Liquefied Natural Gas project risk and appraisal

Presented by Dr. Himadri Banerji at the 7th
PRESENTED AT 7TH LNG WORLD, BRISBANE

LNG World Marcus and Evans Brisbane 4th
September 2012
AUSTRALIA, 4TH SEPTEMBER 2012
PROJECT RISK AND APPRAISAL

Dr. HIMADRI BANERJI

SUMMARY OF DISCUSSIONS
Overview of global natural gas
and LNG industry
-LNG Projects Are More Costly Than Ever to Develop

September 2012
Overview of market risks for LNG: South Korea, Japan, India and China
-LNG Demand is Fast Outgrowing Supply
- Asian LNG Demand to Double between 2010-2017
Forecasting natural gas and liquefied natural gas prices
- LNG Pricing in Asian Markets to rise in link with oil
- India in Mega Deals for Shale LNG from US with price
advantage
Project Risk and Appraisal
Market, financial environmental and technological risks
Project Evaluation Concepts, Methodology and Analysis
Estimating and Risk Assessment in Big Ticket LNG Project Expenses: Capital,
Operational & Maintenance
A Case Study on Project Appraisal

Kochi LNG Terminal

Source Analyst Presentation by Petronet 2011

Global LNG Capacity Most Optimum Scenario mtpa

LNG PROJECTS ARE MORE COSTLY THAN EVER TO DEVELOP
CAPEX/ton of installed liquefaction
capacity has during the last decade made
a permanent shift from an average figure
below 500 USD/ton to typical range of

September 2012
range of 1500 – 2500 USD/ton

The IHS CERA Upstream Capital Costs
Index (UCCI) shows more than a doubling
of costs in the oil and gas industry.
However, due to the uniqueness often
attributed to developing LNG projects,
current LNG development costs exceed
the average for the oil and gas industry

Flex has consistently communicated a
CAPEX range of USD 550-700
ton/liquefaction capacity. For the project
in PNG we expect to be in the lower end
of this range.

September 2012

September 2012
Quality Parameters LNG

September 2012
NUCLEAR RENNAISANCE
THE SOLAR CHALLENGE
AND THE

LNG PROJECT RISK MITIGATION MATRIX
Type of Risk Risk Allocated to Mitigation
Market Risks Project Co./Off-taker Suitable agreements
-Off-take Off-taker/Guarantor Credit Enhancement

September 2012
- Payment.
Technology EPC Contractor Continuing Support
- Availability EPC Contractor Guarantee, Warranty
- Facility Design & Project Co. Insurance
Performance
- Damage
Financial Project Co. Hedging,
- Interest Rate Project Co.
- Inflation Project Co.
- Fx Fluctuation
Force Majeure Project Co. Insurances
Back to back clauses of
Agreements

WHAT IS PROJECT APPRAISAL

Project appraisal is a generic term that refers to the process of assessing, in
a structured way, the case for proceeding with a project or proposal. In
short, project appraisal is the effort of calculating a project's viability.

It often involves comparing various options, using economic appraisal or
some other decision analysis technique[

HOW PROJECT APPRAISAL

Process
1. Initial Assessment
2. Define problem and long-list
3. Consult and short-list
4. Develop options
5. Compare and select Project

Types of appraisal
1. Technical appraisal
2. Commercial and marketing appraisal
3. Financial and economic appraisal
• Cost-benefit analysis
• Economic appraisal
• Cost-effectiveness analysis
• Scoring and weighting
4. Organisational or management appraisal
5. Environmental Impact Appraisal

THE BASIC STEPS..ELABORATED
STEP MAIN PROCEDURES IN BRIEF

1. EXPLAIN THE STRATEGIC CONTEXT • Refer to underlying policy or strategy, e.g. policy
statements, statutory requirements, or business plans.

• Indicate how the proposal is expected to contribute to the
relevant strategic aims and objectives.
2. ESTABLISH THE NEED FOR EXPENDITURE • Establish the need for expenditure by:-

o analysing the expected demand for services; and

o identifying deficiencies in current service provision.

• Justify and quantify the proposed level of service provision
over the appraisal period.

