by Perry Williams, Senior Energy Writer, MEED
South Korean engineering, procurement and construction contractors are winning contracts based on their low fees, flexibility and willingness to take on risky, fixed-price projects.
Any international contractor questioning whether the global recession has scared off South Korean contractors from the region will have received an emphatic “no” in the past few months.
In late March, SK Engineering & Construction (SK E&C) won the $805m contract to install compression units at Abu Dhabi Company for Onshore Operations’ (Adco) Bab oil field, with a bid about $100m lower than that of its nearest competitor. The award came as a shock to other contractors, who were astonished that their bids, which were in the low $900m range, were so far off the pace. Kwang-Chul Choi, president of SK E&C, describes the company’s pricing on the deal as a “calculated risk”.
SK’s success follows Samsung Engineering’s construction contract for the olefins conversion unit being built by Abu Dhabi Polymers company (Borouge), and GS Engineering & Construction’s (GS E&C) $1.14bn green diesel deal. It proves that Abu Dhabi is becoming more open to the prospect of Korean firms working on its landmark projects.
The dominance of Korean firms in the Gulf market has developed over the past five years, as Western contractors’ dominance in the 1980s and 1990s has waned.
With a new-found emphasis on achieving competitive prices, sources in the emirate say Abu Dhabi National Oil Company (Adnoc) has made sure its subsidiaries, such as Abu Dhabi Gas Industries Company (Gasco), are aware that Korean companies are to be considered for prequalification for all future projects.
Korean companies have also been targeting countries in the wider Middle East and North Africa region. Less than two months after SK’s Abu Dhabi contract award, one of its rivals, Samsung Engineering, won a $1.2bn contract from Algerian state energy company Sonatrach to upgrade its Skikda refinery.
The contract award was swift and unexpected after Sonatrach made the decision to delay the final bid deadline from December 2008 to reassess the market.
In both cases, Korean engineering, procurement and construction (EPC) contractors plan on using the project awards as a springboard for further growth.
“Having Korean contractors in the UAE will elicit cheaper bids from US and European contractors too,” says Choi. “As long as they know [Korean] contractors are there, they cannot place too high a bid. We welcome that opportunity.”
Yeon-Joo Jung, president and chief executive officer of Samsung Engineering, says the company wants to build on a strong Gulf base and diversify further into North Africa.
“In terms of North Africa, we are targeting resource-abundant countries such as Algeria and Libya,” says Jung.
“Samsung has built its Middle East project track record in countries like Saudi Arabia, the UAE and Bahrain. But we believe we can expand our geographical markets and target the regions that offer project opportunities.”
Both contractors are showing the sort of flexibility that has made Korean firms such a force in the region’s EPC markets.
Prior to the Asian financial collapse in 1997, Korean firms complained that they were not being given a fair opportunity to bid for major EPC contracts in the Middle East, and in some instances, oil and gas subcontract work.
This was because they were largely regarded as civil construction companies. Major clients across the region had doubts over their engineering skills, as well as their ability to perform on large-scale contracts.
But attitudes have changed as Korean firms have slowly met and then exceeded clients’ expectations. According to Choi, Korean contractors now effectively manage to combine low prices with strong capabilities.
“At the moment, I think we are at an optimum point where Korean contractors can deliver a capability with a very competitive price and [the client] can place trust in our delivery,” says Choi.
“Most of the mechanical and structural facets of Korean firms’ businesses are on a par with the top tier [of contractors], but there needs to be more done [with regard to] our engineering capabilities.”
Over the past five years, contractors have flocked to Saudi Arabia, Qatar and Kuwait to bid on megaprojects worth billions of dollars.
But as those countries have delayed work while waiting for the demand outlook in the market to become clearer, Korea has successfully turned its attention to Abu Dhabi and Algiers’ newfound appetites to push through their own ambitious schemes.
“There are plenty of opportunities despite the global financial crisis,” says Choi. “In the past, Korean contractors perhaps were not always qualified to participate, and that in itself was [a bar to entry].
“Now that this barrier has been removed, I see more than enough opportunities.”
