What is the outlook for building new LNG facilities?

Rising construction costs will play a large part in determining what plants are built T. Phalen and J. Scotti, Fluor Corp, Houston, Texas editorial@HydrocarbonProcessing.com Global natural gas (NG) demand is forecasted to rise at an average rate of over 2%/yr. On a worldwide basis, available NG supplies exceed demand. However, there is a mismatch between gas producing regions and gas consuming regions. Liquefied natural gas (LNG) production and transportation is one answer to solving this mismatch. For this reason, most forecasts, including the International Energy Agency (IEA) WEO 2006 forecast, predict that up to 70% of the increase in gas trades among regions will be LNG. Overall, between 2004 and 2030, IEA expects LNG demand to grow by 6.6%/yr, a similar rate to the preceding decade.1 Need for new LNG supplies. Several LNG liquefaction trains are in construction and are scheduled to come online over the next few years to meet current demand. Forecasters are predicting that even with liquefaction capacity currently under construction, LNG supplies will fall short of demand by the year 2015.2 Frank Harris, head of global LNG for Wood Mackenzie predicts that this crossover between supply and demand will occur in the 20132014 time frame.3 The time to construct an LNG project in today's environment is four years. To meet future demand requirements, the next wave of LNG projects are being studied. In fact, Woodside Energy has announced plans to construct a new LNG train every two years and, in total, 17 new LNG projects have been announced in the Australia, Timor Sea and Papua New Guinea region.4 However, rising facility costs coupled with uncertainty in the delivery of projects have caused owners to evaluate the attractiveness of proposed projects. The volatility and risk introduced into the global economic outlook over the last few months just serves to amplify the uncertainty surrounding project economics. Based on the list of currently announced projects, the most likely region to produce the next round of LNG facility construction is also the one with the most intense competition for resourcesWestern Australia. Prevailing wisdom is that not enough engineering, procurement and construction (EPC) capacity is available to meet the needs for potential projects in this region.

Fig. 1

Contractor backlog trends. EPC contractor backlog has doubled in three years.

Fig. 2

Process plant industry bookings for contractors; manpower requirements grew by over 90% between the start of 2004 and the end of 2007.

Why is the market reluctant to proceed with all of these projects in parallel? In a word: Risk. LNG liquefaction projects are large, complex programs located in remote areas requiring significant new infrastructure. The large capacities associated with each proposed project, coupled with future market uncertainties and lengthy times-to-market for newly authorized projects (typically five years from authorization to commercial operation) expose these projects to increased risk relative to competing projects. The size and breadth of each project can put a tremendous strain on regional resources. Unprecedented price escalation further complicates project financial viability. From 2005 through 2008, all indications are that LNG project costs have escalated in excess of the 20%/yr rate as compared to other upstream projects, thus creating a high degree of economic uncertainty for liquefaction projects. LNG liquefaction costs were reported around $200/metric tpy (mtpy) in 2005.5 However, 2005 may represent the low point for LNG facility construction costs. Currently, onshore LNG liquefaction costs are being reported in the range of $1,300/mtpy to $1,500/mtpy of capacityan average annual increase of 50% to 60% in the price per ton.6 These reported increases are on the high side of actual experience, and the mtpy for a well run project is probably the minimum expected cost in the current market, implying the average annual increase in the cost of facilities is still 30% to 45%.7 What factors are driving sharp price increases for LNG facilities? Demand for EPC services, equipment and material has experienced record growth, with all sectors of the market rapidly expanding infrastructure after years of neglect. This growth has strained existing resources in several areas. Market conditions impacting LNG facility projects include: Doubling of the EPC project technical resource requirements between 2005 and 2007, with Cambridge Energy Research Associates (CERA) reporting a possible 10%15% deficit of people to staff projects by 2010.8 Average current shop loads at 70%100% of available capacity, as opposed to 60% average load over the previous 10 years. Escalation in two key commodities for LNG facility constructionstainless steel pipe, and large compressors and gas turbineswith total increases of 90%150% and 20%50%, respectively, during 20062007. Escalation for 2008 slowed to 10%20% for stainless steel pipe and 5%15% for compressors and turbines;9 however, costs for carbon steel/pipe increased by 70%90% in the first half of 2008. Constraints on the availability of skilled and unskilled labor to support construction, with a potential shortfall of 15% in skilled labor in 2008.

