Energy market 2020: trends and new opportunities in non-traditional sectors

April 2020  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2020 Issue

In a little over a decade, the US shale boom led to rapid US natural gas production. In 2016, the US went from a net importer to net exporter of natural gas on a monthly basis for the first time since 1957. The excess shale gas supply sharply drove down domestic gas prices. The Henry Hub natural gas spot price declined from $8.86 per MMBtu in 2008 to current pricing of around $2 per MMBtu. The Energy Information Administration (EIA) projects spot prices to hover around $2 per MMBtu at least over the short term, with an annual average of $2.21 per MMBtu in 2020 and $2.53 per MMBtu in 2021.

In the US, the current  state of oversupply is being met with low levels of demand. These current low levels of demand could be attributed to three main factors – first, an increase in global supply with export facilities coming online around the world over the past few years, second, oversupply in liquified natural gas (LNG) inventories in China and other Asian nations as a result of significant purchasing activity in 2019, and third, a relatively warm winter throughout the northern hemisphere, not to mention the potentially compounding effect of the current coronavirus spread. In this context, there have been recent reports of certain offtakers choosing to delay or cancel scheduled cargoes, and instead paying contractual penalties.

Excess supply of natural gas continues to persist as US shale gas production remains at near record levels. However, excess supply, coupled with depressed global demand, has led some to posit that the US shale boom is actually a bust. Some suggest that a natural gas price of less than $2 per MMBtu is not economically profitable for producers and, in the short term, has already spurred a wave of spending cuts, layoffs, merger activity and restructuring in the upstream sector.

During the shale boom, US LNG exports rapidly increased from almost zero in 2015 to an average of approximately 5.0 billion cubic feet per day (Bcf/d) in 2019, according to EIA data. According to Platts Analytics, offtake deals signed during the first wave of US LNG supply ranged from $2.25 to $3.50 per MMBtu for liquefaction at the LNG export facilities. However, US LNG exporters expect lower pricing in the second wave as a result of record low LNG prices and weak demand in Asia and Europe. Historically, long-term offtake contracts were indexed to oil prices and one of the important drivers of US LNG export trade was the opportunity to negotiate LNG supply contracts indexed to the less-volatile US Henry Hub natural gas price without geographic restrictions. However, much of the price advantage has since eroded and the desire to enter long-term contracts has therefore been stymied. Multiple US LNG export projects that have received Federal Energy Regulatory Commission (FERC) approval and Department of Energy LNG export approval have yet to obtain the long-term pricing arrangements necessary to make the underlying LNG projects viable or financeable.

In this new price environment, opportunistic sponsors and investors in the global market have emerged looking to effectively create their own demand and to take advantage of pricing arbitrage opportunities elsewhere. Some of these projects seek to take advantage of the low pricing to convert gas into other products, such as plastics, fertilisers and explosives. Some projects will act as a bridge to a more renewable energy-powered future for certain jurisdictions, while others are responding to intermittency issues created by existing renewable energy sources. We are seeing a number of new projects that have recently closed or are coming to market in the midstream and downstream sectors in the US and Latin America, including petrochemicals, LNG to power infrastructure and logistics, gas-to-liquids and ammonia, as well as an increasing push in the maritime industry for LNG-powered vessels.

In January, Gulf Coast Ammonia LLC, owned by joint venture partners Starwood Energy and Mabanaft GmbH, announced that it closed on a non-recourse project financing for its world-scale anhydrous ammonia plant in Texas. The ammonia facility is expected to produce 1.3 million tons of ammonia per year to be used in fertiliser production. The project, which is set to commence operations in the first half of 2023, once built, is expected to be the world’s largest single-train ammonia synthesis loop. Ammonia is essentially made from natural gas. The project provided an opportunity for its offtakers, primarily fertiliser producers, to essentially back-leverage into relatively inexpensive US natural gas to ensure low-cost and relatively stable sources of natural gas supply.

