Anyone who doesn’t think the North American liquefied natural gas (LNG) industry has been evolving only needs to look back about two years to see how far things have come.
For instance, the North American market appears to have adequate regasification capacity on the ground or under construction. There will be a need for more incremental capacity, says Chuck Zabriskie of the Royal Bank of Scotland (RBS). But for now, those in the know are aware of who the winners and losers most likely will be in the terminal development race, even if, like Zabriskie, they aren’t saying so publicly.
Zabriskie, the bank’s head of structured energy finance for North America, spoke last Thursday to a Houston audience at Lukens Energy Group’s quarterly breakfast forum. His topic: North American LNG: What we’ve learned about regasification development in the last two years.
While the gas industry used to fret over not having enough regasification capacity, today’s worries are directed upstream, where there is genuine concern among some that the United States might not get all the LNG it needs/wants. “I wouldn’t say I’m losing any sleep on the issue,” Zabriskie said.
The banker said he expects that North American regasification units will generally be underutilized, regasifying LNG at about 70% of their capacity. However, the cushion of extra regasification capacity is necessary to allow for optionality in cargo destinations and the development of an LNG spot market.
Zabriskie noted that the holders of regasification capacity are generally a well-heeled bunch that can afford to allow about 1 Bcf/d to lie fallow while it waits for an attractive arbitrage opportunity. Unlike what some in the industry predicted, LNG regasification developers have not repeated the mistakes made by merchant power generators when they overbuilt capacity in the years around the turn of the century. “I think everyone’s been rather prudent about the whole thing,” Zabriskie said of the LNG camp.
This is because lenders have “enforced discipline,” and most projects have been developed on the back of firm contracts. Regasification projects in North America have generally been structured according to one of three models: tolling, merchant, and integrated.
Under the tolling model, the regasification terminal developer provides capacity to an LNG owner in exchange for a reliable and well defined stream of revenue. In the merchant model, revenue is derived from the difference in the purchase price of LNG and the sales price of natural gas. Sponsors may earn profit from trading, marketing and optimization. Under an integrated model, liquefaction, regasification and often shipping are owned in common, typically by a joint venture.
Zabriskie said that over the last three years each of these models has materialized and variations upon each model also have become evident. He noted that the majority of projects have used the tolling model, securing long-term, firm capacity agreements to support their financing.
In 2004 Zabriskie said that the thinking at RBS was that most greenfield LNG construction financing would be sourced in the bank market and then refinanced in the bond markets just before or soon after terminal operations began. However, since then market conditions — low Treasury rates and credit spreads — combined with appetite for higher yields among investors created a developer’s market for financing.
Capital market investors have accepted construction risk for projects that demonstrate reliable future cash flows. And record levels of liquidity and narrow credit spreads have allowed projects to be financed on terms that would have seemed very aggressive two years ago, he said. Additionally, several private equity investors have put money behind greenfield LNG-related projects.
While LNG and energy in general have been attracting plenty of capital lately, project developers that don’t have their upstream LNG supply lined up are likely going to have to wait for the next round of liquefaction projects, Zabriskie said. “It is hard to see too many upstream projects not committed.”
What remains to be seen is whether the Gulf of Mexico becomes a “sink” for global LNG or a “backstop” for cargoes looking for an attractive home on a piecemeal basis. Because of the pipeline connectivity of the Gulf and the abundance of storage in North America, the market is one in which it’s relatively easy to come up with “make-up” gas for cargoes diverted from the United States. At any rate, what once was considered an attractive landing price of about $3.50 has arguably increased “substantially” due to higher costs, Zabriskie said, noting that regasification projects that were early to the game are likely to enjoy an economic advantage over those at the tail end of the development boom due to rising costs.
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