Each of these factors contributes to the total cost escalation as the industry resorts to the age old method of allocating scarce resourcesprice increases. In addition, the shortages and constraints tend to lengthen the development and construction cycle of facilities, further straining overall project economics and resources.

The convergence of each of these factors at the same time frame is driving the size and breadth of the increases. In addition, the facility increases are also being driven by increases in the overall pricing and schedule uncertainty within the EPC market. Contractors are pricing in increased contingencies across all EPC markets to factor in the uncertainties around obtaining the required resources and materials in a timely fashion and at the price predicted. This is particularly true in the LNG facility market as these projects tend to be in remote locations with limited infrastructure. They also are complex projects with multiple partners and large capital facilities. Contractor capacity limitations. The global energy sector is facing a severe shortage of qualified technical resources. Since the early 1980s, the investment in energy and infrastructure has been relatively low. The industry as a whole has focused on internal efficiencies and cost cutting as a method for enhancing profitability. As a consequence, the number of technical workers actively employed in the industry has declined dramatically. Recent concurrent growth in capital investment in all sectors of the energy and infrastructure markets has strained the available technical resource pool to the breaking point. The need for technical resources in all parts of the energy sector and, in particular, for EPC contractor services has skyrocketed. According to a new analysis by CERA, there could be a potential 10%15% deficit of people by 2010 to staff the over 400 major projects expected to come onstream over the next five years.8 A major EPC company's internal review of the publicly reported backlog for 12 major contractors in the engineering and construction industry shows that contractor backlog has doubled over the last three years. While this trend is expected to moderate over the near term, the contractor community continues to experience unprecedented workloads. Limited excess capacity is available in the system to absorb new work. This growth in backlog is reflected in the demand for technical resources. An internal EPC company's forecast of industry manpower requirements for the same period indicates that manpower requirements to meet these growth demands almost doubled between the beginning of 2005 and the end of 2007. This growth is forecast to level out for the near term. However, resources will continue to be strained. This forecast is based on available data on capital expenditures and trends in the industry and assumes continued strength in global oil prices. This accelerated growth in an industry facing an aging work force and years of declining population is putting a severe strain on the resource pool. Contractors have responded to this demand for resource by increasing pricing for services and stretching project time lines in an attempt to level demand and meet the available needs. The results are higher costs for engineering and management services and longer project time lines. In the LNG marketplace, this effect has been magnified. LNG liquefaction has been dominated in the past by a few contractors. In recent years, the number of contractors involved in the engineering, procurement and construction of LNG projects has increased to include other major contractors. Yet, the experienced resource pool remains limited. Since 1994, the backlog of LNG train construction has more than doubled. In addition, LNG projects continue to compete with other energy projects for resources as these same technical personnel can work on refineries, gas plants or chemical projects. As the demand for large, complex LNG projects grows, the expansion in price and schedule accelerates to moderate demand. Given the current market conditions, cost increases of services translate directly into a corresponding increase in the total LNG facility capital cost. Scarcity of key resources translates into extended EPC schedules. To combat this problem, owners should engage and commit contractor resources early in the project development cycle. The old strategy of competitive bids at each stage of a project in today's environment can result in qualified bidders declining to participate, risk premiums being added to pricing, and uncertain access to qualified project teams. By committing early in the project development to an EPC contractor and working with them to develop a viable strategy, an LNG facility owner can tie up valuable resources for the project and lower risk. The schedule and risk benefits of

