CAPEX - Q2 2017
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CAPEX Q2 2017

Similar to H1 2017, the second half of the year is anticipated to witness multiple challenges. Thus, companies in the energy market should adjust expectations

 

While oil prices witnessed some stability after OPEC and non-OPEC members decided to curb oil production, with oil prices still relatively low, OPEC (excluding Nigeria and Libya whose output remained restricted by unrest) and non-OPEC members have decided to extend production cuts until March 2018 to support oil prices. After analyzing various scenarios, the group believes that a 9 month extension would bring oil inventories to its five years’ average and support prices to stabilize at approximately USD 55 a barrel. Similar to the targeted cuts in H1 2017, it was decided that for the extended 9 month period, the group would cut production by the same 1.8 million barrels per day (bpd).

"OPEC believes that a 9 month extension to production cuts would bring oil inventories to its five years’ average and support prices to stabilize at ~USD 55 a barrel."

Although the announcement of the extension of production cuts was expected to spur oil prices in an upward direction, crude prices have seen a downward correction. This decline indicates that market participants are not convinced of efforts taken by OPEC and that non-OPEC members hold the key to price stability in the short term. This uncertainty stems from the fact that there is an increase in production from the US and other non-participating countries such as Brazil or Canada.

Additionally, with some of the world’s largest economies witnessing a decline in GDP growth, demand for commodities such as oil from these countries has also fallen. While China saw its annual GDP growth rate* fall from 6.9% in 2015 to 6.7% in 2016, US saw it fall from 2.6% in 2015 to 1.6% in 2016, UK saw it fall from 2.2% in 2015 to 1.8% in 2016 and Russia saw its annual GDP growth rate continue to be negative, from -2.8% to -0.2%. With both market forces (supply & demand) being unfavorable for the energy market, oil prices have not been able to rise.

As OPEC and non-OPEC members are still figuring out the best way to support the energy market, project owners have continued to be cautious while awarding projects. This has led to Q2 2017 being the weakest quarter in terms of project activity over the past 3 years. This quarter, the GCC energy market witnessed only c.USD 4.1bn worth of project awards – c.70% lower than that seen the previous quarter (c.USD 13.7bn) – with only one mega project in the GCC being awarded; KAHRAMAA’S Qatar Transmission: Phase 13: Cables worth c.USD 1bn. An analysis of the weak project activity that took place this quarter reveals that this was not due to project cancellations but rather due to postponements from mega-projects. As project owners want to be careful in the current market, more in-depth evaluations are being carried out for large projects which are leading to a delay in timelines.

"Project owners have continued to be cautious while awarding projects. This has led to Q2 2017 being the weakest quarter in terms of project activity over the past 3 years."

In addition to slower project activity in Q2 2017, regional tensions have been an issue this quarter. The unity of the GCC countries has become a concern as Saudi Arabia, UAE and Bahrain have cut diplomatic ties with Qatar. While this move will impact businesses operating in these countries, it can also impact the aforesaid countries’ energy related strategies at a national level. Moreover, due to the growing unrest arising out of the civil war in Yemen, a Saudi-led coalition of several GCC and African countries has been focusing on resolving this issue. As the political scenario in Yemen has been relatively unstable in 2017, it has diverted the attention of these countries from developing oil & gas assets to fixing regional tensions.

Similar to H1 2017, H2 is expected to witness multiple challenges in the energy sector. As these challenges are anticipated to influence how the energy market will pan out to be by the end of this year, it is important to understand the types of challenges we can expect to see.

1) Funding: This has been a key factor which has led to project postponements & cancellations and has thus led to weak project activity. Funding issues are expected to continue to affect the GCC market given the low oil price environment

  1. Oman’s Duqm Refinery has witnessed multiple delays with funding being the key reason for delays. In April, Oman Oil Company (OOC) had signed an MoU with Kuwait Petroleum International (KPI) and agreed that both companies would provide 35% of the investment capital while the remaining would be raised from local and international banks. However, with Oman’s credit rating recently being reduced to “Junk” status by rating agency Standard & Poor’s, local and international banks are wary of the situation and thus will not be willing to lend. As such, KPI is now considering establishing a deal with South Korean EPC contractors to take a 20% stake in the Duqm Refinery with KPI and OOC increasing their contribution to 40% each
  2. BAPCO’s key Refinery Modernization program in Sitra is facing similar funding issues. Given that Bahrain cannot finance the mega-project on its own, BAPCO is in discussions with the shortlisted EPCs to finance the project through Export Credit Agencies (ECA) funding. As such, the award of the project is highly dependent on whether necessary funds can be arranged

2) Geopolitical Uncertainties: Geopolitical uncertainty related to cabinet reshuffles and economic sanctions has resulted in a climate of uncertainty within the GCC projects market, resulting in an increase in project delays. Internal factors (reassessment of feasibility plans) as well as external factors (project financing) are resulting in greater delays in awards

  1. With Saudi Arabia having recently witnessed a cabinet reshuffle and the ushering in of a new crown prince, there is a lot of uncertainty in how the energy market will pan out to be – both within the country and the region, given that Saudi Arabia’s performance affects that of the GCC
  2. Given that GCC members have cut its diplomatic ties with Qatar, Qatar too will likely struggle to obtain funding for several key projects due to likely inflationary pressures. This would lead to longer project schedules and thus higher costs for project owners in Qatar

3) Localization: While localization has recently been emphasized globally – with the US advocating ‘Make America Great Again,’ India encouraging ‘Make in India’ and UK pushing for Brexit – the GCC has now begun adopting this mindset as well with many GCC countries, such as Saudi Arabia and Oman, enforcing stricter adherence to localization policies. While such policies support the development of the country’s economy and assist growth, there are consequences for enforcing these policies as well – increase in costs and timelines for executing projects. With the emergence of strong localization initiatives, EPCs will be forced to procure locally as well as sub-contract works to local contractors which might not have the experience and international exposure for the required jobs. Moreover, companies might consider setting up a local office or facility in order to adhere to such rules leading to higher costs. As companies such as McDermott and Lamprell are already in the process of setting up their yards in KSA, and companies such as AMEC FW have recently opened up a new office in Oman, it is likely that other companies will follow suit to establish their local presence

 As such, Contax Partners relies on its proprietary Tiering methodology (where Tier 1 projects have a 70% or greater probability of going ahead and Tier 2 projects have a 30% probability of being awarded), to forecast a realistic scenario of what the energy market might look like. After factoring in various challenges that the region has recently faced, Contax Partners has further reduced its forecasts of the expected projects to be awarded at the end of this year – estimated to be approximately USD 24.9bn. A sector split of planned projects categorized as Tier 1 for this year reveal that most projects are anticipated to take place in the refining and oil & gas production sectors (33% and 28% respectively). On the other hand, a country-wise split of Tier 1 projects for this year depict that most projects will take place in UAE, Oman and Saudi Arabia (27%, 23% and 18% respectively).

As 2017 presents opportunities in a difficult market place, Contax Partners can support project owners, contractors and suppliers understand market conditions, maximize the opportunities that are present in the region and guide them on the underlying risks related to execution. Through its dedicated research team and detailed Tiering methodologies, Contax Partners can help companies evaluate which projects are likely to go ahead and which projects are likely to suffer delays. For more information on how to consolidate your position and take advantage of a challenging energy market, contact the Director of Business Advisory Services, Ann-Marie Carbery, at This email address is being protected from spambots. You need JavaScript enabled to view it.

*Source: OECD Economic Outlook - Statistics and Projections

-Shamlee Epari, Research Consultant
Contax Partners

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