Where funding the non-Govt sectors is in view:-
Assess Additionality i.e. establish that the proposed assistance is
the minimum necessary.
3. DEFINE THE OBJECTIVES AND CONSTRAINTS • Define the expected outcomes and outputs.

• Specify targets that are SMART
i.e.Specific Measurable Achievable Relevant and Time-
dependent.

• Include implementation targets e.g. dates, milestones.

• State the key constraints on the project, e.g. technical,
financial, legal, timing etc.

• Indicate the relative priority of individual objectives or
elements of the proposals

• Provide sufficient detail to enable option generation and
option performance assessment.

THE BASIC STEPS..ELABORATED….CONTD
4. IDENTIFY & DESCRIBE THE OPTIONS • Identify and describe a baseline option, usually the status
quo, and a suitably wide range of alternative options.

• Consider variations in scale, quality, technique, location,
timing and funding method.

• Choose a suitable number of options for full appraisal.

• Where some are rejected before full appraisal, explain
reasons for rejection.
5. IDENTIFY & QUANTIFY THE MONETARY COSTS AND • Detail capital costs, including any refurbishment costs, and
BENEFITS OF OPTIONS annual recurrent costs and benefits of all options.

• Express costings in total rather than incremental terms, to
expose full resource consequences.

• Include opportunity costs and residual values for all assets
employed, whether already owned or not.

• Assess displacement, and adjust costings accordingly.

• Adjust for inflation and (where relevant) tax differences.

• Where cost savings or efficiency improvements are
projected, indicate whether they will represent financial
savings or redeployment of resources.

• Consider costs and benefits to other parts of the public and
private sectors.

Where funding the non-Govt sector is in view:-Assess Cost-
Effectiveness by reference to relevant ratios such as cost per job,
public assistance to project cost, etc.


6. APPRAISE RISKS AND ADJUST FOR OPTIMISM BIAS • Prepare a risk log identifying and quantifying the main risks
associated with the proposal.

September 2012
• Consider how risks compare under the different options.

• Adjust costs, benefits and timing assumptions for optimism
bias.

• Develop suitable risk management and risk reduction
strategies.


7. WEIGH UP NON MONETARY COST & BENEFITS (INCLUDING • Identify all relevant non-monetary costs and benefits - economic,
SUSTAINABILITY, EQUALITY & LIFETIME OPPORTUNITIES) social, environmental and others

• Quantify them in suitable units where possible.

• Show how they compare under the different options e.g. "list and
describe" in simpler cases; use "impact statement" or "weighted
scoring method" in others.

• Consider need to screen for and/or assess in detail Sustainability,
Equality & Lifetime Opportunities.

• Decide whether any specific types of impact assessment are
required e.g health, environmental, transport, equality or integrated
impact assessment.

• Explain assumptions clearly e.g. basis of quantification. Where
employed, weights and scores should be explained individually.

• Interpret the results of the non-monetary analysis.
8. CALCULATE NET PRESENT VALUES (NPVs) AND ASSESS • Identify phasing of monetary costs and benefits over suitable time
UNCERTAINTIES period, adjusted for inflation, optimism bias and (where relevant)
displacement and tax differences.

• Calculate NPV (or NPC) for each option, using correct discount
rate.

• Include spreadsheets detailing the calculations, including
disaggregation of cost/benefit items.

• Show, for each year, the discount factors used, the total NPV for the
year, and the cumulative NPV to that year.

• Identify the price basis and base year for discounting.

9. ASSESS AFFORDABILITY AND RECORD ARRANGEMENTS • Affordability: Include budget, cash flow and funding statements,
FOR FUNDING, MANAGEMENT, PROCUREMENT, MARKETING, phased over time.
BENEFITS REALISATION, MONITORING, AND EX POST
• Management: Give details of proposed personnel, procurement
EVALUATION
method, timetable, benefits realisation plan, accommodation needs,
staffing issues etc.

• Procurement: Assess alternative procurement options.

• Marketing: Provide market assessment and marketing plan as
appropriate

• Benefits Realisation: Include draft BRP in OBC and final version in
FBC.

• Monitoring: Indicate how the proposed option will be monitored
during and after implementation.

