5 August 2002
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8 August 2013
A new specialism is developing in the legal services marketplace as the liquefied natural gas (LNG) industry goes from strength to strength, requiring law firms to combine their energy, shipping and project finance practices.
Natural gas is the fastest growing primary energy source in the world. According to the US Department of Energy's 'International Energy Outlook 2002' forecast, consumption almost doubled between 1990 and 2000 and is set to double again, to 162 trillion cubic feet by 2020. This exponential growth in gas usage is attributable to the competitive price of gas as against other primary fuels; environmental concerns; energy security issues; market deregulation and overall economic growth.
Traditionally, natural gas has been transported by pipeline, with most of the fuel consumed in Europe coming from Russia. For major markets in North America and the Far East, however, the importation of natural gas by pipeline is either impractical or uneconomical. As a result, a number of these markets, particularly Japan and Korea, became over-reliant on oil as their primary energy source. The oil price hikes of the 1970s prompted a number of gas buyers and suppliers to consider shipping as an alternative method of transporting natural gas.
Shipping natural gas was not considered economically viable due to the area it occupies in its gaseous state. When cooled to 162°C, however, natural gas liquefies and takes up 1/600 of the volume it requires in its gaseous state, making transportation by ship economically viable.
Although LNG activity originated in the Atlantic basin, the biggest growth in the industry came from Asian markets, which in the past 20 years have experienced the largest demand for LNG. But this trend is changing as the US and Europe have started importing LNG in significant quantities.
LNG projects are typically developed as an integrated chain of dedicated facilities and activities, from gas production, transmission, liquefaction and storage in the exporting country, to shipping in specialised LNG tankers and regasification and distribution in the importing country. There are often different entities responsible for each stage of the process. Given the nature of this transaction chain, the LNG industry is characterised by a small number of large projects, with heavy government involvement and long lead times - around 5-10 years.
Integrated supply projects have been developed in Qatar, Oman, Malaysia, Indonesia and Brunei, where capacity was fully committed to creditworthy buyers which assumed market risk through their take-or-pay purchasing obligations, while sellers took the price risks through indexation to crude oil prices. This sharing of risk, allowing the exploitation of gas reserves that would not otherwise have been economic and the implementation of projects that would not otherwise have been viable, has supported the development of new project financing structures for the LNG industry.
LNG projects have evolved from traditional structures sponsored by government agencies in exporting countries, to fully integrated structures in which separate upstream and downstream joint ventures share the LNG revenues. More recently, a wider variety of finance options have been considered, including a more sophisticated portfolio approach to LNG trade and risk; a larger role for local debt and currency markets; a broader use of hedging instruments; greater involvement of multinational development agencies; and more complex risk-sharing project financings. Many parts of LNG projects are put out to tender, involving a wide range of jurisdictions and so inevitably there is extensive legal involvement.
A number of recent developments have substantially increased the size, scope and viability of the LNG projects industry worldwide. The introduction of competition in the gas and power markets in Europe (pursuant to the 1998 European Directive for the Internal Market in Natural Gas) and the US combined with the introduction of the Kyoto protocol, has led to a major increase in the demand for natural gas.
Another factor is the emergence of China and India, which, with limited gas reserves of their own, are expected to become large buyers of LNG. With both countries leading the world growth rate tables - 6 per cent to 8 per cent growth in each case - the resultant impact on LNG demand is expected to be significant.
Growth will also be spurred by a major reduction in LNG costs, which have been cut by half through mature design, increased scale and competition among contractors, suppliers and lenders, making previously borderline projects viable.
Surging US demand for LNG has resulted in the development of a short term trading market in LNG as suppliers try to maximise profit by arbitraging gas prices and entering into 'ship saving swaps', where deliveries closer together are swapped at a profit with deliveries further apart.
Many of the global oil companies are becoming more involved in the building and purchasing of LNG shipping vessels. In the past five years, the first speculative orders of LNG tankers have been fulfiled, creating shipping capacity to support short-term LNG trading.
Further growth is en-couraged by the development of economically viable floating LNG plants that enable the exploitation of remote offshore wells and smaller gas reserves. Recent announcements include Shell and Woodside Petroleum in the Timor Sea, a Shell/Texaco joint venture which is considering building a floating LNG plant in Namibia, and Kværner Oil & Gas is considering building a floating plant in Indonesia.
Sustained growth in this dynamic market contrasts it with the more sluggish performance in other natural resources and transportation sectors and this is likely to continue. n
Andrew Wettern is an international finance partner and Ian McNeill is an international corporate partner at Watson Farley & Williams