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LNG finance
Following the supply chain
UNCTAD
Financing needs in the LNG sector are huge.
Extraction and
gathering pipelines
Liquefaction,
storage and loading
Transportation
(tanker)
US$ 2 to 10 billion, depending on size and
location. Costs have gone down sharply over
the past decade.
Five to ten vessels needed, at over US$ 150 million
each (costs have almost halved in the past ten years).
Receiving terminal;
regasification, storage
At 1 billion cubic feet of gas/day, construction cost
of US$ 500 million to US$ 1 billion.
Transportation
(pipeline)
Power
plant
UNCTAD
Utility / Local
Distribution Company
Practices are changing
LNG producers
LNG vessel
Receiving terminal;
regasification, storage
Pipeline
Power plant
UNCTAD
Increased willingness to bear risk,
by selling LNG at netback prices
Off-balance sheet leasing finance,
with long-term charter contracts.
Mitigates risk by using toll-based
contracts, with capacity reserved
under long-term contracts
Increasing
investments
upstream
and in
transport
?
Mitigates risk by having powerplants agree to
throughput guarantees, under long-term contracts
And in Asia, many of the long-term
contracts are expiring from 2005 onwards.
Financing schemes
LNG producers
LNG vessel
Receiving terminal;
regasification, storage
Pipeline
Power plant
UNCTAD
Corporate finance, esp. for initial trains in
«risky» countries, project finance otherwise
Shift towards project finance, underpinned by
long-term charter agreements.
Growth of stand-alone schemes (SPVs), relying
on project finance backed by tolling contracts
Project finance with take-or-pay
throughput contracts
Growth of merchant plants, using project
finance
LNG project
Very long lead times, and expensive – around 250 US$ per
tonne of installed liquifaction capacity.
UNCTAD
LNG project
UNCTAD
Typically, a project finance structure
Local (state) company may have to
be a shareholder. Problem: they
may be much weaker (in
management and financing
capacity) than the other
shareholders. Project structuring
should be such that this difference
does not create problems.
A risk is that shareholders may change in the course of the
project. Are new shareholders sufficiently committed to the
project, do they have the capacity to manage it, and would
they agree to the project finance structure?
UNCTAD
EPC contract(s) with liquidated
damages. Usual problems of
project finance, with perhaps a
somewhat greater importance of
timing-related risks (because of the
supply-chain links created for the
project). Who will cover these?
One practical issue is when the construction is deemed
complete – only when a LNG cargo has been successfully
produced. This will be done only if there is a buyer. But can
the LNG producer trigger the start of a supply contract? What
will happen if it turns out that the plant does not perform
satisfactorily?
UNCTAD
Note that there is a move away from turnkey contracts with
one general contractor (who then takes responsibility for subcontractors), there are now often multiple contracts with
different contractors.
Problem: if there is a problem, they may try to shift the blame.
The project company (and its banks) needs to ensure that
- the liquidated damages clauses of the various contracts fit
together
- and that the timing and completion tests of the various
components are well synchronized.
UNCTAD
It is common to use operations
& maintenance contracts, with
liquidated damages in case of
non-performance.
But are all risks properly
covered?
UNCTAD
If the gas is associated to oil production, normally no large
problems (except for practicalities of building the pipeline from
the fields to the LNG plant – obtaining rights of way,
government licenses etc.).
But if a separate gas project, possible complications when the
gas project is not fully equity financed. If banks are involved in
financing the gas field, there can be complicated intercreditor
negotiations.
UNCTAD
Risks both before and during the project:
- delays in the government granting
licenses/concessions, and unwillingness/
inability to pass proper legislation
- during the project, political risk: government
reneges on commitment, starts (creeping)
nationalization, etc.
UNCTAD
Financiers generally insist on forward sales of much of the LNG
that is expected to be produced, to creditworthy buyers. The
term of these sales has to exceed the tenor of the financing by
several years, to enable financiers to recuperate eventual
payment delays. Financiers would also like a high degree on
certitude with respect to the prices to be received.
LNG producers may want more flexibility, to enable them to
react to favourable spot market conditions; and may also want to
respond positively to buyers’ requests for more flexible pricing
arrangements. For projects with large equity finance, this may
be feasible.
