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Project Financing - LNG Projects

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  1. Project Financing- LNG Projects John D. WhiteBaker Botts, London Successfully Managing Project Finance in the GCCEmirates Towers Hotel, Dubai23 May 2005

  2. Overview • Amount of Financing Required • Financing Challenges • Financing Objectives • Drivers for Successful LNG Project Financing • Sponsor Objectives • Project Risk Identification/Allocation/Mitigation • Conclusions • Questions

  3. Amount of Financing Required • Currently 141 MTA of Global LNG export capacity. • Additional 168 MTA of Global LNG export capacity is planned by 2010. • Huge new investment in shipping, regasification, pipeline and related infrastructure is needed. • International Energy Agency estimates over $250 billion will be spent by the gas industry over 30 years for LNG projects.

  4. Preferences for Simplicity Transparency in cash flows Equity Corporate finance Strategic assets Collateral Amortisation Aversion to Complexity Merchant risk Certain indexes Leverage Contingent equity Distributions Structured finance Single asset deals Ratings triggers Refinancing risk Financing Challenges

  5. Sponsor constraints Credit rating Legal and contractual Limited/full recourse Credit pooling/severality Cost and tenor Equity requirements Accounting Off-balance sheet Financing covenants Collateral Rating Appetite for completion/ operating and other risks Political risk Refinancing risk Tax Financing source Financing ObjectivesWhether any LNG financing is successful depends on its fit with sponsors’ objectives:

  6. Sponsor equity Lending Traditional bank Private placement Mezzanine Shipper finance ECA/IFI Public equity markets Private equity Public and 144A debt markets Islamic finance Lease Tax-exempt /industrial revenue Securitisation/Receivables financing Combinations of the above Financing SourcesCertain markets are better for particular objectives and assuming certain risks.

  7. Drivers for Strong Projects • Strong sponsors • Competitive costs and compelling economics • Strategic product • Well-crafted contractual arrangements • Operating track record • Highly rated host country

  8. Integrated Finance Model • Financing all across value chain theoretically makes sense. • For majors, LNG projects are all about accessing upstream reserves. • Profits taken over LNG chain. • Vast investment in each link in LNG chain. • Strategic importance may drive success in each link in chain. • May support multiple markets.

  9. Integrated Finance Model (cont'd) • Integrated model faces numerous practical problems: • Exposure to multi-jurisdictional, varied risks familiar to Big Oil, but lenders wary of resulting complexity, bankruptcy and legal risks. • Difficulty maintaining alignment across LNG chain. • Hard to attain transparent contractual arrangements that forge integration across LNG chain. • Interdependency of links manifests itself in “weak link” theory. • Many majors averse to project financings unless required by their partners (which may not be invested in all links) or for political risk mitigation.

  10. Project Risk Identification/Allocation/Mitigation Sound LNG project financing requires evaluation and allocation of risks and rewards and mitigation, including: • Completion • Operating • Gas Supply • Liquefaction • LNG and Gas Offtake • LNG Shipping • Regasification • Pipeline Transportation • Others This list is not nearly exhaustive. Risks compounded by “project-on-project” risk.

  11. Completion Risk • Risk that the project will not be completed on time or within budget, and will not perform as expected. • Engineering, design, procurement, physical completion and start-up of the project. • Includes legal, regulatory, financial and other aspects. • As segments of LNG chain are financed as separate projects, interdependency of links introduces project-on-project risk.

  12. Completion Risk Mitigants • Proven contractor • Turnkey contracts • Fixed cost and scope • Liquidated damages • Performance bonds/retainage/LOCs/guarantees • Sponsor guarantees • Completion tests • Proven design • Insurance/contingency amounts • Properly vetted permitting process • Technical, Shipping and Marine studies

  13. Operating Risk • Operating risk is the risk that the project, once complete, will not perform as expected. • Experienced creditworthy service provider • Safety, security and environmental safeguards • Permits • Strong agreements • Incentives for good performance/penalties for bad • O&M reserves • Insurance

  14. Gas Supply • Availability of Adequate Gas Reserves • Reserve risks ("Proven" vs. "Probable") • Development costs • Dedication to chain • Transport to Liquefaction Facility • Gas Quality • Gas Price • Operating Risk, including Force Majeure/Environmental/ Permitting

  15. Liquefaction • Delay in Completion • Production Quantity • Technology • Cost Overrun • Expansion Economics • Operating Risk, including Force Majeure/Environmental/ Permitting

  16. LNG and Gas Offtake • Volume Purchase Obligations • Pricing transparency (take or pay/deliver or pay) • Credit of Offtaker/limits on credit support • Depth of Market - market studies • Long-term offtake but flexible terms • Destination flexibility • Conditions precedent • Operations, Link with Shipping/Regas, Force Majeure

  17. LNG Shipping • Requires longer lead time than earlier LNG deals • FOB v. DES • Time Charter v. Ownership • Delay in Construction of Vessels • Cost Overruns • Size of Vessels/Economies of Scale • Operating Risk, including Force Majeure/ Environmental/ Permitting • Destination Flexibility

  18. Regasification • Link to LNG supply • Licensing • Delay in Construction • Cost Overrun • Open Access • Security • Distance to Market • Connection to pipeline system • Gas meets pipeline specifications - interchangeability • Operating Risk, including Force Majeure/Environmental/ Permitting

  19. Pipeline Transportation • Adequacy of current/new take-away pipelines • Delay in Construction • Distance to major end-use market • Pipeline transportation agreements • Terms of service (e.g., firm or interruptible) • Availability of ancillary services (balancing/park and loan/load swing) • Force majeure • Open access/common carrier issues • Storage

  20. Project-on-Project Risk • What links are absolutely necessary to success of this project? • Construction of completion tests • Intrusiveness to other projects • Partial sponsor guarantee fallaway/debt service reserve/other sponsor support • Effect on debt capacity • Contamination from other projects • Alignment

  21. Expansion Risks Could be more robust than a greenfield project • Economies of scale • Operating history may mitigate completion and operating risks • Regulatory regime known • Government support • Supplement to financing structure but those results depend on front-end planning with greenfield project • PSC • Host government agreements • Permits

  22. Expansion Risks (cont'd) • Flexible financing structures • Excess capacity but even best laid plans can succumb to • Separate financings on trains • Non-alignment • Change in circumstances • Lack of control over service providers/shared facilities • Priority and coordination of use • Unforeseen events

  23. Weak Links Successfully financing LNG projects requires solving weak link theory • Most liquefaction projects are in sub-investment grade countries • Can project surmount country ratings? • Weaker counterparties • Ability to address capital calls and contingencies • Credit enhancement and liquidity • Cost recovery/carried interests • Incentives/penalties • Dealing with financing delay

  24. Environmental, Social and Regulatory • Equator Principles - sustainable development • Environmental • Security • Social and Political • Archaeological • Local Content and Employment • Labour Practices

  25. Political Risk • Expropriation • Political violence • Currency convertibility/transferability • Terrorism

  26. Questions? John D. WhitePartner Baker Botts 99 Gresham Street London EC2V 7BA Telephone +44 20 7726 3423 Fax +44 20 7726 3523 E-mail john.white@bakerbotts.com www.bakerbotts.com