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 engineering, procurement and construction (EPC) suppliers but also owner's engineers at chemical companies, who are 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 including Ludwigshafen, and Dormagen, Germany; Al Jubail, Saudi Arabia; and Freeport, Texas, in the US.

Assuming that figures published by the American Chemistry Council (ACC) are on the mark, worldwide investment in chemical plants and equipment will double within eight years, reaching a total of €487 billion by 2018. If that is the case, growth in chemical plant manufacturing will far outstrip the cross-industry average worldwide. The German Engineering Federation (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, but role allocation between operators, owner's 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," said Professor 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 increasingly inhospitable locations around the world.

Setbacks for South Korea, Inroads for China

Roughly two-thirds of all EPC projects in the Middle East are now awarded to contractors from South Korea. In the past, South Korean 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. For example, earnings at South Korean company Daelim were down 90% year-on-year in 2013. Samsung Engineering reported a loss in excess of €220 million. As a result, the EPC supplier was merged with the heavy industries shipbuilding unit as of Dec. 1, 2014.

"We are seeing less aggressive pricing and a reduced willingness to accept risk on the part of competitors from South Korea," reported AGAB spokesman 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 approach could even cut non-performance and warranty costs by 23%.

America - Industrial Plant Manufacturing El Dorado

One of the reasons 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 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 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 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.

Owner's Engineers Seek Best Project Execution

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 staffing 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 engineering procurement construction management (EPCM) 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.

EPC and engineering partnerships are viable options on large projects. For small to medium-size projects below €100 million, EPCM is usually the only choice 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 that affects mid-tier companies in particular.

"Especially in regions like Africa, customers want EPC," said 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."

Mid-tier system suppliers often have an advantage compared with 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. (rk)