Sunday 30 December 2018

Sponsor completion guarantees in LNG construction financing: Part I


As the world of North American LNG financings continue to evolve, OGInsights explores the use of completion guarantees in construction financings.

At a high level, the project sponsor guarantees debt service under a guarantee until the construction is complete. To the extent that a project does not reach completion (normally by a certain long-stop date), then the sponsor will be obliged to repay all of the debt under the guarantee.

The provision of a guarantee comes with a number of benefits:

  1. Lenders are more likely to agree to the equity funding of a project to be back-ended (i.e. construction costs are first funded by debt before equity rather than pro rata). This improves project economics (NPV and IRR).
  2. Lenders will allow use of pre-project completion cash flows as a source of “equity” funding towards the project, thus replacing “hard” equity contributions. In the absence of a guarantee, lenders typically do not give credit to such uncontracted cash flow and such cash generated is trapped until project completion is achieved (as normally insisted upon by lenders). When a guarantee is in place, lenders are more or less agnostic to whether pre-completion LNG sales are contracted or spot sales and can give credit to such cash flows.
  3. Lower pre-completion debt costs – reduced commitment fees and margins, reflecting that of the sponsor corporate credit strength (with normal adjustments for pricing and tenor). Pricing could be c.15-30bps cheaper under a construction guarantee structure fr example
One possible downside is that higher amounts of debt are drawn in the early years of construction (vs. when no guarantee is in place) if equity funding is back-ended, and hence interest costs could be higher, although this is partly offset by the lower debt pricing mentioned above.

Note that in a financing without a completion guarantee, lenders require hedging at financial close of the facility with a substantial amount (typically >60%) under either fixed interest rate or hedged throughout the construction and operations period. A construction guarantee provides more flexibility with regard to hedging during the pre-completion/construction period as the interest rate risk is borne by the sponsor; at project completion, lenders will require fixed rate/hedging in place concurrent with the release of the guarantee.

Financing structures continue to evolve to support LNG projects with lenders and sponsors driving the innovation to (i) enable projects and (ii) improve project economics whilst managing the risk that lenders are exposed to.

In Part II, OGInsights explores the conditions that constitute project completion.

#US #LNG #financing

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