LNG project developers are looking for innovative ways to secure financing as long-term sales contracts that traditionally underpinned borrowing are becoming harder to procure.
Most LNG projects were typically built in places with an overabundance of gas by oil majors or supported by sovereign-backed international oil companies (IOCs). Independents without the balance sheet of IOCs have been attracted by improved economics, but at the same time buyers are demanding greater flexibility.
“The LNG business used to be a point-to-point, structured market that would take a stranded asset and turn it into something valuable using long-term contracts to credit-worthy European and Asian utilities. You could get returns of 10-12% with lower risk for something otherwise almost valueless,” said Jason Feer, Global Head of Business Intelligence at Poten & Partners.
Conventional project finance is primarily based on debt, which at around 5-6% cost of capital is the cheapest available. But banks are wary of lending without the certainty of having a high percentage of future output contracted for 20 years ahead with low counterparty risk.
“Producers have to deal with smaller, less credit-worthy counterparties not willing to sign long-term contracts and even if they do, the bank may not consider them bankable. Typically you had to sell 85-90% of volume on long-term contracts and the banks would shower you with money… now it’s very hard to get those contracts,” said Feer.
While oil majors can use their own capital, start-ups with no cash flow are seeking funding based only on a spreadsheet, says Sam Margolin, Managing Director at Wolfe Research. “The presence of oil majors is going to make the project finance market more competitive,” he said. “It’s a circular model for independents… they have to manage the roundabout. You have to have government approval for commercial agreements, but having the financing is what pushes governments to approve the project. There has to be a first mover. But there’s plenty of room for creativity.”
“We are all watching a more fungible and flexible market develop, which by its own nature will require more flexible financing,” agrees Eric Dyer, Head of Energy at EAS Advisors. Some projects have resorted to using equity finance, but at somewhere between 10-15% cost of capital, it is more expensive than debt.
Houston-based Tellurian offered a much higher proportion of equity than usual for its nearly $28 billion Driftwood LNG terminal in Calcasieu Parish, but it recently backtracked and has switched back to a higher level of debt. The new plan is roughly $20 billion debt and just $8 billion equity, compared to $24 billion equity and $3.5 billion debt under the previous structure.
The revised offering means partners would pay less up front at $500/ton down from $1,500/ton, but LNG would be delivered free on board at $4.50/mmBtu, up from $3/mmBtu previously. Tellurian said the new structure was in response to feedback from potential partners, and it shows how difficult it is to move away from traditional financing methods for major projects.
“The Americas are doing great at cutting cost and there’s some really creative financing but you need 70-75% of your balance sheet to be debt, and to get that you need long-term contracts,” Eric Dyer says.
Eric’s firm handled the financing for Magnolia LNG, a mid-scale modular project with $1.5bn equity finance from Stonepeak Infrastructure Partners and $270 million pre-FID funding raised to date for Magnolia LNG’s two export projects (Louisiana and Nova Scotia). But a final investment decision has been delayed after tariffs imposed between the US and China have disrupted contract negotiations, showing just how important it still is to secure long-term sales agreements. A quarter of the offtake or 2 mtpa is contracted with Meridian/Uniper for 20 years, but this is dependent on the UK terminal being constructed.
There are other funding methods, at least to raise equity finance, says William Breeze, Partner at Herbert Smith Freehills. For example, prepayment financing would mean a developer without deep pockets could effectively sell its equity LNG output forward to a third party. Pre-export financing would rely on the LNG being sold in the spot or short-term market. Both of these options would be highly structured, meaning there would be plenty of restrictions, and would be more expensive. But they might be an option for national oil companies without the financial strength of international oil companies, for example, Breeze said.
Part of the problem of financing LNG export terminals, other than the huge outlay required, is the lack of standardisation for each project and sometimes complicated geography and weather conditions. Japan's Inpex Corp was forced to delay production from its Ichthys field in Australia by two years, pushing the cost up to $40 billion, from the original $34 billion.
‘What you’ve seen traditional stick-build construction in the global LNG sector and the promise of economies of scale never lived up to their potential of lower costs,’ Eric said. “Cost is king. We are seeing more US LNG export projects adopt modular and mid-scale construction to bring down costs because they can build liquefaction units in a warehouse, ship and assemble them on their sites.”
The banks have good reason to be cautious. These projects carry a high degree of risk, and have left a ‘trail of tears’, said David Seaton, CEO of Fluor at Gastech 2018. Engineering firms like Bechtel and KBR are protecting their margins while developers are pushing for lower costs to achieve the prices that the customers are demanding. CB&I was struggling financially due to big cost overruns before it was acquired by McDermott.
While there is room for creativity in short-term financing for LNG export terminals, these projects still need long-term contracts to secure funding. But although long-term buyers are harder to find and may be more demanding, they are still there.
“It’s all very well for Japan, China and India to say 'I can buy cheap gas on the spot market', but if you can’t do that and the lights go out people are going to be very angry,” Breeze said.
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