Mohammad Fahad Raza examines the shifting business model that is changing the way EPC companies do business within the modern energy landscape
The engineering, procurement and construction (EPC) industry has witnessed commoditisation, with several new companies opening with relatively low cost structures, resulting in a significant drop in profit margins. Also due to the economic downturn, the industry has gone through consolidation, with a diminishing of profits leaving little left to invest for innovation and improvement.
Although the industry plays a vital role in shaping the infrastructure and upstream elements of the energy sector, further decline in profit margins saw any kind of savings passed onto oil companies instead of being investing in improving the business bottom-line. Companies have traditionally aligned themselves to their client’s needs, i.e. hydrocarbon production, but in such difficult times where hydrocarbons are getting more expensive to produce amid increasing development of alternate sources of energy, oil companies are shifting their ambitions and adjusting strategic goals.
In the existing business model, rising construction and material costs are also presenting challenges to EPC companies. In the following assessment, I identify a few strategic options which have been successfully adopted by several companies in countering nose-diving profits and what I see as an unsustainable industry model going forward.
Diversification across the energy equation
Diversification is often seen as the best mitigation of business adversities, with all leading EPCs having expanded their operations from conventional construction expertise to also include asset management, refining, production, operation and most importantly future-oriented technology.
Keeping in view the competitive assets and competencies developed in the course of building a successful business, these organisations have strategically selected future energy programs. Carbon capture, storage and processing, solar concentrated plants, nuclear energy and other environmental programmes are just a few examples of the types of expertise developed. This trend is helping companies in reducing business risk, maintaining healthy order books, expanding client bases, improving efficiency and above all, boosting diversify.
As we expect energy demand to grow exponentially, conventional sources of energy production are coming under considerable pressure. If this continues, companies in this space will be unable to deliver the desired output due to embedded inefficiencies, price volatility, supply instability and the overall nature of production and resource availability.
Energy demand has to be addressed by the global energy mix, and the present fossil fuel-dominsted dominated energy portfolio will be replaced by a much wider range of fuel mix. Although fossil fuels remain the dominant energy source, the global environmental impact is seeing clean energy initiatives moving up the agenda.
Through the term ‘clean energy’, I refer to energy sources which have minimal or zero environmental impact. Provided that fossil fuel sources are subjected to considerable fluctuation, lean availability, varied and at some places high extraction and production costs, it is imperative that energy leaders or government agencies take immediate steps to introduce alternate energy sources to the market, in moving beyond conventional hydrocarbons.
Similarly, these trends of how we make, move and consume energy also have to be reflected by the EPC Industry. Moving beyond the acquired knowledge and expertise, EPCs will be developing new technologies, in line with the growing diversification within the energy sector. EPCs need to consider their capability to adapt as primary facilitators of the modern energy technology, or else face the negative impacts of the industry’s restructuring, which could result in diminishing profits for those who fail to adapt.
However, the approach must be entirely holistic in nature, needing to cover every aspect of delivering the technology for their sustained existence. This is not the first time the EPC industry has witnessed such a period of change. In the recent past, EPC companies have increasingly expanded their roles to also include project management, financial control, designing or engineering consultant, contracting, development and even supply.
Many companies have formed joint ventures with engineering companies or even collaborated as suppliers to form even larger EPC partnerships for complex projects. Companies have been developing their competencies in order to perform varied functions.
This should also be of increasing to government agencies, who are promoting change as a way of serving both social and economic interests. Industry is expected to be the change agent for government and their constituents, as part of the process of making greener technology more efficient and more widely available. Therefore, the concept of these businesses needs to evolve further to ensure sustainability; in addition to macro-level adaptation, considerable attention is also needed at the individual company level.
Consolidation among EPC players
High complexity and low commonality are some of the key characteristics which define the operations of the industry. Possibly in response to this, mergers and acquisitions have become a strategic choice for securing growth and expanding into other geographical areas.
Decision-makers in the industry are realising that M&A is evolving as the primary method for easing manpower shortages, increasing service offerings and restructure companies for larger-scale and more diversified projects.
Remarkably, investment in hydrocarbon extraction and refining has begun a shift from companies based in the west toward eastern economies, just as companies have shifted their attention respectively. As a result, coordination complexities have also increased considerably. Also due to the complexity and quantum of scope, often a project is distributed among multiple contractors. This has resulted in engineering and procurement activities often being executed in fragments, by several companies and multiples offices.
Joint ventures and joint operations based on individual expertise on a time-to-time basis demands seamless flow of information. Such stuctures sees the formation of ‘Virtual Enterprises’. This concept best supports the strategic growth and improvement of competitiveness.
Planning, organisation and execution of infrastructure prior to initiating a joint operation is an essential requisite for seamless operation. Additionally, the adequate apportion of risk and potential information bottlenecks as software compatibilities needs rigorous assessment.
In synchronised form, the Virtual Enterprise forms an association which utilises existing organisational skills and technology to enable the compression of geographical and time effects. This setup enables the association to work in collaboration on varied project life cycles simultaneously. Moreover, organisations need to develop mutual trust and well written contracts to reduce inevitable friction while undertaking day-to-day joint exercises.
Mohammad Fahad Raza, a supply chain professional working in the commercial department of the National Petroleum Construction Company, Abu Dhabi, wrote this article as part of a study he conducted into the potential strategic options open to the industry in creating a sustainable industry and optimal operating environment.