• Evaluation: Record pre-implementation levels of resource use and
service provision. Indicate factors to be evaluated, when, how and
by whom.

Where funding the non-Govt sector is in view:-Assess Viability i.e.
examine cash flows, management & financial arrangements to ensure that
funding is not wasted on proposals that will fail prematurely.
10. ASSESS THE BALANCE OF ADVANTAGE BETWEEN THE • Write up the steps of the appraisal in the order shown here.
OPTIONS AND PRESENT THE RESULTS & CONCLUSIONS
• Give details of assumptions and calculations, using appropriate
appendices.

• Include summary of main results (i.e. NPVs/NPCs, unquantifiables
and uncertainties) for each option.

• Draw out the balance of advantage among options, assess VFM and
affordability, and record conclusions and recommendations.

KEY CONSIDERATION IN PROJECT APPRAISAL LNG
Perspective – Midstream – LNG Re-gasification Facilities
Key Considerations
1. LNG facilities are part of long chain comprising of producing field, liquefaction plant,
cryogenic tankers, re-gasification facilities and off-takers making contractual structure
the key consideration.

September 2012
2. Location - Availability of all season ports for LNG receipt
3.Connectivity to evacuation facilities/pipelines
4.No established pricing benchmark – mostly coupled with oil markets
5.LNG facility investment are capital intensive investments are front end loaded – more
reliance on debt financing
6.Revenue Model – Re-gasification charges usually based on capital cost recovery
method.
7. Key Financing Requirements
Presence of back to back contract between links of LNG chain to share project
risk among buyers and sellers
Take or Pay type of agreements both with supplier, tankers and off-takers.


To attract investors to an LNG project,

September 2012
the price of a unit volume of gas delivered into a
pipeline must at least equal the combined costs of
producing, liquefying, transporting, storing, and
revaporizing the gas, plus the costs of the capital
needed to build necessary infrastructure—and a
reasonable return to investors.


Project investors are relying on two sources or
repayment

September 2012
⎯Strength of sponsor -ability to get project financed,
⎯
constructed and operating effectively
⎯Strength of project economics -dependable revenue
stream

Project economics are driven by
⎯Cost and constructability

September 2012
⎯Quality of off take credits and contracts
⎯Underlying factors
⎯
−Source and price of inputs
−Markets for outputs
−Operating risks

Regardless of sector, these areas are thoroughly reviewed by credit
analysts
at rating agencies, bonds and investors

September 2012
Cost Optimization:.

Lower and upper share of various cost items in total LNG chain (%)

September 2012
Source: US Department of Energy, Energy Information Administration, The Global
Liquefied Natural Gas Market: Status & Outlook, 2003

A CASE STUDY ON PROJECT APPRAISAL
Appraisal and Evaluation done for : (i) an equity investment in
Petronet LNG Limited (PLL) for a 5.4% shareholding; and (ii) a
partial credit guarantee (PCG), without a Government guarantee,
to support a PLL bond issue of up to Rs7 billion, amounting in

September 2012
exposure terms to Rs3.525 billion.
The funds were to be used to construct and operate a liquefied
natural gas (LNG) import and regasification terminal (the
Project) with a 5.0 million metric tons per annum (MMTPA)
capacity at Dahej in Gujarat state.

The Project would serve gas users along the 2,500-kilometer
(km) Hazira-Bijaypur-Jadgishpur (HBJ) pipeline that covers
Gujarat, Western Madhya Pradesh, Rajasthan, Delhi, Haryana,
Western Uttar Pradesh, and Uran, Maharashtra.
At appraisal in 2003, the Project was to be financed based on a
debt-equity ratio not exceeding 70:30 and achieve an economic
internal rate of return (EIRR) of 23.0%.

Four state companies
Bharat Petroleum Corporation Limited (BPCL),
Indian Oil Corporation Limited (IOC),

September 2012
GAIL, and
ONGC (collectively referred to
as the sponsors)—formed PLL to develop LNG facilities at Dahej,
Gujarat and Kochi, Kerala.

