Project Financing- LNG Projects

John D. WhiteBaker Botts, London

Successfully Managing Project Finance in the GCCEmirates Towers Hotel, Dubai

23 May 2005

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Overview

Amount of Financing Required

Financing Challenges

Financing Objectives

Drivers for Successful LNG Project Financing

Sponsor Objectives

Project Risk Identification/Allocation/Mitigation

Conclusions

Questions

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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.

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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

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Financing Objectives

Whether 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

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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 Sources

Certain markets are better for particular objectives and assuming certain risks.

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Drivers for Strong Projects

Strong sponsors

Competitive costs and compelling economics

Strategic product

Well-crafted contractual arrangements

Operating track record

Highly rated host country

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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.

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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.

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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.

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Environmental, Social and Regulatory

Equator Principles - sustainable development

Environmental

Security

Social and Political

Archaeological

Local Content and Employment

Labour Practices

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Political Risk

Expropriation

Political violence

Currency convertibility/transferability

Terrorism

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Questions?

John D. WhitePartnerBaker Botts99 Gresham StreetLondon EC2V 7BA

Telephone +44 20 7726 3423Fax +44 20 7726 3523E-mail john.white@bakerbotts.com

www.bakerbotts.com