In July 2019, Chevron Phillips Chemical Company LLC and Qatar Petroleum announced they have signed an agreement to jointly pursue the development of a new petrochemical plant in the Gulf Coast region of the US. Energy Security Partners, through GTL Americas, is developing a $3.5bn gas-to-liquid (GTL) processing facility to be built in Jefferson County, Arkansas that some suggest will be the first of its size to be built in North America. It will convert low-cost natural gas into refined liquids products. The project company’s senior vice president has indicated that the Jefferson County site was selected due to its proximity to major natural gas pipelines, among other assets.

The adoption of IMO 2020, the low sulphur emissions regulation that came into effect on 1 January 2020, has prompted a revolution in the shipping industry as it relates to its fuel supply. Historically powered by heavy fuel oil in diesel engines or marine gas oil for gas turbine engines, LNG is increasingly becoming the fuel of choice for new build vessels including tankers, cruise lines and ferries. LNG as a power source offers operators a viable compliant alternative, being significantly cleaner, more efficient and a less expensive fuel source that also causes less wear and tear. This has also led to significant growth in the need for bunkering services, which is the process by which vessels carry LNG to LNG-powered vessels such as cruise ships and refuel them without the cruise ships needing to dock at an LNG facility.

We are also seeing a wave of integrated LNG-to-power projects in Latin America as companies seek new outlets for US LNG oversupply in light of reduced LNG demand in Asia and Europe. Puerto Rico, along with several Latin American countries, including those most impacted by recent climate events, are seeking short and medium-term solutions as they transition to cleaner energy sources while seeking to ensure cheaper and reliable power.

Contrasting with those countries transitioning away from conventional, less-clean energy, a number of Latin American countries are already heavily dependent on hydroelectric, solar and wind power. For example, approximately 90 percent of Ecuador’s power generation is sourced from renewables, mostly hydro but also solar and wind energy. In Brazil, hydroelectric power accounts for approximately 70 percent of total electricity generated. Accordingly, droughts in these countries can cause disastrous electricity shortages.

These countries are therefore turning to LNG in the search for reliability and to ensure uninterrupted power supply. Adding gas-fired power to a grid has proven to be an effective mitigant to the intermittence of wind, solar and hydroelectric power, as a cleaner, more efficient and less expensive alternative to diesel and heavy fuel oil. As a result, increased LNG demand is spurring private investment opportunities for the small-scale rapid deployment of highly efficient power capacity plants. Technological innovations have provided new options to make small-scale delivery possible using conventional shipping infrastructure and vessels.

The trend is largely driven by opportunistic energy and infrastructure funds that have access to significant capital (given the capital costs of these projects are not insignificant) and relationships with banks to obtain financing and execute quickly.

El Salvador, which relies on imported diesel and heavy fuel oil for almost half of its energy consumption, is also experiencing a wave of integrated LNG-to-power projects. Invenergy’s 378 MW EDP scheme recently reached financial close and is believed to be the largest private investment in the country’s history. EDP is also seeking to buy and move gas through the region to create additional investment opportunities.

Some of the long-term supply agreements supporting these LNG-to-power projects are based on flexible portfolio trading (with generation following the load demand curve) rather than more restrictive take-or-pay contracts. Some suggest that this approach is well-suited for floating storage regasification units (FSRUs) and produces higher margins for sellers with a growing ‘global order book’. Considering the capital-intensive nature of these projects and the interface between the FSRU, the LNG supply and the power plant, these projects are not easy to construct or operate. Financing provided by development banks, such as the World Bank’s International Finance Corporation, Inter-American Investment Cooperation and Inter-American Development Bank has also played an important role in several project financings for these LNG-to-power projects.

Despite significant headwinds, not least of which the ongoing global concerns about the coronavirus and its potential impact on LNG demand, 2020 is shaping up to be a big year of opportunity and innovation in the energy market worldwide.

Karen Smith and Eamon Nolan are partners and Simone M. King is a senior associate at Vinson & Elkins LLP. Ms Smith can be contacted on +1 (212) 237 0010 or by email: ksmith@velaw.com. Mr Nolan can be contacted on +1 (212) 237 0052 or by email: enolan@velaw.com. Ms King can be contacted on +1 (212) 237 0057 or by email: sking@velaw.com.

© Financier Worldwide

BY

Karen Smith, Eamon Nolan and Simone M. King

Vinson & Elkins LLP

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