Middle East Economic Survey

VOL. LI

No 25

23-June-2008

REGIONAL/GENERAL

Soaring Oil Prices Push MENA Steel Demand To New Peaks

By Melanie Lovatt

The following is an abridged version of an article written by MEES Finance Editor Melanie Lovatt for Steel Business Briefing (SBB) Insight in April this year.

Soaring oil and gas prices have propelled Middle East and North African (MENA) steel demand to record highs, as the region’s oil producers have channeled their windfall profits into scores of new projects. There has been a corresponding jump in steel demand, boosting imports of oil country tubular goods (OCTG), linepipe and plate for everything from oil/gas exploration to storage tanks. Downstream development has also increased demand for structural, special and stainless steels for new refineries and petrochemical facilities.

On top of this, “petrodollars” are funding the Gulf’s unprecedented building boom, with steel use for other industrial projects, infrastructure and real estate on a distinct uptrend. The Gulf region is expected to invest around $500bn (€315bn) expanding crude oil, gas and related hydrocarbon industries over the next five years, and this oil expansion is a major factor in the forecasts of increased steel demand (see chart).

MENA’s per capita steel consumption has climbed to 248kg, and in the GCC area this figure is 378kg (above China and closing the gap on Europe). GCC steel consumption will increase to 19.7mn tons this year from 15mn tons in 2005, according to the Gulf Organization for Industrial Steel Consulting. Although MENA’s steel production is growing, it remains low in global terms, and the jump in demand has largely been met by imports.

As a result of the oil price climb, which broadly speaking has been sustained for half a decade, and spiked recently at over $135/B, all MENA producers are focusing on increasing production, though with differing degrees of success. Gulf producers in particular are not only trying to meet high export demand for both oil and gas, but also increases in domestic consumption as they push through industrial development plans. A good indication of oil and gas drilling activity is the pipe imports into the MENA region 2005-07 (see table), with most of the big oil and gas producing countries seeing a large increase in imports in 2006 and 2007 compared to 2005.

As oil and gas is extracted, reservoirs are depleted, and producers are constantly battling to top up their production with new finds. Unsurprisingly, with current high prices, oil and gas exploration and drilling activity has been stepped up across the board and the region’s rig count has risen.

* International Iron & Steel Institute and ArcelorMittal Estimates.

MENA Steel Pipe Imports (Tons)

Imports are of seamless and welded pipe in carbon and stainless steels, and comprise drillpipe, linepipe and casing/tubing.

Source:  Iron And Steel Statistics Bureau.

*  Preliminary.

Higher Steel Grades

When oil and gas fields mature, extraction becomes more difficult and requires increased efforts to maintain production levels. New field developments increasingly require more complex drilling and production technologies, which result in greater steel use as drilling distances increase. Tougher reservoir conditions also require special high quality down-hole steels. Saudi Aramco plans to add almost 3m b/d of crude production by 2011, but it is also making a considerable outlay to maintain the potential of its current fields. Another large increase in crude oil production is planned by Abu Dhabi National Oil Company (ADNOC), in the UAE, which is planning to more than triple output by 2012.

The growing demand for gas, increasingly used to fuel the region’s expanding power industry and provide feedstock to its petrochemical sectors, is also pushing recovery efforts towards harsher environments, as ‘easy’ reserves are depleted. ADNOC recently moved forward on plans to develop its $10bn-plus onshore Shah ultra-sour gas field, and the project could provide a template for further development of complex gas fields in both Abu Dhabi and the wider region. The company is also pushing forward on its large integrated gas development project.

Natural gas is also the main focus of Saudi Aramco’s exploration efforts. But some disappointing exploration results have meant that the large offshore Karan gas field is being fast-tracked. Reserves are potentially sour gas with greater corrosive properties, so clad steel, rather than alloy carbon steel, may be needed in equipment on the wellhead and processing platforms and in pipelines. The cost difference is significant: high performance carbon steels for this sector cost around $2,000/ton, while super-duplex clad steels can be over ten times this price. Sometimes producers have to err on the conservative side and opt for the higher performance materials.

Transporting The Product

Gas can be exported as liquefied natural gas (LNG) via ships, or through pipelines. Both involve a considerable amount of steel, with the rapid growth of the LNG sector also spawning regasification terminals (also needing steel) at destination markets, and an expansion of the LNG shipping fleet (more steel).

Algeria, the largest gas producer in Africa, is advancing plans to hike gas output by developing known reserves and intensifying its exploration activities. Exports will rise over the next few years with the completion of a number of major pipelines and LNG projects. Algeria is also committed to sustaining oil production levels, with $48bn earmarked for upstream projects and pipelines over the next five years. Egypt, meanwhile, has also recently decided to move ahead with plans to develop more LNG capacity.

