Liquid Markets
Financial flexibility is the name of the game in the restructuring
global LNG market. As sponsors look to cash in on new and changing
opportunities, lenders must also adapt. Driven by the huge sums
needed, project financing is the preferred route in the LNG world ?
but traditional deal structures no longer sit comfortably. Industry
fragmentation and differing regional conditions have meant that
each deal is scrutinised carefully before raising required funds.
There is no shortage of action and new players are moving in with vigour. Union Fenosa has planned development of unprecedented capacity in Egypt, BP has secured a stake in China's Guangdong terminal and Nigeria harbours aspirations to rival Algeria as chief supplier to the Iberian peninsular. Sellers are looking beyond the traditional hotspots. Enron's preliminary termination notice to India's Dabhol plant, however, illustrates that the road to expansion is a rocky one.
Historically the industry was run by a handful of big players transporting from producers in South Asia to consumers in North Asia but in recent years this pattern has eroded. Demand and supply have been increasing in tandem but conditions and destinations are diversifying. Japan, currently the world's biggest importer saw demand fall over the last year. It is to emerging Asian markets and a potentially voracious US appetite that eyes are now turning. New markets mean new rules.
The key dynamic occurring under the market's current expansion and fragmentation is a shift away from the characteristic long-term take-or-pay contracts. Asia's financial crisis and de-regulating energy markets in all corners of the globe were key factors in sparking this off. Sponsors have now woken up to the value of flexibility and an ability to cash in on fluctuating demands. Short-term contracts have come in to favour. New developers, exploiting specific components of the market, have moved onto the scene and competition has kicked in. When political conditions prompted ExxonMobil to pull out of the Arun LNG facility in Indonesia Indonesia's Pertamina had to buy LNG to meet its contractual supply requirements to. Australian suppliers stepped in to fill this role on a short-term basis. Malaysia's Petronas have also struck up short term contracts with its buyers.
Spot the difference
At the extreme end of this trend the spot market, concentrated in the Atlantic Basin, has been maturing. The Californian power crisis and rocketing indigenous prices have led to gas being a highly valued commodity. Since natural gas can't be piped across oceans, LNG should be entering its heyday. The highly de-regulated market is indeed proving a profitable arena for Middle Eastern players to sell excess capacity. Australian sellers are also looking to get a piece of the action. But competition is fierce since volume entering the US is capped by availability of shipping facilities and receiving terminals. Although there are developments underway addressing these physical constraints, exponential growth of LNG imported into the US is not likely be seen in the near future. (see below)
Spot trading in LNG has been the subject of much discussion recently but bankers are quick to point out that it actually only accounts for a very small percentage of the market (5%). It may rise but will never make up the majority. ?This is certainly not the crude oil market,? was a phrase echoed by many. Production of LNG is an expensive process with many costly links in the industry chain. The upstream, downstream and shipping facilities are completely inter-dependent. Production terminals, with construction costs in the region of $2bn, could not raise debt solely against operation in the spot market. ?In Asia the market will remain the same,? predicts Steven Craen, SG. ?Japan and Korean do not have their own gas and will continue to commit to purchase agreements. In Europe and the US, however, LNG is a marginal resource and spot trading will emerge. Its extent hinges on an ability to develop the US market.?
The real value for producers of the growth of spot trading in the Atlantic Basin is the creation of a platform for cashing in surplus capacity. Utilised as such it can be a mechanism for underwriting projects financed against the increasingly popular short-term contracts in other regions.
The LNG market is becoming a more diverse and competitive environment. LNG is increasingly seen as a commodity, although few believe that the peculiarities of the industry will allow this trend to increase to the extent of crude oil.
Opportunities for innovative financings within LNG are on the rise and downstream and shipping facilities are emerging as independent entities. ?The role they are playing is an interesting one,? states Troy Alexander, partner at White & Case in New York. ?Regasification terminals used to rely solely on the producers but now opportunities for project financing them independently are arising.? There are indeed plans to build terminals for importing into the US with no LNG source secured. A model likely to be replicated across the Atlantic Basin is the tolling system used at the Sines project that signed at the end of 2000. Non-recourse financing was raised for the $270 million project with no offtake agreements in place. The terminal will operate as a tolling facility, charging a fixed fee for re-gasing the liquid.
Shipping facilities are likewise coming into their own from a financing perspective. Last year BP became the fist LNG producer to place a tender for LNG tankers that will load spot cargoes. Neither the end consumer nor the supply source was identified.
