United States: New World LNG – Big Opportunities In Small-Scale And Bulk-Break Projects

Two increasingly important aspects of the LNG contracting world to note are LNG import projects deliberately structured to be of a much smaller scale than has been customary, and projects for the breaking of larger bulk LNG cargoes. These small-scale and bulk-break LNG projects both result in the import/export shipment of LNG through smaller terminals by smaller ships and much greater flexibility in terminal operations.

Small-scale and bulk-break LNG projects have the capacity to allow LNG importation to penetrate hitherto undeveloped markets. The emergence of such projects will require a re-think of the way in which conventional LNG import projects have been contracted for and operated if their potential is to be fully realised.

Conventional LNG Project Structuring

Conventional contracting for the sale and purchase of LNG over the last decade has resulted in LNG trades characterised by a number of features:

Tramline trading  The popular conception of LNG sales and transportation arrangements is that an LNG ship is loaded at the liquefaction facilities, makes the laden voyage to the regasification facilities at the intended port of delivery, discharges its cargo and then makes the ballast (unladen) voyage back to the liquefaction facilities.

This cycle is repeated with a frequency derived from whatever is required to meet the requirements of the LNG sale and purchase agreement between the seller and the buyer and gives rise to the characterisation of such arrangements as 'tramline trades' (sometimes also called 'point to point trades'), because the LNG ship moves between the liquefaction facilities and the regasification facilities, laden and then unladen, with a monotony reminiscent of a tracked tram service.

This operational model remains very much the norm. On the ballast voyage the LNG ship would not carry any LNG (beyond the minimum necessary to act as a cooling heel), although loading a full backhaul cargo could always be a possibility. What is not ordinarily possible is to have a partial unloading of a cargo prior to the ballast voyage, because the remaining part cargo of LNG sloshing1 around within the LNG containment system would not be good for the stability of the LNG ship on the continuation of its voyage.

Delivered means delivered  In an ex-ship LNG sale and purchase agreement the expectation is that the seller will deliver the cargo to a nominated principal delivery port, but could be persuaded to divert that cargo to an alternative delivery port prior to effecting the actual delivery by agreement with the buyer (where there could be an agreed commercial incentive between the parties to effect such a diversion).

At the intended delivery port the buyer will take delivery of the cargo, regasify it and apply it (in its regasified state) to whatever the intended commercial purpose is (whether that means sending the regas into reticulation for industrial or domestic consumption or using it as a feedstock for petrochemical production or for power generation).

Trans-shipment of the LNG cargo into another ship offshore at the delivery port, or re-loading the unloaded LNG cargo into another LNG ship at the delivery port (in either case as a pre-cursor to the onward transportation of that LNG cargo) would not ordinarily be conceived of as an option. Indeed, some ex-ship LNG sale and purchase agreements actively seek to prohibit such an activity (to the extent, consistent with applicable competition law principles, that it is legally permissible to do so), because it gives the buyer an opportunity to circumvent any agreed destination diversion and benefit sharing principles in the LNG sale and purchase agreement.

Increased ship sizes  As LNG has continued to grow in importance in the global energy mix, LNG-carrying ships have continued to grow bigger too, with a drive to load as much cargo as possible into a single hull in the interests of maximising the associated delivery economics. Bigger, it would seem, is better.

The relative size of an LNG ship is determined by its LNG cargo-carrying capacity, rather than by reference to the more conventional measure of the deadweight tonnage (dwt) of the hull.

The very first LNG ships had small LNG cargo-carrying capacities, reflective of the inherent design limitations of the time. The first real commercial LNG ship, the Methane Princess, entered service in 1964 with an LNG cargo capacity of 27,400m3. The smallest conventional LNG ships operating today are the B-class ships, with a cargo-carrying capacity of up to 90,000m3.

The first 'super large' LNG ship was the Q-Flex class which, with an LNG cargo capacity of between 210,000 m3 and 216,000m3, was almost twice the size of the preceding generation of LNG ships. The first Q-Flex class ship was delivered into service in 2007.

