(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, Sept 3 Order books for major engineering
and construction companies serving the oil and gas sector have
fallen in the last year, pricing is becoming increasingly
aggressive and profit margins have shrunk, all of which suggest
pressures on the engineering supply chain are starting to ease.
Exploration, production and refining in the petroleum
industry as well as the supply chain are characterised by long
lead times as well as long and pronounced investment and price
Between 2005 and 2008, the industry struggled to cope with a
sudden upsurge in demand. But the boom is now nearly a decade
old and the supply chain is starting to adapt.
Falling order backlogs imply a better balance between demand
and supply at engineering firms - which should in turn help
contain cost pressures and boost supply for the oil and gas
industry over the next five years.
Most of the world's oil refineries, natural gas liquefaction
plants, gas-to-liquids plants, petrochemical facilities, mines
and electricity transmission networks are designed and built for
their owners by just a handful of giant engineering and
construction companies that have the expertise to manage these
Engineering, procurement and construction (EPC) companies
handle the front-end engineering and design (FEED) work,
purchasing of raw materials and components, construction,
sub-contracting and project management.
Megaprojects like Qatar's Pearl GTL plant are so large they
create their own "weather" in the global engineering system -
driving worldwide price rises for the engineers and specialist
supplies required to complete them. Such is the pressure they
create on the supply chain, the global engineering industry can
only handle a relatively limited number of them at any one time.
Privately-owned Bechtel as well as listed companies like
Fluor, KBR, Chicago Bridge & Iron,
Foster Wheeler, and smaller specialists like MasTec
are responsible for delivering almost all the big
projects in oil, gas, petrochemicals and mining.
The main exceptions are some projects managed directly by
in-house engineering teams at the major international oil
companies such as Exxon and top miners like Rio Tinto
and BHP Billiton. But even there, outside
engineering companies may be responsible for some of the
Like demand for geologists and oilfield services companies,
contracts placed with engineering and construction companies are
a key indicator of the pace of investment in the oil and gas
sector and can show when bottlenecks are emerging in the supply
Across the sector, engineering firms report both the value
of new contracts they are awarded and the total "backlog" of
work for which they have secured firm contracts but not yet
Backlogs are a useful measure of the project queue. Whether
the backlog is growing or shrinking indicates how many new
projects are being commissioned, how quickly the engineers are
completing existing orders, and how long new projects are likely
to be delayed.
In practice, assessing the state of backlogs industry-wide
is difficult. Some companies do more work in oil and gas, while
others more on power and infrastructure projects. The
geographical focus differs with some involved heavily in North
America and others with a more diversified client base.
Some firms report the total estimated cost of projects in
the backlog, others just the part attributable to them (i.e. net
of charges that will flow through to the end client). Bechtel,
the largest of them all, is privately owned so does not report
detailed information at all.
Nonetheless, Fluor, which is the largest publicly listed
engineering and construction company by market capitalisation
and backlog, publishes the most consistent and detailed
information, and can serve as a reasonable proxy for the
Between September 2005 and September 2008, Fluor's reported
backlog of oil and gas projects quadrupled from $5.2 billion to
$22.8 billion, driven by surging demand for exploration and
refining, as well as soaring inflation in the cost of the
projects themselves (Chart 1).
Fluor's profit margin climbed from 4.6 percent to 5.6
percent, and briefly touched an extraordinary 6.2 percent in the
third quarter of 2008. Operating profit tripled from $242
million in calendar 2005 to $724 million in 2008, according to
the company, as the oil and gas industry scrambled to respond to
Soaring demand and profit margins in turn drove a peak in
engineering companies share prices in 2007-2008 (Chart 2).
Chart 1: link.reuters.com/nyv72v
Chart 2: link.reuters.com/qyv72v
Backlogs were reduced briefly during 2009 and the first six
months of 2010 as a result of the financial crisis, which caused
a hiatus in oil and gas investment, but swiftly rebounded,
reaching $19.5 billion by the end of June 2012, just $3 billion
below their previous peak.
In the last 12 months, however, the backlog has shrunk. By
the end of June 2013, Fluor reported the backlog of oil and gas
work was down to $18.7 billion.
KBR, another large engineering company with a lot of oil and
gas work, also reported its backlog of hydrocarbons projects was
down, from $9.4 billion to $8.7 billion, over the same period.
By contrast, Foster Wheeler saw its oil and gas backlog rise
from $2.2 billion to $2.7 billion. But the company admitted the
"competitive environment remains challenging, with commercially
aggressive bidding as the norm." Bid invitations and contract
award dates continue to slip, the company added.
The slowdown has been even more pronounced in
mineral-related projects, where mining companies have cancelled
or postponed projects in response to lower prices for iron ore,
coal, copper and other metals.
In the most recent quarter, Fluor's margin on oil and gas
projects was just 3.74 percent, a small improvement on 2012 and
2011 when profit touched just 3.3 percent, but down by more than
60 percent from the highs recorded in 2008.
If the engineering and construction sector is a leading
indicator for future oil and gas production, refining and
transportation, it is signalling comfortable increases in supply
for the remainder of the decade.
(Editing by David Evans)