Eastern opportunities
Traditional purchase agreements will continue to reign in Asia, even if they are of a dwindling length. The dynamic making a real impact on financing structures in this region is the growing appetite for LNG within non-investment grade countries. Emerging markets, with increasing power needs and bids to improve environmental records, are turning to LNG. This shift to offtake agreements with non-investment grade utilities inevitably makes bankers nervous.
?Five years ago, no banker would have considered financing an LNG project with an Indian offtake,? points out Jefferey Culpepper, head of oil and gas at Deutsche. But now such deals are closing. New techniques have emerged, with guarantees woven in. The distinction between financing greenfield plants and financing an expansion of existing trains is an important one. In the latter instance, lenders can take comfort from a proven track record and existing revenue streams can reduce senior debt.
Qatar's Ras Laffan, with plans to raise approximately $1.2 billion of debt to fund build out of a third train, provides a good template. Already in operation is a two-train plant, majority owned by Qatar Petroleum and Mobil QM Gas, with investment grade Kogas in place as sole offtaker. Financing for the $3.4 billion project, signed in 1996, was comprised of bond issues, an uncovered commercial tranche, an ECA tranche and equity to the tune of $980 million. The new train, however, is to provide the LNG for supply and purchase agreements signed in 1999 with Petronet LNG Ltd of India. Structures put in place to mitigate perceived risk of this non-investment grade offtake are to include export cover on commercial tranches and a direct loan from ExxonMobil, parent to Mobil QM. It is believed that this is $300 million. To further protect the credit of the original project, the new financing is being implemented in a separate company, RasGas Co Ltd. Standard & Poor's recently confirmed its triple-B plus rating on Ras Laffan's bonds.
Atlantic LNG of Trinidad, looking to widen the geographical base of its customers, is also undergoing expansion. With no specific offtake agreements in place, however, sponsors BV, BG, Respol, Cabot and Tobago LNG have opted to fund trains three and four corporately.
In the case of greenfield projects, the need to raise senior debt is likely to be greater but lenders will still want increased risk of non-investment grade offtakers soaked up somewhere. Mike Powell, regional head of project finance, CSFB, points to export credit cover, larger equity injections and contingent sponsor support. Stephen Craen, SG suggests a less conventional option of underwriting merchant risk with the option to trade in the spot market. Many also point to a trend towards maximising local financing. This is likely to be particularly prevalent for financing the lower cost regasification terminals.
Investor confidence in India's LNG market may have suffered a setback by Enron's announcement that they are to withdraw from the $2.9 billion LNG Dabhol Power plant, of which they have an 80% stake. Of the $1.8 million phase 2 financing signed in 1999, $500 million was earmarked for construction of a regasification terminal. Enron have in place an agreement with Oman LNG to supply 1.2 million of LNG. But the Indian project has been hampered with controversy. Enron have been accused by many critics of excessively high tariffs and offtaker MSEB has defaulted on payments since December 2000.
?This may have repercussions for LNG financings in India, with lenders scrutinising projects more carefully and demanding increased securities,? suggests Jefferey Culpepper. But like many others, he does not believe that it signals the end, continuing, ?Enron took on a pioneering project, demanding excessive financial benefits. But with conditions now settling, India will be a very important LNG market.? Stephen Craen agrees, pointing to important structural differences between Dabhol and Petronet's two regasification projects in developmental stage.
India has so far been the greatest LNG consumer within the emerging Asian markets but China will be rivalling it in the near future. Gas currently accounts for only 2% of China's energy needs but claims to reduce dependence on coal have led to projections of this figure rising to 7 to 8% by 2010. If this prediction is to be realised, there will have to be a significant increase in LNG imports. BP has secured the tender for a 30% stake in the first step on this road, the Guangdong terminal. BP's initial investment into the 3m tonnes a year plant due on stream in 2006 will be $180 million. A consortium formed by China National Offshore Oil Corporation will take 33%, local Guangdong companies 31% and two Hong Kong energy firms 6%.
Nigeria, potentially a major producer of LNG, is also hoping to increase its presence on the expanding global scene. So far, all LNG plants have been financed the corporate way but investor confidence has allegedly been improved by recent shifts in the political backdrop. An insider suggests that the market can expect to see non-recourse financings for trains within the next 18 to 24 months.
