The Likely Effects of the Current Credit Crunch on Contractors in the Energy Sector

The worldwide banking sector has been thrown into disarray over the past few weeks with nationalisation, bankruptcy and acquisition of leading banks. The stock markets is reeling with the Nikkei loosing some 10% today on Friday 10th October. The world is being driven into a recession and the prospect of a depression can no longer be discounted.

At the same time, the hope within the energy sector is that additional supplies of energy come to market through the construction and commissioning of the mega projects within the energy sector in the Middle East.

The leadership of these contractors have faced spiralling costs, lack of resource availability, declining productivity, delays in materials being available and to have survived this buffeting. What are the challenges now being faced by the credit crunch.and how can owners mitigate their risks?

Existing Projects

  1. Suppliers throughout the value chain will have difficulty in financing their business, with lines of credit being either withdrawn or cut back at a time of peak activity and significant swings in their requirements for working capital.
  2. We have already seen that the debtor days within the Middle East have increased over the past three months. Prior to June 2008, we had noted that on average they were below 90 days but have risen to above 110 days by the end of September 2008.
  3. The requirement for contractors to have their claims settled “quickly” is becoming paramount to enable them to finance their business.
  4. Many foreign owned companies are now relying on the Middle East to provide an ever increasing level of profit contribution and cash generation to the group operations, as other markets plummet in terms of demand. This will force these companies to seek to repatriate earnings.
  5. Finally, the leadership of many of these organisations are being distracted by worries on their personal wealth. In many cases they are heavily leveraged and exposed to the equity and real estate markets in the Middle East.

New Projects

  1. The viability of many projects will now be challenged as shareholders review their market assumptions which underpinned their feasibility studies.
  2. Projects requiring project finance will find that the appetite of the financial markets has significantly changed and that financing will be extremely selective. Therefore a number of projects currently being bid and planned may never see the light of day.
  3. Project Owners will assess the market and consider that they once again have an upper hand over the contractor, substantially increasing the contractual and payment terms and conditions.

Suggested actions for contractors in this changed market

  • Focus on the cash flow earnings of projects by achieving productivity, reducing debtor days, and ensuring that claims are transparent and can easily be settled by project owners.
  • Focus on identifying those projects that are the most likely to go ahead and then prioritise by quality of owner.

Suggested actions for owners in this changed market

  • Focus on gaining market knowledge surrounding your EPC and Subcontractors so that you fully understand their drivers in this turbulent market.
  • Revalidate and focus upon the projects that are most likely to take place given the current market conditions.

Contax are able to assist both contractors and owners in meeting the very challenging times we are experiencing and would welcome the opportunity to discuss these issues.

4 Responses to “The Likely Effects of the Current Credit Crunch on Contractors in the Energy Sector”

  1. Tony Brannon Says:

    Yes indeed the credit crisis and its impact on the world has been profound. In Bermuda, where I live, AIG have their offshore headquarters. XL Capital took a massive hit. Many reinsurers are being hit with massive losses not only in their exposure to sub prime but also to their investment portfolios getting slammed. Downsizing, cut backs, spending are all being felt in Bermuda either in the real estate world where house rentals are being given up as people lose their jobs or restaurants sitting empty as corporate execs have had their expenses slashed or withdrawn.

    Then too we have the Europeans led by Sarkozy who wants ALL tax shelters closed and even President elect Obama has said he wants to bring US business back onshore to the USA.

    So every country has to face how well it manages this crsis. Bermuda has never ever faced such tumult, and one can only hope that we pull out stronger and more unified as a country.

    The chinese today just put out a massive stimulus package and we should see the world markets rally here. However, the road to recovery in the financial world will be long, the rules of the game have to change. But we will get there.

  2. Suneel Mahamuni Says:

    Comment from Suneel Mahamuni:

    Even the finance ministers of G-7 talked of strong “fundamentals” of world economy around this time last year! Two months back the only topic they were discussing was the rise in oil prices. I will not be surprised, if some one write a novel on current financial crisis and wins a nobel prize next year. But that will not offer immediate solution to this crisis.

  3. Suneel Mahamuni Says:

    Projects under Conceptual Stage may not get affected with this current crisis. By the time these projects come for EPC Bidding, it will be atleast two years down the line. Project Owners have already recognized drop in material costs and are expecting drop in future project budgets.

  4. Andrey Tankilevich Says:

    Interesting situation in Russia – due to huge foreign reserves (half of a trillion USD) the country is wethering the crisis reasonably well (so far). But all the measures taken by the government, the president and the parlament are not showing at the Joe the Plumber level. Why? Go back to the Item 5 of Existing Projects section of Tony’s comment – current Russian “elite” – a corrupted Government officials turned businessman/MPs/Oligarkhs and their closest friends and families are busy saving their portfolios – converting it in “safe haven” type papers and sending it overseas. Once this process is completed, they MIGHT turn their heads to actually exucuting the Medvedev-Putin anti-crisis plan. Putin advised on TV last night – although the banking industry in general reducing the outflow of funds from the country, the Banks which received federal help to keep afloat ($10Bln so far and 12 more coming next month) have actually showed the tendency to increase the capital outflow overseas – pathetic is not it?

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