CHAPTER 14 HOW LATIN AMERICAN LNG MARKETS AND U.S. EXPORTS ARE RESHAPING THE LNG MARKET
| Jurisdiction | United States |
(Apr 2015)
HOW LATIN AMERICAN LNG MARKETS AND U.S. EXPORTS ARE RESHAPING THE LNG MARKET
Partner
King & Spalding
Houston
Monica Hwang
Associate
King & Spalding
Houston
[Page 14-1]
VERA DE GYARFAS is a Partner in the Global Transactions Practice Group at King & Spalding. Ms. De Gyarfas' practice is focused on energy projects in Latin America and Africa representing companies in upstream exploration and production projects, LNG and other gas projects, under joint ventures, profit sharing agreements, operating services agreements, EPC contracts, oilfield service contracts, LNG contracts as well as in mergers and acquisitions. Ms. De Gyarfas' expertise in LNG involves the negotiation and drafting of host government and other investment agreements, analysis of existing regulation and Government negotiations, LNG sales and purchase agreements, gas supply agreements and terminal usage agreements, among others.
I. Introduction - Sales and Purchases of Liquefied Natural Gas ("LNG")
Traditionally, long-term take-or-pay "ToP" LNG sale and purchase agreements ("LNG SPAs") provide the foundation for the development of an LNG export project. These are contracts with terms of 20 years or longer. A buyer under an LNG SPA with ToP provisions must take and purchase an annual contract quantity of LNG and, if it fails to so take, it must nonetheless pay for the quantity not taken but retains the right to take that quantity at a later time.
The advantage of the ToP feature is best understood in context of the overall development of an LNG export project. Historically, LNG export projects are developed in connection with discoveries of stranded gas reserves - i.e., reserves that are located at a remote distance from available markets for the gas, including due to a lack of domestic gas demand or infrastructure. Ah LNG export project is the means by which producers can monetize the reserves by liquefying the gas and shipping LNG to consuming markets. The costs for an LNG export project, and particularly the LNG plant infrastructure, are high.1 Thus, producers will not undertake the development of (and lenders will not project finance) a project unless and until they can be assured of revenues to cover costs plus a suitable return on investment.
Aside from the LNG plant itself, other major cost components must be considered such as the costs for (i) upstream production and pipelines to deliver the gas to the LNG plant, and (ii) constructing or chartering ships, if the producers are responsible for delivering the LNG to the consuming market. A ToP LNG SPA provides a reliable stream of revenues to support all these costs.
The success of an LNG Project rests on securing unconditional ToP LNG SPAs covering sufficient annual contract quantities to provide the level of revenues to cover project costs and return on investment. Further, these ToP LNG SPAs must be with creditworthy buyers to assure timely payment of revenues. And, for project financing purposes, certain "bankable" terms must be included in the ToP LNG SPAs to meet the requirements of project lenders.
II. US LNG Supplies
During the past few years, all eyes have been on the development of LNG export projects in the U.S. The increased supply of gas from shale has transformed the US gas market from one
[Page 14-2]
focused on imports during the first decade of this millennium and the design and construction of import terminals to the design and planning of more than five export projects that are currently under construction plus 15 more projects that are currently seeking permitting approval.2
As the first of these projects have achieved positive final investment decisions and begun construction, these projects have impacted the LNG industry in various ways. And developments in proposed LNG SPA terms may be rooted, at least in part, in these U.S. LNG projects. To understand how U.S. LNG projects may influence the development of the Latin American LNG industry, it is important to understand how these projects differ from traditional LNG export projects.
a. Uniqueness of US Gas Market
As discussed in Part I, traditional LNG export projects are developed to monetize stranded gas reserves. This is the biggest difference between the U.S LNG projects and traditional LNG projects. The U.S. has a long-established domestic gas market, with strong demand and an extensive network of infrastructure to deliver gas from the production fields to the ultimate consumers.
The well-developed U.S. gas market means that US LNG projects are developed not as a necessary component to monetize stranded gas reserves, but as businesses in and of themselves. In traditional LNG projects, the upstream gas producers sponsor the LNG project and get a return on both the upstream gas production and the liquefaction and sale of such gas as LNG. In U.S. LNG projects, the project developer typically has no stake in the upstream gas production and may purchase gas supplies from any number of gas producers or marketers. US LNG projects are to date owned by entities other than the upstream gas producers and obtain revenues from the rendering of liquefaction services either through tolling models or through the direct sale of LNG, as described below.
U.S.' well-developed gas market means liquidity (i.e., a producer can easily find a buyer for its gas production and a buyer can easily find a gas supplier) and price transparency. Sales and purchases of gas are often transacted through online exchanges and priced based off of published indices such as NYMEX Henry Hub. Indeed, the Henry Hub index is what first drew the attention of traditional Asian LNG buyers. The prices of traditional LNG SPAs are linked to oil indices such as Brent and thus subject LNG buyers to fluctuations in LNG prices for factors that affect the oil markets but have little or no relation to the supply and demand of gas. Henry Hub allows LNG buyers to clearly segregate the value of the underlying gas commodity from the cost of the LNG plant infrastructure and thereby a more transparent way to price the LNG.
b. Project Structures - Tolling versus LNG Sales Model
The predominant model for U.S. LNG export projects is a tolling structure.3 Under a tolling structure, the project developer of the LNG plant provides liquefaction services
[Page 14-3]
to the customer. The US LNG project receives gas delivered by the customer, treats and liquefies such gas and delivers the resulting LNG to customer at the berth for loading. Customer pays a fee for the right to use such services and typically incurs additional costs based on its actual use of such services. Customer, and not the project developer, is responsible for procuring gas for delivery at the inlet to the LNG plant. Customer is also responsible for procuring LNG ships and any downstream marketing and resale of the LNG.
The other model for U.S. LNG export projects is Cheniere's LNG sales structure.4 Under this structure, Cheniere agrees to deliver LNG at the berth to its customers pursuant to LNG SPAs. This means that Cheniere purchases the gas from producers, liquefies such gas and then sells LNG to buyers. What differentiates Cheniere's LNG SPAs is that it has offered many of its customers a right that is not found in traditional LNG export projects sales contracts - the right to pay a fixed charge and cancel scheduled quantities, in exchange for a "cancellation fee". This fixed charge is effectively equivalent to a tolling fee and covers the capital and other fixed costs of the LNG plant. Thus, Cheniere's LNG sales structure is more appropriately characterized as a synthetic tolling structure.
In both models, the customers (tolling) and the US LNG project (LNG sales) do not depend on one sole source of supply (e.g. an upstream stranded reserves export project) but rather they have the flexibility of the well-developed US gas market. As LNG pricing is largely a function of the gas commodity plus liquefaction costs, low shale gas prices triggered the boom in the development of U.S. LNG export projects.
c. Considerations in Electing a Project Structure
While both the U.S. tolling and synthetic tolling/LNG sales structures require customers to pay a fixed fee to cover the fixed costs of the LNG plant, there are differences between the two structures which warrant careful consideration by project developers and customers alike. There are variations within each of these two main structures and the project structure can and should be tailored for each LNG project depending on the participants involved and their respective goals and risk appetites. That said, a few of these differences are described on a high-level below to illustrate the importance of the choice of project structure.
(i) who is responsible for upstream gas and transportation arrangements? Under a tolling structure, the...
To continue reading
Request your trial