Things did not stop there however. The next development in LNG ship sizes was not long in coming, with the introduction of the Q-Max class. The first commercial cargo delivery from a Q-Max ship took place in 2009. The Q-Max class ship is a scale bigger again than the Q-Flex, with a total length of 345 metres, a beam of 54 metres and a draft of 12 metres. With the Q-Max the maximum LNG cargo-carrying capacity was increased to 266,000 m3.

The growth in LNG ship sizes has not been without its attendant problems however. An LNG ship must be able to access the port for which the LNG cargo delivery is intended, and this has simply not always been possible with the new generation of super ships. The dimensions of the Q-Flex ships were such that at the time of their introduction to service only two-thirds of the LNG import terminals then operating worldwide were able to accommodate such a ship without modification. When the Q-Max ships were introduced to service the figure for readily-compatible LNG import terminals dropped to less than a half.

Pipelines for short distances  There is a school of thought which says that over 'shorter' distances it is economically preferable to transport gas by pipeline, that those pipeline economics will inevitably deteriorate as the distance over which the gas needs to travel increases and that for 'longer' distances it is only really economically efficient to transport gas in the form of LNG (which, in part, explains the obsession with increasing LNG ship sizes (see above)).2

This is of course an inexact science, with many variables to take into account, and the cut-off point between 'shorter' and 'longer' will not be a single factor which applies to every gas commercialisation project.

To import or to export  The LNG world has historically been divided into those countries which export LNG and those countries which import it. Those countries in turn will have LNG export (liquefaction) terminals or LNG import (regasification) terminals in situ.

The choice between export and import has historically been a binary one, although the US has recently seen some attempts at gender reassignment with the planned conversion of some import terminals to export terminals because of the US shale gas revolution. Several countries (such as Malaysia and Indonesia) are also looking at having both sets of facilities within their markets.

The sales expectation  Traditional LNG sales contracts have been characterised by being for large and relatively inflexible volumes of LNG, for sales to economically robust counterparts with significant levels of credit support behind them, of long durations with little scope for revision, with relatively inelastic (and preferably) oil-indexed prices and with high take-or-pay commitments in protection of the seller. 

The buyer has also historically been the owner/operator of the LNG import facilities, or has contracted with an equally sound third-party LNG import facility owner for the provision of LNG regasification services.

The features identified above have together resulted in the establishment of operational and commercial structures for LNG sales, transportation and processing projects which are inevitably sizeable, inflexible, expensive and difficult to replicate in anything other than a limited set of circumstances. Small wonder then that participation in LNG projects has sometimes been described as "a rich man's club."

Small-Scale and Bulk-Break Projects  What They Bring

The principal use of LNG is as a feedstock for power generation, in order to secure the widely-known ecological advantages and operational and economic efficiencies associated with burning gas (compared to dirtier, less efficient and more expensive feedstocks such as coal or fuel oil) to make electricity.

Migrating to an energy economy founded on gas as a means of generating power is a key imperative for most countries, and LNG represents the most flexible means by which a country not possessed of indigenous gas reserves can access import supplies from the global gas market. In addition, LNG can be consumed as a vehicle fuel, which adds to the attraction for certain markets.

Despite its obvious attractions however, LNG simply does not flow as readily as it should into every prospective gas economy. This paucity of market penetration is, in significant part, driven by the market expectations of traditional LNG exporters, for whom the ideal import economy is still (largely) characterised by the willingness of an LNG buyer to commit to large volumes, long-term contracts, relative inelasticity of pricing (preferably also with prices indexed to crude oil or oil products) and almost sovereign-rated levels of credit support. Japan, Korea and Taiwan typify such import economies.

