US Liquefied Natural Gas (LNG) is booming. Several LNG liquefaction facilities are currently been built, and more are expected. But what are the operational complexities and associated risks for either project developers with a Sale and Purchase Agreement (SPA) or/and customers with a Liquefaction Tolling Agreement (LTA) willing to access opportunities in the US LNG Market?
Traditionally, liquefaction projects have been linked with the development of the upstream gas resources – getting the gas from a remote location to market. In the US, however, there is an active competitive gas market which LNG players can easily use to access the US shale gas resource base and associated pipeline network. US LNG projects thus disaggregate access to the resource from the liquefaction, and this enables different business models – capacity tolling agreements – to be used.
As gas can be readily procured, and given that some investors in the liquefaction facilities are not seeking to take any commodity price risks, offtakers are offered Liquefaction Tolling Agreements (LTA). Alternatively, the owner of the liquefaction facility might offer LNG Sale and Purchase Agreements (SPAs) that are more suited to LNG buyers.
These commercial models place the operational complexity and associated risk on either the project developers (with an SPA) or the customers (with an LTA).
Under a SPA, the buyer’s risk starts when the title is transferred. In most cases this happens when the LNG vessel is loaded (FOB) or when the LNG is unloaded at the destination if the deal is done on a Delivered Ex-Ship basis (DES). In this model, the liquefaction facility operator must manage all of the operational complexity.
With an LTA, the customer is responsible for the purchase and delivery of gas to the liquefaction facility, the procurement and management of tug and other marine services, the procurement of a power equivalent to its liquefaction-driven demand and sometimes even for the injection of butane as needed. Under this model, buyers must secure the capability to manage a more complex business, with a need for a local presence, than would be the case for a typical LNG SPA purchase.
For those responsible for managing this value chain, a robust commercial and operational framework, a clear business process, system and tool support and risk management protocols are key. Translating commercial contracts and related commitments into a clear set of processes that outline people, process and system requirements is one of the biggest challenges for LNG offtakers in the US.
Baringa has worked extensively with clients to understand and manage operational risks, and we have identified a number of key challenges to be managed:
1) Force Majeure asymmetry: Alignment of Force Majeure (FM) clauses and terms between contracts (gas supply, pipeline transport and particularly any on-sale SPAs signed). Firms could end up being exposed to a situation where a counterparty (e.g., a pipeline operator) declares FM, with the contract party being unable to declare FM in turn (in our example, to the liquefaction plant).
2) Operational readiness failure: Operational processes and controls not sufficiently developed and/or implemented. Establishing a local office capable of managing the operational complexity of a tolling position is key to avoid the significant financial penalties and reputational consequences of failing to adequately respond to operational challenges and adverse events (that will happen!).
3) Schedule management: With capacity payments due regardless of whether or not volumes are lifted, managing a lifting schedule – that accommodates the challenges associated with issues such as Panama Canal congestion, hurricanes in the Gulf of Mexico or simply fog – is a real challenge. The risk of failing to lift volumes driven by delays that cannot be managed would present significant financial impediments and potentially a failure to meet onward sales obligations.
The next wave of US LNG projects have tended to favour an SPA structure, reflecting, perhaps, the fact that such a construct is more attractive to customers and placing the operational onus on the project developers. However, that still leaves a number of existing projects set up with LTAs where these tolling agreements are now being put into operation.