Comment: All at sea?
The fall in oil prices may not be as catastrophic for offshore firms as many predict
Recent news from the Middle East following the rapid decline in oil prices is generally bad. Reports abound that there is “severe cooling” in the market – some anticipating a 2008-style collapse.
Other doom-mongers anticipate expat departures from the GCC in droves as the combined effects of a drop-off in projects, regional political uncertainty, and soaring inflationary costs take their toll on construction work.
However, while these are undoubtedly considerations, there are still positive factors in the regional economy which suggest, in the offshore industry at least, that projects are still proceeding.
The cost of oil is a factor in deciding whether a project is commercially viable or not, but there is only so far it can fall. Headlines of “60% drop in six months” have shock value when the drop is over $50 a barrel, but less so when the daily changes are much lower. The feeling is that the market is slowly now approaching the bottom and current market rates are lower than marginal cost of production (including the capital expenditure for the original investment).
Prices will eventually need to rise at least to cover these costs, and they will do once the surplus production on the market becomes more closely aligned to demand. This will provide certainty.
Saudi Arabia has recently announced that it has no intention of changing its current strategy and will continue to produce at the high rates seen recently. This retains a degree of buoyancy in the KSA construction sector, but we also see a move of offshore oil support vessels and equipment to work in the more resilient local markets for gas production, such as in Qatar.
Oil projects take time to execute – companies seeking to let contracts are still thinking about the price when the oil comes online, not the market price at today’s rates.
While recovery to levels over $100 a barrel is not anticipated in the next year or so, the prices are likely to be increased by the time any new projects are eventually brought online. We should not forget that fuel costs are also a significant aspect of any construction work, so the depression in prices has made new projects potentially cheaper to carry out.
Many players who slowed or stopped new projects in previous downturns learnt to their cost that once the market picks up (and the oil market tends to pick up quite aggressively) supply will have significant lag on demand, further exacerbating costs.
Away from the volatility of assessing the strength of the construction market purely through the spyglass of oil prices, the sector also has some optimistic tales to tell. General shortages in the availability of specialist vessels and equipment continues to keep margins for offshore contractors.
The smell of an upturn in the market over the next few months has also piqued the curiosity of private equity funds keen to look for offshore companies with strong underlying order books.
Companies operating in the sector are also undertaking refinancing activities, in anticipation of growing order books.
We anticipate that governments in the Middle East, keen to stimulate the import of foreign capital, will also be looking to adjustments in their investment regimes to further enhance the market.
About the author:
Robert Blundell is a partner at law firm Holman Fenwick Willan Middle East