The LNG market is shifting from a focus on liquefaction to regasification terminals in countries that are potential importers of LNG. Activity is increasing.
How will these projects be structured and financed? What are the main risks? We decided to take a closer look.
The US LNG liquefaction industry has had a remarkable rise in the span of just a few years.
The industry was essentially non-existent as recently as 2009 when only the Kenai LNG project in Alaska, with a capacity of 1.5 million tons per annum, was in operation, and there were no other announced liquefaction projects in development.
By January 2016, five projects totaling 62 million tons per annum of nominal capacity were under construction and more than another 30 announced projects were awaiting final investment decisions amounting to another 320 million tons per annum of nominal capacity.
One month later, the first commissioning cargo of US LNG departed from the Cheniere Sabine Pass export terminal to a crowd of cheering workers, Cheniere executives and government officials.
That the first cargo was departing on a ship named Asia Vision seemed appropriate given that the US LNG liquefaction industry’s rapid growth had come about in large part based on the strength of long term contracts signed with global and Asia-based offtakers eager to exploit differentials between LNG prices in Asia that were between five and six times those at Henry Hub in Louisiana. Yet the Asia Vision was destined not for Korea or Japan but for Brazil — its maiden voyage perhaps a more potent symbol of the rapid, evolving and global nature of the LNG trade rather than an ode to the US LNG export industry’s beginnings.
Between 2013 and 2016, the price of natural gas decreased both domestically (from $3.64 an mmBtu at Henry Hub in November 2013 to $2.59 an mmBtu in June 2016) and internationally (from $15.40 an mmBtu for landed LNG in Tokyo in November 2013 to $4.55 an mmBtu in June 2016). At the same time, global nominal liquefaction capacity, which had already increased from 254.4 million tons per annum at the end of 2009 to 301.5 million tons per annum at the end of 2015, was projected in early 2016 to rise an additional 44% by 2021 to 433.55 million tons per annum, with about half of the increase coming from US liquefaction facilities under construction.
As a result, the market for new long-term offtake contracts has shifted in the buyer’s favor, and development of additional liquefaction projects has slowed.
The buyer’s market is now causing attention to shift to regasification and LNG-to-power projects in a number of countries, many of which are new to the global LNG trade and with limited or no existing capacity to import LNG. A year ago, only 33 countries imported LNG. By 2025, this number is projected to grow to more than 50, with the new importers increasing global demand by a projected 150 million tons per annum.
Ownership and Financing Structures
A regasification facility is a land based or offshore terminal — referred to as a “floating storage regasification unit” or “FSRU” — that regasifies LNG brought in by tanker.
A regasification facility owner earns its revenues either by purchasing the LNG and selling gas, or by selling capacity to terminal users. An integrated LNG-to-power project refers to a project that both regasifies LNG and produces power to sell to an offtaker or on the spot market.
The threshold structuring consideration is then whether it is possible for a regasification facility to be financed as a standalone entity based on its gas or tolling revenues, or if a regasification facility is only financeable together with an associated power plant as an integrated LNG-to-power project.
Generally speaking, the likelihood of a regasification facility being financed separately turns on the strength of the downstream market for natural gas in the receiving country and the appetite of project lenders to take project-on-project risk. Thus, regasification facilities in new importing countries are much more likely to be financed as integrated LNG-to-power projects either with the power plant being an anchor tenant or the regasification facility being dedicated entirely to the power plant.
There are three likely financing structures.
In the most basic structure, the power plant and the regasification terminal are owned by the same entity and financed by the same lenders as a true integrated LNG-to-power project. This is the least flexible structure, and would be most likely to be employed for a smaller project where the regasification facility is not expected to provide gas to any other customers.
An alternative structure involves separate special-purpose vehicles owning the regasification facilities and the power plant, with both projects being financed jointly by common lenders. From the lenders’ perspectives, this arrangement is an integrated LNG-to-power project, but the regasification owner and the power project owner will enter into an arms-length tolling arrangement or gas sales agreement. Variations on this structure could involve both special-purpose vehicles being jointly and severally liable for the loans, use of a holding company to borrow one tier above the two special-purpose vehicles, or an on-lending arrangement. This structure is more likely to be employed where the regasification facility has additional capacity for future customers, but a downstream market does not currently exist. Lenders to such a project are likely to require that the majority ownership and control of the regasification facility owner and the power plant owner are the same. However, in the future, the two legs of such a project could be refinanced separately and ownership split if the downstream market develops.
