Refinery and Petrochemical Construction Costs Continue Measured Rise, Spurred by a Weakening U.S. Dollar and Higher Commodity Prices

Downstream costs continue to march back to prerecession levels as activity picks up with revived projects benefitting from the cost declines emanating from the great recession

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Wednesday, November 17, 2010 7:05 am EST

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CAMBRIDGE, Mass.

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IHS
"The momentum in the rise of costs back to prerecession levels is really a ‘slowmentum’ reflective of the broader global economic recovery"

CAMBRIDGE, Mass.--(BUSINESS WIRE)--The costs for designing and constructing downstream refining and petrochemical projects rose 3 percent from Q1 2010 to Q3 2010, according to the latest edition of the IHS CERA Downstream Capital Costs Index (DCCI). It was the third straight increase for the index since prices bottomed out at 9 percent below peak 2008 levels. Costs are now just 4 percent below their 2008 peak.

The IHS CERA DCCI is a proprietary measure of project cost inflation similar in concept to the Consumer Price Index (CPI). It provides a benchmark for comparing costs around the world and draws upon proprietary IHS and IHS CERA databases and analytical tools. The current DCCI rose from 175 to 180 over the past six months. The values are indexed to the year 2000, meaning that a project that cost $100 in 2000 would cost $180 today.

Higher commodity prices and a weakening U.S. dollar continued to be the driving force behind the steady rise of costs in the downstream sector.

“The momentum in the rise of costs back to prerecession levels is really a ‘slowmentum’ reflective of the broader global economic recovery,” said IHS CERA Chairman and author of the Pulitzer Prize-winning book, The Prize, Daniel Yergin. “Activity is increasing and prices are rising, albeit with a healthy dose of caution.”

Commodities prices were driven by the global economy’s recovery and increased construction activity as the impact of the fiscal stimuli was felt by the wider economy. Steel prices continued to show high degrees of volatility as iron ore producers switched from adjusting prices annually to adjusting them every quarter, reflecting market-based demand-supply fundamentals.

The continued weakening of the U.S. dollar also contributed to the rise of commodity prices while also driving up costs of equipment, labor and engineering and project management costs. The dollar’s fall was driven by the U.S. Federal Reserve’s second round of quantitative easing to reinvigorate the U.S. economy—the Fed recently announced a $600 billion plan to purchase treasury bonds over the next eight months.

Robust downstream construction activity in China, India, and the Middle East continues unabated, according to the index. Record refining and ethylene capacity additions came online in 2009 and more projects are in various stages of engineering and construction. This trend is expected to continue until 2015. Government policies encourage investment in the downstream sector in anticipation of increasing demand for transportation fuels, plastics and fibers.

China plans to increase refining capacity by 50 percent in the next five years. Similarly, the Middle East is emerging as a major hub for petrochemicals with advantageous feedstock and government policies that incentivize diversification into other industries supported by petrochemicals. Large complex refineries with integrated petrochemicals are emerging as the “new standard” to position the downstream sector for profitability.

The capacity additions in Asia will continue to put downward pressure on margins as excess capacity emerges in the face of tepid consumer demand. Refiners and petrochemical companies in Organization for Economic Cooperation and Development (OECD) countries—which have been rationalizing refining capacity—will continue to face rising pressure to shutdown older and less efficient plants with poor economics.

“The economic outlook ahead appears to be mixed with rising prospects that the recent momentum will give way to an impending slowdown,” said Farooq Sheikh, lead researcher for the IHS CERA Capital Costs Analysis Forum for Downstream. “China also appears to be slowing down as the government increasingly restrains the fiscal stimulus and has recently increased interest rates by a quarter percent in fear of a real estate bubble.”

Developing countries are showing increasing concerns about capital flows into their markets creating an asset bubble. Capital controls and higher interest rates are being employed to temper unbridled growth.

As a result, the IHS CERA DCCI concludes that another modest increase is expected in downstream capital costs in the near term as recovering construction activity and further increases in raw materials prices push costs closer to their prerecession highs.

About the IHS CERA Downstream Capital Costs Index (DCCI)

The IHS CERA DCCI tracks the costs of Costs of equipment, material, labor (skilled and unskilled), and engineering and project management used in the construction of a geographically diversified portfolio of more than thirty refining and petrochemical construction projects. It is similar to the consumer price index (CPI) in that it provides a clear, transparent benchmark tool for tracking and forecasting a complex and dynamic environment. The DCCI can be tracked on the IHS Index Web Site: www.ihsindexes.com. The DCCI is a work product of IHS CERA’s Capital Costs Analysis Forum for Downstream (CCAF-D). For information on the Capital Costs Analysis Forum for Downstream, contact Farooq Sheikh at Farooq.sheikh@ihs.com

About IHS CERA (www.ihscera.com)

IHS CERA is a leading advisor to energy companies, consumers, financial institutions, technology providers and governments. IHS CERA (www.cera.com) delivers strategic knowledge and independent analysis on energy markets, geopolitics, industry trends, and strategy. IHS CERA is based in Cambridge, Mass., and has offices in Bangkok, Beijing, Calgary, Dubai, Johannesburg, Mexico City, Moscow, Mumbai, Oslo, Paris, Rio de Janeiro, San Francisco, Tokyo and Washington, DC.

About IHS (www.ihs.com)

IHS (NYSE: IHS) is a leading source of information and insight in pivotal areas that shape today’s business landscape: energy, economics, geopolitical risk, sustainability and supply chain management. Businesses and governments around the globe rely on the comprehensive content, expert independent analysis and flexible delivery methods of IHS to make high-impact decisions and develop strategies with speed and confidence. IHS has been in business since 1959 and became a publicly traded company on the New York Stock Exchange in 2005. Headquartered in Englewood, Colorado, USA, IHS employs more than 4,200 people in more than 30 countries around the world.

IHS is a registered trademark of IHS Inc. CERA is a registered trademark of Cambridge Energy Research Associates, Inc. Copyright ©2010 IHS Inc. All rights reserved.

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