The new world of LNG import economies (such as Brazil, India and China) are large and relatively prosperous developing economies, well capable of joining the ranks of the established LNG importing nations. But for many smaller countries the expected major-scale economics of building significant LNG import facilities can be crippling. In a market with no track record of gas importing, an absence of a gas-centric energy economy and precious few of the commercial characteristics identified above in respect of established LNG import projects, the chances of securing development finance through the provision of third-party debt (for which long-term, creditworthy, major-scale gas demand is critical) will be slim. Thus, despite the obvious need, the door could remain closed to importing LNG into such markets. Something needs to be done to break this cycle, and that something could be small-scale LNG.

Small-scale LNG entails the deliberate development of a relatively small and highly flexible regasification facility. Because of the smaller dimension of size, small-scale LNG projects present lower levels of total project cost (both capital cost and operating cost), reduced project build times and correspondingly reduced risks of non-completion. This gives such projects a better chance of being financed off balance sheet by project sponsors, or of being financed by a development bank.

In the bulk-breaking of LNG much can be learned from the world of oil and oil products sales and transportation contracting. Of relevance to LNG sales and transportation contracting, and LNG cargo management, are modified forms of the concepts of cargo splitting (that is, decomposing a single, large cargo into a number of smaller cargo lots) and lightering (that is, transferring a cargo from one vessel to another (typically smaller) vessel to enable the onwards transit of that smaller cargo into markets where larger vessel access is not possible).

Bulk-break projects are essentially small-scale, but small-scale projects do not necessarily have to apply all the components of bulk-breaking.

Small-scale and bulk-break LNG import projects demonstrate a number of characteristics:

Short-run LNG projects  Gas, in the form of LNG, will be transported over distances which are significantly less than the distances which the conventional wisdom dictates are the natural province of LNG. Thus, LNG is no longer confined to transportation over 'longer' distances, and will be shipped over distances where the pipeline transportation of gas might otherwise have been expected.

Smaller terminals  Several small-scale LNG import terminals have been developed or are presently in the design phase in the Baltic, most notable of which is the Nynäshamn import terminal in Sweden.3 A smaller terminal size leads to faster build times (it took approximately two and a half years for the Nynäshamn terminal to move from project approval to project inauguration), lower capital costs and lower operating costs. These factors combine to make possible the construction of economically tenable facilities for the import of LNG where previously such an import might not have been an option.

Some small-scale LNG import projects have also identified floating storage and regasification units (FSRUs) as being an indispensable tool in the drive of a country towards becoming a first-time LNG importer.4 The technology of ship-to-ship LNG transfers has developed to the point of industry acceptance, and the FSRU in theory represents a less risky proposition for an investor since it can be re-deployed to a more attractive location if necessary, thereby obviating the risk of investing into a potentially stranded terrestrial asset.

Smaller ships  A smaller terminal size lends itself to the use of correspondingly smaller ships, and here there have been some interesting developments. In stark contrast to the Q-Flex and Q-Max world (see above), new-build small-scale LNG barges and ships with cargo-carrying capacities of anything between 1,000m3 and 30,000m3 are appearing. This new generation of ships is engineered also to be able to unload part cargoes across different terminals, such that part-loaded voyages can be undertaken without exposure to the dangers of sloshing.

LNG unloading and loading options  The resultant LNG import terminal could be androgynous, with combined regasification and liquefaction facilities. Thus, the LNG ship would unload LNG at the terminal (whether in whole or in part) but LNG in store could also be reloaded into an incoming LNG ship and taken away from the terminal, for delivery elsewhere. Re-loading for export could be very much part of the business model. LNG could also be loaded onto bunker barges and transferred from barge to ship offshore for LNG ships which burn LNG as an engine fuel, and LNG could also be trans-shipped offshore from one vessel to another. This envisages a series of ship movements which would be quite inconceivable in a traditional LNG import project structure.

LNG offtake options  In contrast to the conventional LNG import terminal model, it does not necessarily follow that all LNG which is taken into the terminal will be regasified and the resultant regas sent out by pipeline to its eventual delivery destination. In a small-scale terminal, the pipeline send-out of gas through a grid connection could always be a possibility but LNG could also be loaded into specialist trucks or railcars which can then be used to transport the LNG in smaller volumes, to destinations which hitherto would have been inaccessible to LNG.

