lng market dynamics and keys to pursuing project development … · cove point maryland dominion...

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2012 Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.

LNG Market Dynamics and Keys to Pursuing Project Development Financing

Mark Habib, Director

Corporate Ratings

July 4, 2012

2.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

2

Agenda

• Tight LNG Markets Likely to Persist

• Likely Supply Options

• Longer Term LNG Risks

• Typical Project Structures

• Project Finance Overview


3

As Global Demand Accelerates,Supply Is Struggling to Catch Up


LNG Supplies Are Tight and Only Becoming More Stret ched

• Supply disruptions stemming from instability have lowered volumes from several

countries in 2011

• Steadily increasing LNG demand

• Unplanned demand shock after Japan’s March 2011 earthquake, tsunami and nuclear

outages

• We expect Asian demand will accelerate with growth from China and India


Qatar is the World’s Largest Producer . . .

• Qatar is now the largest producer of LNG in the world, wit h 77 mmtpa of capacity and almost 10 bcfpd of exports in 2011

• Key to the Qatari strategy has been controlling the su pply chainof LNG production

• The significance of this strategy has been several-f old but primarily it has allowed Qatar to:

A) Pioneer new technology in the sector, such as some of the largest liquefaction trains (7.8 mmtpa at RasGas 3) an d largest LNG vessels (the Q-Max at 5.7 bcf and Q-Flex at 4.6 bcf).

B) Be the provider of first choice when sudden deman d for LNG isrequired


. . . However, its Moratorium has Slowed Supply Gro wth

• In 2005, Qatar imposed a moratorium on further gas development in the North Field. The moratorium is due to expire around 2014, but may be delayed.

• Our rated Qatari projects are all in operational phase with no construction remaining and capex limited to maintenan ce. Qatari projects core advantages include low cost of prod uction from vast probable and proven reserves in the North Fie ld.

• Qataris still consider prospects for LNG demand to be buo yant in the medium and long terms and have not ruled out f urther debottlenecking of existing LNG trains or new LNG deve lopment projects once the outcome of the current studies is kn own.


7

Options For Supply Growth


North American Shale Is Driving Global Basis Spread s

• U.S. Benchmark Henry Hub prices at their lowest level in over a decade

• Crude-linked LNG prices in Europe and Asia present large spread

opportunities


US Import Market Is Reversing To An Export Market

• Shale production has led to an oversupplied domestic market

• Import forecast down to 1 bcf per day from more than 12 bcf per day

• Almost 20 bcf per day of US LNG import capacity mostly sitting idle

• About 90 mmtpa (approx. 12 bcf per day) of export capacity now being planned in US

Project Location SponsorsApproximate

capacity (mmtpa)Cameron Louisiana Sempra Energy 12Cove Point Maryland Dominion Resources, Inc. 8Freeport Texas ConocoPhillips 13Gulf Coast LNG Texas Michael Smith 20Jordan Cove Oregon Veresen Inc., Energy Projects

Development6

Lake Charles Louisiana Southern Union Co., BG Group 15Sabine Pass LNG* Louisiana Cheniere Energy Inc. 16* Received DOE non-FTA export license and FERC approval to construct


U.S. Export Projects Likely, but . . .

• Sensitivity to domestic natural gas prices and energy security may slow US project approvals – Similar concerns in Israel

• We expect only a few other projects will join Sabine Pass

• The global arbitrage could be unpredictable – Similar concerns in Israel

– Exports will rely on natural gas/crude oil spreads rather than cost of

production

– If spread expectations compress, offtaker interest and SPA terms could

weaken

– US has a larger, more balanced market than typical, “stranded”

exporters

– Long term demand creation and incremental exports could raise prices

• Timing is at least 4 years until initial volumes available


The Canadian LNG Sector is Emerging

• In contrast to the U.S., Canada has been a natural g as exporter for years

– LNG not viewed as a threat to Canadian gas requirements

– LNG volumes still small relative to supply

– NEB believes price signals will cause supply response

• Two projects have received NEB export approval at Kitim at, BC

– Kitimat LNG and BC LNG

– Full production is still 3-4 years away, assuming positive FID

• Geography is good to service Asian markets

• Infrastructure is a concern

– extensive pipeline and other infrastructure will need to be built


Australian Market Development Robust, but Delays Po ssible

• Market is dominated by long term offtake contracts

• Spot volumes are small but growing. Mainly sourced from Middle East and Atlantic Basin.

