Project Financing LNG Projects

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
Financing Challenges

• 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

5
Financing ObjectivesWhether any LNG financing
is successful depends on its fit with sponsors
objectives

• 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

6
Financing SourcesCertain markets are better for
particular objectives and assuming certain risks.

• 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

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.

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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
• OM 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

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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

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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 [phone]
3423 Fax [phone] E-mail john.white_at_bakerb
otts.com www.bakerbotts.com