this approach can typically outweigh any cost advantage relative to a traditional competitive bid approach. In addition, an LNG facility owner can broaden access to key resources by using teams of contractors on its projects. The liquefaction portion of any LNG facility project typically represents 34%38% of the total projecta large undertaking by itself. By employing several contractors on the nonliquefaction work, an owner can reduce risks by increasing the pool of qualified resources to complete the work. Also, the owner can take advantage of the relative strengths for each contractor. Escalation of equipment and material. The rising demand for equipment and materials to support projects across energy and infrastructure projects has strained suppliers' ability to respond, resulting in delivery schedule and cost increases. Logistics challenges have compounded these challenges. An increase in demand for shipping resources to move materials and equipment from one continent to another, combined with growing worldwide consumer demand, has resulted in longer transit times and greater need for advance planning. The net result is that, even when materials and equipment can be sourced from lower-cost regions, higher transportation prices and increased lead times may still negatively impact project financials, leading to cancellations. Even among finished goods suppliers who are not experiencing labor or production capacity issues for their products, competition exists for raw materials with other equipment manufacturers. The current constraints span the raw materials, finished materials and equipment sectors. All of this demand for equipment and material has resulted in continued price increases, extended delivery times and increased shop loads as illustrated in Fig. 3. In 2006 alone, stainless steel pipe, a key commodity for LNG facility construction, experienced a 45%60% price increase. This was followed by an increase of 25%40% in 2007. Major compressors and gas turbines also experienced a significant increase in costs. In the same years, 2006 and 2007, the cost of these machines jumped 15%25% and 8%20%, respectively. Other commodities also showed sharp increases in the same period.

Fig. 3

Equipment and Material Escalation Forecast compressors and stainless steel.

Fig. 4

Intense demand for construction resources globally.

The impact of material price escalations on LNG facility costs was dramatic. Projects seeking authorizations during this period faced an uncertain future in terms of price and delivery of key materials. In this environment, it was difficult to predict the ultimate economics for a project, ultimately resulting in several project delays or cancellations. Going forward, some moderation of equipment and material escalation is expected. In 2008, the cost escalation followed the trend of the previous two years. However, there are signs that these increases are moderating. Over the near term, steel prices may see a decline. The steel market will likely offer more favorable pricing mid- to late-2009 through 2010. Certain finished product equipment suppliers will continue near capacity until current orders are filled, followed by a period of available capacity in mid-2009. Based on current backlog of orders, suppliers will hold on to current margins as long as they can. However, mid- to late-2009 may be a good time to be a "buyer" again. This could be good news for LNG projects going forward. Equipment and material pricing should stabilize and provide a "window of opportunity" for projects to move forward with a level of certainty. Early procurement strategy. To capture this window of opportunity, owners may want to apply an early procurement strategy. Early procurement will allow owners to lock in pricing at favorable levels and to limit the project's exposure to future inflation. In addition, early procurement has proven successful in addressing market constraints to keep projects on schedule and within budget. By identifying long-lead materials and equipment during the facility design phase, purchasing becomes a strategic function that supports execution in line with the project's desired parameters. This approach requires close integration of the EPC contractor and supplier, who work in conjunction with the owner to prioritize decisions related to supply constrained items. In essence, suppliers become partners in the design process. An added benefit is that an integrated approach reduces or eliminates duplication in the supply chain. This reduces the demand for critical engineering and skilled labor resources. This strategy has been validated by Construction Industry Institute research and is critical in today's overheated environment. Partnering with key suppliers during the development phase of a project can inject more predictability into the equipment and supply chain. The net result is a more controlled, managed and efficient project cost and schedule. Scarcity of construction labor. Rising demand for construction labor supporting projects across a spectrum of EPC projects has highlighted a declining pool of skilled labor. Several international "hot spots" have emerged as areas of high construction activity. They include Alberta, Canada; Western