Thus increasing demand and changing conditions have created a maturing market. This process is still very much underway but developers and buyers are becoming increasingly sophisticated. Union Fenosa has plans to develop huge amounts of LNG in Egypt. Although not historically a major player in the industry, it is stocking up in readiness to supply the growing market in the Iberian peninsular. In total, there are currently 10 to 12 trains under discussion in Egypt. One industry player speculated that these will not all come to fruition since there is simply not enough gas and went on to suggest that the government is likely to encourage potential developers to work together in order to capture the greatest possible share of European and US gas markets.
Developers are also interacting with each other in new and complex ways as they expand and diversify. In Trinidad, Tractebel, through its recent purchase of Cabot LNG, is pushing for a swap arrangement with Gas Natural, which has an offtake agreement with Atlantic LNG's third train.
The global LNG market is undergoing significant structural change. Although a demise of long term contracts and steadily increasing shift towards spot trading is an overstatement, offtakes are certainly weaker and competition greater than in the past. The road is not completed and the direction it takes hinges largely on an ability to develop the US market. In the face of changing conditions, lenders must also adapt. Although project financing has and is likely to continue to play a significant role in funding LNG development, it must be adapted to provide comfort in light of new concerns.
US opening
The 1970s witnessed a brief US flirtation with LNG, sparked off by gas deficiencies but domestic response and resulting price decline stopped the developing market in its tracks. Current shifts in the US power landscape, however, are providing a new window of opportunity. Developers are certainly paying attention, with BP having announced plans to increase imports, mainly from production in Trinidad. El Paso are planning to purchase LNG for shipping to the US from a train to be built in Australia and Chevron have proposed a terminal in California, presumably to be fed from their interests in Australia. Egypt, with its grand plans for development, is also a potential source for feeding the US.
Imports into the US are currently constrained by total capacity of regasification facilities. Many believe, however, that the domestic power market's conditions are not conducive to the appearance of significant regasification activity within US borders. One player pointed to the political risk associated with conflicting federal and state stipulations. No one is prepared to invest in a facility in a state where regulations could change over the next ten years. The majority of terminals are likely to be built in surrounding countries, with gas then piped to wherever it is best priced. Enron have indeed stated an intention to build a pipeline from LNG import terminals in the Bahamas.
The role of LNG in US power is potentially huge but there is a long way to travel. Setting up production is slow and costly. Set against a backdrop in a highly de-regulated atmosphere with volatile prices, risk is significant. It is likely that US activity will remain a minority component of the global LNG market for the forseeable future.
There is no shortage of action and new players are moving in with vigour. Union Fenosa has planned development of unprecedented capacity in Egypt, BP has secured a stake in China's Guangdong terminal and Nigeria harbours aspirations to rival Algeria as chief supplier to the Iberian peninsular. Sellers are looking beyond the traditional hotspots. Enron's preliminary termination notice to India's Dabhol plant, however, illustrates that the road to expansion is a rocky one.
Historically the industry was run by a handful of big players transporting from producers in South Asia to consumers in North Asia but in recent years this pattern has eroded. Demand and supply have been increasing in tandem but conditions and destinations are diversifying. Japan, currently the world's biggest importer saw demand fall over the last year. It is to emerging Asian markets and a potentially voracious US appetite that eyes are now turning. New markets mean new rules.
The key dynamic occurring under the market's current expansion and fragmentation is a shift away from the characteristic long-term take-or-pay contracts. Asia's financial crisis and de-regulating energy markets in all corners of the globe were key factors in sparking this off. Sponsors have now woken up to the value of flexibility and an ability to cash in on fluctuating demands. Short-term contracts have come in to favour. New developers, exploiting specific components of the market, have moved onto the scene and competition has kicked in. When political conditions prompted ExxonMobil to pull out of the Arun LNG facility in Indonesia Indonesia's Pertamina had to buy LNG to meet its contractual supply requirements to. Australian suppliers stepped in to fill this role on a short-term basis. Malaysia's Petronas have also struck up short term contracts with its buyers.
