Rising steel prices impact offshore development costs

Timothy J. Moreau
EDG Inc.

The rising cost of raw steel – up 50% to $600/ton from $400/ton for some steel types since June 2003 – and general instability in the international steel market are causing alarm in many industries, including the offshore market.

As a direct result, fabricated steel – an essential material for the exploration, development, production, and distribution of hydrocarbons – now costs $6,000/ton, up from a previous price of $4,000/ton. These cost hikes and the availability of steel are impacting all phases of the offshore oil and gas industry.

In fact, raw materials costs for some aspects of offshore fabrication, such as pipe and pipe-fitting, have tripled over the last year, and platform deck plating, made from steel, has become especially scarce because of increased demand and a lack of raw materials. Problematic economic conditions and huge industrial growth, particularly in China, are driving this global demand, resulting in surging costs.

Underscoring these points, energy analysts predicted at the 2004 Offshore Technology Conference in Houston in May that the price of steel could triple in 2004. While second-quarter reports haven't shown a dramatic increase, energy analysts eagerly await third- and fourth-quarter price reports on the future of this vital commodity and its impact on the development of offshore facilities.

For offshore platform fabrication and equipment alone, steel represents 10% to 35% of the overall cost for a new-build structure. For a high-end product, such as a fixed or floating platform, this percentage may be of minimal impact and generally can be absorbed within the first year of production.

Greater impact is apparent, however, as the life cycle of a field matures and offshore facilities require modifications and upgrades to sustain changes in production or to accept new field tie-ins. In these instances, steel is the chief material in the development of new topsides equipment.

Regardless of a project phase or life span of a field, dramatic increases in the price of steel can quickly escalate project cost and delay delivery of an installation. This reality finds projects eager to order steel as early as possible in an effort to lock in more favorable costs while avoiding volatile market prices.

Historically, core activities in the offshore industry have relied upon carbon and alloy steel production for pilings, jackets, caissons, deck plating, helidecks, boatlandings, girders, bars, beams, stairs, handrails, gauges, and fasteners. In both onshore and offshore sectors of the oil and gas industry, technological innovations also require an increased variety of steel applications.

For their durability and resistance to corrosive environments, corrosion-resistant alloys have been used offshore for more than a decade. Typical applications include production tubing and tree systems, subsea manifolds and flowlines, pipeline systems, and other process components.

While the need remains constant for the offshore industry, worldwide demand for steel has surged. Inventories of many steel products are low, and shortages have appeared in a number of steel market segments. Raw materials for steel production have become scarce, greatly influenced by Chinese industrial expansion and compounded by ineffective trade tariffs and the weak US dollar, making imports less competitive while increasing import prices.

When President Bush imposed heavy tariffs on steel imports in 2002, the move was intended to protect the domestic steel industry, long a backbone of American industrial progress, from cheap foreign imports. Bush lifted the tariffs in December 2003 in response to pressure from the World Trade Organization, which ruled that the Section 201 tariffs were illegal. The removal of tariffs, however, has not lead to lower steel prices caused by a flood of steel imports, as expected by many large steel makers. Other factors have caused raw material shortages and steadily rising prices.

Chinese industrial expansion

China is rapidly consuming the world's output of scrap metal, essential for steel production. The Chinese consumption of scrap metal has diminished the domestic scrap supply and tripled its cost. Pulling in large quantities of iron ore and scrap from international sources, Chinese expansion also has doubled freight rates for large bulk carriers of these materials.

Even so, Chinese steel output last year lagged behind the steady growth of steel demand in that country, causing China to become the world's largest importer of steel mill products and fueling price increases in many steel markets. China's consumption of steel last year rose 38 million tons – as much as the combined yearly steel usage of Mexico and Canada – for a total of 31% of world steel usage.

The cost of producing steel also has grown because of the higher price of energy used in steel production and because of the shortage of coke, used to fuel steel furnaces. In addition to Chinese industrial consumption, large factory and mine fires in West Virginia and China caused additional instability in coke supply rates.

Competition from larger manufacturers in the steel industry has left smaller producers unable to find material and therefore unable to maintain their work force and to honor contracts. Analysts believe that some steel users are double-ordering because of increasing prices. Many domestic mills have been fully booked for some products through 2Q 2004, and some have stopped taking orders for the year. This double-ordering eventually may cause a glut of supply and drop prices as supply catches up with demand.

With so many production cost variables in play, the analytical perspectives of steel fabricators and procurement specialists can be either optimistic or pessimistic. The optimistic model holds that fuel prices and other steel production costs will drop as global political stability increases. Increasing demand eventually will result in greater supply as new mills come on line and older facilities are reinvigorated.

The less optimistic view holds that the current steel market climate is not an economic "bubble" and that demand will continue to exceed supply as global political tensions increase. With slight variances, steel prices were relatively unchanged from 1980 through 2003, and from this perspective, the industry was long overdue for a drastic realignment.

Following this view, some steel fabricators report that project bids may be delayed up to four months in anticipation of 30-40% price hikes, though most project bids are good for only 90 days.

For offshore projects, this uncertainty contributes significantly to cost and schedule overruns. While labor costs remain relatively constant, material costs can represent half of an offshore construction project, leading fabrication and procurement professionals to seek more cost-effective alternatives.

Piping alternatives

Transmission and distribution systems have globalized the demand for steel pipe. Cost increases in steel pipe and pipefittings find some industries resorting to other grades of steel and alternative commodities, such as aluminum, plastic, and composite materials.

Oil and gas construction technology is adopting some of these strategies. For example, the recent development of X-120 high-strength steel allows for thinner-wall, higher- strength pipe, reducing overall steel tonnage and potentially resulting in pipeline cost savings.

In exchange for using less steel, however, other factors may impact the end design. For example, the corrosion allowance may require a thicker, longer-term strength material. In short, operators and designers continually balance initial greenfield capital expenditures against life-of-field operating expenses.

The use of composite material piping also provides an alternative to conventional steel pipe. The cost of manufacturing and erecting offshore structures can be cut significantly if steel pipelines are replaced with lighter composite materials. The US Department of Commerce estimates that reducing the topside weight of deepwater structures could save $250,000 per meter of water depth, an average of $150 million per unit.

Composite material pipes also could be used for fire water piping, sea water cooling, draining systems, and sewage. Researchers at Purdue University and the University of Houston are studying the feasibility of other structural applications, such as tethers and production risers.

The high cost to replace steel in retrofit applications could be offset by the increased longevity of composite materials. Barriers to this alternative include concerns about fire resistance and vulnerability to impact and vibration.

The future

At the close of 2Q 2004, a slight slowdown in China's economic activity has made more steel and raw materials available to the global market. In fact, central departments of the Chinese government, including economic planning, banking, and land management, are taking steps to curb investment in the current brimming steel economy. Further, the Chinese leadership has intentionally decreased the net purchases. This action has slightly tapered the country's exponential growth rate.

A weak US dollar usually makes foreign goods just as expensive as domestic, but steel imports, responding to the termination of 2001 tariff duties and problematic domestic availability, increased 23% in 1Q 2004, causing the US Congress to consider a comprehensive steel import and licensing system.

As long as the US dollar is weak, domestic prices for raw materials are expected to continue leveling off; therefore, currently rising steel prices may begin to level in the near future. Nevertheless, under the current conditions of rising steel prices, the best way to reduce risk is to order steel as early as possible in a project cycle, and as soon as engineering/design defines steel shapes and quantities.