UNCTAD
Traditionally, in Asia LNG import contracts:
- are of a long-term nature (over 17 years)
- are of a take-or-pay kind (buyer will pay for a
specified minimum amount, whether or not the
quantity is taken)
- had prices linked to crude oil prices, but within an
agreed band.
These specifications carried risks for the
importers, but in the traditional
environment, they could manage these.
UNCTAD
LNG import contracts:
- of a long-term nature (over 17 years)
- of a take-or-pay kind
- prices linked to crude oil prices, but
within an agreed band.
Demand was rising
fast, so little risk of
having to take « too
much »
Importers were
regulated utilities that
could pass on fuel
costs to consumers.
How are contracts likely to be affected by liberalization and
privatization? Long-term take-or-pay commitments become
risky where demand and competitive position are uncertain.
UNCTAD
But for new projects, will financiers accept that LNG
producers take on more price risk?
Commercial risk
mitigants
Political risk
mitigants
LNG producers
+
Total risk appetite is limited
Still, financiers have some flexibility. In the Nigeria LNG
project (high political risk, but also much equity investment)
they were willing to accept allocation of 12% of gas sales to
non-investment grade offtakers, and 10% for short-term trade.
If the buyer is a SPV, the bank may want parent company
guarantees, and/or access to the SPV’s revenue stream.
UNCTAD
LNG producers may wish to build more security into a SPA
by taking a first claim on the revenues that their buyer
generates by selling the LNG or its product (e.g., electricity).
There are then intercreditor issues, with the financiers of the
buyer. These normally do not have large problems with LNG
producers taking a first claim, but only as long as business
operates as normal. In case of default, they want first claim
themselves.
LNG producers and importers may wish to build in some
flexibility with respect to the start of the contract; e.g., the
producer may have the right to deliver alternative fuels as
substitute to its LNG delivery obligations.
UNCTAD
Financiers will want to see arrangements in
place for the LNG to reach buyers. The LNG
shipping market is very narrow (141 vessels
in early 2003, expected to increase to close to
200 by the end of 2006), and most ships
belong to LNG producers or importers, and
are already committed. Constructing ships
takes up to three years, and shipyard capacity
is tight.
LNG producers thus have to decide whether to invest in their
own ships, or, by signing long-term charter contracts, enable
others to build them.
UNCTAD
A series of legal undertakings will be used to manage risk
UNCTAD
Financing a LNG regasification plant, with associated storage
facilities and pipelines
UNCTAD
A LNG regasification plant could be financed with a similar
structure as the LNG production trains… But the risks are
larger, and clearly, legal agreements are not enough…
Rashtriya
Chemicals &
Fertilisers
ADGas
Oman
LNG
20 yrs
20 yrs SPAs
Metropolis
Gas Corp.
MLNG Tiga
(Petronas)
LNG receiving and
regasification plant
and pipelines
gas
LNG
Dabhol
natural Power PPA
LNG vessels were financed on
the basis of long-term charter
contracts.
UNCTAD
Ispat
Energy
Two types of LNG regasification projects –
is the plant a buyer, or not?
Bundled projects
Tolling projects
Regasification
plant
Regasification
plant
Offtaker
Offtaker
Offtaker
(power, pipelines,
desalination, etc.)
Offtaker
One owner (de facto)
Local regulations on ownership of gas may
make tolling approach necessary.
UNCTAD
From a financier’s perspective, the difference is large
Bundled projects
Regasification
plant
- what are the purchase agreements?
(multiple suppliers or only one?)
- what are the sales arrangements?
- how are price risks dealt with?
- what is the risk of non-delivery by
the LNG supplier?
Offtaker
(power,
desalination, etc.)
One owner
UNCTAD
- what is the risk of non-payment by
the offtaker’s buyers (e.g., the local
electricity board, captive gas buyers,
water company)?
Bundled projects
Regasification
plant
In the supply contracts, security of supply is
important:
- credit rating of the supplier
- force majeure clauses in the contract
- contract default risk by importer (banks may wish
to ensure the importer pays the seller)
Offtaker (power,
desalination, etc.)
One owner
Financiers
may ask for
step-in rights
UNCTAD
- shipping arrangements
Also, the financiers will have a close look at the
details of the sales contract. E.g., if these
contain pricing clauses that directly link, say, the
price that a local electricity board pays to the
electricity production cost, will local political
conditions in effect allow this? They may also
want bank L/Cs, and local escrow accounts.
