United States: Project Finance 2019

I. LNG Project Development: A Brief History

For multiple decades now, LNG export projects developed and constructed around the world have consistently appealed to lenders involved in project financings. In many respects, LNG export projects are perfectly suited to what we think of as a “classic” project financing: their development and construction phases are capital-intensive; and they recoup their high development and construction costs by attracting creditworthy offtakers, including large oil and gas conglomerates, to purchase LNG pursuant to long­term sale and purchase agreements. Though LNG projects and related project financings follow different structures – from fully integrated to tolling and trustee borrowing structures, some of which will be discussed in more detail below – these features of LNG development and construction are present in virtually every major LNG export project.1

That said, LNG export projects that are brought to the project finance markets as of early 2019 have evolved significantly in structure and risk allocation from their counterpart projects that were first funded through traditional project finance methods, beginning more than 20 years ago. For example, in December 1996, Ras Laffan Liquefied Natural Gas Co. (RasGas), which in broad strokes comprises an incorporated joint venture between Qatar Petroleum and Exxon Mobil Corporation, raised an initial $2.55 billion of debt financing from export credit agencies (ECAs) – more on them later – and in the capital markets to fund the first two liquefaction trains at RasGas’ project in Qatar.2 At the time of the initial RasGas financing, the ECAs, the rating agencies and bond investors were evaluating what is known in the LNG industry as a “fully integrated” project, by which we mean that the relevant project company who owns the LNG production trains also has an ownership stake in all other components of the project, such as hydrocarbon extraction and delivery of hydrocarbons to the project site. In addition to its direct ownership of the project’s liquefaction trains themselves, for example, RasGas received a concession from the Qatari government to drill for, produce and sell natural gas from certain formations of Qatar’s voluminous natural gas fields.3 In addition to the upstream assets and liquefaction and storage facilities comprising the RasGas LNG project, for the purposes of providing financing to the project, the lenders diligenced not only offtake agreements but also the shipping arrangements and port facilities on both the loading and receiving side. From this starting point, RasGas and its affiliates began a years-long period of securing several rounds of financing and refinancing, with additional trains receiving their initial stage project financing up through 2009.4 Project financing terms with each succeeding financing reflected successful execution by Qatar Petroleum and its partners of the earlier projects.

There are upsides and downsides to this integrated structure employed by projects like RasGas. One major upside from the financiers’ perspective is the integrated project’s ability to benefit from strong sponsor support – in RasGas’ case, completion support from the sponsors as well as the implied ongoing support of the Qatari government. Given the upstream component of any integrated project, such projects require significant equity investment of the kind that only large multinationals and state-owned sponsors have the financial wherewithal and industry experience to provide. At the same time, such projects can achieve higher leverage ratios, with third-party financing covering more than the total cost of the liquefaction components of the project alone as the lenders are able to include the upstream assets in the overall project’s value. On the downside, however, the lenders need to get comfortable with the upstream risk (e.g., the quality of reserves as well as the project parties’ ability to safely drill, extract and deliver hydrocarbons to the LNG plant). In addition, from the lenders’ standpoint, the interconnectedness of components of an integrated project creates a potential domino effect where underperformance in one area of the project’s value chain cannot be separated from another (e.g., in an integrated project which involves extraction of field and gas condensate, there is an additional considerations relating to sufficiency of condensate storage and lifting, since reaching storage capacity for condensate could lead to curtailment in LNG production) and lenders need to identify, mitigate and, where a risk cannot be completely mitigated, properly allocate such risks among the various project participants.

Now that the US has become a major exporter of natural gas (following recent discoveries of natural gas wells and the use of fracking as a means of extraction), US LNG export projects have benefited from abundant gas supply and the market’s corresponding view that US LNG export projects have minimal gas supply or other upstream risks compared to their international counterparts. Thus, US LNG export projects that have reached financing stages or have been successfully project financed have a much more disaggregated structure than early-stage LNG financings like RasGas. This trend is only continuing to accelerate, especially in the US, as we write in the first half of 2019. In the disaggregated structure, broadly speaking, the project company seeking financing will usually only own the liquefaction trains themselves and necessary ancillary equipment and, in some (but not all) cases, export terminals and berths and storage tanks. Under this framework, gas will be supplied by third-party vendors and LNG will be purchased by third-party offtakers, ideally with title to the gas being transferred at the project company-owned LNG facility. An affiliate of the project company often will own a lateral pipeline that connects the export project to nearby interstate gas pipelines, but this affiliate will be distinct from the special-purpose project company and lenders may sometimes require that these pipeline affiliates be included in the project financing for the purposes of the collateral and covenant packages.

Projects and sponsors are exploring and adopting different approaches in an effort to minimise project costs. While LNG export project structures have evolved in recent years, the market for LNG has been particularly robust, and there has been fierce competition among project companies to enter into sale and purchase agreements with creditworthy offtakers, which has pushed sponsors to reduce construction costs so that they can offer more competitive terms to their customers. In response, in the US, we have seen a trend towards modular fabrication and construction, whereby the liquefaction train equipment and materials are largely manufactured offsite. In theory, modular fabrication should minimise time spent on construction work on the ground, in that the principal construction contractor on-site should only have to install the equipment once it arrives. However, even though project sponsors have begun to realise certain efficiencies in developing and constructing LNG projects, including through modular construction and planned expansion of those projects in multiple phases, the possibility for tension between sponsors and capital providers nevertheless exists and perhaps is augmented by such a disaggregated approach. For example, it remains to be seen how the lenders price this risk in light of the construction delays some US LNG projects have experienced, with Cheniere’s projects having been an exception. Internationally, we have seen sponsors develop “megatrains” that are capable of producing close to 8 MTPA of LNG on their own. Megatrains were initially implemented and financed as part of the Qatargas II project, where Trains 4 and 5 have nameplate capacity of 7.8 MTPA of LNG.

This chapter will discuss in more detail trends in financings of LNG export projects, with a focus on those located in the US. In part II of this chapter, we will examine how project sponsors and developers are frequently turning to new sources of financing, including private equity and mezzanine lenders who support less-experienced sponsors and help satisfy a project’s capital requirements, and how the roles of “more traditional” project finance lenders (like ECAs and bondholders) have adapted to account for the LNG industry’s evolution. Part III of this chapter will analyse new trends in allocation of construction risk and mitigation, with sponsors offering alternative solutions to the traditional engineering, procurement and construction (EPC) framework to achieve cost savings. Finally, part IV of this chapter will touch on regulatory considerations, which are attracting more and more attention from the lenders given challenges to some of the LNG projects.

Footnotes

1 This chapter will not discuss LNG-to-power projects but rather will focus on the liquefaction part of each LNG project.

2 “The Evolution of Ras Laffan Liquefied Natural Gas Co. LTD. (RasGas)”, by Neil B. Kelly, Managing Director, Ras Laffan Liquefied Natural Gas Co. Ltd., Twelfth International Conference & Exhibition on Liquefied Natural Gas, Perth, Australia, May 4–7, 1998.

3 Ibid.

4 Ibid.

To view the full article, please click here

Originally published in ICLG

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