Crude awakening

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GROWTH INDUSTRY: Saudi Aramco has come a long way between the 1930s and the present day. Total oil production in 2007 stood at 3.11 billion barrels.

As Saudi Aramco celebrates its 75th anniversary, the world's largest state-owned oil company is under pressure to boost production as the price of crude soars to new highs. Yet these expansion plans are far from secure, as the oil price is offset by equally significant increases in the costs of adding capacity.

As birthday parties go, Saudi Aramco did it in style. Last week the oil giant's 75th anniversary celebrations filled the streets of Riyadh with bright lights and loud music, as Saudi Arabia saluted its rebirth as one of the world's wealthiest nations.

Aramco has plenty of reasons to celebrate. The state-owned national oil company of Saudi Arabia is the largest oil corporation in the world, and also the world's largest in terms of proven crude oil reserves and production.

Its output capacity is scheduled to reach 12 million barrels per day (bpd) by the end of 2009, and the company has committed to investment exceeding US$129bn on new energy projects over the next five years.

The massive spending programme comes as oil and petrochemical companies are hit by soaring costs caused by escalating material prices and a shortage of so-called EPC contractors - responsible for the engineering, procurement and construction of refineries.

The prices charged by oil engineering companies have risen at least 70% since 2004, according to research from Merrill Lynch.

In today's market, the rise of China and India, alongside the Gulf's own construction boom, means that boosting capacity represents a significant challenge - even for giants such as Aramco.

"In the Middle East, the increase in capacity has certainly been sluggish, and that's a reflection of the fact that some of the projects are getting increasingly complicated," says David Butter, chief energy analyst at the Economist Intelligence Unit (EIU).

"Construction costs are becoming very high, and there's a shortage of engineering skills and capable contractors."

Global steel rebar prices broke through the US$1000-a-tonne barrier in late March of this year.

They shot up from US$600 a tonne to well above US$800 a tonne in the three months to end-January 2008, reflecting the huge demand for long products from the booming Asian construction industry. Concrete prices have soared 30% in the last year alone.

"We've seen in the last few years that oil supply problems have been bringing new projects into the marketplace, and that the rising cost of steel - among other things - has been a major factor in slowing down the development of these projects," echoes Gerard Burg, a commodities and energy analyst at National Australian Bank.

"I think there is a possibility that some attempts to bring new supply will be delayed, and I think that all the major oil companies are facing similar challenges in bringing production into the market."

A recent study by Cambridge Energy Research Associates concludes that the cost of building refineries has risen by 76% since 2000.

Aramco has earmarked US$70bn to be spent by international and domestic joint ventures, and the remaining US$59bn on projects solely undertaken by the Saudi company, but some of these projects could be slowed or even scrapped if costs rise too quickly.

"OPEC and the Gulf oil producers are not immune from escalating costs and a shortage of available skilled labour to expand capacity," agrees Harry Tchilinguirian, a senior analyst at BNP Paribas in London.

He notes the example of Aramco's 500,000 bpd Khursaniya field expansion, which was initially scheduled to come on line in 2007, but has been delayed repeatedly.

Start-up has now been postponed because the construction of a plant to process associated gas from the oilfield has yet to be completed, according to Khalid Al-Falih, Aramco's executive vice president of operations, who admitted that the delay was "really a disappointment".

He added that the plant would be "ready in a few months".

In addition, Tchilinguirian argues that the same construction cost increases mean that the overheads of oil reserve assessment are also on the rise.

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