Cost run-ups not to affect GCC refinery projects

Current refinery projects in the Gulf Co-operation Council are worth more than $146 billion (Dh536bn) – indicating the region's appetite for the industry remains robust despite capital cost run-up and massive delays.

Data from project information specialist ProLeads shows the value of ongoing and planned projects currently at around $146.5bn, with Saudi Arabia leading the race with 28 projects worth $94.4bn.

The world's largest exporter of crude oil is followed by Oman, which is not a member of Opec, with seven projects worth $19.5bn and Kuwait with 17 projects worth $13.9bn.

Bahrain ranks fourth with four projects valued at $9.5bn followed by the UAE with five projects worth $7.2bn. Qatar, the world's largest exporter of liquefied natural gas but Opec's smallest exporter of crude oil, is investing $2bn in new refineries.

Opec has repeatedly said the dramatic increase in oil prices has been driven largely by a shortage of refineries to process crude, in addition to speculators, who the 13-nation cartel blame for aggravating the unprecedented escalation of prices.

The International Energy Agency (IEA), the energy watchdog of the leading 26 industrial countries, says in its recently released Medium-Term Oil Market Report 2008-2013 that the tightness in the distillate market is arguably the single biggest cause of the current increase in prices.

Abdullah bin Hamad Al Attiyah, Qatar's Deputy Premier and Minister of Energy and Industry, said: "There is more floating crude oil and no buyers, especially since most refineries in the world lack refining capacity and cannot treat more crude."

Refiners across Asia, the major destination of the Middle East's crude, expressed little interest in extra supplies when Saudi Arabia pledged to increase production to 9.7 million barrels per day (mbpd) in June to curb the soaring market price.

The 250,000 bpd increase followed the promise of an extra 300,000 bpd in May. The moves were welcomed by consumers – but refiners said they were not able to buy more crude due to its quality and price.

Mohammad bin Dhaen Al Hamli, UAE Minister of Energy, said: "Global markets are suffering from a shortage of oil products, not crude oil. A shortage of refineries is one of the main reasons behind the increasing prices as a result of the policies adopted by industrial nations not to invest in new refineries."

World crude oil distillation capacity was estimated to be about 85,460 million barrels per calendar day (mbcd) at the end of 2007 while global oil product demand is expected to average 86.8 mbpd in 2008, according to industry estimates.

Demand is expected to rise to 94.14 mbpd in 2013 and experts have reported a shift in the demand of global refined product towards lighter fractions such as gasoline, diesel, LPG and naphtha.

Currently there is an acute shortage of diesel and gasoline worldwide because of high demand and limited refinery output. Most of the demand comes from developing economies such as India and China, who are both showing a strong requirement for gasoline. Experts attribute the demand to the growth in the number of cars as the middle-class expands. The fact that refinery projects in the region are running at multi-billion dollar levels, however, is not necessarily good news.

Arab Petroleum Investment Corporation says despite higher capital budgets, energy investment in the Middle East and North Africa appears to be losing momentum.

"Policymakers and project sponsors who until recently have been boasting ambitious investment plans have voiced concerns about two critical issues that can seriously impede future development prospects," it said.

Firstly, project costs have been escalating unrelentingly and show no sign of abating. Secondly, recent problems in the global credit markets, which are looming larger, may also constrain the flow of capital into the region. Past reviews up to the one for 2006-2010 showed that rising capital investment was usually matched by an increase in the number of projects.

"Obviously several factors can affect the investment outlook," it said. "As already anticipated in previous analyses, soaring EPC costs have prompted most sponsors to postpone or even cancel some of their capital projects on the grounds of expected lower returns."

Assuming oil and gas export prices remain strong, retained earnings are expected to provide project sponsors with enough funds to self-finance the upstream and associated midstream operations.

By contrast, funding prospects for the highly leveraged downstream are uncertain. The required annual volume of debt of $49bn exceeds by 25 per cent the all-time record of $39bn achieved in the loan market in 2006. In addition, current trends in global credit conditions and the consequent re-pricing of risk have been translating into tighter lending standards and higher borrowing costs.

Saudi Arabia is expected to provide the real litmus test next year when two mega projects, Total in Jubail and ConocoPhillips in Yanbu, both Saudi Aramco joint venture export refineries – look for $30bn to 40bn.

They will be followed by the world's biggest project financing, the Kingdom's $20bn-and-rising Ras Tanura petrochemicals refinery project, which will look for cash late next year or early in 2010.

In October last year ConocoPhillips dropped out of Abu Dhabi's International Petroleum Investment Company's (Ipic) refinery project because skyrocketing costs were making profitability less feasible.

Terry Newendorp, Chairman and CEO of US-based Taylor-DeJongh, said: "It's instructive to know that ConocoPhillips, a major oil company with major capital capabilities, has found it appropriate to withdraw from a couple of major refineries, one of which is in the UAE. That obviously reflects that they didn't believe they could capture sufficient refining margin based on the capital cost."

Ipic has, however, confirmed that it will go ahead with a planned refinery in the UAE with or without the US supermajor. It is pushing ahead with the construction of a major grassroots refinery in Fujairah and two others in Morocco and Pakistan despite a sharp rise in the capital required because of high construction costs.

The company is expected to pump nearly $3bn into a joint venture in Morocco, $5bn into the project in Pakistan and between $6bn and $10bn in the Fujairah refinery, according to oil industry sources. The projects are part of Ipic's intensified investment drive in refining and petrochemicals despite a surge in the costs of such projects, which sources say have nearly doubled in five years.

The completion of Kuwait's 615,000 bpd Al Zour refinery – slated to be the biggest downstream facility in the Middle East by 2010 – is expected to be delayed by a year.

Kuwait, however, remains aggressive over its refinery projects and has announced plans to issue tenders next month to upgrade two of its three existing oil refineries at an estimated cost of $15bn.

The news follows the award in May of a $15bn contract to an international consortium to build a fourth Kuwaiti refinery at Al Zour – taking the total planned investment in refinery capacity in the coming years to $30bn. Earlier this year the government said it intended to invest a total of $51bn over the next five years to increase both upstream and downstream capacity in the hydrocarbons sector.

The concentration of almost three-fifths of that investment in new downstream activities reflects both current global shortages in refinery capacity and a shift in the types of oil Kuwait expects to be refining in coming years, according to Oxford Business Group.

The tenders relate to the Mina Abdullah and Mina Al Ahmadi refineries. The former, built in 1958, has a capacity of 270,000 bpd while the latter, constructed in 1949, has a capacity of 466,000 bpd.

By the completion of the contract the two are expected to have a combined capacity of 800,000 bpd. Kuwait's third and newest refinery, Shuaiba, has a capacity of 200,000 bpd. However, Kuwait National Petroleum is currently considering whether Shuaiba remains viable and may well close the plant once the upgrades are complete.

The massive investment will see refinery capacity converted to higher value petroleum products – essentially lighter fractions such as petroleum and diesel – which account for the greatest global shortfalls in supply. OBG said the upgrading was necessary for a second reason – Kuwait not only wants to change the fractions produced by its refineries but also has to change the grades of oil it refines.

The announcement of the new tenders for Mina Abdullah and Mina Al Ahmadi appears preemptive, anticipating a future for Kuwait's refining sector which requires ever more intensive processes to convert heavier oils into lighter refined products.