Over the last several years, a shale gas revolution has occurred within the United States, creating an abundance of natural gas, a significant reduction in natural gas prices, and a corresponding boom in the construction of private infrastructure projects. As discussed below, this sudden proliferation of domestic mega-projects has important implications for both owners and contractors in drafting construction contracts.
The Shale and Natural Gas Boom
The recent US production of shale gas, which is a source of natural gas, has transformed the natural gas market. According to the US Energy Information Administration (EIA), US shale production has increased by 50% percent per year since 2007 and US proven shale reserves have grown by five-fold over that same period. The EIA projects that US shale production will increase from 23% of total US gas production in 2010 to 49% by 2035.
This growth in shale gas production has coincided with, and in some cases caused, an increase in international demand for US natural gas. For instance, after the 2011 Fukushima earthquake, Japan shut down all of its nuclear power plants, which produced 30% of Japan's electrical power. Japan now seeks to replace nuclear energy with natural gas. Further, US natural gas prices have fallen to mid-1970s levels and far below the prices in Europe and Japan. As a result, international demand for US cheap natural gas has risen, and analysts predict that by 2020 the US could export nearly 30% of the natural gas that it produces.
In addition, within the US, the shut-down of coal-fired power plants has increased the need for the construction of domestic natural gas-fired power plants. Regulators forecast that natural gas-fired generation will overtake coal-fired generation by 2020.
Emergence of Mega-Projects in the US & International Participation
The combination of these market conditions have led to the construction of the largest private projects ever built in the US. Market experts estimate that private companies have recently invested $120 billion in liquefied natural gas (LNG) infrastructure. Analysts anticipate that $64 billion will be spent to build at least seven LNG export facilities on the Gulf Coast alone. Approximately $71 billion in new chemical-related projects are also expected to be built in the US, including a $21 billion petrochemical complex in Louisiana.
Numerous international construction companies, who were previously not active in the US construction market, are seeking to take advantage of these US opportunities, including Japan's Chiyoda and JGC, South Korea's Samsung, Brazil's Odebrecht and Spain's ACS. Many of these contractors are entering into joint ventures with US contractors, which has generated more competition and expertise and allowed contractors to assume larger risks.
Much of the construction boom is occurring along the US Gulf Coast. For example, in addition to the numbers above, over 60 construction projects worth nearly $90 billion, are expected to be built in Louisiana over the next five years. As a result, a labour shortage is likely to occur as the labour demand for skilled workers along the Gulf Coast is estimated to increase by 55% from 2013 to 2015.
Owners should be aware of this trend and attempt to control escalating labour costs through effective contracting. For instance, owners should specifically define labour shortage as a non-force majeure event. Also, under a reimbursable contract regime, an owner may consider offering incentives to the contractor for building the project with lower than expected labour or equipment costs.
The size of these mega-projects are such that many companies cannot afford, or do not wish, to build them using their balance sheet. While commercial bank lending is commonly used to finance projects on a non-recourse or limited recourse basis, the sheer size of these mega-projects may dictate supplementing (or in some cases, largely supplanting) commercial bank lending with lending by an export credit agency (ECA).
An ECA is a governmental or quasi-governmental lending entity that often lends money on more favourable terms than a commercial bank. However, there are often stringent conditions attached. For instance, many foreign ECA's require the contractor to source its supply of manufactured goods or construction materials for the improvement of the project from the country that is providing ECA financing for the project (this is often called "tied-financing"). Thus, when ECA financing is involved, the sourcing of manufactured goods or construction materials should be identified early in the negotiation or bidding process, as the sourcing location could potentially affect the price of the project.
The US Gulf Coast region is particularly susceptible to devastating hurricanes, and insurance claims can be high in the region. For example, according to the Hurricane Insurance Information Center, more than $30 billion in insurance claims were filed after Hurricane Katrina in 2005. Accordingly, builders-risk coverage for windstorm damage is becoming more costly amid this US construction boom, and owners and contractors should factor this potential increased cost into their projects.
These are just some of the legal issues that owners and contractors face in the current US construction market. Bottom line, the US construction boom has created many more opportunities for domestic and international contractors and additional demand for US construction attorney expertise.