Australia; West Africa and the Middle East. Out of these four areas, Western Australia (WA) is also an area of high actual and potential LNG construction activity. Mark Greenwood, JP Morgan energy analyst, notes that the labor shortage "is going to prevent projects from proceeding. There are eight major new LNG projects planned in WA and the Northern Territory targeting startup between 2012 and 2015, and we expect only two or three of them will get up and running. The rest of them will be delayed and labor will be a constraining factor."4 The short supply of skilled workers is driving wages and project costs higher. During the past four years, Australian local construction labor costs have jumped 38%. "Gaining access to experienced people is becoming a long lead item for projects, with the boom in resources and generally tight labor situation in Australia. This is not expected to change in the near term," said Jim Willetts, Woodside Energy.4 In the past, the "457 Visa" that enables Australian businesses to sponsor skilled overseas workers to fill positions on a temporary basis has not been applied widely in the Australian construction industry. Today, large resource projects are pursuing reforms to the sponsorship, monitoring and compliance obligations associated with this labor source. Pay and conditions for these skilled overseas workers are aligned with project wide union agreements and, consequently, the cost of the skilled overseas workers typically exceeds that of similar local workers. One approach to improving labor productivity and overcoming shortages is the increased use of technology. However, applying technology in construction work places additional demands on skill levels needed among both field craft and staff. Projects demand higher technical competence, are also creating a demand for improved training and education. The limited quantity of technically literate construction resources is also expected to exacerbate the labor shortage's inflationary impact. Modularization. Prefabrication has been used in the past to cope with labor shortages. Streamlining the construction process at the job site allows for the quality- and logistics-controlled production of labor-intensive portions of work in controlled environment. This allows skilled labor to work in a centralized location with greater total efficiency, as the resources are not dedicated to a single project but may alternate between projects with no time lost traveling from one dedicated site to another. This also results in lower costs, both in wages and travel, as well as opening of the market to specific skilled labor that would resist relocation. The declining fuel costs will also help the economics of modularization as transportation expenses will also decline. Modularization use in nontraditional areas such as LNG and mining construction projects, as well as the increasing demand from traditional projects, is placing a strain on fabrication yard capacity. McDermott's Indonesian yard completed the fabrication of modules for the fifth LNG liquefaction train for the Woodside operated North West Shelf facility in Karratha, Australia. Modules for Woodside's first Pluto LNG project, also in Karratha, are currently under fabrication in Thailand. Moving module fabrication offshore has become a cost-effective solution to resolve the skilled labor shortage in Australia. The success of a modular approach also requires an efficient engineered solution to module design, good craft productivity in the fabrication yards and proper management of shipping. However, the large LNG projects currently proposed may require on the order of 100,000 tons of module fabrication to reach their goals of reducing site labor. This potential fabrication volume will put a strain on worldwide fabrication capacity. Yards capable of fabricating the complex modules expected for an LNG project are currently running at near capacity, providing little relief to the labor shortages' inflationary pressures. As illustrated in Fig. 5, worldwide demand for module fabrication is predicted to surpass supply in the same period as the predicted LNG construction. LNG module fabrication will have to compete for this scarce fabrication capacity with other energy projects making project planning and logistics difficult. The key to success will be early planning and commitment of fabrication contractors.

Fig. 5

Global demand for modular fabricationglobal demand exceeds supply.