Finally, the regasification facility and the power plant may be owned and financed separately. Separate financings are more likely in countries with developed gas markets where the regasification owner has multiple potential customers.
In this structure, the equity ownership and control of the regasification facility and the power plant do not necessarily need to be the same. Lenders to such projects will need to evaluate complex project-on-project risks. Regasification lenders will need to carefully analyze the project schedule for the power plant and the liquidated damages if the power plant does not achieve commercial operations by its guaranteed date. They will also need to consider the market for additional potential regasification customers and to negotiate adequate intercreditor protections to assure that the power plant is required to continue to fulfill its obligations in the event of a foreclosure by the regasification lenders. Lenders to the power plant will need to perform a similar analysis of the construction schedule for the regasification project and potential liquidated damages and to negotiate reciprocal intercreditor protections. The power plant lenders will also need to analyze the ability of the power plant to buy gas from another source or use another fuel (for example, diesel) for operations if the regasification project is not completed on time.
FSRUs v. Land-Based Terminals
The developer of an LNG-to-power project must decide whether to employ a land-based terminal or an FSRU.
Land-based terminals are more permanent and can be built to allow for a much larger storage capacity. They also typically have lower ongoing operating costs. However, construction costs for land-based terminals are generally higher and the construction period is longer than for an FSRU.
FSRUs, on the other hand, may be constructed by converting existing LNG tankers in as few as 12 months or by building a new vessel, which typically requires a 24-to-36 month construction period. FSRUs allow for more rapid fuel switching, are more adaptable to onshore space constraints and may require fewer permits.
FSRUs are the fastest growing sector in the LNG world and are generally favored in new importing countries where there is not an existing gas market.
In 2015, Egypt, Jordan and Pakistan added FSRU-based import facilities, as did Colombia and Poland in 2016. Nevertheless, regasification projects in other countries, including the AES Colón project in Panama and the Jorf Lasfar terminal project under development in Morocco will use land-based terminals. Terminals in Ghana and Croatia were originally projected to be land-based but have reportedly since switched to FSRUs.
Given the current demand for FRSUs, FSRUs could potentially be financed separately from an associated power project even in a country with no downstream gas market, with the FSRU lenders relying in part on the ability to redeploy the FSRU if the power plant does not reach commercial operation.
Development of regasification and LNG-to-power projects is on the rise because of the amount of LNG that is available globally and competitive pricing.
However, regasification and LNG-to power projects offer new importing countries additional benefits, including the ability to add to electric generating capacity on an expedited basis, alleviate intermittency issues caused by wind and solar projects and address environmental concerns in countries that rely heavily on diesel fuel or coal. For countries such as South Africa and Panama, regasification projects are seen as a potential catalyst for development of domestic natural gas markets.
As a result, regasification projects often enjoy strong governmental support, but they are complicated projects, and other considerations may come into play for potential sponsors or lenders.
The existence or potential to develop a downstream gas market is one such consideration.
If a joint financing structure will be used, local counsel will have to weigh in on the appropriate tax structure and third-party access rights to terminal capacity and confirm that license conditions do not prevent cross-collateralization of assets.
Other issues also need to be analyzed, including fuel price risk, creditworthiness of counterparties, contractual terms and permitting and real estate rights. The difference between the typical oil and gas project and an integrated LNG-to-power project is the analysis becomes more complex given the larger number of counterparties and shared facilities. The regasification project and power plant may be built by different contractors, requiring analysis of finger-pointing risk. Force majeure provisions must be traced through gas supply agreements, terminal use agreements and power purchase agreements to analyze whether penalties could be incurred under power purchase agreements or terminal use agreements when gas supply is excused. For projects in developing countries, review of dollarization and foreign exchange rules are critical.
Regasification and integrated LNG-to-power projects that have properly allocated these risks have been successfully financed. They are likely to remain a growth area at least through the next couple years.