• LNG price typically linked to crude oil with an ‘S’ cu rve formula, to provide downside protection for producers in a low p rice environment, and for buyers in a high price environment

• Delays have and may continue to occur, keeping market s tight

– Tight labor and contractor markets raise project execution risks

– Marketing could be more challenging as competition heats up

– High Australian dollar increases capital and operating costs


Large number of planned LNG projects in Australia

Australian and Papua New Guinea LNG development pip eline


14

Long Term Risks for LNG


Shale Production a Major Unknown

• Unconventional production techniques likely to prolif erate, but how quickly?

• Major resources in importing regions that if tapped, could back out LNG demand

• A 40% increase in worldwide recoverable gas

• China's technically recoverable shale resources = 1,275 tcf, a 12-fold increase

• Deposits in Europe, South America and India among other countries


Will the Crude Link Last?

• The crude-index convention stems from the 1970s Japanese market

• Natural gas displaced liquid fuels, primarily power generation

• To equate their energy content, a barrel of crude should be six times more expensive than one mmBtu

• Prices have decoupled, but more gas competition coul d erode the crude link over time

• Competition from distributed shale production

• Competition from greater LNG capacity and spot volumes


17

Typical Project Structures


Traditional Project Structure

• Typically an integrated model – producers line up behin d LNG projects

– JVs common due to high capital requirements

• Allows producers to capture oil based netbacks for natu ral gas reserves

• Variable cost of production is the economic driver

– Not gas/oil price arbitrage

• Long term contract and pricing mechanism underpin return on investment


Some Unique Features in Qatar

• Low break evens, and highly rated sponsors

• Aggregate contract terms with roughly 60% exposure to crude and 40% to natural gas (although contract terms vary with e ach importer),

• Control of shipping fleets and key contracts (such as with Exxon Mobil in the US) have allowed for destination flexibility in the context of robust pricing under new spot arrangements, and

• Adequate liquidity relative to refinancing risk are all supportive of continued high ratings in the ‘A’ category.

• Geopolitical Stress (Straits of Hormutz)


U.S. Looks to a Different Model

• Decoupled, midstream approach

• “Tolling” arrangement with limited commodity exposur e

– Gas is market-sourced and costs are a pass through to offtaker

– Fixed take-or-pay capacity fee for use of liquefaction facility covers all fixed costs

and return to sponsors

– All upside and downside borne by offtaker

• Projects are “selling” the HH/Brent spread

• Viability dependent upon:

– Enough customer interest to lock in sufficient long term tolls

– Strong contractual structure

– Operational performance


Israeli Model Could Be a Hybrid Approach

• Both models being discussed but inter-ministerial c ommittee interim findings advocate a decoupled, midstream approach

• But . . .

– Exports could represent a sizeable portion of production

� More similar to typical “stranded” market suppliers

� Economic incentive to export could put owners’ financial interests at odds with energy security objective

– Surrounding infrastructure development still required

� Which players will own each part of the value chain?

– Upstream production concentration

� Gas may not be as liquidly sourced as in the U.S. model

� Supply must be managed to avoid defacto integration through contracts


22

Project Finance Overview


Key Project Analysis Components

Technology Construction

Operations & maintenance Resource

Legal structureContractual structure

CounterpartyCompetitiveness

Financial performance

A BottomA Bottom--Up ApproachUp Approach

Project documents

Financing documents

Default rating:for debt tenor

Project financepeer group

Payment in full and on time

Knowledge

General project-level

risks

Project-specific

risks


Technology

Key Rating ConsiderationsKey Rating Considerations

Mitigants• Significant, but not the largest

risk in most project deals

• Performance tests and penalties in construction contracts

• Technology provider committed to performance

• Strong track record and warranty

• Commercially proven?

• Revolutionary or evolutionary?

• Is the supplier a major firm with a large market opportunity?

• Can technology meet pro forma forecasts?

Issues


Construction and Operations & Maintenance

Mitigants• Fixed-price, date-certain

Engineering Procurement and Construction (EPC) contracts

• Large Liquated Damages (LDs) for delay and performance shortfalls.

• Creditworthy counterparties or financial backing- Little credit for surety bonds

• Contingency and reserves

• Not completed on time, on budget, or to performance:

- Cash flow loss?- Offtake contract at risk?- Additional funding required?