Korean firms have adapted well in capitalising on the absence from the market of more established Western contractors, who are reluctant to open themselves to more risky, fixed-price contracts. This willingness to take on risk means Korean construction firms have continued to win contracts despite the global recession.
Korean firms won $7.5bn worth of contracts in the Middle East between 1 January and 31 May 2009, compared with $27.2bn in total in 2008 and $22.8bn in 2007, according to the International Contractors Association of Korea (ICAK).
For the first quarter of 2009, Saudi Arabia remained the biggest market for South Korean builders, awarding $1.45bn worth of orders, followed by Libya with $1.2bn, then the UAE with $1.19bn, and Algeria with $940m.
South Korea’s government has set its construction firms a target of winning $40bn worth of work globally this year, down from a record of $47.6bn worth of work won in 2008. But with just $8.2bn achieved globally in the first quarter, it remains a tall order.
However, the cancellation of one large contract in Kuwait in particular has severely dented Korean contractors’ morale and revenue streams in a market where they have dominated for the past decade.
Kuwait’s government cancelled the planned $15bn Al-Zour refinery in mid-March, after an investigation over the way contracts were awarded by the client, state-owned Kuwait National Petroleum Company (KNPC).
The Korean contractors, including SK, Daelim, GS E&C and Hyundai Engineering & Construction (Hyundai E&C), were forced to write down an estimated $9bn worth of contracts. While few expect to lose substantial amounts of money on the work they have done so far, several confirm the cancellation will be a major blow to their finances in the future.
“In the past six months, we have been facing a very difficult situation like we have never experienced before,” says one executive at GS E&C. “The Kuwait refinery project was a big one and most Korean contractors took a part of it.”
Despite the situation in Kuwait, contractors remain hopeful that KNPC will retender construction contracts on the refinery this year, although it seems unlikely it will continue with the original selected companies.
“Kuwait disappointed us by terminating the project, but we remain in talks,” says Jung-Mo Jang, associate director of international business at Hyundai E&C. “We cry together with other Korean contractors, but it might still get back on track.”
However, Kuwait is not the only country where contracts have been cancelled.
In April, Dubai government-run real estate firm Nakheel cancelled its estimated $1.1bn contract with South Korea’s Samsung Corporation to build the Village Centre development on the Palm Jumeirah.
Korean oil company SK Energy has also suffered from the political fallout in Iraq between Baghdad and the northern Kurdistan region. Iraq’s Oil Ministry threatened to cease oil exports to Korea because of SK’s participation in a production-sharing contract with the Kurdistan Regional Government (KRG).
This series of contract cancellations demonstrates that Korean companies are not immune from the slowdown, although the major EPC firms offer mixed opinions on how the current economic downturn will change their short-term fortunes.
“I have some doubt as to a short-term recovery, but I think that by the end of this year, the global economy will start to rebound and that will drive up the downstream markets, including the petrochemicals and refinery sectors,” says Samsung’s Jung.
“This is the result of market imbalance as well as demand and supply. But I think this change in the landscape will definitely bring some changes on the owners’ side as well.”
Doosan relies on the Middle East for about half of its revenues. Seok-Won Yun, vice-president for power at Doosan, says the impact of the global downturn has been noticeable in the utility sector. “We have been in the Middle East since the late 1970s, and the financial crisis situation is very significant,” says Yun. “Both of our big projects are being delayed and it is having a serious impact on our Middle East operations.”
Korean firms are used to dealing with a crowded contracting market, but the sheer potential of one rival in particular, Chinese contractors, is causing some concern.
Firms such as China Harbour Engineering Company and China Huanqiu Contracting & Engineering Corporation have made significant inroads into the regional construction, industrial, power and water sectors, and are soon expected to figure in the hydrocarbons field.
Enterprising companies such as Samsung have been partnering with Chinese firms on selected projects, mainly in a supplier capacity, with an eye to future partnerships.
“Even though we do not have collabor-ations with EPC contractors in China, we have work experience with Chinese suppliers in Saudi Arabia such as Jilin Chemicals,” says Samsung’s Jung. “We had a big delegation with some very notable Chinese companies about two years ago. It was by no means talks for a possible collaboration, but it was a learning expedition.”