The sponsors include some of the largest companies in India.
BPCL is engaged in refining crude oil, and production and
distribution of petroleum products. IOC, the largest company in
India in terms of sales, is engaged in refining and distributing
petroleum products. GAIL is the
dominant gas transmission and marketing company, while ONGC
produces the majority of the natural gas in India.

The project facilities comprised
(i) two full-containment LNG storage tanks, each with a

September 2012
gross capacity of 160,000 cubic meters (m3);
(ii) recovery system for re-condensation of the boil-off gas;
(iii) send out facilities, including “shell and tube” and
“submerged combustion” vaporizers;
(iv) auxiliary facilities, including a 23-megawatt (MW) gas-
fired captive power plant;
(v) electrical and utilities production control systems;
(vi) metering, fire, and gas detection and protection systems;
(vii) a jetty; and
(viii) initially, a breakwater.

FINANCIAL EVALUATION

Deciding on key indicators (Financial Ratios, IRRs. Project Cost)

September 2012
Deterministic assessment of the same with the use of a financial
model
Performing sensitivities on specific assumptions for the purpose of
quantifying risk factors identified.
Identifying the top 10 variables that have the maximum impact on
key
indicators
Probabilistic analysis based on the top 6 variables identified
Conclusions of probabilistic analysis

(The key indicators relevant to the analysis include Equity IRR
(Principal Indicator), Project IRR, DSCR, ADSCR, LLCR and PLCR
and Project Cost)

For the purpose of assessment of returns to equity
investors, a deterministic financial model was made,

September 2012
based on a range of assumptions (Low Case,. Base
Case and High Case). The Base Case assumptions have
already been discussed in the previous Chapter.
The top 10 variables that have maximum impact on
selected indicators (including returns to equity
investors) were identified using the Tornado Diagram
(an analysis tool).


LNG SOURCING AND LNG PRICE
PLL signed a sales and purchase agreement (SPA) with
Ras Laffan Liquefied Natural Gas Company Limited
(Rasgas), obligating PLL to purchase up to 7.5 MMTPA

September 2012
of LNG for 25 years.

The agreement had two stages. In the first stage, PLL
would
take 5.0 MMTPA on a take-or-pay basis up to 2009. After
2009, PLL could take the remaining 2.5 MMTPA subject
to the mutual agreement of both parties.

The purchase price initially was set at $2.53 per
million British thermal units (MMBTU), and it will be
rebased regularly in accordance with a defined formula
after 2009.


LNG SOURCING AND SHIPPING

Rasgas, a joint venture between Qatar Petroleum
(70%) and Exxon Mobil (30%), has access to the

September 2012
largest non-oil associated gas fields in the world.

An international consortium led by Mitsui OSK Lines
provided two dedicated special purpose tankers with
capacity of 138,000 m3 each to transport LNG to PLL
under a 25-year contract under terms that were
commensurate with the Rasgas contract.


MARKET
GAIL (60%), IOC (30%), and BPCL (10%) (collectively referred to as the off takers)
are purchasing gas from the LNG terminal. The off take contract is take or pay, with
terms that are back-to-back with PLL’s SPA.

September 2012
The off takers initially were to transport the gas from the PLL terminal to consumers
through an expanded 528 km HBJ pipeline system, and eventually through a new 485
km pipeline connecting Dahej to Uran.

IOC and BPCL have executed gas transport agreements through GAIL, which is
responsible for expanding the existing and proposed pipelines.

The off takers intended to use the gas for internal consumption, or to sell it
under long-term contracts to industrial users.

One third of the output would be consumed by IOC and BPCL at their refineries; one
third would be sold to large end-use consumers, such as Hindustan Petroleum
Corporation Limited, ONGC, and a fertilizer company; and the balance sold to smaller
end-use consumers, such as power and fertilizer companies that are customers of
GAIL.


NATURAL GAS PRICE
PLL’s gas sales price to end users is set commercially without
any Government control.

September 2012
The price consists of the LNG rate, taxes and duties, and a
regasification charge that reflects actual costs of LNG supply.

As presented in the RRP, the gas price was estimated to average
$3.27 per MMBTU at PLL’s delivery point n the first 5 years of
operation; and, after the off takers add transport charges and
sales tax, $3.80 per MMBTU at the end-user point.

