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LNG Canada shows 'proof of concept' in funding large LNG export projects

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LNG Canada shows 'proof of concept' in funding large LNG export projects

The financing model that brought the roughly $31 billion LNG Canada project to a final investment decision could signal a shift toward funding the next wave of North American LNG projects with equity investments instead of relying on debt.

"It tilted the whole scale in favor of this project," said Kenneth Medlock, senior director of the Center for Energy Studies at Rice University's Baker Institute for Public Policy. "That's going to be more the norm as we go forward ... There will be variations on the theme, but that's the basic idea."

The recent decision by a group of investors led by Royal Dutch Shell PLC to commercially sanction the LNG Canada project happened without first securing the usual long-term off-take contracts. Other North American developers have struggled in the current global LNG market to line up these types of contracts.

Most North American LNG developers have planned to finance projects with a mix of debt and equity. While larger developers willing to take on market risk can finance projects using a larger amount of equity or corporate debt, many U.S. projects have looked to project-level financing to provide the majority of funding. Traditionally, that has meant securing long-term contracts to satisfy lenders who want to see guaranteed cash flows over decades.

But that could change as buyers increasingly prize shorter contracts and flexibility, market observers said. "Ultimately, if we are going to move to a world where contracts get shorter and shorter and become more flexible, in some ways debt financing is going to be increasingly difficult," Deloitte Services LP analyst Thomas Shattuck said. "And equity investment from the buyers is one logical solution to that problem."

Questions remain about what sort of companies would be attracted to making such an investment in U.S. LNG projects and at what kind of volumes. Likely candidates could be buyers in regions with strong demand growth, such as utilities in Asia or large traders, Shattuck said. They could be large LNG producers that buy and sell the commodity, but many of these are building their own projects or have large off-take agreements with projects already being built.

"This is clearly another avenue, and LNG Canada kind of works as a proof of concept that that business model can attract interest and be brought to [a final investment decision]," Shattuck said. "It just remains to be seen if that can be replicated elsewhere."

Shell, one the world's biggest shippers and leading producers of LNG, invested in a 40% stake in LNG Canada and partnered with large buyers of LNG. Each of the joint partners — PetroChina Co. Ltd. with 15%, Korea Gas Corp. with 5%, Malaysia's Petroliam Nasional Bhd. with 25% and Japan's Mitsubishi Corp. with 15% — will provide its own natural gas supply and transport and market its share of LNG. They will focus on sales in Asian markets, drawing on two trains capable of producing a total of 14 million tonnes per annum of LNG in Kitimat, British Columbia. A spokesperson for LNG Canada said the plant is targeted to come online in 2023 or 2024. The facility could later be expanded to four trains.

Analysts said the LNG Canada decision increased competition for second-wave U.S. LNG developers facing pressure to reach a final investment decision to be ready for an expected supply gap in the mid-2020s.

Some U.S. export hopefuls might adopt some sort of hybrid model, Medlock said. Some already have pursued equity partnerships with LNG buyers. One is Tellurian Inc., which, without the balance sheet of an oil and gas giant such as Shell, has pursued a model offering equity stakes in its proposed 27.6 mtpa Driftwood LNG export venture. Under the company's plan, investors would get access to LNG from the Gulf Coast at a target price of $3/MMBtu, which they could ship for their own purposes or resell.

Experts have warned that U.S. LNG projects in development could suffer delay because of uncertainty stemming from trade tension between the U.S. and China, which threatens access to a key market. And LNG buyers' push for shorter and more flexible contracts could add more risk to the export industry and create market uncertainty, S&P Global Ratings said in an Oct. 3 report.

"These increasing risks could mean that liquefaction sponsors will have to provide more equity or take on more balance sheet risks at the sponsor level in making final investment decisions," S&P Global Ratings said.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global.