Spot the difference
At the extreme end of this trend the spot market, concentrated in the Atlantic Basin, has been maturing. The Californian power crisis and rocketing indigenous prices have led to gas being a highly valued commodity. Since natural gas can't be piped across oceans, LNG should be entering its heyday. The highly de-regulated market is indeed proving a profitable arena for Middle Eastern players to sell excess capacity. Australian sellers are also looking to get a piece of the action. But competition is fierce since volume entering the US is capped by availability of shipping facilities and receiving terminals. Although there are developments underway addressing these physical constraints, exponential growth of LNG imported into the US is not likely be seen in the near future. (see below)
Spot trading in LNG has been the subject of much discussion recently but bankers are quick to point out that it actually only accounts for a very small percentage of the market (5%). It may rise but will never make up the majority. ?This is certainly not the crude oil market,? was a phrase echoed by many. Production of LNG is an expensive process with many costly links in the industry chain. The upstream, downstream and shipping facilities are completely inter-dependent. Production terminals, with construction costs in the region of $2bn, could not raise debt solely against operation in the spot market. ?In Asia the market will remain the same,? predicts Steven Craen, SG. ?Japan and Korean do not have their own gas and will continue to commit to purchase agreements. In Europe and the US, however, LNG is a marginal resource and spot trading will emerge. Its extent hinges on an ability to develop the US market.?
The real value for producers of the growth of spot trading in the Atlantic Basin is the creation of a platform for cashing in surplus capacity. Utilised as such it can be a mechanism for underwriting projects financed against the increasingly popular short-term contracts in other regions.
The LNG market is becoming a more diverse and competitive environment. LNG is increasingly seen as a commodity, although few believe that the peculiarities of the industry will allow this trend to increase to the extent of crude oil.
Opportunities for innovative financings within LNG are on the rise and downstream and shipping facilities are emerging as independent entities. ?The role they are playing is an interesting one,? states Troy Alexander, partner at White & Case in New York. ?Regasification terminals used to rely solely on the producers but now opportunities for project financing them independently are arising.? There are indeed plans to build terminals for importing into the US with no LNG source secured. A model likely to be replicated across the Atlantic Basin is the tolling system used at the Sines project that signed at the end of 2000. Non-recourse financing was raised for the $270 million project with no offtake agreements in place. The terminal will operate as a tolling facility, charging a fixed fee for re-gasing the liquid.
Shipping facilities are likewise coming into their own from a financing perspective. Last year BP became the fist LNG producer to place a tender for LNG tankers that will load spot cargoes. Neither the end consumer nor the supply source was identified.
Eastern opportunities
Traditional purchase agreements will continue to reign in Asia, even if they are of a dwindling length. The dynamic making a real impact on financing structures in this region is the growing appetite for LNG within non-investment grade countries. Emerging markets, with increasing power needs and bids to improve environmental records, are turning to LNG. This shift to offtake agreements with non-investment grade utilities inevitably makes bankers nervous.
?Five years ago, no banker would have considered financing an LNG project with an Indian offtake,? points out Jefferey Culpepper, head of oil and gas at Deutsche. But now such deals are closing. New techniques have emerged, with guarantees woven in. The distinction between financing greenfield plants and financing an expansion of existing trains is an important one. In the latter instance, lenders can take comfort from a proven track record and existing revenue streams can reduce senior debt.
Qatar's Ras Laffan, with plans to raise approximately $1.2 billion of debt to fund build out of a third train, provides a good template. Already in operation is a two-train plant, majority owned by Qatar Petroleum and Mobil QM Gas, with investment grade Kogas in place as sole offtaker. Financing for the $3.4 billion project, signed in 1996, was comprised of bond issues, an uncovered commercial tranche, an ECA tranche and equity to the tune of $980 million. The new train, however, is to provide the LNG for supply and purchase agreements signed in 1999 with Petronet LNG Ltd of India. Structures put in place to mitigate perceived risk of this non-investment grade offtake are to include export cover on commercial tranches and a direct loan from ExxonMobil, parent to Mobil QM. It is believed that this is $300 million. To further protect the credit of the original project, the new financing is being implemented in a separate company, RasGas Co Ltd. Standard & Poor's recently confirmed its triple-B plus rating on Ras Laffan's bonds.
Atlantic LNG of Trinidad, looking to widen the geographical base of its customers, is also undergoing expansion. With no specific offtake agreements in place, however, sponsors BV, BG, Respol, Cabot and Tobago LNG have opted to fund trains three and four corporately.
In the case of greenfield projects, the need to raise senior debt is likely to be greater but lenders will still want increased risk of non-investment grade offtakers soaked up somewhere. Mike Powell, regional head of project finance, CSFB, points to export credit cover, larger equity injections and contingent sponsor support. Stephen Craen, SG suggests a less conventional option of underwriting merchant risk with the option to trade in the spot market. Many also point to a trend towards maximising local financing. This is likely to be particularly prevalent for financing the lower cost regasification terminals.