One factor that causes tension in Seoul’s export drive is the constant volatility in its local currency. On the Al-Zour project, for example, the four Korean contractors could face combined losses of more than $50m because of currency fluctuations.
Each contractor received 2-3 per cent of the total value of its bid in advance, which in the majority of cases was transferred into the contractor’s domestic currency.
If contractors return these payments to KNPC in dollars, they face a 30 per cent loss because of the country’s currency weakening against the dollar.
“When we won the project last year, $1 was equal to 1,000 won, [but] now we have to pay back the money to KNPC, and $1 is worth 1,300 won,” says Hyundai’s Jang. “We are losing money and have to be compensated.”
But Korean firms can also use currency fluctuations in their favour. One Korean contractor, who preferred to remain anony-mous, says he recently used the difference in the exchange rate to win a competitive bid for a major oil project in the region.
“When the bid was submitted, [the currency rate] was 1,490 won a dollar, and when we signed the contract it was 1,345 won a dollar,” says the contractor. “So that exchange rate alone is worth a lot. I was able to adjust and that option was not open to European or US contractors because they do not have that sort of currency fluctuation.”
One senior European EPC contractor agrees that he cannot always price bids as competitively as Korean firms. But he questions the sort of margins that some Korean companies are making in the region. “I think [the margin] would be as low as 2-3 per cent at the moment on some of these big jobs, which is just too small for a big established company like ours,” says the European contractor. “The Koreans are winning, but at what cost?”
Many Korean firms are also hoping to convince regional oil producers of their commitment to the region by developing a stronger presence on the ground. Strict new rules are increasingly being imposed, which require international firms to create domestic joint ventures and adhere to quotas for the training and employment of local workers.
The trend for big-hitters such as Saudi Aramco and Libya’s National Oil Corporation to require more stringent investment terms reflects the fact that few of the large energy projects around the region make a significant long-term contribution to the development of local skills. It is a major issue for every Korean company that operates in the region’s energy sector.
“It is not a matter of whether we are happy or not,” says the executive at GS E&C. “It is a trend. We had the same policy in Korea in the 1970s, when we were also developing our local firms, so we understand the logic.”
Hyundai’s Jang is equally relaxed about the new rules. “Every country wants to protect its own local businesses and contractors, so I think that is logical,” he says.
But the reality of how the plan will manifest itself on large-scale projects is yet to be seen.
“In some countries, they do not have enough local engineering capacity to deal with huge projects,” says Jang. “Their manpower and capacity is very small, so they need international contractors who are capable of dealing with megaprojects.”
According to one Korean executive working in Saudi Arabia, the new policy only exists on paper at the moment.
“I think at a working level at Saudi Aramco they are hesitating because it is new to them,” he says. “Doing all engineering work in Saudi Arabia requires a big commitment from both sides, and I think we will see some changes before it is implemented for the first time on the Yanbu export refinery project later this year.”
Despite their reputation for risk taking, few Korean EPC contractors are actively looking to enter Iraq because of ongoing security concerns, even though oil majors will start operations on a slew of oil fields this year.
Hyundai E&C was one of the leading builders in Iraq before the 1991 Gulf War, carrying out key infrastructure projects to build hospitals, roads, highways and railways. But re-entering the country is not a priority. “It is not for us at the moment,” says Jang. “We will not rule it out, but we will have to wait and see.”
However, SK E&C says it is more likely to enter Iraq than its neighbour Iran, which still suffers from the impact of US sanctions.
“Iran has been inviting us and other contractors to its shores, but we have been very cautious,” says Choi.
But he sees opportunities in potentially partnering with one of its associate companies, SK Energy, which is working on exploration and production deals in the Kurdistan region.
“There has been some confusion or conflict over where SK should operate [in Iraq], but over the medium term, SK Energy needs to buy oil, and we would like to build a facility there to help if we can,” says Choi.
The next 12 months are likely to provide a stern test for Korean contractors in the region. Despite successfully shedding their ‘low-cost’ tag, competition in the market remains intense and fewer landmark projects will come to the market.
But Choi remains confident about Korean companies in the region despite the downturn.
“When things do not go well, that is when Korean contractors really have the advantage,” he says. “They are ready to jump in and mix and match to get a very good price. I cannot see that changing.”