$3.6 billion Abu Dhabi Gas Development deals inked

Significance
Abu Dhabi has awarded four more contract packages at the challenging and expensive Shah sour gas project, seeing costs fall significantly from inflated US$13–15-billion pre-financial-crisis predictions, perhaps even dropping below the long-quoted US$10-billion threshold, making the project look increasingly attractive for the emirate.

Implications
With the sulphur recovery and pipeline package, the utilities and offsite package, and the gas gathering package now being signed, together with some already awarded deals, savings on the total US$10-billion budget are starting to look within reach, as Abu Dhabi utilises the past year’s global slump in projects to its advantage.

Outlook
Still lacking an experienced IOC partner, the Abu Dhabi National Oil Company (ADNOC) might struggle to co-ordinate the preparation and launch of the project, but so far it has managed to keep up the pace following ConocoPhillips’s April withdrawal.

Detailed Analysis: Heading in the right direction

The Abu Dhabi Gas Development Company (ADGDC), the former joint venture (JV) vehicle for the operation of the Shah sour gas project by state-owned Abu Dhabi National Oil Company (ADNOC) and ConocoPhillips (though for the moment solely owned by ADNOC until a new private partner is found), yesterday signed contracts for four awarded contract packages. The deals at the technically challenging—and therefore prestigious—unconventional gas project went to companies that had for a significant time been seen as front-runners until awards were confirmed earlier this year, but saw costs coming in significantly below previous estimates—even before and following the 2007–08 peak of the global oil and gas industry’s cost inflation curve.

Italy’s Saipem has emerges the largest winner at the Shah project, confirming its award of the sulphur recovery unit and liquid sulphur transport pipeline, valued at about US$1.648 billion. South Korea’s Samsung Engineering secured the contract for the utilities and offsite facilities construction package valued at US$1.496 billion, while a consortium of Spain’s Tecnicas Reunidas and India’s Punj Lloyd signed up for the US$463-million gas gathering contract. Yesterday’s ceremony brings the tally of signed engineering, procurement and construction (EPC) contracts to US$3.6 billion, with the total tally of awarded—but not necessarily yet signed—contracts coming in at about US$5.5 billion.

Set in Stone?

Not all contracts at the project have been awarded yet, and not all of those awarded have been signed. Nevertheless, with some of the largest deals now finalised and filed, it is becoming apparent that the widely quoted US$10–11-billion cost of the project looks set to come down significantly.

The cost control effort looks even more impressive when compared with 2007–08 cost escalations—on the back of global shortages in materials, skills, and machinery—that led developers to expect the unconventional Shah sour gas project to come in at levels between US$13 billion and US$15 billion.

ADNOC balked at committing at that stage—quite rightly so, as it turns out—given the production cost per mmBtu of gas that would have ensued. Abu Dhabi, like its neighbours, has historically been used to cheap gas for domestic use, most often in the form of associated production on the back of its oil output, although its more recent gas shortage—at a time when domestic power demand has been rising as an effect of the federation’s tremendous economic growth—has forced it to look to more unconventional reserves to supply the domestic markets.

These are—and will continue to be for a considerable time—generously subsidised, making it in ADNOC’s interest to keep production costs down to a minimum, as it will end up paying the difference between actual production cost and the low market cost for perhaps decades, before thorough reforms in this area are achieved.

Still, with large upstream projects again being scaled up in the region, particularly in Iraq but also probably in Oman’s tight gas play, while Abu Dhabi continues to award projects moving its long-term oil (and associated gas) production capacity forward, the risks of future cost overruns at the challenging project should not be underestimated.

Outlook and Implications: The Experience Challenge

The sour gas project, which is expected to produce about 1 bcf/d of raw gas of a very corrosive quality with a high rate of toxic impurities, will only result in about 500 mmcf/d of sales gas after it has been treated. The high levels of impurities, however, demand that the whole production and treatment chain is sealed to a significantly greater extent, and must also be built using more expensive materials, able to withstand the corrosiveness and other challenges. Very high levels of associated sulphur also require the construction of a pipeline able to transport stripped and molten sulphur to a Ruwais plant on the Abu Dhabi coast—in itself a costly and challenging project.

Abu Dhabi, used to being a stable, large-scale, upstream investment destination able to offer low profit margins to investors, also offered very low margins to the IOC partner bidders for the project. ConocoPhillips in the end agreed to a deal widely seen in the industry as relying almost completely on sulphur monetisation to produce any returns. The troubled supermajor withdrew from this and several other projects earlier this year, leaving the spot as ADNOC partner vacant, but with the global sulphur market looking quite unattractive for the medium and possibly even the long term, there has not been a scramble by other IOCs to fill the position. ADNOC has been successful in awarding contracts that have lowered the costs significantly on its own now, although it is impossible not to see a lot of ConocoPhillips’ legwork involved in the pre-April processes for selection and detailed contractor negotiations.

Going forward, ADNOC’s lack of experience with any form of unconventional gas—and very sour gas in particular—is likely to become a problem, although the company might struggle to sweeten the project terms enough to sufficiently rekindle the interest of the previous runners-up. Shell was the foremost among these, but Occidental also potentially remains in the fray.

Hopefully the success in reining in costs at the Shah project means that ADNOC will feel a little bit more able to sweeten the financial terms for an IOC partner, ensuring that the relevant experience is brought into the project. Otherwise the scheme shows every sign of risking suffering schedule overruns and cost inflation again, as the region’s planned large-scale upstream developments get under way between now and the Shah project’s estimated third-quarter 2014 completion.