Contax Identifies Market Signals as Middle East Project Costs Escalate

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Reported by Richard Finlayson, Senior International Editor for Industrial Info Resources (Sugar Land, Texas)--“Risk” has been a much discussed and inspected concept in the past few weeks, as the subprime mortgage saga unwound on Wall Street. Who held the knowledge of where the risk lay? How now to handle the risk in new opportunities?

In the Middle East, industrial project owners learned, between 2003 and 2006 that initial engineering, procurement and construction (EPC) contract investment estimates had the very real risk of escalating by 60% to 120% by the time the project was completed, and sometimes before the first soil was turned on site.

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The underlying input cost rise accounts for only part of the increase. Because of this cost escalation, projects are now being postponed and canceled, as the owners can see no other way to avoid the risk of rising prices and execution delays. Adding to the challenging conditions is the situation on construction sites where 30% to 50% of project managers have had no training to support the positions they hold. It is a problem for all major owners and contractors and impacts on costs, health and safety.

“In May 2005 there was a correlation between input and output on projects, but by 2007 there was none,” said Tony Bury, Chairman of Dubai-based Contax Group, “There has been an element of cost input increase in the price rise. The costs of inputs have grown by 40% to 50% over the three years, some of which resulted from EPC contractors’ inability to manage costs and project complexity.

“But other factors have doubled the actual amount of the escalation. Five years ago, the EPC contractor would not pass on the full cost of the risk contained in a contractual project commitment. The inherent risk was his to manage. Today, faced with rising uncertainty and project risks, the contractor factors in full risk premiums and profitability requirements, and these are accepted. The project owners have been unable to resist contractors’ pricing behavior in the current ‘sellers’ market, as they have no real alternatives available. At the same time, the buoyant energy price environment in which the owners live has allowed the profitability threshold of projects to rise.”

Although more than $450 billion in project investments is to be awarded in 2007 and $1 trillion in investments planned through 2010, the Middle East environment is less buoyant than it appears. Contax believes that the current contracting and pricing strategies are unsustainable in the medium-to-long-term.

“Projects are announced every week, but not all of them will see the light of day,” Bury said. “We receive on average an email a day from people checking whether some project has been delayed or canceled. Price escalation risk, plus the bottlenecking of scarce resources, causes delays in project completion. These delays hold back the planned allocation of the resources to another project, and the ripple effect compounds cost increases. Owners can no longer assume that the initial contract price will hold. It can be subject to increases of 80%, 100% or 120% before the new plant is commissioned. Models based on the old format of project costs contained in the original contract no longer obtain, and the added risk factors can double the eventual project investment.”

The risk factor has projects on a knife edge and the higher price surge lies in the stakeholders' hands. Contax executives believe that the owner has to step up his game or he will not be competitive in the new pricing regime. In fact, he must pre-empt the vagaries of the market by ensuring that the fullest market knowledge arms him with the ability to cover forward market environment options in his project planning. Market knowledge is an imperative if the project supply chain is to be united. Shell in Qatar built its own offloading facility as the local port may not have had the required capacity for their project supply plans. Simple, when you have knowledge to act rather than face a future bottleneck with contingency plans.

Planning a project, however excellent the technological specifications, now demands a scan around the sector horizon for as much input as possible. One plant executive planning synergies by merge and/or acquisition with another plant with a similar profile cannot assume that his target is passive. The target plant’s management could be launching its own expansion plans, which would unbalance the synergies or even reverse the outcome of the merger and acquisition. Owners benchmarking their project while thinking on limited knowledge will lose out. Cannibalizing the project management team or the contractor from an on schedule project to bolster the performance of a lagging project can be a ”must do” decision, but it impacts on the bottom line. The extension of completion schedules is a capital burner.

The new project management model demands the sharing and minimizing of risk between the owner and the contractor. Contax has developed a set of recommendations aimed at helping contractors and owners achieve this objective. These include developing strategies to gain market share in core markets, including a thoughtful M&A strategy; developing new business models to exploit new, high-growth markets; aligning professional business development with corporate strategy; managing performance of underlying value drivers; building and nurturing competencies that generate long-term success and acquiring and developing talent in a market that is resource–constrained; and expecting higher performance.

Minimizing and sharing the risks at the operational level is a matter of who is best suited for specific tasks. If a local owner is in a venture with a major like Shell, then the latter would be better suited to organizing and leveraging international finance. Likewise, the contractor would be best suited to procuring local labor and resources. This sort of process controls and reinforces the real margins for both parties in the project rather than putting them at risk with contractual responsibilities carved in stone.

The new business culture in the Middle East is receptive to the sharing concept with increased transparency in deal making and the old payback routines falling away. Immigration procedures are now online, cutting out the ”interventions” by officials that once slowed the process and increased the cost of applications.

The annual ”Doing Business” report from the International Finance Corp (World Bank) saw Egypt top the list of countries worldwide, making the most progress in simplifying its business regulation. Saudi Arabia also earned high marks for an improved business climate. The report said Saudi Arabia has eliminated layers of bureaucracy that previously made it one of the toughest places in the world to start a business. The emergence of the Middle East was the prominent feature of the “Doing Business” report this year.

In this new business environment Contax has re-engineered the project management support model with ”risk” input from its 4,000 company project database and intensive feedback from clients and associates. Looking for and identifying market signals, Contax is ready to pre-empt project risks.

Industrial Info Resources (IIR) provides marketing communication services ranging from industrial database solutions to market forecasting, custom analytics, and specialty promotions that support high-level image campaigns.