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Technology vs. Execution Expertise: Industrial plant manufacturer positioning in global marketplace

| By Chemical Engineering

  • Trend towards large and mega projects continues
  • European industrial plant manufacturers face major challenges
  • Investors in the chemical industry are looking for new project partnership models

The chemical industry is a booming sector for industrial plant manufacturers.Among other things, the shale gas bonanza in the US is inundating European and especially German industrial plant manufacturers with new projects.However the challenges associated with increasing project size affect not only EPC suppliers but also owner engineers at chemical companies, whoare now looking for new forms of collaboration.

When the chemical industry does something, it tends to do it in a big way. Chemical producers such as BASF, Bayer and Dow have launched huge projects around the world in places like Ludwigshafen, Dormagen, Al Jubail and Freeport. Industry leader BASF has set its sights on increasing annual turnover from the current level of 74 billion euros to 110 billion euros by 2020. To make this figure a reality, the company is investing around 4 billion euros a year in new plants and equipment. The picture is similar at BASF rival Dow. The US chemical maker has multiple mega projects underway. At the Al Jubail site in the Saudi Arabian desert, Dow together with the oil company Saudi Aramco is building the Sadara petrochemical complex at a cost of around 10 billion euros. In June, Dow began construction of an ethane cracker in Freeport, Texas at a cost of 1.3 billion euros. The plant is expected to produce 1.5 million t/a of plastic and elastomer products starting in 2017.

Assuming that figures published by ACC (American Chemistry Council) are on the mark, worldwide investment in chemical plants and equipment will double within the space of eight years, reaching a total of 487 billion euros by 2018. If that is the case, growth in chemical plant manufacturing will far outstrip the cross-industry average worldwide. The VDMA Large Industrial Plant Manufacturing Group (AGAB) has recorded annual growth of roughly 5% for about the last eight years. This growth is driven by global megatrends including worldwide population growth, the rise of the middle class in emerging nations and strong demand for raw materials.

This is of course welcome news, but it also creates a whole series of challenges for chemical industry investors and industrial plant manufacturers. In recent years, not only has the project structure continued to evolve, role allocation between operators, owner engineering teams and industrial plant manufacturers has also become more fluid.

“Demand volumes in the industrial plant manufacturing sector tend to remain constant, but the demand structure presents a moving target as project size continues to increase,” observed Prof. Aldo Belloni who has Executive Board responsibility for the Engineering Division at Linde. This trend often creates a problem for European industrial plant manufacturers. Their traditional strength has been technological expertise, but they have only limited project execution capacity.

Personnel resources for carrying out construction work are in short supply, and to take on the financial risks associated with mega projects they need a critical (turnover) mass. Not only that, industrial plant manufacturers must have the capability to install highly complex high-tech systems at increasing inhospitable locations around the world.

Setbacks for competitors from South Korea, Chinese suppliers making inroads

Particularly between 2008 and 2014, German industrial plant manufacturers lost out to rivals from South Korea and China on a number of large projects in the Middle East. Roughly two-thirds of all EPC projects in the Middle East are now awarded to contractors from South Korea. On the Sadara project mentioned above for example, Daelim is constructing the naphtha/ethane cracker at a cost of 725 million euros. In the past, Southeast Asian competitors have been willing to accept substantial risk and their pricing has been extremely aggressive. The latest business reports show that the pricing was actually too aggressive. Earnings at Daelim were down 90% year-on-year in 2013. Samsung Engineering reported a loss in excess of 220 million euros. As a result, the EPC supplier will be merged with the Heavy Industries shipbuilding unit as of December 1st, 2014.

“We are seeing less aggressive pricing and a reduced willingness to accept risk on the part of competitors from South Korea,” reported AGAB spokesperson Helmut Knauthe. However despite the fact that recent developments have restricted the risk appetite of South Korean industrial plant manufacturers, pressure remains intense in the international EPC business. This is due in part to Chinese suppliers who have ramped up their efforts to acquire projects in the Middle East, with increasing success. Besides aggressive pricing and a willingness to accept risk, the Chinese also offer attractive financing schemes.
Industrial plants manufacturers from the Western industrialized nations are unable to offer anything comparable. In order to increase their competitiveness, these companies are looking at ways of enhancing their productivity. One strategy is intensive workflow and (industrial plant manufacturing) product standardization. A study carried out by VDMA and management consultants Maexpartners indicates that the effective use of modularization in systems engineering could reduce cost by an average 15%. This approachcould even cut non-performance and warranty costs by 23%. The German-Korean energy products and services supplier Doosan-Lentjes has had good experience so far with this game plan. Using the Reference Product Model, the company has succeeded in reducing its internal execution costs by as much as 30%.

