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Client-Contractor Balance a Challenge in Energy Sector

Boom and bust are part of the multi-billion dollar oil and gas industry, but maintaining the “right” balance between clients and contractors will always be a major challenge. The scenario is more acute in times like these, when crude oil prices have dropped nearly 50% compared with the last summer and brought in its wake a slow-down in project activity. In North America–which is home to the prolific shale oil and gas plays, such as Eagle Ford in Texas, Bakken in North Dakota and Marcellus in Pennsylvania–producers are doing everything in their might to protect their balance sheets and at the same time focus on core assets.

 

“Deploying capital diligently is a major challenge these days,” said Tim Chitester, Senior Vice President (Philadelphia, PA) adding “protecting themselves from a slowdown and facing the consequences of a decrease in cash flow are also top of mind for them.” A decrease in oil prices is also watched closely by contractors, as it would imply an immediate reaction from their clients in the form of project cancellations and laying off staff. The fear of filing claims by contractors against their clients is also another issue that starts surfacing, he said. There is probably no silver bullet solution as to how both clients and contractors can plan for a slowdown in project activity, but one way out could be what has been taking place in Alberta, Canada where oil sands projects with a total capacity of more than $1.5 million billion have been put on hold in light of the low oil price environment.

 

This has also translated into some 14,000 job losses for contractors. But despite the depressed scenario, clients have still retained several contractors by lowering the manhour rates and also carrying out more engineering and design work, rather than awarding procurement and construction contracts. Design and engineering activity comes at a lower expenditure for a client, compared with lump sum construction jobs, and yet keeps contractors busy. “Layoffs have a negative impact for the oil and gas industry as not only do both the client and contractor lose experienced hands, but also intellectual expertise and knowledge. A difficult task for both clients and contractors is to gauge the pace of project activity, as both agree that with an uptick in prices there will be a rush to ramp up oil production along with a soaring demand for labor, materials and equipment,” Chitester said. “A new relationship is probably taking shape in Western Canada’s oil industry, where neither clients nor contractors are burning bridges,” Justin Bouchard, co-head of energy research with Desjardins Securities, said in a recent research note. “Both parties realize they need each other and particularly when prices rise.”

 

In another emerging phenomenon, clients and contractors have granted their staff long leave with just a basic pay, but without any other benefits. Some have also been offered reduced work hours, rather than complete layoffs, indicating that a new relationship has been struck by oil and gas clients and contractors in Alberta. Despite the low prices, it is still not all gloom and doom in North America’s oil industry. Some investments are still flowing into the shale oil plays in the U.S. and Canada and development of shale gas resources is also on the agenda. One of the drivers of that investment in the natural gas sector of the U.S. is the cheap feedstock prices that have opened an opportunity for the coal-fired power plants to switch to the use of gas. Utilization of gas resources is also on the radar of some entrepreneurs that plan to build industrial projects in the U.S. In British Columbia, Canada a final investment decision is nearing this summer on a $36 billion liquefied natural gas (LNG) project making it the single largest investment in North America in the past few years. The investment will be made by Malaysia’s Petronas and will be followed by similar moves by Shell and Chevron. “Planning and managing the demand and inflow of labor will be a major issue when activity picks up. There will be a call on fabricators of equipment and all others related to such activity,” Chitester said.