definitely on the upside of the cycle," said Tom Gallatin, senior vice-president and general manager of John Brown's southern U.S. region. Gallatin says John Brown has quite a bit of work in methanol right now, both overseas and in the U.S. The expansion of Methanex's methanol plant in Chile is the company's biggest project.

Southeast Asia is a focal point for refinery and petrochemical plant construction, and Latin America is quite active on the petrochemical side.

The U.S. chemical industry is doing mostly revamp-type projects. Although some operators may call these projects "new plants," they are simply building new capacity on open sites in existing plants.

Table 1 (63954 bytes) shows ethylene capacity additions in the planning and construction phases. The data are from Oil & Gas Journal's latest construction survey (OGJ, Oct. 17,1994, p. 71). The survey lists construction projects for basic petrochemicals and derivatives at 291 sites around the world. Of those, 171, or 59%, are in the Asia/Pacific region, 60 of which are in China.

Bowen has seen a boom in the petrochemical industry for the past 4 or 5 months. Business is so good that there aren't enough petrochemical process engineers to go around.

Areas of heavy activity include the Asia/Pacific region, especially China and India, and the Middle East. But Bowen expects construction to pick up in the U.S. soon.

Petrochemical demand grows at about 50% the rate of growth in gross national product. So current U.S. ethylene capacity of 45 billion lb/year and 56% growth/year amounts to a new plant each year, Bowen said.

In addition, many U.S. ethylene plants are aging and have been stretched in terms of capacity. This increases the potential for problems and unexpected downtime, as happened last year at Exxon Chemical Co.'s. Baton Rouge ethylene plant.

Cole expects in the next 5 years to see an increase in demand for several petrochemical products, including ethylene, polyolefins, fibers, ammonia, and methanol. Target markets for these commodities are developing countries, especially China and India.

Even in the U.S., Kellogg has contracts to build new polymer plants for Exxon and Phillips Chemical Co., and an unannounced fiber precursor project to be built on the Texas Gulf Coast.

REFINING

E&C firms' refining business remains moderate.

Cole says U.S. refiners are through with the major wave of environmentally driven projects, and big projects going on now will be adapting refineries to process different crudes.

For example, Lyondell-Citgo Refining Co. is revamping and expanding its Houston refinery to enable it to run 200,000 b/d of heavy Venezuelan crude. M.W. Kellogg is the main contractor for the project.

Similarly, Petroleos Mexicanos is helping finance the upgrade of Shell Oil Co.'s Deer Park, Tex., refinery. This project will give Pemex an outlet for its Maya crude while it upgrades and expands its refining base in Mexico.

Table 2 (45525 bytes) lists major refinery upgrade and expansion projects.

Outside the U.S., more grassroots refineries are being built, especially in the Far East and in oil producing countries with high demand. Table 3 (87431 bytes) lists grassroots refinery projects, planned and under construction.

Cole says producing and exporting countries such as Venezuela are likely to add heavy crude processing refineries and upgraders that will enable them to sell more reduced crude.

Other countries in South America are starting to increase their industrial growth, said Bechtel's George Friddle, vice-president and manager of business development. "Russia is a potential that everybody is trying to get their arms around," he said.

"I think a lot of companies are fighting shy in Russia," Bowen said, because Russians tend to believe western companies can do anything and everything.

Stone & Webster isn't able to finance large projects in the region, so it probably will follow the multinational companies, Bowen said. Otherwise, the company will continue to favor small-scale projects like modernizations.

EFFECTS OF DOWNSIZING

Because of intense competition as a result of downsizing in the process industry, E&C contractors must provide a broader slate of financing arrangements, perform more projects based on turnkey contracts, and undertake more financial risk than they have in the past.

As a whole, the petroleum industry, including operating and E&C companies, is reacting to a flat market by "skimming the fat from the system," Oliver says.

This streamlining has affected E&C companies in a number of ways.

Processors rely more heavily on E&C companies for the services of engineers. For project work, operators want to bring in engineers with enough experience, typically 5-10 years, to work independently. Operators prefer to hire more experienced engineers, those with 15-20 years of experience or more, for their permanent payrolls.

Bowen said this hits E&C firms twice. Operators vie for permanent services of their senior engineers and contract for services of their engineers with moderate experience levels.

"It places an almost insurmountable burden on our organization," Bowen. said.

Another effect of downsizing is that management execution methods have changed.

In the past, clients put large teams of engineers into E&C companies' offices during project execution. These engineers directed the work and served as an interface between the engineering team and the operating company.

Now, clients typically send only one or two engineers to contractors' offices to work on a project. This change has occurred for two reasons, Bowen says. Operators do not have the staff they used to have, and they realize that heavy oversight does nothing but add to the overall cost of the project.

"Savvy operating companies have learned there is an appropriate level of involvement, and it's less than it used to be," Bowen said.

Operators now look at the total installed cost of a project. They used to be concerned with engineering cost hours. Considering the "life cycle cost," the cost of a plant during its entire life, Oliver said, engineering is insignificant from a cost standpoint.

Customers want to produce a product more cheaply than their competition. So E&C companies are trying to give the customer market advantage. This is a major shift from simply providing engineering or construction. It forces the contractor to look at the entire project from an optimization standpoint.

Another effect of downsizing is that contractors provide more services earlier in projects than in the past. It is not uncommon for E&C companies to become involved early in the economic feasibility stage of a project.