Applying all of the above characteristics together gives what is sometimes called a 'milk round'5 or multi-drop LNG project model. A small-scale LNG ship could undertake a number of part-cargo unloads (and re-loads) across multiple small-scale import terminals within a region, moving energy around in the form of LNG according to local needs. The economics of doing so could make it more attractive to move LNG through a combination of short-run coastal deliveries, specialist trucks and railcars than to develop a pipeline network to deliver gas.

To give some context, small-scale LNG projects are making their presence felt principally in the Baltic region, through the development of various bulk-breaking LNG import terminal projects. The Baltic is a region characterised by the need to import energy in order to meet demand, relatively poor interconnectivity of gas pipeline and other energy infrastructure, and pressing regulatory and economic needs to increase the consumption of cleaner and less expensive energy forms (principally, moving from the combustion of naphtha and fuel oil to the combustion of gas).

The essential features of any small-scale or bulk-break project makes it inherently suited to any geography where localised centres of gas demand are not adequately serviced by pipeline gas feeds. In Asia, the Indonesian archipelago, Malaysia, the Philippines and Thailand would all potentially benefit from the introduction of such projects, and the model also lends itself naturally to development opportunities in the Caribbean and in Central America.

New Form Project Structures and Contracts

Small-scale and bulk-breaking LNG projects have certain obvious differences to conventional LNG projects in the way that they are structured, and the associated project contracts could also require some significant re-working from traditional LNG sales and processing contract forms.

An aspiring LNG buyer/importer could lack the financial and technical capability to build, own and operate an LNG import terminal. But a small-scale LNG import terminal does not have to be owned by the person which is also the LNG buyer/importer. Such a terminal could be owned and operated by an entity (or even collectively by a consortium of entities, coming together to share personnel, infrastructure and overall project costs) without an involvement in the business of LNG sale and purchase, providing a service to the aspiring LNG buyer/importer as a third-party customer.

The customer which wishes to access the LNG import terminal, without having to be a terminal owner in its own right, would contract with the terminal owner entity for the provision of certain defined LNG management services at the terminal. This would enable the terminal owner entity to earn tariff revenues from contracted terminal customers, which in turn would support the costs of the terminal's development.

In support of this model a terminal use agreement would be entered into between the terminal owner entity and the customer, in order to recite the provision of the required services. The services to be provided would reflect the needs of the customer, to be drawn from a menu which could recite the bulk-breaking options (including any of unloading LNG from a ship or loading LNG into a ship, trans-shipment, bunkering, LNG storage, LNG regasification and then send out of gas by grid connection to a pipeline or the send out of LNG by specialist truck or railcar).

The terminal use agreement could be written as a single, composite agreement between the terminal owner and the customer which relates to a package of services to be provided by the terminal owner, or alternatively a customer of the terminal could contract for the provision of all or only some of the defined terminal services. In the latter case there could be a series of modular, service-specific contracts between the terminal owner and the customer (with care taken to eliminate duplication or inconsistency across the suite of contracts).

The terminal use agreement, in whatever form it takes, would apply appropriate generic terms and conditions relating to the determination of the method of payment for those services and to the consequences of the terminal owner entity's performance failure, and also rights and obligations between the various customers.

The duration of the terminal use agreement will be key, in conjunction with provisions which relate to the customer's commitment to pay for reserved capacities at the terminal. This will be of particular relevance where the costs of construction of the import terminal are project-financed (whether initially or through a subsequent re-financing). The operational premise of the terminal, and the financial underpinning for its development, could however be delivered by a multiplicity of short-term capacity access contracts (and the lower level of terminal development costs (see above) could make this more tenable as a basis for financing).

Within the emergence of bulk-break and small-scale LNG project opportunities, one constant which continues is the need for effective contracts for the sale and purchase of LNG. These contracts will still be required in order for an LNG seller to make LNG available to a buyer, howsoever the LNG is to be imported.