Despite the potential difficulties, this approach has been applied to upstream projects for years. With the proper planning and experience, it will continue to be the best option for managing LNG facility risks going forward. At present, limited LNG facility modularization has taken place. We would expect this to increase and become more sophisticated with the next round of facility construction. Outlook. In the short term, we can expect LNG facility cost escalation to continue at a similar high rate for the next few years. There are signs that the equipment and material pricing is beginning to stabilize. If this occurs in 2009, then we can expect more stabilized cost growth going forward. However, this stabilized escalation trend is still expected to be higher than historic norms. To combat and manage the cost uncertainties facing the LNG EPC market and to lower project risks, these strategies can be applied: Commit EPC resources early in the project. Owner's should partner with an EPC contractor early in the project development cycle and get key project management, engineering and construction resources committed to the project. Early construction planning can mitigate labor shortage issues. Utilize multiple contractors for a project. Owner's can broaden their access to key resources by engaging multiple contractors in a single, large, complex project. Strategic sourcing and supplier integration. The opportunity to influence project cost is greatest at the beginning of a project. By bringing suppliers into the project early, one can improve the security of supply for critical components, improve overall facility optimization and reduce work requirements for critical engineering service firms by eliminating duplication. Modularize facilities. Modularization is an acknowledged strategy to combat the impact of construction labor shortages. Streamlining the work processes at the site and shifting labor to a more controlled yard environment reduces construction cost risks. Engage module fabricators early. Fabrication capacity will be at a premium in the near term. It is essential to engage fabricators early in the process to commit available capacity and drive design efficiencies. Designing to known fabricator capabilities will improve project economics and labor utilization. Modify contracting strategies to improve risk sharing. Contracting strategies, which apply reimbursable terms or negotiated lump sums to share the risk, can reduce risk premiums and contingencies to lower overall project costs. The increasing demand for LNG over the next 20 years means there will be a corresponding demand for LNG facility construction over the same period. The question is: Who will construct the facilities to meet this demand? Rising costs in LNG construction will play a large part in determining what plants get built. The use of key strategies to mitigate cost increases and reduce risk will improve the profile of any potential project. HP Acknowledgments

The authors would like to thank Fluor Corp. management for permission to publish this article. Our gratitude also goes to colleagues at Fluor Corp.Daryl Johnson, Harry Homan, Patti Nanney and others, for their contributions and constructive comments while writing this article. LITERATURE CITED
National Petroleum Council, "Facing the Hard Truths about Energy," July 2007. "Despite rising costs, global LNG supply is set to increase dramatically over the next eight years," IndustrialInfo.com, Dec. 11, 2007. 3 "LNG likely to be in short supply by 2013, says forecast," Hydrocarbon Processing, July 2007, p. 17. 4 "Skill woes cloud LNG Plans," News Limited Australia, Sept. 27, 2008. 5 Yost, C. C. and R. N. DiNapoli, "LNG Plant CostsPast and Present Trends and a look at the Future," AIChE Spring Meeting, 5th Topical Conference on Natural Gas Utilization, April 1014, 2005. 6 "Samsung Heavy Industries secures $567.8 million floating storage and offloading LNG order," Industrial Info Resources, Sept. 26, 2008. 7 Jenson, J. T., "Special report: Global LNG Trade to 2020 marked by uncertainty," Oil and Gas Journal, Feb. 25, 2008. 8 "Engineering Talent Squeeze'People Deficit' Like to Cause Further Delay in Some Oil & Gas Production Projects through 2010: CERA," news release, Cambridge Energy Research Associates, Oct. 4, 2007. 9 "2008 Material Market Outlook," Fluor Supply Chain Solutions, January 2008.
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Bibliography
"Upstream project costs showing signs of peaking, says CERA," Hydrocarbon Processing, July 2007, Vol. 86, p. 17. Phalen, T. and J. Scotti, "Update on LNG facility construction," 2008 OTC conference proceedings, OTC 19306, May 2008.

The authors Tom Phalen is vice president of upstream operations at Fluor Corp. He has over 32 years of experience in the engineering and construction industry. His career with Fluor has included assignments in process engineering, pipeline engineering, engineering management and project management and as general manager of the Houston office. He is currently responsible for directing Fluor's upstream project operations for North America and LNG facilities on a global basis. Jim Scotti is senior vice president and chief procurement officer at Fluor Corp. He is responsible for $11 billion annual spending and more than 2,000 resources in procurement, contract management, material management, sourcing, travel services, logistics and export control within Fluor worldwide. Fluor procurement is a center-led approach that emphasizes global sourcing and leverages the company and project spend across all business groups.