LNG project financing in emerging markets

Dominic Ikechukwu Ogbata's picture
Dominic Ikechukwu Ogbata, Senior Learning Analysis Officer, Nigeria LNG Limited
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The panel discussions at the recently concluded Gastech Conference and Exhibition in Barcelona, provided enormous insights into prospects and developments in LNG. Global trends point to a positive outlook for gas in terms of investment opportunities. 

Investment in LNG projects is long-term and highly capital intensive and the capital outlay is in billions of dollars. LNG projects have long gestation periods with high-risk exposures and involve very complex network (people and processes). For this reason, a mix of equity and debt financing options is advocated for investors going into LNG projects, especially for developing countries where political risks, foreign exchange risks and poor corporate governance are high.

The equity component of the funding for such projects is provided via a Consortium or Special Purpose Vehicle (SPV). This consortium is comprised of companies with commercial ties to the project, such as International Oil Companies (IOCs), state-owned Oil and Gas Corporations of the host country, natural gas import and supply companies as well as some power utilities integrating upstream in order to secure fuel imports. Creating a consortium (Public Private Partnership - PPP) that cuts across the private and state-owned corporations will ensure greater capacity in order to manage and absorb potential risks inherent in this venture.

Project finance is a prudent strategy common to most investors. It ensures optimal utilisation of funds in delivering LNG projects. It considers a mix of funding options available to a project in order to minimise the overall cost of capital. It also implies risk sharing on two sides – the Joint Venture or the SPV on one side and the lenders on the other side. 

The decision to lend money to the project will depend on the risk profile and the future cash flows for the project which is guaranteed by the off-take agreements signed for the project. The project’s off-take agreements serve as a security for loans to the project.  

It is important to highlight risks in LNG project financing in order to keep them in view for proper evaluation and management. The risks come in different forms, though not limited to country risks (environmental, legal, political and security), economic, liquidity, construction, operating, upstream supply, downstream market, and credit & payment risks, etc. A proper risk management framework will highlight mitigations and provide assurance to both the investors and the lenders to the project.

Project financing comes with the benefit of off-balance-sheet project finance without any recourse to the sponsors’ asset base. It provides high leverage which makes it a very prudent financing strategy when compared to on-balance-sheet project finance because interest rates are tax deductible, while dividends are not. The net effect is that project finance lowers the total cost of financing.

Since project finance means that all debt repayment is amortised and tied solely to the projected cash flows during the operations phase, lending institutions will predicate their evaluation of a project on those risk factors which have a direct impact on expected future cash flows.  Any significant change or contingencies impacting a project’s cash flow should be reflected in fundraising conditions. This should also reflect in the debt ratio as well as the price of debt and equity.

As a guide, the debt ratio should increase proportionally to the long-term sales-and-purchase agreements for the project’s output. Conversely, debt ratio should decrease with an increase in the capital outlay in terms of upfront investment costs of the project. It should also decrease with an increase in country risk.

In conclusion, investment in LNG projects is highly profitable in developing countries where there are abundant gas reserves. However, due to high country risks, project financing through Public Private Partnership is recommended. This is because involving the government of the host country will enable the project to absorb those risks which often manifest through state parastatals and government regulatory agencies. The other aspects of the risks will be better absorbed by utilising existing mechanisms and support channels of the IOCs participating in the Joint Venture. 

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