ALBERTA's EMPLOYMENT FIGURES IN 2014 LIKELY TO BE DRAGGED DOWN DUE TO OUTSOURCING OF ENGINEERING AND FABRICATION WORK

A report released by Conference Board of Canada last week predicts a bright outlook for Alberta’s economy in 2014 but cautions that it may be stunted by pipeline risks. As per the report, Alberta will lead the country in employment growth in 2014 at 2.8 per cent whereas Canadian employment growth is forecast for 1.4 per cent. The report also forecasts Alberta’s economy to grow more quickly than any other province in 2014, but adds that the lack of pipeline development continues to present a significant downside risk to the forecast.

Alberta’s growth is obviously predicated on momentum in oil and gas sector. According to a report by a Calgary investment bank, capital spending in the Alberta oil sands will rise to a record of about $32 billion in 2014 (more than half of which will go to in situ projects). Canadian Association of Petroleum Producers (CAPP) predicted oil sands production will grow to 5.2 million barrels per day by 2030, up from 1.8 million barrels per day in 2012.

All the above should be good news for Alberta, isn’t it? Are the employment figures going to be really that good even if the pipeline constraints (to move the bitumen from oil sands projects to refineries and/or export) get removed? Probably not! Why? What is the problem?

Here is the reason: The greater portion of engineering cost of a project and thus potential for greater employment lies in the detailed engineering phase (of the project). Unfortunately, substantial chunks of detailed engineering (DE) work is being increasingly outsourced to low cost work centres (LCWC) of Engineering, Procurement and Construction (EPC) companies operating in Alberta/Canada. The EPC companies in Alberta are under tremendous pressure from the owner companies to farm out work to their LCWCs (in China, India, Philippines and such). If an EPC company does not have a LCWC, it is scrambling to set up one because it knows it would be thrown out of the bidding race if it did not have one.

Aside from DE phase being the greater source of employment in the EPC companies, fabrication and supply of equipment and construction of modules also constitutes a huge chunk of total project cost and this area too is a major source of employment. Unfortunately, dark clouds are hovering on this area too since significant amounts of work is being parceled out to other countries, e.g., South Korea and China.

Now, the owner companies may argue that the fabrication yards in Alberta are completely loaded up hence they are parceling work to Asia. This may be partly true, but the important question to ask is: Why are the fabrication/modularization yards not being expanded and/or new fabrication/modularization yards being set up in Alberta?

The answer that one gets is: Fabrication/modularization in Alberta is more expensive than Korea and the Asian yards are sometimes faster too (in completing the work). These assertions are open to genuine challenge and may not hold water if one takes in to account the transportation costs (from Asia), owners’ project management costs (at Asian yards), on-site rectifications necessitated by engineering / fabrication lacunae, possibility of expediting the fabrication in Alberta yards with suitable incentives and so on.

One may say the EPC companies in Alberta/Canada are already full to their capacity which is why DE work needs to be outsourced to LCWCs. That was true in 2005, 2006 but NOT now at this point in time. At the present time, the EPC companies in Alberta/Canada have enough slack to absorb most of the work that is likely to be generated in 2014 and beyond.

The fact of the matter is that the mad scramble to farm out work to LCWCs is causing layoffs in Alberta because the current situation of EPC market in Alberta is sluggish and very weak. Almost every day one hears some technical and/or non-technical personnel (estimators, cost controllers, document management folks, planners, schedulers etc) being let go off. This is ironical for Alberta (with so many new projects expected); indeed it is unacceptable and downright reprehensible and condemnable!

So what should be done? Well, the Province MUST step in and put the boot on the owners neck (like US did with BP during the gulf oil spill in 2010). Some actions on the lines mentioned below must be taken ASAP:

·       60-70% of TOTAL engineering work (DBM+FEED+DE) must be carried out in Alberta. Jobs may be outsourced to LCWCs only if there no capacity in Alberta (and Canada).

·       Not only engineering must be done in Alberta, substantial amount of orders for equipment, and fabrication/modularization must be placed in Alberta first (and in Canada).

·       There should be a continual gap analysis on capacity available in Alberta for supply of equipment, modules and how much of it is utilized. Owners must explain to provincial government why they went to an outside country for supply of equipment, modules etc. if there was underutilized capacity available in Alberta and Canada.

·       There should be tax incentives given to the owner companies for engineering and material sourced from within Alberta and Canada.

Just as a background to people regarding engineering costs: As a ball park figure, contractor engineering is generally in the cost range of 8% to 14% of total project costs (TPC) for greenfield projects, 10% to 18% for brownfield projects.

So, let us consider a project of a billion dollar TPC. The LCWCs at best may provide a saving of 30-50 million dollar during the DE phase. However, anecdotally a lot of it tends to get negated due to engineering and procurement re-work, necessitated to rectify errors and omissions of LCWC engineering, during the construction phase. At the end of the day, the net saving hardly amounts to 15-25 million – a piddling saving of 1.5-2.5% of TPC. Therefore, the notion that sending DE work to LCWCs brings about substantial savings is actually grossly misplaced and overblown, this is something the owner companies need to get in to their heads.

Summary: If the tax incentives can cover some of perceived saving – owing to out sourcing work to LCWCs – the owners would feel incentivized to keep maximum amount of work within Alberta and Canada. That being said, the EPC/EPCM companies should also try to effect economies in man-hour costs as far as possible. In any case, the owner companies got to be requested, cajoled, and coaxed to make sure the EPC work is maximized in Alberta. They must remember that they have a CSR (corporate social responsibility) toward the province (Alberta) whose resources they would be exploiting to generate profit for their investors for helluva long time – after all, the oil sands projects have a pretty darn long productive life.