America is now the industrial plant manufacturing Eldorado

One of the reasons why business has been good for the European and German industrial plant manufacturing industry in recent years is the shale gas bonanza in the US.  There are ample supplies of oil and gas in the market, and chemical companies are now paying far less for their raw materials. The industry is investing huge sums to expand its production facilities. The market research firm HIS estimates that the exploitation of unconventional energy sources such as shale gas and shale oil will stimulate investments amounting to 79 billion euros in the US alone by 2025. The actual figure could even be higher than that. 126 chemical projects with a total investment volume of $66 billion were announced during 2013 in the US alone. By 2018, ACC predicts that 10% of global investment in the chemical industry will take place in the US. The core strength of industrial plant manufacturing service providers based in Europe is the ability to deliver high-tech solutions. A division of labor between process designers and planning teams on the one hand and engineering firms which actually build the plants is a model which is commonly used in America. However, industrial plant manufacturing projects are subject to the rules of supply and demand. Customers and EPC contractors can expect to be confronted with massive costs increases.  Plant construction companies are already reporting an increase in project installation costs, particularly in the Gulf region states of Texas and Louisiana. Due to an expected cost increase from 10 billion euros to nearly 16 billion euros, the energy company Shell decided in December 2013 to cancel plans for construction of a gas-to-liquids plant in Louisiana. Sasol of South Africa still plans to invest in a GTL plant in Louisiana, which could cost as much as 11 billion euros. However, a final decision on the project is not expected to be made until the front-end engineering design (FEED) is completed in 2016.

Owner’s engineers looking for the best project execution model

Under the present circumstances, the engineering teams at the chemical companies need to find the right balance between internal resources and third-party engineering services and they must decide how to allocate the roles and responsibilities. Given the current shortage of construction resources in North America, few suppliers can afford to commit themselves to a lump sum turnkey price set long before project completion. Even investors that have substantial owner’s engineering capacity simply do not have the manpower to execute the projects entirely on their own. As a result, a number of different project execution models are currently being employed in the chemical industry. The traditional approach taken by the internal engineering teams is the EPCM (Engineering Procurement Construction Management) model. In contrast to EPC contracts where the client turns over complete engineering, procurement and construction responsibility to an industrial plant manufacturer, customers using the EPCM model retain complete responsibility for, and control of, the project.
Both the EPCM and the EPC models are used by the engineering teams at BASF, for example. In addition, the company also establishes “engineering partnerships” under which industrial plant manufacturing partners take responsibility for projects at pre-defined conditions without a bidding process. The engineering partners are selected up front following a request for quotations which is not related to any specific process. “One thing is clear however. During the conceptual design phase, we use our own people to the maximum extent possible because that is where we can apply maximum value leverage,” explained Prof. Wolfgang Gerhardt, Senior Vice-President of Engineering at BASF.

ACHEMA 2015 is the meeting point for industrial plant manufacturers, their customers and suppliers

Which project execution model is selected depends on a number of factors. For BASF projects which are based primarily on the company’s own technology and where new facilities are being integrated into existing sites and facilities, the owner’s engineering based ECPM model is preferred. If facilities and equipment which are similar in nature are built multiple times based on third-party technology, execution follows the standard EPC model. When time is of the essence, the owner’s engineers skip the request for quotation phase and work with engineering partners which have been previously selected following a competitive bidding process.

Project size is another factor. EPC and engineering partnerships are viable options on large projects. For small to medium-size projects below 100 million euros, EPCM is usually the only choice available because these projects are low on the priority list for large EPC suppliers.

However, there is definitely demand in the global marketplace for EPC partners who are willing to take overall responsibility, and this is a factor which affects mid-tier companies in particular. “Especially in regions like Africa, customers want EPC,” reported Dr. Reinhold Festge, President of the German Engineering Federation (VDMA) and Partner at Haver & Boecker, a mid-tier systems provider. Festge advocates collaboration between German and European industrial plant manufacturers to provide “EPC capability”. The “Excellence United” initiative brings together five manufacturers of special pharmaceutical machinery. The partnership is able to deliver single-source solutions worldwide, and it illustrates how the strategy can work in practice.

Mid-tier system suppliers often have an advantage compared to traditional EPC suppliers in one respect. Many already have local service organizations in the target markets (Asia, Africa, South America and Russia). Industrial plant manufacturers such as Outotec which supplies systems for the metallurgy industry believe that setting up local service organizations is an effective strategy for gaining a foothold in new markets, and it also compensates for the ups and downs of the project business which is susceptible to the effects of economic cycles.

Summary: The medium-term outlook for industrial plant manufacturers that provide products and services to the chemical industry is more than positive. However, the markets and the structure of the projects are changing. Faced with increased competition from Asia, companies will find it even harder to acquire large projects. Moreover, changing market conditions will influence role allocation between owner engineering teams and industrial plant manufacturing service providers.

Learn more about current trends in industrial plant engineering and meet the global movers and players at ACHEMA 2015, the worldwide forum for the process industries in Frankfurt (June 15-19, 2015):