The characteristics described above in respect of traditional, long-term LNG sale and purchase agreements could be unsustainable in a country for which a small-scale LNG import project is a possibility, and a new sales contracting paradigm will be required.

Agreements for the sale and purchase of LNG could be written on the basis of firm term sale and purchase commitments, or call-off arrangements under a form of master sales agreement (MSA). The MSA could also be used as the basis for a hybrid strip-sale contract. Credit support provided in favour of the seller in respect of the buyer's LNG purchase commitment could be structured through a combination of pre-payment by the buyer on an individual cargo basis, short-life letters of credit or the seller's provision of credit risk insurance in respect of the buyer (at the buyer's expense).

Where English law is selected to govern the LNG sales arrangements care will need to be taken to ensure that there is effective separation of title and risk transfers in a multi-owner cargo in respect of which individual entitlements cannot readily be identified.

Other essential contractual issues which concern any seller of LNG relate to clarity around the legal status and financial covenant of the buyer (with the provision of collateral support in mitigation of the latter point), having a clear and compellable form of contract and having access to the legal machinery necessary for the effective resolution of contractual disputes and for the enforcement of recoverable remedies. These issues are of equal application to LNG sale and purchase agreements associated with major-scale LNG projects and to those which underpin any small-scale project.

Conclusion

Small-scale terminals with bulk-breaking capacity and multiple send-out options, allied to a new generation of nimble, littoral LNG ships with aggressive scheduling and fleet optimisation techniques, could prove to be indispensable in enabling gas, in the form of LNG, to be delivered into hitherto closed markets in a cost-effective manner. The inherent operational flexibility of such terminals, the relative ease with which such terminals can be constructed, and the proportionately low capital and operating costs associated with such terminals all combine to make them an attractive proposition.

To match the infrastructure, a new generation of contracts for the provision of services to customers at the terminal, and for the sale and purchase of LNG (including the provision of credit support) could be required.

Small-scale capacity, operational agility, rapidity of deployment, cost-competitive delivery and flexible, responsive contracts are not characteristics traditionally associated with LNG projects, but the advent of a new way of looking at these LNG import/export projects could see LNG cast in an entirely new light.

Footnote

1 'Sloshing' is not as casual a term as it first might seem – see (for example) the Sloshing Assessment Guidance Document for Membrane Tank LNG Operations, issued by Lloyd's Register in May 2009, where sloshing is defined as "...the violent motion of the free surface of a fluid in a partially filled container or tank."

2 See Greenwald, 'Liquefied Natural Gas: Developing and Financing International Energy Projects' (Kluwer Law, 1998), which suggested that, because of its inherently high costs and inefficiencies, the transportation of gas in the form of LNG was really only suited to transportation over long distances (not defined, but observing that the economics of transporting gas as LNG would prevail over distances of 2,000km in comparison with offshore gas pipelines, and would prevail over distances of 5,000km in comparison with onshore gas pipelines).

3 In Sweden, the Linde Group has built the Nynäshamn import terminal (with 20,000m3 of LNG storage capacity) on the east coast, Skangass AS is developing an import terminal (with 30,000m3 of LNG storage capacity) on the west coast at Lysekil and a joint venture between Swedegas and Vopak is considering the possible development of an import terminal (with an initial 20,000m3 of LNG storage capacity) on the west coast, at Gothenburg. Other small-scale developments are being suggested for Hamburg and Tallinn. Contrast the scale of these terminals with major-scale European LNG import terminals with significantly larger levels of LNG storage capacity, for example at the Isle of Grain (960,000m3), GATE (720,000 m3) and Dunkerque (570,000 m3).

4 See, for example, Klaipedos Nafta's LNG import terminal project in Lithuania, which is based on the use of an FSRU.

5 A uniquely British concept whereby a full-laden delivery vehicle makes early-morning doorstep deliveries of milk to multiple customers, dropping off full bottles of milk and collecting empty bottles for return.

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