Middle East Sees Unprecedented Boom With Shortage Of Contractors & Bonanza For Banks.

*** This Is Not The Cycle Of Equity; It Is The Cycle Of Commodities; And The Big Investment Bank, Funds & Hedging Managers Have Moved Into Oil, Other Energy Futures & Metals

*** Because Fatal Accidents Have Become More Frequent Than During Previous Cycles, The Cost Of Insurance In The Middle East Has Also Risen

*** So The Best Contractors Are Getting More Selective In The Middle East Projects Market

*** Some Int'l Contractors Have Merged With Others In Order To Be Strong Enough The Risk Of A Turnkey Job

*** Some Of The Best Contractors Have Also Gone Into Own E&P And Utility Businesses

With world oil prices and revenues having been high for the fifth consecutive year, the Middle East is experiencing an unprecedented situation. There is plenty of money and more than $200 billion worth of projects, mostly in the Persian Gulf, but not enough contractors willing to bid for turnkey jobs. Qualified international banks are the highest profit earners from the implementation of projects.

It is a boom for project finance as the number of banks involved is limited to those international investment people who since the 1970s - in several cases since the late 1990s - have prepared themselves to work in a volatile but most lucrative part of the world and locals who have learned from them. There are three main categories of project financiers in the Middle East:

1. Investment bankers working in countries that are part of the global business cycle and recognised internationally as being credit worthy, such as the six Arab Gulf Co-operation Council (GCC) states, Egypt, Jordan, Lebanon, Tunisia, etc.

2. Investment bankers working in countries partly isolated from this cycle because of US sanctions, such as Iran, where the fees for packaging a project finance transaction are higher than in the case of the first category because of the higher risks.

3. Highly prestigious Wall Street investment bankers working out of London or another European base, or directly from New York, who have financed some of the biggest energy projects in the Middle East - such as Goldman Sachs which raised almost $2.5 billion for Qatar's first RasGas LNG venture in December 1996 (see brief profiles of Qatar's LNG ventures in Gas Market Trends of this week).

Most of the international investment bankers operating in the Middle East, with the exception of their US counterparts, are involved in the first two categories. Bankers of the third category like Goldman Sachs would be moving to the Middle East if and when the US project in Iraq succeeds (see News Service and OOD5 in this week's APS Diplomat Package). Goldman Sachs and the other heavyweights of the third category would have to move to this vital part of the energy world in view of its huge prospects, despite an irreversible shift to alternative sources of energy worldwide (see Oil Market Trends of this week).

Because the number of international investment bankers in the second category is more limited their fees would be getting higher in 2005 if Iran faces a US-led blockade sanctioned by the UN. The chances for and against such a blockade at the moment appear to be 50-50 (see News Service No. 17 of last week's Diplomat); and the possibility of China vetoing a UN Security Council resolution against Iran does not seem to be high for the time being, despite the huge LNG/oil deal just initialled by Beijing and Tehran (see Gas Market Trends of this week).

The number of qualified international and local engineering and construction contractors in the Middle East has been reduced gradually since the mid-1990s, not only because of competition that has been getting increasingly severe, but more recently because of the volatility and rapidly rising prices of steel and other commodities required for their contracts to be executed on time and as agreed.

As a result, competition among contractors is no longer as keen as it used to be in the mid-1990s when JGC Corp. of Japan, for example, cut its price by more than 50% in order to win the engineering, procurement and construction (EPC) contract for the RasGas LNG plant.

Although the competition after JGC's move led to a major reduction in the cost of gas liquefaction plants and receiving/re-gasification terminals around the world, a resultant decline in international contractors' profitability led to the collapse of many engineering and construction companies.

In the same way, shipyards building LNG tankers in the mid-1990s began to compete with each other so fiercely that the cost of new vessels came down from more than $250 million to less than $150 million. But now that there is a huge boom in the shipping business, with most oil tankers having become too old and freight rates are at a record high, shipyards on both sides of Suez are overbooked with orders for LNG carriers. But while technology has helped them reduce costs, shipyards are unable to raise the price of newbuildings and some of them in the West are running the risk of getting bankrupt because of high steel and manpower costs.

Yet it is the international engineering and construction contractors which have been hit most in the Middle Eastern market for projects and the background to this goes back to the 1990s. The JGC move to win the RasGas EPC in mid-1995 had been provoked by earlier competition from Chiyoda Corp. of Japan which, in order to survive, had to cut the EPC price of the first QatarGas LNG plant. In that venture, Mitsui of Japan had secured Chubu Electric as a client for QatarGas and got Mobil to replace BP as Qatar's leading partner in the LNG project. After lobbying by Mitsui and Marubeni Chiyoda agreed to bid for the first two trains at a low price of $1.395 bn and got the contract in June 1993.

Chiyoda thus beat a $1.52 bn bid by the Kellogg/JGC partnership (a partnership dating back to the early days of a transformed Japanese navy, which is interesting to note, with Kellogg of Dresser Industries boasting it had built most of the important LNG trains and receiving terminals around the world), and a $1.7 bn bid by Foster Wheeler (see Vol. 57, Gas Market Trends No. 11).

That cycle of competition among the contractors - not just in the LNG sector but also in refining, power or petrochemical plant construction, etc. - compelled Chiyoda to ask for a huge loan from Mitsubishi Corp. and Tokyo-Mitsubishi Bank. Because it was no longer making enough profit to service its debt, Chiyoda was taken over by the two creditors, which got Kellogg Brown & Root (KBR) to get a minority stake in the huge Japanese contracting group in order to downsize it and making more competitive. That was in the late 1990s. By then Kellogg had been sold and merged with Brown & Root, because it had become unprofitable, and eventually KBR was acquired by Halliburton.

By the beginning of this decade, all three main Japanese engineering and construction companies - JGC, Chiyoda and Toyo Engineering - had been downsized in order to be able to compete for projects in the Middle East. But even Halliburton, which got the biggest contracts in Iraq, now is suffering because its KBR unit is making huge losses as a result of its Iraqi contracts to supply US forces there with almost anything including meals. KBR is making huge losses because of many of its staffers in Iraq are getting killed by insurgents. Now Halliburton is facing one of two choices: either getting rid of KBR, or restructuring it to become profitable - and both choices are costly (see Iraq survey in APS Diplomat's OOD4c of Oct. 4).

These are just examples of the way and the reasons why international contractors in the booming Middle East and elsewhere in the world are suffering and will continue to suffer because of rising prices of steel and other commodities required for their turnkey jobs. And the risk of fatal or technical accidents, such as the recent collapse of a new construction site at Dubai International Airport, has led to a rise in the cost of contractors getting insurance for their turnkey project. With the insurgency in Iraq having increased in recent month, no sane contractor would want to have a job there unless he is paid high enough to take up a life insurance policy in favour of his family.