This price was considerably higher than the subsidized domestic
gas price of $2.84 per MMBTU being charged at the time of
appraisal, though it was commercially attractive due to the
substantial demand supply gap in the market.


CONSTRUCTION
PLL and a consortium led by Ishikawajima-Harima Heavy
Industries Company Limited
Signed the EPC agreement in January 2001. Construction was

September 2012
completed on schedule, and the plant was mechanically
complete in December 2003.
At the same time, GAIL doubled the capacity of the HBJ pipeline
by laying a new 82 km pipeline from Dahej to Vemar, Gujarat;
and a 528 km pipeline parallel to the existing HBJ pipeline from
Vemar to Bijaypur, Madhya Pradesh.
The Dahej-Uran pipeline identified in the RRP was not
constructed due to delays in the tender process, and completion
was rescheduled to 2007.
The first shipment of gas arrived from Qatar in January 2004,
initiating the commissioning period. Commercial supply
commenced on
schedule in April 2004.


PROJECT COST
The actual project cost of the PLL plant was less in local currency
terms than the initial cost estimate in the RRP.

September 2012
This cost saving resulted from a decision by PLL not to proceed with
the construction of the breakwater that had been included in the
original design. (Originally, a 660-meter breakwater was included in
phase I to restrict downtime during the monsoon period. Based on
the morphological data collected in the early stages of breakwater
construction, PLL concluded that the breakwater was not required.
The plant could accommodate any potential delays arising from the
lack of a breakwater by increasing storage capacity, and an
additional
LNG storage tank would provide greater operating flexibility.

As a result, PLL decided to reallocate breakwater funds to construct
a third tank, which will be part of the phase II expansion that will
increase plant capacity to 10 MMTPA by 2009.


FINANCIAL EVALUATION

September 2012
Financial performance has been strong. In its first year of operations, PLL
recorded a net loss of Rs284 million in 2004 as the plant ran at 50% capacity. In
2005, the plant utilized 100% of its capacity utilization and achieved a profit of
Rs1,755 million, more than five times the appraisal estimate of Rs335million.
This improvement in projected performance, which is attributed to lower-than-
expected operating expenses and interest costs, is the reason for the material
increase in the FIRR.
Sensitivity analysis of critical variables, such as the exchange rate and movements
in the LNG price, indicate that the FIRR is reasonably robust.
Long-term debt as a percentage of total assets does not exceed 50%.

September 2012
ADB REPORT ON PROJECT EVALUATION PETRONET

September 2012

PLL signed an agreement with Ras Laffan Liquefied Natural Gas Company Limited
(RasGas) of Qatar for the supply of 5.0 MMTPA of LNG for 25 years at a free on board
(FOB) price of $2.53 per MMBTU for the first 5 years of operation, starting in 2004.

After accounting for items such as shipping, customs duties, pipeline charges,
regasification,

September 2012
and sales tax, the delivered price is $4.25 per MMBTU.

After 2009, the fixed price will become a variable price for a 60-month transition period.
The participating parties have agreed to an increase of $0.13 per MMBTU for each $1.00
increase in the price of oil above $20 per BBL.

This formula does not have a ceiling, allowing the price of LNG to rise to more than $6
per
MMBTU if the price of oil stays at more than $50 per BBL.

PLL’s delivered gas price was very competitive initially relative to the Hazira terminal
gas. Royal Dutch Shell, which has been promoting its Hazira terminal as a merchant
terminal, sourced its first LNG consignment from Australia’s North West Shelf project at
a price of $3.70 per MMBTU, which is significantly higher than PLL’s purchase FOB price.

RIL’s gas discovery in the KG Basin will affect the future competitiveness of LNG
imports?