WORK FORCE

Downsizing has not had much effect on the experience level of the engineering work force. But because of downsizing, Friddle said, if a company needs an engineer with 25 years of experience designing for a particular chemical, that engineer can be found easily. There is an incredible amount of experienced talent available for work.

Houston is the major U.S. market for expertise in the chemical/petrochemical industry. Finding staff has not been a problem for most Houston E&C companies.

But as business picks up, Gallatin said, highly skilled areas become a problem. Process engineers, for example, are a fairly tight market now.

Because the petrochemical industry is cyclic and has experienced major downturns in recent years, the number of chemical engineering graduates from colleges also tends to be cyclic. Unfortunately, says Richard McCue, vice-president of olefins technology for Stone & Webster, the cycles don't match.

About 4 years ago, 1,000 chemical engineers entered the market in the U.K. Of those, McCue said, about half accepted financial-type positions because of the lack of engineering opportunities.

CONTRACT STRUCTURE

Downsizing also has changed the way contracts are structured.

Gallatin said there is an "overwhelming trend" to focus more on business units and less on central projects and engineering groups. This places more focus on business drivers such as capital costs, project schedule, safety, plant capacity, and product quality.

More and more contracts include incentives based on those factors.

"More risk sharing is being placed on contractors, no question about it," said Friddle, who added that operators are more willing to share with contractors the savings generated by this type of agreement.

Contractors give two types of guarantees: E&C companies that license process technologies incorporate process performance guarantees into contracts for their units. Nonlicensers' guarantees cover workmanship defects.

Penalties for defects are more onerous, Cole says, because clients require them to be more so. They want contractors on the line to finish on time.

Cole adds that, in this environment, rewards are sometimes greater.

Another trend is toward turnkey contracts. Saudi Arabian Oil Co. let a $1-1.5 billion turnkey contract to Bechtel last year for portions of its Ras Tanura refinery upgrade.

FINANCING

Contractors are being asked more and more to assist with project financing, much of which is referred to as "creative." In fact, the parent companies of many E&C firms, Lummus Crest and Stone & Webster, for example, have subsidiaries that set up financing for clients.

Oliver says the utility industry built itself on so-called "off balance sheet" work, or contractor-financed projects. Now the processing industry is moving in this direction. Internationally, this is called "privatization."

There has been a wave of privatization in Latin America. And many Indian companies are showing good profits and attracting private investors. U.S. Export Import Bank support has boosted business in Russia for many E&C companies.

Gallatin says John Brown is seeing more "globalization" of financing.

Non-U.S. companies, especially European firms, are investing in U.S. plants. Some of John Brown's major U.S. jobs are funded and controlled by European companies such as Bayer, for whom John Brown is building maleic anhydride capacity, and Akzo, for whom the company is building a catalyst plant.

Oliver predicts the new financing arrangements will help stabilize revenues over time. Contractors will have to take an equity position in jobs and thus accrue their revenues during an extended period. This will help level out revenues in a cyclic industry, although it will not affect the cyclic nature of contractors' work loads.

COMPETITION

"Competition in this business has always been fierce," said Gus Tiranno, senior vice-president of ABB Lummus Crest Inc., Bloomfield, N.J.

Emerging competition in the E&C industry is coming from developing countries. Japanese E&C companies have been present in the world market for a number of years, and now companies from Korea, China, Venezuela, Argentina, and Chile are becoming more aggressive.

One way E&C firms deal with this competition is to develop alliances with competitors. These alliances can take the form of complete or partial acquisitions, exclusive process licensing agreements, nonexclusive associations developed to win a contract, or anything in between.

Kellogg, for instance, has an alliance with Phillips Petroleum Co. in plastics. Nearly all of Phillips' plastics design work is done at Kellogg's offices.

Stone & Webster has developed "traditional" (nonexclusive) contracting alliances in certain regions, as have many E&C firms. Stone & Webster's partners include Technimont in Italy, JGC Corp. in Japan, and Hyundai Engineering & Construction Co. Inc., Daelim Industrial Co. Ltd., and Daewoo Corp. in Korea.

These sorts of alliances can be an advantage when extra resources are needed. Bowen says projects are becoming so large that E&C companies need to form such combines to handle the increased size.

Another factor affecting E&C firms' competitiveness is technology licensing. Licensing a technology for a project can gain entry into the engineering/procurement/construction (EPC) portion of the project. E&C firms that do not license processes must compete on the basis of project management ability alone.

Bechtel, which has been strictly an E&C firm, is improving its competitiveness by throwing its hat into the process licensing ring. Bechtel has teamed with Conoco Inc. to offer a delayed coking technology to the refining industry Oliver says the company is examining other such opportunities but declines to reveal any more information.

Friddle says Bechtel also is becoming more competitive by focusing on improving execution methods and eliminating wastes. By this method, the company is trying to drive out redundancies and demonstrate a fully integrated EPC approach.

This approach includes proper project planning through such means as "constructibility." Friddle defines constructibility as careful project layout for maximum ease of construction and maintainability. Maintenance is seen by operators as "low hanging fruit," an area in which profits can be effectively improved with little or no capital outlay.

THE FUTURE

The outlook for E&C revenues typically is moderate.

ABB Lummus Crest, for example, expects its 1995 revenues to be 3-4% higher than 1994 revenues.

Ups and downs in the E&C industry appear to be flattening a little with each cycle. Although there is a ray of hope in that flattening, the process industry still has a lot to learn about planning to alleviate those cycles.

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