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LNG power play

Weak prices are an opportunity for LNG-to-power developers. But projects need the right partners and location to succeed

It's no secret that a global liquefied natural gas glut has pressured prices from Europe to Southeast Asia. LNG imports into Japan now cost buyers just $8 per million British thermal units—less than half the price two and a half years ago. Europeans are importing LNG for even less, for around $5-6/m Btu.

Faced with saturated gas markets and persistently low prices, both power buyers and gas producers spy an opportunity to develop LNG-to-power projects.

These projects typically consist of an LNG import terminal to receive, store and regasify the LNG, and a connected gas-fired power plant to burn the fuel to produce electricity.

Several LNG-to-power projects are under development or recently came online. Malta's Electrogas LNG-to-power project began operating in April. In Panama, the Colon LNG-to-power project—the country's first gas-to-power plant—is under construction after winning a government tender in 2015 to supply power. Morocco and South Africa have also announced plans to build LNG-to-power projects, and both are still in early development stages. In Chile, the GNL Penco-Lirquén LNG terminal and the accompanying Central El Campesino power plant are under development.

It's a clear trend—but getting it right can't be taken for granted. A successful LNG-to-power project needs three key elements in place: the right parties, the right location and the right structure.

The right finance partners

For a start, developing and financing an LNG-to-power project must combine the right project sponsors, power purchasers, LNG supplier and engineering contractors.

The sponsors oversee the myriad of tasks to develop the project, including negotiation of the power-purchase agreement (PPA), LNG sales-and-purchase agreement (SPA) and other deals. They must also obtain permits, secure land rights and financing arrangements, and engage the government, the local community and any affected indigenous groups. To be successful, the sponsors need sufficient financial backing and a firm grasp of significant laws and regulations governing the local power market and of the practical impact they will have on the proposed LNG-to-power project.

The power buyers will need to sign long-term PPAs to buy a sufficient quantity of power, for a sufficient period of time. This also needs to be done at the right price and with sufficient credit support to provide the revenue stream to support the development and project financing of the facilities. In some countries, the power purchasers may include private utilities and large industrial companies. But in most, the sole power purchaser will be a government utility. Developing an LNG-to-power project in those countries will typically start with the government utility issuing a power tender under which it requests proposals from power producers to provide and then sell the electricity to the government utility under a PPA. In the tender, the government utility will specify the requirements for the power plant, including the permitted fuel types.

Ensuring government support is essential, especially if the project is in response to a government utility's power tender

Once the PPA is awarded, it will become the backbone of the LNG-to-power project, and the sponsors will seek to develop and finance the project around the terms of the PPA. Accordingly, the terms of the PPA and in particular the creditworthiness of the power purchasers will be critical to the success of the project. The LNG supplier—the party that will commit to deliver the baseload quantity of LNG to the project on a long-term basis—will need to agree in the LNG SPA to deliver a pre-determined quantity of LNG, in accordance with the needs of the power plant and the PPAs.

The engineering, procurement and construction (EPC) contractors are responsible for designing and building the project. To secure project financing, the sponsors will need to sign a lump-sum turn-key EPC contract on the whole project or, at a minimum, each major facility; and each lump-sum turn-key EPC contract will need to be with a reputable and creditworthy EPC contractor. If the sponsors can't do this, the lenders might demand that they provide completion guarantees on the project's construction.

Location, location, location

A successful LNG-to-power project needs a location that guarantees host government support, good access to infrastructure and workable laws and regulations.

Ensuring government support is essential. This is particularly the case for LNG-to-power projects being proposed in response to a government utility's power tender. Without the backing of the host government, the tender may never even be issued. If it is, the terms of the tender may be inadequate to allow an LNG-to-power project to compete competitively or succeed. This is also the case, but usually less so, for projects proposed outside a government utility's power tender. This is because as those projects do not necessarily rely on the government or its utility to buy the power, they will need government support in aspects of development including obtaining permits, negotiating any tax cuts, working with indigenous people groups and building relationships within the community.

$8/m Btu - Japanese LNG import prices

Naturally, the right location will also be physically able to support an LNG-to-power project. The regasification terminal will need to be located onshore—or offshore where the sponsors can obtain the necessary land rights and other concessions—and where the waters at the proposed berth location meet minimum metocean conditions. The power plant will need to be adjacent to the regasification terminal or at another location that can be connected to the regasification terminal by a new or existing gas pipeline. The power plant will also need to be close to the power purchasers or somewhere it can be connected via new or existing power transmission lines to the power purchasers. Ideally, the regasification terminal would also be located near other industrial or commercial companies that could potentially buy natural gas directly from or through the terminal, possibly as part of a future expansion.

The right laws and regulations in place are also critical. These allow the sponsors to carry out the development and obtain permits in a reasonable timeframe. If such laws and regulations are not yet in place, the sponsors will need to negotiate and obtain satisfactory host government agreements, under which the host government will make the necessary changes to its laws and regulations to support the project.

Structural significance

A successful LNG-to-power project needs the right structure, particularly where pricing and quantities are concerned.

In structuring an LNG-to-power project, the parties must agree on both wholesale power and LNG sales prices that dovetail with one another. The power price must be high enough to cover all project costs, including the LNG price, and equity return. The way the power price is calculated and the currency of the power price will also be important, as lenders will want assurance that these align with the LNG price as well as the pricing formula and currency used. They will also want to ensure that any pricing risk—both for foreign exchanges and commodities—is passed through the LNG-and-power-price formulas. If this risk can't be mitigated, lenders may need protection through hedging or other sponsor commitments. Sponsors often find themselves balancing the competing needs of power purchasers and the LNG supplier and will often seek to finalise the LNG and power prices at the same time, ensuring the two work properly together.

Another key part of structuring an LNG-to-power project is making sure the quantities of LNG to be bought for the project match the quantities of power to be sold. The two are often in tension: power purchasers want maximum flexibility to accommodate fluctuations in electricity demand while LNG suppliers want maximum certainty to align deliveries at the project with firm, upstream supply arrangements. In most projects, the proposed PPA terms will need to establish sufficient certainty around quantities of power to be sold, in turn supporting a minimum level of LNG fuel supply. Similarly, the proposed LNG SPA terms will need to give the project some flexibility to increase—or decrease—the quantities of LNG supplied. This will need to be done with sufficient notice and within certain parameters agreed by the parties.

While the appetite for developing LNG-to-power projects has clearly increased since LNG prices around the globe began to fall two and a half years ago, success depends on the key elements all being in place at the same time.

David Jetter is a partner specialising in project development and LNG at Baker Botts law firm

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