1. Following the supply chain
LNG finance
Following the supply chain
UNCTAD

2. Financing needs in the LNG sector are huge.
Extraction and gathering pipelines
US$ 2 to 10 billion, depending on size and location. Costs have gone down sharply over the past decade.
Liquefaction, storage and loading
Transportation (tanker)
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
Utility / Local Distribution Company
UNCTAD

3. Receiving terminal; regasification, storage
Practices are changing
Increased willingness to bear risk, by selling LNG at netback prices
LNG producers
Increasing investments upstream and in transport
Off-balance sheet leasing finance, with long-term charter contracts.
LNG vessel
Mitigates risk by using toll-based contracts, with capacity reserved under long-term contracts
Receiving terminal; regasification, storage ?
Mitigates risk by having powerplants agree to throughput guarantees, under long-term contracts
Pipeline
And in Asia, many of the long-term contracts are expiring from 2005 onwards.
Power plant
UNCTAD

4. Receiving terminal; regasification, storage
Financing schemes
Corporate finance, esp. for initial trains in «risky» countries, project finance otherwise
LNG producers
Shift towards project finance, underpinned by long-term charter agreements.
LNG vessel
Growth of stand-alone schemes (SPVs), relying on project finance backed by tolling contracts
Receiving terminal; regasification, storage
Project finance with take-or-pay throughput contracts
Pipeline
Growth of merchant plants, using project finance
Power plant
UNCTAD

5. LNG project
Very long lead times, and expensive – around 250 US$ per tonne of installed liquifaction capacity.
UNCTAD

6. Typically, a project finance structure
LNG project
UNCTAD

7. Local (state) company may have to be a shareholder
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

8. EPC contract(s) with liquidated damages
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

9. the liquidated damages clauses of the various contracts fit together
Note that there is a move away from turnkey contracts with one general contractor (who then takes responsibility for sub-contractors), 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

10. But are all risks properly covered?
It is common to use operations & maintenance contracts, with liquidated damages in case of non-performance.
But are all risks properly covered?
UNCTAD

11. 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

12. 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

13. 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

14. 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

15. - of a long-term nature (over 17 years)
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

16. But for new projects, will financiers accept that LNG producers take on more price risk?
Commercial risk
mitigants
LNG producers
Political risk
mitigants +
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

17. 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

18. 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

19. A series of legal undertakings will be used to manage risk
UNCTAD

20. Financing a LNG regasification plant, with associated storage facilities and pipelines
UNCTAD

21. Rashtriya Chemicals & Fertilisers
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
Metropolis Gas Corp.
20 yrs
Dabhol Power
LNG
20 yrs SPAs
natural gas
PPA
LNG receiving and regasification plant and pipelines
MLNG Tiga (Petronas)
Ispat Energy
LNG vessels were financed on the basis of long-term charter contracts.
UNCTAD

22. Offtaker (power, pipelines, desalination, etc.)
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
Local regulations on ownership of gas may make tolling approach necessary.
One owner (de facto)
UNCTAD

23. Offtaker (power, desalination, etc.)
From a financier’s perspective, the difference is large
Bundled projects
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?
what is the risk of non-payment by the offtaker’s buyers (e.g., the local electricity board, captive gas buyers, water company)?
Regasification plant
Offtaker (power, desalination, etc.)
One owner
UNCTAD

24. Offtaker (power, desalination, etc.)
Bundled projects
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)
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.
Regasification plant
Offtaker (power, desalination, etc.)
One owner
Financiers may ask for step-in rights
UNCTAD

25. From a financier’s perspective, the difference is large
are the tolling contracts sufficiently long-term?
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.
Tolling projects
Regasification plant
Offtaker
Offtaker
Offtaker
UNCTAD

26. The financier will normally look for the following:
Tolling projects
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).
Regasification plant
Offtaker
Offtaker
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

27. 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

28. Buyer and seller agree to use a third party.
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 year finance, while the economic life of a LNG vessel is more than 40 years.
UNCTAD

29. Shipyard Shipping company LNG buyers or sellers
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
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.
UNCTAD

30. 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 well-managed? What are the political risks? How creditworthy is the seller?
Is the shipping route safe (narrow straits, etc.)? How well will the vessels be managed?
What is the experience of the ship-builders?
Is the offloading port a good one, and well-managed? What are the political risks? How creditworthy is the buyer?
UNCTAD

31. Common structure once the vessel has been built:
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
Specialized leasing company
Shipping company
Client
Lease payments
Transport fees
Financiers
Mortgage
UNCTAD

32. 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