Downstream Demand

The GCC’s downstream expansion has also gathered pace as government-owned oil companies, which control the majority of the Middle East’s energy reserves, have sought to capitalize on the global shortfall in refining capacity. Current plans will increase refining capacity by over 50%. Final investment decisions are due to be made on many of the nine planned new GCC refineries, most of which are in Saudi Arabia, and possibly on Algeria’s Tiaret refinery, this year.

Oil producers’ attempts to add value to the oil and gas production chain have encouraged them to push downstream and resulted in an unprecedented expansion in petrochemicals production. National Chevron Phillips in Saudi Arabia, for example will use killed (ie completely deoxidized) carbon steel for equipment and piping for its $5bn petrochemicals facility under construction. The largest petrochemical expansion is taking place in Saudi Arabia, where many projects are being built and a number are on the drawing board, but there is significant investment under way or planned in Abu Dhabi, Algeria and Egypt.

Consumption Outlook

With a large number of projects on the drawing board, steel consumption in the MENA oil sector is expected to continue growing, especially given that the supply/demand forecasts for oil suggest that prices will remain high and thus continue to encourage capacity expansions. However, there are potential constraints to growth, and specifically political problems are stalling development in two of the region’s key countries: Iraq and Iran. Continued security issues in Iraq are hampering current production, let alone development efforts, and Iran is failing to fulfill its potential, particularly on the gas side.

Iran was the largest steel pipe importer in the MENA region in 2006, so it has managed to bring in raw materials, although since then sanctions have tightened and US pressure has increased. Its main suppliers in both 2006 and 2007 were Ukraine, Romania and the Czech Republic. Domestic politics are also slowing development in Kuwait, but in Sudan there are signs that upstream activity is gathering pace.

Gas Supply/EPC Challenges Shortage?

Politics aside, a further potential threat to the region’s development plans is gas availability. Qatar has put a moratorium on further development of its massive North Field while it evaluates the best way to monetize its gas. Other countries are also realizing that gas resources are finite and are facing some difficult choices over whether to use gas for export, or for growing domestic power and petrochemical industries.

Another pressing problem which has hit all production sectors is the global jump in engineering, procurement and construction (EPC) costs, which has pushed up project price tags two- and even threefold in the last few years. The rise is even more pronounced for Gulf countries as a result of the slump in the dollar’s value, as their currencies are dollar-pegged. EPC costs are on a continuing uptrend on the back of an increase in raw materials prices and a growing shortage of qualified engineers. This is leading to the mothballing or postponing of a number of projects in the region, and delays in some which are under construction. Further cancellations are possible.

As a result of cost increases a number of the region’s proposed gas-to-liquids (GTL) projects have also been put on hold. The complexity of the process means that, like LNG, these projects are extensive steel users. For example, the Shell-led Pearl GTL plant under construction in Qatar needs 100,000 tons of pipe and 100,000 tons of structural steel. The soaring cost of GTL facilities ($18bn for Pearl), coupled with their still not fully developed technologies, has seen further Qatari expansion in this sector put on hold, with Algeria, Iran, and Egypt also shelving plans. The rising costs are also of growing concern on huge programs to improve recovery from ageing wells, and the magnitude of the investment needed is even difficult for oil majors to digest, despite their windfall profits.

Financing Problems

Projects seeking funding will suffer the double problem of high EPC prices and a jump in borrowing costs triggered by the US subprime lending crisis. Last year, before the effects of this were felt, the cost of debt for new energy sector projects had reached an all-time low in the GCC, as international banks were competing to add oil assets to their books. However, the subprime crisis has increased banks’ costs of funding and reduced intra-bank lending, pushing up borrowing costs. While many banks insist that they will step up to finance well thought out oil projects by commercially strong companies, the full ramifications of the crisis have yet to be felt. There is little visibility on whether banks are likely to pull back temporarily or longer term, and if they do, it is uncertain whether alternative sources of funding (bonds, Islamic banks, capital markets and private equity) will be able to fill the gap.

There are also growing concerns that the US economic slowdown could drag the rest of the world into recession and push down oil prices. The sensitivity of project activity to oil/gas prices is difficult to determine because of the large lag time between planning and implementation. Although many oil companies and their financiers appear to be inserting $50/B oil into their project development models, the pain threshold is different from country to country. Nonetheless, despite some areas of concern, ultimately the outlook for steel demand from the MENA oil and gas sector remains strong.