Prospects
A UBS Investment Research paper published in March 2010 predicted LNG orders of up to US$30 billion from floating liquefied natural gas (FLNG) projects globally over the next three years. The potential for FLNG projects has been long acknowledged as the likely best solution for commercialising stranded gas fields. However, only recently has a consensus grown that the technical, financial and political risks are sufficiently manageable to make certain projects viable.
Given the size of these projects, banks are likely to play a significant role in how they are structured. Regardless of whether the projects are funded by way of corporate finance or project finance, an underlying FLNG project needs to be bankable. This briefing examines the risks associated with this relatively new sector and how prospective deals could seek to overcome the uncertainty associated with FLNG projects.
Asia Pacific hot-spot
While a number of FLNG projects are planned around the world, Asia Pacific has emerged as the front-runner to host the first of these challenging projects. Indonesia, Malaysia and Papua New Guinea each have proposed projects at various stages of planning. However, Australia in particular can anticipate a number of FLNG projects. For example, with the headlines of "Darwin set to be floating LNG hot-spot", The Sydney Morning Herald reported on the observations of the Northern Territory government in this sector. With at least five FLNG projects planned for the waters off the northern coast of Australia, there is great potential for FLNG 'down under'.
What are the risks?
Project structure will largely determine the risk profile for a bank. If it is a corporate financing the main concern will be the credit risk of the borrower or any parent / sponsor guarantor. If, however, it is structured on a project finance basis, cash flow could be affected by one or more of the risks stated below, and it will be key to determining the viability of the project and its pricing.
The principal risks involved with FLNG projects would include the following:
Reservoir and offtake risks
This is where the comparisons between FLNG and oil FPSOs and onshore liquefaction terminals are worth considering. The first FLNG project financings are likely to follow the model for independently operated oil FPSOs and traditional LNG liquefaction projects which, when it comes to reservoir risk, routinely require debt to be repaid by the time estimated remaining recoverable reserves reach a specified percentage of the initial certified reserves, with a minimum level of offtake to be secured under long-term take-or pay obligations. We would expect this position to be matched with FLNG projects.
Political risks
The track record for offshore operations is good. In fact, there is a strong case that the risks are lower compared to land based projects. Due to emission issues and the need to secure commodity supply, the support of national governments to increase gas production and its share of energy consumption is strong. Increasingly, the signals are encouraging with support of export credit agencies and multilateral agencies assisting with initial development.
Design and construction risks
Oil FPSO financiers have been reluctant to take design and construction risks without corporate support. It is also worth noting that typically one year's additional operational support is required for the period following the start of commercial operation [of FPSO projects.]. With FLNG projects it is anticipated that the first of these financed projects will either be with turn-key financings or fully guaranteed to, at least, the commencement of operations, if not more likely for such post-[construction/operation] support to exceed the one year post-[construction/operation] guarantee for FPSO projects.
Market risks
Oil financiers do not consider they take oil price risk, although this price may affect the robustness of the offtake contract and typically any financing that relies on project revenues will require some degree of price hedging. With FLNG the market price for gas (particularly in Asia Pacific) is less clear, in recent years, than for oil. We would therefore expect banks to be unwilling to take market price risk and will closely scrutinize the LNG contract price and price re-opener mechanisms.
Technological risks
Whilst technology is, unquestionably, a big concern, the floating production technology is proven in the oil industry, and most of the gas liquefaction and loading technology has been proven onshore. Banks will have very limited capability of assessing this risk in-house and strong, reliable, independent guidance may well be scarce, if indeed available at all. The risk is, therefore, most likely to be required to be shared between non-bank participants, at least until the first FLNG project has reached steady-state commercial production and the technology has been shown to work in the field.
Operational risks including health and safety and environmental risks
For both oil FPSOs and onshore liquefaction projects the identity and track record of the operations and maintenance (O&M) provider is key and reputations have to be built over time. The banks will be expected to require strong credentials for both maritime and liquefaction providers and to be protected from the impact, both in terms of potential liability and cash flow reduction of O&M failings. This will have to be covered partly by corporate support and the insurance market.
Force majeure (perils of the sea, etc.)
Oil FPSO financiers do sometimes take redeployment risk for force majeure termination, although that is currently mitigated by oil price economics making the actual exercise of termination rights less likely. With FLNG projects, due to the size and the novelty of the market, it is anticipated that banks will not take termination risk in this case and will look to the sponsors to assume this risk. It also remains to be seen if the marine insurance market can fully cover marine perils in this sector.
Structural, legal and credit risks
Oil FPSO financings are typically simply structured with the banks taking off-taker risk and the latter taking market risk. FLNG projects may incorporate more features from onshore liquefaction projects in passing credit risk up or down the LNG value chain. This will make for more complex financing structures, but this has typically been a strength of banks in the international project finance markets.
Future developments
We expect that the initial FLNG units will be owned and operated by oil majors or national oil corporations (in those countries where national oil companies are actively involved in production activities) and financed on a corporate basis. Project financings could be used in due course but in the early days of financing FLNG projects, due to the novelty, size and reduced liquidity, pricing on a project financing basis is likely to be higher and terms tighter than is the case for the financing of current oil FPSO or onshore LNG projects. This is only to be expected as the cost of funding is priced to match the perceived risks of the early FLNG projects. However, we would expect that as the FLNG experience and market grows and develops in the next couple of years and as the banks identify, assess and structure the relevant risks accordingly, the appetite hence liquidity will similarly increase and pricing for the [project] financing of FLNG projects will be more competitive.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