• Meeting O&M cost forecasts, maintaining performance

• Demand for labor and materials highly correlated to economic growth

Issues



Resource Risks

Mitigants• Long-term record of resource

performance

• Expert resource characterization

• Conservative estimates

• Rate to lower end of price and availability cycle

• Robust financial performance

Issues• Sufficiency over debt tenor

• Short-term, long-term variability

• Contractual nature of exposure

- Basis risk?

• Price uncertainty

•Commodity pass through, or

•Cost of production



Legal Structure

Mitigants• Single purpose with restrictions

on additional debt

• SPE structure with legal ring-fencing

• All project accounts fund at close with no delayed tranches or unfunded reserves

• Cash controlled with clear waterfall, trustee held accounts and distribution tests

Issues• Single asset rating through debt

tenor

• Bankruptcy remoteness

• Funding adequacy

• Cash management



Contractual and Counterparty Risk

Mitigants• Long-term record of breakeven

below actuals

• Cost competitive with peers

• Rate to lower end of spread cycle

• Strong counterparty with limited termination risk, and parent guarantees as appropriate

Issues• Who “owns” commodity and

spread risk?

• If project, how do breakevens compare to historical levels?

• If offtaker, how strong are the termination provisions and contract terms, and what is the counterparty’s credit worthiness?



Competitiveness

Important With and Without Offtake ContractsImportant With and Without Offtake Contracts

With ContractWithout Contract• Performance relative to peer

group

• Low breakeven price?

• Is performance sustainable over the long term?

- Debt rating is good for the debt tenor

• What’s the benefit for the offtaker?

• Out-of-market price?

• Is there potential for renegotiation?

• Potential to secure other offtakers

• Price re-openers

• Volume reduction options


Financial PerformanceFinancial Performance


Analysis• Robust performance in stress

scenarios supports higher credit ratings

- Avoid becoming too focused on ratios

• Structural features cannot overcome poor financial performance

• Conservative assumptions for investment grade ratings

Issues• Capitalization and financial

flexibility• Inflation risk• Interest rate risk• Currency risk• Liquidity risk• Coverage of fixed obligations• Credible forecast results


Keys to LNG Project Finance Creditworthiness

• Credit worthy counterparties

• Demonstrated technology and construction track record

– EPC contract with reliable counterparty with enough schedule and

budget cushion to ensure adequate completion

• Demonstration of sustainable feedstock supply

– Through infrastructure access to reliable and/or diverse gas supply

• Predictable minimum cash flows

– Project exposure can be mitigated by low breakevens relative to

historical and projected commodity prices

– Strong capacity agreements that offload commodity risk for fixedcapacity payments

• Amortization within contract terms

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2012 Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.

LNG Market – The Israeli Perspective

Etai Rappel, Associate Director

Corporate and Infrastructure Ratings

July 4, 2012


Key Points to Remember

• Israel is new to the natural gas export market and an y development will take some time to come online

• Geopolitical situation and reliance on natural gas ma ke domestic consumption a key government objective

• Regulatory framework

• Primary local offtaker at this point is Israel Electric (anchor)

• Interconnect of fields to pipe network

• Export possibilities

• Pricing

• Is there enough money in the market to fund everything , is external financing an option?

• Project related risks


Taking the First Step – Deliveries of Gas to Israel via Pipeline

• Securing the pipeline (robustness of network)

• Regulatory framework is incomplete and untested

– How is pipeline traffic regulated

– Who decides when and how to add additional pipelines and landingpoints

– Shishinsky framework untested

• Current main offtaker is IEC (BB+/CW Negative; ilAA-/C W Negative).

– IEC is close to meeting the single borrower’s constraint in most local lenders

– Is there over-leveraging of IEC?

– Are there enough additional offtakers for everyone regardless of exports


Looking to the Future – Israel as a Natural Gas Expo rter

• Market dynamics

– Is there enough demand in the world looking forward to justify the development of

export facilities? What will happen to prices?

• Is there enough money to finance field, pipeline an d liquification projects?

– Local market can only provide part of the financing

– Most costs are in dollars vis local lending in Shekel

– Global refinancing wall, Basel III – is there enough money and desire to invest in

Israel in the world in upcoming years

• Liquification Facilities

– Major cost item

– Who will own and operate them? Where will they be built?

• Offtakers

– Who will buy export gas? Which companies will be offtakers?


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lng market dynamics and keys to pursuing project development … · cove point maryland dominion...

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