INDIA IN MEGA DEALS FOR SHALE LNG
Indian companies with Shale Gas exploiting the massive US shale
gas find acquiring operating interests in the terminals.
RIL: 3.8 Billion Dollar in Shale Gas Assets plus another 1.5 billion proposed
in next five years..with shale gas potential contribution to EBIT of $1.25

September 2012
Billion
GAIL has bought 20% stake in Carrizio Oil & Gas’s shale assets of $300
million, in talks with Macquarie Energy which owns partly the US based
Freeport LNG Terminal
ONGC has signed a MOU with Japan’s Mitsui to pursue jointly the
opportunities in the entire LNG value chain and source LNG on spot and long
term contracts
Reliance Industries, ONGC and Gail in equity participation in the
east coast based terminals of proposed seven LNG Terminals in US.
Potential to ship gas to India @Less than $10 /mmBtu as against the
present day support or APM price of $4.2/mmBtu
Reliance Industries, ONGC and Gail participates in equity in the East
coast based terminals of proposed seven LNG Terminals in US.
Cheaper than the $13.2/mmBtu of the proposed TAPI pipeline
(Turkmenistan-Afghanistan-Pakistan –India) with its own
Geopolitical Risk.

DR. HIMADRI BANERJI :PROJECT ADVISORY & STRUCTURED
FINANCE IN ENERGY INDUSTRIES (OIL, GAS, POWER)
• Assistance to Government Agencies for implementation of
projects with private sector participation through
BOOT/BOT/BOO routes.

September 2012
• Assistance in preparation of bid documents including relevant
contracts and agreements, evaluation of bids and selection of
bidder.
• Assistance to private parties in preparation and submission of
bids for projects through competitive bidding
• Assistance in tariff filing to generating, transmission and
distribution companies and franchisee / restructuring and
privatisation of State Electricity Boards.
• Policy advisory to Central & State Governments, Centre and State
Electricity Regulatory Commissions.
• Preparation of Business, Investments and Financing Plan
• Identification of sources of Finance and Syndication of Rupee and
Foreign currency loan.

DR. HIMADRI BANERJI :PROJECT ADVISORY & STRUCTURED
FINANCE IN ENERGY INDUSTRIES (OIL, GAS, POWER)
• Advisory for renewable energy projects with Advisory for
Projects under Indian Solar Mission

September 2012
• Appraisal of projects in various Energy industry sectors.
• Investment appraisals for review of capital budgeting
decision process of companies
• Securitisation and other structured finance products
Due Diligence
Capital Structuring
Financial Modelling
Risk Analysis
Financial Viability Studies
Project Development
EPC Contract Risk Management Support

STATE SPONSORED PROJECTS:
SYSTEMIC WEAKNESSES IN FISCAL MANAGEMENT

• Technical know-how in modern fiscal management
practices.
• Comprehensive, current information databases.

September 2012
• Robust analytical tools and techniques that correspond to
internationally accepted standards.
• Integrated management information systems and
systematic approaches to the fiscal decision-making
processes.
• Transparent, consistent and institutionalized fiscal
practices, reporting systems, and structures that promote
the desired accountability for the effective and efficient
mobilization, allocation and utilization of public funds.

STATE SPONSORED PROJECTS IN INDIA:
SYSTEMIC WEAKNESSES IN FISCAL MANAGEMENT

Inadequate fiscal management
expertise and institutional infrastructure to perform
revenue and expenditure projections and distributional

September 2012
analysis,
assess multiplier and elasticity effects, and run policy
simulation and develop alternative policy scenarios.
This includes their inability to establish strong links
between budgetary outlays and program outcomes for
efficient and to
ensure effective delivery of results,
establish debt and investment frameworks to improve their
quality and profile, and
conduct rigorous project appraisals to ensure selection of socio-
economically viable projects.

TO CONCLUDE:

Despite spending large sums of money, governments and donors
in many countries have been limited in their ability to develop
successful, sustainable programs due to the inadequacy of fiscal
management expertise and infrastructure.

September 2012
Such inadequacies prevent the productive absorption of funds.

They also prevent states from equipping themselves with the
necessary fiscal shock absorbers to cushion them against
unexpected fiscal challenges - some arising out of discretionary,
unplanned decision-making and others as a result of increased
globalization.

More often than not, these unexpected challenges can and have
served as the tipping points, seriously affecting the fiscal
condition of even fiscally healthy states

September 2012
VALVE STATION: An LNG Tanker being filled...courtesy Germanischer Lloyds

THANK YOU

Liquefied Natural Gas project risk and appraisal

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