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HOT TOPICS

& NEWS

IS A PERFECT STORM BREWING?

By Nigel P. Wilson, National Director of Insurance Services within FAMIS Group of American Appraisal Associates, Inc.

THE PROCESS PLANT BOOM + A LABOR & MATERIAL SHORTAGE + THE FALLING US DOLLAR

Are the indices used for process plants truly measuring cost increases? Or is the combination of a construction boom and the falling US dollar creating a situation for much greater cost increases of a permanent nature?

Capital-intensive process industries are undergoing a major construction boom, particularly in the refining, energy and chemical sectors. Currently, an estimated $86 billion worth of projects are under construction or planned in the Athabasca Oil Sands in Northern Alberta

(1). A $1.65 billion integrated iron ore mine/steel mill production facility in the Mesabi Iron Range of Minnesota is about to break ground(2). Globally, oil refining capacity is expected to expand 1.7% per year for the next five years, this is 20 – 30% more expansion activity per year than recorded in the recent past(3).

The downside of this boom is that it is exhausting labor pools near and far; from carpenters and pipe fitters to project managers and engineers. In Alberta, firms have built new airstrips to fly in personnel. Temporary foreign- employee programs are being established with workers coming from as far afield as Portugal, South Africa, the UK, India and the Philippines. Competition for labor has been so fierce that companies are now offering perks such as food service, recreation and internet/TV.

Additionally, the global shortage (and in some areas a backlog) of raw materials and specialized process machinery is adding further fuel to the fire. As a result, we have seen steep cost increases during the past couple of years:

Lead times for engineered equipment have increased by up to 50% in the last 6 – 12 months (3).

In some areas there is a backlog that has directly increased the lead times for specialized equipment, hence delaying projects or adding cost if you are willing to pay a premium for a position higher up the

waiting list.

The new IHS/ Cambridge Energy Research Associates (CERA) Downstream Capital Cost Index (DCCI),

which measures the costs of building new oil refineries and petrochemical plants indicates an 8% increase in the six months preceding October 2007, and a 66% increase since 2000 (3).

Capital costs for Athabasca Oil Sands projects in Alberta (including extraction facilities, upgrader plants and support infrastructure) have increased from $25,000 (US$) per daily barrel of oil (four years ago) to $40,000 per barrel today (1).

Even small ticket items are increasing; tires for CAT 797B heavy haul trucks which normally cost $40,000 each, have risen to $60,000

(4)

.

Although not as dramatic, the construction activity in Northern Alberta has caused localized construction costs to increase at double the rate for other areas of Canada. Statistics Canada’s latest non-residential construction index for Edmonton shows a 13.3% increase versus only 6.1% for Toronto

(5)

.

(6) Since 2000, the worldwide capital cost of liquefied natural gas (LNG) plants have tripled from $200 per tonne to $600 per tonne

A necdotally, American Appraisal Clients are reporting increases of even greater proportions. Add all of the above to the dramatic change in US$ exchange rates and a perfect storm is brewing. While, such market driven price fluctuations are not unprecedented, the challenge is to measure them accurately and account for when market demand re-balances, and cost increases slow or even reverse.

Sources

1.

Engineering News Record, Canada Cost Report 4Q, December 17, 2007

2. 3.

www.minnesotasteel.com

Cambridge Energy Research Associates, Press Release, Refinery and Chemical Plant Construction Costs Reach New High, November 7th, 2007

4.

Engineering News Record, Alberta’s Booming Oil Sands Boast Cold Weather, Hot Market. February 20, 2008

5.

Statistics Canada, Non-Residential Construction Price Index, Fourth Quarter 2007

6.

Swiss Re, Energy Construction Boom – a paradigm shift for insurers, November 2007 & Petroleum Economist, April 2007

Nigel P. Wilson is the national director of insurance services within the Fixed Asset Management & Insurance Solutions (“FAMIS”) group of American Appraisal Associates, Inc. nwilson@american-appraisal.com

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