The shifting risk and reward equations created by LNG’s commoditisation will lead to fundamental changes in financing
Increasing industry confidence that gas, and LNG in particular, will grow in importance at least in the first stage of the energy transition has been tempered with concerns surrounding the huge costs, complexities and delays typically associated with major LNG projects.
The path ahead for LNG seems clear. Led by China’s rapacious appetite, trade in the liquefied commodity is estimated to rise at a CAGR of about 4pc during 2018-40 to 757bn m3, according to the IEA’s World Energy Outlook 2018, while LNG use in bunkering is projected to increase at a CAGR of 11pc during 2025-40 to reach 49bn m3.
This rising demand is expected to create a shortfall by the early 2020s, the anticipation of which has driven the approval of mega-projects such as the $40bn LNG Canada project. It has also heightened expectations over looming FIDs including the 12.88mn t/yr Mozambique LNG project, the 27.6mn t/yr Driftwood LNG proposal in Louisiana and the $25.5bn Arctic LNG 2 venture, which will access reserves of some 10tn m3—all due to take place this year.
But there are doubts that the traditional LNG project funding model—whereby traditional debt remains the mainstay of capital investment, as it has in the past decade—will survive this rapid evolution.
Changing contract structures could lead to a greater need for LNG export project developers to price and absorb increased market risk, while financiers will likely also seek to share more of the risk with developers—implying a greater share of equity funding. Already, the ratio of debt funding for LNG projects has seen an overall reduction over the last decade.
At LNG2019 in Shanghai, Petroleum Economist sat down with Andy Brogan, global oil & gas sector leader at consultancy EY, to gather his thoughts on the shape of future LNG project funding.
PE: Will the majors with larger balance sheets be better placed to absorb life-cycle risks as the LNG market evolves?
AB: Project financing used to work through first putting together a vehicle that borrowed money, and putting in place a series of contracts around it with parties such as customers, construction companies and others. When put all together this created a very low-risk, low-volatility vehicle in terms of cash flow, which meant that money could be borrowed very cheaply over a long period of time.
What is happening now is that, because the off-takers are tending to prefer more flexibility, that part of the equation—the low-volatility in revenues—has become more difficult to achieve. Without, it becomes very difficult to put the same type of funding structure in place, and this means that companies which were used to structures like that will find it harder to finance and therefore develop projects.
Naturally, this would not be the case for majors with healthier balance sheets. So, the changes give them another competitive advantage beyond this that they currently enjoy for these projects in terms of supply chains, engineering and other factors such as stakeholder management skills. Ultimately, due to the complexity and capital intensity involved in production and supply, oil majors will have a key role to play in LNG capacity generation.
PE: Could these changes lead to more private equity getting involved in the LNG market, as we have seen for example in the North Sea?
AB: It would really depend on where the project was located, and how much capital is involved for the firm in that particular geographical region. In the North Sea, as in the US with shale, the private equity firms are entering highly developed financial ecosystems so with equity they can also bring in various forms of debt.
In other countries, putting that debt together will be trickier, and harder to guarantee. It has been done with oil projects, but LNG is more early days in this respect.
PE: Will a wider expansion in terms of LNG customers, such as larger volumes being taken by countries with lower macroeconomic credit ratings, impact on project financing?
AB: Some projects in certain countries can be disproportionally impacted by this, because it is possible to have a project finance structure based on the credit rating of the customer rather than the credit rating of the country the project is located in.
This is particularly valuable, say, for a country that is located in a relatively high-risk region. But, certainly the riskier the location, the more reliance there has to be on equity in one form or another.
PE: There is a lot of talk over the need for increased liquefaction capacity, but also of a number of projects coming on stream to meet the expected shortfall—is there a danger that a supply crunch could never come?
AB: There is a lot of production scheduled to come on, but there is a lot of demand there too. The market is expected to tighten to balance around 2022, and the US liquefaction plants would like to be in a place that ensures the next wave has to come from there. If you are seriously looking at China’s [LNG imports] rising from 70bn m3 to 280bn m3, that still requires a lot more production capacity.
There is a lot of optimism in the LNG market, and the certainty shown by the Chinese government puts the policy flooring under the market which suggests that the bullishness shown at events like this has reasonable justifications behind it.