From a financier’s perspective, the difference is large
- are the tolling contracts
sufficiently long-term?
Tolling projects
Regasification
plant
- do they cover a sufficiently
large part of capacity?
- is there a minimum monthly
fee?
- how are force majeure
events defined?
- how creditworthy are the
tolling clients? If not good,
then the financiers may want a)
L/Cs; and b) to have greater control
on actual LNG flows.
UNCTAD
Offtaker
Offtaker
Offtaker
Tolling projects
Regasification
plant
Offtaker
Offtaker
The offtakers will normally reserve
a certain processing capacity, and
pay a price for this which is partly
fixed (capacity charge), partly
variable (cost-based).
Offtaker
The financier will normally look for the following:
- offtakers guarantee to pay a minimum monthly processing fee
irrespective of the quantity that has actually been processed (a
« firm fee ».
- in total, these firm fees are enough to cover debt service
- the offtakers pay damages for non-performance; and maintain
sufficient credit support.
Weather risk management?
UNCTAD
Vessel finance
LNG vessels are often purpose-built for specific needs and for
specific routes. Transport costs account for a major part of the
landed price of LNG (20-35%), so anything that can be done to
make transport more efficient is useful.
UNCTAD
During the negotiations of the SPA, shipping arrangements
need to be agreed on:
- The buyer is responsible for transport, buying FOB (issue: this
does not fit well with netback pricing arrangements, as the buyer may not
deliver the LNG to the most valuable destination).
- The LNG is sold on a delivered basis, CIF (requires sophisticated
logistics skills for the seller; and SPA contracts should ideally allow for
cargo swaps; possible scheduling problems when buyer does not own
regasification plant).
- Buyer and seller agree to use a third party.
The vessels (of over US$ 150 million each) are normally
financed out of equity, or through a project financing structure.
Islamic finance is also possible (Brunei gas). Banks tend to
provide 10-12 year finance, while the economic life of a LNG
vessel is more than 40 years.
UNCTAD
Shipyard
LNG vessels take 30 – 34 months to build. Risks of delays, which
would compromise shipping company’s ability to meet charter
obligations. Shipyard has to agree to liquidated damages for delays.
Finance: only for 50-80%, unless if significant part of capacity is
pre-sold under long-term charters.
Shipping
company
Normally, long-term charters with fixed fee structures (fixed
component, plus cost-based payment for operating & fuel expenses).
Two major risks: default by contracting party (so banks may insist on
investment-grade counterparts), and default by the shipping company
on its charter obligations, which allows cancellation of contract.
LNG
buyers or
sellers
UNCTAD
Default by the shipping company can be the result of
technical problems, or of the arrest of the ship under
maritime law by unpaid crew or suppliers.
In a project finance structure, the financiers will mitigate the
risks in the usual systematic way of project finance.
Is the loading port a good one, and wellmanaged? What are the political risks? How
creditworthy is the seller?
What is the
experience of the
ship-builders?
Is the offloading port a good one, and wellmanaged? What are the political risks? How
creditworthy is the buyer?
UNCTAD
Is the shipping route safe
(narrow straits, etc.)?
How well will the vessels
be managed?
If the underlying SPA is strong (note the risks, e.g., Dabhol),
long-term charters will ensure a consistent cash flow. This
makes it possible to provide non-recourse finance, with
assignment of payments under long-term charter agreements.
(Financiers may have to build in room must be built in for swap agreements
and other methods to reduce costs).
Common structure once the vessel has been built:
Finance for
procurement
of vessels
Financiers
UNCTAD
Specialized
leasing
company
Mortgage
Lease
payments
Shipping
company
Transport
fees
Client
Protecting the charter contracts is important for the financiers.
They will, for example, build clauses into financings which are
meant to reduce the risks that these charters are cancelled. E.g.,
ratios for the shipping company (minimum account of cash
balance to be held; ratio of current assets to current liabilities;
ratio of net debt(gross earnings), to ensure that if financial
developments put the performance of the shipping company at
risk (e.g., create problems for it to pay its bills), the financiers
can accelarate loans, or stop lease contracts.
And if the shipping company gets into problems, the bank
generally has step-in rights: the charter clients agree on the
possibility of ownership on the vessel being transferred to
another party – this is not a reason for cancellation of the charter
contract.
UNCTAD
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