West Asia-based oil and gas companies are seeking a cut in the prices of orders awarded to engineering and construction firms after key commodity prices, including those of steel and other inputs, dropped, sources said.
Aramco, Abu Dhabi National Oil Company and Dubai Electricity & Water Authority among others are now seeking reduction of as much as 10 per cent in the price of the contracts from construction companies such as Larsen & Toubro and Punj Lloyd, sources said.
If the construction companies were to accede to the request, they would in turn need to negotiate contracts with their suppliers leading to renegotiations of contracts down the value chain.
A cut in the price of orders could mean a squeeze in the margin of these construction companies. A price reduction of 5 per cent could impact engineering & construction companies’ operating profit margin by as much as 12 per cent, JP Morgan said in a recent report. The reason for the hit can be attributed to the firm contract signed by the construction companies with the suppliers making it difficult to renegotiate prices.
“None of our clients have approached us for discussions or negotiations of a price cut,” a Punj Lloyd spokesperson said declining to be named. “The volatility in commodity prices will impact our vendors as in 80 per cent of the cases, the contracts are back to back.”
Punj Lloyd gets about 25 per cent of its orders from West Asia while Larsen & Toubro gets 15 per cent of its orders from the same region. Larsen & Toubro declined to comment on the development.
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The renegotiation of contracts could further delay execution of some projects as liquidity crisis is already impacting schedules and could trigger a penalty clause. “In such an environment, enforceability of protective clauses is suspect,” JP Morgan said in a recent report to its clients.
Engineering & construction contracts normally incorporate charges for the delays caused by clients and a penalty for cancellation.
Analysts fear that the renegotiations may not be restricted to the West Asian region and instead, could spread across the globe which could affect the companies’ operating margin. Accordingly, JP Morgan reduced Larsen & Toubro’s earning estimate by 12 per cent and for Punj Lloyd by 25 per cent in the fiscal year ending March 2010.