Investor confidence in India's LNG market may have suffered a setback by Enron's announcement that they are to withdraw from the $2.9 billion LNG Dabhol Power plant, of which they have an 80% stake. Of the $1.8 million phase 2 financing signed in 1999, $500 million was earmarked for construction of a regasification terminal. Enron have in place an agreement with Oman LNG to supply 1.2 million of LNG. But the Indian project has been hampered with controversy. Enron have been accused by many critics of excessively high tariffs and offtaker MSEB has defaulted on payments since December 2000.
?This may have repercussions for LNG financings in India, with lenders scrutinising projects more carefully and demanding increased securities,? suggests Jefferey Culpepper. But like many others, he does not believe that it signals the end, continuing, ?Enron took on a pioneering project, demanding excessive financial benefits. But with conditions now settling, India will be a very important LNG market.? Stephen Craen agrees, pointing to important structural differences between Dabhol and Petronet's two regasification projects in developmental stage.
India has so far been the greatest LNG consumer within the emerging Asian markets but China will be rivalling it in the near future. Gas currently accounts for only 2% of China's energy needs but claims to reduce dependence on coal have led to projections of this figure rising to 7 to 8% by 2010. If this prediction is to be realised, there will have to be a significant increase in LNG imports. BP has secured the tender for a 30% stake in the first step on this road, the Guangdong terminal. BP's initial investment into the 3m tonnes a year plant due on stream in 2006 will be $180 million. A consortium formed by China National Offshore Oil Corporation will take 33%, local Guangdong companies 31% and two Hong Kong energy firms 6%.
Nigeria, potentially a major producer of LNG, is also hoping to increase its presence on the expanding global scene. So far, all LNG plants have been financed the corporate way but investor confidence has allegedly been improved by recent shifts in the political backdrop. An insider suggests that the market can expect to see non-recourse financings for trains within the next 18 to 24 months.
Thus increasing demand and changing conditions have created a maturing market. This process is still very much underway but developers and buyers are becoming increasingly sophisticated. Union Fenosa has plans to develop huge amounts of LNG in Egypt. Although not historically a major player in the industry, it is stocking up in readiness to supply the growing market in the Iberian peninsular. In total, there are currently 10 to 12 trains under discussion in Egypt. One industry player speculated that these will not all come to fruition since there is simply not enough gas and went on to suggest that the government is likely to encourage potential developers to work together in order to capture the greatest possible share of European and US gas markets.
Developers are also interacting with each other in new and complex ways as they expand and diversify. In Trinidad, Tractebel, through its recent purchase of Cabot LNG, is pushing for a swap arrangement with Gas Natural, which has an offtake agreement with Atlantic LNG's third train.
The global LNG market is undergoing significant structural change. Although a demise of long term contracts and steadily increasing shift towards spot trading is an overstatement, offtakes are certainly weaker and competition greater than in the past. The road is not completed and the direction it takes hinges largely on an ability to develop the US market. In the face of changing conditions, lenders must also adapt. Although project financing has and is likely to continue to play a significant role in funding LNG development, it must be adapted to provide comfort in light of new concerns.
US opening
The 1970s witnessed a brief US flirtation with LNG, sparked off by gas deficiencies but domestic response and resulting price decline stopped the developing market in its tracks. Current shifts in the US power landscape, however, are providing a new window of opportunity. Developers are certainly paying attention, with BP having announced plans to increase imports, mainly from production in Trinidad. El Paso are planning to purchase LNG for shipping to the US from a train to be built in Australia and Chevron have proposed a terminal in California, presumably to be fed from their interests in Australia. Egypt, with its grand plans for development, is also a potential source for feeding the US.
Imports into the US are currently constrained by total capacity of regasification facilities. Many believe, however, that the domestic power market's conditions are not conducive to the appearance of significant regasification activity within US borders. One player pointed to the political risk associated with conflicting federal and state stipulations. No one is prepared to invest in a facility in a state where regulations could change over the next ten years. The majority of terminals are likely to be built in surrounding countries, with gas then piped to wherever it is best priced. Enron have indeed stated an intention to build a pipeline from LNG import terminals in the Bahamas.
The role of LNG in US power is potentially huge but there is a long way to travel. Setting up production is slow and costly. Set against a backdrop in a highly de-regulated atmosphere with volatile prices, risk is significant. It is likely that US activity will remain a minority component of the global LNG market for the forseeable future.
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